International Business: The New Realities: Fifth Edition

International Business: The New Realities
Fifth Edition
Chapter 6
Political and Legal Systems
in National Environments
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Learning Objectives
6.1 Describe political and legal environments in
international business.
6.2 Understand political systems.
6.3 Understand legal systems.
6.4 Describe the participants in political and legal systems.
6.5 Identify types of country risk produced by political
systems.
6.6 Identify types of country risk produced by legal
systems.
6.7 Know about managing country risk.
What is Country Risk?
• Exposure to potential loss or adverse effects on company
operations and profitability caused by developments in a
country’s political and/or legal environments.
• Similar to “political risk,” but also can include economic
challenges
• Each country has unique political and legal systems that often
pose challenges for company performance.
Example
• Coca-Cola’s business fell off in Germany when the government
enacted a recycling plan. New laws required consumers to return
non-reusable soft drink containers to stores for a refund of 0.25 euros.
Rather than cope with the unwanted returns, big supermarket chains
pulled Coke from their shelves.
Dimensions of Country Risk

Country Risk in Selected Countries
Sources: Based on Economist Intelligence Unit, “Risk Briefing,” 2018, http://viewswire.eiu.com/

; Euler Hermes Country Risk Ratings, 2017,
www.eulerhermes.com/economic-research/country-risks/Pages/country-reports-risk-map.aspx
; Euromoney, “Euromoney Country Risk,” 2018, www.euromoneycountryrisk.com/

Political and Legal Systems (1 of 2)
• Political system: A set of formal institutions that

constitute a government. It includes legislative bodies,
political parties, lobbying groups, and trade unions. The
system also defines how these groups interact with each
other.
• Three major types of political systems:
– Authoritarianism
– Socialism
– Democracy
• These categories are not mutually exclusive

Functions of Political Systems
• Provide protection from external threats.
• Ensure stability based on laws.
• Govern the allocation of valued resources among the members of a
society.
• Define how society’s members interact with each other.

Political and Legal Systems (2 of 2)
• Legal system: A system for interpreting and enforcing laws.
The laws, regulations, and rules establish norms for conduct.
It incorporates institutions and procedures for ensuring order
and resolving disputes in commercial activities, as well as
protecting intellectual property and taxing economic output.
• Four major types of legal

systems:
– Common Law
– Civil Law
– Religious Law
– Mixed Systems

Sources of Country Risk
Political System Legal System

• government Laws, regulations, and
• political parties rules that aim to:
• legislative bodies • ensure order in
• lobbying groups commercial activities
• trade unions • resolve disputes
• other political institutions • protect intellectual
property
• tax economic output

Political Systems: Authoritarianism (1 of 2)
• Government controls all economic and political matters.
• Either theocratic (religion-based) or secular
• A state party is led by a dictator. Membership is mandatory for
those wanting to advance.
• Power is sustained via secret police, propaganda, regulation of
free discussion and criticism.
• Today: Some countries in the Middle East and Africa; Cuba,
North Korea.
• Ex-authoritarian states tend to have much government
intervention and bureaucracy.

Political Systems: Authoritarianism (2 of 2)
• China (1949-1980s)
• Germany (1933-1945)
• Soviet Union (1918-1991)
• Spain (1939-1965)

Political Systems: Socialism
• Capital is vested in the state and used primarily as a

means of production for use rather than for profit.
• Group welfare outweighs individual welfare.
• Government’s role is to control the basic means of
production, distribution, and commercial activity.
• Socialism occurs in much of the world as social
democracy (e.g., Western Europe, Brazil, India).
• Government intervention in the private sector.
• Corporate income tax rates are higher.

Political Systems: Democracy
• Economic activity occurs freely, as per market forces.

• Limited government: The government performs only
essential functions that serve all citizens, such as
national defense, maintaining law & order, foreign
relations, and providing basic infrastructure.
• Private property rights: The ability to own property and
assets and to increase one’s asset base by accumulating
private wealth. Property includes land, buildings, stocks,
contracts, patents. Encourages initiative, ambition,
innovation.

Examples of Countries Under Various
Political Systems
Elements of Elements of Largely Democratic
Authoritarianism Found in Socialism Found in
Afghanistan Bolivia Australia
Iran China Canada
North Korea Egypt Japan
Venezuela India New Zealand
Several countries in Africa Romania United States
(such as Eritrea, Sudan,
Equatorial Guinea,
Zimbabwe)
Blank Russia Most European countries
Blank Tanzania Most Latin American countries

Relationship Between Economic and Political
Freedom
Sources: International Monetary Fund, World Economic Outlook Databases, 2017, www.imf.org
; Daniel Kaufmann, Aart Kraay, and Massimo Mastruzzi, “The Worldwide Governance Indicators: A Summary of
Methodology, Data and Analytical Issues,” World Bank Policy Research, Working Paper No. 5430, 2010,
www.worldbank.org
Note: On the horizontal access, a high score indicates better quality national governance
Democracy and Openness (1 of 2)
• Democracy is associated with “openness”, the lack of

regulation and barriers to the entry of firms in foreign
markets.
• Openness is associated with:
– Successful market entry.
– Increased market demand.
– Competition on quality, which improves overall
product quality.
– Increased competition, leading to efficiencies and
lower prices.

