In The Media

Fortune favours the bold: smartly investing in high-risk export markets

by Will Mazgay (feat. Elinor Sloan)

Canadian Manufacturing
September 19, 2017

TORONTO—Japan has long been a safe and stable market for Canadian goods. But after North Korea launched a ballistic missile over its territory in late August and then tested what it claims was a hydrogen bomb in early September, a shadow has been cast over the nation.

Political risks are common in many of the world’s premier markets, but what makes the case of Japan unique is that the threat it faces has nothing to do with what is happening within its own borders. Instead, it is an outside actor that poses a danger.

This is a case of what Elinor Sloan labels as risk “beyond the black box of the state” in her paper “Trends in International Security and Trade” for the University of Calgary’s School of Public Policy.

Sloan is an author and professor of International Relations at Carleton University in Ottawa who contributed to the University of Calgary in August 2017.

Getting the Full Picture

Canadian firms should understand the full picture of risk, that which includes not just activities within a state’s borders but its relations with its neighbours and outside powers, before they start trading or investing in a new market.

To do this, Sloan says firms need to seek advice not just from experts in individual countries but international relations specialists as well, who look specifically at regions as a whole and how geopolitical players interact with each other.

“So you’d have to bring onboard into your risk assessment division, if you have one, a specialist who is an expert not on Mexico, or not just on a particular country in Africa, but on the region as a whole,” she said.

For smaller firms that can’t afford in-house risk management services, Sloan says the best resources are crown corporations like Export Development Canada, which conducts political risk assessments of countries around the world to determine the level of political risk insurance it should offer Canadian businesses in support of their overseas investments.

The Business Development Bank of Canada also offers international market selection consulting services.

However, the issue with the market assessment services provided by these organizations—according to Sloan—is that they focus mainly on what is happening within the black box of the state: addressing internal issues of crime, corruption, instability or violence.

“To the extent external inter-state dynamics are accounted for, it is in the realm of ‘bad neighbourhoods’ where conflict in one state spills over into the host country,” Sloan said in her paper.

While border security is an important consideration in risk assessment, these analyses don’t take into consideration the complexities of a country’s political interactions with its neighbours or great world powers, or the consequences that can result from fractured diplomacy.

It is because small firms rely on internationally-focused crown corporations for solid export advice that Sloan believes they must do more.

“It’s those crown corporations that need to up their game in broadening their perspective,” she said.

Sloan says that current government approaches to risk assessment may be predicated on the way countries export, focusing not on regions but on specific countries.

If a company is setting up shop in a new market, its leadership wants to know that the market is internally safe, stable and open to their products. A conflict with a foreign power could alter the situation on the ground, but the most immediate and pressing factors are those relating to what is happening within the country’s borders.

“I don’t know why exactly risk assessment has focused specifically only on countries, but it’s probably because the way companies export logically puts them (crown corporations) in that direction,” Sloan said.

Perhaps international relations are too nebulous a concern for most companies, which are primarily concerned with corruption, instability and violence within the countries they are doing business in—as it affects their operations—and as a result organizations like EDC have tailored their approach to this mentality.

Regardless of the reason, Sloan believes it is crucially important for these organizations to provide information about international relationships as it pertains to potential conflicts and security risks, because the markets with the greatest growth opportunities for Canadian exporters are also markets at risk from conflict with their neighbours or interference from outside powers.

Big Risks: Big Opportunities

“So when you look at the primary candidates for export growth in the future, you are looking at India and China,” Sloan said.

Sloan’s paper cites a report from the U.S. Department of Agriculture that forecasts the U.S., China, India and Japan to be the world’s four largest economies by 2030. However, while Japan’s growth is expected to stagnate and the U.S. will simply remain a juggernaut, China and India are set to experience dramatic economic expansion.

PricewaterhouseCoopers, in a similar report, has China and India surpassing the U.S. as the world’s biggest economies—measured by GDP at Purchasing Power Parity—by 2050, with Indonesia replacing Japan to round out the top four.

Conversely, the two reports find traditional markets for Canadian goods, like Europe, are trending in the opposite direction, forecasting significant decline.

This means that the juiciest commerce opportunities are in a geopolitical tinderbox: Asia Pacific.

Sloan points to the possibility of a naval war between China and the U.S. in East Asia as one of the most extreme scenarios. The struggle between these two powers for influence and control in the Pacific Ocean is compounded by China’s abrasive behaviour towards its Southeast Asian neighbours, and stern American demands for freedom of navigation throughout Pacific waters.

Another trouble spot according to Sloan is South Asia. India is concerned by what it perceives as Chinese aggression in its waters and China’s new friendship with India’s mortal foe, Pakistan. The spectre of a nuclear war between India and Pakistan has haunted the region since both countries joined the nuclear club in the 1990s.

Pakistan is forecast to be in the top 20 of global economies by 2030, but it is a market that presents substantial political risks, both international concerns like its relationship with India, and domestic troubles such as terrorism.

Sloan also identifies Bangladesh, along with Egypt and Nigeria, as countries that have strong potential for growth, but these states too are plagued by terrorism and political violence.

While terrorism largely falls within the black box of the state, it can be directly affected by a country’s interactions not only with its neighbours, but with the world’s great powers as well.

“So often, it involves the United States,” said Sloan. “So for instance in Africa, you’re not just looking at borders between countries, you might be looking to the degree to which the U.S. or China is involved in Africa—is involved in let’s say addressing terrorism. So it can be outside countries addressing these issues, and you have to take it up to that level.”

