Sridharamurthy, National School of Business

POLITICAL ENVIRONMENT
Political Systems

Political systems have two dimensions

a. Degree of Collectivism vs. Individualism
b. Degree of Democracy vs. Totalitarianism

These dimensions are interrelated; systems that emphasize collectivism tend towards totalitarian,
while systems that place a high value on individualism tend to be democratic.

However, a large gray area exists in the middle. It is possible to have democratic societies that
emphasize a mix of collectivism and individualism. Similarly, it is possible to have totalitarian
societies that are not collectivist.

Collectivism
Collectivism refers to a political system that stresses the primacy of collective goals over
individual goals. The needs of society as a whole are generally viewed as being more important
than individual freedoms. In such circumstances, an individuals right to do something may be
restricted on the grounds that it runs counter to the good of society or to the common good.
Advocacy of collectivism can be traced to the ancient Greek philosopher Plato. In modern times
the collectivist system is largely the domain of nations that have embraced socialism.

Socialism
Socialism traces its intellectual roots to Karl Marx (18181883), who argued that the few benefit
at the expense of the many in a capitalist society where individual freedoms are not restricted.
Capitalists expropriate for their own use the value created by workers, while paying workers only
subsistence wages in return. Marxs socialism is built on the premise that if the state owned the
means of production, the state could ensure that workers were fully compensated for their labor.
Thus, the idea is to manage state-owned enterprise to benefit society as a whole, rather than
individual capitalists. This political perspective was the foundation of all communist nations.

The ideology of socialism is split into two broad camps.

a. Communism
b. Social democracy

Communists believed that socialism can only be achieved through violent revolution and
totalitarian dictatorship. Communism reached its high point in the late 1970s, when the majority
of the worlds population lived in communist states. It was swept out of Europe by the largely
bloodless revolutions of 1989. Today, China is the last major Communist power left. Although
China is still nominally a communist state with substantial limits to individual political freedom,
in the economic sphere the country has moved sharply away from strict adherence to communist
ideology. Apart from China, communism hangs on only in some small states, such as North
Korea and Cuba.

Social democrats committed themselves to achieving socialism by democratic means and turned
their backs on the violent revolution and dictatorship advocated by the communist version of
socialism. Social democracy has had perhaps its greatest influence in a number of democratic
Western nations including Australia, Great Britain, France, Germany, Norway, Spain, and
Sweden, where social democratic parties have from time to time held political power. Other
countries where social democracy has had an important influence include India and Brazil.

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However, experience has demonstrated that in many countries, state-owned companies have
performed poorly. Protected from significant competition by their monopoly position and
guaranteed government financial support, many state-owned companies became increasingly
inefficient. In the end, individuals found themselves paying for the luxury of state ownership
through higher prices and higher taxes. In the 80s and 90s, many nations that were once socialist
in orientation, devoted considerable effort to selling state-owned enterprises to private investors (a
process referred to as privatization), which we will discuss later in the chapter.

Individualism
Individualism is the opposite of collectivism. In a political sense, individualism refers to a
philosophy that an individual should have freedom in his or her economic and political pursuits.

In contrast to collectivism, individualism stresses that the interests of the individual should take
precedence over the interests of the state Like collectivism, individualism can be traced to an
ancient Greek philosopher, in this case Platos disciple Aristotle (384322 B.C.). According to
Aristotle, communal property receives little care, whereas property that is owned by an individual
will receive the greatest care and therefore be most productive.

Individualism is built on two central tenets. The first is an emphasis on the importance of
guaranteeing individual freedom and self-expression. The second tenet of individualism is that the
welfare of society is best served by letting people pursue their own economic self-interest as
opposed to some collective body (such as government) dictating what is in societys best interest.
Therefore, individual economic and political freedoms are the ground rules on which a society
should be based.

Some say that with the end of the Cold War, individualism has finally won a long battle with
collectivism. It has clearly not. But as a guiding political philosophy, individualism has been on
the ascendancy. This represents good news for international business, since in direct contrast to
collectivism, the pro-business and pro-free trade values of individualism create a favorable
environment within which international business can thrive.

Democracy versus totalitarianism

Democracy refers to a political system in which government is by the people, exercised either
directly or through elected representatives. Totalitarianism is a form of government in which one
person or political party exercises absolute control over all spheres of human life and opposing
political parties are prohibited.

The democratictotalitarian dimension is not independent of the collectivismindividualism

dimension. Democracy and individualism go hand in hand, as do the communist version of
collectivism and totalitarianism.

However, gray areas exist; it is possible to have a democratic state where collective values
predominate, and it is possible to have a totalitarian state that is hostile to collectivism and in
which some degree of individualismparticularly in the economic sphereis encouraged. For
example, China also has seen a move toward greater individual freedom in the economic sphere,
but the country is still ruled by a totalitarian dictatorship.

Democracy
Democracy, as originally practiced by several city-states in ancient Greece, is based on a belief
that citizens should be directly involved in decision making.

