Principle
Learning Objectives
- Country risk, what types of risks are
caused by different political and legal systems.
- Differences in legal
systems and their impact on international business.
- Differences in political
systems (and economic systems) and their impact on
international business.
- Notion of political economy.
- How country risk can be
managed.
What is
Country Risk?
Exposure to
potential loss or adverse effects on company operations and profitability
caused by developments [or cross-country differences] in political and/or legal
environments.
• Also known as ‘political risk’
• Each country has unique political
and legal systems that often pose challenges for company
performance
and legal systems that often pose challenges for company
performance
• Example
Coca-Cola’s business fell off in Germany when the government enacted a recycling plan. New laws required consumers to return nonreusable soft drink containers to stores for a refund of 0.25 euros. Rather than cope with the unwanted returns, big supermarket chains pulled Coke from their shelves.
Coca-Cola’s business fell off in Germany when the government enacted a recycling plan. New laws required consumers to return nonreusable soft drink containers to stores for a refund of 0.25 euros. Rather than cope with the unwanted returns, big supermarket chains pulled Coke from their shelves.
Problems in IP Protection
• Regime Deficiencies:
– large number of countries are not
signatories of international conventions
– the conventions have number of
loopholes for types of intellectual property
• Enforcement Inadequacies:
– no international enforcing authority
– individual countries not very
enthusiastic in implementing laws
• Philosophical Differences between
countries
Differing views on Intellectual Property Protection (IPP)
The Rule of Law
Existence
of a legal system where rules are clear, publicly disclosed, fairly enforced,
and widely respected by individuals, organizations, and the government.
• Common in the advanced economies.
• The legal system is: (i) applied to
all citizens equally; (ii) issued via recognized government authorities; and
(iii) enforced fairly and systematically by police forces and formally
organized judicial bodies.
• Economic activity suffers and
uncertainty increases when the rule of law is weak.
Legal Systems
• Legal system: A system for interpreting and
enforcing laws. The laws, regulations, and rules establish norms for conduct.
It incorporates institutions and procedures for ensuring order and resolving
disputes in commercial activities, as well as protecting intellectual property
and taxing economic output.
• Four major types of legal systems:
§
Common
law
§
Civil
law
§
Religious
law
§
Mixed
systems
Legal Systems: Common Law
• Originated in England and spread to
Australia, Canada, the U.S., and other former members of the British
Commonwealth (also known as case law).
• Interpretation is based on tradition,
prevalent customs, past practices, and legal precedents set
by courts via interpretation of statutes, legislation, and past rulings.
•
e.g., trademark protection: ownership by
“priority in use”
•
“Sony
restaurant” in New York
•
Burger King (a food-shop in Adelaide): Hungry
Jack in Australia
• Judges have much power to interpret laws based on the
circumstances of individual cases. Thus, common law is relatively flexible.
Legal Systems: Civil Law
• Found in France, Germany, Italy,
Japan, Turkey, and much of Latin America (legacy of Roman law; the most
prevalent in terms of # countries).
• Based on an all-inclusive system of
laws that have been “codified”—clearly written by legislative
bodies.
• Laws are more “cast in stone” than common law and not strongly
subject to interpretation by courts.
•
e.g., trademark protection: ownership by
“priority in registration”: “Nike” in Spain
• A key difference is that common law
is mainly judicial in origin and based on court decisions, whereas civil
law is mainly legislative and based on laws passed by national and state
legislatures.
Sampling of Differences Between Common Law and Civil Law
Legal Systems: Religious Law
Strongly
influenced by religious beliefs, ethical codes, and moral values, which are
viewed as mandated by a supreme being - e.g., Islamic law spells out
norms of behavior. regarding politics, economics,, contracts, and many other social and business issues.
norms of behavior. regarding politics, economics,, contracts, and many other social and business issues.
•
business
implications for banking (charging of interest)
•
Leasing,
not borrowing
•
Share
of bank profits, not interest, for depositors
•
Norms
Legal Systems: Mixed Systems
• Two or more legal systems operating
together.
• The contrast between civil and
common law has become blurred as countries combine both systems.
• Totalitarianism is most associated
with religious law and socialist law.
• Democracy is associated with common
law, civil law, and mixed systems.
• Example
Legal systems in Philippines & S. Africa have elements of civil and common laws.
Legal systems in Philippines & S. Africa have elements of civil and common laws.
• Lebanon, Morocco, and Tunisia share
elements of civil law and Islamic law.
Foreign Laws and the Marketing Mix
• Product
– differences in safety requirements
– packaging, labeling and warranty
laws
• Pricing
– price controls for “essential goods”
– price collusion between competitors
• Promotion
– regulations on comparative
advertising
– what can be advertised and how (cigarette
advertising)
– Restricted sales promotion
techniques
• Distribution
– big store laws (e.g., Japan)
– operating restrictions
Types of Country Risk Produced by Legal Systems
Country
risk arising from the host country’s legal system
• Foreign investment laws (FDI related
issue will be discussed in subsequent lectures).
•
e.g.,
Japan: The “large-scale
retail store law”
restricted foreigners from opening warehouse-style stores like Toys“R”Us, in favor of smaller Japanese retailers.
