A MODEL FOR MAKING FOREIGN DIRECT INVESTMENT DECISIONS

INCORPORATING REAL VARIABLES FOR POLITICAL AND

ECONOMIC RISK ANALYSIS
Carl B. McGowan, Jr., Norfolk State University
Susan E. Moeller, Eastern Michigan University
The Foreign Investment Risk Matrix (FIRM) developed by Bhalla (198) !ses politi"al and
e"onomi" risk meas!res #or F$I de"ision making% FIRM may be !sed to develop a matrix that
"ategori&es "o!ntries based on politi"al risk and e"onomi" risk as a""eptable' !na""eptable' or
!n"ertain #or investment% (e dis"!ss "o!ntry risk analysis' methods o# de#ining "o!ntry risk' and
"o!ntry risk servi"es% (e demonstrate the model !sing three meas!res o# politi"al risk and three
meas!res o# e"onomi" risk% )#ter determining the gro!p o# "o!ntries that *o!ld be a""eptable
#or F$I' the m!ltinational "ompanies "an #o"!s on #!rther analysis o# a""eptable "o!ntries%
0
A MODEL FOR MAKING FOREIGN DIRECT INVESTMENT DECISIONS
INCORPORATING REAL VARIABLES FOR POLITICAL AND
ECONOMIC RISK ANALYSIS
The Foreign Investment Risk Matrix (FIRM) developed by Bhalla (198) !ses politi"al and
e"onomi" risk meas!res #or F$I de"ision making% FIRM may be !sed to develop a matrix that
"ategori&es "o!ntries based on politi"al risk and e"onomi" risk as a""eptable' !na""eptable' or
!n"ertain #or investment% (e dis"!ss "o!ntry risk analysis' methods o# de#ining "o!ntry risk' and
"o!ntry risk servi"es% (e demonstrate the model !sing three meas!res o# politi"al risk and three
meas!res o# e"onomi" risk% )#ter determining the gro!p o# "o!ntries that *o!ld be a""eptable
#or F$I' the m!ltinational "ompanies "an #o"!s on #!rther analysis o# a""eptable "o!ntries%
Introduction
n this !a!er, we show how a "ultinational fir" can use rea#ily availa$le "easures of
!olitical an# econo"ic risk to create a two%#i"ensional "o#el for &' analysis. Bhalla ()*+,-
#escri$es a four%ste! !rocess that can $e use# for !olitical an# econo"ic risk analysis an# ste!
two is calle# the &oreign nvest"ent .isk Matri/ (&.M-. &.M allows a "ultinational
cor!oration to assess the !olitical an# econo"ic risk of countries an# allows the #ecision "aker
to classify countries into "ulti!le risk grou!ings. n this !a!er, we #e"onstrate how to use
Bhalla0s "o#el for a "ultinational cor!oration to e/ecute country risk analysis in%house, which
re#uces the nee# to !urchase !olitical an# econo"ic risk infor"ation fro" either consultants an#
analysis services an# !er"its the "ultinational cor!oration #ecision "aker to create a "o#el for
a s!ecific co"!any or &' !ro1ect.
2ver the last two #eca#es, the a"ount of #irect foreign invest"ent overseas has increase#
su$stantially. U.S. #irect invest"ent a$roa# grew fro" 3405.+ $illion in )*+4 to 3),5++.* $illion
(value# at historical cost- in 400, which is an annual growth rate of )0.,6 (Borga an# 7orgason,
4008-. n 400,, U.S. #irect foreign invest"ent was largest in the Unite# 9ing#o" at 3454.:
$illion or );.46 of total U.S. #irect foreign invest"ent, followe# $y invest"ents in Cana#a an#
the Netherlan#s at 3)*4.8 $illion an# 3)5+.* $illion, res!ectively, which is )0.+6 an# )0.06 of
)
the total U.S. #irect foreign invest"ent. (Borga an# 7orgason, 4008-. <hile "ost U.S. #irect
foreign invest"ent is in countries in Euro!e an# North ="erica, the a"ount of invest"ent in
=frica an# the Mi##le East grew $y ):6, followe# $y Euro!e ()86-, Cana#a ()06-, =sia an#
the >acific .egion (56-, an# ?atin ="erican an# the .est of the <estern @e"is!here (56-. t is
a#vantageous to $e an early entrant in an e"erging "arket for a "ultinational cor!oration. Early
entry !rovi#es "arket !ower which yiel#s "ono!olistic !rofits resulting fro" new sources of
#e"an#, acAuisition of chea!er raw "aterials, an# econo"ies of scale.
