National Differences in Political Economy

Introduction

Countries have different political systems, economic systems, and legal systems. Cultural practices can vary dramatically from country to country, as can the education and skill level of the population, and countries are at different stages of economic development. All of these differences can and do have major implications for the practice of international business. They have a profound impact on the benefits, costs, and risks associated with doing business in different countries; the way in which operations in different countries should be managed; and the strategy international firms should pursue in different countries.

Political Systems

Political system mean the system of government in a nation. Political systems can be assessed according to two related dimensions.

Collectivism and Individualism 

Socialism

While successful capitalists accumulate considerable wealth, Marx postulated that the wages earned by the majority of workers in a capitalist society would be forced down to subsistence levels. Marx argued that capitalists expropriate for their own use the value created by workers, while paying workers only subsistence wages in return. Put another way, according to Marx, the pay of workers does not reflect the full value of their labor. To correct this perceived wrong, Marx advocated state ownership of the basic means of production, distribution, and exchange .His logic was that if the state owned the means of production, the state could ensure that workers were fully compensated for their labor. Thus, the idea is to manage state-owned enterprise to benefit society as a whole, rather than individual capitalists.

The communists believed that socialism could be achieved only through violent revolution and totalitarian dictatorship, while the social democrats committed themselves to achieving socialism by democratic means and turned their backs on violent revolution and dictatorship.

Social democracy also seems to have passed its high-water mark, although the ideology may prove to be more enduring than communism. Social democracy has had perhaps its greatest influence in a number of democratic Western nations including Australia, Britain, France, Germany...

However, experience has demonstrated that far from being in the public interest, state ownership of the means of production often runs counter to the public interest. In many countries, state-owned companies have performed poorly. Protected from significant competition by their monopoly position and guaranteed government financial support, many state-owned companies became increasingly inefficient. In the end, individuals found themselves paying for the luxury of state ownership through higher prices and higher taxes.

Individualism

Individualism is the opposite of collectivism. In a political sense, individualism refers to a philosophy that an individual should have freedom in his or her economic and political pursuits. In contrast to collectivism, individualism stresses that the interests of the individual should take precedence over the interests of the state.

Individualism is built on two central tenets. The first is an emphasis on the importance of guaranteeing individual freedom and self-expression. The second tenet of individualism is that the welfare of society is best served by letting people pursue their own economic self-interest, as opposed to some collective body dictating what is in society's best interest.

The central message of individualism, therefore, is that individual economic and political freedoms are the ground rules on which a society should be based. This puts individualism in direct conflict with collectivism. Collectivism asserts the primacy of the collective over the individual, while individualism asserts just the opposite. This underlying ideological conflict has shaped much of the recent history of the world.

Democracy and Totalitarianism

Democracy refers to a political system in which government is by the people, exercised either directly or through elected representatives. Totalitarianism is a form of government in which one person or political party exercises absolute control over all spheres of human life and opposing political parties are prohibited.

Democracy

The pure form of democracy, as originally practiced by several city-states in ancient Greece, is based on a belief that citizens should be directly involved in decision making. In complex, advanced societies with populations in the tens or hundreds of millions this is impractical. Most modern democratic states practice what is commonly  referred to as representative democracy. In a representative democracy, citizens periodically elect individuals to represent them. These elected representatives then form a government, whose function is to make decisions on behalf of the electorate. To guarantee that elected representatives can be held accountable for their actions by the electorate, an ideal representative democracy has a number of safeguards that are typically enshrined in constitutional law.

Totalitarianism

In a totalitarian country, all the constitutional guarantees on which representative democracies are built--such as an individual's right to freedom of expression and organization, a free media, and regular elections--are denied to the citizens. In most totalitarian states, political repression is widespread and those who question the right of the rulers to rule find themselves imprisoned, or worse.

Four major forms of totalitarianism exist in the world today. Until recently the most widespread was communist totalitarianism. As discussed earlier, communism is a version of collectivism that advocates that socialism can be achieved only through totalitarian dictatorship. A second form of totalitarianism might be labeled theocratic totalitarianism. Theocratic totalitarianism is found in states where political power is monopolized by a party, group, or individual that governs according to religious principles.

