OHT 1

SM 3.01 INTERNATIONAL BUSINESS

MANAGEMENT
January 2000
Lecture 2
POLITICAL ECONOMY AND INTERNATIONAL
BUSINESS

• Political systems
• Political environment of international business
• Economic systems
• International legal framework
• Economies in transition
• Implications for business

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What is Political Economy?

• Political economy refers to the political, economic,

and legal systems of a country.
• These systems are not independent of each other.
• They interact and influence each other, thereby
affecting the level of economic well-being in a
country
• The differences in political economy can influence
the benefits, costs, and risks associated with doing
business in different countries.

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1. POLITICAL SYSTEMS

• Political system refers to the system of government

in a country.
• There are 2 dimensions:
- Collectivism or Individualism
- Democracy or Totalitarianism

• Collectivism
- refers to a system that emphasises the importance of
collective goals over individual goals

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- the need of society as a whole are generally viewed

as being more important than individual freedoms

• Individualism
- refers to a philosophy that an individual should have
freedom in his or her economic and political pursuits
- individualism emphasises that the interest of the
individual should take precedence over the interests
of the state
- individualism translates into an advocacy for
democratic political systems and free market
economics

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• Democracy

- refers to a political system in which government is by the

people, exercised either directly or through elected
representatives.
- most modern democratic states practice representative
democracy where citizens periodically elect individuals to
represent them.
- these elected representatives then form a government,
whose function is to make decisions on behalf of the
electorate.

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• Totalitarianism
- is a form of government in which one person or
political party exercises absolute control over all
spheres of human life, and opposing political parties
are prohibited.
- a totalitarian country denies citizens all
constitutional guarantees on which representative
democracies are built.
- for example, individual’s right to freedom of
expression and organisation, a free media, and
regular elections.

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There are four major forms of totalitarianism in the world

today:

• Communist Totalitarianism - Form of totalitarianism

that advocates achieving socialism through
totalitarian dictatorship.
• Theocratic Totalitarianism - Form of totalitarianism
in which political power is monopolised by a party,
group, or individual that governs according to
religious principles.

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• Tribal Totalitarianism - Form of totalitarianism found

mainly in Africa in which a political party that
represents the interests of a particular tribe
monopolises power.
• Right Wing Totalitarianism - Form of totalitarianism
in which individual economic freedom is allowed but
individual political freedom is restricted in the belief
that it could lead to communism.

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2. Political Environment of International

Business

• A crucial aspect of doing business in a foreign country is

that permission to conduct business is controlled by the
government of the host country.
• The host government controls and restricts a foreign
company’s activities by encouraging and offering support
or by discouraging and banning its activities, depending
upon the interests of the host.
• The philosophy of the government towards business in
general and foreign business in particular should also be
taken into account.

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Some issues for consideration in the political environment of

a country are:

• Importance of political stability

• Common political risks, harassment, and nationalism
• Managing political risks
• Positive political - business interaction

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1. Importance of political stability

- Stable governments are more likely to ensure
continuity in government policy as it affects business.
- Stable systems allows international firms to plan
their affairs with some degree of certainty.

- Political instability arises from:

• political risks of doing business in a foreign
country
• political harassment
• excessive nationalism

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2. Common political risks

- A range of political risks exist, for example, one extreme
an international firm may lose all control, ownership of
assets and market access;
- at the other extreme, it may simply face customs delays
or problems in obtaining working visas.
- A international firm can lose ownership of foreign assets
in one of 4 (four) ways:

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• Confiscation
- requires nothing more than a government decision
to take control of a foreign firm’s assets in its country
- no payment is made to compensate the firm for its
loss

• Expropriation
- differs only in that compensation is given for the
firm’s assets
- in most case the payment is not negotiable

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• Nationalisation
- is the process whereby a government decides to
take over ownership of an industry for its own control
- government ownership and management of an
industry may give it more control over the country’s
economic life - usually related economic sovereignty,
national defence or control of strategic industries.

