Chapter 3 – Governmental and Legal Systems

Chapter 3 – Governmental and Legal Systems

The Political Environment
• Major impact on MNC’s/MNE’s by domestic and international political environments.
• MNCs/MNEs must adjust their strategies and practices to accommodate the new perspectives and
actual requirements of government policies
• Political systems integrates the diverse elements of a society.

Role of Executives
• Evaluate, monitor, and forecast the dimensions and dynamics of foreign political
environments.
• Study how government officials exercise authority, legislate policies, regulate enterprise, and
punish wrongdoers
• Monitor how politicians are elected and whether and how they depart
• Assess whether the rule of law or of man prevails.
• Gauge whether freedom is a practical ideal or a wishful abstraction.
• Based on their analyses, they forecast business scenarios, always mindful that political stability
rewards investment while political uncertainty penalizes it
Chapter 3 – Governmental and Legal Systems
Manager’s role (study the following)
• Structural dimensions and power dynamics of the government
1. Institutions, organizations and interest groups
2. Norms and groups that govern political activities
• Nation’s political system:
• Mission is to integrate different groups into a functioning, self-governing society.
• The rights of citizens under governments ranging from fully democratic to totalitarian
(ideology of the system)
• Focus of the political system is on individuals or the broader collective. (individualism or
collectivism)
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Individualism or collectivism
Individualism
• People should be free to pursue economic and political endeavors without constraint.
Government interest should not influence individual behavior
• Synonymous with capitalism and is connected to a free-market society, which encourages
diversity and competition, compounded with private ownership, to stimulate productivity.
Collectivism
• Needs and goals of society at large as more important than individual desires.
• Individual rights should be sacrificed and property should be commonly owned. (Luthans &
Doh, 2015).
Chapter 3 – Governmental and Legal Systems
Spectrum analysis (Luthans & Doh, 2015)
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Democracy
• A government “of the people, by the people, for the people.”
• All citizens are politically and legally equal, entitled to freedom of thought, opinion, belief, speech, and association, and
command sovereign power over public officials.
• A democratic government protects personal and political rights, civil liberties, fair and free elections, and independent
courts of law.
• These principles and practices institutionalize political freedoms and civil liberties that, by endorsing equality, liberty,
and justice, support individualism.
• Ways: Representative, Multi Party, Parliamentary, Social
• Steady diffusion of Democracy during the 2nd half of the 20th century. Between 1950 and 2009, the number of
democratic political systems grew from 22 out of 154 countries (14 percent) to 90 out of 193 countries (47 percent).

Business implications (democracy)

