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Subject COMMERCE

Paper No and Title Paper No.11: International Business

Module No and Title Module No.15: ROLE OF POLITICAL ENVIRONMENT

IN INTERNATIONAL BUSINESS
Module Tag COM_P11_M15

COMMERCE PAPER No.11 : INTERNATIONAL BUSINESS

MODULE No. 15: ROLE OF POLITICAL ENVIRONMENT IN
INTERNATIONAL BUSINESS
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TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
3. IMPORTANCE OF POLITICAL ENVIRONMENT IN INTERNATIONAL
BUSINESS
4. POLITICAL ENVIRONMENT AND ITS IMPLICATIONS FOR
INTERNATIONAL BUSINESS
5. POLITICAL RISKS
6. POLITICAL SOVEREIGNTY
7. SUMMARY

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1. Learning Outcomes
After studying this module, you shall be able to

 Appreciate the differences in the political systems of various countries and their
implications for international business
 Distinguish between aspects of democracy and totalitarianism
 Understand the meaning of political risk and type of political risks
 Identify ways in which MNCs can deal with political risk

2. Introduction

Political environment refers to the influence of the system of government and judiciary in a nation.
The system of government in a nation exercises considerable impact on its business. . Political
system, political parties in power, political parties in the opposition, political maturity of the parties,
number of political parties, political awareness of people, political stability and others have an
important impact on the business environment in a country. The economic policies pursued by
a Government are to a great extent the by-product of political environment that companies face
domestically and internationally.

Let me try to explain this by an example of a company doing business in USA would not find
much difference in the political environment of Canada as the two countries have a democratic
set up of selecting a government. Whereas, if an Australian company intends to do business in
Rwanda or Russia it would have to face many challenges. International business managers and
MNC’s should therefore try to foresee and understand these differences and existence of different
political groups in the host countries in order to avoid political tensions and instabilities.
Therefore, Political environment plays an important role in international business and an
international company cannot ignore the political situations in the home or the host country if it
has to operate successfully abroad. A company doing business outside its home country should
carefully study the government structure in the target country and analyze salient issues arising
from the political environment.

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3. IMPORTANCE OF POLITICAL ENVIRONMENT IN

INTERNATIONAL BUSINESS
According to Daniel’s etal, “A political system includes the complete set of institutions, political
organisations, and interest groups, as well as the relationships among institutions and the political
norms and rules that govern their activities.” Thus, a political system ensures some level of
stability in social relations and should be able to hold together people from different ideologies.
Differences in political ideologies change the national boundaries. For example, the difference in
ideologies lead to the partition of India and Pakistan in 1947 or the breakup of USSR.
Thus, a manager in order to do business in a foreign country needs to understand the political
environment which comprises of three dimensions:
(1) The home country perspective
(2) The International perspective
(3) The host country perspective
All these dimensions have to be carefully analysed by an international business manager. The
political set-up of any country influences the carrying of international business as one needs to
take decision as whether to invest or not, how to develop the identified markets and how to plan
the strategic formulation. Thus, political environment is relevant to international business, as
political factors play a vital role in the following areas:
(a) The nature of regulatory framework.
(b) The main areas of governmental control over MNC activities.
(c) The relative importance of various pressure groups within a nation.
(d) The likelihood of trade embargoes i.e. prohibitions on trade with particular nation.
(e) The degree of losses from political risks and the extent to which insurance can be taken.

(f) The tax regimes pertaining with specific countries

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4. POLITICAL ENVIRONMENT AND ITS IMPLICATIONS FOR

INTERNATIONAL BUSINESS
Appraisal of the political environment includes any national or international political factors that
can affect its operations. A factor is said to be political when it derives from the government
sector. The following are the elements of the political environment:
1. Form of Government:

The government is an integral part of every foreign and domestic business activity. Thus, a
multinational firm is affected by the political environment of the home country as well as the host
country. The ideal political climate for a multinational firm is a sable and friendly government.
Unfortunately, many governments are not always friendly and stable and changes in goals and
attitudes can cause a stable and friendly situation to become risky.
2. Stability of Government Policies:

Regardless of whichever government is in power or new political parties which are elected, the
concern of the multinational corporations is the continuity of set of rules or code of behavior. A
change in government, whether by elections or coups does not always mean a change in the
level of political risk. In Italy, for example, there have been more than 50 different governments
formed since the end of World War II. While the political turmoil continues in Italy, business goes
on as usual. Pepsi company operated profitably in the Soviet Union under one of the most
extreme political systems. If there is a potential for profit, companies can function under any type
of government as long as there is some long run predictability and stability.
3. Political Parties, their Philosophy and Ideology

Understanding the political systems helps an international manager to have an idea of political
systems and their impact on international business. Governments may be parliamentary (open) or
absolutist (closed).
 Parliamentary Governments: In parliamentary governments people are consulted and
are allowed to participate in decision-making on all important issues.
 Absolutist Governments: In absolutist government, the ruling government dictates
government policies, rules and regulations on all citizens without considering the
viewpoint of the ordinary people. For example, Saudi Arabia and North Korea have
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parliamentary type political systems where people are

not allowed to express their voice. Hence they are classified as monarchies and
dictatorships. Business in these countries is based on government policies rather than
the people’s needs.

Governments can be further classified as two party system, multi-party, single- party and one-
party dominated.
A. Two party System: Under this system two major parties take turn of controlling the
government. The USA and UK are the examples of two party system. For example, in
USA we have the Republican Party which represents the business interest and the
Democratic party represents the labour.
B. Multi-Party system: Under this system there are many parties and no party is strong
to gain the control of the government. For example, Germany, France, Israel, Poland
are examples of multi-party systems.
C. Single Party System: In this system only one dominant party gets the opportunity to
control the government, though several parties exist. For example, Egypt has a single
part system.
D. One-party dominated system: In this system, though there are more than one
party, the dominant party rules the government and it does not allow any opposition
party to come up. The former USSR, Cuba, Libya are examples of this system.
4. Role of Government in Home Country:

The firm’s home country’s political environment can constrain its international operations as
well as its domestic operations. It can limit the countries that the international firm can enter.
For example, the United States prohibits its firms from dealing with Cambodia, Cuba, Libya
and North Korea.
4.2 Democracy versus Totalitarianism
The political scenario often varies between the two extremes: ie, democracy on one hand and
totalitarianism on the other.
Democratic Form of Political System Democracy is one of the basic form of political system. It
refers to a political arrangement in which the supreme power is vested in the people. It rests on
the principle of “ Government of the people, for the people and by the people.” It rests on the
ideology that all citizens should be equal politically and legally; should enjoy widespread freedom
and should participate in political process. A democratic form of government exhibits a system,
where the public, in a democratic manner elects their representatives who do the ruling. A
representative democracy rests on the assumption that if the elected representatives fail to

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perform adequately they will be voted down in the next

election. India is the world’s largest democracy. The Principles of democracy are –
(1) Prominent rule of Law
(2) Universal right to vote
(3) Freedom of opinion, expression, speech and association.
(4) Limited term for elected officials.
(5) An accessibility to political decision-making process.
(6) An independent and fair court system with high regard for individuals right and property.

Political rights and civil liberties help for evaluating the freedom of citizen. Some of the indicators
of political rights and civil liberties are:
1. Conduct of elections fairly and competitively
2. Power and ability of voters in casting their rights
3. People’s ability in forming political parties and groups.
4. Existence of safeguards of minority rights.
5. Degree of freedom of the press.
6. Equality of all individuals under the law.
Countries such as, Australia, Bahamas, Canada, Japan and South Korea are high in political
rights and civil liberties. Whereas countries such as, Brazil, Ethiopia, Malaysia and Russia
are partly free countries. China, Egypt, Saudi Arabia and North Korea are not so much free
countries.
Democracies vary not only in the citizens participation in decision-making but also in the
degree of centralization of control. Canada and USA are highly decentralized as they
delegate significant political authority to provincial governments. Whereas political systems in
France, Japan and India are highly centralized and multinational companies enjoy easy
system to deal in such countries. Even the countries having mature democracies are facing
problems of corruption, indifference of people and maximizing personal interest rather than
national interest by the politicians.

