America Is Not Ready for a War With China
How to Get the Pentagon to Focus on the Real Threats
For most of the past four decades, a recurring nightmare has plagued corporate counsels, risk managers, and the CEOs of the world’s largest multinational corporations. Ever since the U.S. Foreign Corrupt Practices Act (FCPA) was enacted in 1977, they’ve believed that somehow, somewhere, in spite of millions spent honing compliance systems and a robust anti-corruption ethos, some failure of process or principle in one of their far-flung global operations would bring the U.S. Justice Department’s criminal division knocking at their door.
“It was not terribly long ago,” the chief counsel of one of the world’s largest agribusinesses told me recently, “that we looked at corruption as a regulatory risk—something anchored in our desire not to run afoul of the FCPA. It was basically a defensive posture, and we developed processes to manage it.” But the events of the past five years have demanded a more strategic approach, he said. “We look at what’s happening in China and Russia, in Brazil, in Malaysia, and even in our own”—U.S.—“politics, and it’s clear that corruption, or at least a public perception that the fix is in, is eating away at the status quo all over the world.”
He might well have added the Panama Papers, leaked last week from a Panamanian law firm, which document the ties between senior politicians from China, Pakistan, Russia, Syria, the United Kingdom, Ukraine, and others and a network of shell corporations in tax havens around the world. The revelations have already claimed one head of government, Icelandic Prime Minister Sigmundur Gunnlaugsson, who resigned after it was revealed that he and his wife owned an offshore company. That is not illegal in itself, of course—remember 2012 Republican candidate Mitt Romney’s defense of his own Cayman Islands listing. But so sensitive have electorates become to even the appearance of corruption that such revelations are enough to topple governments and end political careers.
Corruption remains an enormous regulatory risk. In fact, it arguably looms larger today thanks to the passage of FCPA-like statutes in Brazil, the United Kingdom, and the European Union and to high-profile anti-corruption drives from Santiago to Shanghai. As Control Risks noted two years ago in its annual RiskMap forecast, as the global boom in commodity prices subsided, it would lead “rent seekers” around the world (those who live off of government largesse and graft), who could once rely on graft from growing commodities sectors, to have to redouble their efforts to compromise supply chains and extract bribes wherever possible. That forecast is now playing out in Brazil, Malaysia, Russia, South Africa, and even in the developed world.
In the emerging markets, however, the long commodity boom did wonders before petering out starting in 2013. It created jobs, new industries and trade relationships, and millions of middle-class consumers in places where few previously existed. To take just one example, Nigeria’s economy grew by more than five percent annually for the entire period between 2003 and 2013, and in spite of the downturn in oil prices that has strained state revenues, the size of its urban middle class (those with significant discretionary income) is expected to roughly triple to 12 million by 2030.
But the boom also raised expectations. The members of the world’s new urban middle class, newly influential, demand decent schools, accountable governments, and basic services. The recent emerging market downturn has dashed their expectations, however, and fueled outrage in particular at corruption. That anti-corruption sentiment has become a decisive factor in elections, an existential threat to governments, a rallying point for populist movements, and, as in China, a rationale for crackdowns that carry serious political as well as economic consequences. The phenomenon is not confined to the emerging markets. In the United States and Europe, the fallout of the 2008 financial debacle and the ensuing eurozone crisis stoked a similar mass reaction—a sense among many, especially blue-collar industrial workers displaced by cheap overseas labor—that the game is rigged.
In the United States, the discontent has manifested in sharp divisions in the two major political parties, each of which is riven in this presidential election year by insurgent factions, Bernie Sanders on the Democratic side and Donald Trump on the Republican. Income inequality and anger at elites is common to both movements. In Europe, the revelation that many governments, with the Greek case being especially egregious, had cooked their books and were effectively insolvent shattered public faith in the institutions of the European Union. The result has been a wholesale change of EU governments since the crisis began, with only one governing coalition, German Chancellor Angela Merkel’s CDU-SDP coalition, surviving its first appointment with the voters after the onset of the crisis in 2010. Since then, populist movements of the right and left, all of them bent on either leaving or sharply constraining the EU, have gained ground. In just one example, the United Kingdom plans to hold a referendum on June 23 to decide whether to stay in the EU, and polls indicate that a yes vote is anything but guaranteed.
In short, in economies the world over, public disaffection set in motion by near universal disgust over corruption and financial scandals is shattering the global political status quo and with it, the assumptions upon which corporate strategy and risk management programs are based. It’s time to take a new look at political risk.