&ro" 400) to 4004, U.S. #irect foreign invest"ent in in#ustrialiBe# countries grew at a
rate of a$out +6. Che largest growth, however, was in countries classifie# as e"erging "arket
countries. Growth in U.S. #irect foreign invest"ent in =frica an# the Mi##le East e/cee#e# )06
in 4004 an# ):6 in 400,, although the a$solute #ollar a"ount investe# still re"ains s"all,
(Borga an# 7orgason, 4004 an# 4008-. Chese tren#s !rovi#e evi#ence for the nee# for
"ultinational cor!orations to have access to a relia$le "o#el for !re#icting country risk as the
risks of entering a new foreign "arket #irectly are not only higher, $ut are also #ifficult to
forecast.
2$taining relia$le an# accurate forecasts of country risk are necessary for any MNC
#ecision "aker. Country risk relates to the likelihoo# that changes in a foreign $usiness
environ"ent will occur an# will re#uce the !rofita$ility or riskiness of an overseas &'. Che two
"ain co"!onents of country risk that investors nee# to consi#er are !olitical risk an# econo"ic
risk for a country. Butler an# JoaAuin ()**+- #efine !olitical risk Das the risk that a sovereign
host govern"ent will une/!ecte#ly change the Erules of the ga"e0 un#er which $usinesses
o!erate.F Che authors show how !olitical risk can affect the future cash flows of a &' an# how
4
!olitical risk can $e factore# into the reAuire# rate of return. >olitical risk refers to the risk that
the !olitics within a country will affect a "ultinational0s &' in that country.
Butler an# JoaAuin ()**+- #evelo! a "o#el of !olitical risk that shows how !olitical risk
i"!acts the cost of ca!ital for an invest"ent. n the Butler%JoaAuin "o#el, the i"!act of a
!olitical risk change on the cost of ca!ital of the invest"ent #e!en#s on the i"!act of the
!olitical risk change on the e/!ecte# return of the invest"ent an# the covariance of the return on
the invest"ent an# the return on the "arket. f the e/!ecte# i"!act of the change in the !olitical
environ"ent on e/!ecte# future cash flows is negative an# if the covariance $etween the
e/!ecte# future cash flows fro" the invest"ent an# the return on the "arket is negative
(!ositive-, the effect of a !olitical risk change is to increase (#ecrease- the cost of ca!ital for the
invest"ent. f the e/!ecte# i"!act of a change in the !olitical environ"ent has a !ositive i"!act
on e/!ecte# future cash flows an# the covariance $etween the cash flows fro" the invest"ent
an# the return on the "arket is !ositive (negative-, the effect of a !olitical risk shock is to
increase (#ecrease- the cost of ca!ital for the invest"ent. Che i"!act of a !olitical risk change is
#eter"ine# $y the i"!act the change on the e/!ecte# rate of return an# the covariance of the
return on the invest"ent an# the return on the "arket.
Bhalla ()*+,- shows that a change in !olitical risk can result fro" !olitical changes #ue
to elections, revolts, recessions, or wars an# the resultant change in !olitical risk can lea# to
e/!ro!riation, higher ta/es or tariffs, re#uce# &' incentives, local ownershi! reAuire"ents,
local content reAuire"ents, or currency inconverti$ility. Che net effect "ay $e the loss of assets,
the ter"ination of o!erations, re#uce# after%ta/ inco"e, higher i"!ort costs, re#uce# revenue,
"anage"ent restrictions, higher o!erational costs, or an ina$ility to re!atriate fun#s. Macro%
econo"ic "is"anage"ent $y the govern"ent can lea# to higher inflation an# higher interest
,
rates lea#ing to higher costs, !lanning #ifficulties, an# higher interest costs. 2ther ty!es of
!olitical #ifficulties such as la$or unrest or strikes can lea# to higher !ro#uction costs an#
!ro#uction interru!tions.
MNC nee# to #eter"ine future risks to a &' fro" !olitical risk an# future risks fro" the
country0s econo"ic environ"ent $oth of which affect the !rofita$ility an# riskiness of &'. Cwo
ty!es of econo"ic factors affect MNC &'G "acro%econo"ic factors an# "icro%econo"ic
factors. Macro%econo"ic factors woul# inclu#e fluctuations in a country0s inflation rate,
e/change rate, ta/ rate, an# interest rates, while "icro%econo"ic factors woul# inclu#e #e"an#
for a fir"0s !ro#ucts, the availa$ility of local la$or, local wage rates, an# e"!loy"ent laws.
t is i"!ortant that the MNC !lanning to invest overseas $e a$le to analyBe a country0s
!olitical an# econo"ic risk. MNC can !urchase country risk infor"ation fro" a consulting
service an#Hor the MNC can create their, own in%house analytical "o#el. <hen MNC !urchase a
consulting service, the "o#el #evelo!e# "ay not reflect the s!ecific environ"ent of the country
an# the s!ecific &' !ro1ect since consulting services !rovi#e general ratings for country
!olitical an# econo"ic risk an# "ay not !rovi#e s!ecific in#ustry, fir", or !ro1ect infor"ation
an# #etails in the analysis. f MNC create country !olitical an# econo"ic risk analyses for
s!ecific &' characteristics, they can tailor the &' risk analysis with less uncertainty.
