IBUS2101 I t International Business ti lB i Strategy Week5: Political, Legal & Economic Environments Semester 1, 2011 S t 1

Agenda
Part I: Political & legal environments Part II: Economic environment Part II: A tale of two countries in Asia

Part I: Political and legal environments What is a political system?

- A political system is the system of government in a nation. i - It comprises the relationships and institutions by which governments generate policies in response to the demands or support of the general public. - Government refers to the formal institutions and processes that are responsible for making and enforcing the collective decisions for society. society Political systems can be assessed according to: - the degree to which they emphasise collectivism as opposed to individualism - the degree to which they are democratic or totalitarian.
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Political systems
o Collectivism
Stresses the primacy of collective goals over individual goals; In modern times, this collectivist mantle has been picked up by socialists. , p p y Socialism is a political system that believes in state ownership of a countrys means of production, distribution and exchange so that all can benefit. Holds that an individual should be free to determine his or her economic and political pursuits. Focuses on guaranteeing individual freedom and self-expression and self expression letting people pursue their own self-interest in order to achieve the best overall good for society. Translates into an advocacy for democratic political systems and free market economics. Since the late 1980s, democratic ideals and free market economics have swept away socialism and communism in many states.
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o Individualism
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Political systems
o Democracy - Refers to a political system in which government is by the people, exercised either directly or through elected representatives. - The most common form of democracy today is representative democracy, where elected representatives vote on behalf of constitutes. o 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. - Four major forms of totalitarianism: - Communist totalitarianism - Theocratic totalitarianism - Tribal totalitarianism - Right-wing totalitarianism
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Implications on FDI
Shifting ideology and FDI
The radical view - traces its roots to Marxist political and economic theory; - The MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalistimperialist home countries. The free market view - traces its roots to the international trade theories of Smith and Ricardo; FDI by MNEs increases the overall efficiency of the world economy Pragmatic nationalism - FDI has both benefits and costs; Recognising this, countries adopting a pragmatic stance engage in policies that actively pursue FDI in a belief that FDI serves the national interest, as benefits outweigh the costs.
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Legal systems
What is a legal system?
- Refers to the rules, or laws, that regulate behaviour, along with g g the processes by which the laws of a country are enforced and through which redress for grievances is obtained.

Different legal systems

- Common law: based on tradition, precedent and custom, a common law system is found in most of Great Britains former colonies, including the US. - Civil law: based on a very detailed set of laws organised into codes. Over 80 countries, including Germany, France, Japan and Russia, operate with a civil law system. - Theocratic law: Islamic law is the most widely practiced theocratic law system (based on religious teachings) in the modern world.
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Legal systems
Various laws related with IB:
Contract law: is the body of law that g y governs contract enforcement. Product Origin laws: frequently determine duties and tariffs to be paid. Product Liability laws: determine liability and allowable damages for product safety, also vary widely. Competition laws: like antitrust regulations and insider trading laws, vary widely f id l from country t country. t to t Marketing and Distribution laws: determine allowable practices, vary widely across countries.
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Legal systems
Property rights (and corruption):
- legal rights to use an economic property (resource) and to derive income and benefits from it - important for the functioning of business, but can be violated by either private action or public action.

Intellectual property (IP) right and protection:

- Intellectual property (IP) refers to property, such as computer software, a screenplay or the chemical formula for a new drug that is the product of intellectual activity. - P t t th Patent: through exclusive use rights, it protects th i h l i i ht t t the inventor t of a product for a certain period of time - Copyright: Gives exclusive rights to authors, composers, playwrights and artists to publish and dispense their work. - Trademark: Officially registered designs and names that protect owners product designations.
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Legal systems
Protection of IP rights
- differs greatly from country to country. - While many countries have stringent y g intellectual property regulations on their books, the enforcement of these regulations has often been lax.