A third form of totalitarianism might be referred to as tribal totalitarianism. Tribal totalitarianism is found principally in African countries . Tribal totalitarianism occurs when a political party that represents the interests of a particular tribe.

A fourth major form of totalitarianism might be described as right-wing totalitarianism. Right-wing totalitarianism generally permits individual economic freedom but restricts individual political freedom on the grounds that it would lead to the rise of communism. One common feature of most right-wing dictatorships is an overt hostility to socialist or communist ideas.

Economic Systems

Market Economy

In a pure market economy all productive activities are privately owned, as opposed to being owned by the state. The goods and services that a country produces, and the quantity in which they are produced, are not planned by anyone. Rather, production is determined by the interaction of supply and demand and signaled to producers through the price system. If demand for a product exceeds supply, prices will rise, signaling producers to produce more. If supply exceeds demand, prices will fall, signaling producers to produce less. In this system consumers are sovereign. The purchasing patterns of consumers, as signaled to producers through the mechanism of the price system, determine what is produced and in what quantity.

Given the dangers inherent in monopoly, the role of government in a market economy is to encourage vigorous competition between private producers. Governments do this by outlawing monopolies and restrictive business practices designed to monopolize a market. Private ownership also encourages vigorous competition and economic efficiency. Private ownership ensures that entrepreneurs have a right to the profits generated by their own efforts. This gives entrepreneurs an incentive to search for better ways of serving consumer needs. That may be through introducing new products, by developing more efficient production processes, by better marketing and after-sale service, or simply through managing their businesses more efficiently than their competitors.

Command Economy

In a pure command economy, the goods and services that a country produces, the quantity in which they are produced, and the prices at which they are sold are all planned by the government. In addition, in  a pure command economy, all businesses are state owned, the rationale being that the government can then direct them to make investments that are in the best interests of the nation as a whole, rather than in the interests of private individuals.

While the objective of a command economy is to mobilize economic resources for the public good, just the opposite seems to have occurred. In a command economy, state-owned enterprises have little incentive to control costs and be efficient, because they cannot go out of business.

Mixed Economy

Between market economies and command economies can be found mixed economies. In a mixed economy, certain sectors of the economy are left to private ownership and free market mechanisms, while other sectors have significant state ownership and government planning. In mixed economies, governments also tend to take into state ownership troubled firms whose continued operation is thought to be vital to national interests.

State-Directed Economy

A state-directed economy is one in which the state plays a significant role in directing the investment activities of private enterprise through "industrial policy" and in otherwise regulating business activity in accordance with national goals.

Private Action

Private action refers to theft, piracy, blackmail, and the like by private individuals or groups. While theft occurs in all countries, in some countries a weak legal system allows for a much higher level of criminal action than in others.

However, there is an enormous difference between the magnitude of such activity in Russia and its limited impact in Japan and the United States. This difference arises because the legal enforcement apparatus, such as the police and court system, is so weak in Russia.

Public Action

Public action to violate property rights occurs when public officials, such as politicians and government bureaucrats, extort income or resources from property holders. This can be done through a number of mechanisms including levying excessive taxation, requiring expensive licenses or permits from property holders, taking assets into state ownership without compensating the owners .

The Protection of Intellectual Property

Intellectual property refers to property, such as computer software, a screenplay, a music score, or the chemical formula for a new drug, that is the product of intellectual activity. It is possible to establish ownership rights over intellectual property through patents, copyrights, and trademarks. A patent grants the inventor of a new product or process exclusive rights to the manufacture, use, or sale of that invention. Copyrights are the exclusive legal rights of authors, composers, playwrights, artists, and publishers to publish and disperse their work as they see fit. Trademarks are designs and names, often officially registered, by which merchants or manufacturers designate and differentiate their products .

The philosophy behind intellectual property laws is to reward the originator of a new invention, book, musical record, clothes design, restaurant chain, and the like, for his or her idea and effort. Such laws are a very important stimulus to innovation and creative work. They provide an incentive for people to search for novel ways of doing things and they reward creativity.

