The Political and Legal Environments Facing Business

Chapter 3
Chapter Objectives
■To discuss the philosophies and practices of a political system
■To profile trends in contemporary political systems
■To explain the idea of political risk and describe approaches to managing it
■To discuss philosophies and practices of the legal system
■To describe trends in contemporary legal systems
■To explain legal issues facing international companies
Political Economy
The political economy of a nation refers to how the political, economic, and legal systems
of a country are interdependent
– they interact and influence each other
– they affect the level of economic well-being in the nation
Introduction

■ Political and legal risks faced in foreign markets are considerable. These risk
often govern the market entry decisions.

■ The national political environment is shaped by variables such as political

ideology, the economic system and the strength of nationalism. It is in the
interests of international firms to monitor continually their activities in a market in
relation to these variables because they contain the underlying forces that influence
the degree of political risk.

■ Government influence local, regional and state government bodies as well as

the national government
Political and Legal Factors Influencing International
Business Operations
Business implications of the political environment
– Carefully examine the political climate
– Study the history of the government’s
intervention in foreign business activities

Analyze the foreign government for its:

• Stability
• Competence in economic management
• Frequency of changes in policy toward foreign
investment
• Nature of the relationship between the
government and the people
Definition of a Political System
■ Political system refers to the system of government in a
nation
■ The complete set of institutions , political organizations,
and interest groups, the relationships among institutions,
and the political norms and rules that govern their
functions.
■ It also influences the extent to which government
intervenes in business and the way in which business is
conducted both domestically and internationally.

■ Firms must obviously study the political environment. They need to

know how official exercise authority? How are officials elected,
monitored and replaced? Do people respect the rule of law (if not
how they go about challenging authority?)
 Political System

■ Political system refers to the system of government in a nation

■ Assessed according to
– the degree to which the country emphasizes collectivism as opposed to individualism
– the degree to which the country is democratic or totalitarian
 Individualism vs. Collectivism
■ It is useful to profile the similarities and differences among political systems according to the
general orientation within a society concerning the primacy of the rights and role of the individual
versus that of the larger community.
■ Individualism: Under an individualistic paradigm (e.g., the United States, Australia), political
officials and agencies play a limited role in social transactions.
■ Collectivism: Under a collectivist paradigm, the government defines economic needs and priorities,
and it partners with business in major ways (Bangladesh, South Korea, Vietnam, Singapore, Malaysia
have instituted collectivist principles)

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3-10
The Political Spectrum

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 Democracy
■ A democracy represents a political Democracy is a govt. “of the people, by
system in which citizens participate in the people and for the people” (Abraham
Lincoln)
the decision-making and governance
process, either directly or through
elected representatives
■ Five types:
– Parliamentary (Bangladesh/India/Australia)
– Liberal (Japan/NZ)
– Multiparty (Canada, Germany, Italy)
– Representative (USA)
– Social (Norway/Sweden)

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Types Of Democracy

Parliamentary: The citizens exercise political power by electing

representatives to a legislative branch of government called a parliament.
The executive branch typically consists of a cabinet headed by prime
minister regarded as head of government and there is no formal separation
of powers between executive and legislative branches. Bangladesh, India
and Australia are some of examples.

Liberal: In liberal democracy, a special constitution is originated to protect

certain individual freedoms, such as freedom of speech, assembly, and
religion and certain individual liberties, such as right to protect private
property and privacy. All citizens both public and private, are treated equally
before the law and receive due process under it. Japan and New Zealand
are representatives of liberal democracy.

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Types Of Democracy

Multiparty: Multiparty democracy consists of three or more political parties that has the
capacity to gain control over government either separately or in coalition. The multiparty
system prevents the leadership of a single party from setting policy without checks and
balance imposed by opposition parties. Canada, Germany, Israel, Italy all are examples of
this democracy

Representative: In a representative democracy people elects representatives who holds

ultimate sovereignty. Representatives are charged with the responsibility of acting in the
people’s interest, at the same time enjoying sufficient authority to deal directly as they see fit
with changing circumstances but not enough to act according to their own preferences. United
Stated of America is an example of this democracy.