• In a democracy, MNEs invest and operate based on economic, not political, standards.
• Business environments promote commerce, expand trade, and streamline exchange, both within and across countries.
• Market activities, not bureaucratic regulation, organize a productive business environment.
• Managers and consumers are free to do as they see fit. In political terms, freedom sanctions rights and liberties; in
economic terms, it legitimizes profits and prosperity.
• Brazil, India, Indonesia, and Turkey provide cases in point. Their belief in central planning run by a strong state had led to
stagnant if not failing economies 20 years ago. Now these countries are converting the energy of their emerging
democracy into dynamic business environments (Daniels, Radebaugh, & Sullivan, 2019).
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Totalitarianism
• Totalitarianism refers to a political system in which there is only one representative party, which
exhibits control over every facet of political and human life.
• Power is often maintained by suppression of opposition, which can be violent.
• Media censorship, political repression, and denial of rights and civil liberties are dominant ideals. If
there is opposition to government, the response is imprisonment or even worse tactics, often torture.
This may be used as a form of rehabilitation or simply a warning to others who may question the
government (Luthans & Doh, 2015).
• Different degrees: Authoritarianism, Fascism, Secular, Theocratic
Business implications (Totalitarianism)
• Managers in totalitarian systems face markets that are radically different from those in democracies.
• Private enterprise, if permitted, supports state control of economic activities. For instance, the
Chinese government, under the direction of the CCP, owns and manages large swathes of the
economy. The state is the majority owner of 99 of the 100 largest publicly listed Chinese companies,
39 of which are among the 500 biggest in the world.45 Similarly, 129 huge conglomerates in finance,
media, mining, metals, transportation, communication, and so on answer directly to the CCP.
Likewise, China’s provincial and municipal officials control thousands of medium-sized and smaller
ones.46 Add it all up and you have an authoritarian system that rejects many of the practices found in
a democracy (Daniels, Radebaugh, & Sullivan, 2019).
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Standard of Freedom
• Freedom House, an independent watchdog organization that promotes liberty worldwide, helps
frame our interpretation.
• “Freedom is possible only in democratic political systems in which the governments are accountable
to their own people; the rule of law prevails; and freedoms of expression, association, and belief, as
well as respect for the rights of minorities and women, are guaranteed.”
• Three (3) types of systems:
1. A “free” country exhibits open political competition respect for civil liberties, independent civic
life, and independent media. There are inalienable freedoms of expression, assembly,
association, education, and religion. Examples include Australia, Brazil, India, and the United
States.
2. A “partly free” country exhibits limited political rights and civil liberties, corruption, weak rule
of law, ethnic and religious strife, unfair elections, and censorship. Examples include
Guatemala, Pakistan, and Tanzania.
3. A “not free” country has few to no political rights and civil liberties. The government allows
minimal to no exercise of personal choice, relies on the rule of man as the basis of law,
constrains religious and social freedoms, and controls a large share, if not all, of business
activity. Examples include China, Russia, Saudi Arabia, Iran, and Vietnam.
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Political risks
• Investing and operating internationally exposes MNEs to risks that arise from a country’s political
system.
• This class of risk, referred to as political risk, is the potential loss arising from a change in
government policy
• Risk that political decisions, events, or conditions will affect a country’s business environment in
ways that force investors to accept lower rates of return, cost them some or all of the value of their
investment, or threaten the sustainability of their operation.
Classifying political risks
• The evaluation of political risk often applies a macro-micro criterion.
• Macro risks affect all companies in a given country; micro risks are project-specific actions that
affect individual, usually foreign-owned, companies.
• Intensity level of the types of risks and classes: systemic, procedural, distributive, and catastrophic.
Chapter 3 – Governmental and Legal Systems

Figure 2.2.3. Classes and Characteristics of Political Risk

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan (2019)
 Chapter 3 – Governmental and Legal Systems
Classes and characteristics of political risks:
Systematic political risks
• As a rule, a country’s political processes aim not to punish specific companies arbitrarily. If they did, few
would hazard the investment. More often, investors face political risk that follows from shifts in public policy.
New political leaders, for instance, may adopt policies that differ from their predecessors’—say, reducing the
individual benefit of business activity by increasing tax rates to improve collective welfare.
Procedural political risks
• Around the clock, people, products, and funds move from point to point in the global market. Each move
creates a procedural transaction between subsidiaries, companies, or countries. Political actions sometimes
impose frictions that slow or stop these transactions. The repercussions of, say, public fraud or a partisan
judicial system can raise business costs.
Distributive political risks
• Countries see successful foreign investors as agents of innovation and sources of prosperity. Often, as MNEs
generate greater profits in the local economy, the host government may question whether it is getting its
“fair” share of the rewards. In some situations, change is immediate.
Catastrophic political risks
• Catastrophic political risk includes political developments that adversely affect the operations of every firm
in a country. It typically arises from macro flashpoints— ethnic discord, illegal regime change, civil disorder,
insurrection—that disrupt society.
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Legal Environment
• The legal system specifies the rules that regulate behavior, the processes by which laws are
enforced, and the procedures used to resolve grievances. Legal systems differ across countries due
to variations in tradition, precedent, usage, custom, or religious precepts.
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Type of Legal system
• Managers operating internationally face legal environments anchored in a variety
of philosophies and principles.
Common Law
• A common law system relies on tradition, judge-made precedent, and usage. It
respects established case law in resolving disputes. Judicial officials refer to
statutory codes and legislation, but only after considering the rules of the court,
custom, judicial reasoning, prior court decisions, and principles of equity.
Civil Law
• A civil law system relies on the systematic codification of accessible, detailed
laws. It assigns political officials, rather than government-employed judges, the
responsibility to translate legal principles into a compendium of regulatory
statues.
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Theocratic Law
• A theocratic law system relies on religious doctrine, precepts, and beliefs. Ultimate legal
authority is vested in religious leaders, who regulate business transactions and social
relations based on their interpretation of a sacred text.

