2. Economic and Political Environment – Fundamentals of International Business

CHAPTER 2

Economic and Political Environment

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

  • Understand the meaning of the term business environment
  • Distinguish between the international and domestic business environment
  • Understand the basic features of the international business environment
  • Analyse the specific characteristics of the international economic environment
  • Identify the dominant political ideologies of the world
  • Understand the changing role of transnational and regional forces in shaping political systems
  • Appreciate the different dimensions of political risk in business decision making

THE SHARING ECONOMY

Who hasn’t heard of AirBnb and Uber? These household names are the icons of the sharing economy—a new disruptive model of the market which has supplanted traditional existing models. The sharing economy focuses on the collective use of underutilized assets to improve their efficiency and sustainability and thus, benefit the community. The essence of the sharing economy is to utilize idle resources into use and get producers to produce fewer, more efficient products for constant usage. It marks an era in which consumers’ value access over ownership and experiences over assets.

This is clear in the case of Uber. The economy has several vehicles which remain idle for long periods of time—their drivers could use Uber’s ride-hailing app, so that each individual vehicle is put to more use. That also means that the automobile industry will face pressure to produce fewer, better-made vehicles that are able to withstand greater usage. In the sharing economy, the aim is to match people and resources.

Sharing resources is not new but the new model is not about philanthropy or being helpful. It is not helping a friend by sharing your spare guest room, but charging rent from him or a stranger, for its use as an idle resource. The sharing economy is a model of ‘crowd-based capitalism’ – a model of peer-to-peer commercial exchange which combines elements of ‘gift’ with the ‘market’. Easily recognizable names in the sharing economy include transportation companies like Uber and Lyft, space firms like Airbnb, the goods giants eBay and Etsy and financial services including Lending Club, Prosper, and Funding Circle. Others in the same category include TaskRabbit, France’s BlaBlaCar, China’s Didi Kuaidi, and India’s Ola.

The success of the new sharing economy is based on the components of frugality and social responsibility. The model emerged soon after the global downturns which taught society the benefits of saving and the importance of shared resources. The new economy model aims to give consumers the path to more sustainable consumerism as it changes the manner in which people take vacations, dress, get transportation, eat, and access financing programs.

Functioning over a period of time has highlighted the drawbacks of sharing as it erodes the essence of the community and overuses its resources. This is evident in the case of AirBnb—in cities like Barcelona landlords have realized that short-term rent from well-off Airbnb users is more than what the conventional tenant can pay who lives and works in the city year-round. This not only pushes up rents, it also pushes out young Spaniards from their own city spaces. The system of sharing resources has actually intensified inequality and resentment in society. The city of Amsterdam has actually put restrictions on short-term renting out by residents after street protests against the swamping of the city by tourists last year. The story resonates across Paris, Berlin, Venice and Lisbon.

The future of the model remains to be seen!

References: When is Sharing Not Really Sharing–https://www.weforum.org; Airbnb and the so-called sharing economy is hollowing out our cities–https://www.theguardian.com; The Sharing Economy: Why it Works and How to Join–https://www.forbes.com; last accessed on 8 September 2018.

INTRODUCTION

The business environment of a firm consists of all the factors and forces which influence its life and development. These factors may be internal or external. Internal factors are generally controllable by the firm, but external factors are largely uncontrollable. The business environment for a firm engaged in international business has become more complex, with expanding and deepening ties between nations around the world and between the many organizations within these societies. With the growth of international business, many large organizations now see themselves as global in orientation, not rooted in any one society.

The business environment for such a business may be visualized in terms of layers, beginning with the immediate internal environment within the organization and moving outwards to the external environment surrounding the business and influencing its organization and operations. The external environment includes an array of dimensions, including economic, legal, political and technological factors. While these factors influenced only the internal environment of the home country a few decades ago, today, the environmental horizon of business has widened and business is forced to interact with international forces and simultaneously deal with national and local factors.

The domestic business environment consists of the factors and forces which originate within the home country. The international business environment is more complex and diverse since it consists of all factors and forces which have an influence on its working environment and are linked to different countries of operation.

