Country Differences in Political Economy

Political, Economic, Legal Systems How do they differ? How do they influence a country’s ability to achieve meaningful economic progress? What are the main changes they are undergoing? How do these affect benefits-costs-risks of doing business in a country? How does their nature affect ethical issues of doing business in a country?

“The System of Government in a Nation” Political Systems “The System of Government in a Nation” Government by the people exercised directly or through elected representatives Emphasis: “good of society”, “common good” Individualism Collectivism Democratic Totalitarian Emphasis: guaranteeing individual freedom and self-expression One person or political party exercises absolute control over all spheres; opposing parties prohibited 3

Democracy: Totalitarianism: Government is by the people, exercised either directly or through elected representatives (representative democracy) Safeguards hold elected representatives accountable Totalitarianism: One person/party exercises absolute control over all spheres of human life (competing political parties are banned) Communist totalitarianism Theocratic totalitarianism Tribal totalitarianism Right wing totalitarianism

World’s Religious Philosophies 6 7 8 1 5 4 3 2 5

Economically-Relevant Characteristics of Religious/Spiritual Philosophies Protestant Christianity: Work ethic, wealth creation, individual freedom Islamic fundamentalism: Pro free enterprise, right to private property, keep contractual obligations, avoid deception, sin to collect interest Hinduism: Spiritual progression (reincarnation), aesthetic (non-material) lifestyle, self-reliance, caste system Buddhism: Spiritual achievement but lack of support for extreme aesthetic behavior or caste system Confucianism: High moral/ethical conduct, loyalty, reciprocal obligations, honesty 6

Economic Systems REALLY A CONTINUUM, WITH ALL ECO’S MIXED TO SOME DEGREE Highly Mixed e.g., Canada… state-owned health-care, electrical, liquor; also France Pure Command products, quantities, price planned, most business state-owned Pure Market not planned by anyone, no restrictions Market Mixed Command State-Directed - e.g., Japan, S. Korea… gov’t plays significant role in directing investment via “industrial policy” State-Directed 7

Legal Systems and International Business A Legal System is: rules - laws - that regulate behavior process through which laws are enforced grievances are redressed Businesses must observe Home country laws Host country laws International Laws and Treaties Different Legal Systems Common Law Civil Law Theocratic Law Bureaucratic Law Dispute resolution Where to arbitrate? Validity of contracts and decisions

Legal Systems property rights protection of Intellectual Property use of a resource, use made of income from resource enforcement issues, public vs private action violations protection of Intellectual Property Patent, copyright, trademarks, industrial property (Paris Convention) WTO/GATT product safety and product liability criminal / civil liability contract law document that specifies conditions under which an exchange will happen rights/obligations of parties differences based on legal tradition common law system civil law system

Differences of Economic Development GDP per capita; does not factor cost of living differences Purchasing Power Parity index: adjusts per capita GDP by cost-of-living Static picture Human Development Index: life expectancy, literacy, PPP based average incomes

Political-Economic Progress Trend from totalitarian, command toward democratic, free-market systems Innovation is engine of growth [for products, processes, strategies, organizations, management practices, countries Innovation needs: creativity market economy strong property rights the “right” political system Economic progress is related to Democracy IT limits gov’t ability to control citizen access POLITICAL & ECONOMIC ENVIRON OF A COUNTRY MATTERS BECAUSE WHEN ECO FREEDOMS RESTRICTED, SO MAY BE FIRM’S ABILITY TO OPERATE EFFICIENTLY WHEN POLITICAL FREEDOMS RESTRICTED, BOTH ETHICAL AND RISK CONCERNS ARISE Poor Eco. Performance records of command & control governance… perhaps because INNOVATION is the root of competitive advantage SHIFT TOWARD A FREE-MARKET SYSTEM INVOLVES AT LEAST THREE DISTINCT ACTIVITIES (next slide) 11

The Migration Path of Economic Transformation Deregulation Removal of legal restrictions to free markets. Privatization Transfer of state ownership of property into private hands. Evolution of legal systems to protect property rights. The road of transformation is rocky 12

Restrictive Trade Policy and Politics Protecting jobs and industries: emerging industries. Increasing exports. National security. Retaliation. International product domination: Subsidies for “first mover” advantages (New Trade theory).

