Module No and Title Module No.15: ROLE OF POLITICAL

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PAPER No.11 : INTERNATIONAL BUSINESS

MODULE No. 15: ROLE OF POLITICAL ENVIRONMENT IN INTERNATIONAL BUSINESS

Subject COMMERCE

Paper No and Title Paper No.11: International Business

Module No and Title Module No.15: ROLE OF POLITICAL ENVIRONMENT

IN INTERNATIONAL BUSINESS

Module Tag COM_P11_M15

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TABLE OF CONTENTS

1. Learning Outcomes

2. Introduction

3. IMPORTANCE OF POLITICAL ENVIRONMENT IN INTERNATIONAL

BUSINESS

4. POLITICAL ENVIRONMENT AND ITS IMPLICATIONS FOR

INTERNATIONAL BUSINESS

5. POLITICAL RISKS

6. POLITICAL SOVEREIGNTY

7. SUMMARY

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1. Learning Outcomes

After studying this module, you shall be able to

Appreciate the differences in the political systems of various countries and their implications for international business

Distinguish between aspects of democracy and totalitarianism

Understand the meaning of political risk and type of political risks

Identify ways in which MNCs can deal with political risk

2. Introduction

Political environment refers to the influence of the system of government and judiciary in a nation.

The system of government in a nation exercises considerable impact on its business. . Political

system, political parties in power, political parties in the opposition, political maturity of the parties,

number of political parties, political awareness of people, political stability and others have an

important impact on the business environment in a country. The economic policies pursued by

a Government are to a great extent the by-product of political environment that companies face

domestically and internationally.

Let me try to explain this by an example of a company doing business in USA would not find

much difference in the political environment of Canada as the two countries have a democratic

set up of selecting a government. Whereas, if an Australian company intends to do business in

Rwanda or Russia it would have to face many challenges. International business managers and

MNC’s should therefore try to foresee and understand these differences and existence of different

political groups in the host countries in order to avoid political tensions and instabilities.

Therefore, Political environment plays an important role in international business and an

international company cannot ignore the political situations in the home or the host country if it

has to operate successfully abroad. A company doing business outside its home country should

carefully study the government structure in the target country and analyze salient issues arising

from the political environment.

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3. IMPORTANCE OF POLITICAL ENVIRONMENT IN


According to Daniel’s etal, “A political system includes the complete set of institutions, political

organisations, and interest groups, as well as the relationships among institutions and the political

norms and rules that govern their activities.” Thus, a political system ensures some level of

stability in social relations and should be able to hold together people from different ideologies.

Differences in political ideologies change the national boundaries. For example, the difference in

ideologies lead to the partition of India and Pakistan in 1947 or the breakup of USSR.

Thus, a manager in order to do business in a foreign country needs to understand the political

environment which comprises of three dimensions:

(1) The home country perspective

(2) The International perspective

(3) The host country perspective

All these dimensions have to be carefully analysed by an international business manager. The

political set-up of any country influences the carrying of international business as one needs to

take decision as whether to invest or not, how to develop the identified markets and how to plan

the strategic formulation. Thus, political environment is relevant to international business, as

political factors play a vital role in the following areas:

(a) The nature of regulatory framework.

(b) The main areas of governmental control over MNC activities.

(c) The relative importance of various pressure groups within a nation.

(d) The likelihood of trade embargoes i.e. prohibitions on trade with particular nation.

(e) The degree of losses from political risks and the extent to which insurance can be taken.

(f) The tax regimes pertaining with specific countries

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4. POLITICAL ENVIRONMENT AND ITS IMPLICATIONS FOR


Appraisal of the political environment includes any national or international political factors that

can affect its operations. A factor is said to be political when it derives from the government

sector. The following are the elements of the political environment:

1. Form of Government:

The government is an integral part of every foreign and domestic business activity. Thus, a

multinational firm is affected by the political environment of the home country as well as the host

country. The ideal political climate for a multinational firm is a sable and friendly government.

Unfortunately, many governments are not always friendly and stable and changes in goals and

attitudes can cause a stable and friendly situation to become risky.

