BSB119 T W 6

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1 BSB119 – GLOBAL BUSINESS TUTORIAL 6: THE POLITICAL ENVIRONMENT Please read the case “Doing Business in Coup-prone Fiji”, the closing case in chapter 6 (pp.271 to 274) of your textbook and answer the questions below. 1. What types of political risk are encountered by firms operating in coup-prone Fiji? (8 Marks) Political risk is the risk of strategic, financial or personnel loss for a firm as a result of non-market factors such as macroeconomic and social policies or events related to political instability. As a result of, the expected outcome or value of a given economic action for a business may be impacted. There are three specific types of political risk which are encountered by firms when operating in foreign countries:  Ownership risk;  Operations risk, and;  Transfer risk. Ownership risk refers to the risks incurred as a result of policies and actions which inhibit ownership or control over local operations. This occurs as a result of government’s attempts to maintain a great deal of ownership over many commercial services. For example, in Fiji the government maintains a significant proportion of ownership in major services whilst other industries are heavily regulated. This is noteworthy given the control the Fijian government maintains over the judiciary whilst the country remains without a constitution to protect the rights of citizens and business (Hill, C., Cronk, T. & Wickramasekera, R, 2011). Additionally, countries with this type of political regime typically take a hard line with respect to foreign investment. This is typified by the actions of the Fiji government in relation to both News Ltd and Fiji Water. In September 2010, News Ltd sold its controlling stake in Fiji’s main daily newspaper after the government imposed strict new foreign ownership limits on media companies (Ligaiula, 2010). Similarly, Fiji Water, a US owned company, withdrew its operations from Fiji as a result of the Fijian Government increasing taxes which would only impact this particular company (Ligaiula, 2010). Operations risk refers to the risks incurred as a result of policies and actions that constrain the management and performance of local operations. Arguably, countries operating in unstable political conditions face a significant risk to their operations. This occurs as a result of policies which may seek to constrain the investment opportunities and importance of management whilst also impacting on the performance of operations. For example, as a result of the political situation the ability to access credit for investments in Fiji during 2011 has declined significantly when compared to previous years (World Bank, 2011). In addition, the situation which arose at Vatukoula (Fiji’s largest gold mine) further illustrates the impact of operations risk in an unstable political environment (Hill et al, 2011). Whilst the mine was owned by Emperor Mines, the area was occupied by armed guards which ultimately resulted in the withdrawal of staff and thus, the removal of any further business potential. The mine has subsequently been sold to a London based company who have recommenced mining operations. However, the mine has yet to return to optimal production as experienced until 2005, with operations in 2009 being equivalent to approximately one-third of its prior production levels. It would be reasonable to deduce that similar situations have arisen in other coup prone nations such as Burma and many African states. Finally, transfer risk refers to the risks incurred as a result of policies and actions which limit the transfer of money, capital, people and product into and out of a country. According to World Bank statistics, the ability to do business across boarders for Fiji has increased slightly on 2010 (World Bank, 2011). However, comparatively speaking to OCED countries, the results for Fiji are poor. This is due to the significant number of compliance documents which are required to be completed in accordance with government requests. As a result, this has a negative impact on the time associated with importing and exporting products to Fiji which on average takes approximately 10 days longer than OECD countries (World Bank, 2011). However, it is noted that compared to Asia and OECD averages, the cost of importing and exporting products from Fiji is substantially lower (World Bank, 2011). This may be a reflection of the current economic climate rather than the influence of political forces. Furthermore, the impact of an unstable dictatorship government on the ability to move a product into and out of a country may be substantial. This is highlighted on the 2 communication restraints imposed on the media in countries such as Burma, China and Fiji. For example in Fiji, the government maintains control over what is shown on television and is able to force a newspaper to issue a correction to allegedly false or misleading articles (Freedom House, 2010). It may further be argued that the inability to access international websites and regulation over speech may negatively impact on the ability to transfer money, product and capital into a country. There are two additional aspects of political risk which should also be considered:  Macro-level risk, and;  Micro-level risk. Macro-level risk considers non-project specific risks which affect all participants in a country. Examples of macro-level risk include government currency actions, regulatory changes, sovereign credit defaults, and corruption and government composition changes. Any of these events could have significant implications on foreign investment. In Fiji, official corruption is widespread which has had a substantial impact on economic recovery. Although the government has endorsed measures to create an anti-corruption agency since 2004, this is yet to become legislation (Freedom House, 2010). Similarly, it is argued that the instable and ongoing change in government in coup prone nations poses a significant macro-level risk. For example, Fiji has had four coups in the past 20 years and is currently ruled by decree giving police and military significant powers (Hill et al, 2011). Furthermore, micro-level risk refers to risks encountered by a specific company. It is necessary when seeking investment that companies give consideration to the industry and relative contribution of the firm to the local economy as well as the macro risks. In an unstable political environment, it is necessary to examine how the local instability may impact on the business endeavour. This study may look specifically at the regulatory environment of the potential industry. If an Australian company were seeking to invest in a newspaper in Fiji, it would be necessary to analyse the current regulatory requirements relating to foreign ownership percentages before such a proposal is considered. Therefore, it can be seen that political risk for business involves understanding the host government and how its actions may impact on a business venture. Arguably, it can be deduced that operations in an unstable coup-prone nation such as Fiji are subject to significant levels of political risk. It is imperative to the success of the venture that these risks are fully understood and where possible, accounted for before a business venture is undertaken. 