Political Uncertainty and the Economy

Introduction

Social, political, and institutional instability can affect the economy. Political risk may occur due to a particular decision that the government takes. Political risks may be direct or indirect. An example of an immediate political risk is expropriation. An indirect political risk can occur when a decision made by the government prompts another actor to act in a way that affects a business. For example, third parties can obtain illegal advantages when the government fails to see that the rule of law gets enforced. Expropriation occurs when the government takes the shares of a firm from the owners, and it is the most common type of political risk.

The motivation for the government to confiscate might come from its need to gain political support in the next elections from voters. In some countries, companies dealing with natural resources, security, and pensions get expropriated because the state owns companies of such nature. The government can also form policies that enable them to take money from firms. Social unrest, such as demonstrations, is an indirect political risk that may affect the operations of a firm. Countries with high unemployment rates and a population where the majority are the youth are likely to experience social unrest. There is some government, e.g., in Argentina, which support protests and strikes that can eventually affect the economy. Civil wars and wars are also political risks that can affect the economy. The election of a new government is also a risk as businesses need to adjust to the requirements of the new governments

Politics Uncertainty and its Negative Effect to the Economy

Political instability can destroy the economy if the problem addressing the uncertainty is not solved promptly. Political instability affects the growth of the GDP, inflation, and numerous privatized investments. Political instability leads to a high rise in inflation, a slow rate of GDP growth, and reduces private investments (Dupas and Robinson). A research done by Kostakis in 2014 revealed the growth of Asian countries to be at 3.11%, with an average growth rate of 2.52% between 1990-2010. The growth rate of Sub-Saharan African countries was at 1.14%. in America, it was at 1.88%, European countries at 1.57%, while the middle east and Latin America countries shared a growth rate of 2%. The above results were because, in Asian countries, the fiscal policies were very sustainable compared to the countries of other continents which had budgetary policies that were unsustainable (Kostakis).

Countries that have a high growth rate have these characteristics in common; they have a high number of public and private investments, the consumption by the government is lower, the ratio of pupil to the teacher is low, and they have smaller debts. Industrial employment rates are also high in such countries. Countries with a slow growth rate lack these characteristics.  For a country to experience economic growth, there needs to be growth in the industrial sector. According to the research, investment by public and private sectors, government effectiveness, management of corruption, and enforcement of the law led to a growth in GDP. Factors that inhibited the growth of GDP included the ratio of pupils to teachers, the rate of fertility and mortality, consumption of the government, and rate of inflation. However, the research found out that there is no sure way to estimate economic growth. Data from across countries is hard to interpret and can be quite fragile and sensitive to conditional information (Kostakis)

How Firms Can Adapt During Political Uncertainty

Examples of political uncertainties in different countries are as Yellow Vest Movement that happened in France, the Brexit that occurred in the UK, and the civil conflicts in Venezuela. Such uncertainties have adverse impacts on the economy of a country because most companies face difficulties such as high costs of inputs and a change in the behavior of customers. Many companies might close down because of such problems. Before a business adapts to uncertainties, they must evaluate the scope of the risk and identify its nature. The firm can then determine whether it can adapt to the uncertainty or not. Uncertainty may cause one firm to close down while another adapts and continues to operate. Businesses are different, and the capacity of one company to adopt is different from another. The evaluation is, therefore, necessary (Laker and Roulet).

Companies can adapt to uncertainties by practicing a strategy called hedging, where a firm can shift its headquarters from the location of high risk to a different location. The firm can also decide to reduce costs in some of its functions, such as internal operations of the human resource department. In this way, companies will be able to manage the impact of the drop in sales. Firms that have not established a well-known brand and do not have enough reserves of money may face difficulty in adapting to the uncertainties. They can, however, use a strategy called salvaging, where they exhaust their cash reserves to remain operational. They also have to avoid selling assets that will be of benefit once the uncertainty ends. This strategy may include temporarily shutting down (Costa and Figueira)

Companies that adapt to political risks usually experience growth of sales soon after the difficult times pass due to a lack of competition at the time. An example of this is the case of a company called Renault located in Argentina, which faced political uncertainty in 2001 and used a salvaging strategy by reducing its exports to Brazil and still maintained a 20% share in the market. Even with the current inflation in Argentina, the sales of the company have grown to 16.3%. Another strategy that companies may use to adapt to uncertainties can be rebalancing where companies can shift to new geographical areas and aim for new markets. An almost similar approach to rebalancing is the shifting approach where companies move their operations abroad where the markets are more stable and secure. This approach is different from rebalancing because it is more systematic and happens quite fast (Laker and Roulet).

Uncertain political environments can create stronger economies in countries where businesses have relocated following political uncertainty in another country. For example, in Scotland, firms are looking forward to gaining economically from the Brexit situation in the UK. The firms are looking forward to getting more opportunities in the market due to Brexit in England. The country has plans to become independent from the UK to join the European Union. Through shifting and rebalancing strategies, most companies are relocating from England to different areas such as Paris, Singapore, and Frankfurt (Laker and Roulet).

Conclusion

Different firms can, therefore, react differently to uncertainties by anticipating the difficulties ahead and responding strategically. These adaptation strategies mostly depend on the resources that a company has and its evaluation of the risk. Un affected companies can benefit due to political uncertainties experienced by companies in a particular company. However, companies can predict and manage difficulties.

ssWorks Cited

Costa, L., and A. Figueira. “Political Risks and Internalization of Enterprises: A Literature Review.” SciELO Analytics (2017). <https:..doi.org/10.1590/1679-39556933>.

Dupas, P., and J. Robinson. “The (Hidden) Costs of Political Instability: Evidence From Kenya’s 2007 Election Crisis.” Journal of Development Economics (2012): 314-329.

Kostakis, I. “Public Investments, Human Capital and Political Stability.” Economics Research International (2014). <https://doi.org/10.1155/2014/709863>.

Laker, B., and T. Roulet. “Managing Uncertainty: How Companies Can Adapt During Times of Political Uncertainty.” Havard Business Review (2019). <https://hbr.org/amp/2019/02/how-companies-can-adapt-during-times-of-political-uncertainty>.