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• Domestication
- represents a variety of pressures that can be placed
on a foreign-owned firm to transfer ownership and /or
control to local citizens
- for example, a foreign investor may be forced to sell
shares of stock to local investors at a predertimned
price
- other examples of domestication policies include
pressure to employ nationals at top decision-making
levels; permits required for importing personnel or
technology

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• Political harassment
- may affect exporters as well as firms that enter foreign
markets through foreign production, joint ventures or
licensing
- a government’s power to license may be used to
harass - for example, a licence may be required to
acquire foreign exchange, hire or fire personnel
- changes in tax policy can also be used to capture
more revenue and penalise business
- another form of harassment for the foreign firm is
social unrest, for example, damage to property from
riots

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• Nationalism
There are 2 forms:
- Patriotism - citizens of every nation typically have
some sense of national identity, which manifests itself
in national feelings, pride and attitudes toward foreign
firms and their products
- Chauvinism - is the excessive form of patriotism

Note: A strategy to avoid this might be to develop as

local an image as possible

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3. Managing Political Risk

There are 2 ways of doing it:
1. Avoidance - that is avoidance of investment or by
the withdrawal of current investment by selling or
abandoning plants and assets

2. Adaptation - accommodating the risk through

adaptation to the political regulatory environment
- The adaptation can take many forms:

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• Equity sharing - includes the initiation of joint
ventures with nationals (individuals or those in firms,
labour unions, or government) to reduce political risk

• .Participative management - requires that the firm

actively involve nationals including those in labour
organisations or government in the management of
the subsidiary

• Localisation of the operation - includes the

modification of the subsidiary’s name, management
style, and so forth, to suit local tastes.
- Localisation seeks to transform the subsidiary from a
foreign firm to a national firm

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• Development assistance - includes the firm’s active

involvement in infrastructure development (local
sourcing of materials and parts, management
training, technology transfer, etc)

4. Positive political-business interaction

- the safest long-term strategy for minimising political
risk is to acknowledge the importance of positive
interaction with host government
- remind personnel that they are “guests” in foreign
country and that continued permission to operate is
contingent on showing the benefits brought to host
countries

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- benefits in the form of resource or product transfer,

employment or income contributions, social or
cultural benefits
- another approach towards establishing a positive
political-business interaction may be political payoff
or bribe

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3. ECONOMIC SYSTEMS

• There is relationship between political ideology

and economic systems
• In countries where individual goals are are more
important than collective goals - likely to find free
market economic system
• In countries where collective goals are given
primacy over individual goals, markets are likely
to be restricted rather than free
• There are 3 broad types of economic systems

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• Market economy

• is an economic system based on the private

ownership of of the productive assets of capital and
land
• economic decisions are decentralised with decision
making authority arising from the individual ownership
of the means of production
• goods and services produced is determined by the
interaction of supply and demand - decisions are
coordinated by the market
• the role of government in a market economy is to
encourage vigorous competition among producers

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• private ownership ensures that entrepreneurs have a

right to the profits that are generated by their own
efforts
• money and material incentives are the main
motivating forces reflecting private ownership of the
means of production and an individualistic value
orientation

• Centrally Planned Economy

• is an economic system based on state ownership of

the productive assets of capital and land

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• production takes place in state owned enterprises

that comprise the “business” sector
• the government directs them to make investments
that are in the best interests of the nation as a whole,
rather than in the interests of private individuals
• decision-making authority is based on monopoly of
political power and state ownership
• the organisational structure of the state owned
“business” sector is authoritarian, hierarchical and
centralist
• control is exercised by layers of ministerial and
regional officials and by general surveillance from the
political party

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• Mixed Economy

• in a mixed economy, certain sectors of the economy are

left to private ownership and free market mechanisms,
while in other sectors there is significant state ownership
and government planning
• in the mixed economy the government intervenes in
those sectors where it believes private ownership is not
in the best interests of society
• for example, Britain, Australia and Sweden have
extensive state-owned health system that provide free
health care to all citizens
• in these countries it is felt that government has a moral
obligation to provide for the health of its citizens

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4. International Legal Framework

