Chapter 3

The Political and Legal Environments Facing Business





!                   Discuss the different functions that political systems perform.

!                   Compare democratic and totalitarian political regimes and discuss how they can influence managerial decisions.

!                   Describe how management can formulate and implement strategies to deal with foreign political environments.

!                   Study the different types of legal systems and the legal relationships that exist between countries.

!                   Examine the major legal issues in international business.



Chapter Overview


When companies source, produce and/or market products in foreign countries, they may encounter challenging political and legal environments. Chapter 3 provides a conceptual foundation for the examination of the political and legal dimensions of international business operations. It compares major political regimes and discusses their potential influence upon the development and implementation of appropriate political and legal strategies. It also explores the major types of legal systems that exist today, as well as the legal relationships among countries. The chapter concludes with an examination of major legal issues in international business.



Chapter Outline


OPENING CASE: The Hong Kong Dilemma [See Map 3.1]

Swire Pacific Ltd., a major hong prominent in Hong Kong business circles, is a subsidiary of British-based John Swire & Sons, which has nearly 90% of its assets in China. Swire Pacific Ltd. must learn to cope with an unstable regional and global economic environment and also succeed in the new political environment developing in Hong Kong. The case discusses Swires approach to dealing with the transition in Hong Kong by establishing a close working relationship with the Chinese. It also raises Swire’s concerns about the firms future in both Hong Kong and China. What will be the effect on Hong Kong as China continues to position Shanghai as a major center of international business? Is Swire correct in pegging its future to that of China?


Teaching Tip: Carefully review the PowerPoint slides for Chapter 3. For additional visual summaries of key chapter points, also review text Figures:

·         3.1—Political and Legal Influences on International Business

·         3.2—The Political Spectrum.



For a multinational enterprise to succeed in countries with different political and legal environments, its management must carefully analyze the fit between its corporate policies and the political and legal conditions of each particular nation in which it operates.



A countrys political system integrates the various parts of its society into a viable, functioning whole. It also influences the extent to which government intervenes in business, and thus the way in which business is conducted both domestically and internationally.



A political ideology is the body of constructs, theories and aims that constitute a sociopolitical program (e.g., liberalism or conservatism). Pluralism indicates the coexistence of a variety of ideologies within a particular society. The ultimate test of any political system is its ability to hold a society together. While shared ideologies create bonds within and among countries, differing ideologies tend to split societies apart.

A.                The Impact of Ideological Differences on National Boundaries

History, culture, politics and geography all contribute to the definition of national boundaries. When a political system collapses, those under the system often fragment into smaller sociopolitical groups. When operating in a foreign country, it is very important for managers to understand feelings that could cause political tension and instability.

B.                 The Political Spectrum

MNEs may be able to operate effectively in both democratic and totalitarian regimes, but democracies usually offer greater economic freedom and enact more legal statutes designed to safeguard individual and corporate rights.

1.                  Democracy. A democracy represents a political system in which citizens participate in the decision-making and governance process, either directly or through elected representatives. Contemporary democracies share the following characteristics: freedom of opinion, expression and the press; freedom to organize; free elections; an independent and fair court system; a nonpolitical bureaucracy and defense infrastructure; and access to the decision-making process. Nonetheless, in decentralized democracies (e.g., Canada and the USA) companies may still face different and sometimes even conflicting laws from one state or province to another.

a.                   Political Rights and Civil Liberties. Political rights include fair and competitive elections, the empowerment of elected representatives, the right to organize and the protection of minorities. Civil liberties include freedom of the press, equality under the law and personal freedoms.

b.                  Stability in Democracies. Many democracies that have emerged since the early 1970s are fragile and unstable. At the same time, confidence in politicians and government has generally declined in many of the more mature democracies.

2.                  Totalitarianism. Totalitarianism represents a political system in which citizens seldom if ever participate in the decision-making and governance process; power is monopolized and opposition is neither recognized nor tolerated. In theocratic totalitarianism, religious leaders are also the political leaders. In secular totalitarianism, the government usually imposes order through military power. Variants of totalitarianism include fascism, authoritarianism and communism.