The international business environment may be broadly classified into the following:

  • Economic environment
  • Political–legal environment
  • Cultural environment
ECONOMIC ENVIRONMENT

The economic environment of an international business consists of the economic systems of the home and host country, and various economic variables such as the level of economic growth and development, inflation and the fiscal and monetary policy. A business firm needs to evaluate all these variables in order to succeed in the international arena.

 

The economic environment of an international business consists of the economic systems of the home and host country, and various economic indicators such as GDP, growth, development and inflation.

Economic Systems

An economic system determines the basic rules regarding ownership and control of productive resources within an economy. A basic principle in economics is that available resources are scarce and can be put to multiple use. The economic system is the basic decision-making framework which specifies the basic rules regarding the use of economic resources in activities of production and distribution of goods and services for the satisfaction of human wants.

 

An economic system determines the basic rules of the game regarding ownership and control of productive resources within an economy.

Economic systems are classified on the basis of ownership and control of resources. There are two extreme points on the scale—the capitalist or market-based system and the command based or state-owned economic system. The mixed economy combines the features of both market based and command based systems in different combinations and lies between the two end points on the scale.

Capitalist or Free Market Systems

The free market economy, also called the capitalist system or the pure market economy may be defined as a system where the market determines the use of productive resources for production and distribution. It is based on the following basic principles:

Pursuit of self interest: The main objective of a business firm is to operate for profit. This is a central principle of capitalism given by Adam Smith in 1759, as the concept of the ‘invisible hand’ which guides the functioning of the capitalist economy. According to this, an individual’s pursuit of self-interest is the invisible hand which guides him towards economic activity which is focused at profit maximization. Smith argued that the maximization of individual self interest in turn leads to the greater good of society as a whole. This guiding principle is associated with capitalism in its purest form, that is, laissezfaire capitalism. The British and the US economies are examples of pure capitalism and also the countries in which it originated.

 

The basic principles of the free market or the pure market economy are private ownership of the means of production and the freedom of business firms to operate for profit.

There are three central elements of the free market system—freedom of enterprise, competitive markets, and private property.

Freedom of enterprise: It is the right of all individuals in a society to pursue any economic activity in any form they desire. Freedom of enterprise flourishes in an open society in which individuals are free to compete in the marketplace and accumulate private wealth. In a laissezfaire economy, the government takes on a regulatory role. Transparent and fair regimes of business regulation and a stable and impartial legal framework are the pre-conditions for a healthy free enterprise.

Private ownership of the means of production: The capitalist system is guided by the forces of the market which determine the answers to the central questions of what, how and for whom to produce. In order to maximize profits, firms choose the cheapest methods of production to produce commodities which are likely to demand the highest prices in the market. An obvious drawback of this system therefore, is that anyone who does not have purchasing power cannot be a part of the process of decision making in this system and there are wide gaps between the rich and the poor.

Competition: Competition is the essence of the market economy, which is characterized by various combinations of interaction between buyers and sellers leading to price determination at different levels for goods and services. The central economic decisions of what, how and for whom to produce in an economic system are based on the free forces of demand and supply. The key factors that make the market economy work are consumer sovereignty, that is, the right of consumers to decide what to buy and freedom for companies to operate in the market. The consumer has the freedom to decide how to spend the wages and property incomes generated by his labour and property ownership. The producer or business firm also has the freedom of operation in the market.

Command Economy

A command economy, also known as a centrally planned economy, is based on the socialist principles of collectivism. It is based on the theory of communism originally propagated by Karl Marx, visualizing an idealistic classless society. In this system, all economic activity, including pricing and production decisions, are determined by a central government plan. The government owns and controls all productive resources, all production is done in state owned factories and labour unions are also controlled by the government. The two leading examples of this system are the erstwhile USSR and China.

 

A command economy, also known as a centrally planned economy, is based on the socialist principles of collectivism. In this system, all dimensions of economic activity, including pricing and production decisions, are determined by a central government plan.

A basic drawback of socialism is the lack of incentives for the producer. This leads to overproduction, inefficiencies, and inflexibility as recurring problems. The founding fathers of socialism visualized an ideal society, in which all members would be equal. In reality, however, there have been stark inequalities under the domination of the State. The production of consumer goods was completely ignored as the focus was on military production.