Customary Law
• A customary law system reflects the wisdom of daily experience or, more formally,
enduring spiritual legacies and time-honored philosophical outlooks. It anchors legal
systems in many indigenous communities, defining the rights and responsibilities of
members.

Mixed system
• A mixed legal system emerges when a nation uses two or more of the preceding types.
In a sense, legal pluralism results when two or more legal systems apply cumulatively or
interactively.
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Trends in Legal systems
• As the Third Wave of Democratization spread, the philosophy of individualism supplanted that of
collectivism. Legally, this change promoted individual legal rights and instituted practices of due
process.
• The law became more transparent, courts became more impartial and officials became more
accountable in many countries.
• Presently, democracy’s retreat, by signaling the rise of strong states advocating collectivism, pushes
managers to pinpoint likely changes in legal systems.
• Managers begin by accepting that authoritarian governments use the legal system to regulate
business activity so that it unconditionally supports and sustains the state.
• There is no separation of law and state; the state uses the law to control public and private matters.
Bluntly put, justice is not blind but arbitrary, oppressive, and state-serving.
Chapter 3 – Governmental and Legal Systems
Legal issues in International Business
Operational concerns
Getting Started
• Starting a business involves activities such as registering a name, choosing the appropriate tax
structure, obtaining licenses and permits, arranging credit, and securing insurance. Some countries
expedite this process; others do not.
Making and Enforcing Contracts
• Once up and running, companies enter and enforce contracts with buyers and sellers.135 The
sanctity of a contract is vital to business transactions. The United Nations Convention on Contracts
for the International Sale of Goods sets guidelines for negotiating and enforcing contracts. Still,
standards vary across different legal systems. Countries using a common law system, for instance,
encourage precise, detailed contracts, whereas those with a civil law system encourage less
specific agreements.
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Hiring and Firing
• No matter where you are operating, you will have to hire and, when necessary, fire workers. One
would think that common sense would guide legally appropriate decisions. Legal standards around
the world, however, are rarely straightforward. Moreover, local laws cover virtually every aspect of
employment—how workers are hired, what they are paid, how many hours they can work, and
whether they can be fired.
Getting Out or Going Under
• Closing a business involves more than padlocking the doors. In the United States, for example, the
Internal Revenue Service requires reporting the sale of assets, payments to subcontractors, and
termination of retirement plans.
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Strategic concerns
Key Concerns
Country characteristics
• National laws affect the flow of products across borders. To determine charges for the right to
import a product, host governments devise laws that consider the product’s country of origin —
the country where it was grown, produced, or manufactured. Some countries apply this policy to
product labels, under the title COOL (country-of-origin labeling), to inform consumers and
support local producers.
Product safety and liability
• Countries regularly impose product-safety and liability laws that require an MNE to adapt a
product or else forsake market access. As a rule, wealthier countries impose stringent standards,
whereas poorer countries, reflecting developing legal codes and rule-of-man legacies, apply
inconsistent ones.
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Legal jurisdiction
• Countries stipulate the criteria for litigation when agents—whether legal residents of the same or of
different countries—are unable to resolve a dispute. Usually, in the face of a cross-national dispute,
each company petitions its home-country court to claim jurisdiction in the belief that it will likely
receive more favorable treatment. This situation is especially pressing when a MNE from a rule-of-
law system has legal difficulties in a rule-of-man environment.

Intellectual property
• In Adam Smith’s time, countries drew strength from their agricultural prowess. Later, smokestack
industries defined a nation’s prosperity and power. Now countries look to their brainpower to create
might, prestige, and wealth. We call the output of this brainpower intellectual property (IP)—the
creative ideas, innovative expertise, or intangible insights that create a competitive advantage for an
individual, company, or country. The growing power of ideas in the global
End of Presentation
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