<Play> Losses due to counterfeiting:

1) 2) 3) 4)

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Managerial implications
The political and legal environments of a country clearly influence the attractiveness of that country as a market and/or investment site.
ocreates uncertainty ocontributes to costs & risks of doing business oinfluences skills/capabilities required to compete

Sources of political risk

- Macro-political risks: arise from the political forces in the broader or macro-political environment and affect all businesses in the country. country - Micro-political risks arise from political forces that are specific to a firm or industry. - Legal risk arises when the legal system fails to provide adequate safeguards for the conduct of business, e.g. the lack of enforcement of contracts or protection of IP rights.
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Managerial implications
3 types of political risk to which IB is likely to be exposed:
- Ownership risk

- O Operational risk ti l i k - Transfer risk

Political risk can be managed

- first assessing the extent of the exposure (quantify the degree of p political risk by identifying and rating p y y g g political events that are likely to y impact business operations and decisions). - taking measures to reduce the extent of risk: requires knowledge and application of that knowledge

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Accessing political risk

Two types of measures: Political risk
oa subjective rating of the political environment that can help assess where and when a firm might encounter difficulties in managing the political environment. oNumerous agencies produce political risk rankings Euromoney World Economic Forum Institute for International Management Development oRankings R ki Based on surveys of knowledgeable individuals in a region Countries with high political risk (Afghanistan, Rwanda, North Korea, etc) Countries with low political risk (Norway, Switzerland, UK, USA, etc)
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Accessing political risk

oConcept is fine But it is perceptual Heavily influenced by the past

Political hazards
oBetter way to measure uncertainty in the political environment? oReturn to definition of uncertainty in political environment Stability of policies and regulations Uncertainty in policies and regulations oBased on S bili of preferences of actors Stability f f f Ability of actors to enact policy change when preferences change oPolitical hazards (feasibility of policy change) emerges when: No, or few, political constraints oWhat defines extent of political constraints?
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Political hazards: Levels in a political system Executive Upper Legislature Independent I d d t Judiciary Lower Legislature Sub-national Sub S b- ti l Actor Key Features
Independence
Each level effectively independent?

Number
Number of effectively independent levels. The higher the number, the greater the political constraints, and the lower the political hazards.

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Political hazards: Preferences in a political system

Key Feature Liberal Nationalistic

Aligned Actor preferences similar or not. The less the similarity, the greater the political constraints, and the lower the political hazards.

Conservative

Socialist

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High Political Hazards

Key Features
One Level No constraints.

Executive

No opposition Change policy as actors preferences change. G t chance of policy Greater h f li instability. Uncertain environment for foreign investors

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High Political Hazards

Key Features Executive
Multiple Levels Potential for constraints. No effective opposition Preferences aligned. Executives preferences match others. Uncertain environment for foreign investors

Upper Legislature Independent Judiciary

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Moderate Political Hazards

Key Features Executive
Multiple Levels Potential for constraints. Effective opposition Preferences not aligned. More difficult to enact policy change change. Less uncertain environment for foreign investors

Upper Legislature Independent Judiciary

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Low Political Hazards

Executive Upper Legislature Lower Legislature Key Features
Multiple Levels Potential for constraints. Substantial opposition Preferences not aligned. Certain environment for foreign investors Has a status quo bias.

Independent Judiciary J di i SubSub-national Actor

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Effective risk management strategy

Reduce contract risk
- Sign treaties that encourage and protect mutual investment; Create settings where investment can be seized when threatened

Slow input & speed output

- Minimize outright investment; Create staggered technology transfer policies; Accelerate profit repatriation

Seek third partys safeguard

Utilize insurance agencies that specialize in political risk; Build political support at home and in the host through political action, lobbying, or other proactive measure

Embed with local economy ?

- Utilize host country financing; Create local sourcing arrangements; Create alliances with powerful local partners

Remember that business is international, but all politics are local. Try to 21 manage political relationships at the local levels.

Part II: Economic environment

Economic endowments:
o A firms preliminary assessment of the p p y potential of a country as y either a location for production or a market for a firms product would consider the economic variables of its: Size Geography: natural and created resource People Infrastructure Competitiveness.

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Three Economic Systems

the set of structures and processes that guides the allocation of scarce resources and shapes the conduct of business activities in a nation b i ti iti i ti
Spectrum of Economic Systems

Centrally-planned
N. Korea Cuba China Russia Vietnam

Free-market
Brazil Japan India Germany S. Korea France USA Canada UK

Types: Market economy Command economy (centrally-planned economy) Mixed economy

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Economic Transition
The shift from a command or mixed economy to a freer market economy involves least three distinct activities: deregulation, privatisation and i tit ti d d l ti i ti ti d institution development. l t
- Deregulation: removes restrictions on the free operation of product and factor markets. - Privatisation: transfers the ownership of state property into the hands of private investors. Privatisation is seen as a way of increasing the economic efficiency of the organisation. - Institution development: requires the development of supporting institutions such as a reliable legal system and a viable financial system that underpin a market-based economy.