2. Stability of Government Policies:

Regardless of whichever government is in power or new political parties which are elected, the

concern of the multinational corporations is the continuity of set of rules or code of behavior. A

change in government, whether by elections or coups does not always mean a change in the

level of political risk. In Italy, for example, there have been more than 50 different governments

formed since the end of World War II. While the political turmoil continues in Italy, business goes

on as usual. Pepsi company operated profitably in the Soviet Union under one of the most

extreme political systems. If there is a potential for profit, companies can function under any type

of government as long as there is some long run predictability and stability.

3. Political Parties, their Philosophy and Ideology

Understanding the political systems helps an international manager to have an idea of political

systems and their impact on international business. Governments may be parliamentary (open) or

absolutist (closed).

Parliamentary Governments: In parliamentary governments people are consulted and

are allowed to participate in decision-making on all important issues.

Absolutist Governments: In absolutist government, the ruling government dictates

government policies, rules and regulations on all citizens without considering the

viewpoint of the ordinary people. For example, Saudi Arabia and North Korea have

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parliamentary type political systems where people are

not allowed to express their voice. Hence they are classified as monarchies and

dictatorships. Business in these countries is based on government policies rather than

the people’s needs.

Governments can be further classified as two party system, multi-party, single- party and one-

party dominated.

A. Two party System: Under this system two major parties take turn of controlling the

government. The USA and UK are the examples of two party system. For example, in

USA we have the Republican Party which represents the business interest and the

Democratic party represents the labour.

B. Multi-Party system: Under this system there are many parties and no party is strong

to gain the control of the government. For example, Germany, France, Israel, Poland

are examples of multi-party systems.

C. Single Party System: In this system only one dominant party gets the opportunity to

control the government, though several parties exist. For example, Egypt has a single

part system.

D. One-party dominated system: In this system, though there are more than one

party, the dominant party rules the government and it does not allow any opposition

party to come up. The former USSR, Cuba, Libya are examples of this system.

4. Role of Government in Home Country:

The firm’s home country’s political environment can constrain its international operations as

well as its domestic operations. It can limit the countries that the international firm can enter.

For example, the United States prohibits its firms from dealing with Cambodia, Cuba, Libya

and North Korea.

4.2 Democracy versus Totalitarianism

The political scenario often varies between the two extremes: ie, democracy on one hand and

totalitarianism on the other.

Democratic Form of Political System Democracy is one of the basic form of political system. It

refers to a political arrangement in which the supreme power is vested in the people. It rests on

the principle of “ Government of the people, for the people and by the people.” It rests on the

ideology that all citizens should be equal politically and legally; should enjoy widespread freedom

and should participate in political process. A democratic form of government exhibits a system,

where the public, in a democratic manner elects their representatives who do the ruling. A

representative democracy rests on the assumption that if the elected representatives fail to

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perform adequately they will be voted down in the next

election. India is the world’s largest democracy. The Principles of democracy are –

(1) Prominent rule of Law

(2) Universal right to vote

(3) Freedom of opinion, expression, speech and association.

(4) Limited term for elected officials.

(5) An accessibility to political decision-making process.

(6) An independent and fair court system with high regard for individuals right and property.

Political rights and civil liberties help for evaluating the freedom of citizen. Some of the indicators

of political rights and civil liberties are:

1. Conduct of elections fairly and competitively

2. Power and ability of voters in casting their rights

3. People’s ability in forming political parties and groups.

4. Existence of safeguards of minority rights.

5. Degree of freedom of the press.

6. Equality of all individuals under the law.

Countries such as, Australia, Bahamas, Canada, Japan and South Korea are high in political

rights and civil liberties. Whereas countries such as, Brazil, Ethiopia, Malaysia and Russia

are partly free countries. China, Egypt, Saudi Arabia and North Korea are not so much free

countries.

Democracies vary not only in the citizens participation in decision-making but also in the

degree of centralization of control. Canada and USA are highly decentralized as they

delegate significant political authority to provincial governments. Whereas political systems in

France, Japan and India are highly centralized and multinational companies enjoy easy

system to deal in such countries. Even the countries having mature democracies are facing

problems of corruption, indifference of people and maximizing personal interest rather than

national interest by the politicians.

