CHAPTER THREE THE POLITICAL AND LEGAL ENVIRONMENT FACING BUSINESS

Dear students:
When firms source, produce, and/or market products in foreign countries, they encounter dynamic and challenging political and legal environments. Chapter Three provides a conceptual foundation for the examination of the political and legal dimensions of international business operations. It compares major political regimes, discusses their potential influence upon the development of effective business strategies, and considers the relevance of political risk. The chapter also examines the major types of legal systems that exist today, as ell as the strategic and operational concerns they pose. It concludes ith a discussion of intellectual property rights and the associated challenges confronted in an age of globali!ation.
I. INTRODUCTION "or a multinational enterprise to succeed in countries ith different political and legal environments, its management must carefully analy!e the fit bet een its corporate policies and the political and legal conditions of each particular nation in hich it operates. #$ee "ig. %.&.'

II. THE POLITICAL ENVIRONMENT

( political system is the complete set of institutions, political organi!ations, and interest groups, the relationships among those institutions, and the political norms and rules that govern their activities. Thus, it integrates the various parts of a society into a viable, functioning entity. It also influences the extent to hich government intervenes in business and the ay in hich business is conducted both domestically and internationally. The ultimate test of any political system is its ability to hold a society together. A. Individualism versus Collectivism It is useful to profile the similarities and differences among political systems according to the general orientation ithin a society about the primacy of the rights and role of the individual versus that of the larger community. )nder an i !i"i!#alistic paradigm *e.g., the )nited $tates+, political officials and agencies play a limited role in society. The relationship bet een government and business tends to be adversarial, government may intervene in the economy to deal ith market defects, but generally it promotes marketplace competition. )nder a collecti"ist paradigm, the government defines economic needs and priorities, and it partners ith business in major ays. -overnment is highly connected to and interdependent ith business, the relationship is cooperative. . Political Ideolo!" ( political i!eolo$y is the body of goals, theories, and aims that constitute a sociopolitical program *e.g., liberalism or conservatism+. Pl#%alism indicates the coexistence of a variety of ideologies ithin a particular society. (lthough shared ideologies create bonds ithin and bet een countries, differing ideologies tend to split societies apart. The t o extremes on the political

spectrum are democracy and totalitarianism. #$ee "ig. %...'

#. Democrac". ( !emoc%acy represents a political system in hich citi!ens participate in the decision/making and governance process, either directly or through elected representatives. Contemporary democracies share the follo ing characteristics0 freedom of opinion, expression, press, religion, association and access to information, freedom to organi!e, free elections, an independent and fair court system, a nonpolitical bureaucracy and defense infrastructure, and citi!en access to the decision/making process. #$ee Table %.&' In decentrali!ed democracies, e.g., Canada and the )nited $tates, companies may face different and sometimes even conflicting la s from one state or province to another. The defining characteristic of democracy is freedom. 1easures of political rights and civil liberties have been developed to assess levels of &%ee!om, a country may be rated as free, partly free, or not free. #$ee 1ap %..' $. Totalitarianism. Totalita%ia ism represents a political system in hich citi!ens seldom, if ever, participate in the decision/ making and governance process, po er is monopoli!ed by a single agent and opposition is neither recogni!ed nor tolerated. In t'eoc%atic totalita%ia ism( religious leaders are also the political leaders. In sec#la% totalita%ia ism( the government maintains po er through the authority of the state. 2ther variants of totalitarianism include a#t'o%ita%ia ism and &ascism. C. Trends in Political %"stems.

$everal factors have po ered the democrati!ation of the orld. "irst, many totalitarian regimes failed to improve the economic lives of their citi!ens, ho eventually challenged the right of the state to govern. $econd, vastly improved communications technology eakened the ability of regimes to control people3s access to information. Third, many people ho champion democracy truly believe that greater political freedom leads to economic freedom and higher standards of living. (lthough the orld is experiencing general movements to ards democracy and more open economies, this does not necessarily indicate an increasing homogeni!ation of political systems. 4ot all nations embrace the concept of 5democracy5 as defined by Western standards. China and 6ussia are t o examples of countries ith different vie s of democratic governance.

