Chapter 02 - National Differences in Political Economy
OPENING CASE: India’s Transformation
INTRODUCTION
POLITICAL SYSTEMS
Collectivism and Individualism
Democracy and Totalitarianism
ECONOMIC SYSTEMS
Market Economy
Command Economy
Mixed Economy
LEGAL SYSTEMS
Different Legal Systems
Differences in Contract Law
Property Rights and Corruption
Country Focus: Corruption in Nigeria
The Protection of Intellectual Property
Management Focus: Starbucks Wins Key Trademark Case in China
Product Safety and Product Liability
THE DETERMINANTS OF ECONOMIC DEVELOPMENT
Differences in Economic Development
Broader Conceptions of Development: Amartya Sen
Political Economy and Economic Progress
Country Focus: Emerging Property Rights in China
Geography, Education, and Economic Development
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STATES IN TRANSITION
The Spread of Democracy
The New World Order and Global Terrorism
The Spread of Market-Based Systems
The Nature of Economic Transformation
Deregulation
Privatization
Legal Systems
Implications of Changing Political Economy
FOCUS ON MANAGERIAL IMPLICATIONS
Benefits
Costs
Risks
Overall Attractiveness
SUMMARY
CRITICAL THINKING AND DISCUSSION QUESTIONS
CLOSING CASE: Chavez’s Venezuela
1. Understand how the political systems of countries differ.
2. Understand how the economic systems of countries differ.
3. Understand how the legal systems of countries differ.
4. Be able to explain what determines the level of economic development of a nation.
5. Discuss the macro-political and economic changes taking place worldwide.
6. Describe how transition economies are moving towards market based systems.
7. Articulate the implications for management practice of national difference in political economy.
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This chapter focuses on how political, economic, and legal systems collectively influence a country’s ability to achieve meaningful economic progress. The first half of the chapter focuses on the different political, economic, and legal systems that are influential in the world. It is made clear to the reader that these differences are significant, and must be clearly understood by the managers of international firms. The section that focuses on legal systems includes a discussion of intellectual property, including patents, copyrights, and trademarks. Protecting intellectual property is a particularly problematic issue in international trade. The second half of the chapter focuses on the determinants of economic development. The author makes the point that a country’s political, economic, and legal systems have a direct impact on its economic potential.
The importance of innovation, along with the types of systems that facilitate innovation, is discussed. Next, the author discusses the parts of the world that are transition from one politicaleconomic ideology to another. Finally, the chapter ends with a discussion of the managerial implications of differing political, economic, and legal systems of a country.
Summary
The opening case explores describes the changes in India’s political economy since the country gained independence from Britain in 1947. Until the early 1990s, India followed a mixed economy system that was characterized by a large number of state-owned enterprises, centralized planning, and subsidies. The system failed to deliver significant growth and in 1991 India’s government implemented a series of reforms designed to foster increased privatization, inward investment, and exports. While initially successful, economic reform stalled by the later 1990s, and poverty was widespread. Discussion of the case can revolve around the following questions:
Suggestion Discussion Questions
QUESTION 1: What makes India an attractive destination for foreign firms?
ANSWER 1: India has an enormous, untapped potential as a market for foreign firms. The country’s middle class is growing, and the country’s economy is expanding at about 9 percent per year. In addition, with its well educated, but inexpensive workforce, the country is an attractive destination for companies seeking a cheap white-collar workforce.
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QUESTION 2: Since its reform program began in 1991, India has seen a significant turnaround in its economy. What factors might threaten this turnaround?
ANSWER: While India appears to be on the right path toward economic prosperity, issues still remain with the country’s protectionist policies. Employers, employees, and politicians have all expressed concerns that if import barriers are removed, Chinese imports will spell disaster for the country. In addition, archaic labor laws are threatening the ability of firms to operate efficiently, and the country’s privatization program has run into some challenges.
QUESTION 3: Despite its recent growth India still lags other developing countries? Why?
ANSWER 3: From 1994 to 2004, India’s economy grew at about 6 percent per year. More recently, from 2005 to 2007, that growth rate has jumped to about 9 percent per year. Still, India lags other developing economies in economic growth. India continues to be heavily regulated, and much of the country’s economic activity is conducted by inefficient state-run organizations. Most experts believe that this must change if the country is to “catch-up” with other countries.
Teaching Tip: Information on doing business in India is available at
{ http://www.indianembassy.org/newsite/Doing_business_In_India/FDI_Policy_Procedures.asp
}.
INTRODUCTION
A) Different countries have different political systems, economic systems, and legal systems.
Cultural practices can vary dramatically from country to country, as can the education and skill level of the population. All of these differences have major implications for the practice of international business.
B) This chapter explores how the political, economic, and legal systems of countries differ.
Together these systems are known as the political economy of a country.
C) The opening case on India’s efforts to transform its economy illustrates how economic growth in a country can be affected by its politics. India has had a democratic government since 1947, yet economic growth in the country has been constrained for much of that time by policies that limit free enterprise and restrict investment by foreign companies. India has only recently begun to see significant economic growth, thanks to efforts in the 1990s to deregulate the economy. The country still has a long way to go, and much of the country’s economic activity is still handled by stateowned enterprises. Companies considering investing in India must study the implications of
India’s political economy before making an investment.
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POLITICAL SYSTEMS
A) By political system we mean the system of government in a nation. Political systems can be assessed according to two related dimensions. The first is the degree to which they emphasize collectivism as opposed to individualism. The second dimension is the degree to which they are democratic or totalitarian.
