high tax rates that destroy incentives to work, save, and invest
vast state-owned firms run for the benefit of their managers and workers
a citizenry that demands, and a political system that accepts, government responsibility for maintaining and expanding the nation’s standard of living through public-sector spending and regulations (the less stable the political system, the more important this factor will likely be.)
pervasive corruption that acts as a large tax on legitimate business activity, holds back development, discourages foreign investment, breeds distrust of capitalism, and weakens the basic fabric of society
the absence of basic institutions of government – a well-functioning legal system, reliable regulation of financial markets and institutions, and an honest civil service
Alternatively, indicators of a nation’s long-run economic health include the following:
a structure of incentives that rewards risk taking in productive ventures
a legal structure that stimulates the development of free markets
minimal regulations and economic distortions
clear incentives to save and invest
an open economy
stable macroeconomic policies
In summary, from the standpoint of an MNC, country risk analysis is the assessment of factors that influence the likelihood that a country will have a healthy investment climate. Several costly lessons have led to a new emphasis on country risk analysis in international banking as well. From the bank’s standpoint, country risk – the credit risk on loans to a nation – is largely determined by the real cost of repaying the loan versus the real wealth that the country has to draw on. These parameters, in turn, depend on the variability of the nation’s terms of trade and the government’s willingness to allow the nation’s standard of living to adjust rapidly to changing economic fortunes.
The experience of the countries that have made it through the international debt crisis suggests that others in a similar situation can get out only if they institute broad systemic reforms. These countries need less government and fewer bureaucratic rules. Debt forgiveness or further capital inflows would only tempt these nations to postpone economic adjustment further.