The protection of intellectual property rights differs greatly from country to country. While many countries have stringent intellectual property regulations on their books, the enforcement of these regulations has often been lax. This has been the case even among some countries that have signed important international agreements to protect intellectual property, such as the Paris Convention for the Protection of Industrial Property. Weak enforcement encourages the piracy of intellectual property. China and Thailand have recently been among the worst offenders in Asia. Local bookstores in China commonly maintain a section that is off-limits to foreigners; it ostensibly is reserved for sensitive political literature, but it more often displays illegally copied textbooks. Pirated computer software is also widely available in China.

International businesses have a number of possible responses to such violations. Firms can lobby their respective governments to push for international agreements to ensure that intellectual property rights are protected and that the law is enforced. An example of such lobbying is given in the next Management Focus, which looks at how Microsoft prompted the US government to start insisting that other countries abide by stricter intellectual property laws.

One problem with these new regulations, however, is that the world's biggest violator--China--is not yet a member of the WTO and is therefore not obliged to adhere to the agreement.

In addition to lobbying their governments, firms may want to stay out of countries where intellectual property laws are lax, rather than risk having their ideas stolen by local entrepreneurs.. In addition, Microsoft has encountered significant problems with pirated software in China, the details of which are discussed in the Management Focus.

Product Safety and Product Liability

Product safety laws set certain safety standards to which a product must adhere. Product liability involves holding a firm and its officers responsible when a product causes injury, death, or damage. Product liability can be much greater if a product does not  conform to required safety standards. There are both civil and criminal product liability laws. Civil laws call for payment and money damages. Criminal liability laws result in fines or imprisonment.

In addition to the competitiveness issue, country differences in product safety and liability laws raise an important ethical issue for firms doing business abroad. When product safety laws are tougher in a firm's home country than in a foreign country and/or when liability laws are more lax, should a firm doing business in that foreign country follow the more relaxed local standards or should it adhere to the standards of its home country? While the ethical thing to do is undoubtedly to adhere to home-country standards, firms have been known to take advantage of lax safety and liability laws to do business in a manner that would not be allowed back home.

Contract Law

Contract law can differ significantly across countries, and as such it affects the kind of contracts an international business will want to use to safeguard its position should a contract dispute arise. Two main legal traditions are found in the world today--the common law system and the civil law system. The common law system evolved in England over hundreds of years. It is now found in most of Britain's former colonies, including the United States. Common law is based on tradition, precedent, and custom. When law courts interpret common law, they do so with regard to these characteristics. Civil law is based on a very detailed set of laws organized into codes. Among other things, these codes define the laws that govern business transactions.

The Determinants of Economic Development

Differences in Economic Development

Different countries have dramatically different levels of economic development. One common measure of economic development is a country's gross national product per head of population. GNP is often regarded as a yardstick for the economic activity of a country; it measures the total value of the goods and services produced annually. However, GNP per head figures can be misleading because they don't take into account differences in the cost of living.

As can be seen, there are striking differences between the standard of living in different countries..

A problem with the GNP and PPP data discussed so far is that they give a static picture of development. Thus, in time they may become advanced nations themselves and huge markets for the products of international businesses. Given their future potential, it may well be good advice for international businesses to start getting a foothold in these markets now. Even though their current contributions to an international firm's revenues might be small, their future contributions could be much larger.

A number of other indicators can also be used to assess a country's economic development and its likely future growth rate. These include literacy rates, the number of people per doctor, infant mortality rates, life expectancy, calorie (food) consumption per head. In an attempt to estimate the impact of such factors upon the quality of life in a country, the United Nations has developed a Human Development Index. This index is based upon three measures: life expectancy, literacy rates, and whether average incomes, based on PPP estimates, are sufficient to meet the basic needs of life in a country .

Political Economy and Economic Progress

Innovation Is the Engine of Growth

There is general agreement now that innovation is the engine of long-run economic growth.²⁸ Those who make this argument define innovation broadly to include not just new products, but also new processes, new organizations, new management practices, and new strategies. One can conclude that if a country's economy is to sustain long-run economic growth, the business environment within that country must be conducive to the production of innovations.

Innovation Requires a Market Economy

Those who have considered this issue highlight the advantages of a market economy. It has been argued that the economic freedom associated with a market economy creates greater incentives for innovation  than either a planned or a mixed economy. In a market economy, any individual who has an innovative idea is free to try to make money out of that idea by starting a business. Similarly, existing businesses are free to improve their operations through innovation. To the extent that they are successful, both individual entrepreneurs and established businesses can reap rewards in the form of high profits. Thus, in market economies there are enormous incentives to develop innovations.

