Economic risk is the possibility of a project being financially unsustainable due to various factors. It can be difficult to predict and can increase with the size and duration of a project. Economists can help reduce risk, and investors consider it when making decisions.
Economic risk is a nebulous term with a variety of definitions. Simply put, it’s the risk that an effort will be financially unsustainable, for a variety of reasons ranging from a change in economic trends to fraudulent activities that ruin the outcome of the project. Before projects begin, economic risk should be considered to determine if the potential risks outweigh the benefits.
There are a variety of ways to view economic risk, with a variety of modeling systems. In a simple example, imagine a planned housing development. The risk in this case is that development proceeds will not cover development costs, leaving the developer in debt. This can occur due to downturns in the real estate market, unexpected cost overruns, lack of interest in the home, and a variety of other factors.
People can try to predict economic risk, but they are not always successful. Economies are notoriously fickle, and don’t necessarily follow patterns that can be traced or mapped out in advance. The risks of a project not paying for itself increase with the size of the project, and also grow larger the longer a project takes to complete. Production costs, for example, tend to rise, which means that each year a project runs on schedule, the more expensive it becomes.
Economists acting as consultants can charge a hefty fee for their services when asked to map economic risk. In addition to predicting risks, economists can also come up with suggestions that can reduce risk. In the housing development example above, for example, an economist might recommend pre-selling a set percentage of units before construction begins to ensure that the project has sufficient funds to carry it out.
Investors also consider economic risks when considering things like making loans, doing business with another country, or even sending aid supplies to other nations. Domestic risk can be an important consideration for potential investment and lending partners who are reluctant to work with countries that appear to be economically unstable. Balanced against this risk is the very real problem that a nation that is economically unstable may have trouble getting assistance, which in turn increases economic risk for other investors, because the country lacks support.
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