Chapter 3 The Political and Legal Environments Facing Business

Objectives
To discuss the different functions that political systems perform To compare democratic and totalitarian political regimes and discuss how they can influence managerial decisions To describe how management can formulate and implement strategies to deal with foreign political environments To study the different types of legal systems and the legal relationships that exist between countries To examine the major legal issues in international business

Chapter Overview
Chapter 3 provides a conceptual foundation for the discussion of current events in the political environment of international business. Most of the chapter concentrates on political ideologies and the impact of politics on international business. The latter part of the chapter deals with differences across legal systems in different cultures. Overall, the chapter discussed the political and legal systems that managers encounter and the factors they need to consider when operating in different countries. Teaching Tip: The weekly magazine The Economist usually offers excellent coverage of the impact of political issues on international business. You might want to have students read certain articles out of a current issue before class in order to promote class discussion.

Detailed Chapter Outline

OPENING CASE: The Taipans Dilemma The case addresses Hong Kongs changed status when the British lease expired in 1997. The primary question is how Peter Sutch, the chairman (or taipan) of Swire Pacific Ltd. should navigate the changing political environment in Hong Kong. In some ways, Swire has benefit from Chinese control of Hong Konggiven Swires ties with the Chinese government. Teaching Tip: Various PowerPoint slides are available covering the material in this chapter. View PowerPoint slides for relevant topics. I. THE POLITICAL ENVIRONMENT The political environment can have a dramatic impact on the operations of a firm. U.S. managers may be accustomed to a stable political system and a relatively homogenous population. This is often not true in other countries. A political system integrates the parts of a society into a viable, functioning unit. Sometimes that is a very difficult task. A countrys political system influences how business is conducted domestically and internationally. BASIC POLITICAL IDEOLOGIES A political ideology is the body of ideas, theories and aims that constitutes a sociopolitical program (the Democratic and Republican parties are each examples of political ideologies). In a politically pluralistic society, many ideologies coexist. The ultimate test of any political system is its ability to hold a society together despite pressures from different ideologies tending to split it apart. A. The Impact of Ideological Differences on National Boundaries History, culture, language, religion, geography, and political ideology help define national borders. When a political systems collapses, those under the system often fragment into smaller groups (e.g., Yugoslavia, USSR).
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A Political Spectrum Forms of government range from Democracy to Totalitarianism. 1. Democracy. Since democracies usually have economic freedom and legal rules that safeguard individual (and corporate) rights, they are often preferred by MNCs. Contemporary democratic political systems tend to have the following six characteristics: 1) freedom of opinion, expression, press, and freedom to organize; 2) elections in which voters decide who is to represent them; 3) limited terms for elected officials; 4) an independent and fair court system with high regard for individual rights and property; 5) a nonpolitical bureaucracy and defense infrastructure, and; 6) an accessibility to the decision-making process. Winston Churchill referred to democracy as the worst form of governmentexcept for all others. a. Political rights and civil liberties. Political rights include fair elections and power being conferred on the peoples representatives. Civil liberties include a free press, equality under the law for individuals, and personal freedom. b. Stability in democracies. Many new democracies around the world are not yet stable. Few political parties and corruption threaten the systems survival. However, 75% of all people in democracies strongly feel it is the best form of government. 2. Totalitarianism. Forms of totalitarianism include fascism (Mussolinis Italy), authoritarianism (Chile under Pinochet), and communism. Communists believe in the equal distribution of wealth, which entails total government ownership and control of resources.