Democracy and Openness (2 of 2)
Example
• India has steadily lowered entry barriers to its car market.
Foreign carmakers entered the market, greatly increasing
the number of models for sale. Greater competition
increased the quality of available cars, and car prices fell.

Political and Economic Systems
• Authoritarianism is associated with command economies,
wherein the state makes all decisions on what to produce,
how much to produce, and what prices to charge.
• Democracy is associated with market economies and
capitalism, in which decisions are largely left to market
forces, that is, supply and demand.
• Socialism is associated with mixed economies, which
have features of both market and command economies,
combining state intervention and market mechanisms
(e.g., Sweden, Singapore).

National Governance
• National governance refers to the system of policies and
processes by which nations are governed and the manner in
which they develop laws and regulations, conduct public affairs,
and manage public resources.
• National governance is related to political freedom and
economic freedom.
• 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 or other powers, or
– Self-determination for cultural, ethnic, and religious groups
The Rule of Law
• Existence of a legal system where rules are clear, publicly
disclosed, fairly enforced, and widely respected by individuals,
organizations, and the government.
• Common in the advanced economies.
• The legal system is:
– Applied to all citizens equally.
– Issued via recognized government authorities.
– Enforced fairly and systematically by police forces and
formally organized judicial bodies.
• Economic activity suffers and uncertainty increases when the
rule of law is weak.

Legal Systems: Common Law
• A legal system that originated in England and spread to

Australia, Canada, USA, and other former members of
the British Commonwealth (also known as case law).
• The basis of law is tradition, past practices, and legal
precedents set by courts via interpretation of statutes,
legislation, and past rulings.
• Judges have significant power to interpret laws based on
the circumstances of individual cases. Thus, common law
is relatively flexible.

Legal Systems: Civil Law
• Found in France, Germany, Italy, Japan, Turkey, and

much of Latin America.
• Based on an all-inclusive system of laws that have been
“codified” - clearly written by legislative bodies.
• Laws are more “cast in stone” and not strongly subject to
interpretation by courts.
• A key difference is that common law is mainly judicial in
origin and based on court decisions, whereas civil law is
mainly legislative and based on laws passed by national
and state legislatures.

Sampling of Differences between Common
Law and Civil Law
Legal Issues Civil Law Common Law
Ownership of intellectual Determined by registration. Determined by prior use.

property
Enforcing agreements Commercial agreements Proof of agreement is sufficient
become enforceable only if for enforcing contracts.
properly notarized or registered.
Specificity of contracts Contracts tend to be brief Contracts tend to be very
because many potential detailed, with all possible
problems are already covered in contingencies spelled out.
the civil code. Usually more costly to draft a
contract.
Compliance with contracts Noncompliance is extended to Acts of God (floods, lightning,
include unforeseeable human hurricanes, etc.) are the only
acts such as labor strikes and justifiable excuses for
riots. noncompliance with the
provisions of contracts

Legal Systems: Religious Law
• Strongly influenced by religious beliefs, ethical codes, and
moral values, viewed as mandated by a supreme being.
• Most important religious legal systems are based on Hindu,
Jewish, and Islamic law.
• Islamic law spells out norms

of behavior regarding
politics, economics, banking,
contracts, marriage, and
many other social and
business issues.

Legal Systems: Mixed Systems
• Two or more legal systems operating together.
• The contrast between civil and common law has become
blurred as countries combine both systems.
• Authoritarianism is most associated with religious law and
socialist law.
• Democracy is associated with common law, civil law, and
mixed systems.
Example
• Legal systems in Lebanon, Morocco, and Tunisia share
elements of civil law and Islamic law.

Dominant Legal Systems in Selected
Countries
Primarily Primarily Primarily Mixed Systems
Common Law Civil Law Religious Law
Australia Much of western Much of the Bangladesh
Canada Ireland Europe and Middle East and India Indonesia
New Zealand Latin America North Africa Israel Kenya
United Kingdom Japan Russia Afghanistan Malaysia
United States South Korea Mauritania Philippines
Pakistan Sudan
Source: Based on World Legal Systems at www.juriglobe.ca

Actors in Political and Legal Systems
• The government, or the “public sector”, operating at national
and local levels.
• International organizations such as the World Bank, World
Trade Organization, and the United Nations.
• Regional trade organizations, such as the European Union,
and many others.
• Special interest groups

such as labor unions and
environmental advocates.
• Local competing firms,
which oppose foreign firms.