Literature Revie
Er$, @arvey, an# Iiskanta ()**:- #escri$e country risk analysis using five "easuresG
!olitical risk, econo"ic risk, financial risk, a co"!osite risk, an# a country cre#it rating. Che
first four varia$les the authors use are taken fro" +oliti"al Risk ,ervi"es- International .o!ntry
Risk /!ide (C.G- an# the fifth varia$le is fro" Instit!tional Investor. Che e"!irical results
in#icate that the country risk "easures are correlate# with each other, $ut the financial risk
8
"easures contain the "ost infor"ation a$out future stock returns an# !olitical risk "easures
contain the least infor"ation a$out future stock returns. Chese fin#ings su!!ort the use of
!olitical an# econo"ic risk analysis $y investors intereste# in foreign stock "arket returns. But,
MNC consi#ering &' nee# to $e a$le to forecast the effect of future !olitical events an#
econo"ic events.
Er$, @arvey, an# Iiskanta ()**:- fin#ings su!!ort the use of !olitical an# econo"ic risk
analysis using &.M $y "ultinational cor!orations. Multinational cor!orations consi#ering
#irect foreign invest"ents of the $ricks an# "ortar ty!e nee# to $e a$le to forecast the effect of
future !olitical events as well as financial or econo"ic events on their invest"ents. Using &.M
will ena$le a cor!oration to assess this risk for a s!ecific !ro1ect while #ifferentiating $etween a
nu"$ers of countries.
Using annual #ata for the !erio# )*+0 to )**5, Bekaert, @arvey an# ?un#$la# (400)-
fin# that e"erging eAuity "arket li$eraliBation lea#s to an increase in real econo"ic growth.
Bekaert, @arvey an# ?u"s#aine (4004- fin# that e"erging eAuity "arket li$eraliBation lea#s to
increases in "arket integration that lea#s to an increase in real econo"ic growth. Che e"!irical
$reaks that the authors fin# #o not corres!on# with announce# li$eraliBation #ates, $ut reflect the
#ate of actual li$eraliBation such as the announce"ent of the first ='. or the #ate when the first
country fun# is issue#. E"!irical li$eraliBation effect #ates generally occur after the official
#ates. Che authors conclu#e that it is not enough for countries to change the rules to !er"it
foreign invest"ent to $ring a$out "arket integration. &oreign investors "ust still $e a$le an#
willing to invest in the country with li$eraliBe# stock "arkets.
Stoever (4004a- states that there are nu"erous sti"uli for econo"ic li$eraliBation which
will re#uce !olitical risk an# shows the !rocess $y which econo"ic li$eraliBation lea#s to
;
econo"ic #evelo!"ent. =s the host country govern"ent li$eraliBes the !olitical an# econo"ic
environ"ent, "ultinational cor!orations will $e !er"itte# an increase# range of econo"ic
activity. Econo"ic li$eraliBation lea#s to re#uce# restrictions on the actions of "ultinational
cor!orations, which re#uces the costs an# risks to "ultinational cor!orations "aking foreign
#irect invest"ents. <ith re#uce# costs an# re#uce# risks, the "ultinational cor!oration reAuires
a re#uce# rate of return that, in turn, !rovi#es greater $enefits to the host country since "ore of
the e/cess cash flow is left in the host country. =ny country evolving !olicies for foreign #irect
invest"ent shoul# avoi# inconsistency, #evelo! clear !riorities, evolve !olicies over ti"e, "atch
the s!ee# of #eregulation with the rate of econo"ic growth, kee! actions an# state"ents
consistent, "ake refor"s genuine, an# avoi# e/cess !olitical influence in the li$eraliBation
!rocess. Stoever (4004$- #evelo!s a "easure of o!enness for 9orea over the !erio# fro" )*:4
to 4000. 'ata are !rovi#e# for $oth foreign #irect invest"ent into 9orea an# Stoever0s "easure
of o!enness. Chese results show a !ositive relationshi! $etween econo"ic o!enness an# foreign
#irect invest"ent, that is, re#uce# !olitical risk lea#s to increase# foreign #irect invest"ent.
.oll an# Cal$ott (400)- analyBe the #eter"inants of wealth over the !erio# )**; to
)*** for ):4 countries. .oll an# Cal$ott0s e"!irical results in#icate that variation in GN !er
ca!ita across countries can $e e/!laine# $y nine #ifferent "easures of econo"ic o!enness J
!ro!erty rights, !olitical rights, civil li$erties, !ress free#o", an# govern"ent e/!en#itures
!ositively influence GN !er ca!ita. GN !er ca!ita is negatively relate# to e/cessive regulation,
!oor "onetary !olicy, $lack "arket activity, an# tra#e $arriers. .oll an# Cal$ott fin# that
!ositive #e"ocratic events are followe# $y increases in growth in GN !er ca!ita in those
countries while negative #e"ocratic events are followe# $y #ecreases in growth in GN !er
ca!ita in those countries.
