Question

in globalization how political dynamics exacerbate risk relationships. Citr especific examples.

Answer 1

Brexit, Trump and populism in the European Union; these events in 2016 led to an increased interest in political risk in Western democracies. But what has caused this recent intensification of political headwinds? An argument is that digitalization, globalization and other contemporary society characterized developments have put traditional forms of organization, governance, law enforcement and justice under pressure. In 2014, Citibank warned of what they called Vox Populi risk, a new variation of political risk defined as shifting and more volatile public opinion that poses ongoing, fast-moving risks to the business and investment environment. Indeed, earlier digitalization such as the development of the internet have eroded many traditional sectors of the world economy. In the meantime, a new wave in digitalization (blockchain, robotics) will hit affect internationalization momentum. While developments of digitalization have also created new lines of work, a large part of the electorate in Western democracies is less fortunate with these developments. People who have lost their jobs, and who are less flexible to adapt to the new economic circumstances. Brexit and the election of Donald Trump as President of the United States could be seen as a backlash from this section of the electorate. This trend in electoral behavior is seen as a new form of political risk in Western economies, and could have a significant impact on how companies will anticipate their strategy and investments. The challenge for businesses is to address these concerns of the electorate, while at the same time remaining innovative and competitive in the globalized economy.

Since the end of the Cold War, many believed the world to be moving towards a model of universalization. A famous example is Francis Fukuyama, who argued that increasing interconnected and interdependent markets would lead to one definite model of liberal democracies and free-market capitalism ([Fuku92]). Borders would become of less importance and nationalism would make place for internationalization. Because of interdependency and mutual economic interests, international and national conflicts would occur less frequently. In addition, the exponential growth of digital innovations would make the world a ‘global village’ and create a better understanding between different cultures. In other words, because of globalization and digitalization political risk would become less relevant in a modern digitalized and globalized world.

The field of political risk is ‘the type of risk faced by investors, corporations, and governments that political decisions, events, or conditions will affect the profitability of a business actor or the expected value of a given economic action’ ([Matt11]). A risk previously mainly applied when conducting business with oil states or emerging economies. But due to the recent political developments in traditionally stable Western democracies, political risk increasingly lies in the West as well.

In January 2016 Citi Research concluded that ‘the sense that political risks have actually increased in a more globalized and inter-connected world is hard to escape’. Citi Research distinguishes the traditional ‘Old Geopolitical Risks’, e.g. military conflict, weak and failing states, unconventional weapons risk etc. and what is called ‘New Socio-Economic Risks’, which includes Citi Research’s own concept of Vox Populi risk. This includes the rise of new and non-mainstream parties, populism and more protests and referenda. Although there have been periods of Vox Populi risk throughout history, the difference today is that these events are happening in the world’s most developed markets, many of which have enjoyed a sustained period of growth and improvements in living standards and are integrated into the global economy and financial system. What is causing this change? Citi Research believes Vox Populi risk is being fueled by growing perceptions of incoming inequality and anxiety about globalization, particularly amongst the middle classes. In developed markets, this has resulted in new and alternative political parties which are having an impact on the public and economic policies.

The post global financial crisis also saw the return of political risks to developed economies. Citi Research’s Political Analysis stated in its research that it now spends at least as much time monitoring non-mainstream party politics in developed economies as the emerging market-based geopolitical risks, for the first time in 20 years. The annual average number of elections, government collapses and mass protests (called Vox Populi risk events) have increased by a remarkable 54% since 2011 compared to the previous decade. In addition, they see little sign of this trend of political risk reversing .

But how can companies effectively cope with this emerging ‘Vox Populi’ risk? Companies should understand political risk; where it comes from and what could be done to in order to mitigate it.

First, it is important for companies to address the concerns of the electorate concerning the impact of globalization and digitalization on society. As stated, globalized trade policies have been a political choice and the digitalization to a much lesser extent. Meanwhile, the question whether lower production costs from offshored jobs benefit Western consumers remains to be debated. The degree to which price declines benefit consumers is largely unknown. Economist Paul Krugman wrote in 2007 ([Krug07]) that free trade with low-wage countries is a win-lose situation for many employees who find their jobs offshored or with stagnating wages. Two estimates of the impact of offshoring on U.S. jobs were between 150,000 and 300,000 per year from 2004-2015. This represents 10-15% of U.S. job creation. U.S. opinion polls indicate that between 76-95% of Americans surveyed agreed that outsourcing of production and manufacturing work to foreign countries is a reason the U.S. economy was struggling and more people aren’t being hired. Trade can at the same time lead to more goods being available at a lower price, but with the consequence of enduring unemployment and decaying infrastructures (unused factories). But even if changes in trade policy could be enacted, they won’t address the massive productivity-driven job losses in industries like manufacturing. It is important for companies to give their employees certainty. As stated, manufacturing work is now vastly over-represented in emerging markets. When taking a look at Chinese factories, these are still crowded with workers who assemble the products. While the implementation of robotics is on the rise, employees are still far from redundant. In order to mitigate Vox Populi risk in the long run, companies should reconsider the role of offshoring in their policy decisions. Offshoring shouldn’t be completely abolished, but companies should also consider the important role they fulfill in society.

Secondly, retraining workers should become one of the primary objectives for companies facing strategic changes. Instead of merely reaping the benefits of the cost reductions coming with digitalization, companies should invest a substantial amount of these resources into their own employees. In addition, companies should be able to oblige their employees to invest in themselves, whether their job is redundant or not. In Denmark, for example, companies have already adopted a proactive approach into ‘activating’ the unemployed with either on the job training in the public or private sector. In cooperation with the Danish government companies invest in both the employed and unemployed to provide practical job-related training. Underlying this model is a recognition by both the public and the private sector that unemployment in the age of globalization and digitalization is increasingly likely to be driven by a skills mismatch between candidates and the jobs available.

Thirdly, it is important for companies to embrace political risk and anticipate on it. Vox Populi risk comes forth from a certain discontent within a society. Companies should keep track of these societal developments and debates. Instead of losing touch with society, companies should stand within it by taking the leading role and anticipating its important responsibilities. A good example for addressing the concerns of the public is the KPMG True Value, the method that not only considers financial profits, but also calculates the value for society, the environment and the people. Whether a business decision involves outsourcing of production lines, or the digitalization of traditional services. It remains important to look beyond merely the financial gains.

Obviously, many other factors contribute to the surge in the politically unstable climate. These include the debates surrounding immigration, government policies, security and the growing gap between the people and politicians. By focusing on the social values and consequences of business decisions, and addressing the concerns of the people, companies could at least weather some of the social unrest and create social cohesion.