International Business: The New Realities

by

Cavusgil, Knight and Riesenberger

Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall
Realities of Doing Business in Russia
High rate of piracy in software, music, DVDs, and other
goods.
Anti-piracy laws and law enforcement are weak.
Obtaining business licenses requires bribing officials.
SMEs may spend 20% of their net income on bribes.
There is substantial organized crime and killings.
Criminal raiders may seize independent businesses.
Conditions in Russia are typical of many emerging
markets and developing economies.
Copyright 2012 Pearson Education, Inc. publishing as Prentice Hall 7-2
What is Country Risk?
Exposure to potential loss or adverse effects on company
operations and profitability caused by developments in a
countrys political and/or legal environments.
Example
Coca-Colas business fell off in Germany
when the government enacted a
recycling plan. New laws required
consumers to return nonreusable soft
drink containers to stores for a refund of
0.25 euros. Rather than cope with the
unwanted returns, big supermarket
chains pulled Coke from their shelves.
Also known as
political risk
Each country has
unique political
and legal systems
that often pose
challenges for
company
performance
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Dimensions of Country Risk
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Country Risk in Selected Countries
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Political and Legal Systems
Political system: A set of formal institutions that
constitute a government. It includes legislative
bodies, political parties, lobbying groups, and trade
unions. The system also defines how these groups
interact with each other.
Three major types of political systems:
Totalitarianism
Socialism
Democracy
These categories are not mutually exclusive