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Managerial implications
The economic environment of a country clearly influences the attractiveness of that country as a market and/or investment site.
o The overall attractiveness of a country depends on balancing the likely long-term benefits of doing business in that country against the likely costs and risks.

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Managerial implications
Three factors that are reasonably good predictors of a countrys future economic prospects:
- economic system system, - property rights regime, and - the quality of its deep institutions.

Benefits
- Resource endowments, both created and natural. - A stable and buoyant economy. - The size of the market, the present wealth of consumers, and the likely future wealth of consumers. - The phase of the business cycle. - A potential future economic star, and gain first-mover advantages and establish loyalty and experience in a country.
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Managerial implications
Costs (of living and doing businesses)
Macroeconomic instability Inflation t I fl ti rate Tax burden Redistribution of income

Risks
Economic risk is the likelihood that economic mismanagement and economic instability will cause drastic changes in a countrys business environment that adversely affects the profit and other goals of a business enterprise. Two very visible indicators of economic mismanagement: inflation rate and the related policy actions of governments, and the level of business and government debt in the country.
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Part III: A tale of two countries in Asia

Geography

Source: http://www.map168.com/

Play
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Legal systems

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Political Risk Scores

Political Risk Country Bangladesh Brunei Cambodia China Hong Kong India Indonesia Japan Korea North Korea South 1992 5.3 17.7 1.3 13.3 16.2 6.4 12.6 12 6 20.0 3.2 16.6 2002 9.1 17.9 4.3 16.9 19.9 14.8 6.9 69 21.5 0.0 18.3
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Political Risk Country Malaysia Mongolia New Zealand Pakistan Philippines Singapore Taiwan Thailand Vietnam 1992 15.3 4.8 17.3 8.2 8.0 18.0 17.3 17 3 13.6 5.5 2002 16.72 5.74 22.35 8.46 12.60 23.25 21.14 21 14 14.73 11.12

Sources: Euromoney, Nowhere to Lend to, Euromoney, September 1992, pp. 65-71; Euromoney, Country Risk, Euromoney, September 2003, pp. 287-292.

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Political Hazards Scores

Political Hazard Country Bangladesh g Brunei Cambodia China Hong Kong India Indonesia Japan Korea North Korea South 1992 0.56 1.00 1.00 1.00 1.00 0.41 1.00 0.46 1.00 0.52 2002 0.61 1.00 1.00 1.00 -0.59 0.50 0.42 1.00 0.76 Country Malaysia y Mongolia New Zealand Pakistan Philippines Singapore Taiwan Thailand Vietnam Political Hazard 1992 0.70 0.80 0.75 0.54 0.83 0.94 0.78 1.00 1.00 2002 0.46 0.93 0.52 1.00 0.46 0.97 0.68 0.49 1.00

Source: Witold J. Henisz, POLCON Database ( http://www-management.wharton.upenn.edu/henisz/), 31 April 02, 2003.

China Surpassed Japan in 2010

Source: IMF
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GDP composition

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Widening gap between Rich and Poor

Source: Chinatells.com
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Population: Labour supply to Shrink?

Source: United Nation

Pag e 35

China: Manufacturing
macro-environment culture government law and regulation politics economy

Factor (input) conditions infrastructure finance human resources

Conditions for China to develop manufacturing?

Demand conditions institutional buyers individual buyers export buyers

Related and supporting Cluster suppliers distribution channels transport and communications

Competitive context law and regulation entry barriers exit barriers

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India: Manufacturing

Indias labor regulations - among the most restrictive and complex in the world - have constrained the growth of the formal manufacturing sector, where these laws have their widest application. World Bank, 2009
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India: Manufacturing
macro-environment restrictive law and regulations politics p Factor (input) What conditions were conditions Demand conditions wrong for India to poor energy infrastructure * no obstacle develop powerful unions

manufacturing?

Related and supporting cluster poor transport and comms

Competitive context highly protected from imports

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India: Outsourcing
macro-environment new industry little government regulation new i d industry not unionized

Factor conditions skilled engineers English speaking university graduates low salaries not tied to old cities not land intensive

What conditions were right for India to develop outsourcing?

Demand conditions sophisticated U.S. clients Indians overseas

Related and supporting cluster good intl communications could self-provide electricity

Competitive context positive externalities service providers validating each other

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You should now understand

Key features of political, legal, and economic systems Managerial implications of understanding these country differences on IB Key differences between Chinas and Indias environments

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