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Index

Sr.!No.! ! ! Topic! Page!No.!

1.! Introduction! 3!

2.! Global!Political!Environment! 3!

3.! Types!of!Political!System!! 5!

4.! Political!Interdependence!! 6!

5.! Government!Intervention!in!Trade! 7!

6.! Political!Factors!affecting!Business! 9!

7.! Political!Risk! 10!

8.! Measuring!Political!Risk! 13!

9.! The Perils of Political Instability and Uncertainty! 16!

10.! The!Contrasting!examples!of!India!and!China! 17!

11.! Why!Businesses!like!a!stable!MacroPEnvironment! 18!

12.! Political!Strategies!for!Conduction!International!Business! 19!

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Introduction Business practices and operations in the international political environment are influenced by the forces and processes of globalization, including political, social, and policy risks. Political risks refer to the potential effects of a change in government on a business. Social risks refer to pressures put on businesses by environmental or other pressure groups. Policy risks refer to the potential effects resulting from change in policy or rights on a business (Frynas, 2002). The process of globalization refers to the increasingly free flow of ideas, people, goods, services, and capital that is leading to the integration of economies and societies. Businesses have adapted to the changing global political environment by identifying political risks prior to investment in foreign business activities and investments. The following sections provide an overview of the current global political environments and political risks. Global Political Environment A political environment is characterized by the regulatory environment, local attitudes towards corporate governance, reaction to international competition, and labor laws. Political environments around the world are changing due to the forces of globalization. Globalization is characterized by the permeability of traditional boundaries of nations, cultures, and economic markets. According to Thruow (1995), the fundamental economic forces and events influencing globalization and political turmoil around the world include: • The end of communism • The shift from an economy based on natural resources

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to one based on knowledge industries • Demographic shifts • The development of a global economy • Increased trade liberalization • Advances in communication technology • Increased threat of global terrorism • An era without a dominant economic, political, or

military power Globalization creates a turbulent global socio-political environment characterized by competing political actors, shifting power relations, and politically driven changes in national economies around the world. Businesses work to find opportunity and profit to be had from these political and economic changes. The political turbulence and upheaval has resulted in a move from centralized economies to a decentralized global economy and has created numerous emerging markets. These emerging markets refer to the capital markets of developing countries that have liberalized their financial systems to promote capital flows with nonresidents and have become broadly accessible to foreign investors. Business opportunities, including international investments and joint ventures, in the global economy are increasingly tied to trade pacts such as the North Countries are privatizing many state-owned industries and allowing foreign investors to purchase pieces of them through joint ventures or allowing local operations to participate in these projects (Stites, 1995). Emerging markets, often occurring in countries experiencing political upheaval, will continue to increase in the expanding global market. Businesses, participating in the new global economy, will continue to seek out new manufacturing and sales opportunities in foreign

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markets and countries. Ultimately, globalization brings businesses new opportunity and new risks. Political risks are one of the major problems and considerations for businesses in the global political environment. Opportunities and liabilities are growing proportionately in the new global economy. The following section describes and analyzes the influence of political risk on business activities and operations. Types of Political Systems Governments are responsible for passing and enforcing the laws of the country. Most countries have a democratic model. The general population has the right to vote in free elections. Individuals may own property and run businesses and have free press and free speech. Most have a market or capitalist economy. Totalitarian systems (North Korea, Cuba, Myanmar) centralize power and often use military control. Governments are single party or a dictatorship. Citizens have little say in the governing. Most have a command economy. In reality most countries have a mixed system of government. Most countries also have a mixed economy, having elements of both market and command economies. Recent political events have changed Russia (formerly Communist) and China (still communist) and have created more open markets and trade. Even Canada’s

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trade with Communist Cuba has increased. Doing business with countries in political transition is risky because of the instability of political, economic and social institutions. Political Interdependence Recent greater interdependence caused pressure for countries to change their political, economic and cultural practices. For example, South Africa faced economic isolation from the world because of apartheid, but eventually gave in to international pressure. Canada prefers to deal with democratic countries, but important opportunities exist in non-democratic countries (China). Sometimes a strong authoritarian government provides stability that a shaky democratic government could not. When a trade war occurs countries will act aggressively in international markets and other areas to promote their own trading interests. In 2001 Canada banned Brazilian beef officially because of mad cow disease, but it was suspected it was because of the sale and subsidy of Canadian and Brazilian-made aircraft. Grocery stores and transportation companies lost business in the crossfire. Interdependence also happens because of economic imperialism. A less-developed country can address the needs for a developed country by providing raw materials and markets.