75% of countries have democracies of some order. Of them, 1/3rd are more pluralistic, 1/3rd are

some 50:50 type and remaining 1/3rd are more totalitarian.

4.3 Totalitarianism form of political system

Totalitarianism, also called authoritarianism, is a form of government in which individual freedom

is completely subordinated to the power of the authority of state and concentrated in the hands of

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one person or in a small group, which is not constitutionally

accountable to the people. For example, Nazi Germany under Adolf Hitler is an example of

totalitarian governments.

A. Theocratic totalitarianism: Political system that is under the control of religious leaders

is theocratic totalitarianism. In such a system religious leaders are the political leaders

and they frame and enforce laws and regulations that are based on religious beliefs.

Afghanistan and Iran are examples of political dispensation.

B. Monarchy : This political system is a form of authoritaritism. It is based on the ideology

that king is the supreme power and the country is ruled by the royal family of the country.

The residents follow the norms and code of conduct as laid by the supreme power, and

he is preceded by his son or daughter. It can be as absolute Monarchism or

Constitutional monarchism, depending upon the degree of decision-making and control.

C. Dictatorship : At times when economic depression arises and a pure democratic system

is not workable in a complex society with a large constituency, there arises a need to

bring change in the political set-up. This gives rise to Dictatorship, where the power is

exercised by one man in an autocrat manner. It is based on the principle of obedience,

which believes that people show efficiency and productivity when they are forced to

follow certain rules and regulations.

5. POLITICAL RISKS

Political Risks

International business firms face political risk when they conduct business with the outside world.

Political Risks may be defined as any governmental action or politically motivated event that

could adversely affect the long-term profitability or value of firms. It involves the risk of a change

in government policy that would adversely impact a company’s ability to operate effectively and

profitably. Political risk affects different firms in different ways. It can threaten the market of an

exporter, the production facilities of a manufacturer or the ability of a firm to repatriate its profits

from a host country to home country. When the perceived level of political risk is lower, a country

is more likely to attract investment. The level of political risk is inversely proportional to a

country’s stage of development. All other things being equal, the less developed a company, the

greater the political risk. It can be confiscation, expropriation, domestication or nationalization,

general instability risk and operation risk.

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Confiscation: The most severe political risk is

confiscation which means seizing a company’s assets (properties, investments) without

payment or compensation. Chinese government’s seizure of US property in 1949 when

Chinese communist party took power is an example of confiscation.

Expropriation: Less drastic, but still severe is expropriation requiring some

reimbursement for the government-seized investment. Compensation is generally

provided to foreign investors, although not often in the “prompt, effective and adequate”

manner provided for by international standard. For example, Indian government

nationalized commercial banks with compensation in July 1969. Expropriation of copper

firms

Nationalisation: Nationalisation is the process of shifting the ownership of private

property from private individuals or institutions to the Government. It is an intense feeling

of national pride and unity an awakening of a nation’s people to pride in their country. In

other words national interest and security are more important than international

consideration. These feelings of nationalism can be manifested in a variety of ways

including, “buy our country’s products only”, restriction on imports, restrictive tariffs and

other barriers For example, Burma nationalized entire foreign trade. Poland and Czech

communists nationalised 100 per cent of their economy.

Domestication: In domestication foreign business firms relinquish control and ownership

in favour of domestic investors either partly or fully. In this host countries take steps to

transfer foreign investments to national control and ownership through a series of

government decrees. For example, in India Indian Leaf Tobacco Development Co and in

South Africa, Pepsi, General Motors and Barclays Bank have faced domestication.

Entry Restrictions: If allowed to enter the country the firm may be restricted as to the

industries it may enter. It may be prohibited from acquiring a national firm. It may not be

allowed a 100 per cent ownership but may be required to enter a joint venture with

national firm.

Quotas and tariffs: The country’s quotas and tariffs may limit the firm’s ability to import

equipment, components and products, forcing a higher level local procurement than it

may want.

