Political and Legal Systems
in National Environments
International Business: The New Realities, 4th Edition, Global Edition
by
Cavusgil, Knight, and Riesenberger
Copyright © 2017 Pearson Education, Ltd.
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Learning Objectives
6.1 Distinguish political and legal environments.
6.2 Understand political systems.
6.3 Understand legal systems.
6.4 Know the participants in political and legal systems.
6.5 Identify types of country risk produced by political sys
tems.
6.6 Identify types of country risk produced by legal syste
ms.
6.7 Know about managing country risk.
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Realities of Doing Business in Russia
• High rate of piracy in software, music, DVDs, other g
oods.
• Anti-piracy laws and law enforcement are weak
Obtaining business licenses requires bribing officials.
• SMEs may spend 1/5 of their net income on bribes.
• There is substantial organized crime, and killings.
• Criminal raiders may seize independent businesses.
• Conditions in Russia are typical of many emerging
markets and developing economies.
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What is Country Risk?
Exposure to potential loss or adverse effects on company
operations and profitability caused by developments in a
country’s political and/or legal environments.
• Also known as “politi Example
Coca-Cola’s business fell off in Germ
cal risk.”
any when the government enacted a
recycling plan. New laws required co
• Each country has un nsumers to return nonreusable soft d
ique political
rink containers to stores for a refund
and legal systems th of 0.25 euros. Rather than cope with
at often pose challen the unwanted returns, big supermark
et chains pulled Coke from their shel
ges for company
ves.
performance.
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Dimensions of Country Risk
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Country Risk in Selected Countries
Source: Based on Economist Intelligence Unit (2015), “Risk Briefing,” www.viewswire.eiu.com, and Euler Hermes Countr
y Risk Ratings (2015), http://www.eulerhermes.com.
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Political and Legal Systems
• Political system: A set of formal institutions that con
stitute a government. It includes legislative bodies, p
olitical parties, lobbying groups, and trade unions. Th
e system also defines how these groups interact with
each other.
• Three major types of political systems:
 Totalitarianism
 Socialism
 Democracy
• These categoriesCopyright
are ©not
mutually
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Education, Ltd. exclusive
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Functions of Political Systems
• Provide protection from external threats.
• Ensure stability based on laws.
• Govern the allocation of valued resources among t
he members of a society.
• Define how society’s members interact with each ot
her.
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Political and Legal Systems (cont’d)
• Legal system: A system for interpreting and enforci
ng laws. The laws, regulations, and rules establish
norms for conduct. It incorporates institutions and pr
ocedures for ensuring order and resolving disputes i
n commercial activities, as well as protecting intelle
ctual property and taxing economic output.
• Four major types of legal systems:
 Common Law
 Civil Law
 Religious Law
 Mixed Systems
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Sources of Country Risk
Political System
•government
•political parties
•legislative bodies
•lobbying groups
•trade unions
•other political institutio
ns
Legal System
Laws, regulations, and
rules that aim to:
• ensure order in com
mercial activities
• resolve disputes
• protect intellectual pr
operty
• tax economic output
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Political Systems: Totalitarianism
• Government controls all economic and political matte
rs.
• Either theocratic (religion-based) or secular
• A state party is led by a dictator. Membership is man
datory for those wanting to advance.
• Power is sustained via secret police, propaganda, re
gulation of free discussion and criticism.
• Today: Some countries in the Middle East and Africa;
Cuba, North Korea.
▪ China (1949–1980s)
• Ex-totalitarian states tend to ▪ Germany (1933–1945)
have much government
▪ Soviet Union (1918–1991)
intervention and bureaucracy. ▪ Spain (1939–1965)
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Political Systems: Socialism
• Capital is vested in the state and 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 pr
oduction, distribution, and commercial activity.
• Socialism occurs in much of the world as social dem
ocracy (e.g., Western Europe, Brazil, India).
• Government intervention in the private sector.
