Chapter 3:
Political and Legal
Systems
Learning Objectives
3-1 Explain how politics and laws influence business
3-2 Interpret political risk
3-3 Appraise the principles and practices of the legal
environment
3-4 Describe key legal issues facing international
companies
Opening case
• 3-1. Identify three compelling economic
reasons to invest in China. Then identify three
compelling political reasons to avoid doing so.
Recommend a criterion one could use to trade
off the opportunities of operating in China
versus the risks of doing so.
• 3-2. What sort of operational safeguards
would you advise a company to adopt in order
to better manage the risks of China’s legal
environment?
Political and Legal Forces
Objective 3-1
Figure 3.1 Political and Legal Factors Influencing IB Operations
Political system
• The political system of a country shapes its
economic and legal systems.
• Political system:
– (1) specifies institutions, organizations, and
interest groups and
– (2) defines the norms and rules that govern
political activities.
• The mission of a political system is clear-cut:
integrate different groups into a functioning,
self-governing society.
Political System
=
System of Government in a Nation
(Charles W.L. Hill, 2015)
Political system
• Political systems can be assessed
according to two dimensions:
– The degree to which they emphasize
collectivism as opposed to individualism.
– The degree to which they are democratic or
totalitarian.
• These dimensions are interrelated;
Political system
•The doctrine of individualism emphasizes
the primacy of individual freedom, self-
expression, and personal independence
•The doctrine of collectivism emphasizes the
primacy of the collective (e.g., a group,
party, community, class, society, or nation)
over the interests of the individual.
Political system
• Democracy: a government “of the people, by
the people, for the people.” Modern-day
democracies translate this ideology into the
principles that all citizens are politically equal,
entitled to freedom of thought, opinion,
belief, speech, and association, and command
sovereign power over public officials.
• Totalitarian system (Totalitarianism):
subordinates the interests of the individual to
that of the collective
Political risk
Objective 3-2
• What is political risk? => refers to the threat that
decisions or events in a country will negatively
affect the profitability and sustainability of an
investment.
• is the risk that political decisions, events, or
conditions change a country’s business
environment of the value of their investment or
threaten the sustainability of their operation.
• is the potential loss arising from a change in
government policy
What is Country Risk?
Exposure to potential loss or adverse effects on company
operations and profitability caused by developments in a
country’s political and/or legal environments.
• Also known as Example
‘political risk’ Coca-Cola’s business fell off in
Germany when the government
• Each country has enacted a recycling plan. New laws
unique political required consumers to return
and legal systems nonreusable soft drink containers to
that often pose stores for a refund of 0.25 euros.
challenges for Rather than cope with the unwanted
company returns, big supermarket chains
pulled Coke from their shelves.
performance
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Political Risk Map
Objective 3-2
Map 3.1 Map of Political Risk, 2015
Source: Based on Marsh Political Risk Map 2015; and AON Political Risk, http://www.aon.com/2016politicalriskmap
The State of Political Freedom
Map 3.2 Map of Freedom
Source: Freedom House, “Map of Freedom 2015,” at https://freedomhouse.org/report/freedom-world/freedom-world-2015. Used by
permission of Freedom House.
Political Risk
• https://www.credendo.com/country-risk
• Short-term political risk indicators (up to 1 year):
Short-term external liabilities, foreign exchange
reserves and the current account balance
• Medium/long-term (beyond 1 year): countries’
solvency (an assessment economic and financial
situation, of the political situation and a payment
experience analysis for each country)
• country_risk_summary_table_78.xlsx
Country (political) risk - dimensions
• Harmful or unstable political system
• Laws and regulations unfavourable to foreign firms
• Inadequate or underdeveloped legal system
• Bureaucracy and red tape
• Corruption and other ethical blunders
• Government intervention, protectionism and barriers to
trade and investment
• Mismanagement of failure of the national company
Country (political) risk - dimensions
• Risky countries:
Syria (war), Zimbabwe (corruption, bribery, fraud and
political turmoil)
India (Hindu nationalists that came to political power in
1996 openly opposed foreign investment and foreign
influence on Indian society and enacted laws that
targeted foreign firms)
Types of Political Risk
Based on Sources of Political Risk
1. Risk relating to property ownership
2. Risk relating to governmental intervention to
organization (on international business)
3. Risk relating to fund transfer/project:
currency inconvertibility and transfer
restriction risk
4. Political Violence Risk: war, riots, terrorism
Types of country risk produced by
political system
2. Risk relating to governmental intervention to
organization (on international business)
• Sanctions (Impose tariff/quota)
• Embargoes (Ban on the import/export;
• Boycotts against firms or nations
Types of Political Risk
Based on Sources of Political Risk
3. Risk relating to fund transfer/project
– Currency inconvertibility
– Foreign exchange control
– Regulation for fund transfer and transfer
restriction risk
Types of Political Risk
Based on Sources of Political Risk
4. Political Violence Risk:
– includes all violent act(s) undertaken with a political
objective;
– this concept is broader than ‘war’ and includes i)
‘terrorism’ (political, religious and ideological
objectives) and ii) political violence damage (damage
to material assets as a result of political violence);
– for the purposes of analysing the political violence
risk, types of business interruption as a result of
political violence damage are included.
