When did society first become aware of risks as we know them today? And what were the driving factors behind the emergence of risk intelligence?
Join PRINCEPS Advisory or a brief historical excursion where we take a look at the main overarching themes that have contributed to the evolution of risk intelligence over the centuries.
The novelty of risk
Risk, as we perceive it today, is in itself a relatively modern concept.
Until the introduction of new ideas during the Renaissance period, many of the hazards we now view as preventable were instead understood to be acts of God over which humans had no influence. A shift in this mindset, accompanied by the introduction of the number zero into the European numbering system, allowed for more advanced calculations and an analytical approach to risk. This was further enhanced by the invention of probability theory in the 17th century, which provided people with a method of precise prediction and decision making.
The growth of bureaucratic states in the following centuries then provided data which facilitated early analyses and predictions, bringing about a somewhat structured approach to risk. With the existence of a comprehensive discipline such as political risk intelligence still far out of reach, the evolution of our approach to risk with each decade can be traced to overarching themes as well as major political developments.
The early years of risk assessment
The nineteenth century and especially its second half led to a rapid expansion of European imperialism, and with it, international business. During this period, business was mostly closely intertwined with the interests of the state and as such supported by governments. The key challenge, therefore, was not dealing with political risks as much as logistically securing the realisation of business across long distances.
However, this dynamic changed with the developments of the early twentieth century. The first world war and the Russian Communist revolution of 1917 both resulted in growing hostility toward foreign companies in Europe. The management of distance was thus replaced by an emerging need to manage relationships with governments and their representatives in order to navigate hostile political environments. For the first time, political risk became a consciously addressed concern.
An interesting case of this can be found in early 20th century Germany. Its involvement on the losing side of both world wars as well as the inter-war establishment of the Nazi regime made German-owned firms especially vulnerable to political risk. Therefore, many firms devised elaborate organisational structures for their businesses, designed to circumvent real and potentially hostile government interventions. A good example of this is Beiersdorf, the multinational producer of personal care products and adhesives – as a largely Jewish owned and managed company, Beiersdorf faced a uniquely challenging combination of home and international political risk.
After the Second World War ended, many companies and investors could not properly evaluate the risks associated with the emergence of new opportunities brought about by the rebuilding of post-war Europe. With the rapid inflow of both cross-border finance and direct investment, the concept of political risk insurance was first introduced in relation to the Marshall Plan in 1948. In an effort to encourage U.S. equity investments to assist in European reconstruction, the U.S. government began a programme of issuing long-term political risk guarantees to ensure the US investors’ ability to convert funds and subsequently remit dollars.
However, the establishment of risk management as an independent discipline did not occur until the post-war era and even then placed its key focus on pure risks, such as natural disasters and other unforeseen incidents. Motivated by the high costs or pure impossibility of insuring businesses against some of these occurrences, risk management and subsequent mitigation were established as a form of self-insurance. Several sources date the origins of the discipline to the second half of the 1950s, with the first two books on the topic published in the early 1960s. However, these too only focused on so-called pure risks such as natural disasters or death, with financial and political risk management not becoming significant until the following decade.
Risk management professionalised, decade by decade
The 1970s were a relatively turbulent decade in comparison to the post-war boom of the 1960s, and as such, they saw the emergence of both financial and political risk management on a larger scale. Various price fluctuations linked to oil shocks and subsequent inflation led many companies including banks, insurers and nonfinancial enterprises to prioritise financial risk management. The study of political risk was then gradually consolidated, centred around the theme of expropriation, while also firmly embedding itself into the academic sphere.
The state of the 1970s economy resulted in the following decade being dominated by a debt crisis which in turn led to a shift toward neoliberal economic policy in the West. This was a concern from both financial and political risk perspectives. The subsequent meltdown of capital markets in developing countries then dominated the political risk agenda of the following decade.
The 1990s also saw financial risk management evolve into a corporate affair, placing the major decisions in firms’ risk management policy in the hands of top management. This in turn fostered a more systematic approach to how processes, structures, and mechanisms that influence the control and direction of corporations are set up, propelling the term „corporate governance“ onto the scene and becoming an integral component of managing risks.
New millennium, new risk environment
While the events of the 20th century appear to allow for a neat categorisation, decade by decade, the 21st century has been significantly more difficult to navigate.
Globalization has made risks more intertwined and internationalised than ever before. While the mainstream approach to political risk has taken inspiration from the events of 9/11 to pinpoint the main threat as menacing rogue nations, the “clash of civilizations” or economic retaliation among once friendly nations, each region around the world has been growing in complexity in terms of the identification of relationship networks and power balances.
Furthermore, this still only accounts for one area of the risks businesses are facing today.
The emergence of new technologies has allowed political activities affecting businesses to occur virtually anywhere - inside homes, on the streets, on the cloud, in chat rooms and on social media sites. Risks no longer stem from major political developments alone. The immense shareability of everyday life has created opportunities for the emergence of risks in spaces and situations, which previously would have been dismissed as insignificant.
As a result, a new major sub-field of risk intelligence labelled as reputational risk intelligence has been gaining traction with the onslaught of digital technologies. The exponential growth of the information ecosystem constituted by the media, social media networks, and the technology allowing for the instant recording of information and its sharing across the globe has placed enormous pressure on corporations to develop processes to protect their reputation.
For a global international conglomerate, a related negative event happening on one side of the world can destroy the company’s reputation everywhere else. Look no further than the current turmoil concerning major companies such as Google, Renault or Nestlé leaving the Russian market as a reaction to its brutal assault on Ukraine.
Even a slow, albeit adequate reaction, can then cause significant damage in situations where the public`s emotions can take over and quickly change the perception of an organization as complacent or simply “not doing the right thing“. Reputational risk intelligence then has to identify what events or actions can threaten the company’s reputation on one hand, and develop strategies in order to either minimalize the probability of risk occurrence or its impact on the other.
What started with the introduction of the zero has now evolved into an established field of risk intelligence which is continuously forced to improve. As the global society is likely to face numerous serious challenges and issues in the decades to come, one thing is, at least, certain for us professionally – the need for high-quality risk intelligence is not going anywhere, and if anything, is likely to be higher than ever.
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Sources used:
Risk management: history, definition, and critique (Georges Dionne, 2013)
Managing political risk in global business: Beiersdorf 1914-1990 (Geoffrey Jones and Christina Lubinski, 2015)
The history of risk (Centre for Innovation - Leiden University)
Managing 21st-century political risk (Condoleeza Rice and Amy Zegart, 2018)
European Business, Dictatorship, and Political Risk, 1920-1945 (Christopher Kobrak, Per H. Hansen, and Christopher Kopper, 2004)
Political Risk Insurance History (Sovereign Risk Insurance LTD)
Political Risk Analysis (Britannica)