Collectivism and Individualism
B) Collectivism refers to a system that stresses the primacy of collective goals over individual goals. When collectivism is emphasized, the needs of the society as whole are generally viewed as being more important than individual freedoms. Advocacy of collectivism can be traced to Plato, in modern times the collectivist mantle has been picked up by socialists , and their champion, Karl
Marx.
Socialism
C) Communists generally believed that this could only be achieved though revolution and totalitarian dictatorship, while s ocial democrats worked to achieve the same goals by democratic means.
D) While state owned firms might have been intended to promote the public interest, experience suggests that this isn't always the case. In many countries the performance of state owned companies has been poor. Protected from significant competition by their monopoly position, and guaranteed governmental financial assistance, many state owned enterprises became increasingly inefficient. Consequently, a number of Western democracies voted social democratic parties out of office and moved toward free market economies by selling state-owned enterprises to private investors, a process known as privatization .
Individualism
E) Individualism refers to a political philosophy that an individual should have freedom over his or her economic and political pursuits. In contrast to collectivism, individualism stresses that the interests of the individual should take precedence over the interests of the state.
F) Individualism, while advocated by Aristotle, in modern days was encouraged by David Hume,
Adam Smith, John Stuart Mill, and most recently, Hayek and Milton Friedman. Individualism focuses on i) guaranteeing individual freedom and self-expression, and ii) letting people pursue their own self-interest in order to achieve the best overall good for society. The U.S. Declaration of Independence and the Bill of Rights embody the spirit of individualism.
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G) While collectivism asserts the primacy of the collective over the individual, individualism asserts the opposite. This ideological difference shapes much of recent history and the Cold War.
Individualism is usually associated with democratic political systems and free markets.
Democracy and Totalitarianism
H) Democracy and totalitarianism are at different ends of a political dimension . Democracy refers to a political system in which government is by the people, exercised either directly or through elected representatives. Totalitarianism is a form of government in which one person or political party exercises absolute control over all spheres of human life, and opposing political parties are prohibited. There are four major forms of totalitarianism in the world today.
Democracy
I) Democracy in its pure state, with each individual voting on every issue, has generally been replaced by representative democracy , where elected representatives vote on behalf of constituents.
Video Note: A central theme in President George Bush’s administration is a focus on spreading democracy around the globe. To learn more about this, consider the iGlobe Experts Discuss
Global Democracy.
Totalitarianism
J) Under totalitarianism, a single political party, individual, or group of individuals monopolize the political power and do not permit opposition. There are four major forms of totalitarianism: communist totalitarianism , (form of totalitarianism that advocates achieving socialism through totalitarian dictatorship), theocratic totalitarianism , (form of totalitarianism in which political power is monopolized by a party, group, or individual that governs according to religious principles), tribal totalitarianism (form of totalitarianism found mainly in Africa in which a political party that represents the interests of a particular tribe monopolizes power), right wing totalitarianism (form of totalitarianism in which individual economic freedom is allowed but individual political freedom is restricted in the belief that it could lead to communism). There has been a general trend away from communist and right wing totalitarianism and towards democracy.
ECONOMIC SYSTEMS
A) There is a connection between political ideology and economic systems. In countries where individual goals are given primacy over collective goals, a free market system is more likely to exist. In contrast, in countries where collective goals are dominant, enterprises may be stateowned, and markets may be restricted. Three broad types of economic systems can be identified-a market economy, a command economy, and a mixed economy.
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Market Economy
B) In a pure market economy the goods and services that a country produces, and the quantity in which they are produced, is not planned by anyone. Rather price and quantity are determined by supply and demand. For a market economy to function, there must be no restrictions on either supply or demand - no monopolistic sellers or buyers.
Command Economy
C) In a pure command economy the goods and services that a country produces, the quantity in which they are produced, and the price at which they are sold are all planned by the government.
Resources are allocated "for the good of society". The government owns most, if not all, businesses.
Mixed Economy
D) A mixed economy includes some elements of each. Until recently, Great Britain, France, and
Sweden were all considered mixed economies. Today, however, as a result of extensive privatization, these countries function as market economies.
LEGAL SYSTEMS
A) The legal system of a country refers to the rules, or laws, that regulate behavior, along with the processes by which the laws of a country are enforced and through which redress for grievances is obtained.
B) The legal environment of a country is of immense importance to international business because a country's laws regulate business practice, define the manner in which business transactions are to be executed, and set down the rights and obligations of those involved in business transactions.
Differences in the structure of law can have an important impact upon the attractiveness of a country as an investment site and/or market.
Teaching Tip: The Encyclopedia of Corporate Governance is a site that contains a broad base of information about international law and the legal systems of the countries of the world. This site is available at { http://www.encycogov.com/B14IntCorpGov.asp
}.
Different Legal Systems
C) The common law system (based on tradition, precedent, and custom) evolved in England over hundreds of years. It is now found in most of Great Britain’s former colonies, including the United
States.
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D) A civil law system is based on a very detailed set of laws organized into codes. Over 80 countries, including Germany, France, Japan, and Russia, operate with a civil law system.
E) Islamic law is the most widely practiced theocratic law system (based on religious teachings) in the modern world.
Differences in Contract Law
F) Contract law is the body of law that governs contract enforcement. A contract is a document that specifies the conditions under which an exchange is to occur and details the rights and obligations of the parties involved. The United Nations Convention in Contracts for the
International Sales of Goods (CIGS) establishes a uniform set of rules governing certain aspects of the making and performance of everyday commercial contracts between sellers and buyers who have their places of business in different nations. By adopting CIGS, a nation signals to other nations that it will treat the Convention’s rules as part of its law.