Mixed Economy

The mixed economy exists in between the market and command systems. It is characterized by private enterprise in some sectors and significant state ownership and government planning in others. The fundamental concept underlying this concept is the notion of the welfare state which originated in the US after the Great Depression. Countries, such as the United Kingdom, France and Sweden follow this model in the developed world, so do India and Brazil amongst the developing countries.

 

The mixed economy exists in between the market and command systems. It is characterized by private enterprise in some sectors and significant state ownership and government planning in others.

Another term used to describe the mixed economy is market socialism. In this system, although the state owns significant resources, the allocation of the resources comes from the market-price mechanism. The model of market socialism gives a dimension of social justice to capitalism and is characterized by state ownership in key sectors and extensive social welfare programmes aimed at reducing the inequalities found in capitalism. The system allows for both state and private ownership of industry. The state usually keeps industries which are crucial for national interest under its control, such as heavy industry, banking, oil and airlines, to ensure that they continue to function even in the absence of profitability. Maintaining public enterprises and running social welfare programmes imposes a huge burden on the state and is responsible for the budget deficits discussed later in the chapter.

France is an example of market socialism, where the government owns significant economic resources but it allows supply and demand to set prices. The social market model in Sweden gives great importance to social welfare. Although the market determines prices, a lot of economic activity is controlled by the government through fiscal policies.

In the modern world, no economy can be called a purely free market or a completely command economy. Most market economies have some degree of government ownership and control, whereas most command economies are moving towards a market economy and away from command concepts. On the spectrum of economic systems, Hong Kong and the US represent two countries at the market end of the spectrum, and Cuba and North Korea represent two countries at the command end of the spectrum. In Hong Kong and the US, the government plays a very small role in economic activity, desiring instead to provide a stable environment in which economic activity can take place. In communist countries, such as Cuba and North Korea, the government still owns and controls most aspects of economic activity. China is an example of a communist country that has made the transition from being a command economy to a market economy with a strong role for the State.

Transition Economy

A transition economy is one that is making the shift from one economic system to another. The late 1980s and early 1990s saw many countries moving away from centrally planned economies towards free market economies. This included the erstwhile Soviet Union followed by more than 30 countries in Eastern Europe, Asian states like China and Vietnam and African countries like Angola, Ethiopia and Mozambique. The process of transition is characterized by deregulation, privatization and the creation of legal systems to safeguard property rights.

Bird’s-eye View

Economic systems are the basic decision frameworks for an international business. They range from free-market systems on one end to socialist systems on the other extreme. There are several countries which follow a middle path called, ‘mixed economy’ and many other nations are in the process of making a transition from socialism towards a more market-oriented system.

Economic Indicators

This section lists some economic indicators that are important for decision making by an international business manager.

Gross Domestic Product (GDP)

GDP is the total market value of all final goods and services produced within the country in a given period of time (usually a calendar year). There are two ways of measuring GDP: Real GDP is the current market value of final output. Nominal GDP is the real GDP adjusted for a price change by dividing it by the price index or GDP deflator. The GDP is a useful economic indicator since it allows us to assess the rate of productivity of the economy and is also an indicator of domestic market potential.

 

GDP is the total market value of all final goods and services produced within the country in a given period of time, but GNI is a broader measure of economic activity since it includes income earned from abroad as well.

Gross National Income (GNI)

GNI is the broadest measure of economic activity. It is the market value of final goods and services newly produced by a national economy, including income earned by national residents from overseas operations. It includes gross domestic product (GDP), which is the value of the total economic activity produced within the geographical boundaries of a country in a single year, from the efforts of both domestic and foreign residents.

Per capita GNI refers to GNI of a nation divided by its total population. Those countries with high populations and high per capita GNI are the most desirable in terms of market potential. Those with low per capita GNI and low populations are the least desirable, and the other countries fit somewhere in between.

Why do we use GNI as an economic indicator? The basic demand for a product depends on the income level of the consumer. While deciding to do business abroad, a firm must therefore evaluate the income level of the country to be able to estimate the demand for its products.

Economic Growth

Economic growth is the change in GDP of a country from one year to the next. Quantitative and monetary growth of an economy is measured by changes in the gross domestic product, between two time periods.

Economic Development

Economic development is a broader concept compared to economic growth. It includes qualitative factors, such as literacy rates, level of health care, quality of housing and levels of health standards.

