1. International Business
Lecture 2
Formal Institutions
Ms. Reem Quashem

2. Introduction
International Business is more complicated than domestic businesses as countries differ in many ways.
There are different political, economical and legal systems which varies depending on the level of economic development
Cultural practices vary as well including education and skill level of population.

3. Institution based view
The institutional framework governing a particular context is made up of formal and informal institutions governing individual and firm behaviour.
Coase (1930)and Williamson (1970) developed the concept of Transaction Cost Economy
Transaction costs are the costs associated with economic transactions or, the costs of doing the business
Transaction costs however are to a large extent influenced by the institutions governing the market
Transaction cost also increases due to opportunism

4. Institution based view
Institutional framework includes formal institutions and informal institutions
Formal institution include institutions representation by laws, regulations, and laws.
On a national level it is normally the government or supra natural bodies like European Union who set the rules
Informal institutions are the rules that are not formatted but exist in for example norms and values
This concerns what behavior are morally right and wrong, and what is important that shape behaviors without being ‘cast in mind’

5. What do institutions do?
The key role of an institution is to reduce uncertainty because uncertainty can be potentially devastating
For example
Political uncertainty such as expropriation may render long range planning obsolete
Economic uncertainty such as fear that a partner may fail to carry out its obligation set out in a contract may result in economic losses
Therefore it reduces peoples willingness to make long term commitments, or commitments at all
It increases transaction costs
Discussion topic: how does it increases transaction cost?

6. Institution based view
Opportunism
Act of seeking self-interest with guile
In other words it is the conscious policy and practice of talking selfish advantage of circumstances – with little regard for principles, or with what the consequences are for others
Examples include misleading, cheating and confusing other parties in a transaction

7. Political Systems
Political system refers to the rules of the game on how a country is governed politically.
Businesses interact with political system only indirectly, yet business persons need to understand the political system because it shapes the commercial rules and regulations for the business
It can be major source of risks

8. Types of Political System
Democracy
It is a political system in which governments derive their legitimacy from their election by their citizens.
Provides individuals right to freedom of expression, opinion and organization
Free media
Regular elections in which all eligible citizens are allowed to vote
Universal adult suffrage (providing rights to minors)
Limited terms
Fair court system
Nonpolitical state bureaucracy
Nonpolitical police force
Free access to state information

9. Political systems Totalitarianism (or dictatorship)
It is a political system in which one person or party exercises absolute political control over the population
An important ideology supporting totalitarian regimes has been communism which had been embraced throughout Central and Eastern Europe and the former Soviet Union until the late 1980’s
It is still the official ideology in China, Cuba Laos, North Korea and Vietnam
Communist totalitarianism
Theocratic totalitarianism
Tribal totalitarianism
Right-w ing totalitarianism

10. Political Systems
Individualism (16th century Protestant trading nations)
Opposite of collectivism
Individual should have the freedom in his or her economic and political pursuits
Interests of the individual should take precedence over the interests of the state
Provides freedom of self expression and welfare of society is best served by letting people pursue their own economic self interest.
Collectivism
A political system that stresses the primacy of collective goals over individual goals
The needs of the society as a whole are generally viewed as being more important than individual freedoms
Socialism
Traced back to Karl Marx ( ). He believed that if the state owned the means of production, the state could ensure the workers were fully compensated for their labor

11. Why Political System matters to International Business?
Political system determines who sets the rules, and whose interest may be reflected in the rules.
For example in centralized country such as France or the UK, the regulations and taxation rates tend to be uniform across the country, while decentralized countries such as the USA may have considerable variations that require adaptation even within the country
Political systems also determine where and how businesses may be able to influence legislative processes through lobbying (mostly legal) or corruption (usually illegal)

12. Why Political System matters to International Business?
They influence how frequently the rules of the game for business are changed, a major source of political risk
It is the risks associated with political changes that may negatively impact on domestic and foreign firms

13. Economic System
Economic System refers to the rules of the game on how a country is governed economically
There are three types of economic syste: Pure market economy, command economy, and mixed economy
Pure market economy is characterized by the ‘invisible hand’ of the market forces first noted by Adam Smith in The government takes the hands off approach known as laissez faire. All factors of production are privately owned and individuals are free to engage in all sorts of contracts as long as they pay taxes.

14. Economic System
Pure command economy is defined by a government taking, in the words of lenin, the ‘commanding heights’. An economy in which all factors of productions are government- or state-owned and controlled, and all supply, demand and pricing are planned by the government
Historically many countries in the 19th century came close to pure market economy like UK, and USA. However, no country have ever achieved pure market economy.
Similarly country have ever achieved a pure command economy.

15. Economic System
Mixed economy is where element of both market economy and command economies exist, where although most of the factors of production are privately owned, there is still some government intervention exists.

16. Varieties of Capitalism Views
A scholarly view suggesting that economies have different inherent logics on how markets and other mechanisms coordinate economic activity
A Liberal Market Economy is where the coordination happens predominantly by companies reacting to price signals of the market.
Companies are predominantly financed by issuing share that are traded on the stock exchanges
labour markets are flexible and employees enjoy relatively little job protection
Countries such as USA, UK and Australia

17. Varieties of Capitalism Views
Coordinated Market Economy is a system of coordinating through a variety of other means in addition to market signals.
These countries provide more job protection
Firms have less opportunity to raise capital through the stock market, or to incentivize managers by linking their salary or bonus to stock market performance

18. Varieties of Capitalism

19. Legal Systems Legal Systems
Rules of the game on how a country’s laws are enacted and enforced
Civil law
A legal tradition that uses comprehensive statutes and codes as a primary means to form legal judgments.
Common law
A legal tradition that is shaped by precedents and traditions from previous judicial decisions.
Case law
Rules of law that have been created by precedents of cases in court.

20. Legal Traditions

21. Property Rights
Property rights is the legal rights to use an economic property (resource) and to derive income and benefits from it.
Intellectual property rights are the rights associated with the ownership of intellectual property
Property traditionally refers to tangible pieces of property
(such as land).
Intellectual property specifically refers to intangible property

22. Intellectual Property rights
Patents
Legal rights awarded by government authorities to inventors of new technological ideas, who are given exclusive (monopoly) rights to derive income from such inventions through activities such as manufacturing, licensing, or selling
Copyrights
The exclusive legal rights of authors and publishers to publish and disseminate their work (such as this book, a photo or a piece of software
Trademarks
Exclusive legal rights of firms to use specific names, brands and designs to differentiate their products from others

23. Corporate Governance
It s the rules by which shareholders and other interested parties control corporate decision making
The rules of corporate governance control corporate decision makers (typically managers)
The role is to distribute the rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders and spells out the rules and procedures for making decisions
It is important because it ensures that managers act in the best interest of the firm, rather than their personal interest