Chapter 3: Political and Legal Systems

1. Chapter 3: Political and Legal Systems

2. Lesson outline Types of legal systems - common, civil, religious, bureaucratic Home country laws Foreign Corrupt Practices Act (FCPA) Host country laws - ownership issues, intellectual property rights

3. Lesson outline Political risk & the political environment - Factors affecting the level of political risk Options for dealing with political risk Applications of today’s material to understanding how nations are doing - Political risk signals government (in)competence - Effects of corruption on economic growth - Impacts of MNCs on host countries

4. Types of legal systems Common law is law based on the cumulative wisdom of judges’ decisions on individual cases through history. Civil Law is based on a detailed listing, or codification, of what is and is not permissible. A key difference between common law and civil law lies with the role of the judge. In the common law system the judge acts as a neutral referee, while in a civil law system, the judge takes on many of the tasks that would be completed by lawyers in a common law system.

5. Types of legal systems Religious Law is based on the officially established rules governing the faith and practice of a particular religion. Bureaucratic Law, followed by communist countries and dictatorships, is whatever the country’s bureaucrats say it is, regardless of the formal law of the land. Bureaucratic law is frequently inconsistent, unpredictable, and lacking in appeal procedures.

6. Home country laws • Trading restrictions • sanctions & embargoes • Extraterritoriality • transfer pricing, antiboycott laws, antitrust law • even "purely" domestic laws affect international competition • highly controversial when used against nations • Effects on international competitiveness

7. Foreign Corrupt Practices Act (FCPA) • The FCPA prohibits U.S. firms from engaging in bribery overseas. Americans found guilty of violating the FCPA can face time in jail. • However, in some nations, bribes are part of how society is organized. • In other nations corruption is frowned upon within that nation’s boundaries, but bribes to foreign officials are a tax deductible business expense.

8. Foreign Corrupt Practices Act (FCPA) Many argue that the FCPA hurts the competitiveness of US firms abroad. Many others believe its negative effect on US firms abroad is negligible, overall, and argue that dropping the FCPA would lead to greater corruption around the world and, ultimately, even back in the US. The arguments of those on both sides of this issue have merit.

9. Host country laws • Ownership issues • Nationalization was not uncommon in the past. • If a nation expropriates a foreign firm’s assets, the firm receives compensation. • If a nation confiscates that firm’s assets, the firm receives no compensation.

10. Host country laws • Ownership issues • Nationalization is much more likely to occur with large-scale fixed investments, such as in capital equipment, oil pipelines, … in industries such a telecommunications and steel, as well as natural resource extraction industries.

11. Host country laws • Ownership issues • A more common ownership issue today, in practice, is limitations on the percentage of equity which foreign firms are allowed to hold in their subsidiaries in a given nation. • Such restrictions are aimed at increasing local ownership and the local share of profits realized, increasing technology transfer, and preserving foreign exchange by restricting the amount of money likely to be repatriated by foreign firms as dividends.

12. Host country laws • Ownership issues • Restrictions on foreign ownership and on the repatriation of profits, and a fear of nationalization by foreign firms, reduce inward FDI.

13. Host country laws • Intellectual property (IP) issues • IP enforcement around the globe is a major issue for the music, movie, pharmaceuticals, and software industries, in particular. • Essentially, net exporters of IP have strict IP laws and enforcement. Net importers of IP tend to be more lax about legal enforcement of IP rights, even if they have strict laws.

14. Host country laws • Intellectual property (IP) issues • There are legitimate policy questions about the length of patents suitable for developing nations. Firms owning valuable IP tend to want at least the US standard (17 years) for the entire world, while some academics and others argue for a maximum length of 10 years for patents in developing nations.

15. The political environment & political risk • Political risk refers to any changes in the political environment that may adversely affect the value of the firm’s business activities. • Political risk assessment is one of the most basic parts of deciding in which countries to operate and sell and deciding how to structure operations.

16. The political environment & political risk • There is no substitute for a systematic analysis. Also, by the time data has been accumulated and put into written form, conditions may have changed. • So, working with the current business press and working with people who are living in the country in question is necessary to do a high quality political risk assessment.

17. The political environment & political risk • There are 3 kinds of political risk: • 1. ownership risk (nationalization risk) • 2. transfer risk (repatriation restriction risk) • 3. operating risk (every other kind of political risk affecting operations or sales)

18. The political environment & political risk • Macropolitical risk affects all firms operating in a given nation. • Micropolitical risk affects only a selection of firms in that nation (ie: one industry).

19. The political environment & political risk • The questions on p. 73 of your text are a good starting point in carrying out a political risk assessment. • Also, Euromoney sometimes publishes political risk assessments that you can access through the UNCG library system. You can search to see if an assessment is available for your country.

20. The political environment & political risk • What drives political risk higher or lower? • The general feelings of those in power, and of the populace, towards the contribution foreigners are making to the economic health of the nation. • Generally, governments favoring laissez faire policies provide lower political risk, as their default preference is to leave firms alone.