Human Development Index (HDI)

The HDI is a measure of economic development. It is a ranking tool based on factors other than just economic and monetary measures. The HDI is an index combining normalized measures of life expectancy, literacy, educational attainment and GDP per capita for various countries.

Business Cycles

The business cycle refers to phases of fluctuation in output, income and employment generation in an economy. A business cycle may range from 2 to 10 years and consists of four interconnected phases ranging from prosperity, recession, depression followed by recovery. The healthiest phase of the cycle is prosperity with high levels of income and output and low employment, and the worst phase is depression when output, employment and confidence in the economy is at the lowest possible level.

Inflation

Inflation is the increase in the cost of living over a period, usually one year. It refers to a period of continuously rising prices and has a direct effect on the operations of a business firm through its impact on the cost of raw material, wages, prices of finished goods, and the cost of inventory. Economists use different types of indices to measure inflation, but the most commonly used measure is the consumer price index (CPI) which compares the prices of a fixed basket of goods and services for a consumer between different periods.

Balance of Payments

Balance of payments is a record of a country’s transactions with the rest of the world on account of both trade and investment. Surpluses in the balance of payments account are an indication of an excess of foreign exchange inflow over outflow and may lead to an increase in foreign exchange reserves. Deficits, however, are a matter of concern since they indicate foreign exchange scarcity.

 

Balance of payments is a record of a country’s transactions with the rest of the world.

External Debt

External debt is a measure of a country’s borrowings. It can be measured in two ways—the total amount of the debt and debt as a percentage of GDP. Increasing debt levels lead to increasing instability and slow down economic growth.

 

External debt is a measure of a country’s borrowings.

Exchange Rate

The exchange rate is the price of the domestic currency in terms of any foreign currency. For instance the value of the INR in terms of dollar INR/USD. The exchange rate is a very important economic variable since it determines an economy’s inflows and outflows of foreign exchange for trade and investment. For example, if the INR/USD rate is 55 it means that an Indian exporter will earn INR 55 for every dollar worth of goods he sells in the foreign market and an importer will have to pay INR 55 for every dollar worth of goods bought in the foreign market. A change in exchange rate from 55 to 60 will increase the payment burden of the importer but will mean increased earnings for the exporter.

Bird’s-eye View

Economic indicators are important decision-making criteria for an international business. These include economic growth, economic development, inflation, balance of payments, external debt and exchange rate.

DEMOGRAPHIC ENVIRONMENT

Demography is the study of human populations in terms of size, density, location, age, gender, race and occupation. Demographic environment of a country is based on features derived from its population. These include population characteristics such as size, growth rate, age and sex composition, life expectancy, work participation rate, employment status, rural urban divide, levels of education, caste, ethnicity, language and religion.

Population Size

The size and growth rate of the population determines its nature of demand. India is a growing middle-class economy especially post liberalization of 1991, and has seen a growing demand for all categories of consumer durables from mobile phones to refrigerators and washing machines. This has created a huge opportunity for TNCs to invest in the country. However, within this growing population there are different income levels with varying features of demand. People at the lowest end of the income spectrum have demand for basic goods and services, but as the income level rises the pattern of demand changes. In India for instance, there is demand for high end luxury goods such as the Apple iphone at the upper end of the spectrum and also the cheapest mobile phones from local manufacturers for consumers at the bottom of the pyramid.

Age Distribution

The distributional characteristics of population in terms of age have a huge bearing on its market potential. In the current scenario, developing countries with high birth rates are potential markets for fast-moving consumer goods (FMCGs), housing, infrastructure—all of which help in the overall growth of the economy. Countries which have a higher proportion of younger population have a greater demand for technology intensive products such as mobile phones, expensive musical equipment and clothes. The older segment of the population, on the other hand, finds its income level declining and an increase in its medical expenses.

Demographic Dividend

When the majority of a nation’s population falls within the working age group, the added productivity of this group can produce a rise in the rate of economic growth, assuming that policies to take advantage of this fact are in place. This is known as the demographic dividend.

