Globalisation, economic integration, trade and capital mobility, and the free exchange of ideas across borders have not rendered politics obsolete, say Ian Bremmer and Preston Keat in ‘The Fat Tail: The power of political knowledge for strategic investing’ (www.landmarkonthenet.com). “War, terrorism, expropriation, violent changes of government, politically motivated lawmaking, and civil strife are not going away. Governments will continue to change both national and international regulatory regimes, often dramatically,” they add.
For starters, ‘fat tail’ is the unexpectedly thick ‘tail’ or bulge that we find on the tail ends of distribution curves that measure risks and their impact, the authors explain. “They represent the risk that a particular event will occur that appears so catastrophically damaging, unlikely to happen, and difficult to predict, that many of us choose to simply ignore it. Until it happens.”
How do investors and corporate decision makers approach the political risks they face in unfamiliar markets? In one of three ways, note Bremmer and Keat. One, the ‘we are all doomed’ approach; according to this, risks are ignored, ‘because they’re too scary and too complex, and what can we do about them anyway?’
Two, the ‘let the big guys lead’ philosophy, so that ‘we’ll ride along in the wake of the companies that have more resources and are better equipped to deal with the risks.’ And three, the ‘we have our expert’ strategy, which offers the comfort of a company person living in a different country, say, for more than a year: ‘His wife went to school there. He used to vacation there. He seems like he knows what’s going on.’
Alas, none of these strategies is effective, the authors rue. There is no single formula for understanding and managing political risk, they instruct. “In Brazil, monitoring and evaluating the behaviour of political parties and politicians in the National Congress are crucial for the accurate forecast of policy outcomes. In China, analysis of the personal power dynamics within an opaque Communist Party and among elite factions is vitally important.”
Citing the recent responses of governments to the banking crisis as example, the authors observe that increasing numbers of corporations and organisations now recognise the importance of political matters as much as economic fundamentals for market outcomes in many countries around the world.
They caution, however, that politics can be notoriously hard to quantify. “Unlike economic risks, political risks also tend to be more heterogeneous: their causes vary greatly. The way politics impacts economic assets can be equally varied, from a government imposing currency controls, to a mob rioting and burning down a business, to a panic starting among traders.”
To those who try to decode where decision-making power rests, helpful tips in the book include: that in a country like Saudi Arabia, where informal power structures are dominant, attempts to negotiate with the government via formal ministries may not get you very far; and that attempts to win government tenders in Germany by trying to map a particular government official’s network of family and friends will not help much either. Context matters, advise Bremmer and Keat. “The ability to keep an open mind while being both rigorous and creative is necessary in order to successfully mitigate political risks.”
They find that many companies have realised the need to use not force but far more complex methods to mitigate political risk. “Financial options and derivatives, insurance policies, complex legal agreements, commercial treaties, and diplomacy, whether corporate or governmental, provide new levels of complexity and nuance to the possibilities for managing political risks.”
The authors conclude by saying that being able to manage political risk successfully depends on a company or government’s ability to consider different information sources and different theories and methods, and at the same time remain able to question its own assumptions and biases. “Balancing this combination of skills is, at the end of the day, as much art as science.”
Recommended addition to the strategists’ shelf.