75% of countries have democracies of some order. Of them, 1/3rd are more pluralistic, 1/3rd are
some 50:50 type and remaining 1/3rd are more totalitarian.

4.3 Totalitarianism form of political system

Totalitarianism, also called authoritarianism, is a form of government in which individual freedom
is completely subordinated to the power of the authority of state and concentrated in the hands of

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one person or in a small group, which is not constitutionally

accountable to the people. For example, Nazi Germany under Adolf Hitler is an example of
totalitarian governments.

A. Theocratic totalitarianism: Political system that is under the control of religious leaders
is theocratic totalitarianism. In such a system religious leaders are the political leaders
and they frame and enforce laws and regulations that are based on religious beliefs.
Afghanistan and Iran are examples of political dispensation.
B. Monarchy : This political system is a form of authoritaritism. It is based on the ideology
that king is the supreme power and the country is ruled by the royal family of the country.
The residents follow the norms and code of conduct as laid by the supreme power, and
he is preceded by his son or daughter. It can be as absolute Monarchism or
Constitutional monarchism, depending upon the degree of decision-making and control.
C. Dictatorship : At times when economic depression arises and a pure democratic system
is not workable in a complex society with a large constituency, there arises a need to
bring change in the political set-up. This gives rise to Dictatorship, where the power is
exercised by one man in an autocrat manner. It is based on the principle of obedience,
which believes that people show efficiency and productivity when they are forced to
follow certain rules and regulations.

5. POLITICAL RISKS
Political Risks
International business firms face political risk when they conduct business with the outside world.
Political Risks may be defined as any governmental action or politically motivated event that
could adversely affect the long-term profitability or value of firms. It involves the risk of a change
in government policy that would adversely impact a company’s ability to operate effectively and
profitably. Political risk affects different firms in different ways. It can threaten the market of an
exporter, the production facilities of a manufacturer or the ability of a firm to repatriate its profits
from a host country to home country. When the perceived level of political risk is lower, a country
is more likely to attract investment. The level of political risk is inversely proportional to a
country’s stage of development. All other things being equal, the less developed a company, the
greater the political risk. It can be confiscation, expropriation, domestication or nationalization,
general instability risk and operation risk.

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 Confiscation: The most severe political risk is

confiscation which means seizing a company’s assets (properties, investments) without
payment or compensation. Chinese government’s seizure of US property in 1949 when
Chinese communist party took power is an example of confiscation.
 Expropriation: Less drastic, but still severe is expropriation requiring some
reimbursement for the government-seized investment. Compensation is generally
provided to foreign investors, although not often in the “prompt, effective and adequate”
manner provided for by international standard. For example, Indian government
nationalized commercial banks with compensation in July 1969. Expropriation of copper
firms
 Nationalisation: Nationalisation is the process of shifting the ownership of private
property from private individuals or institutions to the Government. It is an intense feeling
of national pride and unity an awakening of a nation’s people to pride in their country. In
other words national interest and security are more important than international
consideration. These feelings of nationalism can be manifested in a variety of ways
including, “buy our country’s products only”, restriction on imports, restrictive tariffs and
other barriers For example, Burma nationalized entire foreign trade. Poland and Czech
communists nationalised 100 per cent of their economy.
 Domestication: In domestication foreign business firms relinquish control and ownership
in favour of domestic investors either partly or fully. In this host countries take steps to
transfer foreign investments to national control and ownership through a series of
government decrees. For example, in India Indian Leaf Tobacco Development Co and in
South Africa, Pepsi, General Motors and Barclays Bank have faced domestication.
 Entry Restrictions: If allowed to enter the country the firm may be restricted as to the
industries it may enter. It may be prohibited from acquiring a national firm. It may not be
allowed a 100 per cent ownership but may be required to enter a joint venture with
national firm.
 Quotas and tariffs: The country’s quotas and tariffs may limit the firm’s ability to import
equipment, components and products, forcing a higher level local procurement than it
may want.
 Exchange Controls: Exchange controls stem from shortages of foreign exchange held
by a country. When a nation faces shortages of foreign exchange, control would be levied
over all movements of capital and selectively against the most politically vulnerable
companies to conserve the supply of foreign exchange for the most essential use. A

