Analyzing Political/Geopolitical Risk Is An Art More Than A Science
John F. Phillips
“The goal of political risk analysis is not to predict the future. It can’t be done. The goal is to create better decisions for your organization by developing insights about key drivers and possibilities.”- Condoleezza Rice and Amy B. Zegart*
We live in an interconnected world and to ignore that fact is to have one’s head in the sand. Politics impacts everything and ignoring or minimizing that fact doesn’t make the reality of political and geopolitical risk go away.
Decision makers ignore political and geopolitical risk at their peril.
That said, understanding political and geopolitical risk can be a real, but not insurmountable challenge.
Despite the evolution of quantitative analysis, algorithms, and now, artificial intelligence (AI), many of the variables that influence political and geopolitical don’t lend themselves to many of the quantitative methods that have become so much a part of research and analysis. Many times the variables that drive risk are difficult to measure. Often, because of its dynamic and everchanging nature, political and geopolitical risk can be very difficult to understand.
Yes, quantitative tools are very useful when working with hard data and to deny that fact is also putting one’s head in the sand. I use them in my research when appropriate, but many times, you just can’t put a square peg into a round hole and shouldn’t try.
Because I contend that much of trying to analyze and understand political and geopolitical risk is based on observation, experience, and a firm understanding of politics, history, economics, culture, and human behavior, I would argue that qualitative analysis is the key that opens the door to understanding political and geopolitical risk.
Political/geopolitical risk tends to be very dynamic in nature. In many cases, the analysis of information and events tends to be subjective and this analysis can be influenced by a variety of factors. Because of its dynamic nature, it can be difficult to understand and measure in real time. There are times when the understanding of information and events can be incomplete or based on false assumptions. In fast moving situations, events can outrun analysis and force a re-evaluation of mitigation strategies based on new facts or an evolving understanding of events. Groupthink or being guided by preconceived notions can often times distort analysis and lead to incorrect conclusions.
In order to simplify the discussion,, let’s address five specific variables (political, geopolitical, economic, historical, social/cultural) that, I believe, impact political/geopolitical risk. In my experience, these variables are better understood through the use of qualitative methods, while at the same time offering opportunities for quantitative analysis when appropriate.
Instead of always knowing the right answers (again, political/geopolitical risk analysis doesn’t always lend itself to concrete or definitive answers), it’s really important to ask the right questions. In keeping with that approach, the following discussion will focus on some questions that I think should guide the analytical process. The lists aren’t all inclusive because there are always new questions that present themselves over time. That said, the questions presented below offer a starting point.
It doesn’t take a rocket scientist (or PhD) to grasp the fact that understanding political/geopolitical risk is based in large part on understanding politics. Understanding politics is more than understanding political figures, campaigns, or current political events. It requires a much deeper dive.
Here are some of the key questions that should be asked when analyzing political factors that impact political/geopolitical risk. Again, the list isn’t all inclusive, but asking these questions usually create the more detailed “follow up” questions that help develop more nuanced analysis and understanding of the factors that impact risk.
Is the system of government democratic, republican, parliamentary, authoritarian, totalitarian? What are key characteristics of the current civic/political culture? How is leadership selected? What are the characteristics of the political decision making process? Are free and fair elections held to select leaders? Is the government a one party, two party, or multiparty system? Is political power transferred in a peaceful and legally prescribed manner, or is power transfer characterized by uncertainty or chaos?
Is the government relatively stable in terms of longevity, or is there constant turnover due to political instability or other factors? How stable are existing political institutions? Is governmental authority clearly defined, or are lines of authority unclear or overlapping? Who are the real decision makers?
Does the government operate under a concept of rule of law? Is rule of law respected? Is there a free press? Is there a right to freely assemble and address grievances to the government or is there a history of political repression?
What is the institutional role of the military? Is the military under civilian control? Is there a history of military influence over or outright military control of the government? Is there a history of military coups? What is the level of political violence? Does the military play a role in the suppression of that violence?
Geopolitical factors, to one extent or another, are interrelated with and driven by many political, economic, and social/cultural factors. There is a linkage between domestic politics and foreign policy in that foreign policy is driven, in varying degrees, by national interests. It can be argued that in many cases, domestic policy is foreign policy and foreign policy is domestic policy.
Understanding that, there are unique geopolitical factors that must be understood in order to analyze, understand, and mitigate political/geopolitical risk.
This is where it can get complicated.
What is the current definition of the international system (unipolar, bipolar, multipolar)? Who are the hegemonic powers? What is the nature and reach of hegemony (world wide or regional)? How do they exercise influence? Is the exercise of that influence political, economic, cultural, military, or combination of all? What is the relationship between the hegemonic powers? What tactics do they utilize to exercise hegemony? What are points of agreement and sources of dispute or conflict between hegemons in multilateral of bilateral systems? What is the nature and level of agreement and disagreement/conflict between hegemons? Historically, how have conflicts been resolved?
