Academic journal article Duke Journal of Comparative & International Law

Political Risk and International Investment Law

Academic journal article Duke Journal of Comparative & International Law

Political Risk and International Investment Law

Article excerpt

TABLE OF CONTENTS  INTRODUCTION I. THE CONCEPT OF POLITICAL RISK        A. A General Definition of Risk        B. Defining and Assessing Political Risk (or Not)        C. Political Risk in Theory and Practice Today        D. Off-the-Shelf Indicators of Political Risk        E. Social Scientific Measures of Political Risk           Based on Democracy and Veto Points II. INTERNATIONAL LAW AS A POTENTIAL MITIGATOR OF        POLITICAL RISK        A. An Introduction to BITs        B. Empirical Studies of BITs and Foreign Investment Flows        C. BITs and Off-the-Shelf Indicators of Political Risk        D. The Imperfect Coverage of BITs        E. The High Costs and Uncertainty of BIT Litigation F. Imagining a World Without BITs CONCLUDING THOUGHTS 

INTRODUCTION

This Article explores some of the conceptual and operational difficulties related to measuring political risk and to international law's arguably rather limited promise to provide meaningful protections against that risk. Part I explores the concept of political risk, providing a working definition of "risk" and examining previous attempts to develop workable definitions of "political risk," which theorists have yet to successfully define. It examines evidence suggesting that, definitional issues aside, businesses only imperfectly attempt to assess political risk and discusses why simple off-the-shelf indexes of political risk and political science indicators of "democracy" and "veto points" are of limited utility for measuring objective political risk. Part II discusses international law as a potential mitigator of political risk. It introduces bilateral investment treaties (BITs) as a major international law mechanism for reducing political risk, reviewing empirical studies of the correlation between BITs and foreign direct investment (FDI) inflows that have attempted to demonstrate that BITs reduce political risk and examining whether BITs are correlated with a prominent off-the-shelf indicator of political risk. It then discusses certain weaknesses of BITs as mitigators of political risk, including their imperfect coverage, the high cost and uncertainty of BIT litigation, and the availability of alternative risk-reducing strategies that might be more effective.

I. THE CONCEPT OF POLITICAL RISK

A. A General Definition of Risk

The standard definition of "risk" is relatively intuitive and easy to grasp. Risk is typically defined as the probability that an event will happen, where the event will have adverse consequences (costs) for the relevant party. (1) Risks may be thought of as greater when the product of probability and costs is higher and as lower when the product is lower. (2) The law review literature on risk sometimes emphasizes a conceptual distinction between risk and uncertainty, where uncertainty is characterized by a lack of knowledge of the true distribution of probabilities of the adverse event. (3) But that conceptual distinction is not of much obvious utility in the present context, as the managers of international businesses will rarely if ever know the true distribution of probabilities, though they may be able to estimate or guess at those distributions with more or less accuracy or bias. (4) Rather, to the extent that managers attempt to assess risk in a mathematical way, they will almost always be working in an environment characterized by significant uncertainty, though they may not have much appreciation of how uncertain their estimates or risk actually are.

B. Defining and Assessing Political Risk (or Not)

The question of which kinds of adverse events a party is interested in predicting can be approached at the ultra-micro level, by attempting to identify any possible adverse event related to a foreign investment that might impose a cost on a business operation. For example, perhaps the company CEO will slip on a banana peel while touring the company subsidiary in Costa Rica, suffering major incapacitating injuries and setting off an internal power struggle that leads to investor worries about succession and causing a sharp drop in the company's share price. …

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