CHAPTER 6 (Political and Legal Systems)

● Definition and dimensions of country risk

○ DEFINITION: Exposure to potential loss or adverse effects on company operations and profitability caused by
developments in a countries political and or legal environments
○ Also known as political risk
○ Each country has a unique political and legal systems that often pose challenges for company performance
○ DIMENSIONS:
■ Harmful or unstable political system, laws and regulations unfavorable to foreign firms, Inadequate
or underdeveloped legal system, Bureaucracy and red tape, Corruption and other blunders,
government intervention, protectionism, and barriers to trade/investment, mismanagement and
failure of the economy
● Two types of country risks
○ Systematic: affects all industries & firms in a country
○ Unsystematic: affects only a subset of firms

● Two sources of country risks

○ legal: Iaws, regulations, rules that ensure order in commercial activities, resolve disputes, protect intellectual
property, tax economic output imposed by the host government.
■ Def: a system for interpreting and enforcing laws, incorporates institutions and procedures for
ensuring order and resolving disputes in commercial activities
○ political: government, political parties, legislative bodies, lobbying groups, trade unions, other political
institutions from the home government.
■ Def: a set of formal institutions that constitute a government,& how these groups interact with each
other
● Types and functions of political systems
○ these categories are not mutually exclusive, they provide protection from external threats, ensure stability
based on laws, govern the allocation of values resources among the members of a society, define how
societies members interact with each other
○ Totalitarianism: A political system where the state holds total authority over society, often characterized by a
single-party rule, government controls all economic and political matters, either theocratic (religion based) or
secular, led by dictator, sustained via secret police, propaganda, regulation of free discussion and criticism, ex
totalitarian states tend to have much government intervention and bureaucracy, some countries in middle
east & africa & cuba & north korea
○ Socialism: A system where the government controls key industries and resources, aiming for social equality
and collective ownership, capital is vested in the state and used primarily as a means of production for use
rather than for a profit, group welfare outweighs individual welfare, government’s role is to control the basic
means of production, distribution, and commercial activity, occurs often as social democracy, corporate
income tax rates are higher, western europe & brazil & India
 ○ Democracy: A political system where the government is elected by the people, emphasizing individual
freedoms and participation, 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 & order, foreign relations, and providing basic infrastructure
■ Private Property rights: The ability to own property and assets and to increase one’s asset base by
accumulating private wealth. Property includes land, buildings, stocks, contracts, patents. Encourages
initiative, ambition, innovation.