Property Rights and Corruption
G) Control over property rights (the bundle of legal rights over the use to which a resource is put and over the use made of any income that may be derived from that source) are very important for the functioning of business. Property rights can be violated by either private action (theft, piracy, blackmail, Mafia) or public action (governmental bribery and corruption, nationalization).
Private Action
H) Private action refers to theft, piracy, blackmail, and the like by private individuals or groups.
Public Action and Corruption
I) Public action to violate property rights occurs when public officials extort income or resources from property holders using various legal mechanisms including excessive taxation, requiring expensive licenses or permits from property holders, or taking assets into state ownership without compensating the owners.
J) In some countries, corruption is kept to a minimum while in other corruption is rampant.
Foreign Corrupt Practices Act
K) The Foreign Corrupt Practices Act makes it a violation of the United States law to bribe a foreign government official in order to obtain or maintain business over which the foreign official has authority, and requires all publicly traded countries to keep detailed records so that it is clear whether a violation of the act has occurred or not.
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Country Focus: Corruption in Nigeria
Summary
This feature describes the corruption that has characterized Nigeria’s economy over the last 40 years. When the country initially gained its independence from Britain in 1960, expectations were high that Nigeria would become an economic heavyweight in Africa. With abundant natural resources and a large population, it seemed the stage was set for success. However, despite earnings of more than $500 billion from oil sales during the period 1970 to 2007, the country still suffered from extreme poverty, illiteracy, and high debt. Several factors have been blamed for
Nigeria’s troubles including political instability and corruption. Furthermore, in 2007,
Transparency International ranked Nigeria one of the most corrupt countries in the world, and the
Human Development Index ranked the country a dismal 159 out of 177.
Suggested Discussion Questions
1. What is meant by corruption? Explain how a corrupt political system affects the well being of a country.
Discussion Points: Corruption in Nigeria involved open and systematic plundering of the nation’s state treasury. Bribery was also a regular part of business. In fact, the situation in Nigeria is so dismal that Transparency International ranked Nigeria one of the most corrupt countries in the world. When a country experiences this sort of activity, returns on business investments are lower, and there is less incentive for inward foreign direct investment. Most students will recognize that this then negatively affects economic growth.
2. With its huge oil reserves and large population, Nigeria was expected to emerge as a major player in Africa. Yet today the country is extremely poor with little expectation for an economic turnaround any time in the near future. Explain how Nigeria came to be in such a sad state.
Discussion Points: Studies show that countries with high levels of corruption have lower inward foreign direct investment, lower levels of international trade, and poor levels of economic growth.
Nigeria is a perfect example of this type of country. Political strife resulting from in-fighting between the country’s various tribes and ethnic groups led to instability and questionable legitimacy in the government. Military dictatorships were inept and corrupt. Because the country is viewed so poorly thanks to its level of corruption and political instability, investors are reluctant to bring in the kinds of funds that could help the economy grow.
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3. Clearly, Nigeria’s corrupt government has been a major factor in the country’s demise. In contrast, other countries including Finland and Canada expressly prohibit corruption. In your opinion, would Nigeria be better off following the example of countries like Finland and Canada?
Why or why not?
Discussion Points: Many students will probably suggest that even if Nigeria explicitly prohibits corrupt behavior, it is unlikely to have little effect on the real way of doing business in the country.
In fact, they will probably point out that Nigeria’s current president, Olusegun Obasanjo, promised to put an end to corruption in the country, but so far has only succeeded in lowering it. Other students however, might see his efforts as a starting point, and view the future more optimistically.
Teaching Tip: The CIA’s World Factbook on Nigeria
{ https://www.cia.gov/cia/publications/factbook/geos/ni.html
} provides a wealth of information on the country.
Teaching Tip: To learn more about Transparency International’s corruption ranking of Nigeria, and general perspective of the country go to { http://www.transparency.org/ }.
The Protection of Intellectual Property
L) Intellectual property refers to property, such as computer software, a screenplay, or the chemical formula for a new drug that is the product of intellectual activity. Intellectual property rights include patents (documents giving the inventor of a new product or process exclusive rights to the manufacture, use, or sale of that invention); copyrights (exclusive legal rights of authors, composers, playwrights, artists, and publishers to publish and dispose of their work as they see fit); and trademarks (designs and names, often officially registered, by which merchants or manufacturers designate and differentiate their products).
Teaching Tip: For information on intellectual property rights including information on international intellectual property rights treaties and protecting trademarks go to the U.S. government’s web page on intellectual property rights at
{ http://usinfo.state.gov/products/pubs/intelprp/ }.
E) The protection of intellectual property rights differs greatly from country to country. While many countries have stringent intellectual property regulations on their books, the enforcement of these regulations has often been lax.
Lecture Note: U.S. exports of intellectual property were nearly $37 billion in 1998. Intellectual property imports were just $11.3 billion. Much of the trade in intellectual property was intracorporate trade. More details can be found at
{ http://www.oig.doc.gov/oig/reports/2000/USPTO-BTD-11747-08-2000.pdf }.
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Teaching Tip: Protecting intellectual property abroad is a key concern for many companies. The
U.S. government maintains a web site devoted to helping companies understand their rights on intellectual property. To learn more, go to
{ http://www.export.gov/regulation/exp_tic_ipr_article.asp
}.
Teaching Tip: For more information on U.S. Trademark law go to
{ http://www.law.cornell.edu/topics/trademark.html
}.