What dynamic governs relationships between the hegemonic powers and other nations (bilateral agreements, bilateral or multilateral treaties, bilateral or multilateral regional alliances (example: NATO)? What is the level of cooperation within alliances and groups? How are disagreements between blocs resolved? Is a military commitment involved in these relationships? What is the level of commitment?
What are military capabilities of countries involved in a particular situation of crisis? Is there a history of using military power to resolve disputes? Does a country have the ability to project military power? Is that capability international or regional and at what level? Can the domestic economy support military action? Is domestic political support for military action sustainable?
At what level is a country integrated into the global economy? Is it a member of trade blocs or other economic groups (G-7, G-20, BRICS, etc.)? What is the level of integration into the international financial system? What are the political ramifications of direct foreign investment?
Political risk refers to the potential for political events to have a negative impact on businesses, markets, or on the macroeconomy. Geopolitical risk can be defined as the impact that international political and economic events (wars, sanctions, alliances, international incidents, formation of trade blocs, etc.) on the international system, both political and economic.
These factors are incredibly important given the interconnected and global nature of macroeconomics, finance, resource markets, supply chains, equity and bond markets, and the international banking system.
Here are some key questions when considering the economic factors that impact political/geopolitical risk.
What economic system(s) (capitalism, social democracy, centralized planning, etc.) define the economic dynamic of a situation? What are the economic policies of the actors (government and private sector) involved in a particular situation?
What are some key economic indicators that may offer explanations for a particular situation? What political/policy changes have come about due to changes in key economic indicators?
Based on the economic system in place, what is the role, power, or influence of central banks? How strong? What is the interest rate environment? How strong are capital markets? What are the characteristics and dynamics of credit markets?
What is the regulatory environment? Is the regulatory bureaucracy competent or corrupt? How strong are legal protections against regulatory abuse? How is influence exercised when dealing with regulatory hurdles?
What is the nature and levels of direct foreign investment? What is the strength of currency vis a vis dollar and other major currencies? Is there a threat of nationalization of private firms? What are the trade policies that could impact a particular situation?
Does a country use economic sanctions is an instrument of conflict resolution?
I argue that understanding history is one of the keys to understanding all of the other variables that define political/geopolitical risk. While past performance may not be indicative of future performance when it comes to investing and finance, understanding past behavior can give clues concerning how a current situation may play out. In many cases, the past does define the future. It places political, geopolitical, economic, and social/cultural variables into some sort of context, provides clues, and assists in anticipating what may happen in the future.
Here are some questions to consider.
What is the history of current political or geopolitical relationships? How did those relationships evolve? What are the commonalities between similar situations that have occurred in the past and the current situation? Is there a historical thread that can be followed that might define future situational dynamics and give clues to possible solutions? What role does the history of a particular nation predict how they might react to a particular situation? How have past situations that are similar to a current situation resolved themselves?
Any question that drills down on historical context can be helpful in trying to understand current and future behavior.
Social/cultural factors can be a key part of trying to understand why things occur. Right now, the United States is involved in an existential struggle over its future political and cultural identity, a struggle largely based on diverse cultural and social differences that have served to deeply polarize society. These differences have heavily influenced politics and economics.
Most countries have a unique national social/cultural identity, a social/cultural DNA. These factors can, and sometimes do, play an important role in behavior.
Social/cultural factors are also present in the private sector as most organizations have a culture that drives behavior. As private sector organizations are influenced by political/geopolitical risk, it is important to understand organizational culture as it can provide clues concerning behavior.
What are some questions that might help drive a better understand the social/cultural factors that may influence political risk?
How diverse is the population or workforce? Is societal mobility defined by class or based on merit? What are literacy rates? Population growth? Rural, urban, or a combination of the two? What are key demographics that describe the population?
What are cultural attitudes toward race, gender, family, social mobility, government, politics, the military? How are cultural or social minorities treated? Stance on immigration? Is the population homogeneous or does it embrace cultural or demographic diversity? What is the role of religion and what impact does that role have on society, culture, and politics?
The dynamics of a particular situation will determine the influence of social/cultural factors. That said, these factors cannot be ignored.
It is really easy to get overwhelmed when trying to analyze and understand the variables that govern political/geopolitical risk. There are so many factors to be considered and not all factors apply to all situations.
The key to successful risk management is to be able to focus on the specific factors that are influencing a situation, devote intense effort in working to analyze and understand those factors, and not get distracted by other factors that little or no impact. In a rapidly developing situation or in a crisis, that can be extremely difficult as time pressure, incomplete or inaccurate information, and the need to act can conspire to make a situation worse rather than solve a problem.
The questions listed above should be a good starting point in terms of getting a handle on political/geopolitical risk.
It is imperative that political/geopolitical risk management be a component of the decision making process. It is well worth the cost to have someone on the decision making team that understands this type of risk, how to analyze it, and help decision makers understand and mitigate the risk.
Being able to survive may depend on it.
*Condoleezza Rice and Amy B. Zegart, Political Risk: How Businesses and Organizations Can Anticipate Global Insecurity, Twelve Publishing, 2018, p.169.