• Corporate income tax rates are higher.
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Political Systems: Democracy
• Economic activity occurs freely, as per market forces.
• Limited government: The government performs onl
y essential functions that serve all citizens, such as n
ational defense, maintaining law & order, foreign relat
ions, and providing basic infrastructure.
• Private property rights: The ability to own property
and assets and to increase one’s asset base by accu
mulating private wealth. Property includes land, build
ings, stocks, contracts, patents. Encourages initiativ
e, ambition, innovation.
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Examples of Countries
Under Various Political Systems
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Relationship Between
Economic and Political Freedom
Sources: James Gwartney, Robert Lawson, and Joshua Hall, Economic Freedom of the World: 2014 Annual
Report (Vancouver, Canada: Fraser Institute, 2014); Freedom House,Freedom in the World 2015 Washington DC
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: Freedom House, 2015).
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Democracy and Openness
• Democracy is associated with “openness”, the lack of
regulation and barriers to the entry of firms in foreign
markets.
Example
• Openness is associated with:
 Successful market entry.
 Increased market demand.
 Competition on quality, which
improves overall product quality.
 Increased competition, leading
to efficiencies and lower prices.
Since the 1980s, India ste
adily lowered entry barrier
s to its car market. Foreig
n carmakers entered the
market, greatly increasing
the number of models for
sale. Greater competition
increased the quality of a
vailable cars, and car pric
es fell.
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Political and Economic Systems
• Totalitarianism is associated with command economie
s, wherein the state makes all decisions on what to pro
duce, how much to produce, and what prices to charge.
• Democracy is associated with market economies and
capitalism, in which decisions are largely left to market
forces, that is, supply and demand.
• Socialism is associated with mixed economies, which
have features of both market and command economies
, combining state intervention and market mechanisms
(e.g., Sweden, Singapore).
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The Rule of Law
Existence of a legal system where rules are clear, public
ly disclosed, fairly enforced, and widely respected by ind
ividuals, 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.
(iii) Enforced fairly and systematically by police forces
an
d formally organized judicial bodies.
• Economic activity suffers and uncertainty increases when the r
ule of law is weak.
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Legal Systems: Common Law
• A legal system that originated in England and spread
to Australia, Canada, USA, and other former member
s of the British Commonwealth (also known as case l
aw).
• The basis of law is tradition, past practices, and legal
precedents set by courts via interpretation of statutes
, legislation, and past rulings.
• Judges have much power to interpret laws based on
the circumstances of individual cases. Thus, commo
n law is relatively flexible.
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Legal Systems: Civil Law
• Found in France, Germany, Italy, Japan, Turkey, and
much of Latin America.
• Based on an all-inclusive system of laws that have b
een “codified” – clearly written by legislative bodies.
• Laws are more “cast in stone” and not strongly subje
ct to interpretation by courts.
• A key difference is that common law is mainly judicial
in origin and based on court decisions, whereas civil l
aw is mainly legislative and based on laws passed by
national and state legislatures.
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Sampling of Differences
between Common Law and Civil Law
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Legal Systems: Religious Law
• Strongly influenced by religious beliefs, ethical codes, and mo
ral values, viewed as mandated by a supreme being.
• Most important religious legal systems are based on Hindu, Je
wish, and Islamic law.
• Islamic law spells out
norms of behavior
regarding politics,
economics, banking,
contracts, marriage,
and many other social
and business issues.
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Legal Systems: Mixed Systems
• Two or more legal systems operating together.
• The contrast between civil and common law has be
come 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 Lebanon, Morocco, and Tunisia share ele
ments of civil law and Islamic law.
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Dominant Legal Systems in Selected Countries
Source: Based on World Legal Systems at www.juriglobe.ca.
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Actors in Political and Legal Systems
• The government, or the “public sector”, operating
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 Uni
on, NAFTA, and many others.
• Special interest groups
such as labor unions and
environmental advocates.