In contrast, in a planned economy the state owns all means of production. Consequently there is no opportunity for entrepreneurial individuals to develop valuable new innovations, since it is the state, rather than the individual, that captures all the gains.

Innovation Requires Strong Property Rights

Strong legal protection of property rights is another requirement for a business environment to be conducive to innovation and economic growth.³¹ Both individuals and businesses must be given the opportunity to profit from innovative ideas. Without strong property rights protection, businesses and individuals run the risk that the profits from their innovative efforts will be expropriated, either by criminal elements, or by the state itself. The state can expropriate the profits from innovation through legal means, such as excessive taxation, or through illegal means, such as demands from state bureaucrats for kickbacks in return for granting an individual or firm a license to do business in a certain area. According to the Nobel prize-winning economist Douglass North, throughout history many governments have displayed a tendency to engage in such behavior. Inadequately enforced property rights reduce the incentives for innovation and entrepreneurial activity--since the profits from such activity are "stolen"--and hence reduce the rate of economic growth.

The Required Political System

There is a great deal of debate as to the kind of political system that best achieves a functioning market economy where there is strong protection for property rights. We in the West tend to associate a representative democracy with a market economic system, strong property rights protection, and economic progress. Building on this, we tend to argue that democracy is good for growth. All these economies had one thing in common at the start of their economic growth-undemocratic governments.

However, those who argue for the value of a totalitarian regime miss an important point-if dictators made countries rich, then much of Africa, Asia, and Latin America should have been growing rapidly for, and this has not been the case. Only a certain kind of totalitarian regime is capable of promoting economic growth. It must be a dictatorship that is committed to a free market system and strong protection of property rights. Moreover, there is no guarantee that a dictatorship will continue to pursue such progressive policies. Dictators are rarely so benevolent. Many are tempted to use the apparatus of the state to further their own private ends, violating property rights and stalling economic growth. Given this, it seems likely democratic regimes are far more conducive to long-term economic growth than are dictatorships, even benevolent ones. Only in a well-functioning, mature democracy are property rights truly secure.

Economic Progress Begets Democracy

While it is possible to argue that democracy is not a necessary precondition for establishment of a free market economy in which property rights are protected, subsequent economic growth often leads to establishment of a democratic regime.A strong belief that economic progress leads to adoption of a democratic regime underlies the fairly permissive attitude that many Western governments have adopted toward human rights violations in China.

Other Determinants of Development: Geography and Education

While a country's political and economic system is probably the big locomotive driving its rate of economic development, other factors are also important. One that has received attention recently is geography. But the belief that geography can influence economic policy, and hence economic growth rates, goes back to Adam Smith.

Education emerges as another important determinant of economic development. The general assertion is that nations that invest more in education will have higher growth rates because an educated population is a more productive population. Some rather striking anecdotal evidence suggests this is the case.

States in Transition

The Spread of Democracy

Among the criteria that Freedom House uses to determine ratings for political freedom are the following:

·                 Free and fair elections of the head of state and legislative representatives.

·                 Fair electoral laws, equal campaigning opportunities, and fair polling.

·                 The right to organize into different political parties.

·                 A parliament with effective power.

·                 A significant opposition that has a realistic chance of gaining power.

·                 Freedom from domination by the military, foreign powers, totalitarian parties, religious hierarchies, or any other powerful group.

·                 A reasonable amount of self-determination for cultural, ethnic, and religious minorities. 

There are three main reasons for the spread of democracy. First, many totalitarian regimes failed to deliver economic progress to the vast bulk of their populations. Second, new information and communications technologies, including shortwave radio, satellite television, fax machines, desktop publishing, and now the Internet, have broken down the ability of the state to control access to uncensored information. These technologies have created new conduits for the spread of democratic ideals and information from free societies . Third, in many countries the economic advances of the last quarter century have led to the emergence of increasingly prosperous middle and working classes who have pushed for democratic reforms.

Having said this, it would be naive to conclude that the global spread of democracy will continue unchallenged. There have been several reversals.