Special Interest Groups Typical Issues
Group Typical Issue Example
Labor unions Oppose imported U.S. united steelworkers union
goods and global opposed imports of steel from
sourcing China
Competing Dislike competition Japanese rice producers
businesses from foreign firms opposed imports of rice from the
United States
Customers May avoid foreign- Motorists in Australia accused B
made products. Dislike P of unfair pricing of petroleum
improper marketing products
practices.
Conservationists Fight against wildlife Environmentalists oppose
loss and destruction of lumber imports from countries
the natural environment with tropical rain forests
Source: Based on World Legal Systems at www.juriglobe.ca

Country Risk Produced by Political Systems:
Government Takeover of Corporate Assets
• Confiscation: Seizure of corporate assets without
compensation.
• Expropriation: Asset seizure with compensation.
• Nationalization: Takeover of an entire industry, with or without
compensation.
Examples
• In Venezuela, ExxonMobil and ConocoPhillips were forced to
abandon multibillion-dollar investments in the local oil industry.
• Gradual yet persistent pressure from the Russian government led
TNK-BP, a Russian subsidiary of British energy giant BP, to sell a
major stake in its oil business to the national gas monopoly Gazprom.

Country Risk Produced by Political
Systems: Creeping Expropriation
• The most common expropriation today.
• The government gradually modifies regulations and laws after
foreign MNEs have made big local investments in property and
plants.
Examples
• Abrupt termination of contracts.
• Creation of laws that favor local firms.
• The governments in Bolivia, Russia, and Venezuela have
modified tax regimes to extract revenues from coal, oil, and
gas companies.

Systems: Embargoes and Sanctions
• Governments may respond to offensive activities of
foreign countries by imposing embargoes and sanctions.
• Sanctions are bans on international trade, usually
undertaken by a country, or a group of countries, against
another who is judged to have jeopardized peace and
security.
• Embargoes are bans on exports or imports that forbid
trade in specific goods with specific countries. Example:
The U.S. has enforced embargoes against Cuba, Iran,
and North Korea, labeled as state sponsors of terrorism.

Country Risk Produced by Political Systems:
Boycotts against Firms and Nations
• Voluntary refusal to engage in commercial dealings with

a nation or a company.
Examples from France
• Citizens boycotted Disneyland Paris, to express
opposition to globalization and takeover of French
farmland.
• French farmers boycotted McDonald’s and crashed a
tractor into a shop to vent their anger with agricultural
policies and globalization.

Systems: Wars, Insurrection, and Violence
• War and insurrection - Indirect effects can be disastrous

for company activities.
• Terrorism: The threat or actual use of force or violence
to attain a political goal through fear and intimidation.
• Some terrorism is sponsored by national governments.
• Terrorism particularly affects certain industries - tourism,
hospitality, aviation, finance, retailing.

Types of Country Risk Produced by Legal
Systems
• Foreign investment laws
• Controls on operating forms and practices
• Marketing and distribution laws
• Laws regarding income repatriation
• Environmental laws
• Contract laws
• Internet and e-commerce
regulations
• Inadequate or underdeveloped
legal systems

Country Risk Produced by Legal Systems
Country risk:
• The Foreign Corrupt Practices Act (FCPA)
• Accounting and reporting laws
• Transparency in financial reporting

Country Risk Arising From the Host
Country (1 of 7)
• Foreign investment laws affect F D I-based entry.
Examples:
• Japan - The “large-scale retail store law” restricted foreigners
from opening warehouse-style stores like Toys”R”Us, in favor
of smaller Japanese retailers.
• Mexico - Foreign oil companies cannot obtain 100% ownership
of Mexican oil firms.
• United States - Restricts inward investments seen to affect
national security. e.g., The U.S. Congress blocked Dubai Ports
World, a Middle Eastern firm, which sought a deal to manage
U.S. ports.

Country (2 of 7)
• Controls on operating forms and practices are laws

and regulations on how firms can conduct production,
marketing, and distribution activities.
Example
• In the telecommunications sector in China, the Chinese
government requires foreign investors to seek joint
ventures with local firms. This ensures local control of the
telecom industry. Thus, China gains access to foreign
capital and technology.

Country (3 of 7)
• Marketing and distribution laws regulate practices in

advertising, promotion, and distribution.
Examples
• Finland, France, Norway, and New Zealand prohibit
cigarette advertising on television.
• Canada and other countries cap prices in the
pharmaceutical and other industries.

