Property Rights, Political Risk, Federalism

1. What is “political risk”?

2. Assessing political risk, property rights

3. Managing political risk

4. Federalism

• Free trade

• Regulatory conflict and preemption

Property Rights, Investment & Political Risk

What is “political risk”?

What sort of political risks can undermine the value of a firm’s investment?

Nationalization or “creeping expropriation”

Law or Policy change (regulatory; monetary)

Terrorism/war/civil strife

How can firms contemplating investment in developing countries predict political risk?

Example: Oil Industry

Early 20th c: rapid growth of international oil industry

1930s-70s: Latin American nationalizations

1960: OPEC formed

1960s-70s: Middle east nationalizations

“corporate managers came to view risk analysis as an ‘ivory tower exercise,’ rooted in academic theory rather than managerial practice.”

HBS Note on Political Risk

Then how do companies (or their investors or insurers) decide when political risk is too great? What characteristics do you think are correlated with political-legal stability, or negatively correlated with political risk?

Investing in Developing Countries:

Political Risk

What should investors look for?

1. Veto points in the policy process (e.g., divided government, separated powers, federalism)?

2. System stability, but peaceful political change?

3. Strong independent bureaucracy & judiciary?

In other words, “credible commitments against arbitrary policy changes”.

Like what?

Investing in Developing Countries:

Political Risk

5th Amendment: “Nor shall private property be taken for public use without just compensation.”

What is a “physical taking”? A “regulatory taking”?Pa. Coal v. Mahon (1922):

• “government could hardly go on” if compensation were required for every diminution of property value caused by regulation

• “if regulation goes too far it will be recognized as a taking …”

What is a “taking” for constitutional purposes? Where does this idea come from?

Penn Central v. City of NY (1978):

• No “set formula”; is “ad hoc, factual inquiry”

• Economic impact on claimant

• Interference with “distinct investment backed expectations”

• Character of governmental action

• Legitimacy of public purpose

Standard analysis of regulatory takings in U.S.

“Lucas-type” categorical takings:

Lucas v. S.C.Coastal Council (1992)

1986: Lucas purchased lots for $975,000 to develop high-end resort homes

1988: SC statute prohibited construction on lots

Trial court determined that land now “valueless” (but had nominal value)

How did the court analyze this problem? Did it use the Penn Central analysis?

If regulation leaves no “economically beneficial use” of the property, then is a taking requiring compensation. Was the land literally valueless?

Lucas v. S.C.Coastal Council (1992)

Is there any exception to the majority opinion’s rule?

The “nuisance exception”: what is it?

Kennedy concurrence: “The common law of nuisance is too narrow a confine … The state should not be prevented from enacting new regulatory initiatives in response to changing conditions, and courts must consider all reasonable expectations whatever their source.

Blackmun dissent: “Today the Court launches a missile to kill a mouse.”

How can corporate managers manage political risk?

• Insurance

• Sharing risk with host nation

Investing in Developing Countries:

Political Risk

Federalism and Government Relations

• Trade

• Multiple regulators

• Boundaries of jurisdiction/authority

• Multiple enforcers

Federalism, Governments & Trade

• Shouldn’t governments protect domestic jobs and local regulatory standards? Aren’t trade restrictions sensible and good?

• Domestic mfr can sell product for $9/unit

• Foreign mfrs can sell product in U.S. for $8/unit

• Without trade, domestic mfr goes out of business

• U.S. imposes tariff of $1 per unit on imports

This is fair, right? What’s so great about free trade?

Federalism, Governments & Trade

• Domestic mfr can sell product for $9/unit

• Foreign mfrs can sell product in U.S. for $8/unit

• $1 per unit tariff on imports

If average HH buys 10 units per year (1 million units of U.S. sales annually), elimination of tariff saves each HH $10/year ($1 million)

Domestic mfr employees lose their jobs.

$1 million spent on other goods/services

saved invested in more productive companies

Do either of these uses of the $1 million create jobs? As many jobs? “Good” jobs?

Federalism, Governments & Trade

So if free trade makes most consumers happy and usually creates wealth, by and large, then why do governments try to restrict it?

• Identified losers, unidentified winners

• Concentrated losers, diffuse winners

• Strategic, national security issues

• “Way of life” issues

What about protecting public health, safety and local community standards and traditions?

EU Commission v. Kingdom of Spain

• Why is the European Comm’n suing Spain?

• Isn’t Spain trying to uphold local standards and local consumer expectations?

• Why can’t each country have its own standards, its own definitions of these terms?

• Can I sell brown lard and call it “chocolate” in Spain?

Europe’s Single Market

• Article 28: “Quantitative restrictions on imports and all measures having equivalent effect shall be prohibited between Member States.”

• Article 29: “Quantitative restrictions on exports, and all measures having equivalent effect, shall be prohibited between Member States.”

Europe’s Single Market

• Article 30: The provisions of Articles 28 and 29 shall not preclude prohibitions or restrictions on imports, exports or goods in transit justified on grounds of public morality, public policy or public security; the protection of health and life of humans, animals or plants; the protection of national treasures possessing artistic, historic or archaeological value; or the protection of industrial and commercial property. Such prohibitions or restrictions shall not, however, constitute a means of arbitrary discrimination or a disguised restriction on trade between Member States.

Europe’s Single Market -- hypotheticals

• France’s largest wine retailer refuses to stock less expensive Italian wines.

• Portugal bans the importation of high-level nuclear waste for disposal.

• French dairy farmers blockade highways on the Belgian border to prevent the importation of Belgian dairy products, maintaining the blockade long enough for the Belgian products to spoil.

U.S. Constitution: The Commerce Clause

Art. II grants Congress the power to “regulate Commerce with foreign Nations, and among the several States …”

Does that language limit state power? How?

• Dormant Commerce Clause

• Purpose of clause

• Gibbons v. Ogden (1824)

• Two-step test

The “Dormant” Commerce Clause

May states regulate cross-border commerce at all?

What can’t states regulate? City of Philadelphia v. New Jersey

If intrastate and intra-EU protectionism is so clearly prohibited under U.S. and EU law, why do member states continue to enact such legislation?

So is the power of the EU and of the American national government overriding and absolute? Are their any limits to their regulatory power?

Federalism and Allocating Legal Authority: Drawing Boundaries

The Federal Government exercises only the authority allocated to it under Article I, Sec. 8 of the Constitution

The Lopez case (1994)

The European Union has the principle of “subsidiarity”

Federalism and Allocating Legal Authority: Supremacy

The Supremacy Clause of the U.S. Constitution

Supremacy of EU law

“This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land . . .”