In fact, the combined effect of this large working population, and health, family, labour, financial and human capital policies can affect virtuous cycles of wealth creation. The relationship between population change and economic growth has taken on added salience in recent years because of demographic trends in the developing world. Since World War II, developing countries have been undergoing a demographic transition at varying rates and times, from high to low rates of mortality and fertility. This transition is producing a ‘boom generation’—a generation that is larger than those immediately before and after it—which is gradually working its way through nations’ age structures. The East Asian nations were at the forefront of this transition; other regions, including Latin America, began their transitions later, in the 1960s and 1970s.

There is an opposite concern in the developed countries of Europe and Japan, where an increasing number of young people either choose not to get married or marry very late, leading to declining birth rates and population. Japan has twice as many old people as it has children. Consequently, the number of its working age population is very low, which has led to a decline in the workforce and an increased burden of pension payments and medical care.

Rural–Urban Distribution

An important feature of population is the changing rural–urban ratio as more and more people move to urban areas in search of better employment and higher wages. This leads to an increase in the size of the market economy in urban areas with a commensurate increase in demand and economic growth.

POLITICAL ENVIRONMENT

Political Ideologies and Systems

The political system refers to the system of governance in an economy. An ideology is a set of integrated beliefs, theories and doctrines, which form the basis of a political system. Political ideology can usually be correlated with economic philosophy. For example, the political ideology of the US is based on the constitutional rights of private property and freedom of choice. This finds its counterpart in the economic philosophy of capitalism. Similarly, countries of the former Soviet Union, China, Cuba, and North Korea have been followers of communism, which believes in state ownership of property. Political ideology, in turn, gives rise to political systems, which form the basis of governance of nations.

 

Political systems are based on political ideology which is a set of integrated beliefs, theories and doctrines.

There are two broad classifications of political systems:

  1. Collectivism
  2. Individualism

Two other important concepts associated with political systems are the notions of democracy and totalitarianism that are discussed later.

 

The dominant political ideologies in the world are individualism and collectivism giving rise to socialist and capitalist systems.

Collectivism

Collectivism is based on the philosophy of the Greek thinker Plato, and emphasizes the supremacy of the needs of the society as a whole over the needs of the individual. In the modern context, the philosophy of collectivism translated itself into the teachings of Karl Marx which gave rise to socialism.

 

Collectivism is based on the philosophy of the Greek thinker Plato, and emphasizes the supremacy of the needs of the society as a whole over the needs of the individual.

The basic teachings of Marxism emphasize the difference between the capitalist owner and the worker in the distribution of profits of the enterprise. Marx felt that the capitalist system exploited the workers who were unable to get fair wages for their labour. He, therefore, advocated state ownership of production and distribution so that the benefits of state enterprise could be shared by society as a whole rather than the individual capitalist.

In the early twentieth century, socialist thinking got split into two distinct schools of thought, which are communism and social democracy.

 

Socialism has two distinct schools of thought, which are communism and social democracy.

Communism: It believed in achieving socialist goals only through a violent overthrow of the existing social order, such as Russia after the revolution of 1917, China after the defeat of Chiang Kai Chek’s forces in 1949 and Cuba after the defeat of the Batista regime in 1959. Communist thinking ruled the world in the 1970s. It was the political philosophy of the erstwhile Soviet Union and its allies of Eastern Europe (Poland, erstwhile Czechoslovakia and Hungary); China; the Southeast Asian nations of Cambodia, Laos and Vietnam; Latin American nations of Cuba and Nicaragua; and the African states of Angola and Mozambique. Communism collapsed in most parts of the world by the 1990s and was replaced by alternative philosophy. The Soviet Union collapsed and was replaced by a collection of 15 independent states. China has also been a traditional communist nation, but has now made the move towards a market-oriented system. In the present context, the only nations which continue to follow communism are North Korea and Cuba.

Social democracy:This is the softer version of socialism and believed that socialist goals could be achieved through the existing electoral system instead of the violence which communist thinking believed in. This system is found in countries such as France, Germany, Sweden, the United Kingdom, Australia, Norway, and Spain in the Western context and also developing countries such as India and Brazil. It is also known as social capitalism which kept strategic and heavy industries such as power, coal, telecommunications and railways under state supervision and allowed the free market forces to operate in other sectors of the economy. However, state-owned companies were largely unsuccessful as business enterprises since they functioned as monopolies in a protected environment with guaranteed financial support. This resulted in a change in power in countries like the United Kingdom and Germany towards a more market-oriented system. India and Brazil also adopted liberalization measures and are fast emerging as important markets and investment destinations.