F) An international agreement signed about 170 nations (as of 2007) to protect intellectual property rights is known as the Paris Convention for the Protection of Industrial Property. Over 180 nations are part of the World Intellectual Property Organization. In addition, a new agreement known as the Trade Related Aspects of Intellectual Property Rights (TRIPS) requires WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years.
Teaching Tip: The World Intellectual Property Organization provides extensive information on various treaties and agreements between countries regarding the protection of intellectual property.
Go to { http://www.wipo.int/portal/index.html.en
} and click on About WIPO, and then on How
WIPO Works, and on Treaties
Management Focus: Starbucks Wins Key Trademark Case in China
Summary
This feature focuses on intellectual property laws in China. When Starbucks entered China in
1999, the company was quickly challenged by a look-alike competitor, Shanghai Xing Ba Ke
Coffee Shop. Not only did the name Xing Ba Ke mimic the Starbucks name, but Xing Ba Ke’s stores were virtual replicas of those operated by Starbucks. In 2003, Starbucks sued Xing Ba Ke for trademark violations. In 2006, Starbucks won its case, and Xing Ba Ke was fined $62,000 and ordered to stop using its name. The case was seen as a break through of sorts, a signal that China was finally caving to pressure from other nations and the World Trade Organization to respect intellectual property rights. Today, Starbucks operates over 300 stores in China and expects the market to become second only to the U.S.
Suggested Discussion Questions
1. Discuss the concept of property rights protection and why it is so important to companies. What does he court ruling against Xing Ba Ke mean for other companies that are already doing business in China, or are considering entering the market?
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Discussion Points: Most students will recognize that firms that depend on proprietary property such a brand name or technology for their competitive advantage probably also rely on property rights protection to ensure that competitors cannot benefit from their efforts. The finding against
Xing Ba Ke is a symbol that property rights protection should be taken seriously, and that blatant violations of property rights will not be tolerated.
2. How important is the Chinese market to Starbucks? Does the presence of look-alike companies like Xing Ba Ke deter firms from entering the market?
Discussion Points: With its growing middle class, the potential in the Chinese market is vast.
Some students might argue that the presence of Xing Ba Ke is actually a positive force for
Starbucks in that the coffee shop helps to promote the idea of coffee consumption in the Starbucks’ way. Most students however, will probably suggest that companies like Xing Ba Ke are a nuisance because they could potentially damage the reputation of Starbucks if customers have a negative experience at the stores, and because they require constant monitoring, and are a drain on profits.
Teaching Tip: To explore Starbucks in more depth, go to the company’s web site at
{ http://www.starbucks.com/
}. Click on “International” to explore individual country sites.
Product Safety and Product Liability
G) Different countries have different product safety and liability laws (safety standards to which a product must adhere). In some cases US businesses must customize products to adhere to local standards if they are to do business in a country, whether these standards are higher or just different.
H) When product standards are lower in other countries, firms face an important ethical dilemma.
Should they produce products only of the highest standards even if this puts them at a competitive disadvantage relative other producers and results in not maximizing value to shareholders? Or should they produce products that respond to local differences, even if that means that consumers may not be assured of the same levels of safety in different countries?
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THE DETERMINANTS OF ECONOMIC DEVELOPMENT
A) One reason for looking at the different political, economic, and legal systems in the world is that collectively these different systems can have a profound impact on the level of a country's economic development, and hence on the attractiveness of a country as a possible market and/or production location for a firm.
Differences in Economic Development
B) Different countries have dramatically different levels of economic development. One common measure of economic development is a country’s gross national income per head of population
(GNI).
To account for cost of living differences between countries, GNI can be adjusted by purchasing power. A purchasing power parity (PPP) adjustment allows for a more direct comparison of living standards in different countries. A drawback of both GNI and PPP data is that they provide only a static picture of development.
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Broader Conceptions of Development: Amartya Sen
C) Nobel Prize winning economist Amartya Sen has argued that development should be assessed less by material output and more by the capabilities and opportunities that people enjoy. Sen’s ideas have been picked up by the United Nations and are reflected in the Human Development
Index (a United Nations developed index based on life expectancy, education attainment, and whether average incomes are sufficient to meet the basic needs of life in a country). The index was developed to gauge a country’s economic development and likely future growth rate.
Political Economy and Economic Progress
D) What is the relationship between political economy and economic progress? This question has been the subject of a vigorous debate among academics and policy makers for some time.
Innovation and Entrepreneurship Are the Engines of Growth
E) Innovation is the process through which people create new products, new processes, new organizations, new management practices, and new strategies. Innovation is often seen as the product of entrepreneurial activity. Entrepreneurs first commercialize innovative new products and processes. There is broad agreement that innovation and entrepreneurship are the engines of long-run economic growth.
Innovation and Entrepreneurship Require a Market Economy
F) It has also been argued that the economic freedom associated with a market economy creates greater incentives for innovation and entrepreneurship than either a planned or mixed economy.
Innovation and Entrepreneurship Require Strong Property Rights
G) Strong legal protection of property rights is another requirement for a business environment conducive to innovation, entrepreneurship, and economic growth.
The Required Political System
H) In the West, it is often argued that democracy is good for economic growth. However, there are examples of totalitarian regimes that have fostered a market economy and strong property rights protection and experienced rapid economic growth. Given all the facts though, it seems likely that democratic regimes are far more conducive to long-term economic growth than a dictatorship, even one of the benevolent kind.
Economic Progress Begets Democracy
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I) While it is possible to argue that democracy is not a necessary precondition for the establishment of a free market economy in which property rights are protected, it seems evident that subsequent economic growth leads to establishment of democratic regimes.
