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International Business

National Differences
In Political Economy (Part 2 of 2)
Lecture 6
• Introduction
• Political Systems
– Collectivism and Individualism
– Democracy and Totalitarianism

• Economic Systems
– Market Economy
– Command Economy
– Mixed Economy
– State-Directed Economy

• The Determinants of Economic
– Differences in Economic Development
– Political Economy and Economic
– Geography, Education and Economic
• States in Transition
– The Spread of Democracy
– The New World Order and Global
– The Spread of Market-Based Systems

• The Nature of Economic Transformation
– Deregulation
– Privatisation
– Legal Systems
– Implications of Changing Political

• Implications for Managers
– Benefits
– Costs
– Risks
– Overall Attractiveness
• Questions

• International business is much more
complicated than domestic business
because countries differ in many ways
• Countries have different political,
economic, and legal systems
• Cultural practices can vary dramatically, as
can the education and skill level of the
population, and countries are at different
stages of economic development
• All these differences can and do have major
implications for the practice of IB
• They have a profound impact on:
– the benefits, costs, and risks associated
with doing business in different countries,
– the way in which operations should be
managed and,
– the strategy international firms should
pursue in different countries
• Focus on how the political, economic, and
legal systems of different countries differ
• Collectively, we refer to these systems as
constituting the political economy of a

• The term political economy is used to stress
that the political, economic, and legal
systems of a country are interdependent;
they interact and influence each other, and
in doing so they affect the level of
economic well-being

The Determinants of
Economic Development
• The political, economic, and legal systems of a
country can have a profound impact on the level
of economic development and hence on the
attractiveness of a country as a possible market
or production location for a firm
• How countries differ in their level of
• How political economy affects economic
The Determinants of
Economic Development
• Differences in economic development
• Various countries have dramatically
different levels of economic development;
one common measure of economic
development is a country’s gross national
income (GNI) per head of population

Differences In Economic Development

• GNI is regarded as a yardstick for the

economic activity of a country; it measures
the total annual income received by
residents of a nation

Differences In Economic Development

• Countries such as Japan, Sweden,

Switzerland and the US are among the
richest on this measure, whereas India and
China are among the poorest; Yr 2005 data
– Japan - $38,950; China - $1,740; US -
$43,740; UK - $37,600; India - $720

Differences In Economic Development

• GNI per person figures can be misleading,

because they do not consider differences in
the cost of living; explain how?
• GNI per capita can be higher in Switzerland
than in US; the higher cost of living in
Switzerland meant that US citizens could
actually afford more goods and services
than Swiss citizens
Differences In Economic Development

• To account for the differences in the cost of

living, one can adjust GNI per capita by
purchasing power; we now refer to the
purchasing power parity adjustment; it
allows for a more direct comparison of
living standards in different countries
• The base for adjustment is the cost of living
in the US
Differences In Economic Development

• There may be striking differences in the

standards of living among countries;
however, one must correctly interpret the
• GNI and PPP give a static picture of
development; China is poorer than US, but
it does not say if China is closing the gap
and how quickly
Differences In Economic Development

• Refer to the economic growth rates; rate of

growth in GDP
• China and India may be currently poor;
their economies are already large in
absolute terms and growing more rapidly
than many advanced nations; they are huge
markets for products of international
Differences In Economic Development

• Why many international businesses are

trying to gain a foothold in these markets

Political Economy
and Economic Progress
• It is often argued that a country’s economic
development is a function of its economic
and political systems
• What is the relationship between political
economy and economic progress?
– Question has been the subject of vigorous
debate among academics and
Political Economy
and Economic Progress
• Innovation and entrepreneurship are the
engines of growth
– Innovation includes products, processes,
new organizations, new management
practices, new strategies; examples: Toys
R Us?
– Increase in production and business
processes lead to an increase in the
productivity of labour and capital, which
further boosts economic growth rates
Political Economy
and Economic Progress
– Innovation is also seen as the product of
entrepreneurial activity; entrepreneurs
first commercialise innovative new
products and processes, and
entrepreneurial activity provides much of
the dynamism in an economy; examples?

