LECTURE 2:

UNDERSTANDING POLITICS, LAWS, AND ECONOMICS.

Institution commonly known as the rules of the game. As economic players, firms play by these rules. However, institutions are not static and they may change, resulting in institutional transitions fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect firms as players (Peng M. W., 2003).

Overall, the success and failure of firms around the globe are to a large extent determined by firms ability to understand and take advantage of the different rules of the game. In other words, how firms play the game and win (or lose), at least in part, depends on how the rules are made, enforced and changed. This calls for firms to constantly monitor, decode and adapt to the changing rules of the game in order to survive and prosper.

Understanding Institutions: Based View. Building on the rules of the game metaphor, Douglass North, a Nobel Laureate in economics, more formally defines institutions as the humanly devised constraints that structure human interaction (North D., 1990). An institutional framework is made up of both the formal and informal institutions governing individual and firm behaviour.

Formal institutions include laws, regulations and rules. In global business, formal institutions may be imposed by home countries and host countries. Their primary supportive pillar, the regulatory pillar, is the coercive power of governments. For example, although many individuals may pay taxes out of a sense of patriotic duty, many others pay taxes out of fear if they did not pay and got caught, they would go to jail.

On the other hand, informal institutions include norms, cultures and ethics. Informal institutions are supported by two pillars: normative and cognitive. The normative pillar refers to how the values, beliefs and actions of the relevant players collectively known as norms influence the behaviour of focal individuals and firms. For example, a recent norm is the rush to invest in China and India.

The cognitive pillar is the second support for informal institutions. It refers to the internalised (or takenfor-granted) values and beliefs that guide individual and firm behaviour. For example, a few whistleblowers reported Enrons wrong doing out of a belief in what was right and wrong. What do institutions do? Uncertainty surrounding economic transactions can lead to transaction costs, which are the costs associated with economic transactions or, more broadly, the costs of doing business. An important source of transactions costs is opportunism, defined as self-interest seeking with guile. Examples include misleading, cheating and confusing other parties in transactions that will increase transaction costs. Attempting to reduce such transaction costs, institutional frameworks increase certainty by spelling out the rules of the game so that violations (such as failure to fulfil a contract) can be mitigated with relative ease (such as through formal arbitration and courts).

Without stable institutional frameworks, transaction costs may become prohibitively high, to the extent that certain transactions simply would not take place. For example, in the absence of credible institutional frameworks that protect investors, domestic investors may choose to put their money abroad.

Institutions are not static. Institutional transitions in some emerging economies, particularly those moving from central planning to market competition (such as China, Poland, Russia and Vietnam), are so pervasive that these countries are simply called transition economies (a subset of emerging economies). Institutional transitions in these countries as well as in India and South Africa create both huge challenges and tremendous opportunities for domestic and international firms for example IKEA.

Management Savvy: It is the growth of the firm that, in the aggregate, leads to the growth of the economy. Not surprisingly, most developed economies are supported by strong, effective and market supporting formal institutions, and most underdeveloped economies are pulled back by weak, ineffective and market depressing formal institutions. In other words, when markets work smoothly in developed economies, formal market supporting institutions are almost invisible and taken for granted. However, when markets work poorly, the absence of strong formal institutions may be conspicuous.

Implications to managers. First, managerial choices are made rationally within the constraints of a given institutional framework. Therefore, managers aiming to enter a new country need to do their homework by having a thorough understanding of the formal institutions affecting their business. The firm will also

need to develop firm-specific resources and capabilities to take advantage of the rules of the game. Secondly, managers should follow the advice of the second proposition of the institution based view: in situations where formal constraints are unclear or fail, informal constraints such as relationship norms will play a larger role in reducing uncertainty....(Read pg 51-52) EMPHASIZING CULTURES, ETHICS AND NORMS: Read Case on Cartoons (unethical)

Informal institutions are about more than just basic customs such as how to present business cards correctly and how to wine and dine properly. Informal institutions can make or break firms, which is why they deserve a great deal of our attention (Salk J. & Brannen M. 2000, Witt M. & Redding G. 2009, Budhwar P. & Parkes C. 2006).