The Spread of Market-Based Systems

Paralleling the spread of democracy has been the transformation from centrally planned command economies to market-based economies. A complete list of countries would also include Asian states such as China and Vietnam, as well as African countries such as Angola...

The underlying rationale for economic transformation has been the same the world over. In general, command and mixed economies failed to deliver the kind of sustained economic performance that was achieved by countries adopting market-based systems.

The Nature of Economic Transformation

Deregulation

Deregulation involves removing legal restrictions to the free play of markets, the establishment of private enterprises, and the manner in which private enterprises operate. In mixed economies, deregulation has involved abolishing laws that either prohibited private enterprises from competing in certain sectors of the economy or regulated the manner in which they operated.

Privatization

Privatization transfers the ownership of state property into the hands of private individuals, frequently by the sale of state assets through an auction. Privatization is seen as a way to unlock gains in economic efficiency by giving new private owners a powerful incentive--the reward of greater profits--to search for increases in productivity, to enter new markets, and to exit losing ones.

The opening case to this chapter details the extent of privatization activity in Brazil, and the Country Focus feature discusses privatization in India. As these two examples suggest, privatization has become a worldwide movement.

Implications

The global changes in political and economic systems discussed above have several implications for international business. The free market ideology of the West has won the Cold War and has never been more widespread than it was at the beginning of the millennium. Although command economies still remain and totalitarian dictatorships can still be found around the world, the tide is running in favor of free markets and democracy.

The implications for business are enormous. However, just as the potential gains are large, so are the risks. There is no guarantee that democracy will thrive in the newly democratic states of Eastern Europe, particularly if these states have to grapple with severe economic setbacks. Totalitarian dictatorships could return, although they are unlikely to be of the communist variety. Moreover, although the bipolar world of the Cold War era has vanished, it may be replaced by a multi-polar world dominated by a number of civilizations. In such a world, much of the economic promise inherent in the global shift toward market-based economic systems may evaporate in the face of conflicts between civilizations. While the long-term potential for economic gain from investment in the world's new market economies is large, the risks associated with any such investment are also substantial. It would be foolish to ignore these.

Implications for Business

The implications for international business of the material discussed in this chapter fall into two broad categories.

Benefits

In the most general sense, the long-run monetary benefits of doing business in a country are a function of the size of the market, the present wealth. While international businesses need to be aware of this distinction, they also need to keep in mind the likely future prospects of a country.

By identifying and investing early in a potential future economic star, international firms may build brand loyalty and gain experience in that country's business practices. These will pay back substantial dividends if that country achieves sustained high economic growth rates. In contrast, late entrants may find that they lack the brand loyalty and experience necessary to achieve a significant presence in the market. In the language of business strategy, early entrants into potential future economic stars may be able to reap substantial first-mover advantages, while late entrants may fall victim to late-mover disadvantages. A country's economic system and property rights regime are reasonably good predictors of economic prospects. Countries with free market economies in which property rights are well protected tend to achieve greater economic growth rates than command economies and economies where property rights are poorly protected. It follows that a country's economic system and property rights regime^.

Costs

A number of political, economic, and legal factors determine the costs of doing business in a country. With regard to political factors, the costs of doing business in a country can be increased by a need to pay off the politically powerful in order to be allowed by the government to do business. The need to pay what are essentially bribes is greater in closed totalitarian states than in open democratic societies where politicians are held accountable by the electorate. Whether a company should actually pay bribes in return for market access should be determined on the basis of the legal and ethical implications of such action. We discuss this consideration below.

With regard to economic factors, one of the most important variables is the sophistication of a country's economy. It may be more costly to do business in relatively primitive or undeveloped economies because of the lack of infrastructure and supporting businesses. At the extreme, an international firm may have to provide its own infrastructure and supporting business if it wishes to do business in a country, which obviously raises costs.

As for legal factors, it can be more costly to do business in a country where local laws and regulations set strict standards with regard to product safety, safety in the workplace, environmental pollution, and the like .It can also be more costly to do business in a country like the United States, where the absence of a cap on damage awards has meant spiraling liability insurance rates. Moreover, it can be more costly to do business in a country that lacks well-established laws for regulating business practice .In the absence of a well-developed body of business contract law, international firms may find that there is no satisfactory way to resolve contract disputes and, consequently, routinely face large losses from contract violations.

