Determinants and Assessment of Political Risk in Central America

By Rarick, Charles A. | SAM Advanced Management Journal, Summer 2000 | Go to article overview
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Determinants and Assessment of Political Risk in Central America

Rarick, Charles A., SAM Advanced Management Journal


Political and social change can produce rapid and unexpected problems for companies operating internationally. Social turmoil, war, revolution, and changes in public politics are often difficult to predict. Global managers need to assess the political environments in which they operate and take action to protect company assets. This paper explores possible predictive determinants of social instability and provides a comparative assessment of the often troubles countries of Central America. In particular, the unstable countries of Nicaragua and El Salvador are compared with the peaceful democracy of Costa Rica.

Political Risk

Political risk comes in a variety of forms and can be minimized by avoiding investment in potentially risky countries. Although entry into sometimes volatile markets may produce additional risks for the multinational corporation, the potential profitability of these markets can make them attractive alternatives supplements to domestic transactions (Abbass, 1995, Johnansson, 1997). Such a strategic move necessitates additional analysis and understanding of the various parameters of political risk. Recent research indicates that most U.S. businesses perceive the main risk of Latin American market penetration to be monetary, such as currency devaluation and inconvertibility (Trivoli, Graham, & Herbig, 1998). There are, however, additional risks that should be explored. Political risk can be segmented into a matrix based upon whether the contingency is initiated by government or nongovernment forces and the extent to which the contingency is unplanned or expected. For example, terrorism would be classified as a c ontingency caused by factors outside government control (not true in all countries) and producing involuntary and unexpected loss. On the other hand, export controls may be expected and are almost always initiated by governments. Torre and Heckar (1990) provide the classification found in Figure 1. Such a typology helps to explain the multidimensional nature of political risk.

Determinants of Political Risk

To assess the political instability of a country or region one must first establish determinants of stability and instability. One factor often assumed to cause discontent is the unequal distribution of income. The empirical evidence seems to show that inequality is a factor in socio-political instability (Park, 1996). The larger the gap between rich and poor, the higher the probability of political and social turmoil.

Unfortunately income equality in many Latin American countries seems to be decreasing, according to recent research (Berry, 1997). Recent economic prosperity has not been widely distributed, resulting in even greater polarization of the income extremes. Economic growth overall (measured in per capita GDP) acts as a mitigating factor, however (Park, 1996). Therefore, it could be hypothesized that political stability could be maintained as lone as economic growth continued, even if the distribution is skewed.

Social scientists have long theorized that economic disparity among differing ethnic groups produces social unrest. Based on research in the U.S., it appears that income inequality coupled with ethnic group size better predicts social conflict (Olzak & Shanahan, 1998). Therefore, another factor to consider in assessing political risk is the homogeneity or heterogeneity of the population and the relative composition of the various ethnic groups. Evidence from research on American riots points to the positive effects of such behavior gained by insurgent groups (Fording, 1997). It is hypothesized, therefore, that insurgent group activity in unequal societies will produce positive gains for the rebelling groups and result in increasing rebellion. Such factors are of interest to the countries of Central America.

History of Conflict in Central America

Central America was colonized by the Spanish who were seeking gold in the New World.

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