•
Mexico:
Foreign oil companies cannot obtain 100% ownership of Mexican oil firms.
• Controls on operating forms and
practices
• Marketing and distribution laws –
e.g. cigarette advertising.
• Laws regarding income repatriation
• Environmental laws and Contract laws
• Underdeveloped legal systems
Home Country Laws
• Export Controls (national security
and foreign policy goals)
• Anti-trust law (preventing
monopolies)
– jurisdiction in foreign markets
– case of Pepsi and Pizza Hut
• Foreign Corrupt Practices Act
– “bribery” versus “facilitating
payments”
Actors in Political and Legal Systems
• The government, or the “public sector,” operating
at national and local levels
at national and local levels
• International organizations, such as the World Bank,
World Trade Organization, and the United Nations
• Regional economic blocs, such as the European Union, NAFTA,
and many others
• Special interest groups,
such as labor unions and
environmental advocates
such as labor unions and
environmental advocates
• Local competing firms,
which oppose foreign
firms
which oppose foreign
firms
Special Interest Groups: Typical Issues
• Political system: A set of formal institutions that
constitute a government. It includes legislative bodies, political parties,
lobbying groups, and trade unions. The system also defines how these groups
interact with each other.
• Three major types of political
systems:
§
Totalitarianism,
Socialism, Democracy
§
These
categories are not mutually exclusive
Political
Systems: Totalitarianism
• Government controls all economic and
political matters.
• Either theocratic (religion-based)
or secular.
• A state party is led by a dictator.
• Membership is mandatory for those
wanting to advance.
• Power is sustained via secret
police, propaganda, and regulation of free discussion and criticism.
• Today: Some countries in the Middle
East and Africa; Cuba, North Korea.
• Former totalitarian states tend to
have much government
intervention and bureaucracy.
have much government
intervention and bureaucracy.
Political Systems: Socialism
• Capital is vested in the state.
• Capital is used primarily as a means
of production for use rather than for profit.
• Group welfare outweighs individual
welfare.
• Government’s role is to control the basic means of
production, distribution, and commercial activity.
• Socialism occurs in much of the
world as social democracy (e.g., Western Europe, Brazil, India).
• Government intervention in the
private sector.
• Corporate income tax rates are
higher.
Political Systems: Democracy
• Economic activity occurs freely, as
per market forces
• Limited government: The government performs only
essential functions that serve all citizens, such as national defense,
maintaining law and order, foreign relations, and providing basic
infrastructure.
• Private property rights: The ability to own property and
assets and to increase one’s asset base by accumulating private wealth. Property includes land,
buildings, stocks, contracts, patents.
• Encourages initiative, ambition, and
innovation.
Political Economy
A term that
stresses that the political, economic, and legal systems of a country are
interdependent; they interact and influence each other, and in doing so they
affect the level of economic well-being
Political
System reflects a political ideology - a body of constructs, theories, and aims
that constitute a sociopolitical program - When operating in a foreign country,
must understand the potential sources of political tension and instability
Economic
Systems -
government’s mix of ownership/control
of the economy - Ownership—who owns the resources engaged in economic activity
•
Most
countries are a mixture of public & private ownership. Countries with
significant state-owned enterprises are moving toward less, not more, public
ownership
Comparative measures of freedom
Political Systems - System of government in a nation:
can be assessed according to two dimensions
Degree to which they emphasize collectivism as opposed
to individualism and the degree to which they are democratic or totalitarian
Classifying Countries by Economic
Systems
An Economic description of
countries might include…
Demand conditions (market potential) or Factor
conditions—inputs to the production process
e.g. Human and Physical resources, Knowledge
resources—research and development, Infrastructure etc.
The broadest macro-economic categorizations are a
measure of economic “freedom” versus economic “control”.
Factors that determine economic freedom include: trade
policy, taxation, government intervention*, monetary policy, capital flows and
investment, wage/price controls, and property rights.
*Economic Freedom is also a key component of next
weeks lecture when we discuss government intervention.
Market Economy
–
productive activities are
privately owned
• the role of the government is to encourage fair competition
which promotes efficiency and entrepreneurship. Should lead to economic growth.
–
no state control over prices or
quantity. {Supply & Demand}
» What do you think the government’s
attitude to Foreign Direct Investment is
under this model?
Command Economy
–
prices & quantities are
planned by the government
• This model is consistent with a collective ideology and the
belief that the government should allocate resources for the good of society.
Often leads to inefficiency
–
are government in a position to
make the best decisions for society/business?
» What do you think the government’s
attitude to FDI is under this model?
Mixed Economy
–
some sectors of the economy are left to private while others
have significant state ownership
–
state involvement in sectors where there is a moral
obligation (e.g.) education, health care, electricity supply or in sectors where companies vital to
the national interest are at risk.
» What do you think the government’s
attitude to FDI is under this model?
• Sub category can be know
as -
State Directed Economy & Socialist
Market Economies
–
the state plays a role in the investment activities of
private firms through industrial policy, with subsidies, grants and other
incentives.