Instruments of Restrictive Trade Policy Tariffs –Direct fees levied on imports Subsidies -- payment to a domestic producer, generated from taxes Import Quotas and Voluntary Export Restraints -- Restriction on the quantity of some good imported into a country Local Content Requirements -- Requires some specific fraction of a good to be produced domestically Initially used by developing countries to help shift from assembly to production of goods Developed countries (US) beginning to implement. Antidumping Policies – Penalties for selling goods in a foreign market below production costs or below fair market value Administrative Policies -- Bureaucratic rules designed to make it difficult for imports to enter a country

Restrictive Trade Instruments: Administrative Policies Bureaucratic rules designed to make it difficult for imports to enter a country. Japanese ‘masters’ in imposing such rules. Tulip bulbs. Federal Express.

Annual Cost to American Consumers for Import Protection $ Millions

The Impact of Privatization Brazil’s changing views on ownership of businesses has had dramatic effects on economic efficiency and foreign investment 1994: Sales = $253m Loss = $310m 1998(3Q): Sales = $934m Profits = $260.2m 2000 = World’s dominant provider of regional jets 17

Implications for Global Business Political, economic, and legal environments of a country influence attractiveness raise ethical Issues Attractiveness balance long-term risks with short-term benefits of doing business in a foreign country benefits depend on: size, wealth, future economic growth first mover advantages identify “star” future economies costs are affected by: political payoffs economic sophistication (may be more costly to operate in LDCs, no infrastructure) legal framework impact on costs

Implications for Global Business Ethical Issues human rights adherence to same standards abroad as at home product safety work safety environmental protection bribes Foreign Corrupt Practices Act (1977) what is unethical is not necessarily illegal

The Nature of Risk Political Risk Economic Risk Legal Risk Likelihood that political forces will cause drastic changes that adversely affect profits and other goals. Economic Risk Likelihood that economic mismanagement will cause drastic changes that adversely affect profits and other goals. Legal Risk Likelihood that a trading partner will opportunistically break a contract or expropriate property rights. CHOOSE You are CEO, $100mil investment in either Russia or Czech Republic: Both investments promise same long run return so choice driven by risk considerations: Assess risks of doing business in each of these nations. Which investment do you favor and why? Consider how your views on investments in Indonesia would be influenced by recent bribery scandals in its banking industry (PriceWaterhouse audit of Bank Bali, holding up $43 bil IMF rescue package) plus violent activity in East Timor (perhaps stirring other suppressed provinces to revolt). 20

Host Countries and the MNC Impact of MNC on host countries Political Economic Environmental Cultural Impact of host country Governments on MNCs (Political Risk) Expropriation, Nationalization Privatization Constraints on ownership Intellectual property rights Offset obligations (profit/capital repatriation, exports, technology transfer)

Benefit, Cost, Risk Tradeoff Costs & risks typically lower in economically advanced and politically stable democratic nations But benefits dependent upon likely economic growth rates Tradeoff likely most favorable in politically stable developing nations that have free market systems GDP/capita and Purchasing Power Parity (PPP) indexes are static. From int’l perspective, good to look at rate of eco growth and the status of its people Human Development Index, factors in literacy rates, life expectencies. Disturbing that some of the worse-off countries are among most heavily populated and rapidly expanding pop’s (most of Africa, India, SW Asia 22

CHOOSE You are a CEO considering a $100mil investment in either Russia or Czech Republic: Both investments promise same long run return so choice driven by risk considerations: Assess risks of doing business in each of these nations. Which investment do you favor and why?

Which country makes best investment site? Country A & B identical size populations, low labor costs, and good access to world markets Country A undeveloped education system, marked stratification between upper & lower classes, dominant religion stresses reincarnation, three major linguistic groups Country B well-developed education system, lack of social stratification, group identification culturally valued, dominant religion stresses hard work, only one linguistic group COUNTRY B supportive of capitalist mode of production and social harmony best economic growth prospects (for pushing products) COUNTRY A not as conducive to capitalist production & social harmony likely conflict between labor & management, and between linguistics groups can be expected to lead to social & industrial disruption. Lack of good educ system and religious leaning toward ascetic behavior can also be expected to work against business goals may experience economic stagnation 24