Individualism

The philosophy of individualism is based on the well-being of the individual as the path to the well-being of society at large. In contrast to collectivism, individualism stresses that the interests of the individual should take precedence over the interests of the state. The basis of individualism are the teachings of Aristotle, who argued that individual diversity and private ownership of property are far more productive than communal property and is the path to social progress. It was redefined in the works of David Hume (1711–1776), Adam Smith (1723–1790) and J.S. Mill (1806–1873). In recent times, it has again been addressed by economists, like Milton Friedman, Friedrich von Hayek and James Buchanan.

 

The philosophy of individualism is based on the well-being of the individual as the path to the well-being of society at large.

Individualism is based on two basic fundamental beliefs:

  1. The guarantee of individual freedom and self-expression as an absolute right of the individual.
  2. The belief in the pursuit of individual self-interest leading to the welfare of the society.

Individualism emerged as the influential political philosophy in the Protestant nations of England and Netherlands, and also influenced the thinking of the American colonies of England. The underlying ideological conflict between individualism and collectivism became the basis of the Cold War after the end of the two World Wars, with the US and the former USSR as their respective champions.

Democracy

Democracy is a system of government in which the people either directly or through their elected representatives decide the rules of governance. Individualism has strong cultural links with the notion of democracy. The basic features of democracy are:

  • The election of representatives for a fixed period of time.
  • An independent judiciary to protect individual property and rights.
  • Separation of the legislature from the executive arm of the government.
  • The right to express opinions freely.
  • A non-political bureaucracy and defence infrastructure.
  • An accessibility to the decision-making process.

Democracy is a system of government in which the people either directly or through their elected representatives decide the rules of governance.

Democracy is a dominant form of government in the world today. It is followed in countries such as the US, Canada, the United Kingdom, Australia and India among others.

Totalitarianism

Totalitarianism is a system of government in which one individual or political party has complete control by virtue of religious belief, tribal power or ideology and either refuses to recognize other parties or completely suppresses them. Communism and fascism are reflections of totalitarian philosophy, which stress the role of strong central governments, such as that of the former USSR, China, Cuba, North Korea, Germany under Hitler, and Spain under Franco after the Spanish Civil War.

 

Totalitarianism is a system of government in which one individual or political party has complete control by virtue of religious belief, tribal power or ideology.

Totalitarianism exists in different forms, such as:

  • Communism is the best-known form of totalitarianism, in which political and economic systems are virtually inseparable. Communists believe in the equal distribution of wealth. Therefore, the government owns all property and takes all decisions regarding production and distribution of goods and services. Since the 1990s however, communism has collapsed almost all over the world. Its staunchest followers like China, Laos and Vietnam also gradually moved towards a market-oriented system. However, they remain totalitarian in denying basic civil rights to their people.
  • Theocratic totalitarianism is said to exist when a religious group exercises total power and represses or persecutes non-followers. Countries such as Afghanistan, Iran and Saudi Arabia limit the freedom of political and religious expression enforcing a totalitarian regime on the basis of Islamic principles.
  • Tribal totalitarianism as found in the African states of Zimbabwe, Tanzania, Uganda and Kenya is the monopolization of power by a particular tribe.
  • Right-wing totalitarianism was found in the fascist regimes of Germany and Italy in the 1930s and the 1940s, under the right-wing dictatorships of Latin America in the 1980s, and in several Asian countries like South Korea, Taiwan, Singapore and Philippines. A basic feature of this form of governance is that although it permits some individual economic freedom, it restricts individual political freedom and is against socialist or communist ideas.

Bird’s-eye View

The political environment provides a system of governance. It is based on political ideology which refers to the certain underlying beliefs, theories and doctrines. Political ideology is linked to different methods of governance, such as democracy and totalitarianism.

Political Risk

Political risk is an important factor to be considered in the evaluation of a country as a potential business destination. It refers to a change in political climate leading to a deterioration of the operating position of the business. Political risk is concerned with political stability, the economic and regulatory climate, and policy continuity.

