Political And Legal Environment

Submitted by-Disha Sahu(05)

M.F.Tech(I)

Introduction

• An international firm needs to operate in countries having diverse political and legal frameworks that at time conflicts with those of its home country.

• International managers need to develop conceptual understanding of major types of prevailing legal systems, such as common law, civil law, and theocratic law and adapt their business strategies accordingly.

• Risks in IB, such as commercial, economic and political risks need to be assessed and managed.

International Political Environment

• International manager need to understand the significance of political decision-making in the host country that may severely influence its overseas operations. They could be-– International Political Systems And Ideologies– Trade embargos and Sanctions– Bureaucracy– Terrorism, crime and violence

International Political Systems And Ideologies

• The political system of a country comprise various stakeholders, such as government, political parties with different ideologies, labour unions, religious organizations, environmental activists, and various NGO’s

• Political behaviour- the acquisition, development, securing, and use of power in relation to other entities, where power is viewed as the capacity of the social actors to overcome the resistance of other actors is termed as political behaviour.

• Ideology- set of beliefs or ideas as to how the society or group should be organized, politically, economically or morally.

• Political Ideology- set of ideas or beliefs that people hold about their political regime and their institutions about their positions and role in it.

International Political Systems And Ideologies

– Types of government-• Economic system-

– Communism – Socialism– Capitalism

• Political system-– Democracy– Totalitarianism

» Secular» Fascist» Authoritarian» Communist» Theocratic

• Structure-– Parliamentary– Commonwealth countries– Monarchies– Theocracy

Communism

• Based on Karl Marx’s Theory of Social Change directed at the idea of a classless society.

• All the major factors of production in a country under communism are owned by the government and shared by all the people rather than profit seeking enterprises, for the benefit of the society.

• Countries following communist philosophy had non-market and weak economies and the governments had an active role in economic planning.

• These countries had rigid and bureaucratic, political systems and indulged in huge foreign debts.

Socialism

• Basic and heavy industries are operated by the government, like mining, exploration, steel, ship building, railways, roads, airlines etc. whereas small businesses may be privately owned.

• The extent of government control is less than communism.

Capitalism-

• Its the economic system in which there is a complete freedom of private ownership of productive resources and industries, providing ‘free market economy’.

• ‘Market oriented system’- market prices are determined by forces of demand and supply.

• Individuals are motivated by the private gains, it leads to product innovation, quality upgradation, increase in efficiency, and lower market prices.

Democracy-

• Derived from demokratia, which means rule of the people or government by the people where citizens are directly involved in decision making.

• Over a period of time, societies have become more complex leading to decision making by people’s elected representatives in democratic countries.

Totalitarianism-• Dictatorial form of centralized government that regulates every

aspect of public and private behaviour.• Citizens are generally deprived of their basic right of freedom of

expression, organizing meetings, free media, tolerance, and elections which are available under democracy. Various forms are-– Secular totalitarianism- government uses military power to rule.– Fascist totalitarianism- right-wing nationalistic political ideology

fundamentally opposed to democracy with a totalitarian and hierarchical structure.

– Authoritarian totalitarianism-aims to control both minds and soul of people and to convert them to its own faith whereas totalitarianism aspires to just rule people.

– Communist totalitarianism-advocates that socialism could be achieved only through totalitarian dictatorship. It is the left wing totalitarianism that believes in equal distribution of wealth and complete government ownership and control on natural resources.

– Theocratic totalitarianism-religious leaders also assume political leadership.

Parliamentary-

• Government consult its citizen from time to time and the parliament has power to formulate and execute laws. Major forms of government are-– Parliamentary republics-Prime Minister is the executive head of the

government and also the leader of the legislature. The President is more of the titular head of the state with little executive power.

– Semi-Presidential system- a President and a Prime minister co-exist. President has genuine executive authority, unlike in a parliamentary republic. But the Prime Minister is the head of the legislature and also heads the government.

– Fully-Presidential system- President is both head of the state and head of the government in fully presidential systems and there is no Prime Minister.

Commonwealth countries-

• Represent constitutional monarchies that recognize the British monarch as head of the state over an independent government.

• A governor-general to each country other than the UK is appointed by the Queen as a representative

Monarchies-

• Constitutional Monarchies- a form of government in which king or queen acts as head of state, while the ability to make and pass legislation resides with an elected parliament.

• Absolute Monarchies- includes countries that have monarch as the executive heads of government, exercising all powers.

Theocracy-

• Derived from Greek word theokratia, means rule of God. The civil lea.der is believed to have a direct personal connection with god in a pure theocracy

Trade Embargos and Sanctions-

• Often used as hostile political measures rather than being based on economic considerations.

• Trade embargos prohibit trade completely with a country so as to economically isolate it and exert political pressure on its government.

• Trade sanctions are used to impose selective coercive measures to restrict trade with a country.

Bureaucracy-

• Form of administration based on hierarchical structure, governed by a set of written rules and established procedures.

• In the present context it is often use to describe inefficient and obstructive administration and red-tapism.

Terrorism, crime and violence-

• Terrorism is a political tactic that uses the threat or violence, usually against civilians, so as to frighten them and build political pressure on the government.