Where Do Informal Institutions Come From? Although formal institutions such as politics, laws, and economics are important, they make up a small (although important) part of the rules of the game that govern individual and firm behaviour. As pervasive features of every economy, informal institutions can be found almost everywhere (Nadkarni S. & Barr P. 2008).

They come from socially transmitted information and are a part of the heritage that we call cultures, ethics and norms. Those within a society tend to perceive their own culture, ethics and norms as natural, rational and morally right (Hofstede G. 1997). This self centered mentality is known as ethnocentrism. Common sense in one society may not be uncommon elsewhere (Michailova S., 2002). Although the regulatory pillar clearly specifies the dos and donts, informal institutions, by definition, are more elusive. Yet they are no less important (Busenitz L., Gomez C. & Spencer J., 2000)

CULTURE: Definition of Culture: Geert Hofstede, a Dutch professor defines culture as the collective programming of the mind which distinguishes the members of one group or category of people from another. Before proceeding, it is important to make two pints to minimise confusion. 1. Although it is customary to talk about American culture or Brazilian culture, no strict one-to-one correspondence between cultures and nation-states exists.

2. Culture has many layers, such as regional, ethnic and religious. Even firms may have a specific organisational culture. Although culture is too complex to dissect in the space, four major components of culture that impact global business were language, religion, social structure and education... Language in business terms (dialogue English contribute largest share and globalisation) read pg 64-65. Religion manifestation of culture beliefs system (Read pg 66-67) Social structure that refers to how a society broadly organizes its members with rigidity or flexibility. Two terms are key to this discussion. Social strafication is the hierarchical arrangement of individuals into social categories (strata) such as classes, castes, or divisions within a society. Social mobility refers to the degree to which members from a lower social category can rise to a higher status. Social structure is the outcome of a societys formal and informal rules of the game that, in turn, give birth to its norms and values. In China, pronounce social stratification can be found along the urban-rural divide (Good example, read pg 67-68). Education Teach the mainstream values and norms and foster a sense of identity. In collectivistic societies, schools often foster collectivistic values and emphasize the right answers in learning. In individualistic societies, schools emphasize individual initiatives and encourage more independent thinking, emphasizing questions with no right or wrong answers. (Good example India education limit entry, pg 68-69)

Understanding CULTURE DIFFERENCES: Three different ways to systematically understand cultural differences: context, cluster and dimension approaches. Then, culture is linked with different firm behaviour.

The Context Approach: Of the three main approaches probing into cultural differences, the context approach is the most straightforward because it relies on a single dimension: context (Hall E. & Hall M., 1987). Context is the underlying background upon which social interactions takes place. (see pg 69)

In low context cultures (such North American and Western European countries), communication is usually taken at face value without much reliance on unspoken context. In other words, no means no. In contact, in high-context cultures (such as Arab and Asian countries), communication relies a lot on the underlying unspoken context, which is as important as the words used. In such cultures, no does not necessarily mean no. Thus, context is important because failure to understand the differences in interaction styles may lead to misunderstanding. (Read further pg 69-70).

Low context culture a culture in which communication is usually taken at face value without much reliance on unspoken context. High-context culture a culture in which communication relies a lot on the underlying unspoken context, which is as important as the words used.

The Cluster Approach: The cluster approach groups countries that share similar cultures together as one cluster: The first is the Ronen and Shenkar clusters, proposed by management professors Simcha Ronen and Oded Shenkar (1985). The second is called the Globe clusters, named after the Global Leadership and Organisational Behavior Effectiveness project led by management professor Robert House (House R. Et al, 2004). The third set of clusters is the Huntington civilisations, popularised by political scientist Samuel Huntington. A civilisation is the highest cultural grouping of people and the broadest level of cultural identify people have (Huntington S., 1996).

The idea that people and firms are more comfortable doing business with other countries within the same cluster/civilisation. This is because common language, history, religion and customs within the same cluster/civilisation reduce the liability of foreignness when operating abroad.

