Geopolitical Risk, Business, and Investment

Originally produced on July 10, 2017 for Mauldin Economics, LLC

By George Friedman

When people think about geopolitics, they tend to think about war, as if the two issues were the same. But that is only partly true.

Geopolitics is the study of the power of nation states, and war is certainly a determinant of power. But it is only one of many. Things like economics, politics, ideology, and technology work together to form national power, and however useful it may be to learn about any single element, they are inseparable. It’s for this reason that the situation in North Korea is (rightly) seen as a geopolitical problem but the Italian banking crisis is (wrongly) not.

Rooted in Geography

Multifaceted though it may be, geopolitics is nonetheless rooted in geography. Geography dictates what is possible and what is impossible. Iceland, for example, can never conquer Europe, nor will it become a major industrial power.

Place is important. Human activity occurs in a place. Business is conducted in a place. Its fate is as tied to that place now as it ever was. Multinational companies are not new. Bankers during the Italian Renaissance did business all over Europe. But the bankers themselves lived in a certain place, and as vast as their interests were, they needed to live in a location where they and theirs were safe. Those with money must always seek safety, for there are always people who want their wealth. Bankers could hire mercenaries, but it was never really clear how loyal they were.

Times have changed but the fundamentals have not. Now, the security of wealth depends on the ability of the state to protect it. Wealth is sometimes created and sometimes granted but always envied and desired.

The free market requires the rule of law. The rule of law is the recognition of the right to property—and the ability and willingness to enforce that right. Otherwise, businessmen, like Italian bankers before them, would pay a steep price to find out just how trustworthy their security guards were.

Investing Abroad Is Riskier

This dynamic is all the more relevant when investing in a foreign state because it is inherently riskier. Will the host country respect foreign ownership or seize the assets?

History is filled with examples of expropriation. Cuba took foreign casinos. Egypt nationalized the Suez Canal. The United States seized Iranian assets. Whatever the reason for doing so, the fact remains that this is not a black swan but an ever-present danger.

Investing in one’s own state involves different, subtler risks. A state government can rewrite tax laws and impose new regulations on property already owned. After all, the state invented the free market. It created the limited liability corporation—a staggering achievement, considering it made it a matter of law that the owner of a business did not have an unlimited exposure to the business’s liabilities.

This was a political decision that made modern capitalism possible. But it left in the hands of the state—the inventor of the corporation—the right to define the boundaries of liability and the obligations and limits placed on a corporation in return for this protection. The alternative, in a truly free market, is that an owner of an asset is liable for that asset.

Put differently, there are so many more risks and opportunities in business than what a spreadsheet can show. Ideally, a business would operate in a country powerful enough to protect it, stable enough to define the laws that govern business, and capable enough to enforce those laws. By this logic, investing in the United States after 1865 or in China after 1977 would have been insane. By 1900, however, the United States became the largest manufacturer in the world. Roughly 30 years after 1977, China became the second-largest economy in the world.

Calculating country risk and opportunity is at least as complex as reading a spreadsheet, and in some cases more important. A superb balance sheet can indicate whether a business is thriving or will be confiscated. It’s important to know the difference, and the examples I provided here are merely a small fraction of variables to consider. Businesses and investors are most at risk when these non-business factors have been stable for a long period of time, as has been the case for the last generation. But as in business, an extended period of anything frequently signals a shift, and in this case a shift that requires understanding and agility.