● Relationship between economic and political freedom

○ greater political freedom leads to higher economic freedom, as democratic systems typically promote free
market practices and protect individual rights.
● Democracy and openness
○ Democracies= associates 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(improves overall product quality, increased competition (efficiencies and lower prices)
● Political and economic systems
○ Political systems (how power is structured) and economic systems (how resources are allocated) are
interrelated, as the political framework influences economic policies and practices.
○ Totalitarianism is associated with command economies, wherein the state makes all decisions on what to
produce, how much at what prices.
○ Democracy is associated with market economies
○ Socialism is associated with mixed economies, which have both features of market and command
economies (Sweden and Singapore)
● The rule of law
○ Legal system where rules are clear, publicly disclosed, fairly enforced, and widely respected by individuals,
organizations, and the government; common in advanced economies; economic activity suffers and
uncertainty increases when the rule of law is weak
● Types of legal systems
○ Common law: originated in england, spread to Australia, Canada, USA, and other former members of the
british commonwealth (case law); basis of law is tradition, past practices, and legal precedents set by courts
via interpretation of statutes, legislation, and past rulings; judges have power to interpret laws based on
circumstances on individual cases, so common law is relatively flexible; mainly judicial in origin and based on
court decisions, prior use, proof of agreement is sufficient by enforcing contracts, very detailed contracts, acts
of god are justifiable excuses for noncompliance with provisions of contracts
 ○ Civil law: Based on an all inclusive system of laws that have been codified ( clearly written by legislative
bodies; France, Italy, Japan, Turkey, Latin America, Germany; laws are more “cast in stone” and not strongly
subject to interpretation by courts; mainly legislative and based on laws passed by national and state
legislatures; registration, commercial agreements become enforceable if properly notarized or registered,
contracts are brief, noncompliance is extended to includes unforeseeable human acts such as labor strikes
and riots
○ Religious law: religious beliefs, ethical codes, and moral values viewed as mandated by a supreme being;
most important based on hindu, jewish, islamic; islamic law spells out norms of behavior regarding politis,
economics, banking, contracts, marriage, and other social and business issues
○ Mixed systems: two or more legal systems operating together, contract between civil and common law has
become blurred as countries combine both systems; totalitarianism is most associated with religious and
socialist law; democracy is associated with common law, civil law, and mixed systems, Bangladesh, India,
Indonesia, Israel, Kenya
● Government takeover of corporate assets
○ government assuming control over private enterprise
○ Confiscation: government seizes assets without compensation.
○ Expropriation: government takes assets with compensation, often at a lower market value.
■ Creeping expropriation: most common, government gradually modifies regulations and laws after
foreign MNEs have made big local investments in. ex: sudden termination of contracts, creation of
laws favoring local firms, modified tax regimes to extract revenues from gas companies
○ Nationalization: government takes control of entire industries with/without compensation.
● Relationship between political systems and legal systems
○ Political systems influence the legal framework of a country. For example, authoritarian regimes may have
less transparent legal systems, while democracies tend to support the rule of law and individual rights.
● Actors in political and legal systems
○ Government: public sector, operating at national and local levels
○ International organizations: world bank, world trade organization, and United nations
○ Regional economic blocs: european union, nafta
