McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
• How world political environment affects international
business.
• Why sovereignty and interdependence of nations is essential
for international business
• Various kinds of government and the way countries are being
ruled and governed internationally has an impact on
international business.
• The political risks involved in international business.
• How a firm can assess vulnerability to political environments
across the world and take preventive measures to avert it.
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 Political Environment
• Companies face multi-
political systems all
over the world.
• Political and legal
environment have a
direct and indirect
bearing
• Multi nationals expose
their assets, business
strategies, expatriate
employees (Eg., Pepsi,
Coke, Wal-mart)

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 Political Environment

The politicians of the home and host countries both affect

and influence business in all its forms.
Multinational firms face labour leaders, environmentalists,
non governmental organisations and social activities for
one reason or the other .

Political systems and global business

The risk and benefits associated with global business are real. Trans-
national business opportunities not only permits but alos invites
nations efforts to exert influence over others.

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 Political Environment

An Independent and Sovereign state

A state that enjoys full legal and constitutional control on its
geographical territory and is free to enter into any kind of trade
agreement with other nation.

Interdependence of Nations
No nation can exist on its own. Today, the governments and their
stability depends on what is happening economically and
politically across nations.

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 Political Environment
Issue of home country vis-à-vis the Host Country
Companies have to be aware of the political problems arise due to
conflicts of interest between the home country and host country.
The day-to-day functioning, policy making, local NGO’s and
political parties, ideologies, both in home country and host
country do affect companies business prospects abroad.

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 Introduction

Question: What is the political economy of a country?

 A country’s political economy refers to its political,

economic, and legal systems
 These systems are interdependent, and interact and
influence each other
 A country’s political system has major implications for
the practice of international business

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 Political Systems

Question: What is a political system?

 A political system is the system of government in a

nation
 Political systems can be assessed
in terms of the degree to which they emphasize
collectivism as opposed to individualism
in terms of the degree to which they are democratic or
totalitarian

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 Political Systems

 Collectivism - stresses the primacy of collective goals

over individual goals
 Individualism - suggests individuals should have freedom
over their economic and political pursuits
 Democracy - government is by the people, exercised
either directly or through elected representatives
 Totalitarianism - one person or political party exercises
absolute control over all spheres of human life, and
opposing political parties are prohibited

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 Economic Systems

Question: What is an economic system?

 There are three types of economic systems: the market

economy, the command economy, and the mixed
economy
 A free market system is likely in countries where
individual goals are given primacy over collective goals
 State-owned enterprises and restricted markets are
common in countries where collective goals are
dominant

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 Economic Systems

 In a pure market economy the goods and services that a

country produces, and the quantity in which they are
produced is determined by supply and demand
 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
 A mixed economy includes some elements of a market
economy and some elements of a command economy

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 Legal Systems

Question: What is a legal system?

 Legal system - 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
laws regulate business practice
laws define the manner in which business
transactions are to be executed
laws set down the rights and obligations of those
involved in business transactions

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 Legal Systems

There are three main types of legal systems:

1. Common law - based on tradition, precedent, and
custom
 found in most of Great Britain’s former colonies,
including the United States
2. Civil law - based on a very detailed set of laws organized
into codes
 found in over 80 countries, including Germany,
France, Japan, and Russia
3. Theocratic law - based on religious teachings
 Islamic law is the most widely practiced
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Macro-Environmental Uncertainties
(Types)
Political Uncertainties  War
 Revolution
 coup d'état
 Democratic changes in government

Government Policy Uncertainties  Fiscal and monetary reforms

 Price controls
 Trade restrictions
 Nationalization
 Government regulation
 Barriers to earnings repatriation
 Inadequate provision to public
service

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(contd.)

