Outline and critically discuss the criteria by which they judge whether or not a country is stable.
International businesses faces a number of risks when they decide to operate overseas. Their ability to make sound investment decisions and to address those risks is directly related to the stability of the country in question. Firms therefore need to develop mechanisms for measuring stability before making the decision to enter a market. There are a few different ways of understanding stability -- political stability, economic stability and exchange rate stability are perhaps the most important, although workforce stability and legal stability are also relevant for many organizations.
International businesses operate in countries with vast differences in political structures and systems. From Communist to totalitarian to capitalist nations, international business must make adjustments for operating based on the local government conditions. Doing this is complicated with the nation in question has a low level of political stability. Regime change -- especially sudden regime change -- can have a dramatic impact on a company's ability to operate in a country. Sometimes, even just the threat of regime change in enough to convince a company to cease international operations, as was the case this past week when energy company Suncor pulled out of Syria (AP, 2011).
In some situations, the company must "feel" a situation, but that is easier for a company that already has operations in the country and contacts. For evaluating a country prior to market entry, it is likely that firms will need to rely on more objective measures. Some of the indicators that can help to determine the risk of regime change in a country are noted by the World Bank (n.d.): violent demonstrations, armed conflict, frequency of political killings, disappearances and tortures; and the level of social unrest. When the underlying cause of conflict and political disturbance in a country is related to religion, ethnicity or even class struggle, the risk of regime change is higher.
There are also published measures that are available. Private consulting firm Maplecroft publishes a "political risk atlas" (2011) that categorizes political risk associated with the world's nations according to a number of criteria. This criteria includes the level of judicial independence from government, resource security, human rights and other measures. Countries whose regimes are unstable or non-existent obviously stand out in this survey (Somalia, DR Congo, Afghanistan) but the survey also characterizes some countries with stable regimes as unstable. Myanmar for example has a stable government but one with little legitimacy that is ripe for revolution. The organization predicted the current troubles in Russia, as Russians have been wary of the Putin/Medvedev's regime's consolidations for years. North Korea and Zimbabwe also make the top ten because their country's underlying conditions are ripe for internal conflict and regime change, even though both rulers have been well-entrenched for a long period of time.
Another dimension of political instability that international companies need to take into consideration is internal instability within the regime and of the regime (Jong, 2006). The former includes such factors as leadership changes within the same regime (as seen in Communist countries, for example) and policy changes within the same regime, no matter who is leader. Regimes that do not follow consistent policies with respect to the treatment of foreign countries are especially troublesome for international business. It is also worth considering that there may be a high degree of different in the way that the central government's policies are implemented at the regional level. In nations ranging from India to China and even the United States, there is a high degree of variance between the political environment and business climate in the different sub-regions. In part, this can also reflect the level of control that the central government has on sub-regions. In some countries, this level of control can change frequently, and it is worth knowing for international businesses what the likelihood of the current status remaining stable is.
Most major economic indicators are widely published, and can shed some light on the economic stability of a country. For a firm engaged in international business, these indicators will be the first set of criteria for determining economic stability. GBP, unemployed, FDI and other measures help to paint a broad picture not only of a country's performance but its long-run stability.
Beyond these measures, however, a qualitative analysis must be done to determine what other underlying factors might contribute. An extreme example would be a company that has economic stability as the result of the exploitation of one resource. Oman is like this with oil, as the country is down to less than twenty years' reserves at current production rates (CIA World Factbook, 2011). The country's economic stability therefore has been better in the past than it will be in the future (and the same can be said for its political stability as a result of this). This is an extreme example, but there are specific underlying conditions that fuel economic stability, and the trends in those conditions should be taken into account to ensure that past performance and future performance are going to be related.
A specific form of economic stability that an international business needs to take into account is exchange rate stability, especially if the company does not have an operating hedge that would allow it to limit transaction exposure. Repatriating money from foreign operations exposes the company to significant exchange rate risk, even if the country has stable political and economic environments in general. For example, as the yen keeps dropping the value of a firm's Japanese business will keep falling in dollar terms. It is important to remember that while firms often use financial hedging techniques to reduce their exchange rate risk, the availability of such hedges varies (Harper, 2010). Hard currencies tend to have liquid markets not only for the currency but for the hedging options as well. For soft currencies, the ability of a firm to hedge can be very different from country to country. For example, it is relatively easy to hedge the Brazilian real, but small Latin American currencies have rather illiquid markets.
International businesses should also weigh the degree of legal risk, in particular if there is separation between the government and the judiciary. If there is not, then this is not a unique form of risk. However, it is worth understanding in particular how the judiciary has protected the rights of other foreign entities in the country. This is another qualitative measure that firms should investigate. They should also have a local lawyer who specializes in key areas (IP, for example) provide a briefing on the local legal environment. Of more significant concern than the actual laws is the degree to which the legal environment is changeable and predictable. The less predictable the legal environment is, the riskier the country is to enter.
There are a number of criteria that an international business needs to take into consideration when making foreign investment decisions. Companies are accustomed to operating internationally in all types of adverse conditions, responding to whatever the locals conditions are. The most difficult situation when operating internationally is the risk posed by sudden changes in the operating environment. Typically such changes are not predictable, and that makes having a good system of analyzing the risk posed by other countries.
Most professional services that undertake this kind of risk assessment focus on key underlying variables that act as predictors of sudden change. The choice of variables for international businesses can be difficult, but if a wide range of variables are chosen so that they indicate broad trends, then that is the best approach to the issue.
It is also important when conducting an analysis such as this to verify the quality of the relationship between the different criteria that are being measured and the track record of that criteria to predict political and economic volatility. Some criteria may not be as accurate a predictor as would be believed, as it may often fail to accurately predict political instability.
Another consideration is what the impact of stability is on business. For example, in recent European history instability is not necessarily going to have a major impact on day-to-day business activities. Greece has seen riots and a new government formed, and the instability is ongoing there, but as long as the country remains in the Eurozone none of this stability is going to dramatically alter the daily business environment. Compare this with the Arab Spring instability, where many regimes fell and the resulting business environment is characterized by chaos and a high level of risk.
Jong (2006) noted, for example, that the level of correlation between most measures of regime stability is actually quite low, or even nonexistent, with GDP growth. While it can be argued that GDP growth itself is only one dimension of a country's attractiveness to international businesses, the GDP growth is an important indicator nonetheless. Jong showed that protests have a…