Causes of Political Risk

There are three main causes of political risk, which are as follows:

  1. Civil disorder: Any unrest that happens due to a sudden change in economic conditions, human rights violations or problems within society leads to civil disorder.
  2. External relations: Differences between the host country and the foreign investor’s home country may result in disruption in work, and the loss of supplies and markets.
  3. Change in political leadership: Frequent changes in political leadership causes changes in operating regulations. Such changes may lead to the breach of existing contracts or the takeover of an investor’s property.

Types of Political Risk

There are three types of political risks, which are related to each other. They are as follows:

  1. Ownership risk: It refers to a likely change in the current ownership or governance structure of a TNC. This can be through nationalization of an existing enterprise or transfer of ownership. Milder forms of ownership risk may arise out of a change in investment rules that force firms to reduce their stake, for example, sharing ownership with a local firm. In the early 1970s, the Indian government established such rules that resulted in a strategic shift toward unrelated diversification and eventually led to the departure of many foreign TNCs from India. In the Indian e-commerce space, Walmart acquired Flipkart through purchase of 77 per cent of its shares, leading to a change in ownership structure and operating environment for the Indian TNC.
  2. Operational risk: This risk refers to a change in the ‘rules of the game’ under which the foreign firm operates. For example, in the e-commerce space, India allows 100 per cent FDI in the marketplace model and disallows FDI in the inventory-based model. Marketplace operators cannot hold inventory and sell products on their platform – they can only facilitate the process for other vendors.

    This policy has been revised over time and changes in it create operational problems for TNCs such as Amazon and Flipkart.

  3. Transfer risk: It refers to restrictions on the free movement of factors of production, such as changes in visa rules for various categories of workers leading to difficulties in migration of workers. For instance, President Donald Trump’s ‘Buy American, Hire American’ policy has led to strengthening of the US visa regime. This could lead to reduction in the H1B category of visas being issued to workers in the Indian technology industry and is in the nature of transfer risk faced by the industry.
INTERNATIONAL BUSINESS NEGOTIATION

A TNC operates at various levels in both the home and host country and has to therefore deal with different sets of parties. Business negotiation is the tool used by a TNC to conduct its business operations at different levels in its operating environment with different sets of people. The process of international business negotiation may occur at three different levels. (Refer to Figure 2.1)

  1. Government–Government: The governments of the home and host countries have to deal with issues of loans, investment guarantees, trading and investment terms and overall economic and political issues. All these issues become the subject matter of negotiation between the governments of the two countries.
  2. Government–TNC: TNCs are global corporations which wield a lot of power on account of their economic strength. However, TNCs have to negotiate with governments of both the home and host countries regarding a range of issues ranging from monetary and tax policies, price controls, technology transfer and approval to borrow funds.
  3. TNC–Subsidiary/Affiliate: A TNC has to deal with its local affiliate or subsidiary which may be a part of a completely different cultural and economic environment. This includes both long term policy issues and day-to-day operational problems.

This creates a set of multiple relationships, which may lead to inter-related negotiation and multilayered bargaining.

Figure 2.1 International Business Negotiations

Objectives of International Business Negotiation

The TNC’s Viewpoint

The primary goal of business negotiation is to create a favorable business environment. This translates into a non-discriminatory environment and equal treatment of foreign firms.

The foreign TNC needs legitimacy and acceptance in the host country. It tries to convince the host country government of its positive role in the local economy and its intended contribution to employment generation, transfer of skills, and overall growth and development of the region.

The Government’s Viewpoint

Negotiation by the government is driven by considerations of national interest because of which it often imposes restrictions on repatriation of dividend or measures to protect domestic industry. Governments of home countries are also aware of the negative externalities associated with TNCs, such as the effect on the environment and misuse of natural resources or adverse working conditions for labour.

