What is economic risk?

Economic risk is a nebulous term with a variety of definitions. In a nutshell, economic risk is the risk that a venture will be economically unsustainable, for a variety of reasons ranging from a change in economic trends to fraudulent activities that ruin the outcome of the project. Before initiating projects, economic risk must be considered to determine whether the potential risks outweigh the benefits.

There are a variety of ways to visualize economic risk, with a variety of modeling systems. In a simple example of economic risk, imagine a planned housing project. The economic risk in this case is that development profits will not cover development costs, leaving the developer in debt. This can be due to housing market downturns, unexpected cost bursts, lack of interest in housing, and a variety of other factors.

People may try to predict economic risk, but they are not always successful. Economies are notoriously fickle and do not necessarily follow patterns that can be followed or mapped in advance. The risks of a project not paying for itself increase with the size of the project and also increase the longer a project takes to complete. Production costs, for example, tend to increase, which means that each year a project is executed on schedule, the more expensive it becomes.

Economists who act as consultants may charge a high fee for their services when asked to estimate economic risk. In addition to predicting risk, 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 certain percentage of units before construction begins to ensure the project has sufficient funding to complete.

Investors also consider economic risks when considering things like taking out loans, doing business with another country, or even sending relief supplies to other nations. Country-level risk can be an important consideration for potential investment and loan partners who are reluctant to work with countries that appear to be economically unstable. Balanced with that risk is the very real problem that an economically unstable nation can have trouble getting assistance, which in turn increases the economic risk to other investors because the country lacks support.