What is Economic Risk?

Economic risk is a nebulous term with a variety of definitions. In a nutshell, it is the risk that an endeavor will be economically unsustainable, for a variety of reasons ranging from a change in economic trends to fraudulent activities which ruin the outcome of the project. Before starting projects, economic risk has to be considered to determine whether or not the potential risks are outweighed by the benefits.

There are a variety of ways to look at economic risk, with an assortment of modeling systems. In a simple example, imagine a planned housing development. The risk in this case is that the profits from the development will not cover the costs of the development, leaving the developer in debt. This can occur because of downturns in the real estate market, unexpected cost overruns, lack of interest in the housing, and a variety of other factors.

People can try to predict economic risk, but they are not always successful. Economies are notoriously fickle, and they do not necessarily follow patterns which can be followed or mapped out ahead of time. The risks that a project will not repay itself increase with the size of the project, and they also get larger the longer it takes for a project to be completed. Costs of production, for example, tend to go up, which means that every year a project runs over schedule, the more costly it becomes.

Economists who act as consultants can command a hefty fee for their services when they are asked to map out economic risk. In addition to predicting risks, economists can also come up with suggestions which may reduce risk. In the housing development example above, for example, an economist might recommend preselling a set percentage of units before breaking ground to make sure that the project will have enough funds to take it through to completion.

Investors also look at economic risks when considering things like making loans, doing business with another country, or even sending aid supplies to other nations. Risk on a national level can be an important consideration for potential investing partners and lenders who are reluctant to work with countries which appear to be economically unstable. Balanced with this risk is the very real problem that a nation which is economically unstable may have trouble getting assistance, which in turn increases economic risk for other investors, because the country lacks support.