            A.        Political Risk

Political risk reflects the expectation that the political climate in a foreign country will change in such a way that a firms operating position will deteriorate.

1.                  Types and Causes of Political Risk. Political actions that may adversely affect a firms operations would include government takeovers of property, operational restrictions and damage to property or personnel. In addition, civil unrest and disorder and antagonistic external relations (including boycotts and other forms of protest) may also negatively impact a firms operations.

2.                  Micro and Macro Political Risks. Micro political risks are those aimed only at specific foreign investments (e.g., a particular MNE), whereas macro political risks affect a broad spectrum of foreign investors.

            B.        Government Intervention in the Economy

When companies move abroad, management must deal with governments that may have different attitudes about their roles in their respective economies—attitudes which may be inconsistent over time. Under an individualistic paradigm the government believes in minimal interference in the economy; it may intervene to deal with market defects but generally promotes marketplace competition. Under a communitarian paradigm, however, whether democratic (Japanese) or authoritarian (Chinese) in nature, the government defines economic needs and priorities and partners with business in major ways.



Formulating political strategies may be more complicated than formulating competitive marketplace strategies. Logical steps include: identifying the issues, defining the nature of the issues, assessing the potential actions of others, identifying key players, formulating alternative strategies, assessing the potential impact of particular activities and selecting and implementing the most appropriate strategy.


Managers must be aware of the legal systems in the countries in which their firms operate, the basic nature of the legal profession (both domestic and international) and the legal relationships that exist between and among countries. Legal systems differ both in terms of the nature of the system and the degree of independence of the judiciary from the political process.

A.        Kinds of Legal Systems

1.                  Common Law. Common law originated in the United Kingdom and is based upon tradition, precedent, custom and usage; therefore, courts play an important role in interpreting the law.

2.                  Civil Law. Civil law, also known as codified law, originated with the Romans and is based upon a detailed set of laws that make up a detailed code that includes rules for conducting business; courts play an important role in applying the law.

3.         Theocratic Law. Theocratic law is based upon religious precepts. The best example is Islamic law, or Shaira. The key for businesses is to adhere to the constraints of ancient Islamic laws while maintaining sufficient flexibility to operate in a modern global economy.

B.                 Consumer Safeguards

Different legal systems provide varying safeguards with respect to product liability and other legal issues. For example, access to and assistance from the legal community, legal fees and the ability to use foreign lawyers all differ across countries.

C.                The Legal Profession

Although lawyers and law firms vary in terms of how they practice law and service clients, MNEs must use lawyers for a variety of services, such as negotiating contracts, formalizing agent-distributor relationships and protecting intellectual property. Just as MNEs have expanded abroad to take advantage of international business opportunities, law firms have expanded abroad to service their clients. The key for managers doing business overseas is to choose a law firm with the needed expertise and overseas connections, whether through the companys own offices, a merger, or correspondent relationships.

D.                Legal Issues in International Business

National laws may affect the business climate both within and beyond a country’s borders and pertain to both domestic and foreign firms. Areas addressed include health and safety standards, employment practices, antitrust prohibitions, contractual relationships, environmental practices, intellectual property, cross-border investment flows, tariffs and non-tariff barriers, to name but a few. In addition, international treaties among nations may also affect the nature and extent of business operations.



Is When in Rome, Do as the Romans Do the Best Approach for Global Ethics?

Cultural relativism implies that there is no method for deciding whether particular behavior is really appropriate. However, it is possible to do so by seeking justification for that behavior; such justification is a function of cultural values (many of which are universal), legal principles and economic practices. Some people argue the legal justification for ethical behavior is the only truly important justification. However, that argument is insufficient because not everything that is unethical is illegal. Moral as well as legal concepts must be considered. Further, the law tends to be slow to develop in emerging areas of business concern. In addition, both laws and legal systems vary among countries. Civil law countries tend to have a large body of laws that specify legal behaviors, while common law countries tend to rely more on precedent than statutory regulations.



Will Democracy Survive?

There is a clear link between political and economic freedom and economic growth. However, democracy does not necessarily mean stability; in fact, in a transition economy political risk is often quite high. Some people argue if a country is to flourish as a democracy, certain preconditions such as economic development must be present. Others feel, however, that democracy is the result of having political leaders who exhibit both the determination and the skills required to assure democratization occurs.