○ Special Interest groups: labor unions and competing businesses, customers, conservationists
○ Competing firms: oppose foreign firms
● Embargoes and sanctions
○ governments to restrict trade and economic relations with other countries, often for political reasons.
○ Sanctions: bans on International trade with extra tariffs, trade barriers, import duties, and import/export
quotas
○ Embargoes: trade activities illegal
● List of countries currently under US sanctions
○ Balkans, Belarus, Burma (Myanmar), Cuba, iran, Iraq, Libya, Lebanon, North Korea, Somalia, Sudan, Syria,
Zimbabwe
● Country risks and HOST country legal systems
○ 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; controls on operating forms and practices: laws and
regulations on how firms can conduct production, marketing and distribution laws: regulate practices in
advertising, promotion, and distribution, it is a problem in China
○ 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
○ 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 th problem is common in developing companies, it can occur in advanced economies too
● Country risks and HOME country legal systems
○ Companies may face challenges due to home country regulations, such as compliance with U.S. laws that
apply internationally (extraterritoriality).
○ The foreign Corrupt Practices Act (FCPA), Antiboycott regulations, Accounting and reporting laws,
Transparency in financial reporting
● Extraterritoriality
○ Extraterritoriality: the application of home-country laws to other countries. For examples, the EU pursued
Microsoft for monopolistic practices
● US laws that affect global business activities
○ These include the Foreign Corrupt Practices Act and various accounting and reporting regulations that apply
to U.S. companies operating abroad.
● Foreign Corrupt Practices Act:
○ (FCPA) (1966, made it illegal to offer bribes to foreign parties. But the act may harm US firms because
foreign competitors are not constrained.
● Accounting and reporting laws
○ U.S. companies must comply with domestic accounting standards, even for overseas operations,
which can complicate financial reporting (degree to which firms regularly reveal substantial financial
and accounting information, varies worldwide)
■ Physical asset valuations: Canada and US are 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
● Financial reporting
○ The requirement for companies to disclose financial information in a transparent manner, adhering
to both home country and host country regulations.
● How to manage country risks
○ Proactive Environmental scanning: management should develop a comprehensive understanding
of the political and legal environment in target countries. EX: local employees, embassy and trade
association officials, consulting firms. Goal is to minimize exposure to country risks
○ Adhere to high ethical standards: especially in varying legal contexts, invite redress form the
governments of the host countries where they do business
○ Partnerships with local businesses: Form strategic alliances to gain market access and reduce
risks. Ex: china and russia partner with local firms who assist in navigating the complex legal and
political landscape
○ Protection through Legal contracts: contract law varies widely, firm must follow the law in each
country, to resolve contract disputes
■ Conciliation: formal process of negotiation whose objective is to resolve differences in a
friendly manner. Least adversarial method and common in china.
■ Arbitration: a neutral third party hears both sides of a case and decides in favor of one party,
based on objective assessment of the facts
■ Litigation: one party files a lawsuit, most adversarial approach common in US
● Risks in international business
○ commercial risk
○ cross-cultural risk
○ currency (financial) risk
○ country risk
● War and insurrection: indirect effects can be disastrous for company activities
● Terrorism: the threat of actual use of force or violence to attain a political goal through fear and intimidation
○ Some terrorism is sponsored by national governments
○ Terroroism particularly affects certain industries- tourism, hospitality, aviation, finance, retailing
 CHAPTER 7A (Government Intervention)

