GLOBAL4 Peng Ch02

Chapter 2
Understanding Politics, Laws, and

economics
2
Understanding
Politics, Laws,
and Economics
Copyright ©2018 Cengage Learning. All Rights Reserved. May not be

scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Learning Outcomes
LEARNING OUTCOMES
1. Identify two types of institutions

2. Explain how institutions reduce uncertainty
3. Identify the two core propositions underpinning an
institution-based view of global business
4. List the differences between democracy and
totalitarianism
Copyright ©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part. GLOBAL4 | CH2 2
Learning
LEARNINGOutcomes (Continued)
OUTCOMES (continued)
5. List the differences among civil law, common law,

and theocratic law
6. Articulate the importance of property rights and
intellectual property rights
7. List the differences among market economy,
command economy, and mixed economy
8. Explain why it is important to understand the
different institutions when doing business abroad
LO 1
Institutions: Rules of the Game
• Not static
• Institutional transaction: Fundamental and
comprehensive changes introduced to the formal
and informal rules of the game
➖Affects firms as players
LO 1
Institutions: Rules of the Game (continued)
• Success and failure of firms are determined

by how firms play the game
• Depends on how the rules are made, enforced,
and changed
• Institution-based view
• For survival, firms must monitor, decode, and
adapt to the changing rules of the game
LO 1
Exhibit 2.1 - Dimensions of Institutions
LO 1
Supportive Pillars
Regulatory pillar
• Coercive power of governments exercised through laws, regulations,
and rules
Normative pillar
• Mechanisms through which norms influence individual and
firm behavior
Cognitive pillar
• Internalized values and beliefs that guide individual and firm
behavior
LO 2
Role of Institutions in Reducing Uncertainty
• Institutions influence decision-making

process of individuals and firms by
constraining the range of acceptable actions
• Economic uncertainty leads to transaction
costs
• Opportunism is an important source of
transaction costs
➖Opportunism: Act of seeking self-interest
with guile
LO 2
Role of Institutions in Reducing Uncertainty

(continued)
• Unstable and unreliable institutional

frameworks:
• Increase transaction costs
• Decrease transactions
• Transition economies
• Emerging economies in which institutional
transitions are pervasive
LO 3
Exhibit 2.2 - Institutions, Firms, and Firm Behaviors
LO 3
Exhibit 2.3 - Two Core Propositions of the Institution-

Based View
LO 4
Political Systems
• Rules of the game on how a country is

governed politically
• Types
• Democracy
• Totalitarianism
LO 4
Democracy
• Political system in which citizens elect

representatives to govern the country on
their behalf
• Allows an individual the right to freedom of
expression and organization
LO 4
Totalitarianism
• Political system in which one person or

party exercises absolute political control
over the population
• Not suitable for business
• Suffers from high political risk
• Political risk: Risk associated with political
changes that may negatively impact domestic
and foreign firms
• Extreme political risk may lead to
nationalization (expropriation) of foreign assets
LO 4
Types of Totalitarianism
Communist Right-wing
totalitarianism totalitarianism
Theocratic Tribal
totalitarianism totalitarianism
LO 5
Legal Systems
• Rules of the game on how a country’s laws

are enacted and enforced
• Reduce transaction costs by:
• Minimizing uncertainty
• Combating opportunism
LO 5
Legal Systems (continued)
• Laws are transplanted from the following

legal traditions
• Civil law: Uses comprehensive statutes and
codes to form legal judgments
• Common law: Shaped by precedents from
previous judicial decisions
• Flexible - Resolves disputes based on judges’
interpretation of the law
• Theocratic law: Based on religious
teachings
LO 6
Property Rights
• Legal rights to use an economic property

(resource) and to derive income and benefits
from it
• Property document is required to prosecute
violators through legal means
LO 6
Property Rights (continued)
• Facilitate economic growth