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THE IMPACT OF THE POLITICAL SYSTEM ON MANAGEMENT DECISIONS A. Political Risk Political risk occurs when there is a possibility that the political climate in a foreign country will change in such a way that the operations of international companies in that country will deteriorate. 1. Types and causes of political risk. Types of political risk include government takeovers of property, operating restrictions, and agitation that damages the companys performance. Such problems can be caused by changing opinions of political leadership, civil disorder, and changes in external relations (such as animosity between the home and host country governments. 2. Macro and micro political risks. If political actions are aimed only at specific foreign investments (e.g., a single foreign company), they are considered micro political risks. If they are aimed at a broad spectrum of foreign investors (e.g., when all foreign-owned private property was taken over by Cuba), they are considered macro political risks. B. Government Intervention in the Economy Some governments adopt an individualistic paradigm and keep intervention in the economy at a minimum. Others adopt a communitarian paradigm wherein the government plays a larger role in the economy. They thrive on a respected, centralized bureaucracy with a stable political party or coalition in power. If a U.S. firm moves from the United States (individualistic) to Germany, Japan, or South Korea (communitarian), it may have to develop new strategies for its relationships with government, suppliers, customers, and competitors. FORMULATING AND IMPLEMENTING POLITICAL STRATEGIES There are certain steps that a company must follow if it wants to establish an appropriate political strategy in its countries of operation. The steps include: 1) Identify the issue (what is the specific issue facing the firmtrade barriers, workers rights?); 2) Define the political aspect of the issue (is it something that can be dealt with outside of politics?); 3) Assess the potential political action of other companies; 4) Identify important institutions and key individuals; 5) Formulate strategies (what are your firms objectives and alternatives for reaching them?); 6) Determine the impact implementing the strategies (how will it affect the firms image?); 7) Select the appropriate strategy and implement. THE LEGAL ENVIRONMENT A. Kinds of Legal Systems 1. Common law. Laws are based on tradition, precedent, and custom (e.g., United States, United Kingdom).
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Civil law. The legal system is based on a detailed set of laws that make up a code (e.g., Germany, France, Japan). 3. Theocratic law. The legal system is based on religious precepts (e.g., Iran). Consumer Safeguards Liability issues are a major challenge for international firms. Different legal systems provide different safeguards for consumers. For example, a survey of 194 big Japanese manufacturers found that only 24 had ever faced a product-liability suit at home and, of those, only seven had lost. In the United States, one auto company had 250 product-liability suits in a year, but only 2 during the same time frame in Japan. (See Exercise 3.2 in the Going Global section at the end of the chapter) The Legal Profession MNEs must use lawyers for a variety of services, such as negotiating contracts and protecting intellectual property. Some law firms have actually become international through mergers with other law firms. More commonly, law firms often establish correspondent relationships with law firms in other countries in order to provide better international services to their business customers. Legal Issues in International Business Laws which govern domestic activities differ from country to country (e.g., minimum wage level, length of workweek). Laws also exist that cover cross-border activities (e.g., import duties, foreign investment regulations). Laws affect so many aspects of international business that legal issues will be addressed in more depth in several additional chapters.
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LOOKING TO THE FUTURE Will democracy survive? The next decade will be critical for democracy globally. Over the past 20 years, some 40 countries have moved toward democracy. The next ten years will determine whether democracy takes root in these countries or whether these countries slip back into totalitarianism. Democracy does not necessarily mean stability. The newer democracies of the 1990s, especially those in the former Soviet bloc countries, are still unstable. Asia is testing alternatives to democracy (e.g., China, Singapore). ETHICAL DILEMMAS AND SOCIAL RESPONSIBILITY Is when in Rome do as the Romans the best approach for global ethics? Simply abiding by a host countrys laws is not enough to fulfill ones ethical responsibilities for several reasons: Not everything that is unethical is illegal Laws are slow to develop in emerging areas of concern Moral concepts must be considered along with legal concepts Laws often need testing by courts The law is not very efficient Though the law cannot be used to determine all ethical disputes, it serves as a guide in many areas. Evaluating potential liability and legality of actions varies between countries with civil law systems and those with common law ones. Civil law countries tend to have a large body of laws that specify the legality of various behaviors. Common law countries tend to rely more on cases and precedents than on statutory regulations. When faced with conflicting laws between countries, management must decide which apply. WEB CONNECTION

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Teaching Tip: Visit www.prenhall.com/daniels for links and additional information relating to the topics covered in Chapter 3. The companion web site also has an online student study guide. The online study guide features fill-in-the-blank and true/false exercises that can be scored online. Incorrect answers are keyed to the text for student review.

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Case Questions and Answers

CASE: THE BATA SHOE ORGANIZATION Teaching Tip: Since much of the detail of the case deals with the Czech Republic and Slovakia, you may want to have your students use the Globe CD-ROM to review the two countries. 1. Based on the economic freedom scales, what kind of differences do you think Bata might face in the Czech Republic and Slovakia? The Czech Republic is clearly further along in its progress to economic freedom than is Slovakia. In the Czech Republic, Bata is likely to face considerably less government intervention in its business than in Slovakia. Private property ownership and protection, property rights, and economic competition are likely to be more common in the Czech Republic. In Slovakia, Bata is likely to face greater political risks. Since economic freedom and political freedom usually go hand in hand (though China and a few other countries serve as exceptions to this rule), there is likely to be more political instability in Slovakia. It also appears from the case that Slovakia may not have a very positive attitude toward foreign investment (despite Batas roots in the region). Batas battle for restitution in Slovak courts may be a long and expensive process. 2. What are the advantages and disadvantages to both Bata and the Republic of Slovakia of having Bata take over his former operations? Why do you think the Czech Republic allowed Bata to reenter the market, but Slovakia had not?