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In complex, advanced societies with populations in the tens or hundreds of millions this is
impractical. Most modern democratic states practice what is commonly referred to as
representative democracy in which citizens periodically elect individuals to represent them?
These elected representatives then form a government, whose function is to make decisions on
behalf of the electorate and it is assumed that if elected representatives fail to perform this job
adequately, they will be voted down at the next election.

Safe guards of representative democracy

An ideal representative democracy enshrines the following safeguards in constitutional law. (1)
An individuals right to freedom of expression, opinion, and organization; (2) a free media; (3)
regular elections in which all eligible citizens are allowed to vote; (4) universal adult suffrage; (5)
limited terms for elected representatives; (6) a fair court system that is independent from the
political system; (7) a nonpolitical state bureaucracy; (8) a nonpolitical police force and armed
service; and (9) relatively free access to state information.

Totalitarianism
Totalitarianism denies its citizens all of the constitutional guarantees asserted by representative
democracies. The most widespread was once communist totalitarianism however, even in the
surviving communist systems in China, Vietnam, Laos, North Korea, and Cuba, there are clear
signs that the Communist Partys monopoly on political power is under attack.

Theocratic totalitarianism is found in states where political power is monopolized by a party,

group, or individual that governs according to religious principles. The most common form of
theocratic totalitarianism is based on Islam and is exemplified by states such as Iran and Saudi
Arabia.

Tribal totalitarianism is most common in African countries such as Zimbabwe, Tanzania, Uganda,
and Kenya. Tribal totalitarianism occurs when a political party that represents the interests of a
particular tribe (and not always the majority tribe) monopolizes power. Such one-party states still
exist in Africa. Saudi Arabia is both a theocratic and a tribal state.

Right-wing totalitarianism generally permits some individual economic freedom but restricts
individual political freedom on the grounds that it would lead to the rise of communism. The
fascist regimes that ruled Germany and Italy in the 1930s and 1940s were right wing totalitarian
states. Until the early 1980s, right-wing dictatorships, many of which were military dictatorships,
were common throughout Latin America. They were also found in several Asian countries,
particularly South Korea, Taiwan, Singapore, Indonesia, and the Philippines. Since the early
1980s, however, this form of government has been in retreat.

Politics of FDI

Typical investment by an MNC can be seen as positive. The businesses essentially think of it as
beneficial to the host country. The following are some of the benefits the MNC manager may
identify-

1. Capital for growth and development

2. Technology for modernization
3. Skills for the local industry
4. Access to foreign markets
5. Explicit contribution to BOT
6. Employment generation
7. Tax revenues
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The host government may see foreign investment as potentially providing the benefits outlined
above, but may also see the negative side to the investment, as explained below:

1. Increased Dependence Many developing countries believe they need to develop their
internal abilities rather than relying on others.
2. Decreased Sovereignty Any dependency on MNCs is seen as loss of control by the host
government. Many countries, especially the small ones, feel that large MNCs can have a
major, possibly dominant, an even harmful impact on their economic, social, and political
systems. For example, encouragement of consumption, imposition of western values in
place of traditional ones, or support to a particular political party may be seen as
potentially harmful Example: East India company in the eighteenth century.
3. Increased Exploitation MNCs are often seen as using Nonrenewable resources,
repatriating profits rather than reinvesting them, and generally profiting at the expense of
the local community. In addition, MNCs may make new products or services available
locally. This can increase consumption, and decrease local savings and investment.
Example- Euro Disney. French media termed it as a cultural Chernobyl.
4. Inappropriate Technology In many cases, the technology provided by the MNCs is either
outdated or too advanced. Sometimes it seems that an MNC is getting rid of its old
technology by sending it to the host. LDC hosts believe that many MNCs pay little
attention to the real needs of the country from a technological point of view, and that
technology is seldom to local needs.
5. Displacement of Local Firms Local firms may feel that they cannot compete with the
MNC and may forgo local investment. Moreover, when unemployment is the concern,
some governments believe that local investments would have been labor intensive, while
foreign investments are capital intensive, thus the net impact of FDI on employment is
actually negative.
6. Outflow of Foreign Exchange- The apparent foreign exchange benefits from investment
and exports can be more than offset, over time, by payments for imported machinery and
parts, and repatriation of profits through dividend payments and other intra-firm transfers.