Country Focus: Emerging Property Rights in China
Summary
This feature explores the effect of a new property law in China. The law, which was passed in
2007, gives both rural and urban land holders more secure property rights. The new law was a much needed response to the changes in China’s economy over the last 30 years. Under the law, urban land holders are granted 40 – 70 year leases, and rural land holders 30 year leases, and both groups have the right to automatically renew their leases. While the law has its limitations, it is a step toward strengthening property rights in China.
Suggested Discussion Questions
1. What prompted the new property law in China? Why did it take so long to actually develop the law?
Discussion Points: China’s economy has undergone significant changes over the last 30 years. The country has shifted from a centrally planned economy where state ownership ruled, to a dynamic market based system where some two thirds of economic activity is now conducted by private companies. So, while the state technically still controls all land, the new law means that private enterprises have a greater opportunity to behave as true land owners. The new law took 14 years to create thanks to significant opposition from Communist Party activists who believe that it violates basic communist policies.
2. China’s new law has implications for both urban land holders and rural land holders, but it is especially important for the latter group. Explain what China’s new property law means for farmers.
Discussion Points: The new law is important for both farmers and other land holders because it grants land holders the right to a long lease and the opportunity to renew the lease. In the past, many farmers found themselves evicted from their farms without compensation when the state took the land for housing or factories. Under the new law, while the state technically still controls all land, and could therefore, appropriate it, farmers have a more stable, secure environment. If the state needs the land, the farmer must be compensated. Still, the law fails to give farmers ownership rights to their land, and effectively prevents them from either acquiring additional land and taking advantage of scale economies, or selling their land, and moving into a more productive situation.
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Lecture Note: More details on China’s new property law are available at
{ http://english.gov.cn/2007-03/08/content_545473.htm
}.
Geography, Education, and Economic Development
J) Geography can also affect economic development. A landlocked country with an inhospitable climate, poor soil, few natural resources, and terrible diseases is unlikely to develop economically as fast as country with the opposite characteristics on each of these attributes.
K) While it can be hard to do much about unfavorable geography, education is something that governments can affect. Numerous studies suggest that countries that invest more in the education of their young people develop faster economically.
STATES IN TRANSITION
A) Since the late 1980s there have been two major changes in the political economy of many of the world’s nations. First, a wave of democratic revolutions swept the world, and many of the previous totalitarian regimes collapsed. Second, there has been a more away from centrally planned and mixed economies towards free markets.
The Spread of Democracy
B) One notable development of the past 15 years has been the spread of democracy (and by extension, the decline of totalitarianism. Three main reasons account for the spread of democracy.
First, many totalitarian regimes failed to deliver economic progress to the vast bulk of their population. Second, new information and communication technologies have broken down the ability of the state to control access to uncensored information. Third, in many countries the economic advances of the last quarter century have led to the emergence of increasingly prosperous middle and working classes who have pushed for democratic reforms.
The New World Order and Global Terrorism
C) The end of the Cold War and the “new world order” that followed the collapse of communism in Eastern Europe and the former Soviet Union, taken together with collapse of many authoritarian regimes in Latin America, have given rise to intense speculation about the future shape of global geopolitics. Author Francis Fukuyama, suggests a more harmonious world dominated by a universal civilization characterized by democratic regimes and free market capitalism, while others, including Huntington, envision a world that is split into different civilizations each of which with its own value systems and ideology.
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The Spread of Market-Based Systems
D) Paralleling the spread of democracy since the late 1980s has been the transformation from centrally planned command economies to market-based economies. The rationale for transformation has been the same the world over. In general, command and mixed economies failed to deliver the kind of sustained economic performance that was achieved by countries adopting market-based systems.
Teaching Tip: The CIA maintains a site with extensive information on every country in the world including a section on current issues. This can be an excellent “first stop” when conducting research on the market potential of a particular country or area. The site is available at
{ https://www.cia.gov/library/publications/the-world-factbook/ }.
Teaching Tip: The U.S. State Department produces a series of annual "Country Reports" to acquaint American businesses with other countries. Each report contains nine sections: (1) Key
Economic Indicators; (2) General Policy Framework; (3) Exchange Rate Policies; (4) Structural
Policies; (5) Debt Management Practices; (6) Significant Barriers to US Exports and Investments;
(7) Export Subsidies Policies; (8) Protection of US Intellectual Property; and (9) Worker Rights.
Information about obtaining these reports is available through the United States Department.
There is also a special section devoted to international business. The site is
{ http://www.state.gov/travelandbusiness/ }.
The Nature of Economic Transformation
E) The shift toward a market-based economic system typically involves at least three distinct activities: deregulation, privatization, and legal enforcement of property rights.
Deregulation
F) Deregulation involves removing restrictions on the free operation of markets, the establishment of private enterprises, and the manner in which private enterprises operate.
Privatization
G) Privatization transfers the ownership of state property into the hands of private investors. In order to attract investment and protect the interests of the private enterprise encouraged by the first two activities, changes typically need to be made to legal systems to protect the property rights of investors and entrepreneurs.
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Legal Systems
H) Laws protecting private property rights and providing mechanisms for contract enforcement are required for a well functioning market economy. Without a legal system that protects property rights, and without the machinery to enforce that system, the incentive to engage in economic activity can be reduced substantially by private and public entities that expropriate the profits generated by the efforts of private sector entrepreneurs.
Implications of Changing Political Economy
I) The implications for business of the move toward free markets and democracy are enormous.
Markets that were formerly off-limits to Western business are now open. However, just as the potential gains are large, so are the risks.