• What impact did the Global
Financial Crisis have on the degree of “state direction” experienced in country
economies?
Relationship Between Economic and Political Freedom
Political Economy and Development
It has been argued that a country’s
economic development is a function of its economic and political systems
Generalizations regarding the nature of the
relationship between political economy and economic progress
–
Innovation and Entrepreneurship
are the engines of growth
–
Innovation and Entrepreneurship
require a market economy
–
Innovation and Entrepreneurship
require strong property rights
–
The required political system is
in place
–
Economic progress begets democracy
States in Transition
The political economy of the world has changed
radically since the late 1980’s.
Two trends have been evident
1. A wave of democratic revolutions swept the world
Main reasons account for the spread of democracy
–
Many totalitarian regimes failed
to deliver economic progress to the vast bulk of their populations
–
New information and communication
technologies, including shortwave radio, satellite television, fax machines,
desktop publishing, and most importantly, the Internet, have broken down the
ability of the state to control access to uncensored information
2. There has been a strong move away from centrally planned
and mixed economies toward a free market economic model
Country Risk Produced by Political Systems: Government Takeover of Corporate Assets
• Confiscation: Seizure of corporate assets without
compensation
• Expropriation: Asset seizure with compensation
• Nationalization: Takeover of an entire industry, with
or without compensation
Examples
• In Venezuela, President Hugo Chavez
confiscated an oil field owned by the French petroleum firm Total.
• In 2006, the Bolivian
government nationalized the oil and gas
industries.
Country
Risk Produced by Political Systems: Creeping Expropriation
• The most common expropriation today.
• The government gradually modifies
regulations and laws after foreign MNEs have made big local investments in
property and plants.
Examples
• Abrupt termination of contracts.
• Creation of laws that favor local
firms.
• The governments in Bolivia, Russia,
and Venezuela have modified tax
regimes to extract revenues from
coal, oil, and gas companies.
and Venezuela have modified tax
regimes to extract revenues from
coal, oil, and gas companies.
Country Risk Produced by Political Systems: Embargoes and Sanctions
• Governments may respond to offensive
activities of foreign countries by imposing embargoes and sanctions.
• Sanctions are bans on international trade,
usually undertaken by a country, or a group of countries, against another
country judged to have jeopardized peace and security.
• Embargoes are bans on exports or imports that
forbid trade in specific goods with specific countries. Example: The U.S. has
enforced embargoes against Iran and North Korea, labeled as state sponsors of
terrorism.
Country Risk Produced by Political Systems: Boycotts against Firms and Nations
• Boycott: A voluntary refusal to engage in
commercial dealings with a nation or a company
Examples
from France
• Citizens boycotted Disneyland Paris
to express opposition to globalization and takeover of French farmland.
• French farmers boycotted McDonald’s, and crashed a tractor into a
shop, to vent their anger with agricultural policies and globalization.
Country Risk Produced by Political Systems: Wars, Insurrection, and Violence
• War and insurrection: Indirect effects can be disastrous
for company activities.
• Terrorism: The threat or actual use of force or
violence to attain a political goal through fear and intimidation.
• Terrorism particularly affects
certain industries, such as tourism, hospitality, aviation, finance, and
retailing
• i.e. airline industry after 911
Managing Country Risk
● Proactive environmental scanning: Management should develop a
comprehensive understanding of the political and legal environment in target
countries.
● Is the “political economy” of
Australia “healthy” and investment friendly?
● Scanning: Ongoing assessment of potential
risks and threats to the firm, via intelligence sources such as:
§ Employees working in the host
country
§ Embassy and trade association
officials
● Goal is to minimize exposure to
country risks.
● Protection through legal contracts: Contract law varies widely. The firm
must follow the law in each country. Three approaches for resolving contract
disputes are:
§ Conciliation is a formal process of negotiation
with the objective of resolving differences in a friendly manner. The least
adversarial method, it is common in China.
§ In arbitration, a neutral
third party hears both sides of a case and decides in favor of one party or the
other, based on an objective assessment of the facts.
§ Litigation occurs when one party files a
lawsuit against another. The most adversarial approach, it is common in the
United States.
A Framework for Analysis of Political Economy - PESTEL
A Framework for Analysis - PESTEL
Political
Government stability
Including political risk
Taxation policy
Can include different policies for foreign investors.
Foreign trade regulations
Market access, FDI regulation.
Membership of Trade Block or
WTO?
Economic
Degree of economic freedom or control.
Economic Transition
Economic Development and Management
GNP trends
Interest rates
Inflation
Unemployment
Disposable income
Sociocultural
Population demographics
Income distribution
Social mobility
Attitudes to work
Consumerism
Levels of education etc
Technological
Government spending on research and development
Government and industry focus on technological effort
Including technology in education
New discoveries /developments
Speed of technology transfer
Environmental
Energy consumption
Environmental protection laws
The environmental challenges presented by global warming are
likely to make the environment a key policy decision for governments worldwide
and also for super-national organisations such as the WTO
Legal
Competition law
Contract law
Employment law
Health and safety
Product safety
Property law
Public/Private violation
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