Country (4 of 7)
• Laws on income repatriation limit the amount of net income
or dividends that firms can bring back to the home country.
• Environmental laws aim to preserve natural resources,
combat pollution, and ensure safety.
• Contract laws affect the sale of goods and services,
intermediary agreements, licensing and franchising, foreign
direct investment, and joint ventures.
• Internet and e-commerce regulations
Example:
• In Germany, firms are responsible for recycling product

packaging.
Country (5 of 7)
• Inadequate or underdeveloped legal systems, or poor
enforcement of existing laws.
• Laws may be weak regarding intellectual property,
pollution, consumer protection, and other areas.
• While the problem is common in developing economies, it
can occur in advanced economies too.
Examples:
• In China and Russia, foreign firms sometimes abandon
business ventures due to erratic legal environments.
• The recent global financial crisis was triggered partly by
poor regulation in the United States and Europe.
Country (6 of 7)
• Extraterritoriality: The application of home-country laws to
other countries. For example, the European Union pursued
Microsoft for monopolistic practices.
• The Foreign Corrupt

Practices Act (1966; U.S.)
made it illegal to offer bribes to
foreign parties. The act may
harm U.S. firms because
foreign competitors are usually
not so constrained.

Country (7 of 7)
• Accounting and reporting laws differ widely around the

world. Two examples:
– Physical asset valuations: Canada and the U.S. use
historical costs. Some Latin American countries use
inflation-adjusted market value.
– R&D costs: Expensed as incurred in most of the
world; capitalized in South Korea and Spain. Some
countries use both conventions.
• Transparency in financial reporting is the degree to
which firms regularly reveal substantial financial and
accounting information. This varies worldwide.

Ethical Connections
• Many countries lack anti-bribery laws for international

transactions.
• The Organization for Economic Cooperation and
Development (OECD) recently called for a ban on
“grease payments,” small-scale bribes intended to speed
up telephone hookups, government paperwork, and other
everyday matters in global commerce.
• A culture of grease payments and other corruption is
corrosive, harming the rule of law and sustainable
economic development.

Managing Country Risk (1 of 3)
• Proactive environmental scanning: Management

should develop a comprehensive understanding of the
political and legal environment in target countries.
Scanning - ongoing assessment of potential risks and
threats to the firm, via intelligence sources such as:
– Employees working in the host country.
– Embassy and trade association officials.
– Consulting firms, such as Business Entrepreneurial
Risk Intelligence (BERI).
• Minimize exposure to country risks.

• Strict adherence to ethical standards: Firms that

engage in questionable practices or operate outside the
law invite redress from the governments of the host
countries where they do business.
• Alliances with qualified local partners: For example,
firms often enter China and Russia by partnering with
local firms who assist in navigating the complex legal and
political landscape.

• Protection through legal contracts: Contract law varies
widely. The firm must follow the law in each country. Three
approaches for resolving contract disputes:
– Conciliation is a formal process of negotiation whose
objective is to resolve differences in a friendly manner. It is
the least adversarial method. Common in China.
– In arbitration, a neutral third party hears both sides of a
case and decides in favor of one party or the other, based
on an objective assessment of the facts.
– Litigation occurs when one party files a lawsuit against
another. The most adversarial approach, it is common in
the United States.

You Can Do It: Christopher Johnson
• Christopher got his undergraduate degree from a state university a few
years ago. Read his profile.
• Christopher’s major: Accounting

• After attending a study abroad program in Istanbul, Turkey, he gained a
global business perspective and a passion to work in international finance.
• Jobs: Deloitte Tax LLP, Chicago; and Ayco (subsidiary of Goldman Sachs)
• “Understanding the role that
international business plays across
cultural variations will allow for a well-
developed global commerce
perspective. Such exposure will also
assist with determining your specific
career path of choice.”

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Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Sources: Based on Economist Intelligence Unit, “Risk Briefing,” 2018, http://viewswire.eiu.com/

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Political system: A set of formal institutions that

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Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Four major types of legal

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Political System Legal System

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Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Capital is vested in the state and used primarily as a

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Economic activity occurs freely, as per market forces.

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Democracy is associated with “openness”, the lack of

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• A legal system that originated in England and spread to

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• Found in France, Germany, Italy, Japan, Turkey, and

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Ownership of intellectual Determined by registration. Determined by prior use.

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Islamic law spells out norms

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Source: Based on World Legal Systems at www.juriglobe.ca

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Special interest groups

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Source: Based on World Legal Systems at www.juriglobe.ca

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

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• Voluntary refusal to engage in commercial dealings with

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• War and insurrection - Indirect effects can be disastrous

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Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

Copyright © 2020 Pearson Education, Inc. All Rights Reserved

• Controls on operating forms and practices are laws

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• Marketing and distribution laws regulate practices in

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• In Germany, firms are responsible for recycling product

• The Foreign Corrupt

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• Accounting and reporting laws differ widely around the

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