The Russian economic system in
transition from a centrally planned, state-run economy to a decentralized
market economy offers a mixture of opportunities
and risks. As with other emerging
economies, risks include access to natural resources, inexpensive labor, and
growing consumer markets. These
opportunities are offset by substantial risks, well-documented in quantitative
studies published by Transparency International, the World Bank, the Heritage
Fund, world-leading consulting firm Ernst & Young, the Economist
Intelligence Unit, and others.
Ranking most of the worlds’ economies in terms of corruption, regulatory
environments, and economic freedom, these studies consistently rate Russia very
poorly in terms of conditions common to business-friendly economies. The most substantial risks in Russia
occur from corruption, the immaturity of credit markets, unpredictability of
business-licensing systems, bureaucracies managing the movement of goods and
capital across borders, and inconsistent application of legal and tax codes. In order to mitigate these conditions,
Russia established several Free Economic Offshore Zones, within which
conditions are more business-friendly.
Even within these zones, businesses must carefully analyze the risks of
the economic climate. Evaluated in
terms of their probability and consequence, risks are mitigated through
controlling, avoiding, or assuming approaches. Any risk-mitigation approach involves costs. If the cost of mitigating risks in
Russia’s economy exceeds the expected benefits of operating there, then the
business case for participating in Russian markets does not exist.
The key to any
good investment is recognizing risks of return capital and managing them by
choosing the right framework. This study will
illustrate methods for finding out whether the business case for investing an
emerging economy is favorable.
The approach is based a basic
concept that any risk must be analyzed in terms of two separate traits. Risk analysis involves estimating the
probability that the risk event occurs and the severity of its consequences.
First, each risk has a certain probability that it will occur. Risks are described with a consistent if-then
sentence style. In terms of the if-then statements used to identify
risks, the likelihood reflects either the if part or the then
depending on the circumstances.
After risks are identified then they are analyzed.
Consequence is the second
important trait for risk. As with
probability, consequences can be either severe or mild. The probability and
consequence are expressed in quantitative terms. In order directly compare different risks; they are assigned
likelihood and consequence levels.
These simple observations form the basis of risk analysis.
Two types of consequences are
considered. These consequences are
important for the topic of this research project. The first important consequence is negative impact to the
ability of corporations operating in emerging markets to deliver goods and
services to their customer. The
second consequence is negative impact to operating costs. The consequences are selected based in
the factors most important to the risk analysis.
It is usually very difficult to
determine the probability and exact consequence of a given risk event. The probability is particularly
difficult. Consequences can be
estimated from a capacity or cost model for the business. For preliminary risk analysis, the
business executives and other business experts evaluate the probabilities and
consequences using their educated judgment.
The Heritage Foundation, a conservative American think-tank,
publishes an Index of Economic Freedom.
This is a study of 161 countries in terms of ten factors or
“freedoms.” These “freedoms” are: Business freedom (regulation), trade
policy, fiscal burden (government debt), government intervention, monetary
policy, wages and prices, foreign investment, banking and finance, property
rights, informal market (freedom from corruption), and labor freedom. The index is based on the assumption
that too much government involvement of economies is harmful to business. As with the World Competitiveness
Yearbook, the factors are rolled up into a single “economic-freedom” score that
it uses to rank the economies it studies.
An economy’s competitiveness is determined in part by its
risk environment. As a result,
studying risk can begin by looking at competitiveness factors for the market in
which one is interested. The IMD
World Competiveness Center publishes a World Competiveness Yearbook that
analyzes 323 competitiveness criteria.
The methodology used to build the yearbook breaks these criteria into
four competitiveness factors.
Economic performance is based on a macro-economic evaluation of the
economy. Government efficiency is
the extent to which government policies are conducive to competitiveness. Business efficiency relates to the
extent to which the national environment encourages enterprises to perform in
an innovative, profitable, and responsible manner. Finally, infrastructure is the extent to which basic
technological, scientific, and human resources meet the needs of business. The factors and criteria are rolled up
into a World Competitiveness Scoreboard that ranks 55 economies on a single
scale. When the factors and
criteria are not favorable to — or even worse, impede — business, they can be
considered risk factors.
The World Bank publishes a study of government regulation in
175 countries. Its analysis is based on ten business processes that involve
dealing with government regulations.
These are: starting a
business, dealing with licenses, employing workers, registering property,
getting credit, protecting investors, paying taxes, trading across borders,
enforcing contracts, and closing a business. For each of these factors, specific metrics are shown. The sections describing each of the
reports also identifies the best ten and worst ten in terms of each
factor. It also ranks all of the
countries in terms of a combination of the factors and calls out which are
making improvements through reform.
Transparency International, a Berlin, Germany-based
non-governmental organization, publishes an annual study focused on
corruption. Each year focuses on a
different sector. For example, the
2005 report studied corruption in construction and post-confliction
reconstruction. The 2006 report
analyzed corruption in the health-care industry. The report in 2007 looked at corruption in the
judiciary. The reports conclude
with a Corruption Perception Index (CPI) that it uses to rank all of the 163
countries studied.
Finally, consulting and auditing firm Ernst & Young
published a study on risk management in emerging markets. Focused on emerging markets countries,
the study was based on interviews with 435 multinational companies with
headquarters in 12 developed-market countries and 501 companies in emerging
markets. This provides a general
discussion risk-management practices in emerging markets, without much specific
information on the risk environments themselves.
Different types of
risks based on the color region where an individual risk is plotted, its significance
is evaluated as either “low,” “medium,” or “high” are plotted on the risk grid
according to the likelihood and consequence levels obtained from tables. The most significant risks are those
that are both likely to occur and have severe or extreme consequences. A highly likely risk event with minor
consequences or a very unlikely event with severe consequences is less
important. This is consistent with the theory of expected values.