● Why is government intervention

○ Governments intervene in trade and investment barriers to achieve political, social, or economic objectives.
○ This intervention can alter the competitive landscape, benefiting specific interest groups like domestic firms,
industries, and labor unions, and is an important dimension of country risk.
● Government intervention and protectionism
○ Protectionism:national economic policies that restrict free trade, aiming to raise revenue or protect domestic
industries from foreign competition.
○ Customs: checks at ports of entry, where officials inspect imported goods and levy tariffs.

● Objectives of government intervention

○ To achieve political, social, or economic objectives like creating jobs and generating revenues.
○ To benefit/ serve interests specific interest groups, such as domestic firms, industries, and labor unions.
○ To alter the competitive landscape, ensuring the safety, security, and welfare of citizens.
○ Ensure safety, security and welfare of citizens (protect national food supply)
● Key instruments of government intervention
○ Tariff: A tax on imports, e.g., on citrus or textile;, can generate substantial government revenue which is key
rationale for protectionism in undeveloped economies
○ Nontariff trade barrier: Regulations or procedures that impede trade.
○ Quota: Limits on the quantity of imports, like restrictions on Japanese cars.
○ Administrative barriers: Documentation and procedures required for imports.
○ Investment barriers: Rules that hinder foreign direct investment, such as Mexico’s restrictions in its oil
industry.
● (Unintended) consequences of government intervention
○ Example: U.S. Steel Industry: The U.S. imposed tariffs on foreign steel imports to protect domestic
manufacturers. This led to:
● Higher steel costs.
● Increased production costs for firms using steel (e.g., Ford, Whirlpool).
● Reduced global competitiveness of U.S. firms.
● Example: Auto Industry: In the 1970s, voluntary export restraints (quotas) on Japanese car imports led to:
○ Reduced incentive for U.S. automakers to innovate.
○ Weakened global competitiveness of Detroit automakers.
● General consequences of PROTECTIONISM: include reduced supply of goods, price inflation, fewer choices for
buyers, and reduced industrial competitiveness.
● Offensive and defensive barriers- the two types of rationale for protectionism
○ Defensive barriers:
● Protect industries, workers, special interest groups.
● Safeguard infant industries- a young industry needs to grow and succeed (Japan protected car industry)
● Promote national security- the US prohibits exports of plutonium and similar products to North Korea
● Protection of the national economy- weak or young economies sometimes need protection from
foreign competitors (India imposed barriers to shield its huge agricultural sector, employing millions)
● National culture and identity: canada restricts foreign investment in its movie and TV industries
● Offensive barriers:
● Pursue strategic or public policy objectives.
○ Protection helps ensure development of industries that bolster the nation's economy.
Countries create better jobs and higher tax revenues when they support high value-adding
industries, such as IT automotive, pharmaceuticals, or financial services
● Aim to increase employment and generate taxes.
○ Protection helps preserve domestic jobs in the short term. However protected industries
become less competitive over time, especially in global markets, leading to job loss in long run