• During recent years, terrorism has become endemic and gained increase global attention consequent to 11 September 2001

International Legal Environment

• Judicial independence and efficiency• International legal systems• Principles of international law• United nations commission on international

trade law

Judicial independence and efficiency-

• The independence of a country’s judicial system from political influences of the members of governments, citizens or firms is crucial for the fair treatment a firm receives in its overseas markets.

International Legal Systems-

• Common Law- based on traditions, past practices and legal precedents set by courts through interpretation of statutes, legal legislations and past rulings. Depends less on written statutes and codes

• Civil Law- based on a set of written statutes. The elaborate legislative codes embody the main rules of law, spelling out every circumstances.

• Socialistic Law- derived from marxist socialist system and continues to influence legal framework in former communist countries as CIS, China. Advocates ownership of most property by the state or state-owned public enterprises, prohibiting free entry to foreign firms.

• Theocratic Law- based on religious doctrine, percepts and beliefs.

• Islamic Finance-under Islamic law, western style finance is haram, or forbidden, to devout Muslims. A substantial amount of oil-money is invested in Sharia-compliant funds.

Principles of International Law-

• International managers need to understand the basic principles that govern the conduct of international law. These are-– Principle of sovereignity- a ‘sovereign’ state is independent

and free from all external control or enjoys a complete legal equality with other states. It governs its own territory, has the right to select and implement its own political, economic, and social systems and has the power to enter into bilateral and multilateral agreements with other nations.

– International jurisdiction- three principles-• Nationality principle-every country has jurisdiction over its citizens,

irrespective of their locations.

• Territoriality principle-every country has the right of jurisdiction within its own legal territory.

• Protective principle-every nation has jurisdiction over conduct that adversely affects its national security even if such behaviour occurs outside the country.

– Doctrine of comity-as apart of the international customs and traditions, there must be mutual respect for the laws, institutions, and the government system of other countries in the matter of jurisdiction over their own citizens.

– Act of state doctrine-all act of other government are considered to be valid by a country’s court, even if such acts are not appropriate in the country.

– Treatment and rights of aliens- Nations have the right to impose restriction upon foreign citizens on their rights to travel and stay, their conduct, or area of business operations. A country may also refuse entry to foreign citizens or restrict their travel.

– Forum for hearing and settling of disputes- courts can dismiss cases at their discretion, brought before them by foreigners. However, courts are bound to examine issues, such as the place from where evidence must be collected, location of the property under restitution, and the plaintiff.

United Nations Commission on International Trade Law-

• UNCITRAL was established in 1966 by the UN General Assembly with the aim to reduce obstacles in international trade.

• Its mandate is to harmonize and unify the laws of international trade.

• Commission is composed of 60 member states elected by the General Assembly, for the term of six years.

• Presently has six working group for areas, such as procurement, international arbitration and conciliation, transport law, electronic commerce, insolvency law and security interests.

Risks in international business

• Types of risk-– Commercial risks– Economic risks– Political risks

• Measuring international business risks• Managing risks in international business

Commercial risks

• As a firm has to deal with the overseas buyer operating in a different legal and political environment in an international transaction, the risks to smooth conduct of the commercial transaction increases manifold. Major commercial risks are-– Non-Payment by the importer at the end of credit period– Non-Acceptance of goods by the importer despite

his/her compliance with the export contract.– Insolvency of the purchaser.

Economic risks-• Countries often impose restrictions on business activities on the

ground of national security, conserving human and natural resources, scarcity of foreign exchange, to curb unfair trade practices and to provide protection to domestic industries. Principle economic risks are-– Import restrictions- to protect domestic industry, national government

often impose selective restrictions on import of goods.– Local content requirements- trade policies often make provisions for

local content requirements for extending export incentives or putting a country of origin label.

– Exchange controls- in view of the scarcity of foreign exchange, countries often adopt stringent exchange control measures, adversely affecting repatriation of profits and sales proceeds to the home country.

Political Risks-

• The possibility of political decisions, events or conditions in an overseas market or country that adversely affect IB is termed as political risk. Major risks are-– Confiscation-process of taking over a property without any

compensation.'– Expropriation-foreign government’s taking over of a company’s

goods, land or other assets, by offering some kind of compensations, which is much lower than the market value.

– Nationalization-government’s taking over the assets and property and operating the business taken over under its ownership.

– Domestication-foreign company’s relinquishing control and ownership to the nationals.

Measuring International Business Risks-

• The country risk rating generally use different criteria to arrive at political, financial, economic and overall risks as-– Business environment risk intelligence index– EIU’s risk indices– Global Political Risk Index– Failed states index

Business environment risk intelligence index-

• Provide risk forecasts for about 50 countries throughout the world and a broad assessment of the country’s business climate.

• Developed by Frederich Haner of the University of Delaware in the US.

• Assesses about 48 countries, four times a year, on 15 economic, political, and financial factors on a scale from 0 to 4.

0-Unacceptable conditions for investment1-Poor conditions2-Acceptable or average conditions3-Above average conditions4-Superior conditions

EIU’s risk indices-

• To monitor Business Environment Ranking so as to facilitate assessment of countries for doing business.