:
=##itional e"!irical fin#ings su!!ort the hy!othesis that there is a !ositive relationshi!
$etween econo"ic o!enness an# econo"ic growth an# #evelo!"ent. 'e"irguc%9unt an#
Maksi"ovic ()**+- an# <urgler (4000- analyBe the relationshi! $etween the legal environ"ent
an# econo"ic #evelo!"ent an# show that increasing the level of legal !rotection increases
econo"ic growth. = !ositive relationshi! $etween financial li$eraliBation an# econo"ic growth
is re!orte# in Beck, ?evine, an# ?oayBa (4000-, @enry (4000-, Jalilian an# 9irk!atrick (4004-,
Jayaratne an# Strahan ()**:-, 9assi"atis (4004-, 9ing an# ?evine ()**,-, ?evine an# Kervos
()**:- an# .a1an an# Kingales ()**+-. Barro ()**)-, .yoo an# S"ith (4004- an# Su an#
&leisher ()**+- show that govern"ent intervention, in the for" of #ay tra#ing li"its, re#uces
"arket efficiency. &ischer an# Sahay (4000- fin# that the for"er Co""unist countries
econo"ies that have !erfor"e# the $est are the countries that were "ost co""itte# to !olitical
an# econo"ic refor".
E"!irical research in#icates that country cre#it ratings are useful to "ultinational
cor!orations in evaluating the riskiness of foreign #irect invest"ent in a !articular country.
Measures of !olitical o!enness are useful in evaluating the !olitical environ"ent of a !articular
country an# "easure the foreign #irect invest"ent environ"ent. >u$lishe# research of the
<orl# Bank in#icates that gross national inco"e !er ca!ita #escri$es the econo"ic environ"ent
an# !otential in countries an# is highly correlate# with other "easures of econo"ic #evelo!"ent.
Chese research results su!!ort the hy!othesis that country risk can $e "easure# $y country cre#it
ratings an# that country risk levels are further relate# to !olitical an# econo"ic risk varia$les.
Forei!n Inve"t#ent Ri"$ Matri%
Bhalla ()*+,- e/!lains a country risk analysis for a foreign #irect invest"ent $y a
"ultinational cor!oration using a four%ste! !rocess. Che first ste! is to create the foreign
5
invest"ent risk "atri/ to #eter"ine which countries !rovi#e a sta$le !olitical environ"ent an#
have econo"ic !otential to give the country the !otential to $e acce!ta$le for foreign #irect
invest"ent. Che secon# ste! is to create a country risk !rofile for each country selecte# in the
first ste! that is a #etaile# analysis of the $usiness environ"ent in each country selecte# in ste!
one. Che thir# ste! creates a foreign invest"ent risk analysis for each country to #eter"ine if the
!ro!ose# foreign invest"ent analysis is co"!ati$le with the econo"ic an# !olitical environ"ent
assu"e# in the country un#er analysis. Che fourth ste! creates a foreign invest"ent risk au#it
that allows the "ultinational cor!oration to "onitor an# re%evaluate the environ"ent on a
continuous $asis to alert the "ultinational cor!oration to avoi# sur!rises that "ay arise fro"
changes in the econo"ic an# !olitical situation in the country in the future.
Bhalla ()*+,- #efines foreign invest"ent risk "anage"ent as the !rocess of evaluating
the !olitical sta$ility an# the "arket !otential of a !articular country $y a "ultinational
cor!oration. Bhalla creates a two%#i"ensional "atri/ with four varia$les for each #i"ension of
!olitical risk an# econo"ic risk calle# the foreign invest"ent risk "atri/ (&.M-. >olitical risk
is #ivi#e# into four categories fro" = to ' with = $eing sta$le, B $eing "o#erately unsta$le, C
$eing volatilely unsta$le, an# ' $eing su$stantially unsta$le. Econo"ic risk is #ivi#e# into four
categories fro" one to four. Category one in#icates acce!ta$le risk, category two in#icates
"o#erate risk, category three in#icates "a1or risk, an# category four in#icates unacce!ta$le risk.
Che s!ecific !olitical risk "easures use# $y Bhalla are govern"ent sta$ility, the "etho# an#
freAuency of changes in govern"ent, an# the attitu#e of the !u$lic towar# govern"ent lea#ers
an# institutions. Che s!ecific econo"ic risk "easures use# $y Bhalla are #efine# in ter"s of the
"arket !otential for the fir"0s !ro#ucts. Che econo"ic risk "easures utiliBe# are the
+
#e"ogra!hic characteristics of the country, the infrastructure in the country, the econo"ic
$rea#th of inco"e, the !er ca!ita GN>, an# the econo"ic growth !otential.