• Local competing firms,
which oppose foreign
firms.
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Special Interest Groups Typical Issues
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Country Risk Produced by Political Systems:
Government Takeover of Corporate Assets
• Confiscation: Seizure of corporate assets withou
t compensation.
• Expropriation: Asset seizure with compensation.
• Nationalization: Takeover of an entire industry, w
ith or without compensation.
Examples
• In Venezuela, President Hugo Chavez confiscated a
n
oil field owned by the French petroleum firm Total.
• In Bolivia in 2006, the Bolivian government
nationalized the oil
and
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Pearson industry.
Education, Ltd.
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Country Risk Produced by Political Systems:
Creeping Expropriation
• The most common expropriation today.
• The government gradually modifies regulations and l
aws after foreign MNEs have made big local investm
ents 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.
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Country Risk Produced by Political Systems: Embar
goes and Sanctions
• Governments may respond to offensive activities of foreign cou
ntries by imposing embargoes and sanctions.
• Sanctions are bans on international trade, usually undertaken
by a country, or a group of countries, against another 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 e
nforced embargoes against Cuba, Iran, and North Korea, label
ed as state sponsors of terrorism.
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Country Risk Produced by Political Systems: Boyco
tts against Firms and Nations
• Voluntary refusal to engage in commercial dealing
s with a nation or a company.
Examples from France
•Citizens boycotted Disneyland Paris, to express op
position to globalization and takeover of French far
mland.
•French farmers boycotted McDonald’s, and crashe
d a tractor into a shop, to vent their anger with agric
ultural policies and globalization.
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Country Risk Produced by Political Systems:
Wars, Insurrection, and Violence
• War and insurrection – Indirect effects can be disas
trous for company activities.
• Terrorism: The threat or actual use of force or violen
ce to attain a political goal through fear and intimidati
on.
• Some terrorism is sponsored by national government
s.
• Terrorism particularly affects certain industries – touri
sm, hospitality, aviation, finance, retailing.
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Types of Country Risk Produced by Legal Systems
Country risk arising from the host country legal e
nvironment:
• Foreign investment laws
• Controls on operating forms and practices
• Marketing and distribution laws
• Laws regarding income repatriation
• Environmental laws
• Contract laws
• Inadequate or underdeveloped legal systems
• Internet and e-commerce regulations
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Country Risk Produced by Legal Systems (cont’d)
Country risk arising from the home country legal
Environment:
• The Foreign Corrupt Practices Act (FCPA)
• Antiboycott regulations
• Accounting and reporting laws
• Transparency in financial reporting
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Country Risk Arising from the Host Country
• Foreign investment laws affect FDI-based entry.
Examples:
•Japan – The “large-scale retail store law” restricted fore
igners from opening warehouse-style stores like Toys”R”
Us, in favor of smaller Japanese retailers.
•Mexico – Foreign oil companies cannot obtain 100% o
wnership of Mexican oil firms.
•United States – Restricts inward investments seen to af
fect national security. e.g., The U.S. Congress blocked
Dubai Ports World, a Middle Eastern firm, which sought
a deal to manage U.S. ports.
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Country Risk Arising from the Host Country (cont’d)
• Controls on operating forms and practices are la
ws and regulations on how firms can conduct product
ion, marketing, and distribution activities.
Example:
In the telecommunications sector in China, the Ch
inese government requires foreign investors to se
ek joint ventures with local firms. This ensures lo
cal control of the telecom industry; and China gai
ns access to foreign capital and technology.
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Country Risk Arising from the Host Country (cont’d)
• Marketing and distribution laws regulate pra
ctices in advertising, promotion, and distributio
n.
Examples:
• Finland, France, Norway, and New Zealand pro
hibit cigarette advertising on television.
• Canada and other countries cap prices in the p
harmaceutical and other industries.
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Country Risk Arising from the Host Country (cont’d)
• Laws on income repatriation limit the amount of ne
t income or dividends that firms can bring back to the
home country.