Political Economy
and Economic Progress
– For a country to sustain long-run
economic growth, the business
environment must be conducive to the
consistent production of products and
process innovations and to
entrepreneurial activity

Political Economy
and Economic Progress
• Innovation and entrepreneurship require a
market economy; explain why and how?
• Innovation and entrepreneurship require
strong property rights; explain?
• Democratic regimes are more conducive to
long-term economic growth; how?
• Economic progress begets democracy; is it
Geography, Education,
and Economic Development
• While a country’s political and economic
systems are probably the big engine driving
its rate of economic development, other
factors are also important; recent focus on

Geography, Education,
and Economic Development
– By virtue of favourable geography,
certain societies are more likely to
engage in trade than others and are thus
more likely to be open to and develop
market-based economic systems, which
in turn would promote faster economic

Geography, Education,
and Economic Development
• Education emerges as another important
determinant of economic development
– The general assertion is that nations that
invest more in education have higher
growth rates because an educated
population is a more productive
population; compare Pakistan and South
Korea in 1960 and mid 1980s
States in Transition
• The political economy of many of the
world’s nation-states has changed radically
since the late 1980s
• During the late 1980s and early 1990s, a
wave of democratic revolutions swept the

States in Transition
– Totalitarian governments collapsed and
were replaced by democratically elected
governments, that were typically more
committed to free market capitalism than
their predecessors had been
• There has been strong move away from
centrally planned and mixed economies and
toward a more free market economic model
The Spread of Democracy

• One notable development of the past 15

years has been the spread of democracy,
and by extension the decline in
• Political freedom grouping countries into
three broad categories; free, partly free, not

The Spread of Democracy

• Freedom House classified some 90

countries as free in 2006; 47% of the
world’s population
• Number of democracies in the world has
increased from 69 nations in 1987 to 123 in
2006; the highest number in history

The Spread of Democracy

• But not all democracies are free according to

Freedom House, because some still restrict
political and civil liberties; e.g. Russia is still
not free; similar issue in Venezuela
• Many of the newer democracies are in
Eastern Europe and Latin America, although
there also have been notable gains in Africa,
during this time; examples?

The Spread of Democracy

• Main reasons accounting for the spread of

• Many totalitarian regimes failed to deliver
economic progress to the vast majority of
their populations; the collapse of the
communism was precipitated by the growing
gulf between the vibrant and wealthy
economies of the West and the stagnant
economies of the Communist East
The Spread of Democracy

• New information and communication

technologies (examples?), have reduced the
state’s ability to control access to
uncensored information; these technologies
have created new conduits for the spread of
democratic ideals and information from free

The Spread of Democracy

• In many countries the economic advances of

the past century have led to the emergence
of increasingly prosperous middle and
working classes who have pushed for
democratic reforms; example of South

The Spread of Democracy

• Entrepreneurs and business leaders, eager to

protect their property rights and ensure
dispassionate enforcement contracts, are
another force pressing for more accountable
and open government

The Spread of Democracy

• However, it would be naïve to conclude that

the global spread will continue
unchallenged; democracy is still rare in
large parts of the world
• Sub-Saharan Africa in 2006: only 11
countries were considered free, 22 partly
free, and 15 not free

The Spread of Democracy

• Among the 27 post-Communist countries in

Eastern and Central Europe, 7 are still not
electorate democracies, and only 13 are
considered as free; primarily in Eastern
• There are no free states among the 16 Arab
nations of the Middle East and North Africa

The New World Order and Global Terrorism

• The end of the Cold War and the “new

world order” that followed the collapse of
communism in Eastern Europe and the
former Soviet Union, taken together with
the demise of the authoritarian regimes in
Latin America, have given rise to intense
speculation about the future shape of
The New World Order and Global Terrorism

• Ideas projected by Francis Fukuyama

– End of history; the end point of
mankind’s ideological evolution and the
universalization of Western liberal
democracy as the final form of
• Others have questioned Fukuyama’s vision

The New World Order and Global Terrorism

• The influential political scientist Samuel

Huntington argues that there is no
“universal” civilization based on
widespread acceptance of Western liberal
democratic ideals
• The countries may be modernizing, but not
becoming more Western

The New World Order and Global Terrorism

• On the contrary, Huntington theorizes that

modernization in non-Western can result in
a retreat toward the traditional
• In contrast to Fukuyama, Huntington sees a
world that is split into different
civilizations, each of which has its own
value system and ideology; examples?
• Impact on international business?

The New World Order and Global Terrorism

• The evolution of a global political system

that is positioned somewhere between
Fukuyama’s universal global civilization
based on democratic ideals and Huntington’s
vision of a fractured world
• That would still be a world, however, in
which geopolitical forces periodically limit
the ability of business enterprises to operate
in certain foreign countries
The New World Order and Global Terrorism

• In Huntington’s thesis, global terrorism is a

product of the tension between civilization
and the clash of value systems and
ideology; others point to terrorism’s roots in
long-standing conflicts that seem to defy
political resolution; examples?