Macroeconomic Uncertainties  Inflation

 Changes in relative price
 Foreign exchange rates
 Interest rates
 Terms of trade

Social Uncertainties  Changing social concerns

 Social unrest
 Riots
 Demonstrations
 Small-scale terrorist movements

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Consensus and Legitimacy

Consensus
Is the widespread acceptance of the decision-making
process in the political system by the individuals and
groups in the system. It is the instrument by which a
government itself becomes legitimized
Legitimacy
Is the use of power of the state by officials in
accordance with prearranged and agreed upon rules.
A legitimate act is also legal, but a lawful command is
not always legitimate

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 Question: What are the implications of the political
economy for international firms?

There are two main implications

1. the political, economic, and legal systems of a country
raise important ethical issues that have implications for the
practice of international business
2. the political, economic, and legal environment of a
country clearly influences the attractiveness of that country
as a market and/or investment site

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 Doing business in foreign markets involves risk
Political risk - 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 - 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 - the likelihood that a trading partner will
opportunistically break a contract or expropriate
property rights

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Political Risk

Political risk is the likelihood that

political forces will cause
unexpected and drastic changes
in a country’s environment that
significantly affects the
opportunities and operations of
a business enterprise

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• Indications of Political Risks –
• Economic Performance of the country
• Political Stability
• Spirit of Nationalism
• Risks related to Government’s Trade Policies
• Risks pertaining to Economic Policy
• Confiscation of International Firm’ Assets
• Expropriation of Firm’s Assets
• Nationalisation of Business Assets (Eg., Bolivia and Gas
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Industry)
Domestication : Domestication refers to the host country insisting on the
following
Using locally manufactured raw material for manufacturing products of
international firms.
Even European community has a local content requirement of 45% for all
foreign-owned manufacturing firms in Europe
Gradual transfer of ownership and management of international firms to local
managers.
Not permitting repatriation of funds and profits above a certain limit and
insisting on profits being deployed back in the local industry.

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• Diplomatic Severances and Political Sanctions (Eg., North Korea and
Nuclear Deal)

• Risks pertaining to NGO’s

• Issues such as child labour, environmental protection, women’s
emancipation, wildlife protection and prevention of cruelty to
animals etc. have often been raised by social activists to protest
against international firms.
• Risks pertaining to Religious and Political Terrorism and
Extremisms
• Terrorism on the Net
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• Risks pertaining to Religious and Political Terrorism and
Extremisms
• International extremists groups target international firms to
extract ransom money by kidnapping their employees and
expatriates. They pose threat to installations, machinery and
property.
• Terrorism on the Net
• Website hackers, threats on internet highway, hijacking entire
websites, floating duplicate and unauthorised websites are some
of the ways international business operations are attacked
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Types of Political Risk

Country-Specific
Is manifested in the mutual hostility between Israel
and Syria. One would expect that Israeli companies
would find little support in Syria, and the same would
apply for Syrian companies in Israel
Company-Specific
Invokes either a favorable or unfavorable response
aimed at a particular company
Project-Specific
Involves special treatment bestowed on a certain type
of project

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Types of Political Risk (contd.)

Transfer Risk
Is the change in the degree of ease or difficulty
experienced in making transfers of capital, goods,
technology, and people in and out of a country
Operational Risk
Is the impact on the operations of a firm caused by
changes in the government’s policies
Ownership Risk
Involves a change in the proportion of equity owned
by a company in a foreign subsidiary

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 3-
The Environments of Political Risk: assessing political risk 36

Host Country International

Environment Organizations
and Groups

Political Risk

Home Country
International Events
Environment

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Host Country Environment: forecasts of anticipated probability,
degree and nature of risk faced by the enterprise in the target
country can be made by international managers.
Home country environment: policy decisions by the home
country government directed at a particular foreign country can
have a serious impact on the operations of companies that have
business dealings and operations in that country.eg restrictions
on technology transfer to the target country.
International organizations and groups : This environment
dimension consists of third parties beyond the home and host
countries. Eg various Islamic fundamentalists groups, WTO,
IMF..eg UN sanctioned trade and investment in South Africa.
International Events:Political risks affect the firm wherever it is
in the world.eg first and second gulf wars caused major
disruptions in the global economic conditions., Oil prices… 2-37
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: Managing Political, Legal and Economic Risk