The Dimension Approach: The dimension approach is more influential. The reasons for such influence are probably twofold. First, insightful as the context approach is, context only represents one dimension. What about other dimensions? Second, the cluster approach has relatively little to offer regarding differences between countries within one cluster. By focusing on multiple dimensions of cultural differences both within and across clusters, the dimension approach has endeavoured to overcome these limitations. Although there are several competing frameworks (Schwatrz S. 1994), the work of Hofstede and his colleagues is by far the most influential.

Hofstede and his colleagues have proposed five dimensions. First, power distance is the extent to which less powerful members within a country expect and accept that power is distributed unequally. For example, in high power distance Brazil, the richest 10% of the population receives approximately 50% of the national income, and everybody accepts this as the way it is. (More example pg 71-73).

Secondly, individualism refers to the idea that an individuals identity is fundamentally his or her own, whereas collectivism refers to the idea that an individuals identity is fundamentally tied to the identity of his or her collective group, be it a family, village, or company. In individualistic societies, led by United States, ties between individuals are relatively loose and individual achievement and freedoms are highly valued. In collectivist societies, such as many counties in Africa, Asia and Latin America, ties between individuals are relatively close and collective accomplishments are often sought after. (Read pg 73). Third, the masculinity versus feminist dimension refers to sex role differentiation. In every traditional society, men tend to have occupations such as politicians, soldier or executive that reward assertiveness. Women, on the other hand, usually work in caring professions such as teacher and nurse in addition to being homemakers. (Examples Japan and Sweden Gender role, pg 73). Fourth, uncertainty avoidance refers to the extent to which members in a culture accept or avoid ambiguous situations and uncertainty. Members of high uncertainty avoidance cultures (led by Greece) place a premium on job security and retirement benefits. They also tend to resist change, which often creates uncertainty. Low uncertainty cultures (led by Singapore) are characterised by a greater willingness to take risk and less resistance to change. Finally, long-term orientations emphasize perseverance and saving for future betterment. China, which has the worlds longest continuous written history of approximately 4,000 years and the highest contemporary savings rate, leads the pack. On the other hand, members of short-term orientation societies (led by Pakistan) prefer quick results and instant gratification. Overall, Hofstedes dimensions are interesting and informative. They are also largely supported by subsequent work. It is important to note that Hofstedes dimensions are not perfect and have attracted some criticms. However, it is fair to suggest that these dimensions represent a starting point for us to figure out the role of culture in global business.

Four criticisms (More on pg 74): Cultural boundaries are not the same as national boundaries Hofstede might inevitably be more familiar with dimensions relevant to Westerners. Thus, crucial dimensions relevant to Easterners (Asians) could be missed. Research based on surveys of more than 116,000 IBM employees working at 72 national subsidiaries during 1967-1973. Both have pros and cons. Because the original data are now 40 years old, critics contend that Hofstedes framework would simply fail to capture aspects of recent cultural change.

Culture and Global Business:

A great deal of global business activity is consistent with the context, cluster and dimension approaches to cultural differences (Evans J. & Mavondo F., 2002) Read pg 75 (Relationship with culture and Global Business). Overall, there is strong evidence pointing out the importance of culture (Chen X. & Li S., 2005). Sensitivity to cultural differences does not guarantee success but can at least help to avoid blunders. Examples (read pg 75-76) Limitation of all framework examples. Chinese manufacturer brand name White Elephant? French managers transfer to U.S sexual harassment with secretary U.S for cheek-to-cheek kiss Japanese (Masculine) company with more female participation in the US facilities?

ETHICS: Definition and Impact of Ethics (Read pg 76): Ethics refers to the principles, standards and norms of conduct that govern individual and firm behaviour (Trevino L. & Nelson K., 2004). Ethics is not only an important part of informal institutions, but is also deeply reflected in formal laws and regulations. To the extent that laws reflect a societys minimum standards of conduct, there is a substantial overlap between what is ethical and legal as well as between what is unethical and illegal. However, in some cases, there is a gray area because what is legal may be unethical.

Managing Ethics Overseas (Read pg 76-77): Three schools of thought: Ethical relativism accept any local practice Ethical imperialism may cause resentment and backlast among locals. Business ethicist respect for human dignity and basic rights, respect for local tradition and respect for institutional context.

