The political environment in a country affects business organizations and could introduce a risk factor that could cause them to suffer a loss. The political environment could change as a result of the actions and policies of governments at all levels, from the local level to the federal level. Businesses must plan for the variability of government policy and regulations.
The political environment in a country affects its economic environment. The economic environment, in turn, affects the performance of a business organization. In the United States, for instance, there are significant differences in Democratic and Republican policies. This has implications for factors such as taxes and government spending, which in turn affect the country’s economy. A higher level of government spending tends to stimulate the economy, for instance.
Governments could change their rules and regulations, which could have an effect on a business. For instance, after the accounting scandals of the early twenty-first century, the United States Securities and Exchange Commission became more focused on corporate compliance and the government introduced the Sarbanes-Oxley compliance regulations of 2002. This was a response to the social environment that called for such change to make public companies more accountable.
Particularly for businesses that operate internationally, a lack of political stability in any country has an effect on operations. A hostile takeover could overthrow a government, for instance. This could lead to rioting and looting and general disorder, which disrupts the operations of a business. Such disruptions have occurred in Sri Lanka, which went through a protracted civil war, and in Egypt and Syria, which have been subject to disturbances as people agitate for greater rights.
One way to manage political risk is to buy political risk insurance. Organizations that have international operations use this type of insurance to mitigate their risk exposure as a result of political instability. There are indices that provide an idea of the risk exposure an organization has in certain countries. For instance, an index of economic freedom ranks countries based on how political interference impacts business decisions in each country.
It is possible to analyse and forecast the impact of government policies on doing business. There's an established model called PEST analysis, which evaluates political, economic, social and technological factors that could affect the cost and difficulty of doing business. The political and economic sides of the analysis are directly government-related, while government policies indirectly affect the social and technological environment. An expanded form of PEST analysis, called PESTEL or PESTLE, adds legal and environmental factors to the equation. These, too, are strongly influenced by government policy.