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Political and Legal Systems (cont.)
Legal system: A system for interpreting and enforcing
laws. The laws, regulations, and rules establish norms
for conduct. It incorporates institutions and procedures
for ensuring order and resolving disputes in
commercial activities, as well as protecting intellectual
property and taxing economic output.
Four major types of legal systems:
Common law
Civil law
Religious law
Mixed systems
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Sources of Country Risk
Political System
Government
Political parties
Legislative bodies
Lobbying groups
Trade unions
Other political
institutions
Legal System
Laws, regulations, and
rules that aim to:
Ensure order in
commercial activities
Resolve disputes
Protect intellectual
property
Tax economic output
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Political Systems: Totalitarianism
Government controls all economic and political matters.
Either theocratic (religion-based) or secular.
A state party is led by a dictator.
Membership is mandatory for those wanting to advance.
Power is sustained via secret police, propaganda, and
regulation of free discussion and criticism.
Today: Some countries in the Middle East and Africa;
Cuba, North Korea.
Former totalitarian states tend to
have much government
intervention and bureaucracy.
China (19491980s)
Germany (19331945)
Soviet Union (19181991)
Spain (19391975)
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Political Systems: Socialism
Capital is vested in the state.
Capital is used primarily as a means of production
for use rather than for profit.
Group welfare outweighs individual welfare.
Governments role is to control the basic means of
production, distribution, and commercial activity.
Socialism occurs in much of the world as social
democracy (e.g., Western Europe, Brazil, India).
Government intervention in the private sector.
Corporate income tax rates are higher.
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Political Systems: Democracy
Economic activity occurs freely, as per market forces
Limited government: The government performs only
essential functions that serve all citizens, such as
national defense, maintaining law and order, foreign
relations, and providing basic infrastructure.
Private property rights: The ability to own property
and assets and to increase ones asset base by
accumulating private wealth. Property includes land,
buildings, stocks, contracts, patents.
Encourages initiative, ambition, and innovation.
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Examples of Countries
Under Various Political Systems
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Relationship Between
Economic and Political Freedom
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Relationship Between
Economic and Political Freedom (cont.)
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Relationship Between
Economic and Political Freedom (cont.)
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Democracy and Openness
Democracy is associated with openness, the lack
of regulation and barriers to the entry of firms in
foreign markets.
Openness is associated with:
Successful market entry
Increased market demand
Competition on quality, which
improves overall product
quality
Increased competition, leading
to efficiencies and lower prices
Example
Since the 1980s, India
steadily lowered entry
barriers to its car market.
Foreign carmakers
entered the market,
greatly increasing the
number of models for sale.
Greater competition
increased the quality of
available cars, and car
prices fell.
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Political and Economic Systems
Totalitarianism is associated with command
economies, wherein the state makes all decisions
about 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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The Rule of Law
Common in the advanced economies.
The legal system is: (i) applied to all citizens
equally; (ii) issued via recognized government
authorities; and (iii) enforced fairly and
systematically by police forces and formally
organized judicial bodies.
Economic activity suffers and uncertainty increases
when the rule of law is weak.
Existence of a legal system where rules are clear, publicly
disclosed, fairly enforced, and widely respected by individuals,
organizations, and the government.
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Legal Systems: Common Law
A legal system that originated in England and
spread to Australia, Canada, the U.S., 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 codifiedclearly written by legislative
bodies.
Laws are more cast in stone than common law
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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Sampling of Differences
Between Common Law and Civil Law
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Legal Systems: Religious Law
Strongly influenced by religious beliefs, ethical codes,
and moral values, which are 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
become 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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Actors in Political and Legal Systems
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The government, or the public sector, operating
at national and local levels
International organizations, such as the World Bank,
World Trade Organization, and the United Nations
Regional economic blocs, such as the European
Union, NAFTA, and many others
Special interest groups,
such as labor unions and
environmental advocates
Local competing firms,
which oppose foreign
firms
Special Interest Groups: Typical Issues
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Country Risk Produced by Political Systems:
Government Takeover of Corporate Assets
Confiscation: Seizure of corporate assets without
compensation
Expropriation: Asset seizure with compensation
Nationalization: Takeover of an entire industry,
with or without compensation
Examples
In Venezuela, President Hugo Chavez confiscated an oil field
owned by the French petroleum firm Total.
In 2006, the Bolivian government nationalized the oil and gas
industries.
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Country Risk Produced by Political Systems:
Creeping Expropriation
The most common expropriation today.
The government gradually modifies regulations and
laws after foreign MNEs have made big local
investments in property and plants.
Examples
Abrupt termination of contracts.
Creation of laws that favor local firms.
The governments in Bolivia, Russia,
and Venezuela have modified tax
regimes to extract revenues from
coal, oil, and gas companies.
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Country Risk Produced by Political Systems:
Embargoes and Sanctions
Governments may respond to offensive activities of
foreign countries by imposing embargoes and
sanctions.
Sanctions are bans on international trade, usually
undertaken by a country, or a group of countries,
against another country judged to have jeopardized
peace and security.
Embargoes are bans on exports or imports that forbid
trade in specific goods with specific countries.
Example: The U.S. has enforced embargoes against
Iran and North Korea, labeled as state sponsors of
terrorism.
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Country Risk Produced by Political Systems:
Boycotts against Firms and Nations
Boycott: A voluntary refusal to engage in
commercial dealings with a nation or a company
Examples from France
Citizens boycotted Disneyland Paris to express
opposition to globalization and takeover of French
farmland.
French farmers boycotted McDonalds, and crashed a
tractor into a shop, to vent their anger with agricultural
policies and globalization.
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Country Risk Produced by Political Systems:
Wars, Insurrection, and Violence
War and insurrection: Indirect effects can be
disastrous for company activities.
Terrorism: The threat or actual use of force or
violence to attain a political goal through fear and
intimidation.
Some terrorism is sponsored by national
governments.
Terrorism particularly affects certain industries,
such as tourism, hospitality, aviation, finance, and
retailing.
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Types of Country Risk Produced by Legal Systems
Country risk arising from the host countrys legal
environment:
Foreign investment laws
Controls on operating forms and practices
Marketing and distribution laws
Laws regarding income repatriation
Environmental laws
Contract laws
Inadequate or underdeveloped legal systems
Internet and e-commerce regulations


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Country Risk Produced by Legal Systems (cont.)
Country risk arising from the home countrys
legal environment:
The Foreign Corrupt Practices Act (FCPA)
Antiboycott regulations
Accounting and reporting laws
Transparency in financial reporting

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Country Risk Arising from the Host Country
Foreign investment laws affect FDI-based entry