There is a clear link bet een political and economic freedom and economic gro th. 7o ever, democracy does not necessarily mean stability, in fact, in a transition economy political risk is often 8uite high. The emergent democracies of the &99:s, especially those of the former $oviet bloc, still restle ith domestic unrest and security threats. (lthough challenges to democracy are many, terrorism stands out above all others. $ome people argue that if a country is to flourish as a democracy, certain preconditions such as economic development must be present. 7o ever, others argue that democracy is the result of having

political leaders ho exhibit both the determination and the skills re8uired to assure that democrati!ation occurs. $till others feel that indirect support may flo from (sia3s alternative conception of democracy, here economic freedom is progressing more rapidly than political freedom. China is a case in point. With a totalitarian democratic system, China has focused on economic gro th in the belief that gro th solves most problems. China;s success ith 5freedom stagnation5 thro s into 8uestion Western ideals of democracy. If democracy proves resilient and resourceful, then managers ill face the task of adjusting their operations during periods of economic crisis, but if democracy falters, then managers ill face the task of rethinking their operations in a orld of increasing state control and repression.

D. Political Ris&. Political %is) is the possibility that political decisions, events, or conditions ill affect a country;s business environment in ays that ill cost investors some or all of the value of their investment or force them to accept lo er than projected rates of return. <eading sources of political risk are0 expropriation or nationali!ation, international ar or civil strife, unilateral breach of contract, destructive government actions, harmful actions against people, restrictions on the repatriation of profits,

differing points of vie , and discriminatory taxation policies. #$ee Table %...' The follo ing types of political risk range from the least to the most destructive. #. %"stemic Political Ris&. Systemic political %is) creates risks that affect all firms because of a change in public policy. 7o ever, such changes do not necessarily reduce potential profits. $. Procedural Political Ris&. P%oce!#%al political %is) reflects the costs of getting things done because of such problems as government corruption, labor disputes, and/or a partisan judicial system. '. Distri(utive Political Ris&. Dist%i*#ti"e political %is) reflects revisions in such items as tax codes, regulatory structure, and monetary policy imposed by governments in order to capture greater benefits from the activities of foreign firms. ). Catastro*+ic Political Ris&. Catast%op'ic political %is) includes those random political developments that adversely affect the operations of all firms in a country.

III. THE LE,AL ENVIRONMENT ( legal system is the mechanism for creating, interpreting, and enforcing the la s in a specified jurisdiction. The three components of modern legal systems are common la , civil la , and commercial la . A. Le!al %"stems. ( legal system is the means and methods a country uses to regulate business practices, define ho companies conduct business transactions, specify the rights and obligations of those engaged in business

transactions, and spell out the methods of legal redress for those ho believe they have been ronged. . T"*es o- Le!al %"stems. -enerally, legal systems fall into one of the follo ing categories0 #$ee 1ap %.%.' #. Common la.. Commo la+ is based upon tradition, judge/made precedent, custom, and usage, therefore, courts play an important role in interpreting the la . Common/la nations include (ustralia, Canada, 4e =ealand, and the )nited $tates. $. Civil la.. Ci"il la+ is based upon a detailed set of la s that comprise a code that includes rules for conducting business, therefore, courts play an important role in applying the la . Civil la nations include "rance, -ermany, and >apan. '. T+eocratic la.. T'eoc%atic la+ is based upon religious precepts, ultimate legal authority is conferred upon religious leaders ho govern society. The best example is Islamic la , or Sharia, hich is based on the Koran, the Sunnah, the ritings of Islamic scholars, and the consensus of 1uslim countries3 legal communities. ). Customar" la.. C#stoma%y la+ anchors itself in the isdom of daily experience or great spiritual or philosophical traditions. Customary la may play a significant role in matters of personal conduct in countries ith mixed legal systems. /. Mi0ed %"stem. A mi,e! le$al system emerges hen t o or more legal systems are used ithin a single country. (lthough the majority of such countries are found in (frica and (sia, the )nited $tates3 legal system combines both common and civil la .

C. T+e Di--usion o- Le!al %"stems The evolution and diffusion of the civil and common la systems gives managers a sense of the degree of current and likely convergence across countries. The diffusion of the common la system is embedded in the coloni!ation of the ?ritish Common ealth. 2ther @uropean countries follo ed the lead of the 6omans in developing their o n civil la traditions and then influenced the legal systems of many neighboring, (frican, and 4orth and $outh (merican countries. 1ore recently, successful efforts to standardi!e la s, particularly ith respect to the conduct of business, can be seen in the actions of the @uropean )nion and in the development of orld ide standards in accounting, disclosure, and bankruptcy. #$ee "ig. %.A' D. Trends in Le!al %"stems. #. T+e Pre-erence -or %ta(ilit" / the backlash against democracy sho s a general preference for political stability. This preference ill shape the ay a country;s leaders regulate business activity. $. T+e In-luence o- National Le!acies / the suddenness of economic gro th in non/democratic countries causes us to consider the importance of national legacy on the development of legal systems. E- U !e%sta !i $ Bases o& R#le B Countries can be classified as follo ing the rule of man or the rule of law. The rule of man places ultimate po er in the hands of one person and is the cornerstone of totalitarian governments.