FOCUS ON MANAGERIAL IMPLICATIONS
A) The material discussed in this chapter has two broad implications for international business.
First, political, economic, and legal systems of a country raise important ethical issues that have implications for the practice of international business. Second, the political, economic, and legal environment of a country clearly influences the attractiveness of that country as a market and/or investment site.
Benefits
B) The long run monetary benefits of doing business in a country are a function of the size of the market, the present wealth (purchasing power) of consumers, and the likely future wealth of consumers. By identifying and investing early in a potential future economic star, firms may be able to gain first mover advantages (advantages that accrue to early entrants into a market) and establish loyalty and experience in a country. Companies that are late to enter a marker may suffer from late-mover disadvantages. Two factors that are reasonably good predictors of a country’s future economic prospects are its economic system and property rights regime.
Costs
C) The costs of doing business in a country are determined by a number of political, economic, and legal factors. Political costs can involve the cost of paying bribes or lobbying for favorable or fair treatment. Economic costs relate primarily to the sophistication of the economic system, including the infrastructure and supporting businesses. Regarding legal factors, it can be more costly to do business in countries with dramatically different product, workplace, and pollution standards, or where there is poor legal protection for property rights.
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Risks
D) As with costs, the risks of doing business in a country are determined by a number of political, economic, and legal factors. Political risk is the likelihood that political forces will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise. Economic risk is the likelihood that economic mismanagement will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise. Legal risk is the likelihood that a trading partner will opportunistically break a contract or expropriate property rights.
Overall Attractiveness
E) The overall attractiveness of a country as a potential market and/or investment site for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country.
1. Free market economies stimulate greater economic growth, whereas state-directed economies stifle growth! Discuss.
Answer: In a market economy, private individuals and corporations are allowed to own property and other assets. This right of ownership provides a powerful incentive for people to work hard, introduce new products, develop better advertising campaigns, invent new products, etc., all in the hopes of accumulating additional personal capital and wealth. In turn, the constant search on the part of individuals and corporation to accumulate wealth enriches the entire economy and creates economic growth. In contrast, in a command economy, private individuals and corporations are not allowed to own substantial quantities of property and other assets. The objective of a command economy is for everyone to work for “the good of the society.” Although this sounds like a noble ideal, a system that asks individuals to work for the good of society rather than allowing individuals to build personal wealth does not provide a great incentive for people to invent new products, develop better advertising campaigns, find ways to be more efficient, etc. As a result, command economies typically generate less innovation and are less efficient than market economies.
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2. A democratic political system is an essential condition for sustained economic progress.
Discuss.
Answer: This question has no clear-cut answer. In the West, we tend to argue that democracy is good for economic progress. This argument is largely predicated upon the idea that innovation is the engine of economic growth, and a democratic political system encourages rather than stifles innovation. However, there are examples of totalitarian regimes that have fostered a market economy and strong property rights protection and experienced rapid economic growth. The examples include four of the fastest growing economies of the past 30 years – South Korea,
Taiwan, Singapore, and Hong Kong – all of which have grown faster than Western economies.
However, while it is possible to argue that democracy is not a necessary precondition for the establishment of a free market economy, it seems evident that subsequent economic growth leads to establishment of democratic regimes. Several of the fastest-growing Asian economies have recently adopted more democratic governments.
3. What is the relationship between corruption (i.e., bribe taking by government officials) in a country and economic growth? Is corruption always bad?
Answer: Economic evidence suggests that high levels of corruption significantly reduce the economic growth rate in a country. By siphoning off profits, corrupt politicians and bureaucrats reduce the returns to business investment, and hence, reduce the incentive that both domestic and foreign businesses have to invest in that country. The lower level of investment that results has a negative impact on economic growth. However, while most students will probably agree that corruption is bad, some may point out that the U.S., despite its Foreign Corrupt Practices Act, does allow “grease payments” to expedite or secure the performance of a routine governmental action.
According to Congress, “grease payments” while technically bribes are not being used to obtain or maintain business, but rather are simply made to facilitate performance of duties that the recipients are already obligated to perform.
4. The Nobel prize-winning economist Amartya Sen argues that the concept of development should be broadened to include more than just economic development. What other factors does
Sen think should be included in an assessment of development? How might adoption of Sen’s views influence government policy? Do you think Sen is correct that development is about more than just economic development? Explain.
Answer: Sen has argued that development be assessed less by material output measures such as
GNP per capita, and more by the capabilities and opportunities that people enjoy. Sen suggests that development be seen as a process of expanding real freedoms that people experience, and as such, that development requires the removal of major impediments to freedom. Governments influenced by Sen might ensure that basic health care and education programs are available especially for women. Many students will agree with Sen and the notion that development is not just an economic process, but a political one too, and that to succeed citizens must be given a voice in the important decisions made for the country.
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5. You are the CEO of a company that has to choose between making a $100 million investment in either Russia or the Czech Republic. Both investments promise the same long-run return, so your choice of which investment to make is driven by considerations of risk. Assess the various risks of doing business in each of these nations. Which investment would you favor and why?
Answer: When assessing the risks of investment, one should consider the political, economic, and legal risks of doing business in either Russia or the Czech Republic. Today, the risk in Russia would probably be considered higher than the risk in the Czech Republic. The Czech Republic has recently been accepted as a member of the EU, and as such gains the benefits and stability offered by the EU. Russia, by contrast, is still many years away from even being in a position to be considered by the EU for membership. Depending upon when you are using the book, this situation could be different. (You also may want to substitute other countries into this question depending on current events and the countries with which you feel your students will be most familiar.)