• Insecure property rights in developing
countries:
• Reduce the average firm size
• Result in the use of technologies that employ less
fixed capital
• Do not entail long-term investment
LO 6
Intellectual Property (IP)
• Intangible property that results from

intellectual activity
• Intellectual property right (IPR): Legal
right associated with the ownership of
intellectual property
• Consists of:
➖Patents
➖Copyrights
➖Trademarks
LO 6
Intellectual Property (IP) (continued)
• Intangible nature of IPR makes enforcement

difficult
• Piracy: Unauthorized use of intellectual
property rights
• Example - Unauthorized sharing of music files
and deliberate counterfeiting of branded
products
LO 7
Economic Systems
• Rules of the game on how a country is

governed economically
• Market economy: Characterized by the
invisible hand of market forces
• Functions that cannot be performed by the
private sector is performed by the government
LO 7
Economic Systems (continued)
• Command economy: All factors of

production are state-owned and state-
controlled
• All supply, demand, and pricing are planned by
the government
• Mixed economy: Includes elements of both
market economy and command economy
LO 7
What Drives Economic Development?
Culture Geography
Institutions
LO 7
Importance of the Role of Institutions in

International Business
• Formal, market-supporting institutions

• Encourage individuals to specialize and firms to
grow in size
• Protect property rights and fuel innovation,
entrepreneurship, and economic growth
• Lack of strong institutions
• Forces individuals to trade on an informal basis
with a small neighboring group
LO 8
Exhibit 2.4 - Implications for Action
Key Terms
KEY TERMS
• Institutional • Totalitarianism
transition (dictatorship)
• Regulatory pillar • Political risk
• Normative pillar • Legal system
• Cognitive pillar • Civil law
• Transaction cost • Common law
• Opportunism • Theocratic law
• Political system • Property right
• Intellectual property
• Democracy
(IP)
website, in ©2018
Copyright wholeCengage
or in part.
Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. GLOBAL4
GLOBAL4||CH2
CH2 27
Key Terms (Continued)
KEY TERMS (continued)
• Intellectual property • Market economy

right (IPR) • Command
• Patent economy
• Copyright • Mixed economy
• Trademark
• Piracy
• Economic system
website, in ©2018
or in part.
GLOBAL4||CH2
CH2 28
Summary
SUMMARY
(Continued)
• Types of institutions - Formal and informal
• Institution-based view of global business
• Considers firm behavior as the outcome of the
dynamic interaction between institutions and
firms
• Democracy and totalitarianism are primary
political systems
• Legal traditions include civil law, common
law, and theocratic law
website, in ©2018
or in part.
GLOBAL4||CH2
CH2 29
Summary
SUMMARY
(Continued 1)
• Property rights are the legal right to use an
economic property and derive income and
benefits from it
• Intellectual property rights include patents,
copyrights, and trademarks
• Economic systems consist of market,
command, and mixed economies
• Before entering a new country, managers
must be aware of the formal institutions
that affect their business
website, in ©2018
or in part.
GLOBAL4||CH2
CH2 30

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Chapter 2

Understanding Politics, Laws, and

Copyright ©2018 Cengage Learning. All Rights Reserved. May not be

1. Identify two types of institutions

5. List the differences among civil law, common law,

Institutions: Rules of the Game

Institutions: Rules of the Game (continued)

• Success and failure of firms are determined

Exhibit 2.1 - Dimensions of Institutions

Role of Institutions in Reducing Uncertainty

• Institutions influence decision-making

Role of Institutions in Reducing Uncertainty

• Unstable and unreliable institutional

Exhibit 2.2 - Institutions, Firms, and Firm Behaviors

Exhibit 2.3 - Two Core Propositions of the Institution-

• Rules of the game on how a country is

• Political system in which citizens elect

• Political system in which one person or

• Rules of the game on how a country’s laws

Legal Systems (continued)

• Laws are transplanted from the following

• Legal rights to use an economic property

Property Rights (continued)

• Facilitate economic growth

Intellectual Property (IP)

• Intangible property that results from

Intellectual Property (IP) (continued)

• Intangible nature of IPR makes enforcement

• Rules of the game on how a country is

Economic Systems (continued)

• Command economy: All factors of

What Drives Economic Development?

Importance of the Role of Institutions in

• Formal, market-supporting institutions

Exhibit 2.4 - Implications for Action

• Intellectual property • Market economy

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