Ethics and Corruption (Read pg 77-79): Ethics helps to combat corruption, often defined as the abuse of public power for private benefits usually in the form of bribery, in cash or in kind (Cuervo-Cazurra A., 2006). Competition should be based on products and services, but corruption distorts that basis, causing misallocation of resources and slowing economic development (Dirienzo C. Et al, 2006)...

NORMS AND ETHICAL CHALLENGES: As an important informal institution, norms are the prevailing practices of relevant players the proverbial everybody else that affect the focal individuals and firms. How firms strategically respond to ethical challenges is often driven at least in part, by norms. Four broad strategic responses are: 1. 2. 3. 4. Reactive (Deny responsibility; do less than required) Defensive (Admit responsibility but fight it; do the least that is required) Accommodative (Accept responsibility; do all that is required) Proactive Strategies (Anticipate responsibility, do more than is required)

Overall, although there is probably a certain element of window dressing in proactive strategies, the fact that proactive firms go beyond the current regulatory requirement is indicative of the normative and cognitive beliefs held by many managers at these firms on the importance of doing the right things (Barnett M. & King A., 2008).

DEBATE AND EXTENSIONS: Informal institutions such as cultures, ethics and norms provoke a series of significant debates. 1. Western values versus Eastern Values 2. Cultural Convergence versus Divergence 3. Opportunism versus Individualism/Collectivism

Economic Development: Western Values versus Eastern Values (Pg 80-81). The Westerns (Protestants Belief) lead to capitalism (performance improve) The Eastern challenge from Islamic blamed on Western civilisation that causes the lacklustre economic performance of Muslim countries. Aggressive marketing of Western products in these countries is seen as a cultural invasion. Eastern challenged from Asian (Confucian) led by Japanese in 1960s, then the four Tigers in the 1970s and China since the 1980s that generated the fastest economic growth in the world and for the longest time though criticised by Weber that lead to the cause of Asian backwards ...

Cultural Change: Convergence versus Divergence (pg 82) Every culture evolves. A great debate thus erupts on the direction of culture change.

In the age of globalisation, one side of the debate argue that there is a great deal of convergence, especially towards more modern Western values such as individualism and consumerism. As evidence, convergence gurus point out the worldwide interest in Western products, such as Blackberries, Levi Jeans, iPods and MTV especially among the youth (Levitt T., 1983) Another side suggests that Westernisation in consumption, does not necessarily mean Westernisation in values. More broadly, the popularity of Western brands in the Middle East does not change Muslim values. Another example, the increasing popularity of Asian foods and games in the West does not necessarily mean that Westerners are converging toward Asian values. Cross convergence the idea in which suggest that when marketing products and services to younger customers around the world, a more global approach may work whereas when dealing with older, more tradition-bound consumers, local adaptation may be a must.

Opportunism versus Individualism/Collectivism: Read through pg 82-83.

MANAGEMENT SAVVY: For savvy managers around the globe, this emphasis on informal institutions suggests tow broad implications: First, it is necessary to enhance cultural intelligence, defined as an individuals ability to understand and adjust to new cultures (Early P.C & Mosakowski E., 2004). Nobody can be an expert, in all cultures. However, a genuine interest in foreign cultures will open your eyes. Acquisition of cultural intelligence passes through three phases (1) awareness (2) knowledge (3) skills (Hofstede, 1997). It is imprudent to ignore culture though it is advisable not to read too much into culture, which is one of many variables affecting global business (Shenkar O. 2001) Secondly, managers need to be aware of the prevailing norms and their transitions globally. The norms around the globe in the 21st century are more culturally sensitive and ethically demanding that they were in, say the 1970s. This is not to suggest that every local norm needs to be followed. However, failing to understand and adapt to the changing norms by behaving in an insensitive and unethical way may lead to unsatisfactory or disastrous results.

Implications for Actions Six Rules of Thumb When Venturing Overseas: 1. 2. 3. 4. Be prepared Slow Down Establish Trust Understand the importance of Language

5. Respect cultural differences 6. Understand that no culture is inherently superior in all aspects.