From a nostalgic point of view, Bata will be able to return to the home country. Bata will gain access to large facilities and a huge market in Eastern Europe and the former Soviet

Union. The Czech Republic will gain access to Batas global design, production, and marketing expertise. They will be able to design better, more fashionable, and more reasonably priced shoes. The Czech Republic might be able to get Bata to invest significant capital into the plant to get it up to world-class standards. Bata will create new jobs for Czech workers.

Bata reentered the Czech Republic and not Slovakia because the two countries have very different economic environments. The Czech Republic is moving more quickly than Slovakia toward a free market system. 3. Given the countries that Bata is operating in, what challenges does Tom Bata face in trying to establish an effective political strategy for the company? Batas presence in dozens of countries complicates its political strategy. By and large Batas operations are independent units established in each country where the firm does business. As such, Bata is able to decentralize control of its political strategygiving subsidiaries significant autonomy in managing relations with their respective government. Since important issues will vary from country to country, Bata must allow subsidiaries to identify the appropriate issues (step one of political strategy formulation) themselves. The strategies that are formulated to deal with those issues are likely to be subsidiary specific as well. 4. Why do you think Tom Bata, Sr. has joined the list of entrepreneurs who cannot bear to loosen their grip on businesses they started? What is the risk to the Bata Shoe Organization if Thomas J. Bata cannot find a way to retire? Having grown a business, it is often hard to turn it over to others who may have different ideas about how the firm should be managed. However, a mature, established business requires a different set of leadership and administrative skills than are needed by a young, growing firm. Thomas J. Bata led his firm through a period of great turbulence and growthbut both the world and the company are now very different than they were in the
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40s, 50s, 60s, and 70s. The biggest danger facing Bata Shoes is the lack of a clear succession plan for the time when Thomas J. Bata either retires or dies. He needs to be laying the framework to provide as smooth a transition to another chief executive as possible. If a successor were being groomed the timing of Thomas J. Batas departure would not be as important, since there would already be someone in place making increasingly important decisions and ready to step in effectively when the time came.