Teaching Tip: Visit for additional information and links relating to the topics presented in Chapter 3. Refer your students to the on-line study guide, as well as the Internet exercises for Chapter 3.



CLOSING CASE: Newmont Mining in Indonesia


1.         What were the key political problems facing Mr. Lahti and Newmont Mining in Indonesia?

When Newmont first began Indonesian operations in 1996, it worked directly with the central government. However, the unwillingness of current leaders to use Suhartos tough tactics on local governments led to a substantial loss of power by the central government. Consequently businesses are now confused as to whether to follow the central or the regional governments laws and policies. Further, local groups have found it the perfect time to demand greater social and environmental responsibility from companies operating in their regions.


2.                  How has the legal situation in Indonesia contributed to Newmont Minings dilemma?

            The turmoil in Indonesias legal system makes it very risky for foreign firms to operate there. Newmonts contract with the central government exempted the company from paying any taxes on mining waste materials. However, Minahasas parliament passed a law allowing the collection of levies from local operations, and the district demanded $8.2 million in back-pay of taxes for waste material. After having to shut down a number of times, Newmont finally settled with Minihasas local courts for $500,000 plus $2,500,000 to be added to employee programs and community development projects. To solve such conflicts, the central government recently passed local autonomy laws. However, with no regulations to govern their implementation, many fear the confusion and problems will simply escalate. In addition, former landowners have blockaded the entrance to the mine, claiming they were not fairly compensated for the value of the land.


3.                  What are the environmental dimensions to gold mining in Indonesia, and whose responsibility is it to protect the environment?

With mounting evidence of pollution problems, Newmont has been under environmental scrutiny ever since the opening of the Minihasa mine. Local environmentalists claimed the tailings Newmont dumps into the ocean contain toxic levels of mercury and arsenic. Despite conducting an environmental risk assessment and detoxifying the tailings before dumping them into the ocean as ordered by the government, local activists continue to protest against Newmonts operation. Others, however, believe the environmental problems are primarily caused by illegal miners who use antiquated mining practices to extract the gold; they also use mercury to separate the gold from the ore and then dump the waste into local rivers. Although Newmont attempted to work with the government in dealing with the illegal miners, the government failed to take action for fear of a demonstration against it.


4.         Evaluate Mr. Lahtis approach to solving Newmonts problems. Could he have done anything differently?

At the time Newmont established its mining operations in Indonesia, the central government was very much in control of the country, and the future seemed reasonably predictable. However, the effects of political and economic turbulence are largely beyond the control of firm managers, particularly in the short run, and certainly so in this case. Although Mr. Lahti was both locally responsive and proactive in his attempts to solve Newmonts problems at the Minishasa Raya mine, it appears the relationship between Newmont and the local activists was largely an adversarial one. If Mr. Lahti had been able to find a way to work in collaboration with the firms employees and local community leaders and activists to address perceived problems with its operation—and to promote its benefits—perhaps he could have achieved greater progress. In addition, Newmont may need to rethink its method of operating in countries with relatively high economic and political risk. Entering into joint ventures with local firms may be a viable alternative.


Additional Exercises: Political and Legal Factors


Exercise 3.1. Ask students to discuss the difficulties faced when a country changes from a totalitarian to a democratic political system. Then have the students compare the political transition of a large country such as Russia to the transition of a smaller country such as Hungary. Ask whether political transition has been a smoother process in one of the two countries and examine both the differences and the similarities in the two processes.


Exercise 3.2. Ask students to identify companies, both domestic and foreign, that operate internationally. Then ask the students to explore the possible sources of political risk for each of those firms, given the countries in which they have a presence and the nature of their products and operations. Be sure to consider both the micro and macro types of risk.


Exercise 3.3. Identify the various home countries of students in your class. Then lead the class in a comparative analysis of some of the laws pertaining to (a) local business activities and (b) cross-border business activities under the following types of legal systems: common law, civil law, theocratic law and Asian law. Conclude by discussing the challenges of dealing with particular types of international business issues in the home countries of your students.