C 211 – Political and Economic Forces

Chapter 2 - Understanding Formal Institutions: Politics, Laws, and Economics

 Explain the concept of institutions and their key role in reducing uncertainty.

o Institutions are commonly defined as the rules of the game

o Institutions have formal/informal components, each w/ different supportive pillars

o Their key function is to reduce uncertainty, curtail transaction costs, and combat opportunism

 Articulate the two core propositions underpinning an institution-based view of global business.

o Proposition 1: Managers and firms rationally pursue their interests and make choices w/in formal
and informal institutional constraints in a given institutional framework

o Proposition 2: When formal constraints are unclear or fail, informal constraints will play a larger
role

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 Identify the basic differences between democracy and totalitarianism.

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o Democracy is a political system in which citizens elect representatives to govern the country

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Totalitarianism is a political system in which one person or party exercises absolute political
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control

 Outline the differences among civil law, common law, and theocratic law.
o

o Civil law uses comprehensive statuses and codes as a primary means to form legal judgments
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vi y re

o Common law is shaped by precedents and traditions from previous judicial decisions

o Theocratic law is a legal system based on religious teachings, such as Islamic law
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 Understand the importance of property rights and intellectual property rights.

ar stu

o Property rights are legal rights to use an economic resource and to derive income and other
benefits from it
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o Intellectual Property refers to intangible property that is the result of intellectual activity
Th

 Appreciate the differences among market economy, command economy, and mixed economy.

o Market economy is characterized by laissez faire and total control by market forces
sh

o Command economy is defined by gov’t ownership and control of all means of production

o Most countries operate mixed economies, w/ a different emphasis on market versus command
forces

 Participate in two leading debates concerning politics, laws, and economics.

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 C 211 – Political and Economic Forces

o What drives economic development:

 Culture, geography, or institutions?

o Private ownership vs. state ownership

 Draw implications for action.

o Have a thorough understanding of the formal institutions before entering a country

o Insisting on formalizing the contract in initial negotiations may backfire in some countries

 Understanding Institutions

o Institutions are commonly defined as “the rules of the game.”

o Institutions have formal and informal components, each w/ different supportive pillars

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 Cognitive Pillar – Refers to internalized, taken-for-granted values and beliefs that guide individual and

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firm behavior

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 Formal Institutions – Laws, regulations, and rules

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 Informal Institution – Include norms, cultures, and ethics

 Institutional Framework – Made up of formal and informal institutions governing individual and firm
behavior
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 Institution Based View – Requires firms to constantly monitor, decode, and adapt to the changing rules of
vi y re

the game to survive and prosper

 Institutions – Popularly known as “the rules of the game”

ed d

 Institutional Transitions – Fundamental and comprehensive changes introduced to the formal and informal
rules that affect firms as players
ar stu

 Normative Pillar – Refers to how the values, beliefs, and actions of other relevant players – Collectively
known as norms – influence the behavior of local individuals and firms
is

 Regulatory Pillar – Coercive power of governments

Th

 What do Institutions Do?

o Key functions of institutions are to reduce uncertainty, curtail transaction costs, and combat
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opportunism

 Institutional Transitions – Defined as “fundamental and comprehensive changes introduced to the formal
and informal rules of the game that affect organizations as players.”

 Opportunism – Defined as self-interest seeking

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 C 211 – Political and Economic Forces

 Transaction Costs – Defined as costs associated w/ economic transactions – or more broadly, costs of
doing business

 Institution Based View of Global Business

o Proposition 1 – Managers and firms rationally pursue their interests and make choices w/in
formal and informal institutional constraints in a given institutional framework

o Proposition 2 – When formal constraints are unclear or fail, informal constraints will play a larger
role

 Political Systems

o Democracy is a political system in which citizens elect representatives to govern the country

o Totalitarianism is a political system in which one person or party exercises absolute political
control

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 Communist Totalitarianism – Centers on a communist party

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 Democracy – Political system in which citizens elect representatives to govern the country on their behalf

o.
Political Risk – Risk associated w/ political changes that may negatively impact domestic and foreign firms