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In “Coca-Colonization” powerful multinationals can exert considerable economic and cultural power over local people. Today, pressure groups and populist movements demonstrate against this and protest against the WTO. How Do Governments Intervene in Trade? While the past century has seen a major shift toward free trade, many governments continue to intervene in trade. Governments have several key policy areas that can be used to create rules and regulations to control and manage trade. • Tariffs. Tariffs are taxes imposed on imports. Two

kinds of tariffs exist—specific tariffs, which are levied as a fixed charge, and ad valorem tariffs, which are calculated as a percentage of the value. Many governments still charge ad valorem tariffs as a way to regulate imports and raise revenues for their coffers.

• Subsidies. A subsidy is a form of government payment to a producer. Types of subsidies include tax breaks or low-interest loans; both of which are common. Subsidies can also be cash grants and government-equity participation, which are less common because they require a direct use of government resources.

• Import quotas and VER. Import quotas and voluntary export restraints (VER) are two strategies to limit the amount of imports into a country. The importing government directs import quotas, while VER are imposed at the discretion of the exporting nation in conjunction with the importing one.

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• Currency controls. Governments may limit the convertibility of one currency (usually its own) into others, usually in an effort to limit imports. Additionally, some governments will manage the exchange rate at a high level to create an import disincentive.

• Local content requirements. Many countries continue to require that a certain percentage of a product or an item be manufactured or “assembled” locally. Some countries specify that a local firm must be used as the domestic partner to conduct business.

• Antidumping rules. Dumping occurs when a company sells product below market price often in order to win market share and weaken a competitor.

• Export financing. Governments provide financing to domestic companies to promote exports.

• Free-trade zone. Many countries designate certain geographic areas as free-trade zones. These areas enjoy reduced tariffs, taxes, customs, procedures, or restrictions in an effort to promote trade with other countries.

• Administrative policies. These are the bureaucratic policies and procedures governments may use to deter imports by making entry or operations more difficult and time consuming.

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Political factors affecting business • Bureaucracy • Corruption level • Freedom of the press • Tariffs • Trade control • Education Law • Anti-trust law • Employment law • Discrimination law • Data protection law • Environmental Law • Health and safety law • Competition regulation • Regulation and deregulation • Tax policy (tax rates and incentives) • Government stability and related changes • Government involvement in trade unions and

agreements • Import restrictions on quality and quantity of

product • Intellectual property law (Copyright, patents) • Consumer protection and e-commerce • Laws that regulate environment pollution

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Political Risk Multinational corporations conducting global business in emerging markets experience lucrative investment opportunities as well as challenges and turmoil. Multinational corporations conducting business in today's global political environment are challenged by political risk. Political risk refers to the risk of a strategic, financial, or personnel loss for a firm because of events related to political instability such as riots, terrorism, coups, civil war, and insurrection, as well as non-market factors such as macro-economic and social policies (fiscal, monetary, trade, investment, industrial, income, labor, and developmentally) (Morales & Kleiner, 1996). Political risk arises from factors and events such as governmental change, shifts in national ideology or policy, civil war, social unrest, economic instability, nationalization, and corruption. Political, economic, and religious environments influence business operations for exporters, traders, investors, banks, and other organizations involved in international commerce. In addition, national governments may institute forced shutdowns and relocations of foreign business. Companies entering foreign markets for the first time, either as investors or manufacturers, as well as established multinational corporations expanding into new foreign markets or ventures must address certain questions in order to assess potential political risk (Wade, 2005): • Is there a tradition of peaceful governmental transition? • How resilient is the political system? • How do nongovernmental agencies, such as trade

unions, churches, media, and the legal system,

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influence the society and government? • Is there demographic stability? • Are there internal social, ethnic or religious tensions

that could lead to a civil war or unrest? • What is the country's trade credit history? • What is the level of unemployment among citizens? Political risk, as a general, global category, is characterized by three factors: catastrophic events, business environment, and public policy (Dugan, 1999).