Since the millennium, most companies have reinvented their internal compliance and risk assessment procedures many times over. Over the past decade and a half, for instance, corporations doing business in the United States have had to meet the successive demands of the Sarbanes-Oxley Act (2002), which greatly increased the accounting and financial disclosure burdens on companies; the Dodd-Frank reforms (2009), which imposed higher capital ratios and new regulations on the financial services industry; as well as the greater exposure to risk many took on in the rush to find yield in the emerging markets once Lehman Brothers’ collapse flattened growth in Europe and the United States. New, too, are myriad and often opaque privacy, labor, data management, and currency laws in local jurisdictions, some of them a direct reaction to the Edward Snowden’s revelations about the activities of the U.S. National Security Agency.
But corruption has been relatively ignored as a source of geopolitical risk. That can’t continue. The list of governments that have fallen, been threatened by mass movements, or been voted out of office due at least in part to corruption backlash is long and growing longer. In the eight years since the 2008 financial crisis, as good a starting point as any, corruption-fueled political risk has afflicted both democracies and dictatorships, advanced and developing economies, small and large countries on every continent. A partial list might go something like this: corruption scandals helped doom India’s Congress Party in the country’s 2014 elections, and Joko Widodo, an anti-corruption crusader and former mayor of Jakarta, rode the issue to presidential power that same year in Indonesia. President Dilma Rousseff’s Brazilian government is under siege and faces a real risk of impeachment due to the revelations of the Lava Jato, or Car Wash, corruption probes of the state oil giant, Petrobras. Malaysian President Najib Razak stands accused of reaping over $1 billion from the state investment fund, 1MDB, and his hold on power, too, is threatened. The creeping intolerance of the Recep Tayyip Erdogan regime in Turkey owes a great deal to his determination to silence opponents who tied his family to bribery allegations, and both Mexican President Enrique Peña Nieto and South African President Jacob Zuma are embroiled in scandals over the construction costs of their lavish residences, in both cases slowing the momentum of important economic reforms. Guatemala’s president resigned and was jailed last September for corruption.
Corruption allegations played a major role in igniting the Arab Spring uprisings that toppled corrupt authoritarian governments of Egypt, Libya, and Tunisia. In Myanmar (also called Burma), they played a role in the victory of the National League for Democracy, led by Nobel Prize laureate Aung San Suu Kyi, over the corrupt generals who ran the country for decades. China’s fierce anti-corruption drive, dating to a 2011 change in China’s Criminal Law, has caught thousands of officials, military officers, and petty bureaucrats in its net, as well as the heads of several large multinational corporations. Although the new rules are not always crystal clear, the consequences of breaking them are stark.
In every instance above, the uncertainties or outright policy changes wrought by these political upheavals produced major changes to the business environment. In a few instances, in Argentina and Myanmar, for example, the changeover appears likely to lower business risk. But in the vast majority of cases, the political movements often seem to catch multinational corporations by surprise with the result that their global brand and local operations become associated with the imperiled status quo. The business environment in Indonesia has grown more complex since Jokowi’s election, reflecting the difficulty his government is having balancing a desire for foreign direct investment against populist demands for increases in corporate tax bills. The anger and violence that led to the ouster of Libya’s Muammar al-Qaddafi is another example. It chased not only his regime but also most foreign firms from the oil-rich country.
The lessons for multinational corporations are clear: in addition to the ever-present need for compliance regimes that satisfy extraterritorial statutes such as the FCPA and United Kingdom’s Bribery Act, the proliferation of more opaque local anti-corruption laws means that more nuanced local programs are also needed. The principles of a compliance program are the same universally, but their execution must differ from market to market.
The good news in all of this is that the risks can be assessed, monitored, and even alleviated, if not ever eliminated entirely. Since 2001, for instance, Control Risks has analyzed international corruption and compliance through surveys and discussions with clients. The results show that although honest companies are still losing business to corrupt competitors, they are doing so at a slower rate than over a decade ago.
The pace of change in the business environment, driven partly by the factors discussed above—but also by the introduction of a host of local laws on corruption, labor rights, data management, and other issues—threatens to reverse this progress. Compliance procedures set from the top often leave gaps, usually because headquarters fail to take local realities into consideration when demanding adherence to relevant laws and ethical standards.
This poses a sharp dilemma for multinational corporations. Over the past decade, particularly those with exposure to the United States and the U.S. Justice Department’s expansive interpretation of its jurisdiction, most have stayed clean. With potential corruption fines often reaching into the hundreds of millions of dollars, procedural reforms and ethical guidelines now in place around the world make it clear that these companies would rather lose business than pay a bribe to win it. But all the compliance in the world cannot address the anger of a disenfranchised population. That requires a more creative calculation, one dependent on tactile political intelligence rather than on lofty legal interpretation.