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Latin America: Political Risk Is Local

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Local issues, more than national elections and federal regulations, present the toughest business challenges.

BY JOHN PRICE

Tip O’Neill, the former Democratic Speaker of the U.S. House of Representatives, coined one of the most oft-repeated adages of American political life:  All politics is local.  That gem of political wisdom is a favorite refrain of pundits when explaining why voters are moved more by local and personal concerns, than by national or international issues that typically dominate the media. 

Political risk suffers a similar irony. And perhaps nowhere is this more apparent than in Latin America. Whether defined as political risk or more broadly as business risk, the kinds of problems that trip up investors and result in significant financial damages for multinational firms stem as much from local sources as they do from national, let alone regional, issues. 

When experienced managers in Latin America diagnose the causes of business interruptions or poor performance, they point to specific local liabilities, either housed within their firm, such as theft, fraud and labor strife, or outside the firm, such as criminal gangs, corrupt unions, illegal competition and local politicians bent on extortion.  Less commonly cited as the root causes of their companies’ ills are changes in national government or new federal legislation.

CIUDAD NEZA

The rough-and-tumble neighborhood of Ciudad Neza, east of the Mexico City airport, provides the backdrop for a classic example of the relative importance of local business risk.  In the early 1990s, Mexico was the darling of all international markets, President Carlos Salinas de Gotari was a celebrated neo-liberal star and Mexico’s business environment was rated one of the most business-friendly in Latin America. At a national level, political risk was low. But at a local level, as a leading bottled water producer discovered, political risk could be high. 

In Ciudad Neza, policing was scarce and income levels low. But with 3 million residents, the market consumed as much bottled water as almost any city of its size in the world, in no small part thanks to the absence of any potable water infrastructure. And yet, the company was losing market share in the periphery of its own bottling plant.  An investigation revealed that competitors had hired street gangs to scare off the company’s drivers, a painful truth that was only revealed after the drivers were “beered and pizza-ed” (as opposed to wined and dined) by the investigators, and the company CEO promised not to fire any of them for telling the truth.

Similar local business challenges are faced by multinational companies throughout Latin America, particularly by firms in natural resource industries, which often operate in remote locations, beyond the political oversight of the national capital and often beyond the reach of effective law enforcement.  Mining companies, energy exploration and extraction firms and forestry outfits learn to take local political risk seriously. 

PERU MINING

Mining firms in Peru, for example, pay handsome royalties to the central government, which spends roughly half in the capital city and returns the other half to the respective provincial government. Unfortunately, only a small trickle of the royalty payments reaches the municipality where the mine is located.  Local citizens see modern mining infrastructure being constructed and wonder out loud: What’s in it for us?  This sows the seeds of discontent that can manifest itself in labor disputes, corrupt local politicians armed with red tape and eager for bribes, the scrutiny of organized crime, the vitriol of NGOs looking to draw attention to their cause, and protests by other disgruntled groups.  Peru enjoys excellent global ratings in many areas of political, regulatory and economic risk, and yet was home to numerous mine shut-downs in 2009, caused by local grievances. 

Understanding risk is essential to investors. Only by accurately measuring risk can you apply an appropriate discounting rate against projected profits.  If the discount is too high, a healthy investment may be overlooked.  If the discount is too low, the investment may result in significant losses. 

LOCAL ALLIANCES

Understanding risk also helps new investors better prepare for and manage their assets.  Local risks can usually be mitigated before they wreak havoc on a firm’s operations.  A good security assessment combined with the implementation of solid IT security and information-sharing protocols can prevent data theft, the most common (and costly) form of theft suffered by large companies in Latin America. Knowing the influential local political players and understanding their fears and aspirations, can be instrumental in designing a community outreach program, placating their needs and converting potential adversaries into useful allies.  Building political allies at a local level can also be instrumental in fending off unwelcome political pressure at the national level.

“Think global, act local” may be the appropriate adage for risk officers grappling to measure the risk that their employer faces in a given market. One must think globally to anticipate any risk from any source.  For example, drilling for oil off-shore in Brazil at an extraction cost of $60 per barrel and a 2020 delivery date cannot be considered without understanding the implications of an expanding Chinese market and the over-indebted U.S. economy.  At the same time, an increasingly vociferous environmental movement in Santos, from where many of the Brazilian off-shore drilling operations will be launched, could prevent or delay the expansion of the port.  What happens in Santos may prove more significant in determining success for deep-sea oil investors in Brazil than the national elections in 2010, even if it doesn’t sell as many newspapers. 

John Price is a Managing Director of Business Intelligence in Latin America at Kroll. This article is republished with permission from Kroll Tendencias, the company’s monthly newsletter.

 

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