The 2008 financial crisis caused global financial markets to crash leaving hedge funds, investors, and firms in extremely deep debt that was hard to recover from due to the recessionary cycle of the economy globally. The financial crisis sparked a debate of how important is maintenance and study of international political economy in the global political and financial order is to determine the solutions to financial and economic crises that occur around the world and limit its harms on nation-states and multinational corporations around the world. Global Political Economy is the study of the intersection of markets and states in the political and economic environments in which they operate and it explains why institutions create rules, norms, regulations vis-à-vis trade and investment and how does it impact the global economy.
The economic shocks of 2008 brought into focus the key themes of the international political economy. The relationship between states and markets was highlighted by the fact that some states failed to restrain their financial markets. Banks were making excessive profits at the behest of society, which ended up paying the costs when the banks failed to repay. The dilemma of who benefitted from globalization was revisited by scholars and practitioners in wake of the crisis especially by those who were harshly affected by financial liberalization. More developed nation-states found dominance in international financial institutions and developing nations were marginalized in terms of participation and voting rights under these institutions creating an unidentified monopoly of developed states.
The rational choice theory has become prevalent in the status quo while discussing issues at the intersection of politics and economics. It is generally assumed that actors’ choices and preferences are known or fixed and that actors make strategic choices as to how to best promote their interests. Rational choice stipulates that even though a policy might not be efficient or maybe wrong, it may have been rational at once. Rational, in the sense, it was the optimal choice given specific incentives and institutional constraints, and opportunities that existed at the time of the decision being made. In the political economy approach, interest groups have applied the theory of rational choice to influence the decision in the international political economy. This approach stems from the explanations of trade policy that focus on interest groups. The analysis of these assumptions reflects those certain economic policies of the government are influenced by specific interest groups and do not necessarily reflect the preferences and prejudices of the government. Further, rational choices provide an impetus to understand the interaction between coalitions and institutions. For example, to understand why banks were able to expose the public to risks through their excessively leveraged activities, the financial sector was able to capture the regulatory system. Since private financial institutions had a greater number of resources, information, and lobbying power than other stakeholders and regulators had little incentive, institutional or personal, robustly to apply regulation.
The industrialized state of the twenty-first century is going through significant stages of adaptation and transformation in response to economic globalization and losing its privileged position in the international system. Not only the rising powers of Brazil, Russia, India, and China but also multinational corporations represent a serious challenge to its once-dominant role. There is now little expectation that major economies will adopt a light regulation economic policy style along the lines of the once-dominant US model. Instead, the notion of the competition state captures best how since the 1990s government actors have created more business-friendly regulatory frameworks actively supporting internationally operating firms in their efforts to generate more growth and employment opportunities. A well-trained domestic workforce becomes, in this context, an important asset to promote a particular territory for the allocation of foreign direct investment.
Despite similar pressures to reduce government expenditure, states have also continued to diversify in the way they provide welfare for different social groups within their societies. It has become popular to privatize public services and leave the task of their delivery to companies rather than the state. Yet, in line with the adjustment process, government agencies and state organizations cannot entirely shed their responsibility for some of the negative effects of radical policies associated with market liberalization, especially in trade and finance.
Economic globalization creates ‘winners’ and ‘losers’, which leads to the issue of inequality in societies. To win the support of the ‘losers’, governments typically have to offer compensatory measures through income redistribution, retraining programs, or further educational opportunities. The budgetary resources necessary for the funding of such activities bring into perspective taxation as the main attribute of modern forms of government as well as an indicator of state power relative to other actors in the international system. As the international controversy around the tax bills of large multinational corporations like Amazon has shown, there is a general public expectation that multinational corporations should make a fair contribution to the states in which they generate their profit. After all, for their business models to succeed they have to be able to draw on a well-developed infrastructure, an educated workforce, and general health care.
ROLE AND SIGNIFICANCE OF POLITICAL RISK IN IPE
International Political Economy relies heavily on international banking regulations, tariffs, foreign trade agreements, etc. The major anchor of these factors in IPE is political risk assessment. Political risk is a risk of an investment’s return which could be affected by political instability or political circumstances that challenge the financial services sector. The instability that affects investment return ranges from frequent changes in government, foreign policymakers, legislative bodies, or military control. The role of political risk becomes more prominent in long term as the time horizon of investment increases and is considered as a type of jurisdiction risk. There are some political decisions and factors that affect the markets as well other than the business factors. There are a variety of decisions governments make that can affect individual businesses, industries, and the overall economy. These include taxes, spending, regulation, currency valuation, trade tariffs, labor laws such as the minimum wage, and environmental regulations. The laws, even if just proposed, can have an impact. Regulations can be set at all levels of government, including federal, state, and local, as well as in other countries.