Discussion Questions and Answers

1. Assume that you are working for a company whose very survival is being threatened by government regulation. What are some of the ways you can help your company through interest articulation? Could you answer that question as easily for a subsidiary of yours that is located in a foreign country? In the United States, we have a relatively open political system with clear means whereby businesses can make their arguments before government representatives. Lobbying, advocacy advertising, committee hearings are all means whereby firms can be heard during the regulatory decision-making process. Political systems vary significantly from country to country, and it could be difficult for HQ personnel to know how to be effectively involved in interest articulation in other countries. Big companies in strategic industries (e.g., petroleum, defense) often centralize political relations at HQ, and HQ deals with governments throughout the globe. Many firms, particularly those pursuing a multidomestic approach to business, rely on their foreign subsidiaries to handle relations with local governments. This approach makes sense when local political expertise is housed at the subsidiary level. 2. In a recent PBS special about Rwanda, the statement was made that the slaughter that took place there in 19931994 had been planned for over one hundred years. What do you think the commentator meant by that statement? The roots of the tragedy in Rwanda go back decades. The massacre stemmed, in part, from a struggle for political control and from abuse of power. Resentment, animosity, and smaller scale violence had been building for many years. It is often difficult for outsiders to fully understand foreign political issues since they are often related to history and culture. Consequently, a multinational firm may have a difficult time dealing effectively with host country politics. It is often advisable to rely on locals who have a better understanding of the political process, are better connected with local politicians, and are more trusted by their fellow nationals to handle political issues on behalf of the foreign firm. 3. In Brazil, voting in national elections is required by law. Brazilian citizens who do not vote are fined. Consequently the percentage of Brazilians who vote is very high. In the United States, it is often a small minority of eligible voters that actually go to the polls on Election Day. Which system is better for selecting true representatives of the people? Which system is more democratic? If democracy indeed protects the rights of the individual, the right NOT to vote is better protected in the United States. A government that restricts the freedom of its citizens is less democratic than the country giving its citizens more freedom. However, one might argue that democracy is a form of representative government and that in countries where voter turnout is sparse, elected officials represent only a small part of the countrys population. Furthermore, in countries such as Brazil, electoral corruption is common. If turnouts were small, politicians might be able to buy enough votes to get elected. By ensuring a large voter turnout, the Brazilian system makes it more difficult for corrupt politicians to buy enough votes to win. 4. Why has Russia had such a difficult time changing from a totalitarian to a democratic political system? What factors need to be present to hasten the transition to a democracy? Democracy relies on several factors. These include freedom of opinion, freedom of expression, freedom of the press, freedom to organize, free elections, limited terms for elected officials, a nonpolitical bureaucracy, a nonpolitical defense infrastructure, and multiple political parties. It is clear that most of these characteristics (if not all) did not exist in the USSR. Such institutions as a free press and a multi-party system do not appear
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overnight. They take time to develop and take time to be accepted. Cultures do not change by decree. These institutions are only now beginning to take root in Russia. Russias political chaos has been exacerbated by the rapid pace of economic changes occurring in the country. 5. Has communism lost its place as the central form of totalitarian political regime? Explain. Probably not yet. Over one billion people live in communist China alone, and communist governments remain in other countries as well (e.g., Cuba, North Korea). Though communisms role has been dramatically reduced with the dismantling of the USSR, it is still possible that some ex-communist countries will return to communism if their move toward democracy and capitalism proves to painful (economically) for their people. Military juntas, another form of totalitarianism have been declining in numbers over the last decade as well. However, there may be a rise in theocratic totalitarianism if certain Moslem countries continue to move in that direction. 6. When China opened the doors to outsiders, it found that it had no legal system or people trained in law. Would you consider that a blessing or a handicap? Explain. Despite all the lawyer jokes in the United States, a legal system is vitally important socially, politically, and economically. The lack of a developed legal system in China has made it difficult for foreign firms trying to do business there. Courts do not protect physical or intellectual property to the same extent that they are protected in most other countries. Local producers have copied the products of foreign firms and have been protected by Chinese courts. Also, businesses need enforceable contracts in order to succeed. Weak contract laws in China have made it more difficult for foreign firms to be assured that local parties will fully carry out activities they have agreed to. The underdeveloped legal system has been an obstacle to Chinese efforts to draw foreign direct investment. 7. Do you think it would be difficult to work in a theocratic legal system? Why? Theoretically, different types of systems (civil law, common law, theocratic law) should not necessarily make it easier or harder for business. The issue is the content of the system, not the type of system itself. Certainly, working in a theocratic legal system would be difficult for firms that come from other types of systems. They would have to learn new laws. Furthermore, there is probably less room for compromise when laws are perceived to be God-given. On the other hand, theocratic systems often have clearly specified laws that change little over time, providing a stable legal basis for the conduct of business. For those of us unaccustomed to laws based on sacred texts, adapting to a theocratic legal system would be difficult. It might be no more difficult, though, than adapting to a common law system would be for someone accustomed to a theocratic system.

Going Global: Additional Exercises

Exercise 3.1: Have international students in your class identify themselves. Ask them to briefly describe the political system in their home countries. Often interesting differences will appear between their attitudes toward and beliefs about democracy and the attitudes and beliefs of American students. A variation on this theme is to have the foreign students describe and comment on the American political process. It if often sobering and thought provoking for American students to see how the U.S. is perceived by individuals from other countries. Exercise 3.2: America is often described as an overly litigious society. One way to stimulate discussion on this point is to have students do a web-based investigation of the number of lawyers per capita between the United States and other developed countries and between the United States and less developed countries. The fact that the United States produces more lawyers per capita than any other country can then be used to explore differences between the U.S. legal system and systems in other countries. An alternative exercise is for students to compare the number of lawyers in civil, common, and theocratic law countries.

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Exercise 3.3: China and Taiwan offer an interesting study in the relationship between political and economic systems. The same is true for North and South Korea. Why does the United States have a One China policy but not a One Korea policy? What is the impact of political totalitarianism on a countrys economic system? Could Taiwan be reunited with Mainland China and maintain its economic system? This discussion fits in well with the opening case (The Taipans Dilemma) since many parallels can be drawn between the expiration of Britains lease on Hong Kong and re-unification with Taiwan. From this general discussion students can be led to talk specifically about the political risk faced by American firms with Taiwanese subsidiaries.

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