Bargaining Power of the TNC

The TNC derives its bargaining power from a variety of different factors:

  • Ownership of technology: The possession of superior technology is an invaluable asset that has huge bargaining power since it can lead to all round growth and development in the home country. For instance, IBM always demanded 100 per cent ownership in local operations since it offered countries access to instrumental technology.
  • Global brands: TNCs such as Coca-Cola, McDonald’s and Chevrolet are global brands which gives them huge bargaining strength. Despite this, they sometimes face difficulties in penetrating regional markets, such as McDonald’s which got permission to operate in Kerala only in 2013, even though it has been a part of the Indian market since 1991.
  • Product diversity: TNCs that offer a great deal of product diversity are preferred since they help to produce a wide range of local products which can help save imports for the country.
  • Export potential: The TNC’s ability to negotiate becomes stronger if its products have export potential which would help the home country to build its export capabilities and also help it to earn foreign exchange.
  • Investment offered: The TNC’s bargaining strength also depends on the amount of investment it is bringing into the host country. The investment in the form of capital also carries with it attendant benefits of skill, technology and employment generation.
CHAPTER SUMMARY
  • The economic environment of an international business consists of several variables, such as the economic system of the home and host country, the level of economic growth and development and the fiscal and monetary policy. All of them have a bearing on the economic aspects of business decision making.
  • An economic system refers to the rules of the game on economic governance. It determines the rules regarding ownership and control of scarce resources within an economy and is classified as a capitalist or socialist system based on these characteristics.
  • The capitalist system also called the pure or free market economy, is characterized by private ownership of the means of production and the freedom of business firms to operate for profit.
  • The command economy, also known as a centrally planned economy, is based on the socialist principles of collectivism rather than individualism and private property.
  • The mixed economy exists in between the market and command systems. It is characterized by private enterprise in some sectors and significant state ownership and government planning in others.
  • A transition economy is one that is making the shift from one economic system to another.
  • There are many economic indicators that help in deciding market or production locations of international business firms. Some of the important indicators are income level and distribution, inflation, economic growth, infrastructure, population and economic stability.
  • The political environment in both the home and host countries influences international trade and investment in multiple ways.
  • The political system is the system of governance in an economy based on an ideology, which is a set of integrated beliefs, theories and doctrines.
  • Political systems are based on either collectivism or individualism and they may be democratic or totalitarian.
  • Political risk is the probability of disruption to TNC operations.
KEY TERMS
  • Economic system
  • Free market economy
  • Command economy
  • Mixed economy
  • Transition economy
  • Inflation, Ideology
  • Collectivism
  • Individualism
  • Democracy
  • Totalitarianism
  • Political risk
DISCUSSION QUESTIONS
  1. What are the different parameters of measuring the economic environment of an international business?
  2. ‘The current global environment is proof of the fact that free market systems lead to growth whereas socialist market systems stifle growth’. Elaborate upon the statement with examples from the current global economic context.
  3. Explain the importance of economic growth in the internationalization strategy of a TNC.
  4. Which economic variables would you consider important for the analysis of economic environment of a TNC?
  5. What is meant by the political environment of international business?
  6. Explain the dominant political philosophies of the global economy.
  7. What are the defining features of democracy? Discuss how a democratic system is more conducive to the world of global business than totalitarianism.
  8. Discuss the implications of increasing awareness about ethical issues for the conduct of international business.
  9. What is international business negotiation?
  10. What are the different levels at which a TNC can have international business negotiation?
EXAMINATION QUESTIONS
  1. ‘A global business firm works in a complex, multifaceted environment’. Explain. (15)

    [B.Com (Hons.), 2007]

  2. ‘A global business firm operates in an environment which is complex and multidimensional’. Elaborate. (15)

    [B.Com (Hons.), 2008]

  3. ‘The global business firm has to work in a complex and multifaceted business environment’. Explain clearly giving relevant and contemporary examples. (15)

    [B.Com (Hons.), 2009]

  4. Explain the salient features of the complex, multidimensional and interrelated business environment in which the multinational corporation has to operate. (15)

    [B.Com (Hons.), 2011]

  5. Discuss how diverse political and economic environment impact international business. (15)

    [B.Com (Hons.), 2014]

  6. Give a brief account of the differences between economic and cultural environment of business between nations and their implications for business. (15)

    [B.Com (Hons.), 2015]

  7. Give a brief account of the differences in the economic and legal environments of business between the nations and their implications for international business. (8)

    [B.Com (Hons.), 2018]

  8. Discuss how diverse political and economic environments impact International Business. (4, 4)

    [B.Com 2018]

  9. A global business firm operates in an environment which is complex and multidimensional. Explain the main features of the international political and legal environment.

    [B.Com (Hons.), 2016]