One of the key factors of why political risk is essential in the global political economy is the inflow of Foreign Direct Investments (FDIs) in host countries. The higher the instability in the region in terms of government, civil wars, corporate espionage, banking regulations, military control, etc., the higher will be the risk of investment returns which will, in turn, guide the amount of FDIs coming into the host country. Significant gains are expected by investing companies and nation-states and to maintain the risk-return ratio, the political risk index is used to measure the sum of investments which can be directed to set up industrial bases and company units of foreign institutions and corporates.
Greater risk and failure to manage that risk can lead to a potential reduction in FDI which can, in turn, lead to slower economic growth and give rise to social issues as well. Social issues like the wage gap, inequality, and corruption can lower the value of international equities or the stakes of foreign companies in domestic companies. The aspects can also affect other asset classes, that is, sudden downfall in economic growth can hamper a company or country’s ability to repay its debts, which will also affect the bond market in the economy. The slow growth of the economy could also depreciate a country’s currency value which will in turn slower exports, increase the country’s import bills, and put the country in a recessionary cycle.
WORKING OF IPE IN CONFLICT AND POST-CONFLICT STATES
Investment strategies in conflict and post-conflict zones require extensive research and impact assessment of political risk since insurgency, civil strife, proxy wars, tariff wars, etc. are always a likely occurrence. To contextualize this study, it is essential to look into the regions of East and West Africa where conflicts have been a regular phenomenon ranging from military coupes, insurgency by non-state actors, constant corruption charges on governments, dissolution of parliaments, the collapse of banking structure, undeveloped and underutilized natural resources, among other things.
The most important factor that investors or lenders look after in an investment into conflict or post-conflict zones is the debt sustainability risk of that country. Debt sustainability is the ability of a country to make enough returns on the initial investment to repay the debt and does not fall into unsustainable debt traps. One of the key roles of political risk assessment in these circumstances is to analyze the sustainability of the country in repaying the debt it will be under after the initial investments have been injected into the economy. International Monetary Fund analyses different scenarios in which Sub-Saharan African (SSA) countries can improve their methods to raise domestic revenues through international financing. It advises SSA countries to improve revenue mobilization and money supply in the economy to reduce their reliance on debt financing for development projects, international trade, exploitation of natural resources, among other factors. It advocates for strengthening its international taxation regime to boost government revenue in SSA countries. Africa is home to a large share of natural resources, which are mostly exploited by multinational enterprises (MNEs).
While extractive industries represent an important share of economic activity in SSA countries, their contribution to domestic revenue remains limited. Both macro-level and country-level evidence point to profit shifting and base erosion by MNEs, through the systematic exploitation of tax and regulatory loopholes. Corrective policy measures to address these revenue shortfalls need to, at the minimum, protect against base erosion on inbound investment and could include the setting-up of transfer pricing regulations applicable to inter-company transactions, the introduction of effective thin capitalization rules. Competition to attract investment by offering advantageous fiscal terms is corrosive and a regional approach to limiting this competition would greatly assist in revenue mobilization.
The IMF’s various interactions with member countries are intended to support them in their development goals while safeguarding macro-stability and debt sustainability. The IMF has three core activities: surveillance, capacity building, and lending. Each of these activities includes components that aim at supporting economic growth, and ultimately development, while simultaneously bolstering macroeconomic stability and debt sustainability. The IMF engages in both bilateral and multilateral surveillance, each placing an important emphasis on growth and development. Bilateral surveillance for individual countries provides an in-depth analysis of the economic potential, key bottlenecks, and policies that could bolster growth and development. Flagship reports such as the WEO/REO, as well as other Fund products provide insightful analysis on how to catalyze investment, promote growth, and create jobs.
These bilateral and multilateral analyses complement each other. The IMF provides lending through programs/arrangements, which aim at making resources available to fund members so that they have the financing needed to allow them to correct imbalances in their economy without resorting to measures that are destructive to the current and future development of the country. IMF-supported programs are aligned and support the country’s development plans.