21. The political environment & political risk • What drives political risk higher or lower? • Economic problems and wide income gaps tend to increase political risk, even as they may bring about new business opportunities. Foreigners often become scapegoats when a nation’s economy softens. • Large gaps between expectations and reality for a country’s citizens can also lead to unrest and uncertainty, increasing political risk.

22. The political environment & political risk • What drives political risk higher or lower? • Clearly, political risk and the likelihood of war are positively correlated. • Dictatorships are more risky than democracies. • As corruption increases, political risk increases. • Political transitions heighten political risk, at least until uncertainty about new government policies have been resolved.

23. The political environment & political risk • What drives political risk higher or lower? • Wholesale structural changes in the political and/or economic landscape (ie: as economic development progresses or falls back) heighten political risk.

24. Coping with political risk • A simple approach is to minimize exposure to whatever kind of political risk seems most problematic. • This is usually done by varying the way the firm extracts its profits from a foreign market or a foreign operation. • For example, a licensing arrangement with a large up-front fee gets around repatriation or “transfer” risk.

25. Coping with political risk • Exporting instead of engaging in FDI avoids ownership and operating risks, albeit perhaps at some cost in terms of sales in that market. • As the “final” option, a firm can choose to bypass a given nation altogether and seek other opportunities.

26. Coping with political risk • Another viable means of minimizing political risk is to seek local allies who can serve as the firm’s advocate in that nation. • For example, a joint venture partner will often serve as the local representative for a multinational corporation seeking to lower its political risk. • Public relations and local corporate giving are other means useful for fostering acceptance of the firm overseas. • Hiring host country nationals for key posts in the subsidiary also tends to reduce political risk, as there will tend to be less criticism.

27. Coping with political risk • In addition, political risk insurance can be purchased, both privately (generally a more expensive option) and through the Overseas Private Investment Corporation (OPIC) and the Multilateral Investment Guarantee Agency (MIGA). • MIGA is a branch of the World Bank, while OPIC is a US institution.

28. Applications of today’s ideas to understanding how nations are doing • The level of political risk can serve as a rough proxy for the competence of the government in guiding the economy. • Thus, evidence that the government is “going astray” in its development policies generally has negative implications for assessments of political risk, and vice versa.

29. Applications of today’s ideas to understanding how nations are doing • Corruption hurts economic growth and development. • Innovation has been suggested as the primary driver of economic growth, and corruption slows down innovation, which in turn can then be expected to slow down economic growth and to hurt the global competitiveness of nationally-based firms.

30. Applications of today’s ideas to understanding how nations are doing • Corruption hurts innovation by rewarding firms with good connections rather than firms with good ideas. The loss of “merit” as the primary basis for deciding competition, through corruption, produces “inbred”, inefficient national champion firms with little expertise at innovation and little chance of competing in global markets, in general.

31. Applications of today’s ideas to understanding how nations are doing • Corruption also serves as a direct deterrent to investment, as “outsiders” will often shy away completely when they realize that the rules of competition are stacked against them in a “corrupt” nation. • The loss of potential investment capital also hurts economic development.

32. Applications of today’s ideas to understanding how nations are doing • It is no accident that Japan, Hong Kong, and Singapore have succeeded in shifting from poor economies to rich economies, as they have successfully tackled the issue of corruption. Many neighboring nations have not, and they are lagging behind these three nations in per capita income.

33. Applications of today’s ideas to understanding how nations are doing • The impact of MNCs on host nations are often substantial and they tend to be complex. • MNCs increase investment, directly create jobs, and they often infuse new technology and ideas into the national economy, all of which tends to help economic growth and often helps global competitiveness. They pay taxes as well.

34. Applications of today’s ideas to understanding how nations are doing • However, MNCs often knock local competitors out of the market, causing layoffs. Also, MNCs tend to keep their highest value-adding activities in their home country. Thus, national governments tend to prefer having their own firms become globally successful so that high value-adding activities will be carried out in their jurisdiction.

35. Applications of today’s ideas to understanding how nations are doing • In addition, the foreign home base of MNCs and their sheer size makes them powerful and relatively difficult for host nation governments to control. • And, MNCs in resource extraction industries can be expected to pack up and leave once the resource they are extracting runs out. • Finally, when retrenchment proves necessary, often MNCs will make cuts first at their foreign operations and in their foreign staffing.

36. Applications of today’s ideas to understanding how nations are doing • Beyond economic impacts, foreign MNCs often bring about a variety of changes, subtle and obvious, in the national culture. • Overall, despite the negatives of inward FDI, a higher proportion of inward FDI in a given nation generally seems to help economic growth and development. • However, on other criteria sometimes foreign MNC involvement in the national economy is a mixed blessing.

37. Lesson outline Types of legal systems - common, civil, religious, bureaucratic Home country laws Foreign Corrupt Practices Act (FCPA) Host country laws - ownership issues, intellectual property rights

38. Lesson outline Political risk & the political environment - Factors affecting the level of political risk Options for dealing with political risk Applications of today’s material to understanding how nations are doing - Political risk signals government (in)competence - Effects of corruption on economic growth - Impacts of MNCs on host countries