1. The Political and Legal Environments Facing Business
Chapter 3
The Political and Legal Environments Facing Business
Chapter 3: The Political and Legal Environments Facing Business

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Learning Objectives
Discuss the philosophy and practices of the political environment
Profile trends in contemporary political systems
Describe current trends in political ideologies and their implications to MNE’s choices
Explain political risk management
Compare the relative benefits and drawbacks of proactive versus passive political risk management
Discuss the principles and practices of the legal system
The learning objectives for this chapter are
To discuss the philosophy and practices of the political environment
To profile trends in contemporary political systems
To explain the idea of political risk and approaches to managing it
To discuss the philosophy and practices of the legal system
To describe trends in contemporary legal systems
To explain legal issues facing international companies
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Learning Objectives
Profile trends in contemporary legal systems
Identify and describe key legal issues facing international companies
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Introduction
Every country has its own political and legal environment
Companies must determine where, when, and how to adjust their business practices without undermining the basis for success
Companies doing business internationally must navigate different philosophies, laws, and attitudes concerning political freedom, property rights, and social responsibility. Managers that understand the differences between countries are in a better position to compete.
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5. The Political Environment
Managers evaluate, monitor, and forecast political environments
A country’s political system refers to the structural dimensions and power dynamics of its government that specify institutions, organizations, and interest groups, and define the norms that govern political activities
The goal of a country’s political system is to integrate the diverse elements of a society. A successful political system unites a society in the face of differing viewpoints. So for example, the peace and prosperity that exists in countries like Sweden and Australia illustrate the success of the political systems in those countries, while the instability and insurrection of Libya’s political system shows its failings.
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6. Individualism vs. Collectivism
primacy of the rights and role of the individual
Collectivism
primacy of the rights and role of the community
One standard way to assess a political system is exploring the degree to which it emphasizes individualism versus collectivism.
Individualism champions the rights of the individual over those of society. From a business perspective, this suggests that managers have the right to make economic decisions largely free of rules and regulations. You might be aware that countries that have an individualist orientation shape their marketplace with the idea of laissez-faire and support the idea that government should not interfere in business affairs. Under this perspective, individuals are presumed to be self-regulating in promoting economic prosperity and growth, acting fairly and justly to maximize personal performance without threatening the welfare of society.
In contrast, collectivism encourages the government to intervene to improve the welfare of the group at the expense of the individual. For business, this means that the ownership of assets, the structure of industries, the conduct of companies, and the actions of managers must improve the welfare of society. Therefore, group members accept the responsibility for making decisions that will benefit everyone. Countries taking a collectivist orientation hold that government will intervene in market situations to ensure that business practices benefit society.
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Political Ideology
A political ideology stipulates how society ought to function and outlines the methods by which it will do so
Most modern societies are pluralistic
different groups champion competing political ideologies
Democrats vs. Republicans in the United States
Democratic Party vs. Liberal Party in Japan
Most countries have competing ideologies. In the United States for example, the Democratic Party competes with the Republican Party to not only describe a vision for the future, but also the means of achieving that future. Most societies today are pluralistic – they have different groups championing different ideologies.
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Spectrum Analysis
A political spectrum outlines the various forms of political ideology
Political freedom measures
the degree to which fair and competitive elections occur
the extent to which individual and group freedoms are guaranteed
the legitimacy ascribed to the general rule of law
the freedom expression
A political spectrum outlines the various forms of political ideology including anarchism, conservatism, secularism, environmentalism, liberalism, feminism, nationalism, socialism, and theocracy.
Managers are concerned with the degree of political freedom in a country and its effect on investment choices and operations decisions.
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9. Spectrum Analysis The Political Spectrum
This Figure shows a political spectrum of the various forms of political ideologies. By configuring ideologies along the central axis we can model different political ideologies in relation to each other. The goal of relativity depends on specifying credible ideas to anchor the endpoints of the axis; reasonably set, one can then position alternative ideas.
In practice, purely democratic and totalitarian systems are extreme exceptions. Looking around the world, one finds that there are variations of each political ideology. For example, democratic systems range from radical on one side (advocates of extreme political reform) to reactionary (advocates of a return to past conditions). Likewise, totalitarian systems emphasize different degrees of state control; fascism aims to control people’s minds, souls, and daily existence, whereas authoritarianism confines itself to political control of the state. This Figure shows that the majority of political ideologies fall between democracy and totalitarianism.