• Environmental laws aim to preserve natural resourc
es, combat pollution, and ensure safety.
• Contract laws affect the sale of goods and services;
intermediary agreements; licensing and franchising; f
oreign direct investment; and joint ventures.
Example:
In Germany, firms are responsible for recycling product
packaging.
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Country Risk Arising from the Host Country (cont’d
)
• Inadequate or underdeveloped legal systems, or
poor enforcement of existing laws.
• Laws may be weak regarding intellectual property, po
llution, consumer protection, and other areas.
• While the problem is common in developing economi
es, it can occur in advanced economies too.
Examples:
•In China and Russia, foreign firms sometimes abandon business ventur
es due to erratic legal environments.
•The recent global financial crisis was triggered partly by poor regulation
in the United States and Europe.
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Country Risk Arising from the Home Country
• Extraterritoriality: The application of home-country
laws to other countries. For example, the European
Union pursued Microsoft for monopolistic practices.
The Foreign Corrupt
Practices Act (1966;
U.S.) made it illegal to
offer bribes to foreign
parties. But the act may
harm U.S. firms because
foreign competitors are
usually not so constrained.
•
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Country Risk Arising from the Home Country (cont’
d)
• Accounting and reporting laws differ widely
around the world. Two examples:
▪ Physical asset valuations: Canada and the U.S. use
historical costs. Some Latin American countries use in
flation-adjusted market value.
▪ R&D costs: Expensed as incurred in most of the worl
d; capitalized in South Korea and Spain. Some countri
es use both conventions.
• Transparency in financial reporting is the degree
to which firms regularly reveal substantial financial
and accounting information.
This varies worldwide.
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Ethical Connections
• Many countries lack antibribery laws for internation
al transactions.
• The Organization for Economic Cooperation and D
evelopment (OECD) recently called for a ban on “g
rease payments,” small-scale bribes intended to sp
eed up telephone hookups, government paperwork
, and other everyday matters in global commerce.
• A culture of grease payments and other corruption
is corrosive, harming the rule of law and sustainabl
e economic development.
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Managing Country Risk
• Proactive environmental scanning: Manageme
nt should develop a comprehensive understanding
of the political and legal environment in target cou
ntries. Scanning – ongoing assessment of potenti
al risks and threats to the firm, via intelligence sou
rces such as:
•
•
•
Employees working in the host country.
Embassy and trade association officials.
Consulting firms, such as Business Entrepreneurial
Risk Intelligence (http://www.beri.com).
• Minimize exposure to country risks.
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Managing Country Risk (cont’d)
• Strict adherence to ethical standards: Firms that
engage in questionable practices or operate outside
the law invite redress from the governments of the h
ost countries where they do business.
• Alliances with qualified local partners: For examp
le, firms often enter China and Russia by partnering
with local firms who assist in navigating the complex
legal and political landscape.
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Managing Country Risk (cont’d)
• Protection through legal contracts: Contract law varies wid
ely. The firm must follow the law in each country. Three appro
aches for resolving contract disputes:
o Conciliation is a formal process of negotiation whose objec
tive is to resolve differences in a friendly manner. It is the le
ast adversarial method. Common in China.
o In arbitration, a neutral third party hears both sides of a cas
e and decides in favor of one party or the other, based on a
n objective assessment of the facts.
o Litigation occurs when one party files a lawsuit against ano
ther. The most adversarial approach, it is common in the U
nited States.
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• Christopher got his undergraduate degree from a state u
niversity a few years ago. Read his profile in Chapter 6.
• Christopher’s major: Accounting
• After attending a study abroad program in Istanbul, Turke
y, he gained a global business perspective and a passion
to work in international finance.
• Current position: Deloitte Tax LLP, Chicago
• “Understanding the role that international
business plays across cultural variations
will allow for a well-developed global
commerce perspective. Such exposure
will also assist with determining your
specific career path of choice.”
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