Bhalla argues that inco"e !er ca!ita an# the #istri$ution of inco"e !er ca!ita are the
"ost i"!ortant varia$les in #eter"ining $oth econo"ic an# !olitical risk $ecause inco"e !er
ca!ita reflects $oth the un#erlying econo"y an# the effectiveness of the !olitical "anage"ent.
Both the level of inco"e !er ca!ita an# the #istri$ution of inco"e !er ca!ita effect econo"ic an#
!olitical risk. More evenly #istri$ute# inco"e !er ca!ita re#uces $oth econo"ic an# !olitical
risk.
Che four #ifferent categories of inco"e are gra!he# on the &.M. Countries will have
su$stantial !olitical insta$ility if they have low inco"e !er ca!ita with !oor inco"e #istri$ution
an# a narrow econo"ic $ase. Countries have sta$le !olitical risk if they have high inco"e !er
ca!ita, even inco"e #istri$ution, an# a $roa# econo"ic $ase. Countries with !o!ulations less
than ; "illion or inco"e !er ca!ita of less than 3;00 were e/clu#e# fro" consi#eration $ecause
they lacke# sufficient "arket siBe for the !ro#uct $eing consi#ere#. Che four !olitical risk
rankings are influence# $y !o!ulation siBe, inco"e !er ca!ita growth rates an# econo"ic
#iversity. Econo"ic risk is #ivi#e# into four categories fro" acce!ta$le to unacce!ta$le, $ase#
on #e"ogra!hics, infrastructure, econo"ic #iversity, #e"an# characteristics, an# econo"ic
growth.
Che &.M is a gra!hic re!resentation of these two #i"ensions. &our categories of
!olitical risk $y four categories of econo"ic risk yiel# si/teen #ifferent categories of countries.
Countries that have !olitical sta$ility an# acce!ta$le econo"ic risk woul# $e in the u!!er left%
han# cell. Countries with su$stantial !olitical insta$ility an# unacce!ta$le econo"ic risk woul#
$e in the lower right%han# cell.
*
= "ultinational cor!oration woul# choose fro" the countries in the cells that "eet the
first roun# of criteria. Chis first !ass will su$stantially re#uce the nu"$er of countries un#er
consi#eration. Stage two of the !olitical risk analysis !rocess is the country risk !rofile (C.>-.
Che C.> is "ore #etaile# an# is $ase# on three sets of criteriaG !olitical sta$ility, social sta$ility,
an# econo"ic sta$ility. = "ultinational cor!oration analyBes these varia$les to #eter"ine if any
internal or e/ternal !ro$le"s e/ist that coul# su$stantially alter the &.M create# in the first
ste!. Che C.> allows the "ultinational cor!oration to eli"inate any country that a!!ears to have
!otential future econo"ic or !olitical !ro$le"s.
Che invest"ent risk analysis, .=, is con#ucte# as stage three. Che .= is con#ucte# to
ensure that the !ro1ect can $e structure# to survive future risks such as !olitical risk, social risk,
an# econo"ic risk. >olitical risk varia$les woul# inclu#e !olitical insta$ility, e/!ro!riation, or
acts of terroris". Social risk varia$les woul# inclu#e la$or unrest. Econo"ic risk varia$les
woul# inclu#e !rice controls, recession, inflation, #evaluation, or foreign e/change controls.
Che fourth stage of analysis is the foreign invest"ent risk au#it, &.=. &.= is an
ongoing !rocess #esigne# to allow the "ultinational cor!oration to antici!ate changes in the
environ"ent that will affect the via$ility of the foreign #irect invest"ent !ro1ect. &.= allows
the "ultinational cor!oration to #evelo! a!!ro!riate strategies for a#a!ting to changes in the
environ"ent or a!!ro!riate e/it strategies. &.= allows the "ultinational cor!oration to #evelo!
an infor"ation #ata $ase of varia$les that will allow the "ultinational cor!oration to "onitor an#
a#a!t the foreign #irect invest"ent !ro1ect to future changes in the !olitical an# econo"ic
environ"ent.