Exchange Controls: Exchange controls stem from shortages of foreign exchange held

by a country. When a nation faces shortages of foreign exchange, control would be levied

over all movements of capital and selectively against the most politically vulnerable

companies to conserve the supply of foreign exchange for the most essential use. A

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recurrent problem the foreign investor is getting profits

and investments converted into the currency of the home country.

Price Controls: Essential products that command considerable public interest, such as,

pharmaceuticals, food, gasoline and cars are often subject to price controls. It may be

used to force foreign companies to sell equity to local interests. In inflationary economies

it can severely limit profitability. A side effect to the local economy can be slow or even

stop capital investment.

General Instability Risk: These risks are due to social, political, religious unrest in the

country. For example, recent coup in Fiji and problems due to Muslim rebels in

Philippines.

Operation risk: These risks are due to the imposition of controls on the foreign business

operation (like production levels, marketing, finance and human resource) by the host

government.

5.2 Indicator’s of Political Instability

Some of the indicators of political instability are:

1. Corruption: Corruption and bribery have become acute and prevalent not only

among bureaucrats but also among politicians during the early stage of political

instability.

2. Social Unrest: Social unrest is caused by clashes between or among community

groups, religious groups and ethnic groups. For example, Hindu-Muslim conflict in

India, Christian-Muslim conflict in Lebanon, white-black conflict in the USA, the civil

war between the Serbs and Croats in Yugoslavia.

3. Attitudes of Nationals: The negative attitude of nationals towards foreign business

and foreigners is a greater risk. These negative attitudes include, exploitation,

colonialism, repatriation, employment to foreigners.

4. Policies of the Host Government: Host government policies affect the operation of

international business directly and internally or externally.

5.3 How to minimize Political Risks?

Political risks cannot be completely eliminated however they can be minimized by

contributing to the change of the attitudes of the people and the government of the country

within which it operates. The measures that can be taken to lessen the degree of

susceptibility of a specific business venture to reduce political risks are:

1. Good Corporate Citizenship: Under this a company is advised to remember:

i) It is a guest in the country and should act accordingly.

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ii) The profits of an enterprise are not solely of the

multi nationals but the local national employees and the economy of the country

should also benefit.

iii) It is not wise to try to win over new customers by fraudulent techniques.

iv) It should try to contribute to the country’s economy and culture with worthwhile public

projects

v) It should train its executives and their families to act appropriately in the foreign

environment.

2. Stimulation of the Local Economy: The foreign company can stimulate the

economic development of the host country by investing in their priority areas /

portfolios. For example, when Toyota, a Japanese carmaker entered the US markets

it tried to convince the political parties that it would generate employment for the

locals in US. Further the foreign company may convince the host country that it would

assist the local companies by purchasing raw materials and other inputs from them

and also assist the local companies as ancillary units. Even the foreign company can

motivate the host economy by being export oriented.

3. Employment of Nationals: Mostly foreign companies feel that the people of

developing countries are lazy, unintelligent, unmotivated and less educated.

Multinational companies can minimize political risks by employing, developing and

promoting the local people.

4. Joint Ventures: If the multinational company owns the entire capital by itself, it can

increase political risk. Hence, it is suggested that the foreign company should allow

the domestic investors to invest and share the ownership by converting the company

into a public limited company. A joint venture with locals helps minimize anti-MNC

feelings, and a joint venture with another MNC adds the additional bargaining power

of a third country.

5. Expanding the Investment base: Including several investors and banks in financing

an investment in the host country is another strategy. This has the advantage of

engaging the power of the banks whenever any kind of government takeover or

harassment is threatened. This strategy becomes especially powerful if the banks

have made loans to the host country.

6. Political Payoffs and Planned Domestication: The former is an attempt to lessen

political risks by paying those in power to intervene on behalf of the MNC. In those

cases where an investment is being domesticated by the host country, the most

effective long-range solution is planned phasing out. This is a meaningful strategy

when it appears that there is rising hostility towards an investment.