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recurrent problem the foreign investor is getting profits

and investments converted into the currency of the home country.
 Price Controls: Essential products that command considerable public interest, such as,
pharmaceuticals, food, gasoline and cars are often subject to price controls. It may be
used to force foreign companies to sell equity to local interests. In inflationary economies
it can severely limit profitability. A side effect to the local economy can be slow or even
stop capital investment.
 General Instability Risk: These risks are due to social, political, religious unrest in the
country. For example, recent coup in Fiji and problems due to Muslim rebels in
Philippines.
 Operation risk: These risks are due to the imposition of controls on the foreign business
operation (like production levels, marketing, finance and human resource) by the host
government.

5.2 Indicator’s of Political Instability

Some of the indicators of political instability are:
1. Corruption: Corruption and bribery have become acute and prevalent not only
among bureaucrats but also among politicians during the early stage of political
instability.
2. Social Unrest: Social unrest is caused by clashes between or among community
groups, religious groups and ethnic groups. For example, Hindu-Muslim conflict in
India, Christian-Muslim conflict in Lebanon, white-black conflict in the USA, the civil
war between the Serbs and Croats in Yugoslavia.
3. Attitudes of Nationals: The negative attitude of nationals towards foreign business
and foreigners is a greater risk. These negative attitudes include, exploitation,
colonialism, repatriation, employment to foreigners.
4. Policies of the Host Government: Host government policies affect the operation of
international business directly and internally or externally.

5.3 How to minimize Political Risks?

Political risks cannot be completely eliminated however they can be minimized by
contributing to the change of the attitudes of the people and the government of the country
within which it operates. The measures that can be taken to lessen the degree of
susceptibility of a specific business venture to reduce political risks are:
1. Good Corporate Citizenship: Under this a company is advised to remember:
i) It is a guest in the country and should act accordingly.

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ii) The profits of an enterprise are not solely of the

multi nationals but the local national employees and the economy of the country
should also benefit.
iii) It is not wise to try to win over new customers by fraudulent techniques.
iv) It should try to contribute to the country’s economy and culture with worthwhile public
projects
v) It should train its executives and their families to act appropriately in the foreign
environment.
2. Stimulation of the Local Economy: The foreign company can stimulate the
economic development of the host country by investing in their priority areas /
portfolios. For example, when Toyota, a Japanese carmaker entered the US markets
it tried to convince the political parties that it would generate employment for the
locals in US. Further the foreign company may convince the host country that it would
assist the local companies by purchasing raw materials and other inputs from them
and also assist the local companies as ancillary units. Even the foreign company can
motivate the host economy by being export oriented.
3. Employment of Nationals: Mostly foreign companies feel that the people of
developing countries are lazy, unintelligent, unmotivated and less educated.
Multinational companies can minimize political risks by employing, developing and
promoting the local people.
4. Joint Ventures: If the multinational company owns the entire capital by itself, it can
increase political risk. Hence, it is suggested that the foreign company should allow
the domestic investors to invest and share the ownership by converting the company
into a public limited company. A joint venture with locals helps minimize anti-MNC
feelings, and a joint venture with another MNC adds the additional bargaining power
of a third country.
5. Expanding the Investment base: Including several investors and banks in financing
an investment in the host country is another strategy. This has the advantage of
engaging the power of the banks whenever any kind of government takeover or
harassment is threatened. This strategy becomes especially powerful if the banks
have made loans to the host country.
6. Political Payoffs and Planned Domestication: The former is an attempt to lessen
political risks by paying those in power to intervene on behalf of the MNC. In those
cases where an investment is being domesticated by the host country, the most
effective long-range solution is planned phasing out. This is a meaningful strategy
when it appears that there is rising hostility towards an investment.
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6. POLITICAL SOVEREIGNTY

Political Sovereignty
Political sovereignty can be defined as supreme and independent political authority. In the
control of international law, a sovereign state is independent and free from all external control,
enjoys full legal equality with other states, selects its own political economy and governs its own
territory. Sovereignty
refers to both the powers exercised by a state in relation to other countries and supreme power
exercises over its own members. A sovereign state is considered free and independent. It
regulates trade, managed the flow of people into and out of its boundaries and exercises
undivided jurisdiction over all persons and property within its territory. It has the right authority
and ability to conduct its domestic affairs without outside interference and uses its international
power and influence with full discretion.