Ma#ura (4000- !resents the &.M in a continuous, varia$le fra"ework instea# of using
#iscrete categories. Che Ma#ura "o#el utiliBes a continuous varia$le fra"ework instea# of
)0
!rovi#ing only si/teen categories. Both econo"ic risk ratings an# !olitical risk ratings are
continuous an# #escri$e# fro" low risk to high risk allowing the "ultinational cor!oration
#ecision "aker to #ifferentiate countries in a continuous fra"ework. Che Ma#ura "o#el
!rovi#es three categoriesG countries that have acce!ta$le risk levels, countries that have
unacce!ta$le risk levels, an# countries with unclear (uncertain- risk levels. Countries in the
uncertain area woul# nee# further analysis for an acce!ta$le or unacce!ta$le #ecision to $e
"a#e. McGowan an# Moeller (400,- #e"onstrate how to #eter"ine the e"!irical $oun#aries in
the !olitical risk an# econo"ic risk s!ace. Che authors use GN !er ca!ita an# the n#e/ of
Econo"ic &ree#o" to categoriBe countries as either acce!ta$le for &', unacce!ta$le for &', or
uncertain for )4+ countries. McGowan an# Moeller (400;- create a si"ilar "o#el using the
sa"e varia$les $ut with "ultino"ial logistic regression.
n this !a!er, we #e"onstrate how to con#uct country risk analysis using rea#ily
availa$le "easures that can $e easily foun# using the internet. <e #evelo! the "o#el using three
"easures of !olitical risk (the attitu#e of the host govern"ent towar# &', conflict, an#
!erceive# corru!tion- an# three "easures of econo"ic risk (GN !er ca!ita, &' !otential, an#
the inflation rate. Chese "easures are use# to #ifferentiate countries that are acce!ta$le for
foreign #irect invest"ent fro" countries that are unacce!ta$le foreign #irect invest"ent.
In&ut Varia'(e"
Che =ttitu#e of Govern"ent towar# &' is "easure# using the n#e/ of Econo"ic
&ree#o" su$%in#e/ for Ca!ital &lows an# &oreign nvest"ent. .estrictions on ca!ital flows an#
&' are "easure# $y &' co#es, restrictions on foreign ownershi! of $usiness, restrictions on the
in#ustries an# co"!anies o!en to foreign investors, restrictions an# !erfor"ance reAuire"ents on
foreign co"!anies, foreign ownershi! of lan#, eAual treat"ent un#er the law for $oth foreign an#
))
#o"estic co"!anies, restrictions on the re!atriation of earnings, an# availa$ility of local
financing for foreign co"!anies.
Che #egree of conflict is "easure# using the Conflict Baro"eter which is !u$lishe# $y
the @ei#el$erg nstitute of nternational Conflict an# is availa$le on the nstitute0s we$ site.
Conflict is #efine# as Dthe clashing of interests on national values of so"e #uration an#
"agnitu#e $etween at least two !arties that are #eter"ine# to !ursue their interests an# win their
case.F Che Conflict Baro"eter has five levels ranging in value fro" one to five. ?evel ) is
latent conflict an# non%violent an# low intensity. D= !ositional #ifference on #efina$le values of
national "eaning is consi#ere# to $e a latent conflict if res!ective #e"an#s are articulate# $y one
of the !arties an# !erceive# $y the other as such.F ?evel two is a "anifest conflict which is non%
violent an# low intensity. D= "anifest conflict inclu#es the use of "easures that are locate# in
the forefiel# of violent force. Chis concerns for e/a"!le ver$al !ressure, threatening !u$licly
with violence, or the i"!osition of econo"ic sanctions.F ?evel three is #efine# as crisis an# is
violent an# of "e#iu" intensity. D= crisis is a tense situation in which at least one of the !arties
uses violent force in single inci#ents.F ?evel 8 is #efine# as severe crisis an# is high intensity.
D= conflict is consi#ere# to $e a severe crisis if violent force is re!eate#ly use# in an organiBe#
way.F ?evel ; is #efine# as war an# is violent an# is high intensity. D<ars are a ty!e of violent
conflicts in which violent force is use# with a certain continuity in an organiBe# an# syste"atic
way. Che conflict !arties a!!ly e/tensive "easures, accor#ing to the situation. Che a"ount of
#estruction is vast an# of long #uration.F
>erceive# corru!tion is "easure# using the Corru!tions >erce!tions n#e/. Che C> is
!u$lishe# $y Crans!arency nternational on a yearly $asis. Che in#e/ is a weighte# average of a
nu"$er of in#e/es an# surveys of !erceive# corru!tion. >olitical corru!tion is #efine# as Dthe
)4
a$use of !ower $y !olitical lea#ers &2. !rivate gain, with the o$1ective o& increasing !ower or
wealth.F
Gross national inco"e !er ca!ita is taken fro" the <orl# Bank, <orl# 'evelo!"ent
n#icators availa$le on the we$ site. Che <orl# Bank in#icates that GN !er ca!ita is not a
co"!lete "easure of econo"ic growth an# #evelo!"ent, $ut "ost other "easures of econo"ic
growth an# #evelo!"ent are highly correlate# with GN !er ca!ita.