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Democracy
In a democracy
all citizens are politically and legally equal
all are equally entitled to freedom of thought, opinion, belief, speech, and association
all equally command sovereign power over public officials
Prominent types of democracy include
Representative
Multiparty
Parliamentary
Social
Understanding the ideals and means of democracy and totalitarianism can help explain the other points on the political spectrum. Democracy calls for participation by citizens in a fair and just decision-making process. Since it supports individualism, companies can make investment and operational decisions based on economic rather than political standards. Under a democracy, commerce and trade is promoted.
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Totalitarianism
A totalitarian system subordinates the individual to the interests of the collective
dissent is eliminated through indoctrination, persecution, surveillance, propaganda, censorship, and violence
Prominent types of totalitarianism include
Authoritarianism
Fascism
Secular
Theocratic
A totalitarian system champions the power of a few over the many. Under a totalitarian system, the government maintains control over many aspects of life, the individual is subordinated to the state, and all opposing political and cultural expression is suppressed. Managers operating in a totalitarian state must make decisions based on political rather than economic standards. Typically, local companies are favored over foreign firms forcing multinational companies to make business deals that would not occur in a democratic environment.
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Political Risk
Political risk refers to the risk that political decisions or events in a country negatively affect the profitability or sustainability of an investment
Types:
Systemic
Procedural
Distributive
Catastrophic
Political risk represents a very real threat for companies today especially in fast-growing, emerging markets where weak legal systems, makeshift institutions, volatile cities, and fragile regimes complicate the business environment. Moreover, the global credit crisis has aggravated political risk across both developed and developing markets.
There are four categories of political risk.
Systemic Risks are risks that impact all firms that operate in the particular political system.
Procedural Risk refers to the risk evolving from the daily movement of people, products, and funds from point to point in the global market. Each move creates a procedural transaction between the units involved, whether units of a company or units of a country. Political actions sometimes create frictions that interfere with these transactions.
Distributive Risk is a result of the profits generated by foreign companies in the local economy. If the host country questions the distributive justice of the rewards of operating in its market, it may wonder whether, as the business grows more successful, it is receiving its “fair” share of the growing profits.
Finally, Catastrophic Risk includes random political developments that adversely affect the operations of every company in a country. Typically, it arises from specific flash points, such as ethnic discord, illegal regime change, civil disorder, or insurrection. It disrupts the business environment in a way that affects every firm in the country. If such disruptions spiral out of control, they devastate companies and nations.
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The Legal Environment
The legal system is the mechanism for creating, interpreting, and enforcing the laws in a specified jurisdiction
Types:
Common law
Civil law
Theocratic law
Customary law
Mixed systems
International managers must be aware of how a country develops, interprets, and enforces its laws. Legal systems vary across counties because of variations in traditions, precedent, usage, custom, and religious precepts.
Modern legal systems are composed of constitutional law which preserves an open and just political order, criminal law which safeguards the social order, and civil and commercial laws which promote fairness.
There are five types of legal systems. A common law system is based on tradition, precedent, custom, usage, and interpretation by the courts. A civil law system relies on a systematic collection of codes and statues that judges must follow. A theocratic system is based on religious precepts. A customary legal system follows the wisdom of daily experience. Finally, a mixed legal system combines elements of the other systems.
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14. Trends in Legal Systems
What is the basis of rule in a country?
The rule of man
legal rights derive from the individual who commands the power to impose them
associated with a totalitarian system
The rule of law
systematic and objective laws applied by public officials who are held accountable for their administration
associated with a democratic system
The retreat of democracy is also changing the legal environment. As countries shift toward totalitarian regimes, the legal system changes to one in which business activity is regulated by the government to support state objectives.
Managers must determine what the basis of rule is in a given country – the rule of man or the rule of law. The rule of man is the basis of a totalitarian system, while the rule of law is the basis of democracy.
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15. Trends in Legal Systems
The Worldwide Practice of the Rule of Law
This Map shows the distribution of the rule of law across the world. Note that the rule of law prevails in wealthier, Westernized countries, but that the rule of man is in place in many emerging economies. In the past, it was common for managers to avoid countries where the rule of man prevailed, but slow growth in countries dominated by the rule of law is forcing managers to reconsider this approach.
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Operational Concerns
Operational issues
Starting a business
Making and enforcing contracts
Hiring and firing local workers
Closing down the business
In general
rich countries regulate less
poor countries regulate more
Managers doing business abroad face a complex political and legal environment that makes decision- making in the multinational company challenging.