Legal Systems and Components
• What is the legal System?
• Components of a legal System
– Constitutional Law
– Criminal Law
– Civil and Commercial Law
Legal Systems and Components
• Constitutional Law: translates the country’s constitution
into an open and just legal system, setting the framework
for government and defining the authority and
procedure of political bodies to establish laws.
• Criminal Law: safeguards society by specifying what
conduct is criminal, and prescribing punishment to those
who breach those standards.
• Civil and Commercial Law: which ensure fairness and
efficiency in business transactions by stipulating private
rights and specific remedies in order to regulate conduct
between individuals and/or organizations.
Types of Legal Systems
Map 3.4 The Wide World of Legal Systems
Source: University of Ottawa, “World Legal Systems,” retrieved February 15, 2016, from http://www.juriglobe.ca/eng/index.php. Used
by permission.
Two Key Legal Concerns Facing IB
• Operational
• Strategic
Two Key Legal Concerns Facing IB
•Operational concerns include:
– Process of starting a business involves
activities such as registering its name, adopting
the appropriate tax structure, obtaining
licenses and permits, arranging credit, and
securing insurance.
– Making and enforcing contracts.
– Hiring and firing rules.
– Ease of closing a business or going out of
business.
Two Key Legal Concerns Facing IB
Objective 3-4
• Strategic concerns include:
– Product regulation laws.
– Product safety laws.
– Legal jurisdiction.
– Intellectual property.
Legal Systems: Common Law
• A legal system that originated in England and spread
to Australia, Canada, USA, and other former
members of the British Commonwealth (also known
as case law).
• The basis of law is tradition, past practices, and legal
precedents set by courts via interpretation of
statutes, legislation, and past rulings.
• Judges have much power to interpret laws based on
the circumstances of individual cases. Thus,
common law is relatively flexible.
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Legal Systems: Civil Law
• Found in France, Germany, Italy, Japan, Turkey, and
much of Latin America.
• Based on an all-inclusive system of laws that have
been “codified”—clearly written by legislative bodies.
• Laws are more ‘cast in stone’ and not strongly
subject to interpretation by courts.
• A key difference is that common law is mainly judicial
in origin and based on court decisions, whereas civil
law is mainly legislative and based on laws passed
by national and state legislatures.
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Legal Systems: Religious Law
• Strongly influenced by religious beliefs, ethical
codes, and moral values and viewed as mandated by
a supreme being.
• Most important religious legal systems are based on
Hindu, Jewish, and Islamic law.
• Islamic law spells out
norms of behavior
regarding politics,
economics, banking,
contracts, marriage,
and many other social
and business issues.
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Legal Systems: Mixed Systems
• Two or more legal systems operating together.
• The contrast between civil and common law has
blurred as countries combine both systems.
• Totalitarianism is most associated with religious
law and socialist law.
• Democracy is associated with common law, civil
law, and mixed systems.
Example
Legal systems in Lebanon, Morocco, and Tunisia share
elements of civil law and Islamic law.
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Dominant Legal Systems in Selected Countries
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Question:
Search and give more details about the Islamic law (especially
applying to the international business)
-Property rights: legal rights over use to
which a resource is put and income derived
-Intellectual Property Rights (IP): patents,
copyrights, trademarks: major bone of
contention especially in info-based economies
-Product safety and liability: standards
protecting consumers
- Enforcement of national and
international laws
Question:
Look for a multinational which troubled the international legal
issues.
- Summarize the case
- Give your recommendations
Democracy and Openness
• Democracy is associated with ‘openness,’ the lack
of regulation and barriers to the entry of firms in
foreign markets. Example
Since the 1980s, India
• Openness is associated with: steadily lowered entry
▪ Successful market entry barriers to its car market.
Foreign carmakers entered
▪ Increased market demand the market, greatly
▪ Competition on quality, which increasing the number of
improves overall product quality. models for sale. Greater
competition increased the
▪ Increased competition, leading quality of available cars,
to efficiencies and lower prices. and car prices fell.
Copyright © 2014 Pearson Education Inc.
Political and Economic Systems
• Totalitarianism is associated with command
economies, wherein the state makes all decisions on
what to produce, how much to produce, and what
prices to charge.
• Democracy is associated with market economies and
capitalism in which decisions are largely left to market
forces, that is, supply and demand.
• Socialism is associated with mixed economies, which
have features of both market and command
economies, combining state intervention and market
mechanisms (e.g., Sweden, Singapore).
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