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 Political System – Refers to rules of the game on how a country is governed politically

 Right Wing Totalitarianism – Characterized by intense hatred of communism

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aC s

 Theocratic Totalitarianism – Refers to monopolization of political power in the hands of one religious
party or group
vi y re

 Totalitarianism (Dictatorship) – Defined as political system in which one person or party exercises
absolute political control over the population
ed d

 Tribal Totalitarianism – Refers to one tribe or ethnic group (which may/may not be majority of population)
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monopolizing political power and oppressing other tribes or ethnic groups

 Political Risk – Involves risk associated w/ political changes that may negatively impact domestic and
foreign firms
is

Legal Systems
Th

o Civil law uses comprehensive statuses and codes as primary means to form legal judgments
sh

o Common law is shaped by precedents and traditions from previous judicial decisions

 Civil Law – Uses comprehensive statuses and codes as primary means to form legal judgments

 Common Law – Shaped by precedents and traditions from previous judicial decisions

 Copyrights – Exclusive legal rights of authors and publishers to publish and disseminate their work

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 C 211 – Political and Economic Forces

 Intellectual Property – Specifically refers to intangible property resulting from intellectual activity (such as
books, videos, and websites)

 Intellectual Property Rights (IPRs) – Rights associated w/ ownership of intellectual property. IPRs
primarily include rights associate with (1) patents, (2) copyrights, and (3) trademarks.

 Legal System – Refers to rules of the game on how a country’s laws are enacted and enforced

 Patents – Legal rights awarded by gov’t authorities to inventors of new products or processes, who are
given exclusive rights to derive income from such inventions through activities such as manufacturing,
licensing, or selling

 Piracy – Unauthorized use of IPRs is widespread, ranging from unauthorized sharing of music files to
deliberate counterfeiting of branded products

 Property Rights – Legal rights to use an economic property (resource) and to derive income and benefits
form it

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 Theocratic Law - Legal system based on religious teachings

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Trademarks – Exclusive legal rights of firms to use specific names, brands, and designs to differentiate

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
their products from others

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 Economic Systems
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o Pure market economy is characterized by laissez faire and total control by market forces

o Pure command economy is defined by gov’t ownership and control of all means of production
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aC s

o Most countries operate mixed economies w/ different emphasis on market versus command forces
vi y re

 Command Economy – Under this system, all factors of production should be gov’t or state-owned and
controlled, and all supply, demand, and pricing are planned by the gov’t
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 Economic System – Refers to rules of the game on how a country is governed economically
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 Market Economy – Term referring to a system characterized by the “invisible hand” of market forces:
Gov’t takes a hands-off approach known as the laissez faire
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 Mixed Economy – By definition, an economic system that has elements of both a market economy and a
command economy
Th

 State Owned Enterprises (SOEs) – Firms at least 10% owned by the state

 Sovereign Wealth Fund (SWF) – State owned investment fund

sh

 Debates and Extensions

o Three leading debates:

 What drives economic development?

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 C 211 – Political and Economic Forces

 What are the most effective and least disruptive institutional transitions toward more
market competition?

 How to best measure political risk?

 Market Transition Debate – Pertains to how to make the transitions work in a most effective and least
disruptive way

 Moral Hazard – Refers to recklessness when people and organizations (including firms and governments)
don’t have to face the full consequences of their actions

 Path Dependency – Present choices of countries (as well as firms and individuals) are constrained by
choices made previously

 Washington Consensus – View centered on unquestioned belief in superiority of private ownership over
state ownership in economic policymaking that is often spearheaded by 2 Washington-based international
organizations: International Monetary Fund and World Bank

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 Management Savvy

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o Managers considering working abroad should have a thorough understanding of formal

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institutions before entering a country.

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o
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In situations where formal constraints are unclear, managers can reduce uncertainty by relying on
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informal constraints, such as relationship norms
o
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vi y re
ed d
ar stu
is
Th
sh

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