The rule of la is the hallmark of democratic governments and holds that authority comes from ritten and transparent la s. F- Implicatio s &o% Ma a$e%s B 6ule of la flourishes in ell/to/do industriali!ed countries such as the )nited $tates, >apan, and most of @urope. When managers from these countries conduct business in emerging markets they may expect to find perplexing and inconsistent legal systems.

IV. LE,AL I%%UE% IN INTERNATIONAL

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T o major areas of concern to international business concerning legal issues are operational concerns and strategic matters. A. O*erational Concerns @fforts to start a business, to enter and enforce contracts, to hire and fire employees, and to close a business are all affected by national la s and regulations. While there appears to be an inverse relationship bet een a country3s per capita income and its tendency to regulate business, the legal systems of the more highly developed countries tend to regulate the major operational features of business activity more consistently than do the less developed nations. "urther, those countries that make it easy to start a business also tend to impose fe er and simpler regulations to hire and fire orkers and impose less regulation in their courts and bankruptcy systems. #$ee Table %.% and %.C' BSt%ate$ic Co ce% s

1any legal issues affect the process of value creation. The follo ing legal contingencies often shape an international competitor3s strategic plans.

#. Product %a-et" and Lia(ilit". 2ften products must be customi!ed in order to comply ith local standards, hich may be higher than those found in a firm3s home market. While product liability la s are very stringent in markets such as the )nited $tates, they are spotty, absent, and at times even arbitrary in many less developed countries. $. Mar&et*lace e+avior. 4ational la s determine permissible practices in pricing, distribution, advertising, and the promotion of products, and they vary idely from one country to another. '. Product Ori!in and Local Content. <ocal content is important to all nations, and most countries push foreign firms to add value locally. In addition, product origin determines applicable fees and may be subject to 8uantitative restrictions as ell. ). Le!al 1urisdiction. @very country specifies hich la should apply and here litigation should occur hen agents are involvedD hether they are legal residents of the same or different countries. /. Ar(itration. 1ost arbitration is governed by the 4e Eork Convention, a protocol specified in &9AF that allo s parties to choose their o n mediators and resolve disputes on neutral ground. C. Intellectual Pro*ert" Ri!+ts I tellect#al p%ope%ty %i$'ts consist of o nership rights to intangible assets, i.e., the right to control and derive the benefits from riting and other creative art forms *copyright+, inventions *patents+, and identifiers *trademarks+. Groblems arise because intellectual property, hether in the form of literature, music, design, soft are, scientific patents, or brand names, is difficult to create but easy to duplicate. Cross/national and cross/

cultural legal differences complicate specifying, regulating, and enforcing intellectual property rights. The costs of piracy, hether in terms of lost sales and royalties or future creativity, are very high for registered o ners. #. T+e C+inese Connection2 or3 45e Can Co*" Ever"t+in! E0ce*t 6our Mot+er. 2f particular concern in the area of intellectual property rights is China. It is believed that the problem is greater in China due to cultural structure, the legacy of a rule/of/ man basis of rule, eak legal enforcement, and the country;s si!e. $. International Pro*ert" Ri!+ts. IG6s constitute a legally enforceable but limited monopoly granted by a country to an innovator. @nforcement of IG6s is difficult due to the fact that there is no ay to globally register a patent, trademark, or copyright. '. Role o- Local Attitudes. Giracy is rooted in fundamental legal, economic, and cultural forces. While some countries may impose prohibitions on piracy, local authorities may actually encourage violations. 1any of these problems stem from legal legacies in emerging markets here the rule of man applies. ). Level o- Economic Develo*ment. -enerally, less developed countries provide eaker legal protection for intellectual property than do industriali!ed nations. While less developed nations feel they have little to gain by protecting intellectual property, developed nations feel it is critical to assuring continuing creativity. /. National Cultural Attitudes. Countries ith a more individualistic orientation vie intellectual property as intrinsically legitimate. In contrast, countries ith a more collectivist orientation extol the virtues of shared o nership