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6. POLITICAL SOVEREIGNTY

Political Sovereignty

Political sovereignty can be defined as supreme and independent political authority. In the

control of international law, a sovereign state is independent and free from all external control,

enjoys full legal equality with other states, selects its own political economy and governs its own

territory. Sovereignty

refers to both the powers exercised by a state in relation to other countries and supreme power

exercises over its own members. A sovereign state is considered free and independent. It

regulates trade, managed the flow of people into and out of its boundaries and exercises

undivided jurisdiction over all persons and property within its territory. It has the right authority

and ability to conduct its domestic affairs without outside interference and uses its international

power and influence with full discretion.

6.1Functioning of Political Parties

The political parties in power influence the international business to a large extent, irrespective of

political system. The influence can be in favour of business or anti-business. A pro- business

political party in power can provide the business community an environment of growth,

competition and concern. Anti-business party in power would exercise a menace of fear. The

integrity of the political leaders and their kith and kin is a great factor which businesses need to

consider. Now businesses themselves identify with one or other party and who gets rewards

depend whose person are in power. When there is a coalition government, not just one single

political party dictates terms for the businesses. There are multiple concerns. Businesses struggle

to please too many political leaders. Parties in opposition and their leaders have the role to

question government’s decisions in the parliament/legislature. In a multiparty system, with

coalition governments running the government involves lot of compromises despite their common

minimum programme. This many times leaves the business community disheartened.

Political maturity of the parties and people and Political Stability

Political maturity of parties involves respecting the verdict; the ruling party must not be unfriendly;

the opposition parties must not be hostile. Incident free political rallies, absence of hooliganism,

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terminological pleasance in referring to individual members,

issue based expression of viewpoints, freedom to elected members to express their views

irrespective of party affiliation, etc are the hallmarks of political maturity. Impartiality of police

system and political non-intervention in its action are real test of political maturity. These are far to

expect. An air of uneasiness prevails which suffocates businesses. Opportunistic ideologies are

followed for short-term electoral gains. That is no maturity. The lesser the number of parties,

more the political maturity of people and the better the governance would be. The developed

world nations have fewer political parties, while less developed countries have too many political

outfits. Businesses suffer more uncertainty with more number of political parties, because the

policy environment becomes shaky.

Political stability is a crucial factor. The political system, the number of parties, ideologies of

parties, animosities amongst different parties, leadership characters of political parties, the

commitment of parties taking power to honor commitments made by previous governments, etc

influence political stability. Political stability also means consistency in political decisions, much

needed for inspiring confidence in the minds of business community, both national and

international. Lack of political stability is an indication of excessive risk businesses suffer.

6.2 Relationship between the State and the Businesses

There could be political instability and yet it may not transform into political risk for businesses.

This is so when the State respects the business enterprises concerned. Barring a few cases in

most countries, today businesses have good relationship with the Government due to LPG policy

pursued widely. Multilateral Investment Guarantee Agency (MIGA), bilateral agreements to

protect mutual investment interests, etc ensure that good relationship prevails between the State

and the MNCs.

Countries choose businesses across the globe for business relationship based on merits of

efficiency rather than political system followed. The USA, sees India as an economic opportunity.

So, political and strategic alliances are on the rise. India is also in good relationship with Japan,

the European Union, Russia, Republic of China and so on. So, business interests develop across

the globe.

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7. Summary

The political environment is an important factor that influences international business. The

political system, political parties in power, political parties in the opposition, political maturity of

the parties, number of political parties, political awareness of people, political stability and others

of the home country and host country have a strong impact on the business environment in a

country. A factor is said to be political when it derives from the government sector. Governments

can be further classified as two party system, multi-party, single- party and one-party dominated.

The political scenario often varies between the two extremes: ie, democracy on one hand and

totalitarianism on the other. International business firms face political risk when they conduct

business with the outside world. Political risk affects different firms in different ways. It can

threaten the market of an exporter, the production facilities of a manufacturer or the ability of a

firm to repatriate its profits from a host country to home country. When the perceived level of

political risk is lower, a country is more likely to attract investment. The level of political risk is

inversely proportional to a country’s stage of development. All other things being equal, the less

developed a company, the greater the political risk. It can be confiscation, expropriation,

domestication or nationalization, general instability risk and operation risk. If political risk exists,

be needs to be properly managed.

Documents

Module No and Title Module No.15: ROLE OF POLITICAL