Political and Legal Systems

in National Environments
OBJECTIVES
Contents
01 Distinguish political and legal environments in international
business. Understand political and legal systems.

Contents
02 Know the participants in political and legal systems

Contents
03 Identify the types of country risk produced by political systems.
Identify the types of country risk produced by legal systems.

Contents
04 Know about managing country risk
  Usual for business people to make
payments to facilitate business, and
some bribes exceed U.S. $100,000,
enough to buy a small flat in Moscow
 Counterfeiting is a problem
 Selling of pirated software, music, and
movies. Russian police are aware of
these products but usually do not issue
fines or arrest the sellers
 Country risk and a confusing legal
system are serious business
impediments in Russia
 Russia’s political system remains
Risks in Russia’s volatile. (Yukos)
 Organized crime is also part of the
Political and difficult landscape. (Chairman)
Legal Systems
 Many direct investors hesitate to
do business in Russia. Instability
in Russia’s legal environment has
triggered much capital flight.
 Ambiguous regulations,
inadequate laws, and capricious
enforcement pose important
challenges
 Exposure to potential loss or
adverse effects on company
operations and profitability
caused by developments in a
country’s political and/or legal
environments
 Sometimes termed political risk

Country Risk
How Prevalent is
Country Risk?
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Political and Legal Environments
in International Business
 The principal functions of a
Political system is political system are to:
a set of formal • Provide protection from
institutions that external threats.
• Ensure stability based on
constitute a laws.
government. It • Govern the allocation of
includes legislative valued resources among
the members of a society
bodies, political • Define how a society’s
parties, lobbying members interact with
groups, and trade each other.

unions.
 A legal system includes
Legal system is institutions and procedures
a system for that:
• Ensure order,
interpreting and • Resolve disputes in civil
enforcing laws. and commercial
activities,
Laws, • Tax economic output.
regulations, and • Provide protections for
private property,
rules establish including intellectual
norms for property and other
company assets.
conduct.
 Political and legal systems are dynamic and
constantly changing. The two systems are
interdependent—changes in one affect the
other. Adverse developments in political
and legal systems give rise to country risk.

Unfavorable developments give rise to new

conditions that may threaten the firm’s
products, services, or business activities

Source of
Country Risk
Political Systems

The world is characterized by three major

types of political systems:
1.Totalitarianism
2.Socialism
3.Democracy
 Totalitarianism

Under totalitarianism, the state attempts to

regulate most aspects of public and private
behavior. A totalitarian government seeks to control
not only all economic and political matters but also
the attitudes, values, and beliefs of the citizenry.
 Totalitarianism
Types Party membership Power Tolerance

Totalitarian states is mandatory for Power is maintained Totalitarian states

are generally either by means of secret
theocratic (religion- those seeking to usually do not tolerate
police, propaganda activities by individuals
based) or secular advance within disseminated through
(non–religion-based). or groups such as
Usually there is a the social and state-controlled mass
media, regulation of churches, labor unions,
state party led by a economic
dictator, such as free discussion and or political parties that
Kim Jong-un in
hierarchy. are not directed toward
criticism, and the use
North Korea. of terror tactics. the state’s goals.
Socialism
capital and wealth should be vested in the
production rather than for profit. Socialism
It remains a viable
system in much of the
world. Social democratic
governments frequently
intervene in the private
sector and in business
activities, as in Italy and
Norway. Corporate
income tax rates are
often relatively high, as
in France and Sweden.
Even robust economies
such as Germany have
experienced net outflows
of FDI as businesses
seek to escape
extensive regulation.
Socialism’s fundamental principle is that
Collectivism is a political
theory associated with
communism. More broadly, it is
state and used primarily as a means of the idea that people should
prioritize the good of society
is based on a collectivist ideology over the welfare of the individua
Collective welfare of people is
seen to outweigh the welfare of
the individual. Socialists argue
that capitalists receive a
disproportionate amount of
society’s wealth relative to
workers. They argue government
should control the basic means
of production, distribution, and
commercial activity.
 Democracy
Under democracy, the individual pursuits of people and firms are sometimes at odds with equality and justice.
Because people have differing levels of personal and financial resources, each performs with varying degrees
of success, leading to inequalities. Critics of pure democracy argue that when these inequalities become
excessive, government should step in to correct them. Each society balances individual freedom with broader
social goals. In democracies such as Japan and Sweden, the democracy’s rights and freedoms are construed in
larger societal terms rather than on behalf of individuals. Virtually all democracies include elements of
socialism, such as government intervention in the affairs of individuals and firms. Socialism emerges because
of abuses or negative externalities
 Democracy
Democracy is characterized by two major features:
1. Private property rights
Individuals can own property and assets and increase one’s asset base by accumulating private wealth.
Property includes tangibles, such as land and buildings, as well as intangibles, such as stocks, contracts,
patent rights, and intellectual assets. Democratic governments devise laws that protect property rights. People
and firms can acquire property, use it, buy or sell it, and bequeath it to whomever they want. These rights are
important because they encourage individual initiative, ambition, and innovation as well as thrift and the desire
to accumulate wealth.