Examples
Japan: The large-scale retail store law restricted
foreigners from opening warehouse-style stores like
ToysRUs, in favor of smaller Japanese retailers.
Mexico: Foreign oil companies cannot obtain 100%
ownership of Mexican oil firms.
United States: Restricts inward investments seen to
affect national security. E.g., the U.S. Congress
blocked Dubai Ports World, a Middle Eastern firm,
which sought a deal to manage U.S. ports.
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Country Risk Arising from the Host Country (cont.)
Controls on operating forms and practices are
laws and regulations on how firms can conduct
production, marketing, and distribution activities.
Example
In the telecommunications sector in China, the
Chinese government requires foreign investors to
seek joint ventures with local firms. This ensures
local control of the telecom industry, and China
gains access to foreign capital and technology.
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Country Risk Arising from the Host Country (cont.)
Marketing and distribution laws regulate
practices in advertising, promotion, and
distribution.


Examples
Finland, France, Norway, and New Zealand
prohibit cigarette advertising on television.
Canada and other countries cap prices in the
pharmaceutical and other industries.
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Country Risk Arising from the Host Country (cont.)
Laws on income repatriation limit the amount of net
income or dividends that firms can bring back to the
home country.
Environmental laws aim to preserve natural
resources, combat pollution, and ensure safety.
Contract laws affect the sale of goods and services;
intermediary agreements; licensing and franchising;
foreign direct investment; and joint ventures.
Example
In Germany, firms are responsible for recycling product
packaging.
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Inadequate or underdeveloped legal systems, or
poor enforcement of existing laws.
Laws may be weak regarding intellectual property,
pollution, consumer protection, and other areas.
While the problem is common in developing
economies, it can also occur in advanced
economies.

Country Risk Arising from the Host Country (cont.)
Examples
In China and Russia, foreign firms sometimes abandon business
ventures due to erratic legal environments.
The recent global financial crisis was triggered partly by poor regulation
in the United States and Europe.
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Country Risk Arising from the Home Country
Extraterritoriality: The application of home-country
laws to other countries. For example, the European
Union pursued Microsoft for monopolistic practices.
The Foreign Corrupt
Practices Act (1977;
U.S.) made it illegal to
offer bribes to foreign
parties. But the act may
harm U.S. firms because
foreign competitors are
usually not so constrained.
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Managing Country Risk
Proactive environmental scanning: Management
should develop a comprehensive understanding of the
political and legal environment in target countries.
Scanning: Ongoing assessment of potential risks and
threats to the firm, via intelligence sources such as:
Employees working in the host country
Embassy and trade association officials
Consulting firms, such as Business Entrepreneurial
Risk Intelligence (http://www.beri.com)
Goal is to minimize exposure to country risks.


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Country Risk Arising from the Home Country (cont.)
Accounting and reporting laws differ widely
around the world. Two examples:
Physical asset valuations: Canada and the U.S. use
historical costs. Some Latin American countries use
inflation-adjusted market value.
R&D costs: Expensed as incurred in most of the world;
capitalized in South Korea and Spain. Some countries
use both conventions.
Transparency in financial reporting is the degree to
which firms regularly reveal substantial financial and
accounting information. Varies worldwide.
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Managing Country Risk (cont.)
Strict adherence to ethical standards: Firms that
engage in questionable practices or operate
outside the law invite redress from the
governments of the host countries where they do
business.
Alliances with qualified local partners: For
example, firms often enter China and Russia by
partnering with local firms, which assist in
navigating the complex legal and political
landscape.
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Managing Country Risk (cont.)
Protection through legal contracts: Contract law varies
widely. The firm must follow the law in each country. Three
approaches for resolving contract disputes are:
Conciliation is a formal process of negotiation with the
objective of resolving differences in a friendly manner.
The least adversarial method, it is common in China.
In arbitration, a neutral third party hears both sides of a
case and decides in favor of one party or the other,
based on an objective assessment of the facts.
Litigation occurs when one party files a lawsuit against
another. The most adversarial approach, it is common
in the United States.
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