Chapter End Solution Covered Arbitrage

International Business
Part Two
Comparative Environmental
Frameworks
Chapter Three
The Political and Legal
Environments Facing Business
Chapter Objectives
• To discuss the goals and functions of a political system
• To profile trends in the emergence and diffusion of contemporary political
systems
• To explain the idea of political risk and describe approaches to managing it
• To understand how political and legal systems affect the conduct of
business
• To describe trends in the evolution and diffusion of contemporary legal
systems
• To discuss the issue of the rule of law versus the rule of man
• To explain legal issues facing international companies
• To explain the idea of intellectual property and to discuss areas of concern
and controversy
Copyright © 2009 Pearson Education,

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Inc. publishing as Prentice Hall
Definition of a Political System
• The complete set of institutions, political
organizations, and interest groups, the
relationships among institutions, and the
political norms and rules that govern their
functions

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Democracy
• is a government “of the people, by the people,
for the people.”
• Wide participation by citizens in the decision-

making process

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Democracy
• Five types:
– Parliamentary
– Liberal
– Multiparty
– Representative
– Social

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Democracy
– Parliamentary
• Citizens exercise political power by electing
representatives to a legislative branch referred
to as the parliament. The legislature is the
source of legitimacy for the various ministers
that run the executive branch.
• Examples include India and Australia.

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Democracy
– Liberal
– a democratic system of government in
which individual rights and freedoms are
officially recognized and protected, and the
exercise of political power is limited by the
rule of law.

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Democracy
– Liberal
– “Liberal Democracy” generally refers to countries with free
and fair elections, a peaceful transfer of power based on
the elections, control of the military by the elected
government, separation of church and state, constitutional
protections for minorities that are not dependent on the
outcome of elections, and an independent judiciary that
applies the laws equally regardless of political, ethnic or
political affiliation.
– Examples include the US and UE.

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Democracy
– Representative
– The law treats all citizens, both public and private,
equally. Elected representatives hold ultimate
sovereignty but must act in the people’s interest.
Officials represent voters and, while mindful of
voters’ preferences, have the authority to act as
they see fit.
– Examples include the US and Japan.

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Democracy
– Multiparty
• A political system whereby three or more
parties govern, either separately or as part of
a coalition. The leadership of a single party
cannot legislate policy without negotiating
with opposition parties.
• Examples include Canada, Germany, Italy, and
Israel.

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Democracy
– Social
• Applies democratic means to guide the
transition from capitalism to socialism.
• Examples include Norway and Sweden.

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Business Implications
– In a democracy, MNEs invest and operate based
on economic, not political, standards.
– Business environments promote commerce,
expand trade, and streamline exchange, both
within and across countries.
– The signaling devices of market activities, not
bureaucratic regulation, organize a productive
business environment. Managers and consumers
are free to do as they see fit.
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Totalitarianism
• A totalitarian system subordinates the individual to
the interests of the collective.
• A single agent in whatever form, such as an individual, a

committee, an assembly, a junta, or a party, monopolizes
political power and uses it to regulate many, if not all, aspects
of public and private life.
• The agent believes it has noble intentions, protecting people
from the hazards of individual choice. Fair game includes
regulating residents’ occupation, income level, interests,
religion, and even family structure.

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Totalitarianism
• Restricts decision making to a few individuals
• Types:
– Authoritarianism
– Fascism
– Secular totalitarianism
– Theocratic totalitarianism

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Totalitarianism
– Authoritarianism
– Tolerates no deviation from state ideology. Day-to-day life
reflects obedience to state authority; resistance incurs
punishment.
– Officials regulate the political environment but pay less
attention to the economic and social structure of society.
– Often lacks an ideology to politicize public and private life.
Examples include Kazakhstan, North Korea, Chad, and
Turkmenistan.

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Totalitarianism
– Fascism
– Organizes a nation based on corporatist
perspectives, values, and systems.
– Advocates a single-party state that controls,
through force and indoctrination, people’s minds,
souls, and daily existence.
– Fascism calls for the merger of state and corporate
power.

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Totalitarianism
– Secular
– A single-party government controls elections,
tolerates dissent as long as it does not challenge
the state, and suppresses other ideologies.
– It grants limited individual freedoms provided one
does not contest state authority or disrupt social
harmony.
– Examples include China, Vietnam, and Venezuela.

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Totalitarianism
– Theocratic
• Government is an expression of the preferred
deity. Leaders claim to represent its interests
on earth. Applies ancient dogma in place of
modern principles. Strict social regulation and
gender regimentation typically ensue.
• Examples include Iran, Afghanistan, and Saudi
Arabia.

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Trends in Political Systems
• Engines of democracy:
– Failure of totalitarian systems to deliver economic
progress
– Improved communication technology
– Belief that democracy leads to improved
standards of living

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Definition of Political Risk
– The risk that political decisions or events in a
country negatively affect the profitability or
sustainability of an investment arising from a
change in government policy.
– force investors to accept lower rates of return,
cost them some or all of the value of their
investment, or threaten the sustainability of their
operation.