Direct Indirect

> Legal Action > Risk Insurance

Defensive/ > Host Operations > Contingency
Dependent on
Reactive Planning
Home > Home Country Govt.
> Control Makeup of Pressure on Host
Management Govt.
> Joint Ventures > Lobbying Home and
Proactive/ > Licensing Host Governments
Merging Agreements > Corporate
> Other Host Partners Citizenship
> Promote Host Goals in Host Country

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 Managing International
Political Risks
Internal firms cannot avoid politically risky regions because
• investments in these markets may provide returns that may
overweigh the risks.
• Of changes in political ,legal and economic environment.
• An International firm can proactively hedge ( strategic and
operational actions) against the implications of politically
imposed risks through various collaborations and strategic
initiatives.

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Authoritarian and Populist Leaders and effect on trade.

Authoritarian Leaders

An authoritarian leadership style is exemplified when a leader dictates

policies and procedures, decides what goals are to be achieved, and directs and
controls all activities without any meaningful participation by the subordinates.
Such a leader has full control of the team, leaving low autonomy within
the group. The leader has a vision in mind and must be able to effectively
motivate their group to finish the task. The group is expected to complete the
tasks under very close supervision, while unlimited authority is self-bestowed
by the leader. Subordinates' responses to the orders given are either punished
or rewarded.

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Populist Leaders

Populism is a range of political approaches that deliberately appeal to 'the

people', In political science, populism is the idea that society is separated into
two groups at odds with one another - "the pure people" and "the corrupt elite“
Populists typically present "the elite" as comprising the political, economic,
cultural, and media establishment, depicted as a homogeneous entity and
accused of placing their own interests, and often the interests of other
groups—such as foreign countries or immigrants—above the interests of "the
people".

Populist politics revolves around a charismatic leader who appeals to and

claims to embody the will of the people in order to consolidate his own power.

Populist parties can be anywhere on the political spectrum. In Latin America,

there was Venezuela's late President Chávez. In Spain, there is the Podemos
party, and in Greece the label has also been applied to Syriza.
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Populism thus has direct consequences for the international order as it exists
today.

States have failed to keep up with the industrial revolution. As labour markets
globally are disrupted by the adoption of new technologies, states have failed
to make up for the loss of jobs as a result of automation and declining
industries. Consequently, trade and economic integration have been seen as
negative drivers, rather than positive ones that can raise standards of living.

Second, states have not been able to properly distribute the benefits of the
international order. Globalisation has allowed for the distribution of tasks to
skilled labour around the world, but that often leads to the sidelining of those
without skills that suit today's needs. In a rapidly-changing economy, this has
created widening inequality that has largely gone unaddressed, fostering
resentment within blue collar communities that have received no assistance to
cope.

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Finally, cultures and values have crossed countries, and as societal fabrics
change rapidly, this has resulted in increasing resistance to the other' -
unfamiliar peoples, ideas, and beliefs that challenge pre-existing norms. The
value enshrined by the international order is the belief that countries are
stronger when they work together - but this cannot exist if people are
mistrustful of this very order for all these aforementioned reasons.

Political events of the past few years have called into question the future of an
integrated international economy

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Summary

Country risk (also known as political risk) refers to the potentially adverse
effects on company operations and profitability caused by developments in the
political, legal, and economic environment in a foreign country. Country risk
includes the possibility of foreign government intervention in firms’ business
activities.

For example, governments may restrict access to markets, impose bureaucratic

procedures on business transactions, and limit the amount of earned income
that firms can bring home from foreign operations. The degree of government
intervention in commercial activities varies from country to country. For
instance, Singapore and Ireland are characterized by substantial economic
freedom—that is, a fairly liberal economic environment. By contrast, the
Chinese and Russian governments intervene regularly in business affairs.

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