The Spread of Market-Based Systems

• Paralleling the spread of democracy since

the 1980s has been the transformation from
centrally planned command economies to
market-based economies
• Example: more than 30 countries that were
in the former Soviet Union or the Eastern
European Communist bloc have changed
their economic systems
The Spread of Market-Based Systems

• Recent examples?
• There has been a similar shift away from a
mixed economy; examples?
• What is the rationale for this economic
• Economic freedom does not necessarily
equate with political freedom; explain?
The Nature of Economic Transformation

• The shift toward a market-based economic

system often entails a number of steps
– Deregulation
– Privatisation
– Creation of a legal system to safeguard
property rights

• Involves removing legal restrictions to the
free play of markets, the establishment of
private enterprises, and the manner in which
private enterprises operate
• Initial constraints in certain countries: tight
control over prices and output, detailed state
planning, prohibiting private enterprises to
operate in most sectors of the economy,
restriction on FDI, limited international

• Similarly, a sharp increase in privatisation

is noted; transfer the ownership of state
property into the hands of private
individuals, frequently by the sale of state
assets through an auction; recent examples
in the local business environment?


• It is seen as a way to stimulate 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; examples?

Legal Systems

• A well-functioning market economy

requires laws protecting private property
rights and providing mechanisms for
contract enforcement
• Impact of a poor legal system in
international business?

Implications of Changing
Political Economy
• The global changes in political and
economic systems invariably have
implications for international business
• For nearly 50 years, half of the world was
off-limits to Western businesses; access to
different markets, though impoverished;

Implications of Changing
Political Economy
• However, just as the potential gains are
large, so are the risks; there is no guarantee
that democracy will thrive in many of the
world’s newer democratic states,
particularly if they are to encounter with
severe economic setbacks

Implications for Managers
• The political, economic and legal systems
of a country raise important ethical issues
that have implications for the practice of
international business; doing business in
countries that deny basic human rights;
corruption is rampant

Implications for Managers
• The political, economic, and legal
environments of a country clearly influence
the attractiveness of that country as a market
or investment site
• The benefits, costs, and risks associated with
doing business in a country are a function of
that country’s political, economic, and legal
systems; balancing the likely long-term
benefits of doing business against the likely
costs and risks

• Size of the market, present wealth of the

consumers in that market, and the likely
future wealth as well
• Identify and invest early in a potential
future economic star, firms can build brand
loyalty and gain experience in that
country’s business practices; first mover
advantages; what about the late comers?

• Political factors: pay off politically

powerful entities in a country before the
government allows it to do business there;
compare different regimes?


• Economic factors: the sophistication of a

country’s economy; difficult to do business
in a country with poor, limited
infrastructure; extreme option of a firm to
set up its own infrastructure – cost
implication? Example of McDonald’s
investment in Russia?


• Legal factors: 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
• Other costs: absence of a cap on damage
awards – effect on insurance rates?


• As with costs, the risks of doing business in

a country are determined by a number of
political, economic, and legal factors
• Political risk: likelihood that the political
forces will cause drastic changes in a
country’s business environment that
adversely affect the profit and other goals of
a business enterprise; examples?

• Economic risk: likelihood that economic

mismanagement adversely affect the
business environment and subsequently the
business enterprise; example
• Impact on the society and political scenery?


• Legal risk: likelihood that a trading partner

will opportunistically break a contract or
expropriate property rights
• The risks arise when a country’s legal
system fails to provide adequate safeguards
in the case of contract violations or to
protect property rights

Overall Attractiveness

• The overall attractiveness of a country as a

potential market or investment site for an
international business depends on balancing
the benefits, costs,and risks associated with
doing business in that country
• Compare economically advanced and
politically stable democratic nations to
politically unstable nations
Overall Attractiveness
• What about likely future economic growth
• General conclusion:
– Other things being equal, the benefit-cost-
risk trade-off is likely to be most
favourable in politically stable developed
and developing nations that have free
market systems and no dramatic upsurge in
either inflation rates or private-sector debt
• Free market economies stimulate greater
economic growth, whereas state-directed
economies stifle growth. Discuss
• A democratic political system is an essential
condition for sustained economic progress.
• What is the relationship between corruption
in a country and economic growth? Is
corruption always bad?