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• Types:
– Systematic
– Procedural
– Distributive
– Catastrophic

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– Systematic
• As a rule, a country’s political processes aim not to punish specific
companies arbitrarily. If they did, few would hazard the investment.
• Increasing tax rates to improve collective welfare.
• such as Venezuela’s program to nationalize energy and media
companies.
• politically motivated polices alter the macro environment, thereby
creating systemic political risks that affect all firms. If democracy
continues faltering, the likely rise in corruption, weakened property
rights,

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– Procedural
• Corrupt officials might pressure a foreign firm
to pay additional monies to clear goods
through customs or obtain a permit to open a
factory.
• For example, Nigeria’s notoriously challenging
business environment is rife with procedural
risks.
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– Distributive
• foreign firms seen as agents of prosperity
- tax discrimination
- unilateral trade barriers
- expropriation of assets

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– Catastrophic
• Catastrophic political risk includes political
developments that adversely affect the
operations of every firm in a country.
• It typically arises from macro flashpoints—
ethnic discord, illegal regime change, civil
disorder, insurrection—that disrupt society

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Legal System & International Business

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Definition of a Legal System
• The mechanism for creating, interpreting, and
enforcing the laws in a specified jurisdiction
• Types:
– Common law
– Civil law
– Theocratic law
– Customary law
– Mixed systems

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• Types:
– Common law
• Common law is developed by judges through the
decisions of courts.
– relies on tradition, judge-made precedent, and
usage. It respects established case law in resolving
disputes.
– prevails in Canada, the United States, India, Hong
Kong, England, New Zealand, and Australia.

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• Types:
– Civil law
– Civil Law is based on strict application of statutory
laws.
– Judicial officers in a civil law system are not bound
by precedent.
– Prevails in Germany, France, Mexico, and Japan.

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• Types:
– Theocratic law
– Theocratic law is based on the inspirations and
instructions of religious teachings.
• Theocratic laws see no separation of church
and state; government, law, and religion are
one.

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• Types:
– Theocratic law
– The most prevalent theocratic system, Muslim or
Islamic law (or Shari’a), based on the Qur’an, the
Sunnah, the writings of Islamic scholars, and the
consensus of legal communities in Muslim
countries.

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• Types:
– Theocratic law
– prevails in the Middle East and northern Africa.
modernists (e.g., Turkey, Indonesia), traditionalists
(e.g., Kuwait, Malaysia), and fundamentalists (e.g.,
Iran, Saudi Arabia) advocate different
interpretations of Shari’a.

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• Types:
– Customary law
– Customary law is based on norms of behavior that
gain legitimacy through long-term practice.
– Few nations operate under a wholly customary
legal system. Instead, this type often plays a role
in countries that have a mixed legal system.

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• Types:
– Mixed systems
– A mixed legal system emerges when a nation
uses two or more of the Preceding types. In a
sense, legal pluralism results when two or more
legal systems apply cumulatively or interactively.

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– Mixed systems
– The Philippines, South Africa, and Guyana, for
instance, follow a blend of civil and common law.
– Nigeria, Malaysia, and Kenya mix common,
theocratic, and customary law.
– Bangladesh, Singapore, and Pakistan blend
common and theocratic law.
– Indonesia, Djibouti, and Oman, conversely, blend
theocratic law with civil codes.

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Legal System and International Business
• All things being equal, every legal system

institutes rules that support business
formation, regulate transactions, and stabilize
relationships.

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Bases of Rules
• Rule of Man
• Rule of Law

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Operational & Strategic Concerns of
Managers

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Operational concerns that face managers
worldwide
• Routine concerns focus managers’ attention

on the day-to-day operations of opening,
running, and closing a business.

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worldwide
• Starting a business
• Entering and enforcing contracts
• Hiring and firing local workers
• Closing down the business

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worldwide
• In theory, business regulations are efficiently
designed, easily accessible, and straightforwardly
administered. Moreover, simple, well-designed work
rules discourage corruption by removing the
incentive to bribe regulators.
• The World Bank, along with the World Economic
Forum, concludes that better business conditions
consistently boost economic growth, job creation,
and trade.

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worldwide
But
Unfortunately
Despite these virtues, big companies and

individuals often experience the opposite.

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worldwide
• A Brazilian entrepreneur recalled his experience in
starting up his first company in his home country,
where obtaining authorizations, licenses, and
permits to start a new business—from seven
different ministries—took about 150 days.
• When he started a U.S.-based business, however,
“within a week I had formed an LLC (limited liability
corporation), incorporated in Delaware, and set up
bank accounts.

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Strategic concerns that face
managers worldwide
• Strategic concerns direct their attention to
long-term issues that shape the
competitiveness, profitability, and
sustainability of the firm.
• A country’s legal environment influences each
aspect, shaping an MNE’s strategic decisions
on making a product, marketing it, and
safeguarding its proprietary features.

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Strategic concerns that face
managers worldwide
• Product origin and local content.
• Marketplace behavior.
• Legal jurisdiction.
• Product safety and liability.
• Intellectual property protection.

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Intellectual property
• Intangible property rights that are a result of

intellectual effort
• Intellectual property rights refer to the right to
control and derive the benefits from writing,
inventions, processes and identifiers
• Local attitudes play a large role in piracy

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The rule of thumb for MNEs
• In countries where the rule of man is the basis

of law, acceptable marketplace behavior is
unpredictable. Managers stay alert to
trumped-up charges, solicitation of bribes,
and favoritism of local rivals.

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The rule of thumb for MNEs
• In countries where the rule of man is the basis

of law, acceptable marketplace behavior is
unpredictable. Managers stay alert to
trumped-up charges, solicitation of bribes,
and favoritism of local rivals.

3-49

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International Business

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• Wide participation by citizens in the decision-

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• Examples include Norway and Sweden.

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• A single agent in whatever form, such as an individual, a

Copyright © 2009 Pearson Education,

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• All things being equal, every legal system

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• Routine concerns focus managers’ attention

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Despite these virtues, big companies and

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• Intangible property rights that are a result of

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• In countries where the rule of man is the basis

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• In countries where the rule of man is the basis

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