&' >otential is "easure# using UNCC='0s nwar# &' >otential n#e/ which is an
eAually weighte# average of the values (nor"aliBe# to yiel# a score $etween Bero, for the lowest
scoring country, to one, for the highest- of )4 varia$lesG G'> !er ca!ita, the growth rate of G'>
for ten years, e/!orts to G'>, the average nu"$er of tele!hone lines !er )000 inha$itants,
co""ercial energy use !er ca!ita, .L' s!en#ing to G'>, the !ro!ortion of tertiary stu#ents in
the !o!ulation, country risk, the worl# "arket share in e/!orts of natural resources, the worl#
"arket share of i"!orts of !arts an# co"!onents for auto"o$iles an# electronic !ro#ucts, the
worl# "arket share of e/!orts of services) the share of worl# &' inwar# stock*
Che inflation .ate is "easure# using the n#e/ of Econo"ic &ree#o" su$%in#e/ for Monetary
>olicy. Che Monetary !olicy in#e/ is $ase# on the inflation rate for the !revious ten years in the
country.
Che =ttitu#e of the @ost Govern"ent an# the nflation .ate are the E& su$%in#e/es
su$tracte# fro" five since the E& in#e/es are highest at one an# lowest at five. Che Conflict
Baro"eter value is taken #irectly since the conflict $aro"eter is value# fro" Bero to ten. Che
C> is transfor"e# $y #ivi#ing the !u$lishe# value $y two. Che GN !er ca!ita varia$le is
assigne# a five for a high inco"e econo"y, one for a low inco"e econo"y, four for a high
"i##le inco"e econo"y, two for a low "i##le inco"e econo"y, an# one for a low inco"e
),
econo"y. Che &' >otential n#e/ is scale# fro" Bero to one an# is transfor"e# $y "ulti!lying
the !u$lishe# values $y ten #ivi#ing $y two.
T+e Mode( A&&(ied to Four Countrie"
&igures ), 4, ,, an# 8 show the values co"!ute# for the Unite# 9ing#o", BraBil, >olan#,
an# .ussia. &or the U9, the scores for =ttitu#e of the @ost Govern"ent, Conflict, an#
Corru!tion are ,.00, 4.00, an# 8.,;, res!ectively. Che values for G' !er ca!ita, &' >otential,
an# nflation are ;.00, 8.:5, an# ,.00, res!ectively. Che weights use# in the co"!utation of the
!olitical risk factor an# the econo"ic risk factor are #eter"ine# $y the cor!orate #ecision "aker
$ase# on the i"!ortance of the in#ivi#ual varia$les to the s!ecific co"!any an# !ro1ect. =n
overall total risk factor can $e calculate# $y taking a weighte# average of the !olitical risk factor
an# the econo"ic risk factor. =gain, the weights are $ase# on the 1u#g"ent of the cor!orate
#ecision "aker. Che !olitical risk factor for the Unite# 9ing#o" is ,.0: an# the econo"ic risk
factor value is 8.)+. n this case, the Unite# 9ing#o" !lots in the region #efine# as acce!ta$le
for &'. Che values for BraBil an# >olan# $oth !lot in the uncertain region an# the values for
.ussia !lot in the unacce!ta$le for &' region.
Che "o#el use# in this !a!er is $ase# on the Bhalla ()*+,- an# Ma#ura (4000- "o#els.
= two #i"ensional gri# is create# where one #i"ension is econo"ic risk an# the other #i"ension
is !olitical risk. Both #i"ensions are scale# fro" one to five. &or a country to $e acce!ta$le for
&', the country "ust $e in the area seg"ente# $y the "ini"u" acce!ta$le level of $oth
#i"ensions, $oth !olitical risk an# econo"ic risk. Chus, in &igure ;, countries that !lot in the
u!!er right han# corner are acce!ta$le for &' an# countries that !lot in the lower left han#
corner are unacce!ta$le for &'. Countries that !lot in the areas $etween the acce!ta$le region
)8
an# the unacce!ta$le region, are uncertain, that is, these countries reAuire further analysis for a
final #ecision.
Co #e"onstrate the use of the &.M, we calculate values for $oth !olitical risk an#
econo"ic risk for four countriesG BraBil, .ussia, >olan#, an# the U9. Chese four countries are
selecte# for illustration !ur!oses only since they !rovi#e !lots in each of the three regions. <e
esti"ate the !olitical risk #i"ension with three varia$lesG the attitu#e of the host govern"ent
towar# &', the level of conflict in the country, an# the !erceive# corru!tion level in the country.
<e esti"ate the econo"ic risk #i"ension with three varia$lesG GN !er ca!ita, the &' >otential
n#e/, an# the inflation in#e/. Each varia$le is "easure# using a !u$lishe# in#e/ that is
availa$le on the internet.