2. Limited government
The government performs essential functions that serve all citizens.
These include national defense; maintenance of law and order and diplomatic relations; and constructing and
maintaining infrastructure such as roads, schools, and public works.
State control and intervention in the economic activities of private individuals or firms is minimal. By allowing
market forces to determine economic activity, the government ensures that resources are allocated with maximal
efficiency.
Time, Money and Reputation.
Democracy’s Link to Economic Freedom and
Transparency

Economic freedom
flourishes when
governments support
the institutions
necessary for that
freedom, such as freely
operating markets and
the rule of law
Political freedom is
characterized by:
• Free and fair elections,
• The right to form political
parties,
• Fair electoral laws,
• Existence of a parliament or
other legislative body,
• Freedom from domination
by the military, foreign
powers, or religious
hierarchies.
• Self-determination for
cultural, ethnic, and
religious minorities.
Political and Economic Freedom
Economic freedom is
related to:
• The extent of
government interference
in business,
• The strictness of the
regulatory environment.
• The ease with which
commercial activity is
carried out according to
market forces.
Political Systems and Economic Systems
The relationship between the two systems

Each political system tends to be associated

with a particular type of economic system.

1
Totalitarianism = command
economies.

2
Democracy = market
economies.
3
Socialism = mixed
economies.
Command Economy
Also known as centrally planned
economy.

State is the dominant Sizable bureaucracy China and Russia still exhibit
force in the production thrives, and central some characteristics of
and distribution of planning tends to be less command economies.
goods and services. However, the system is
efficient than market forces
Central planners make gradually dying out and being
in synchronizing supply
resource allocation replaced by market
decisions, and the state and demand. For example,
economies and mixed
owns major sectors of goods shortages were so economies.
the economy. common in the Soviet
Union that people often
waited in lines for hours to
buy basic necessities such
as sugar and bread.
 Market Economy
Market forces—the Market economies are The task of the state is
interaction of supply closely associated to establish a legal
and demand—
determine prices in a
with capitalism, in system that protects
market economy. which the means of private property and
Government production are contractual
intervention in the privately owned and agreements. However,
marketplace is operated. Participants the government may
limited, and economic
decisions are left to
typically exhibit a also intervene to
individuals and firms. market-oriented address the
mentality and inequalities that
entrepreneurial spirit. market economies
sometimes produce.
 Mixed
A mixed economy exhibits
the features of both a
market economy and a
command economy. It
combines state
intervention and market
mechanisms for organizing
production and distribution.
Most industries are under
private ownership, and
entrepreneurs freely
establish, own, and
operate corporations. But
the government also
controls certain functions,
such as pension programs,
labor regulation, minimum
wage levels, and
environmental regulation.
Economy
In France, for example, the government partly owns
dozens of companies, mainly in the transportation,
communication, and energy industries. Peugeot and
Renault are partially state owned. In Germany, Japan,
Norway, Singapore, and Sweden, the government
often works closely with business and labor groups to
determine industrial policy, regulate wage rates, and/or
provide subsidies to support specific industries. The
past century saw a large increase in the number of
mixed economies and a concurrent rise in government
involvement in economic matters.
 Legal Systems
Legal systems provide a framework of rules and
norms of conduct that mandate, limit, or permit
specified relationships among people and
organizations and provide punishments for those
who violate these rules and norms.

 Legal systems are dynamic—they evolve over

time to represent each nation’s changing social
values and the evolution of their social, political,
economic, and technological environments.

Laws are effective and legitimate if they are:

 Applied to all citizens equally.
 Issued through formal procedures by recognized
government authorities.
 Enforced systematically and fairly by police forces
and formally organized judicial bodies.
 Rule of Law
Nations are primarily governed by one of four basic legal systems:
• Common law
• Civil law
• Religious law
• Mixed Systems
Common Law
Also known as case law.

