Political Risk Is Not Economic Risk

February 12, 2010

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Political Risk Is Not Economic Risk

There’s nothing quite like a New York Times columnist for spouting gobbledegook on matters economic: perhaps only the editorials themselves are worse. Tom “Airmiles” Friedman gives us a lovely example here:

Banks, multinationals and hedge funds often hire foreign policy experts to do “political risk analysis” before they invest in places like, say, Kazakhstan or Argentina. They may soon have to add the United States to their watch lists.

Now he’s right so far, investors really are adding the US (and the UK) to their list of places where political risk is a concern. But Tom then goes on to waffle about leadership, strong government (and the lack of it), inflation, currency matters. No, these are not what people think of as political risk, these are economic risks.

Political risk is when politicians decide that they’re going to tear up the rule of law and stick it to some company or other that they or the public don’t like. Doesn’t matter what the original deal was, what it says in the contract, yeah, let’s get ‘em! Usually of course to get a short term poll boost for said politicians while right royally screwing over the long term economic health of the country.

“That’s what political risk is, that politicians are slimeballs who will never live up to their part of an agreement.”

This happened to Shell in Russia: they invested billions in the Sakhalin oil and gas projects. Once they were actually up and producing the Russian government sucked its teeth and decided to change the rules: no, you can’t export, we’ll change the royalty rates, oooh, my, see, you’ve broken an environmental law so we’ll just force you to sell the whole project, eh? Something very similar happened to BP over their investment in TNK.

Or there’s the example of the Zambian copper mines. No one would invest there because no one could be sure what the law would be next week. So a strong deal was cut: if you change those rules you’ve got to compensate us for the investments we’ve already made. Sure as eggs is eggs of course as soon as the copper was flowing again the government tried to quadruple the royalty rate, change the corporate and income tax rates and disallow depreciation charges against tax…..and they’re still desperately trying to wriggle out of paying compensation. There’s even a little case going on in El Salvador right now. A gold mining company spent $80 million prospecting and actually found gold. Under the contract, either they are allowed to lift the gold or they have to be compensated for their exploration costs. Guess what? The government in El Salvador doesn’t want to let them mine and also doesn’t want to pay back either the costs or the fee that was paid for the right to prospect.

That’s what political risk is, that politicians are slimeballs who will never live up to their part of an agreement. But why should anyone be worried that the US should be added to a list of countries where this might be a problem? Surely we don’t have these sorts of problems?

Oh Yeah? Anyone remember how the bondholders got crammed down in the GM bankruptcy? How the President of the United States overturned the settled law of the land so that his political supporters, the unions, got a better deal than they should have done?

Or how about this one?

In 1995, when oil prices were very low, Congress tried to encourage deep-water drilling in the Gulf of Mexico by giving oil companies relief from some of the royalties they incur for producing oil and gas on public land. .....Representative Edward Markey of Massachusetts hopes to put things right with a bill that would clarify the law and prevent companies from signing new leases in the gulf until they renegotiate the old ones and pay royalties that are due.

Changing the rules of the game after billions have been spent by the companies. BP, as an example, went out and spent a fortune and was able to find oil 6 miles under the Gulf: the deepest anyone has ever drilled. Now that the money has been spent and the oil company is committed, up pops a politician claiming that the rules just be changed: we didn’t really mean it you know, ha, ha, ha, just joshing. Of course we’re not going to let you keep the profits we encouraged you to go and seek, don’t be silly.

That’s what political risk is, that politicians will, well, politicians will act like politicians. Overturn contracts, rip up the rule of law, if it appears that doing so will give them an electoral advantage.

The reason that investors are now beginning to consider political risk when investing in the US? Because the US has become the sort of place where you have to worry about political risk when you invest. This is not, to put it mildly, an advertisement either for the US or for American politicians. It will lower investment and that in turn will lower the living standards of Americans in the future. But it gets votes in the short term and that’s what political risk is, see?

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