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Does partnering with the World Bank shield investors from political risks in less developed countries?
by Jonas Gamso and Roy C. Nelson published in the Journal of World Business.
Foreign investment can be a risky business at the best of times. When an organization engages in global business, it does so in order to look for new opportunities but it also opens itself to additional risk.
Top of the list of major international risks are foreign exchange risk and political risk. There are a variety of ways to hedge against foreign exchange or FX risk. But navigating, or insuring against, political risk is often trickier.
Multinational corporations (MNCs) can mitigate political risks by engaging in joint ventures with local firms, forming partnerships with like-minded companies, or forging larger coalitions that encompass unions, government agencies, special interest groups.
They also can purchase political risk insurance to provide coverage for multinational organizations, investors, and contractors against losses from global political instability.
In a study to be published in November in the Journal of World Business, two Thunderbird professors suggest there may be another way for multinational corporations (MNCs) to hedge against political risk.
New research from Dr. Jonas Gamso and Dr. Roy C. Nelson suggests that partnering with multilateral organizations may be helpful when companies are confronted with volatile government-business relationships. Jonas Gamso is Assistant Professor of International Trade and Global Studies at Thunderbird. Roy C. Nelson is an Associate Professor at Thunderbird, as well as Associate Dean of Thunderbird's undergraduate programs.
“New research from Dr. Jonas Gamso and Dr. Roy C. Nelson suggests that partnering with multilateral organizations may be helpful when companies are confronted with volatile government-business relationships.” Click to tweet
The study, Does partnering with the World Bank shield investors from political risks in less developed countries?, explores whether an association with the World Bank’s investment arm, the International Finance Corporation (IFC), protects foreign investors from aggressive actions by host countries’ governments.
The researchers used country-level data and in-depth interviews with high-level global managers to assess whether investment partnerships with multilateral organizations do indeed protect multinational corporations (MNCs) from aggression by host countries’ governments. They focused on the IFC, the largest development organization focusing wholly on private sector development in poor countries.
“We theorize that firms receive a unique benefit from working with the IFC: Mitigation of certain political risks,” they concluded. “Specifically, host governments in developing countries will hesitate to act aggressively towards investment consortiums that include multilateral organizations, as these governments may look to these organizations for loans and other support in the future.”
This work from Drs. Gamso and Nelson is particularly relevant today. As the World Bank Group celebrates its 75thanniversary, the global economic outlook is dimming and China-U.S. trade wars fuel uncertainty for consumers and businesses alike.
Emerging markets continue to present great opportunities for multinational corporations to grow and gain dominant market share. However, they also present greater risks than developed markets.
“Emerging markets continue to present great opportunities for multinational corporations to grow and gain dominant market share. However, they also present greater risks than developed markets.” Click to tweet
A recent survey of senior executives from Forbes Global 500 companies concluded that geopolitical tensions have increased since 2017, leading to a significant increase in losses as a result of political risk.
The annual Political Risk Survey undertaken by Willis Towers Watson and Oxford Analytica concluded that political risk is now becoming a reoccurring and material cost of doing business. The survey found that55% of global organizations with revenues exceeding US$1 billion have experienced at least one political risk loss worth over US$100 million.
“Companies typically grew up managing cyclical economic risks, not political,” said Simon Coote, deputy director of advisory at Oxford Analytica. “With the recognition of rising losses to political risk, it can no longer be excluded from executive decision-making.”
The IFC’s value in terms of mitigating political risk was a theme repeated by several of the executives interviewed byDrs. Gamso and Nelson. Interviewees highlighted the IFC’s role in reducing hostility and corrupt meddling by host governments.
One interviewee explained that IFC support makes it easier to reject demands for bribes and other illicit requests from authorities: “Every time a government official approaches us for something – a benefit that is not his right – we can easily answer, ‘Oh, we have World Bank [support] so we can’t really give you anything’ … just being associated with the name makes it easy to refuse anything.”
“The IFC’s value in terms of mitigating political risk was a theme repeated in new research by Dr. Jonas Gamso and Dr Roy C. Nelson.” Click to tweet
Another respondent said being associated with the World Bank Group gave his enterprise some reputational clout. “Being with IFC would open some doors for our company. The IFC has experts in different areas, expertise in specialized areas, so they bring a lot to the table. The other thing is that they bring a lot of business connections. They know a lot of people, and sometimes we need something, or if we needed help on a particular issue, they could bring that help to us.”
The influence that the World Bank and IFC enjoy around the world is to a large extent due to the network of influence established in their early years.
The World Bank was created to help rebuild Europe and Japan following World War II. And the IFC was founded a decade later on the idea that the private sector is essential to development. Over the years, they have moved from rebuilding toward a focus on all-round development concerned with health, education, corruption and the environment.
This new research indicates that, at least in developing nations, the World Bank and IFC are having an impact on governance.
Yet, while Drs. Gamso and Nelson believe the study has provided a strong contribution to current literature about political risk in international business, they have a word of advice for business leaders who may follow their findings without putting them in the proper context:
“We offer a caution for managers who may look to our study for guidance as they forge their risk mitigation strategies: While our study identifies a trend whereby IFC project support appears to deter hostile actions by host states, this deterrence effect may not occur in all scenarios.”