Legal system that The basis of common Common law is more

originated in England
and spread to Australia, law is tradition, flexible than other
Canada, the United previous cases, and legal systems because
States, and former legal precedents set it is more open to
members of the British
Commonwealth. by the nation’s courts interpretation by
through interpretation courts. Judges in a
of statutes, legislation, common-law system
and past rulings. have substantial
power to interpret laws
based on the unique
circumstances of
individual cases.
Civil Law
Also known as code Law.

Found in France, Civil law is It is divided into three

Germany, Italy, codes: commercial,
Japan, Turkey, based on an all- civil, and criminal.
and Latin inclusive system
America. Its of laws that have
origins go back to
Roman law and been codified;
the Napoleonic the laws are
Code. clearly written
and accessible.
Both common law and civil law systems originated in Western Europe and
represent the common values of western Europeans. In reality, common-law
systems generally contain elements of civil law and vice versa. The two
systems complement each other, and countries that employ one also tend to
employ some elements of the other.
Religious Law
This legal system is Islamic law, also known as China and Russia still exhibit
strongly influenced by the shariah, is based on some characteristics of
religious beliefs, ethical the Qur’an, the holy book command economies.
codes, and moral However, the system is
of Muslims, and the
values viewed as gradually dying out and being
teachings of the Prophet
mandated by a supreme replaced by market
being. The most Mohammed. Adherents
economies and mixed
important religious legal generally do not economies.
systems are based on differentiate between
Hindu, Jewish, and religious and secular life.
Islamic law. Among Islamic law governs
these, the most relationships among
widespread is Islamic people, between people
law, found mainly in the
and the state, and between
Middle East and North
people and a supreme
Africa.
being.
Mixed Systems
Mixed systems Legal systems in Indonesia China and Russia still exhibit
consist of two or and most Middle Eastern some characteristics of
more legal systems countries share elements command economies.
operating together. In of civil law and Islamic law. However, the system is
most countries, legal Historically, socialist law gradually dying out and being
replaced by market
systems evolve over was a legal system found
economies and mixed
time, adopting in the former Soviet Union, economies.
elements of one China, and a few states in
system or another Africa. It was based on civil
that reflect their law, with elements of
unique needs. socialist principles that
emphasized state
ownership of property.
Command Economy
Also known as centrally planned
economy.

State is the dominant Sizable bureaucracy China and Russia still exhibit
force in the production thrives, and central some characteristics of
and distribution of planning tends to be less command economies.
goods and services. However, the system is
efficient than market forces
Central planners make gradually dying out and being
in synchronizing supply
resource allocation replaced by market
decisions, and the state and demand. For example,
economies and mixed
owns major sectors of goods shortages were so economies.
the economy. common in the Soviet
Union that people often
waited in lines for hours to
buy basic necessities such
as sugar and bread.
Command Economy
Also known as centrally planned
economy.

State is the dominant Sizable bureaucracy China and Russia still exhibit
force in the production thrives, and central some characteristics of
and distribution of planning tends to be less command economies.
goods and services. However, the system is
efficient than market forces
Central planners make gradually dying out and being
in synchronizing supply
resource allocation replaced by market
decisions, and the state and demand. For example,
economies and mixed
owns major sectors of goods shortages were so economies.
the economy. common in the Soviet
Union that people often
waited in lines for hours to
buy basic necessities such
as sugar and bread.
Command Economy
Also known as centrally planned
economy.

State is the dominant Sizable bureaucracy China and Russia still exhibit
force in the production thrives, and central some characteristics of
and distribution of planning tends to be less command economies.
goods and services. However, the system is
efficient than market forces
Central planners make gradually dying out and being
in synchronizing supply
resource allocation replaced by market
decisions, and the state and demand. For example,
economies and mixed
owns major sectors of goods shortages were so economies.
the economy. common in the Soviet
Union that people often
waited in lines for hours to
buy basic necessities such
as sugar and bread.
Command Economy
Also known as centrally planned
economy.

State is the dominant Sizable bureaucracy China and Russia still exhibit
force in the production thrives, and central some characteristics of
and distribution of planning tends to be less command economies.
goods and services. However, the system is
efficient than market forces
Central planners make gradually dying out and being
in synchronizing supply
resource allocation replaced by market
decisions, and the state and demand. For example,
economies and mixed
owns major sectors of goods shortages were so economies.
the economy. common in the Soviet
Union that people often
waited in lines for hours to
buy basic necessities such
as sugar and bread.
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