● Tariff barriers and their role in the world trade history

○ tariffs have historically been used to generate revenue and protect domestic industries.
○ Examples include the Smoot-Hawley Act (1937), which raised U.S. tariffs significantly, leading to
protectionism during the Great Depression.
○ Over time, progressive trade policies like the General Agreement on Tariffs and Trade (GATT) reduced tariffs
and facilitated the creation of the World Trade Organization (WTO).
○ Economic integration leads to lower tariffs with economic blocs (NAFTA & MEXICO)
○ Harmonized code: standardized worldwide system that determines tariff amount. Developing economies
tariffs are common. In advanced economies, tariffs provide significant revenue.
● Types of import tariffs and what they are about
○ Levied tariffs:
■ Ad valorem tariff: A fixed percentage of the product's value, e.g., 10%.
■ Specific tariff: A set amount per unit, e.g., $0.25 per unit.
■ Compound tariff: A combination of both, e.g., $0.50 per unit + 7%.
○ Tariffs can serve various objectives, like protective tariffs (to protect industries), revenue tariffs (to generate
government income), punitive tariffs, antidumping duties, and countervailing duties (to counteract foreign
subsidies).
● Types of non tariff barriers
○ Quotas: Limits on import quantities.
■ Quantitative restrictions on imports of specific products, like the U.S. limiting Japanese car imports in
the 1970s to protect domestic manufacturers.
○ Local content regulation: Requirements for using locally sourced parts.
■ Requires products to contain a certain percentage of locally produced parts to support domestic
industries.
○ Subsidies: Direct payments to domestic industries to support competitiveness.
■ Direct financial support to domestic industries to enhance their competitiveness against foreign
competitors.
○ Administrative barriers: Regulations like testing, certification, health and safety checks, labeling requirements,
and excessive documentation.
■ Complex documentation, testing, and certification requirements that can impede the flow of imports
into a country.
● FDI and government intervention
○ Governments may use barriers like tariffs or investment restrictions to influence FDI.
○ FDI involves the start-up of new operations or the purchase of existing companies, influenced by factors like
market growth, cost advantages, or investment climates.
○ Firms bypass tariffs by entering countries via FDI (toyota building factories in US to avoid tariffs)
○ Reasons for FDI
● Access to new markets and customers.
● Overcoming trade barriers that require a local presence.
● Cost advantages from proximity to raw materials or labor.
● Favorable investment climates in target markets. (Chevy in Korea)
● The positive and negative impacts of FDI for host country and home country
● Host country positive impacts:
○ Capital formation.
○ Technology and management skill transfer.
 ○ Economic development. (regional and sectorial evelopment)
○ Increased competition and entrepreneurship.
○ Improved balance of payments.
○ Job creation.
● Host country negative impacts:
○ Risk of industrial dominance.
○ Dependence on foreign technology.
○ Potential economic disruption.
○ Cultural changes.
○ Influence from foreign governments.
○ “Brain Drain” or talent loss.
● Home country positive impacts:
○ Increase in GNP.
○ Stimulus to economic growth.
● Home country negative impacts:
○ Domestic job losses.
○ Risk of transferring technology and competitive advantages.
● FDI promotion efforts (types of FDI incentives) - host country
● Fiscal Incentives: Tax breaks to attract foreign firms.
● Financial Incentives: Subsidies like land, buildings, loans, or loan guarantees.
● Non-financial Incentives: Support such as government purchases, protection from competitors, or
improved infrastructure.
● Economic freedom
○ It is minimal government intervention in markets, allowing for people to have unrestricted production,
consumption, and investment.
○ It is assessed using criteria like rule of law, trade barriers, and regulations using Index of economic freedom.
○ Economic freedom is prevalent in advanced and emerging economies but more limited in developing ones.
○ Too much regulation harms the economy
● Evolution of government intervention
○ The 20th century saw high levels of protectionism/ isolationism, especially during the Great Depression with
policies like the Smoot-Hawley Act (1937, raised US tariffs to more than 50% compared to 3% today).
○ Post-WWII progressive trade policies and the creation of GATT (1947) led to lower tariffs and the emergence
of the WTO- both contributed to elimination of trade barriers
■ GATT ( General Agreement on Tariffs and Trade): reduced continuous worldwide trade negotiations,
created agency to supervise world trade, created forum for resolving trade disputes and most
favored nation (normal trade relations)- requires each member nation extend the tariff reductions
covered in a trade agreement with one country to all other countries
○ Economic integration, like NAFTA, further reduced tariffs between member countries while maintaining
barriers with non-members.
○ China joined the WTO in 2001, contributing to global tariff reductions.
○ India still has high tariff (20%)
● Responding to government intervention
○ Research and intelligence: Understand trade and investment barriers abroad and scan the business
environment.
○ Entry strategies: Adapt strategies like licensing, joint ventures, or FDI to mitigate exporting with high tariffs
○ Foreign trade zones: Utilize areas with preferential tariff treatment, like maquiladoras-export- in Mexico.
○ Customs classifications:products classified correctly to minimize trade barriers.
○ Investment incentives: Leverage government support, like subsidies, to reduce costs.
○ Lobbying: Advocate for freer trade and reduced intervention to improve market access.
 CHAPTER 7B (Economic Integration)

