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Political Risk
Economic Map of the World: Emerging Markets and Developed Markets
as of June 2006
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Perception of expropriation risk
Increased perception (based on real experience) of greater risk in foreign operations
Sources of risk: Direct source: war, revolution, and civil violence
Indirect source: government policy change (expropriation or nationalization of ownership; regulation of behavior; restrictions on sourcing or remission of earnings)
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What is expropriation?
Used interchangeably with nationalization
An act whereby government takes into ownership of, by compulsion if necessary, private property for a public use
Two types: Mass expropriation: nationalization of most or all
foreign property
Selective expropriation: forced divestment of a single firm to the nationalization of an entire industry. This is to achieve specific political-economic objectives
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Expropriation cases
Russia Bolsheviks revolution in November 1917
new government monopolized banking, abolished private ownership of land and natural resources, and confiscated properties of foreign firms
damage to foreign investors
total losses were over $84 million – equivalent of $1,025 billion in 2003 dollars
major investors then: France (33%); Britain (23%); Belgium (14%) and U.S. (5%) firms (e.g., Kodak and GE)
very few foreign firms could be reimbursed. FDI not permitted until the collapse of the Soviet Union at the end of the 1980s
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World War Ibetween the Triple Entente
(Britain, France and Russia) and Central powers (Germany, Austria-Hungary and Ottoman Empire) in July 1914
each side investigated ownership of firms on their territory, then took over those firms ultimately held by “enemy”
both sides took not only physical assets but also intellectual property, such as patents
wartime expropriations of German corporate assets in Britain reached nearly $8 million – equivalent of $98 mil in 2003 dollars
Expropriation cases
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World War I (continued)until U.S. entry into the War in July 1917, little damage to
U.S. (German) firms in German (U.S.) territories
since U.S. entry into the War in 1917, each of U.S. and German forbade trading goods, payment and remittance of money with the other side and its allies
trade sanctions developed to compulsory appointment of administrator in firms owned by “enemy”, forced liquidating or selling them to local firms, abrogation of trademarks, patents, copyrights
the Bayer brand, Aspirin, and its trademark were sold to Sterling Drug in the U.S. after the War. Bayer had to pay $1 billion to reacquire the right to use the trademark in the U.S. in 1994
Expropriation cases
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Bolivia
during the 1930s, tensions between Standard Oil and the Bolivia government
in 1937, the Bolivia government charged Standard with fraud and expropriated Standard’s assets, valued $1 million to $2 million – equivalent of $ 12.7 million to $25.5 million in 2003 dollars
the State Department of U.S. decided to deny financial or technical support for Bolivia until Standard was compensated
in 1942, Bolivia compensated Standard with $1.7 million, and immediately U.S. granted $25 million development program to Bolivia
Expropriation cases
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Mexico once one of the world’s largest oil producers, thanks to foreign
entrepreneurs
in 1917, the Mexican Constitution declared ‘Mexican state was the rightful owner of the country’s suboil’ (Calvo Doctrine)
in 1937, the Mexican government determined that foreign oil companies were making higher profits and could afford to raise wages and provide social benefits
the government required foreign-owned oil firms to replace foreign drillers with Mexican technicians and to offer extensive social benefits such as supplying library, night and day-schooling for workers and their families and first-class medical services.
Expropriation cases
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Mexico (continued) oil firms protested against the high cost.
on March 1, 1938, the Mexican Supreme Court found the oil firms guilty, and ordered them to adopt the changes within six days - which they failed to do so
on March 18, 1938, Mexican government nationalized oil firms including Royal Dutch Shell and Standard Oil
U.S. oil firms filed complaints to the State Department of U.S.
in 1943, the compensation package ($309.4 million in 2003 dollars) was settled between Mexican government and oil firms
Expropriation cases
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World War II in September 1939, war broke out in Europe
combatants again moved to take control of firms owned by their enemies
in Germany and occupied Europe, Germans converted all U.S.-owned factories and properties into wartime production plants. American parent companies could not protest s their foreign subsidiaries were corporations chartered under laws of countries in which they were operating
in December 1942, U.S. entered the war. Immediately, Germany and Japan took control over the U.S. MNEs in their territories
some of U.S. firms were sold
companies that were not sold by the Germans were often completely destroyed
Expropriation cases
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China in October 1949, communists took power on mainland China
China has been a major host economy until then
British firms alone held $840 million – equivalent of $6.48 billion in 2003 dollars
US-owned power companies did utility operations
though no immediate expropriation of foreign firms like Soviet Union, ‘hostage capitalism’ era continued
foreign firms were put under the direction of planned economy, and were not allowed to close down
many firms had to remit funds from Hong Kong to pay higher wages and taxes than those for Chinese local firms
Expropriation cases
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Cuba in February 1959, Fidel Castro came to power
between 1959 and 1960, U.S.-owned sugar industry was expropriated
in June 1960, Cuba requested ESSO and Texaco refineries to process Soviet crude oil. The oil companies refused. Then, Cuban government expropriated them
in retaliation, U.S. imposed sanctions against Cuba
the largest loss suffered by a single investor was $136.3 million – equivalent of $837 million in 2003 dollars
as of now, no U.S. company has received compensation for its expropriated investments in Cuba
Expropriation cases
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Natural resources in Emerging Markets in the 1970s in the 1970s, emerging market governments expropriated most of the
foreign-owned companies involved in mining, oil, and utilities
between 1970 and 1975, there were 335 acts of expropriations.
Africa (43.2%), Latin America (32.7%), Asia (6.8%), and Middle East / N. Africa (17.3%)
especially, Algeria took more of its FDI than any other less developed countries between 1956 and 1972 as much as $1,746 million in foreign investments
between 1967 and 1972, Algeria nationalized Standard Oil after Arab-Israeli war, took control of Getty Petroleum Company of U.S., and two French oil firms
Expropriation cases
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Classified as: firm-specific
country-specific
global
MNCs need to identify, measure, and manage political risk
Political risk
“We’ve considered every potential risk except the risks of
avoiding all risks.”
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Classification of political risk
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Assessing political risk
Done at two levels: macro
micro
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Predicting firm-specific risk (micro risk):assess the political stability of a country
anticipate the effect of political changes on activities of a specific firm
Different foreign firms have different degrees of vulnerability
Assessing political risk
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Predicting country-specific risk (macro risk):analyze the historical stability of the country in
question
will these trends persist?
Challenging to predict
Assessing political risk
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Predicting global-specific risk:difficult to predict
expect to see new indices devoted to ranking terrorist threats and environmental threats
Assessing political risk
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Global-specific risks: Starbucks
Starbucks found itself an early target of the anti-globalist movement
The company appeared to be yet another American cultural imperialist
Late 1990s - global prices for coffee plummeted; and Starbucks was criticized for not improving life for the coffee growers
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Global-specific Risks: Starbucks
Growing pressure for sustainable development and social responsibility from consumer segments
2000: Starbucks introduced “Fair Trade” coffee to help improve the living standards of coffee growers