IMF financing to many SSA countries, from the Poverty Reduction and Growth Trust, is at concessional terms, currently with zero interest rate. Moreover, IMF-supported programs are increasingly making tangible efforts to protect the most vulnerable in society and safeguard critical investment spending by including specific targets in these areas as part of the program design. The IMF’s third pillar, capacity development (CD), is integrated and complementary to its surveillance and lending role. The IMF delivers CD in its core areas of expertise to improve the capacity of economic institutions, such as central banks and finance ministries, so that they are more effective at developing and implementing policies that lead to greater economic growth and stability. The IMF continues to expand the amount of CD it delivers, with SSA economies being the largest recipients. The IMF uses the so-called Debt Sustainability Analysis (DSA) to assess the risk of debt distress of countries. For countries that normally rely on official external financing on concessional terms, public debt sustainability analysis is typically undertaken using the Low-Income Country Debt Sustainability Framework (LIC-DSF), conducted jointly by World Bank and Fund staff.
To analyze how Western Sahara is dealing with investments in the region, it is essential to study the case. In 2002, the International Court of Justice ruled that only exploitation and exploration of natural resources can be conducted in Western Sahara in compliance with the international laws in place and with the consent of the Saharawi national authorities. Foreign investors may prospectively structure their investments with the Saharawi authorities in Western Sahara in such a way to both deter Morocco’s interference as well as encourage Spain’s protection. The planning of investments protection through International Investment Agreements (IIAs) is a widespread as well as accepted practice by arbitral tribunals as long as it is done to engage in economic activity before an actual investment dispute arises.
Foreign investors interested in cooperating with Western Sahara to develop their natural resources may carry out their investments from countries that have IIAs with Morocco and Spain. This way the future potential investment claims under such IIAs against Morocco (for interfering with a given investment) and Spain (for failing to protect a given investment) will serve as insurance against such political risks covering the damages and loss of profits of foreign investments in Western Sahara. To a great extent, indeed, IIAs often serve the same purpose as political risk insurers, such as the Overseas Private Investment Corporation (OPIC, now renamed US International Development Finance Corporation, DFC).
Any Morocco’s interference with a foreign investment carried out with the consent of Saharawi authorities in Western Sahara may give rise to an arbitral claim against Morocco under the applicable IIA between the foreign investor and Morocco itself. Owing to the arbitral jurisprudence hinting at the extraterritorial application of IIAs, the applicable IIA between the investor’s home-State and Morocco may secure the underlying foreign investment in Western Sahara against Morocco’s transboundary and internationally unlawful acts in Western Sahara.
In the changing global environment where the intersection of politics and financial markets has become an integral part of international relations. The dynamics of state-market relations have evolved over the years and are the major driver of development in a nation-state per se. International Political Economy is the practice of developing a state’s economy by multiple factors like foreign direct investments, trade, sovereign wealth funds, etc. and these factors contribute to the majority of a state’s revenue apart from domestic revenues generated from taxes. Political risk assessment has become an integral part of global economic relations and is a major determinant of gains from international trade. This paper analyzed the role and significance of political risk and impact assessment which is an essential part of the interaction between politics and financial markets.
There are a variety of decisions governments make that can affect individual businesses, industries, and the overall economy. These include taxes, spending, regulation, currency valuation, trade tariffs, labor laws such as the minimum wage, and environmental regulations. The laws, even if just proposed, can have an impact. Regulations can be set at all levels of government, including federal, state, and local, as well as in other countries.
The working of political risk in international political economy is essential to understand how least developed countries and developing countries can increase the inflow of foreign direct investments and generate greater revenue for domestic development purposes. It analyzed the cases of East and West African regions and how volatile is it for investors to invest capital into these regions for exploration and exploitation of natural resources for gains of the host country or personal gains. The case of Western Sahara is of particular importance since investors are worried about insurance for their investments in the region due to constant interference from Morocco over territorial claims and sovereignty breaches.
The International investment agreements (IIAs) provide some relief and insurance to the investors from uncalled for risks like unduly interference from Morocco is the exploration of natural resources, disruption of settlements, breach of trust in government, designation of Non-Self-Governing territory, and assuming control over important decisions in Western Sahara among other things. These case studies are essential to understand the concept of risks in an investment posed due to political reasons and how can insurance and relief be sought by investors in the global economic order. As the world moves away from a hegemonic economic order set by the United States in the early 2000s, these tools of FDIs and FIIs become essential for developing countries and LDCs to boost investments in their countries and walk on a path of sustainable development.
(Ayush Jha works in the field of public policy and writes on issues related to development economics and political economy. He is a final-year student at the University of Delhi).