Taking a holistic approach to risk assessment, one that considers both internal and external threats, is necessary to paint an accurate picture of the world’s most lucrative emerging markets. While these countries are set to become bastions of economic opportunity, many are complicated places: susceptible to abuses of political or economic freedom, prone to conflicts with neighbours that could potentially lead to war, detrimentally impacted by inference from great powers, or stricken by political instability or violence.

Navigating high-risk markets, deciding if or when is the right time to invest, establishing efficient and stable operations, and safeguarding assets can be daunting tasks.

If you don’t have the resources to hire your own experts or find the resources on offer from crown corporations lacking, you may want to consider seeking out a third-party risk assessment firm.

Consult the Experts

Gavin Strong of the London, U.K.-based political risk consultancy Control Risks says his firm helps guide companies through the decision of which markets to approach.

Strong is associate director for the firm’s Mexico, Central America and Caribbean team.

“It is very important for a company looking to make that decision to invest into a new market, to make sure they understand extremely well, the political situation, the security environment and the operational environment,” Strong said.

Strong says companies will seek out his team looking to set up operations in places like the state of Tamaulipas in Northern Mexico, which is an ideal location to start up manufacturing operations because of its proximity to the U.S. But this region is also prone to savage violence, a result of the booming cross-border drug trade.

These are the realities that firms need to be aware of before they invest or start trading.

Ultimately, deciding if it’s worth the risk to do business in volatile markets is a difficult choice that can only be made by a company’s senior leadership.

Strong’s colleague at Control Risks, John Seddon, principal for the firm’s Canadian operations, says, “Different companies take different approaches and have different levels of maturity on how they handle risk.”

Just as different firms have different tolerances and appetites for risk, they also have unique risk management needs.

Seddon says his firm can wear multiple hats while attempting to address issues, such as providing advice or acting as a facilitator between different conduits.

The analyst states that his firm works to develop a coherent view of risk while assessing what can be done about it—putting mitigation plans in place or setting up insurance arrangements to help protect assets.

When it comes to political risk insurance—political risk insurance is a good idea in many markets—one of the best places to start is EDC.

“If anything happens to your asset, say the government seizes it, or if there’s a civil war and it’s damaged, we will pay out against that insurance claim,” said Phil Taylor, EDC’s official spokesperson.

The organization offers a full suite of insurance options for all aspects of international trading, but if you are entering into a high-risk market, insuring your assets in one form or another is advisable.

Entering into a new market with a reliable and knowledgeable partner like Control Risks, insured assets and solid financial backing is a good start, but surviving in high-risk areas requires proactive management as well.

“The security challenge doesn’t represent an insurmountable obstacle to conducting operations in these areas, but it just means you’ve got to be knowledgeable about the situation on the ground, and you’ve got to keep a constant eye on things, particularly red flags, monitoring situations that look like they are heating up,” Strong said.

Consider Social Impacts

Strong also points out that often companies focus exclusively on the security concerns when setting up new operations and don’t consider social risks.

“What we find is there’s so much emphasis on security, it’s easy to forget about social risks, whether there might be push back from local communities over potential environmental impacts or whether they’ve thought about what expectations their arrival in the community might have in terms of job creation, that kind of thing,” Strong said.

The analyst says companies must seek out local community leaders and properly communicate their entry strategy, who they are, why they are there and manage expectations for what they’re going to do in terms of job creation for locals, as well as mitigating environmental impacts.

Failing to address these concerns can put companies at odds with local power brokers and the community itself—and cooperation with both entities is needed for the success of any operation in a foreign market.

“I think sometimes companies go in, spend a lot of money and think ‘right, once we’ve got the contracts and we’ve dealt with the relevant government agencies we’re ready to go,’ and it’s more complicated than that,” Strong said.

Learning these complicated details and developing strategies to address them is key to succeeding in markets with pronounced political, social or security risks, and it is a process that requires a significant investment of both time and money. Given that, entering high-risk markets is not for those simply looking to make a quick buck. Instead, it is companies that are willing to put in the necessary work and commit to sticking around for the long-haul that will find success in these regions.

Market risk scholar Sloan asserts that her international relations-focused risk assessment model is designed for precisely this kind of long-term planning.

“What I’m bringing in is the long-term perspective of how to look at markets in the future…for where Canadians might want to think about doing business and start making inroads now,” Sloan said.

Getting in on high-growth markets on the ground floor is always better than showing up late, when the market is already inundated with fellow foreign competitors.

However, given that many of the world’s most auspicious markets are also prone to risk, both within and outside their borders, Canada’s crown corporations need to broaden their risk analyses to cover potential problems national and interational in nature—Canadian SMEs are relying on this information to make the informed choices critical to their future export success.

On the part of Canadian firms, making smart use of the tools, resources and information available is essential, as is maintaining flexibility, staying on top of changing circumstances and forging sound partnerships with local communities in the markets they aim to operate in.

Control Risks’ Seddon says, “There is a perception that risk relates only to bad things happening, but it is really just uncertainty tied to the objectives of an organization. So in risk, yes there can be downsides, but there’s also opportunity.”

Taking advantage of that opportunity requires diligence and hard work, but those willing to commit to the process of establishing operations in the markets of the future have the chance to gain a valuable edge on more conservative competitors.

Fortune favours the bold.

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