No investment destination better illustrates the importance of managing political risk than China. Over the past 25 years, the Chinese Communist Party’s economic reforms have opened the gates to vast flows of foreign investment, generated almost miraculous growth, lifted hundreds of millions of people out of poverty, and propelled Chinese companies onto the global stage. But the country’s economy and the foreign companies that depend on its vitality are especially vulnerable to external shocks, such as spikes in global commodity prices (particularly energy), epidemics, regional political unrest, and protectionist sentiment in the Western world. Domestic political unrest also poses risks: Rapid growth; the dislocation of tens of millions of people as state-owned companies have shed workers; public anger over land redistribution; widening wealth gaps; and major industrial accidents, including toxic spills, have all fueled social instability. This volatility has the potential to force sweeping governmental action, such as large-scale social spending or systemic crackdowns; disrupt supply chains; endanger fixed assets; and erode investor confidence.
A version of this article appeared in the November 2006 issue of Harvard Business Review.