Just starting a new business creates several concerns related to registering the new company’s name, choosing the appropriate tax structure, getting licenses and permits, arranging credit, and securing insurance. Some countries facilitate this process, while others do not.
Managers must also be aware of how a country’s political and legal environment affects both entering and enforcing contracts. A contract, which is essential to business transactions, is a binding legal agreement that formally exchanges promises, the breach of which triggers legal proceedings. Countries with common law systems tend to encourage precise, detailed contracts, but countries with civil law systems where the civil code deals with many pertinent issues, encourage shorter and less specific contracts.
Another area that managers must explore is related to hiring and firing local workers. However, laws and practices in this area vary greatly across the world. Singapore, New Zealand, and the United States are among the countries with the most flexible labor-regulation statutes. China has the most flexibility in hiring and firing plus the greatest discretion in setting employment conditions, but, Angola, Belarus, and Paraguay place rigid restrictions on firing.
Finally, how a business is closed down must be explored. Some countries make the process quite difficult. In the United States, for example, the Internal Revenue Service requires completing a series of forms that report, among many others points, changes in the business structure, the sale of assets, payments to subcontractors, and termination of a retirement plan. Other countries like Ireland, Japan, and Canada allow companies to close their doors much more easily.
In general we say that there is an inverse relationship between a nation’s wealth and its tendency to regulate business.
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Strategic Concerns
Country Characteristics
Marketplace Behavior and supply chain
Country of Origin and local content
Product safety and liability
Legal jurisdiction
Intellectual property
In addition to basic operation decisions managers must also consider longer term strategic issues and how the political and legal environment might influence them.
A product’s country of origin – where the product was grown, produced, or manufactured – is important for determining import charges. Many countries require companies to ensure that a certain percentage of a good is made locally. These regulations are called local content rules. Today’s slow economic growth have made “buy-local” campaigns very popular.
Marketplace behavior can make strategic decisions challenging especially where rule of man prevails. Governments determine what is permissible in all forms of business activities, including sourcing, distributing, advertising, and pricing products. So managers are vulnerable to abrupt changes that could require them to adjust their manufacturing configuration, their supply chain coordination, and their marketing strategy.
Product safety and liability is another strategic areas of concern for managers. Local standards may require companies to customize their products. Since these standards often reflect cultural values or social norms, companies must adapt the product to boost its appeal to local consumers.
Countries also have legal jurisdiction to stipulate laws that set the criteria for litigation when agents—whether legal residents of the same or of different countries—are unable to resolve a dispute. Typically, in a cross-national dispute, each company petitions its home-country court to claim jurisdiction hoping that this will ensure more favorable treatment.
Finally, companies must consider intellectual property rights and protection in a given country.
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18. Intellectual Property: Rights and Protection
Intellectual property refers to creative ideas, expertise, or intangible insights that grant its owner a competitive advantage
Intellectual property rights refer to the right to control and derive the benefits from writing, inventions, processes, and identifiers
no “global” patent, trademark or copyright exists
The protection of intellectual property has become a hot topic in today’s global economy. Product piracy has become common, and many countries feel that others are not doing enough to safeguard the rights of those who own intellectual property.
It is difficult for companies to maintain control over their intellectual property because no “global” patent, trademark, or copyright exists. Therefore, managers must be especially vigilant to ensure that product piracy does not occur. Yet, it can be exceedingly difficult to do so. The business of intellectual property theft is huge. Some estimates suggest that international trade in pirated goods is more than $600 billion a year.
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19. Intellectual Property: Rights and Protection
Attitudes towards intellectual property
Historical legacies
rule of man versus rule of law
Economic circumstances
levels of economic development
Cultural orientation
individualism versus collectivism
How do countries decide how and if to protect intellectual property? Well, every country’s policies regarding intellectual property are different and reflect the nation’s legal legacies, economic development, and cultural orientation.
The largest share of pirated products is made in countries where the rule of man is dominant. Protection tends to be much better in countries where the rule of law prevails. A country’s economic level of development also plays a role in the protection of intellectual property. Poorer countries typically impose fewer regulations compared to wealthier countries. Similarly, intellectual property rights protection tends to be better in countries where individualism is emphasized, whereas in collectivist societies, protection is much lower.
Can protection be improved? Perhaps, but it could take awhile. Over time, countries that become idea creators tend to improve their protection of intellectual property. China for example, has long been known for product piracy, but as it has become an idea lab in recent years, it has been making a better effort to protect intellectual property. In general, countries that generate intellectual property are strong advocates of protecting ownership rights.
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