6. Read the Opening Case on India in this chapter and answer the following questions: a. What kind of economic system did India operate during 1947-1990? What kind of system is it moving towards today? What are the impediments to completing this transformation? b. How might widespread public ownership of businesses and extensive government regulations have impacted (i) the efficiency of state and private businesses, and (ii) the rate of new business formation in India during the 1947-1990 time frame? How do you think these factors affected the rate of economic growth in India during this time frame? c. How would privatization, deregulation, and the removal of barriers to foreign direct investment affect the efficiency of business, new business formation, and the rate of economic growth in India during the post-1990 time period? d. India now has pockets of strengths in key high technology industries such as software and pharmaceuticals. Why do you think India is developing strength in these areas? How might success in these industries help to generate growth in other sectors of the Indian economy?
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Chapter 02 - National Differences in Political Economy e. Given what is now occurring in the Indian economy, do you think that the country represents an attractive target for inward investment by foreign multinationals selling consumer products? Why?
Answer: a. The economic system that developed in India after 1947 was a mixed economy characterized by a large number of state-owned enterprises, centralized planning, and subsidies. In 1991, India’s government embarked on an ambitious economic reform program. Much of the industrial licensing system was dismantled, and several areas once closed to the private sector were opened.
In addition, investment by foreign companies was welcomed, and plans to start privatizing stateowned businesses were announced. India has posted impressive gains since 1991, however there are still impediments to further transformation. Attempts to reduce import tariffs have been stalled by political opposition from employers, employees, and politicians. Moreover, the privatization program has been slowed thanks to actions taken by the Supreme Court. Finally, extreme poverty continues to plague the country. b. The mixed economy that developed in India after 1947 was characterized by a large number of state-owned enterprises, centralized planning, and subsidies. This system not only constrained the growth of the private sector, but it also consequently limited the effects of competition that typically promote efficiency and productivity in a free market system. The system even limited the actions of private companies, requiring them to get government approval for routine business activities. Production quotas and high import tariffs also stunted the development of a healthy private sector, as did restrictive labor laws that made it difficult to fire employees. Foreign exchange restrictions, limitations on foreign investment, controls on land use, and managed prices further exacerbated the situation. It would appear that India’s rate of economic growth was negatively affected during this time frame. By 1994, India’s economy was still smaller than
Belgium’s despite having a large population. Both GDP and literacy rates were very low, and a huge percentage of the population lived in poverty.
c. In 1991, India’s government embarked on an ambitious economic reform program. So far, the response to the program has been impressive. The economy expanded at an annual rate of about
6.3 percent from 1994 to 2004, and 9 percent annually from 2005 to 2007. Foreign investment is up from $150 million in 1991 to $15.3 billion in 2007. Certain sectors of the economy including information technology and pharmaceuticals have done particularly well. Still, problems persist.
Actions taken by the government continue to limit efficiency gains for private companies and the country’s high rate of poverty is still a major problem. d. India’s gains in information technology and pharmaceuticals are impressive. The country has emerged as a vibrant global center for software development, and India’s pharmaceutical companies have taken a strong global position by selling low cost generic versions of drugs that have come of patent in the developed world. As these industries continue to prosper, other sectors of the economy should also see the benefit of spillover effects.
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e. Foreign investment is up in India. In fact, foreign investment rose from $150 million in 1991 to
$15.3 billion in 2007. However, whether India is an attractive destination for foreign multinationals selling consumer products remains to be seen. Certainly, the large population will serve to attract some companies, but the fact that some 40 percent of the world’s population living in abject poverty are in India will scare other companies away. Moreover, it is still not easy to run a company in India thanks to laws limiting everything from who can be fired to who can manufacture certain products.
Summary
The closing case explores the political and economic situation in Venezuela since Hugo Chavez was elected president in 1998. When Chavez, who ran on a platform against corruption and economic mismanagement, initially took office, Venezuela’s economy was in a deep recession. Once in office,
Chavez consolidated his hold over the government by drafting a new constitution that put him in power until 2012, and reconfiguring the Supreme Court. As a result, Venezuela is now considered to be only
“partly free.” Economically, things have also remained difficult for Venezuela. Unemployment is high, and poverty continues to rise. Corruption is rampant, and there is a move to take certain industries into state ownership, with the oil industry being a particular target. Discussion of the case can revolve around the following questions:
QUESTION 1: Under Chavez’s leadership, what kind of economic system is being put in place in
Venezuela? How would you characterize the political system?
ANSWER 1: It would appear that Chavez is moving toward a socialist regime. Numerous enterprises have been taken over by the state, and other companies have been forced into reorganizing as “workers cooperatives”. The government is also extending its reach into rural areas, where it has seized farms and turned them into state-owned cooperatives. Chavez has also used some of the profits from the country’s soaring oil revenues to increase government spending on various social programs, some of which are modeled after programs in Cuba.
QUESTION 2: How do you think that Chavez’s unilateral changes to contracts with foreign oil companies will impact upon future investment by foreigners in Venezuela?
ANSWER 2: In the oil industry, which the country depends on for some 70 percent of its exports,
Chavez has pushed out foreign companies, and expanded the hold of the state run company.
Chavez announced in 2005 that the state would increase its royalties on oil sales from 1 percent to
30 percent, and that in 2006, the tax rate of oil sales would also increase from 34 percent to 50 percent. Most students will recognize that by making it more difficult for foreign investors to do business in the country, in the oil industry or otherwise, Chavez is threatening future economic growth.
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QUESTION 3: How will the high level of public corruption in Venezuela impact future growth rates?