• Catastrophic events: catastrophic events refer to the political developments that can affect operations of all foreign firms in a country. Theoretical examples include racial and ethnic unrest, civil strife, terrorism, civil war, international conflict, and systemic failure. Real word examples include former Yugoslavia's ethnic unrest, civil war, and international conflict.

• Business environments: business environment risks faced either by all foreign businesses in a region or industry specific risks (related to government corruption, labor strife, and the judicial system). Examples include labor and elections. Labor organizations through much of the world are closely tied to political organizations. This connection between labor and politics brings foreign companies into the midst of political struggles and issues. Foreign elections, which seldom influence foreign business operations directly, do influence public policy. Elections may bring in new officials who alter or shift the business environment to match the new regime. For example, new officials may change the tax code or structure.

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• Public policies: public policy risks include political initiatives such as changes in the tax system, regulatory structure, and monetary system. For example, when a foreign government is forced to devalue currency due to economic crisis, interest rates rise and alter domestic spending habits. This change in monetary policy could potentially ruin a foreign business' investment.

A major concern for any company or an individual before venturing on an international project is whether the political situation in the host country will change in such way that the operating position will deteriorate. It is very a much subjective business-specific event. Haendel (1979) defines it as the occurrence of events that may change the projections for profitability of a global business venture of a given investment. The political actions that may affect the business or construction operations may include governmental takeover of properties (with or without compensation), changes in import or export regulations, or even political insurrections leading to other drastic changes. Failure to analyze and fully understand these risk exposures may seriously affect one's objectives for profit, market share, and long-term relations. "In the broad context of international business, political risk is defined as the risk or probability of occurrence of some political events that will change the prospects for the profitability of a given investment. Macro-political risk events include sociopolitical disorder, power group transfer, and political corruption as well as government interference. Other major concerns also relate to the change of government policies toward foreign

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construction firms and the power group’s involvement or interference in the operation of a project. Foreign companies are extremely vulnerable to the risk associated with changes in government policies, laws, or regulations that could directly impact their right to operate and ability to realize the full expected value of their project returns. The involvement and interference of power groups in a project may take the form of more frequent administrative checks and political corruption. The latter is regarded by many foreign companies as an unavoidable fact of life on projects in certain developing countries, especially in China and Vietnam. There is the associated risk either of spending too much money on corrupt officials or spending it at the wrong place or time—all at the risk of having a government agency subsequently turn against the firm and the project for reasons other than cost or technical considerations." Measuring Political Risk • Instability: The probability of encountering political

risk in a host country is considered to be directly related to the relative stability the country's political system. This instability may have its roots in different economic, political, and social factors. Some specific causal factors may include communal unrest, strained international relations with neighboring countries, social unrest, newly-acquired independence, vested interests of home country industrial groups, proximity to armed conflict, etc. The political instability can thus be measured as qualitative or quantitative accounting of these correlates. An index of political instability is often

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produced using these factors and marketed as political risk analysis (Ashley & Bonner, 1987). This approach of measuring political risk, however, may not be ideal for all situations. Political instability may not always effect all international businesses in a country. In some situations, political instability may lead to changes that may not be at all critical to most construction ventures. Rather than political stability, the direction in changes in government may be more important in certain situations.

• Past patterns: Past patterns of political behavior is at times analyzed to determine political risk involved. However, predicting political risk on the basis of historical records has its own drawbacks. Political situations under which risks were encountered by companies or individuals in the past might have changed altogether; the changed circumstances may provide a better environment for foreign investment (e.g. Vietnam).