● What are economic integrations/ economics blocs?

○ Economic integration = process by which countries in a geographic region form an alliance to reduce barriers
to trade and investment, resulting in increased economic interdependence, 50% of world trade, increased
product choice, productivity, living standards, lower pieces, and more efficient resource use
○ Economic blocs= geographic areas where 2+ countries agree to pursue integration by lowering tariffs and
other trade barriers. Examples include the European Union (EU), NAFTA, MERCOSUR, APEC, and ASEAN, 5
possible levels of economic integration

● Levels of economic & regional integration and their characteristics

○ Free trade area
■ The simplest and most common form of economic integration, Member countries agree to gradually
eliminate formal trade barriers within the bloc, Each member maintains an independent trade policy
with countries outside the bloc. Example: NAFTA (now USMCA).
○ Customs union
■ Similar to a free trade area, but with harmonized trade policies toward non-member countries;
Members enact common tariff and non-tariff barriers on imports from non-members; Example:
MERCOSUR.
○ Common market
■ Builds on a customs union by allowing the free movement of products, services, and production
factors (e.g., capital, labor, and technology). EX: The European Union
○ Economic union
■ The most integrated form of regional economic integration; Involves harmonized fiscal and monetary
policies, common commercial regulations, and sometimes a shared currency; The EU is evolving into
an economic union with the euro as a common currency for some member states.
- Evolution/ development of the European Union
○ The EU began with the 26 founding members: Belgium, Italy, France, Germany, Luxembourg, and the
Netherlands; Expanded to low manufacturing sites like Poland, Hungary, and the Czech Republic. Most of EU
entrants are Eastern Europe- onetime satellites of the Soviet Union, most are emerging markets with fast
economic growth rates; Brexit: The United Kingdom exited the EU as of December 2020.
○ FDI’s into EU:
■ Peugeot Citron (France)- Czech Republic
■ Hyundai (South Korea)- Kia plant in Slovakia
■ Suzuki (Japan)- factory in Hungary
● Features of implications of the EU for the EU members and non members (e.g., Brexit)
○ Market Access: Eliminated tariffs and non-tariff barriers for trade among EU members.
○ Common Market: Free movement of labor, capital, and technology.
○ Trade Rules: Streamlined cross-national customs procedures and regulations.
○ Standards Harmonization: Common technical standards and regulatory enforcement.
○ Fiscal and Monetary Goals: Aims for unified fiscal, monetary, taxation, and social policies.
○ Fortress Europe: A concern for non-EU countries that integration within the EU could lead to more trade
restrictions for outsiders.
● NAFTA/USMCA and its outcomes
● NAFTA (1994):
● Eliminated tariffs and most non-tariff barriers between Canada, Mexico, and the U.S.
● Established trade, investment rules, uniform customs procedures, and IP rights.
● Facilitated the maquiladora program, where U.S. firms set up low-cost factories in Mexico.
● USMCA (2020): Replaced NAFTA with updates to trade and investment agreements.
● FTAA
○ Free Trade Area of the Americas: agreement aimed at creating a free trade zone across North and South
America, from Alaska to Argentina by 2005, to provide free market access across the continent.
● CAFTA- (Central American Free Trade Agreement)
● Signed in 2005, CAFTA provides duty relief for textiles and apparel between the United States and Central
American countries (Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua).
● Effective as of January 2006.
● Other economic integrations focusing on the following:
○ MERCOSUR:
● Acronym: El Mercado Comun del Sur.
● Region: South America. (Initial Argentina, Brazil, Paraguay)
● Details: Major economic bloc with free movement of goods/services, a common external tariff, and
coordinated monetary policies, accounts for nearly all of the region's GDP. May be integrated with
NAFTA and DR-CAFTA as part of a future fee
- CARICOM:
● Acronym: Caribbean Community and Common Market.
● Region: Caribbean.
- CAN:
● Acronym: Comunidad Andina de Naciones.
● Region: South America, including Bolivia, Colombia, Ecuador, Peru, and Venezuela.
- ASEAN:
● Acronym: Association of Southeast Asian Nations.
● Region: Southeast Asia.
- APEC:
● Acronym: Asia Pacific Economic Cooperation.
● Region: Asia-Pacific, promoting free trade across the Asia-Pacific region.
- CER:
● Acronym: Closer Economic Relations.
● Region: Australia and New Zealand.
● TPP and RCEP as emerging economic integrations
○ TPP (Trans-Pacific Partnership): trade agreement with Australia, Brunei, Canada, Chile, Japan, Malaysia,
Mexico, New Zealand, Peru, Singapore, Vietnam, U.S…..The U.S. has since exited.
○ RCEP (Regional Comprehensive Economic Partnership): A free trade agreement between the 10 member
states of ASEAN and its 6 partner states, signed in November 2020.
● International Cartel
○ An association of producers, like OPEC, that agrees to fix prices, allocate sales territories, and restrict
production of a particular good to maintain control over supply and price.
● Why economic integrations?
○ Expand Market Size: Access to a larger marketplace with more goods in the economic bloc.
○ Achieve Economies of Scale: Larger markets lead to economies of scale; internationalization inside the bloc
helps firms learn to compete outside bloc; competition and efficient resource usage inside the bloc leads to
lower prices.
○ Attract Direct Investment: Economic blocs are attractive to foreign firms (e.g., General Mills, Samsung).
○ Stronger Defense & Political Posture: Allows member countries to present a united economic front, e.g., the
EU.
○ Implications of regional integration for firm
■ Internationalization by firms inside the economic bloc: facilitates company internationalization;
expansion into neighboring countries provides experiences, prompting internationalization ot other
markets worldwide
■ Internationalization by firms from outside the bloc: Because external trade barriers mainly affect
exporting, many foreign firms prefer to enter a block through FDI; this way after formation of EU,
Britain became largest recipient of FSI form the US
○ Implications for the firm
■ Regional products and marketing strategy: firms cut costs by standardizing products and services.
Case Inc. reduced its Magnum line of tractors from 17 to only a few versions in Europe, following
integration of the EU
■ Rationalization of Operations: By restructuring and consolidation company operations, managers can
develop strategies and value-chain activities suited to the region as a whole, not just individual
countries. Goal is to cut costs and redundancy, and increase efficiency via scale economies
● Why do some firms favor FTA while others don't?
○ Stronger firms in an industry favor FTAs because they enhance competition and market access.
○ Weaker firms often oppose FTAs, as they may struggle to compete in the larger, integrated market.