• Monitors the operational risks for 150 countries on a scale of 0 to 100, where 0 indicates the least risky and 100 the most risky place to operate.

• Overall score indulges an aggregate of 10 categories of risks, such as security, political stability, government effectiveness, legal and regulatory, macroeconomic, foreign trade and payments, financial, tax policy, labour markets and infrastructure.

Global Political Risk Index-

• Developed by Eurasia Group serves as a comparative index to monitor political risks in 24 emerging markets.

• Serves as an ‘early warning’ system to anticipate critical trends and provide a measure for the country’s capacity to withstand political, economic, security-related, and social shocks.

• Based on 20 indicators in four equal weighted categories-government, society, security and economy on a scale of 0-100.

Failed States Index-• Brought out by ‘Fund for Peace’, an independent organization

and Foreign Policy magazine.• Use 12 indicators covering social, political, economic and military

conditions and ranks on a scale of 0-120 to assess 177 states.0-most stable120-least stable.

• Reasons that contribute to state failure are rampant corruption, severe ethnic or religious divisions, predatory elites who have long monopolized power, and an absence of rule of law.

• State failure is contagious to neighbouring states mainly due to porous borders, cultural affinity and widespread under development.

Managing Risks in IB-

Political risks in IB may be managed either through avoidance or insurance.

• Strategic management of political risks• Insurance and guarantees-– Export credit guarantee corporation– MIGA’s guarantees against non-commercial

(political) risks.

Strategic management of political risks-

• Political risks are beyond control but certain measures are-– Employing locals-strategically employ locals who have a much

better understanding of local politics and are accustomed to operate in their own environments.

– Sharing ownership-in countries with higher level of risks, internationalizing firms should form joint ventures with local companies and share the risks instead of operating alone.

– Increasing perceived economic benefits in the host country economy- FDI laws often encourage investment that provides employment to the local work force, sources local inputs, such as raw material or components, increase the country’s exports or substitutes the import requirement. Therefore, an international firm should attempt to stimulate the benefits to the host company.

– Follow political neutrality-to avoid controversy in a foreign country, it must maintain equal distance from all the political parties and interest group in the host country.

– Assuming social responsibility-carry out business in a socially responsible manner and take up projects involving social welfare of masses.

– Adapting to local environment-must adopt to local environment and local character so as to be perceived as local rather than foreign entities

Insurance and Guarantees-

• Due to fast emerging and far reaching political and economic changes, the payment risks in international transactions have considerably increased.

• Exporters may have to face commercial risk of insolvency or protracted default of buyers, as a foreign buyer going bankrupt or losing his capacity to pay are aggravated due to political and economic uncertainities.

• Most countries have central level-– Export Credit Agencies (ECA) to cover political and commercial risks.– World Bank’s subsidiary, Multilateral Investment Guarantee Agency

(MIGA) guarantees against non commercial risks at the multilateral level.

Export Credit Guarantee Corporation-

• ECGC in India is the principal organization offering variety of schemes for export credit and guarantee.

• Provide protection to the exporters who sell their goods on the credit terms.

• Covers both political and commercial risks.• Facilitates exporters in getting export finances

from commercial banks.

• Benefits provided by ECGC are-– Exporters can offer competitive payment terms to their buyers– Protects exporters against the risk and financial costs of non

payment– Provides exporters a freer excess to working capital.– The insurance cover reduces the exporter’s need for tangible

security while negotiating credit with their banks.– Credit insurance provides exporters a second check on their

buyers.– Exporters get access to and benefits from the credit insurer’s

knowledge of potential payment risks in overseas markets, commercial intelligence including changes in their import regulations.

MIGA’s guarantees against non-commercial (political) risks-

• World Bank Group subsidiary, helps foreign investors cover political risks by offering guarantees against the types of coverage which are-– Currency Transfer Restrictions-

• Protects against losses arising from an investor’s inability to convert local currency into foreign exchange for transfering outside the host country

• Insures against excessive delays in acquiring foreign exchange caused by the host government’s actions or failures to act.

– Expropriation-• Coverage offers protection against loss of the insured investment as a

result of acts by the host government that may reduce or eliminate ownership of, control over, or rights to the insured investment.

• Covers partial losses as well as the ‘creeping’ effect.

– War and civil disturbance-• Coverage protect against loss due to destruction, disapperance,

or physical damage to tangible assets caused by politically motivated acts of war or civil disturbance, including revolution, insurrection, and coup d’etat.

• Terrorism and sabotage are also covered• Extends to events that result in the total inability of the project

enterprise to conduct operations essential to its overall financial viability.

– Breach of contract-• Coverage protects against losses arising from host government’s

breash or repudiation of a contractual agreement with investor.

Summary-

• Government in power and the level of political opposition influences business viability in a country through changes in economic, industrial, and trade policies, regulations and laws.

• Political decisions often distort demand and supply in international markets and hamper free flow of goods and services.

• Political stability in the host country also influences continuity of economic policies and a predicable business environment.

• Conceptual understanding of subtle differences in political and legal environment across the countries facilitate in formulating and implementing effective strategy for IB.

References-