ANSWER 3: Corruption in Venezuela is rampant. In 2007, Transparency International lowered its ranking of the country to 162 out of 179, making it one of the most corrupt countries in the world. Government officials are permitted to demand bribes in return for permission to expand operations or enter new lines of business. Many students will recognize the challenges of operating in an environment like the current situation in Venezuela. Some students will probably suggest that firms may reassess their investments given the new political and economic risks present in the country. Many students will probably conclude that a market that is considered to be only partly free, with rampant corruption and privatization taking place, is no longer a worthwhile destination.
QUESTION 4: Currently, Venezuela is benefiting from a boom in oil prices. What do you think might happen if oil prices retreat from their current high?
ANSWER 4: Oil prices are currently at an all-time high making Venezuela, one of the world’s largest producers of oil, very rich. So far, Chavez has been using the oil profits for various social programs. Most students will probably recognize that if oil prices begin to retreat, these programs will probably suffer. Some students may wonder whether falling oil prices could spell disaster for
Venezuela’s oil industry. Chavez has been maximizing the state’s share of oil revenues by pushing out foreign companies and increasing the hold of state-run Petroleos de Venezuela SA.
Consequently, if prices do fall, this organization will be more significantly affected.
QUESTION 5: In your estimation, what is the long run prognosis for the Venezuelan economy? Is this a country that is attractive to international businesses?
ANSWER 5: A recent World Bank study puts Venezuela as being one of the most regulated economies in the world. The move to take various enterprises under state control is also impeding economic growth. In the oil industry, for example, Chavez has reduced the stakes owned by foreign companies to give the state run company a bigger position. Most students will probably conclude that given the levels of corruption and regulation, the country is just too risky to consider as a destination for international companies.
Nissan’s chief financial officer, Alain Dassas, expects emerging markets in Russia, China, and the
Middle East to be the new growth markets for automakers. In fact, over 75 percent of all global auto sales growth in the next six years is expected to come from emerging markets like China and
India. In both of these markets an emerging middle class could hold the key to future growth.
However, both markets could also be considered risky both politically and economically.
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
Ask students to consider the overall attractiveness of these markets for the auto industry.
What are the economic costs of doing business in China and India?

Then, reflect on the political or legal issues that could threaten the success a firm entering the market.

Finally, ask students to consider the tradeoffs of operating in an emerging market like
China or India as compared to a more established market.
This exercise could be used at the beginning of the discussion of this chapter’s material, and/or again at the end. To take the discussion into greater depth, ask students read the pertinent selections in the additional readings section below. The exercise also works well at the beginning of the implications for managers section.
Use the globalEDGE Resource Desk { http://globalEDGE.msu.edu/ResourceDesk/ } to complete the following exercises.
You work for a manufacturing company that has operations in the U.S. and Western Europe.
However, increasing competition has prompted the firm to examine the option of shifting production to a lower-cost location. You have narrowed the list of potential countries down to
Taiwan, South Africa, and Argentina. Based on the political and economic risk ratings , how would you rate the attractiveness of these three countries for your company? Prepare a brief report summarizing your assessment, including a detailed rundown of risks for your top country choice.
Answer: There are several websites that provide countries’ risk ratings. These resources can be found under the “Reference: Rankings” category at http://globaledge.msu.edu/ResourceDesk/ by searching the term “ risk ratings
.” One of these sources, called “@rating” provides detailed analysis of their risk ratings as well. Once on the @rating website, select the country of interest from the drop down menu. The risk rating and the risk assessment are available for all three countries.
Search Phrase: “Risk Ratings”
Resource Name: @rating
Website: http://www.trading-safely.com/ globalEDGE Category: “Research: Rankings”
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The Market Potential Index (MPI) is an indexing study conducted by the Michigan State
University Center for International Business Education and Research (MSU-CIBER) to compare emerging markets on a variety of dimensions. Provide a description of the indicators used in the indexing procedure. Which of the indicators should have greater importance for a company that markets laptop computers? Considering the MPI rankings, which developing countries would you advise a company selling laptops to enter first?
Answer: The Market Potential Index is an annual ranking study exclusive to the globalEDGE website. It uses the list of emerging markets as identified by The Economist magazine, and analyzes them for their attractiveness to U.S. exporters. It is located under the globalEDGE
Resource Desk and can be found under the “Research: Rankings” category.
Search Phrase: “Market Potential Index”
Resource Name: MSU-CIBER: Market Potential Index
Website: http://globaledge.msu.edu/resourceDesk/mpi/ globalEDGE™ Category: “Research: Rankings”
China is India’s ‘Only Possible Threat’ http://www.businessweek.com/globalbiz/content/may2008/gb20080512_937505.htm
India & China: The Ties That Bind http://www.businessweek.com/globalbiz/content/jun2007/gb20070608_158875.htm?chan=search
Rolls-Royce Targets China’s Really Rich http://www.businessweek.com/globalbiz/content/may2008/gb2008057_847580.htm?chan=search
Emerging Markets Beckon World Carmakers http://www.businessweek.com/investor/content/mar2006/pi20060320_432455.htm?chan=search
Nokia’s Big Plans for India http://www.businessweek.com/globalbiz/content/aug2007/gb20070831_914354.htm?chan=search
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China’s Hybrid Car Future http://www.businessweek.com/lifestyle/content/jan2008/bw20080131_670037.htm
WIPO Guide to Intellectual Property Worldwide http://www.wipo.int/about-ip/en/
Small Business Primer to Filing for Trademarks in a Foreign Country http://www.ita.doc.gov/exportamerica/TechnicalAdvice/ta_trademarks.htm
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