Su##ar, and Conc(u"ion"
&oreign #irect invest"ent has $eco"e increasingly i"!ortant for "ultinational
cor!orations. Che level of foreign #irect invest"ent $y US "ultinational cor!orations outsi#e of
the Unite# States an# $y non%US "ultinational cor!orations into the Unite# States has increase#
#ra"atically over the last twenty years. Che nee# for !olitical an# econo"ic risk analysis has
increase# with foreign #irect invest"ent $y "ultinational cor!orations. Even as so"e countries
an# regions of the worl# have stea#ily re#uce# $arriers to an# restrictions on foreign #irect
invest"ent, other countries an# regions of the worl# have $eco"e increasingly hostile to foreign
#irect invest"ent. =lthough !olitical risk assess"ent services are availa$le, these services
!rovi#e general ratings rather than ratings s!ecific to the actual !ro1ect $eing consi#ere# $y the
"ultinational cor!oration.
>olitical risk is the result of changes the environ"ental circu"stances for the
"ultinational cor!oration. =lthough !olitical risk generally results fro" govern"ental action,
);
social factors can cause the environ"ent to change. n either case, less !olitical risk is #esira$le
for the "ultinational cor!oration. Econo"ic risk change scan result fro" changes in either the
"acro%econo"ic or "icro%econo"ic environ"ent. Multinational cor!orations nee# to $e a$le to
#eter"ine which countries !rovi#e the $est econo"ic con#itions for the !ro#uction an# sale of
the "ultinational cor!oration0s !ro#ucts or services.
Che &oreign nvest"ent .isk Matri/ !rovi#es a fra"ework in which to analyBe the
co"$ination of !olitical risk an# econo"ic risk. Che &.M uses values collecte# $y the
"ultinational cor!oration to evaluate the !olitical risk an# econo"ic risk for a s!ecific country
relate# to the s!ecific !ro1ect un#er review. Che &.M allows the "ultinational cor!oration to
#ivi#e countries un#er consi#eration into countries that are acce!ta$le for foreign #irect
invest"ent, countries that are unacce!ta$le for foreign #irect invest"ent, an# countries that
!rovi#e uncertain environ"ents an# nee# further stu#y $efore an acce!tHre1ect #ecision can $e
"a#e. 2verall, the &.M !rocess allows the "ultinational cor!oration to focus attention on
invest"ent environ"ents with higher likelihoo# to success.
):
&igure ;
)5
&igure ) Unite# 9ing#o"
>olitical risk factors .ating <eight .M<
=ttitu#e of host
govern"ent ,.00 ,;6 ).0;
Conflict 4.00 ,;6 0.50
Corru!tion 8.,; ,06 ).,)
)006 ,.0:

Econo"ic risk factors .ating <eight .M<
GN !er ca!ita ;.00 ,06 ).;0
&' >otential 8.:5 ,;6 ).:,
nflation rates ,.00 ,;6 ).0;
)006 8.)+

Cotal risk factor <eight Ialue <MI
>olitical risk :06 ,.0: ).+,
&inancial risk 806 8.)+ ).:5
Cotal ,.;)
&igure 4 .ussia
>olitical risk factors .ating <eight .M<
=ttitu#e of host
govern"ent 4.00 ,;6 0.50
Conflict ).00 ,;6 0.,;
Corru!tion ).,; ,06 0.8)
)006 ).8:

Econo"ic risk factors .ating <eight .M<
GN !er ca!ita 4.00 ,06 0.:0
&' >otential 4.*) ,;6 ).04
nflation rates 4.00 ,;6 0.50
)006 4.,4

Cotal risk factor <eight Ialue <MI
>olitical risk :06 ).8: 0.+5
&inancial risk 806 4.,4 0.*,
Cotal ).+0
&igure , BraBil
)+
>olitical risk factors .ating <eight .M<
=ttitu#e of host govern"ent 4.00 ,;6 0.50
Conflict ;.00 ,;6 ).5;
Corru!tion ).*; ,06 0.;*
)006 ,.08

Econo"ic risk factors .ating <eight .M<
GN !er ca!ita 8.00 ,06 ).40
&' >otential ).+8 ,;6 0.:8
nflation rates ,.00 ,;6 ).0;
)006 4.+*

Cotal risk factor <eight Ialue <MI
>olitical risk :06 ,.08 ).+4
&inancial risk 806 4.+* ).):
Cotal 4.*+
&igure 8 >olan#
>olitical risk factors .ating <eight .M<
=ttitu#e of host govern"ent 4.00 ,;6 0.50
Conflict ;.00 ,;6 ).5;
Corru!tion ).+0 ,06 0.;8
)006 4.**

Econo"ic risk factors .ating <eight .M<
GN !er ca!ita 8.00 ,06 ).40
&' >otential 4.;: ,;6 0.*0
nflation rates 4.00 ,;6 0.50
)006 4.+0

Cotal risk factor <eight Ialue <MI
>olitical risk :06 4.** ).5*
&inancial risk 806 4.+0 ).)4
Cotal 4.*)
)*
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4)