• the legal environment for international business

consists principally of the laws and courts of the
individual nation states
• the government of a country defines the legal
framework within which firms do business, and
often the laws that regulate business are a
reflection of the rulers’ dominant political ideology
• differences in legal systems can have an important
impact on the attractiveness of a country as an
investment site and /or market

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• Major World Legal Systems

• the two main legal structures found in the world today

are:
- the common law system
- the civil or code law system

• Common law system

- countries at one time under British influence, or former
colonies of Britain
- law not written to cover all foreseeable situations
- cases decided on basis of tradition, common practice,
and interpretation of statutes

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- precedents important in understanding common law

• Civil or Code law system

- codes of of conduct inclusive of all foreseeable
application of law
- codes developed for commercial, civil, and criminal
applications
- laws themselves important factor in understanding
code law

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• Protection of Intellectual Property

- refers to property such as computer software, a

chemical formula, music score
- ownership rights over intellectual property can be
established through patents, copyrights, and trademarks
- the philosophy behind intellectual property laws is to
reward the originator of a new invention, book, musical
record, clothes design, restaurant chain for his or her idea
and effort
- provides an incentive for people to search for novel
ways of doing things and they reward creativity

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- protection of intellectual property rights differs

greatly from country to country
- an international agreement that exists to protect
intellectual property is the Paris Convention for the
Protection of Industrial Property
- the worst offenders in Asia are China and Thailand
(Hill 1997)

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5. Economies in Transition

Two trends have been evident

1.During the late 1980s and early 1990s, democratic
revolutions swept the world -
- For eg. Totalitarian governments collapsed, to be
replaced by democratically elected governments that
were more committed to free market capitalism.
-The most dramatic change has been observed in the
breakup of the Soviet Union

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2. There has been a strong move away from centrally

planned and mixed economies and toward a free
market economic model

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- In Vietnam the ruling Communist Party removed

many price controls and began to shift toward a
market economy.

- India, a democratic country but with strong

government involvement in economic activity and a
mixed economy is now moving in the direction of the
free market model.

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- In 1979 the Communist government of China

started to shift the Chinese economy from a pure
planned economy to a mixed economy.

- By 1995, China had created a number of special

economic zones in which free markets were
allowed to operate without any restrictions;
private ownership was allowed; and foreign
companies were permitted to invest.

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6. Implication for Business

• The political economy of a country clearly

influences the attractiveness of that country as a
market and /or investment site.

• The overall attractiveness of the country as a

market and /or investment site depends on the
benefits, costs, and risks associated with doing
business in that country.

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Benefits
- By identifying and investing early in a potential future
economic star, international firms may be able to build
brand loyalty and experience of business practices in
that country.

- Early entrants into potential future economic stars may

be able to reap substantial first mover advantages,
while late entrants may fall victim to late mover
disadvantages.

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• First-Mover Advantages - Advantages that accrue

to early entrants into a business market.
• Late-Mover Disadvantages - Handicap suffered by
late entrants into a business market.

- A country’s political economy system, together with

its market size (in terms of population) constitute
reasonably good indicators of the potential long-term
benefits of doing business in a country

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Costs

- The costs of doing business in a country can be

increased by a need to pay off the politically powerful
to be allowed by the government to do business in
that country.
- It may be more costly to do business in relatively
undeveloped or underdeveloped economies because
of lack of infrastructure and supporting businesses.
- It can be more costly to do business in a country
where local laws and regulations fail to adequately
protect intellectual property.

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- This can lead to the “theft” of an international

business’s intellectual property - this means in terms
of loss income.

Risks
- Political risk is the likelihood that political forces
will cause drastic changes in a country’s business
environment that adversely affect the profit and other
goals of a particular business enterprise.

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- Economic risk arise from economic mismanagement

by the government of a country.
- Economic mismanagement may give rise to
significant social unrest and hence political risk.

- Legal risk arise when a country’s legal system fails to

to provide adequate safeguards in the case of contract
violations or to provide for the protection of property
rights.

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End of Lecture 2

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