Social: Social democracy is intended to achieve a gradual transition from capitalism to

socialism through democratic means. The belief that society must reform capitalism to remove
its intrinsic injustice is the motivation behind Social democracy or interchangeably known as
democratic socialism. Norway and Sweden are prime example of this democracy
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Fundamental Elements of Democratic Political Systems

3-15
 Totalitarianism
■ Totalitarianism represents a political system in which citizens seldom, if ever, participate in the decision-
making and governance process; power is monopolized by a single agent and opposition is neither
recognized nor tolerated.
■ Restricts decision making to a few individuals. A single agent—whether individual, group or party –
monopolizes political power and tries to mobilize the population towards two ends :

--Unquestioning support for the official state ideology

--Opposition to activities that run counter to the goals of the state
Types of Totalitarianism
 Authoritarianism (N. Korea, Kim regime,
unquestioning obedience by the citizens)
 Fascism (Italy under Mussolini; all embracing;
outside of it no human or spiritual value may exist, much
less have any value; the fascist ideal is control of
people’s minds and souls as well as their daily lives)
 Secular totalitarianism (leaders maintain
power by wielding the authority of the state (E.g.
Communist party in China, similar in Vietnam and
Singapore)
 Theocratic totalitarianism (religious
leaders are also the political leaders such as Taliban in
Afghanistan)
Political Risk
The risk that political decisions or events in a country negatively affect the
profitability or sustainability of an investment.
Some examples of political risk include:
■ War
■ Social unrest
■ Politically motivated violence
■ Lack of Transparency
■ Corruption, nepotism
■ Crime
 Political Stability and Risk
■ Political stability refers to gradual and non-violent change. From a business perspective,
the change should be such that it has a minimum adverse effect on business activities in
the country.
■ Indicators of political instability:

– Degree of social unrest (economic hardship, racial, religious and ideological differences)

– Frequency of changes in the regime (Pakistan)

– Extent to which the country is divided culturally (India, Yugoslavia)

– Religious division (India)

– Linguistic diversity (Tamil & Sinhalese in Sri Lanka)

Political Intervention occurs when government action forces the firm to change its strategies, polices or
operations; Usually this involves government intervening in the operation of the firm to pursue their own
interests.

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Managing the overseas political environment

■Localization of operations: the greater the local ownership of an operation the

less likely it is to be subjected to political risk

When a foreign country demands that a firm reduce its ownership, it has been
suggested that the firm:
■Leaves the country altogether
■Totally indigenizes the company
■Negotiates an arrangement under
the new laws
■Globalization
–Location
–Transfer pricing
–Standardization of marketing
mix factors
McDonald's Global Approach
McDonald's is the largest restaurant company in the world. There are over 37,000 McDonald's locations
in about 120 countries around the world. 
Legal System Video

■ https://www.youtube.com/watch?v=AvD0X9KdDyQ
Definition of a Legal System

Legal System: A legal system is the means and methods a country uses to regulate business
practices, define how companies conduct business transactions, specify the rights and
obligations of those engaged in business transactions, and spell out the methods of legal
redress for those who believe they have been wronged.
 Types of Legal Systems
■ Common law: Common law is based upon tradition, judge-made precedent, custom, and usage; therefore, courts
play an important role in interpreting the law. Common-law nations include Australia, Canada, New Zealand(CIA
facts: about 80 countries follow)
■ Civil law: Civil law is based upon a detailed set of laws that comprise a code that includes rules for conducting
business; therefore, courts play an important role in applying the law. Civil law nations include France, Germany, and
Japan. (more than 100 countries follow civil law system)
■ Theocratic law: Theocratic law is based upon religious precepts; ultimate legal authority is conferred upon
religious leaders who govern society. Example: Iran, Saudi Arabia. The best example is Islamic law, or Shari’a, which
is based on the Quran, the Sunnah, the writings of Islamic scholars, and the consensus of Muslim countries’ legal
communities.
■ Mixed System. A mixed legal system emerges when two or more legal systems are used within a single country.
Although the majority of such countries are found in Africa and Asia, the United States’ legal system combines both
common and civil law.
The Legal Environment
■ International trade usually involves two or more countries and more legal systems
■ Hence the legal complexities are greater for international trade than they are for domestic trade
Differing legal systems and jurisdictions
■ Common law
– Based on traditions, past practices, legal precedents, interpretations via court decision (Australia, USA,
Canada and UK)
■ Code law (France, Germany, Scandinavian countries)
– Is derived from Roman law and operates in most countries where common law is not used
– The legal system is generally divided into three separate codes - civil, commercial, & criminal
– All inclusive system of written rules/codes; courts adopt precedence to fit the case
Differing legal systems and jurisdictions

■ Islamic law
– Is based on the Koran/Qur’an
and is applied to varying degrees by Islamic countries
– It defines a complete system of social and economic behavior, with the
overriding objective of social justice
■ Other legal codes
– Included in this group are tribal or indigenous laws e.g., Aboriginal or
Maori law
Differences between Civil and Common Law

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Freedom Index 2022

https://worldpopulationreview.com/country-rankings/freedom-index-by-country
Human Freedom Score, Personal Freedom Score, Economic Freedom Score
Economic Freedom Index 2022
https://www.heritage.org/index/ranking
1.Rule of Law (property rights, government integrity, judicial effectiveness)
2. Government Size (government spending, tax burden, fiscal health)
3. Regulatory Efficiency (business freedom, labour freedom, monetary freedom)
4. Open Markets (trade freedom, investment freedom, financial freedom)