• Opinion analysis: Political risk may also be measured qualitatively by examining the views of people engaged in governmental decision making and people who may influence future political events affecting business. It involves the analysis of statements of such people to determine their views on business in general, foreign capital investment, the means of effecting economic changes, and their feeling toward the host country in question. Such statements, however, should be analyzed to determine their "inner meanings." (Sometimes statements are made for making emotional appeals or merely to appease a particular interest group or

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social class.) • Political Risk Management (Ashley & Bonner,

1987) • Avoidance: Selecting only safe environments for

business and rejecting regions that are perceived to have greater than average degree of political risk.

• Premium for risk: Increasing the ROI (return on investment) or requiring shorter period of payback.

• Adaptation: Responding to the particular political environment of the host country and structuring the international operations accordingly (e.g. adapting to the local methods, utilization of host country professional expertise, joint venture, etc.).

• Transfer: Sharing of risks with other individuals or companies or reducing the risks through transfer to other agencies.

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The Perils of Political Instability and Uncertainty If there is one thing that business leaders and entrepreneurs hate that is instability in the macro environment. Businesses operate according to forecasts and scenarios about the future that comprise surprises as well as certainties. However, as much as businesses factor in uncertainty, the one thing that wants to avoid at all costs is the instability in the macro environment that results from political gridlock, extremism, and political dysfunction. This is the reason why many emerging markets in Asia and Africa either attract or repel foreign investors. For instance, until recently, African countries were shunned because of the civil war like situation there whereas some Asian countries were similarly avoided by businesses because of the political uncertainty due to frequent regime changes and even coups. As the case of India and China, which we shall discuss in detail in the next section, illustrate, businesses flock to regions and states where there is political stability. Further, businesses like to operate in an environment that is not marred by frequent strikes, social unrest, and chaos as their operations would be hit adversely due to these factors.

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The Contrasting Examples of China and India Turning to the contrasting examples of China and India, the former attracts foreign capital and businesses, as the country is relatively stable politically and socially. Though there are sporadic instances of social unrest that recur in some volatile regions and provinces of the country, on the whole, the country is attractive to foreign businesses. Indeed, the attractiveness is so intense that different regions of the country compete and vie with each other for businesses to set up their operations there. In contrast, India is in the recent past fallen out of favor with businesses that prefer doing business elsewhere and taking their investments to countries that offer political stability. Further, the case of India also resembles China in so far as the competition for businesses to setup their operations is concerned. Indeed, some states in India offer more stability than the others as well as continuity of policies. The last point is very important as more than anything else; businesses prefer the policies that were followed during a government’s tenure to be continued even when there is a change of government. In other words, India and the states where the incoming government changes the policies are certainly not acceptable to the investors who take their projects elsewhere.

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Why Businesses Like a Stable Macro Environment The reasons for businesses favoring political stability is that once they get the permits and the licenses to operate in regions and states, they invest a lot of money in setting up facilities. Further, even during the process of acquiring land and other assets, they need the cooperation of the government to facilitate the same. Apart from this, political instability hurts them as their employees are often forced to skip work because of strikes and other protests and this impacts the profits of the businesses negatively. Moreover, businesses like a region that is friendly and welcoming towards them and not a hostile and unfriendly dispensation. The point here is that political instability hurts everything from profits to operations to the working conditions of the employees and hence, businesses avoid it. The other aspect about political instability is that key laws and regulations are often stuck in the legislatures and the parliaments and key approvals are mired in bureaucratic delays. All these factors conspire to create a situation that is not conducive for businesses. Finally, it is indeed the case that capital is country blind and region blind and migrates and flows to wherever it is welcome and wherever the macro situation is conducive. This is the lesson that politicians of all hues must understand if they are to develop their constituencies.

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Political Strategies for Conducting INTERNATIONAL BUSINESS Some of the steps that an individual or a company may follow in order to establish political strategies: • Identifying the issue (e.g. protectionism,

environmental standards, human rights, workers rights, etc.)

• Defining the nature of the political issue • Assessing the potential political action of other

firms and of special interest groups • Identifying important institutions and key

individuals • Formulation of strategies (objectives, alternatives) • Determining the impact of implementation (both in

home and host countries) • Selection of the most appropriate strategy and

implementation.