6.1Functioning of Political Parties

The political parties in power influence the international business to a large extent, irrespective of
political system. The influence can be in favour of business or anti-business. A pro- business
political party in power can provide the business community an environment of growth,
competition and concern. Anti-business party in power would exercise a menace of fear. The
integrity of the political leaders and their kith and kin is a great factor which businesses need to
consider. Now businesses themselves identify with one or other party and who gets rewards
depend whose person are in power. When there is a coalition government, not just one single
political party dictates terms for the businesses. There are multiple concerns. Businesses struggle
to please too many political leaders. Parties in opposition and their leaders have the role to
question government’s decisions in the parliament/legislature. In a multiparty system, with
coalition governments running the government involves lot of compromises despite their common
minimum programme. This many times leaves the business community disheartened.

Political maturity of the parties and people and Political Stability

Political maturity of parties involves respecting the verdict; the ruling party must not be unfriendly;
the opposition parties must not be hostile. Incident free political rallies, absence of hooliganism,

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terminological pleasance in referring to individual members,

issue based expression of viewpoints, freedom to elected members to express their views
irrespective of party affiliation, etc are the hallmarks of political maturity. Impartiality of police
system and political non-intervention in its action are real test of political maturity. These are far to
expect. An air of uneasiness prevails which suffocates businesses. Opportunistic ideologies are
followed for short-term electoral gains. That is no maturity. The lesser the number of parties,
more the political maturity of people and the better the governance would be. The developed
world nations have fewer political parties, while less developed countries have too many political
outfits. Businesses suffer more uncertainty with more number of political parties, because the
policy environment becomes shaky.

Political stability is a crucial factor. The political system, the number of parties, ideologies of
parties, animosities amongst different parties, leadership characters of political parties, the
commitment of parties taking power to honor commitments made by previous governments, etc
influence political stability. Political stability also means consistency in political decisions, much
needed for inspiring confidence in the minds of business community, both national and
international. Lack of political stability is an indication of excessive risk businesses suffer.

6.2 Relationship between the State and the Businesses

There could be political instability and yet it may not transform into political risk for businesses.
This is so when the State respects the business enterprises concerned. Barring a few cases in
most countries, today businesses have good relationship with the Government due to LPG policy
pursued widely. Multilateral Investment Guarantee Agency (MIGA), bilateral agreements to
protect mutual investment interests, etc ensure that good relationship prevails between the State
and the MNCs.

Countries choose businesses across the globe for business relationship based on merits of
efficiency rather than political system followed. The USA, sees India as an economic opportunity.
So, political and strategic alliances are on the rise. India is also in good relationship with Japan,
the European Union, Russia, Republic of China and so on. So, business interests develop across
the globe.

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7. Summary
The political environment is an important factor that influences international business. The
political system, political parties in power, political parties in the opposition, political maturity of
the parties, number of political parties, political awareness of people, political stability and others
of the home country and host country have a strong impact on the business environment in a
country. A factor is said to be political when it derives from the government sector. Governments
can be further classified as two party system, multi-party, single- party and one-party dominated.
The political scenario often varies between the two extremes: ie, democracy on one hand and
totalitarianism on the other. International business firms face political risk when they conduct
business with the outside world. Political risk affects different firms in different ways. It can
threaten the market of an exporter, the production facilities of a manufacturer or the ability of a
firm to repatriate its profits from a host country to home country. When the perceived level of
political risk is lower, a country is more likely to attract investment. The level of political risk is
inversely proportional to a country’s stage of development. All other things being equal, the less
developed a company, the greater the political risk. It can be confiscation, expropriation,
domestication or nationalization, general instability risk and operation risk. If political risk exists,
be needs to be properly managed.

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MODULE No. 15: ROLE OF POLITICAL ENVIRONMENT IN
INTERNATIONAL BUSINESS