Risks

As with costs, the risks of doing business in a country are determined by a number of political, economic, and legal factors. On the political front, there is the issue of political risk. Political risk has been defined as the likelihood that political forces will cause drastic changes in a country's business environment that adversely affect the profit and other goals of a particular business enterprise. So defined, political risk tends to be greater in countries experiencing social unrest and disorder or in countries where the underlying nature of a society increases the likelihood of social unrest. Social unrest typically finds expression in strikes, demonstrations, terrorism, and violent conflict.

Social unrest can result in abrupt changes in government and government policy or, in some cases, in protracted civil strife. Such strife tends to have negative economic implications for the profit goals of business enterprises.

On the economic front, economic risks arise from economic mismanagement by the government of a country. Economic risks can be defined as the likelihood that economic mismanagement will cause drastic changes in a country's business environment that adversely affect the profit and other goals of a particular business enterprise. Economic risks are not independent of political risk. Economic mismanagement may give rise to significant social unrest and hence political risk. Nevertheless, economic risks are worth emphasizing as a separate category because there is not always a one-to-one relationship between economic mismanagement and social unrest. One visible indicator of economic mismanagement tends to be a country's inflation rate. Another tends to be the level of business and government debt in the country.

The borrowers failed to generate the profits required to meet their debt payment obligations. In turn, the banks that had lent money to these businesses suddenly found that they had rapid increases in nonperforming loans on their books. Foreign investors, believing that many local companies and banks might go bankrupt, pulled their money out of these countries, selling local stocks, bonds, and currency.

On the legal front, risks arise when a country's legal system fails to provide adequate safeguards in the case of contract violations or to protect property rights. When legal safeguards are weak, firms are more likely to break contracts and steal intellectual property if they perceive it as being in their interests to do so. Thus, legal risks might be defined as the likelihood that a trading partner will opportunistically break a contract or expropriate property rights. When legal risks in a country are high, an international business might hesitate entering into a long-term contract or joint-venture agreement with a firm in that country.

Overall Attractiveness

The overall attractiveness of a country as a potential market and/or investment site for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country. Generally, the costs and risks associated with doing business in a foreign country are typically lower in economically advanced and politically stable democratic nations and greater in less developed and politically unstable nations. The calculus is complicated, however, by the fact that the potential long-run benefits bear little relationship to a nation's current stage of economic development or political stability. Rather, the benefits depend on likely future economic growth rates. Economic growth appears to be a function of a free market system and a country's capacity for growth

Ethics and Human Rights

One major ethical dilemma facing firms from democratic nations is whether they should do business in totalitarian countries that routinely violate the human rights of their citizens .There are two sides to this issue. Some argue that investing in totalitarian countries provides comfort to dictators and can help prop up repressive regimes that abuse basic human rights. For instance, Human Rights Watch, an organization that promotes the protection of basic human rights around the world, has argued that the progressive trade policies adopted by Western nations toward China has done little to deter human rights abuses.

In contrast, some argue that Western investment, by raising the level of economic development of a totalitarian country, can help change it from within. They note that economic well-being and political freedoms often go hand in hand.

Since both positions have some merit, it is difficult to arrive at a general statement of what firms should do. Unless mandated by government  each firm must make its own judgments about the ethical implications of investing in totalitarian states on a case-by-case basis.

Ethics and Regulations

A second important ethical issue is whether an international firm should adhere to the same standards of product safety, work safety, and environmental protection that are required in its home country. This is of particular concern to many firms based in Western nations, where product safety, worker safety, and environmental protection laws are among the toughest in the world.

Again there is no easy answer. While on the face of it the argument for adhering to Western standards might seem strong, on closer examination the issue becomes more complicated.

Ethics and Corruption

A final ethical issue concerns bribes and corruption. Should an international business pay bribes to corrupt government officials to gain market access to a foreign country? To most Westerners, bribery seems to be a corrupt and morally repugnant way of doing business, so the answer might initially be no. Some countries have laws on their books that prohibit their citizens from paying bribes to foreign government officials in return for economic favors.