RELATIONSHIPS

The host countries wants the economic benefits of improved trade balances, increased
employment, more foreign exchange, as well as increased power and prestige, but fear the
potential negative consequences such as loss of sovereignty, technological dependence, and
foreign control of key economic sectors. These results in a variety of host-government
policies designed both to attract and confine MNCs. We need to understand purpose of these
restrictions and incentives because they provide both opportunities and challenges for the
firm.
INCENTIVES
1. Tax holidays
2. Exemption from duties
3. Tax incentives
4. Monopoly rights
5. Low interest loans
6. Government concessions and guarantees

RESTRICTIONS
1. Local ownership Eg. Malaysia
2. Local content
3. Local personnel
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4. Location
5. Profit repatriation
6. Forex use

NEGOTIATIONS

The ultimate objective of negotiations, of course, is to minimize the negative impact of

restrictions imposed by the government and to maximize the benefits associated with incentives.
The outcome, however, depends on the strengths of each side. The strength of each party depends
on how much each party needs the other and how much control each side can exert on the other.
The strength of the bargaining position of a firm is also influenced by its home government and
the relationship between the home government and the host government. A positive relationship
between the two governments is likely to smooth negotiations, whereas a negative relationship
may complicate issues.

A MNC can expect a support from a home government as long as the interests of MNC coincides
with that of the home government. A foreign invest can be viewed as either good or bad by the
home country. In reality whatever the MNCs earns in a foreign location is returned to the home-
country shareholders in the form of dividends and capital appreciation. Employees in the home
country are also benefited from the foreign operations because a profitable firm can pay higher
wages. Further, the home country also benefits generally through increased tax collection.

However, a decision to invest in a foreign location may also be seen as not investing in home, and
certain groups will be negatively affected by this decision.

For example;
a. Jobs will be created in the host country rather than in the home country
b. Foreign suppliers may be chosen over home country suppliers
c. The prices of certain goods may change
Those groups feeling the adverse effects will push for home-government restrictions on MNCs.

POLITICAL RISK

Political risk embrace a vide variety of factors varying from government confiscation of the assets
of the an MNC to government encouragement of negative attitudes toward foreign business. To
include this wide range of factors, the Political risk is defined as the possibility of unwanted
consequences of political activity or the uncertainty associated with political events and activities.
Major categories of political risks:

1. Forced Divestment: A situation where in government acquires all the assets of a company
against its will. At worst, the host government may confiscate company assets-I.e. take
them over without any compensation. Alternatively, the host forces the company to sell
its assets to local parties, usually the government itself. Forced divestment can take the
form of
a. Expropriation The take over of single firm
b. Nationalization Take over of an entire industry
Forced divestment is legal under international law as long as it is accompanied by prompt
and equitable compensation. Such a take over does not involve the risk of total loss of
assets unless they are confiscated by the government. However, greater risks are that the
payment will be
i. Less than what the company considers equitable
ii. Payment in nonconvertible currency
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iii. Non-negotiable government bonds

iv. Losses due to impact on other business operations

2. Unwelcome regulation:
It refers to any government imposed requirements that make it less profitable for a
company to operate in a particular location. These include:

1. Corporate or income taxes

2. Local ownership requirements
3. Restrictions on reinvestment and repatriation of profits
4. Limitation on employment and location

The incidents of unwelcome regulations occur regularly and companies should be alert to
these possibilities. In contrast to forced divestment, governments do not reimburse
companies for losses in profitability resulting from the imposition or regulations:
therefore, the potential impact of such regulation must be carefully considered.

3. Interference with Operations

This type of risk may include:
1. Government encouragement of Unionization
2. Government voicing negative sentiments about foreigners
3. Discriminatory government support to locally owned businesses
Such activities are seen as improving a governments popularity and thus enabling them to
stay in power for long

While the forced divestment and unwelcome regulations have an immediate and
identifiable impact on operations, the activities described as interference with operations
may be less obvious and the effects unclear. The effects can have great impact over time
(through lost sales, increased costs, difficult labor relations, and so on); thus, companies
should weigh this political risk with equal attention.

VULNARABILITY TO RISK

The degree of risk faced by company is a function of both the country and company
factors. R=f (c,c)
Country characteristics- Type of government, Level of economic development, Stability of
social and political systems

In general, instability is associated with increased risk. This is because instability implies
uncertainty, which implies risk. Frequent government changes, an unstable economy, and
social disorder would obviously increase a business risk. The acts of terrorism are
especially worrisome to international firms.
Examples: Bomb planting by IRA in London Stock Exchange
Crashing of passenger planes to WTO building in New York
Bomb blasts in BSE
Bombing of Pan Am flight over Scotland

Company factors- Industry, technology, ownership, management

Some industries appear to be more subject to political risk than others because they are
seen as being important to development and the government wishes to maintain control
over them. In addition, these industries are often highly visible to the local population as
the government can use them as a means to maintain political control. Businesses that use
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natural resources, banking and insurance companies, as well as companies involved in

infrastructure projects such as railroads, airlines or communications have historically been
most affected by the government intervention.

High-tech firms with solid grounding research are less affected by govt. intervention, as
local governments would be unable to manage such companies themselves. A companys
ownership is also an important component of its vulnerability to risk, because the local
ownership is usually seen favorably by the government. Wholly owned subsidiaries are at
risk, while joint ventures with local partners are less risky. Management make-up also
determines the risk. 100% foreign management is never viewed favorably.