3 2. Why might the Fijian economy and other small island economies be described as vulnerable? What steps can small island economies take to hedge against these vulnerabilities? (7 Marks) In Fiji, it has been estimated that as a result of the 2000 coup, economy activity declined by 10% (Hill et al, 2011). Furthermore, following the 2006 coup, the economy declined by 7% with the tourism industry being hit particularly hard (Hill et al, 2011). Although Fiji is an upper-middle income country with a considerable per capita income, the nation along with other small island economies faces significant trade and economic development challenges. According to the UN Vulnerability Index, vulnerability is determined by population size, remoteness, export concentration, share of agriculture, forestry and fisheries in GDP, homelessness, instability of agricultural production and instability of exports of goods and services (Birguglio, 2008). Several of these factors will be considered further along with how their impact can be minimised with specific reference to their manifestation in the Fijian economy. Typically, the economies of small island communities are fragile. These economies are open and small-scale with a large reliance on a limited range of resources and products. In Fiji, the major industries are sugar, gold, tourism and clothing exports. Thus, it can be reasonably deduced that the Fijian economy is largely reliable on a very small and narrow range of goods. The Fijian tourism industry was substantially impacted by the 2006 coup. During 2007, tourist arrivals declined by 7% on the previous year, resulting in a substantial decline on occupancy rates and significant job losses (Hill et al, 2011). This was further hampered by the adverse travel warnings issued by governments of significant tourist markets such as Australia (Hill et al, 2011). Expected revenue losses equated to A$1.3 million per day from both the tourism industry and industry’s which are closely related to it. Furthermore, research has shown that smaller economies are unable to exploit economies of scale. In an increasingly globalised economy, economic modelling suggests these smaller players will be wiped out by larger firms who are able to produce goods on a more cost effective basis (Birguglio, 2008). This is highlighted in the current plight of the clothing industry in Fiji. This industry has declined significantly as a result of increased competitive pressures from large manufacturing countries such as China (Hill et al, 2011). Therefore, countries such as Fiji are then forced to import products which results in negative implications on their balance of payments account (Birguglio, 2008). In addition, the population of these countries particularly when compared to large international powerhouses such as India and China is very small. For example, the population of Fiji is less than 850,000 which is quite a small domestic market. This limits the local market for firms seeking to both produce from within or for firms seeking to export their goods into the country. This is further hampered by high international transportation costs which may result in the country being considered an unviable investment option (Birguglio, 2008). Regardless, small developing economies continue to be highly dependent on activity within export markets and foreign exchange. This is highlighted by the significant decline in GDP growth experienced in Fiji during the Global Financial Crisis as illustrated below: Graph 1: Real GDP Growth Data Source: Department of Foreign Affairs and Trade ( As well as being subjected to the economic market dictated by larger players such as Britain, the United States and Australia, smaller nations are also subject to their imposed sanctions on aid, military cooperation and other factors. These larger players have significant ‘pull’ in global organisations such as the United 4 Nations. Payments for peacekeeping operations have earned Fiji US$300million over the past three decades (Hill et al, 2011). Due to the unstable political market, Australia and New Zealand are lobbying to prevent Fiji’s future involvement in these initiatives. Furthermore, the US and UK withdrew a total of US$425million worth of foreign aid to the Fijian economy as a result of the political uprising in 2006 (Hill et al, 2011). There are several steps which small island nations can take to hedge against the vulnerabilities in their economy. Economic resistance refers to the ability of an economy to absorb or recover quickly from adverse shocks (Birguglio, 2008). There are four key areas which should be concentrated on in order to minimise or manage the vulnerabilities and develop economic resistance:  Macroeconomic stability  Macroeconomic market efficiency  Good political governance  Social and environmental conditions Managing macroeconomic stability is important to maximise the ability of the economy to withstand external shocks (Birguglio, 2008). In order to achieve this, governments of small island developing economies should seek to minimise the levels of fiscal deficit and external debt, particularly compared to GDP (Birguglio, 2008). Furthermore, the governments should also seek to minimise levels of unemployment and inflation. In terms of market efficiency, governments should take steps to ensure resources within the economy are allocated in the most efficient manner possible (Birguglio, 2008). Based on the facts presented in the case study on Fiji, it appears that the government is failing to do this largely based on underlying racial problems. Additionally, governments should seek to minimise regulatory restraints and bureaucratic procedures. This would result in the economies becoming broader as a result of increased competition and enhanced market operation (Birguglio, 2008). By operating in a more free, efficient and competitive manner, small island developing economies are positioning themselves in a more appealing manner to foreign investors. The final two factors, good political governance and social conditions are closely related. Tying in with
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