06 BDNG3103 T2

Topic Cultural,
2 Political, Legal
and Economic
Systems
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain the diversity of culture and how the various elements of
culture impact the international firms decisions;
2. Describe the basic political ideologies that exist;
3. Examine the types of political risks faced by international firms
operating in countries with differing systems;
4. Assess the basic legal systems of the world and how they influence
the international firm; and
5. Appraise several types of economic systems and their impact on
firms.
INTRODUCTION
In this topic, we will shift our attention to study in greater depth on the
differences among countries in the aspects of their culture, political and legal,
and economic systems of which we have briefly mentioned in the first topic.
For the international business manager, an awareness of each of these external

environmental factors would help towards a useful understanding and
appreciation of foreign markets and how their firms business can be conducted
more effectively and successfully in foreign country environments. The type of
Copyright Open University Malaysia (OUM)

34 TOPIC 2 CULTURAL, POLITICAL, LEGAL AND ECONOMIC SYSTEMS
products to be sold, how they are promoted and distributed, and pricing
strategies will all be strongly influenced by these factors.
Finally, in this topic, the concept of culture is analysed to help us understand

how diverse cultural values and attitudes shape the demands of consumers, their
tastes and preferences. The different political and legal systems regulate how
businesses can operate in foreign countries while economic systems indicate their
differing emphasis on economic development.
2.1 CULTURE
The following subtopics explain the elements that constitute culture and how the
activities of international business can be affected when cultures differ among
foreign countries.
2.1.1 What is Culture?

Culture is the characteristics and knowledge of a particular group of people,
defined by everything from language, religion, cuisine, social habits, music and
arts.
The Center for Advance Research on Language Acquisition goes a step further,
defining culture as shared patterns of behaviours and interactions, cognitive
constructs, and understanding that are learned by socialisation. Thus, it can be
seen as the growth of a group identity fostered by social patterns unique to the
group.
Let us look at the following terms:
Culture can be defined as a system of values and norms that are shared
among a group of people (such as in a society) and when taken together,
they constitute a design for living.
Values are shared assumptions about how things ought to be, for example,
about what a group believes to be good, right and desirable.
Norms mean the social rules and guidelines that prescribe the appropriate
behaviour in particular situations within the society. A society may be
equivalent to a country.

TOPIC 2 CULTURAL, POLITICAL, LEGAL AND ECONOMIC SYSTEMS 35
SELF-CHECK 2.1
What should a business firm do to adjust itself to a specific culture in a

particular country?
The process of adjusting and adapting to a specific culture other than our
own is known as acculturation, a key success factor in international
operations.
Definition of Acculturation
(a) Cultural modification of an individual, group, or people by adapting to
or borrowing traits from another culture.
(b) A merging of culture as a result of prolonged contact.
(c) The process by which a human being acquires the culture of a
particular society from infancy.
Source: www.Merriam-Webster.com/dictionary/acculturation
A societys culture determines the rules that govern how firms operate in the
society. Firms must build awareness of the cultural diversity of international
markets to operate effectively. Problems may arise when a person from one
culture has to adjust to another culture.
The basic elements that determine culture are social structure, religion, values
and attitudes, language and education, as seen in Figure 2.1, followed by
explanations of each in the subsequent subtopics.
Figure 2.1: Elements of culture

2.1.2 Social Structure

Every society has a social structure that determines the roles of individual
members, the stratification of the society (division of population into classes) and
the individuals mobility within the society.
Although all societies involve individuals living in family units and work
groups, they define family and groups differently and place different importance
on the role of the individual. Americans define the basic family unit as
comprising parents and their children. The Arabs consider uncles, cousins and
in-laws as part of the family unit, while the Somalian society is organised into
clans comprising individuals of the same tribe. American societies therefore
promote individualism and encourage the development of individual talents.
Japanese societies are group-focused and the individuals role is to serve the
group. As employees, their work attitudes will also be similarly focused.
Social stratification systems exist because each culture values some people more
highly than others and distinguish a person by their social class or status. The
caste system in India and the British class structure are examples of this system.
Firms operating in such societies need to take class differences, for example
between supervisors and workers, into account when hiring and promoting
employees. This is to avoid assigning jobs traditionally performed by members of
one group to another group as it may lower the morale and productivity of the
groups concerned.
Social mobility refers to the ability of individuals to move from one class to
another within society. In a rigid system like in India, a lower caste member may
face difficulty interacting and gaining the cooperation of colleagues when they
are promoted to higher supervisory roles.
Apart from workplace relations, the international firm may also need to tailor
promotional messages more carefully so as not to offend groups not targeted.
2.1.3 Religion and Ethics

Religion can be defined as a system of shared beliefs and rituals that are
concerned with the realm of the sacred. Ethical systems are sets of moral
principles or values that are used to guide and shape behaviour. Most ethical
systems are based on religious principles.

There are numerous religions in the world today, some of which are very
influential in certain parts of the world. The major ones, in terms of number of
followers are Christianity with 1.7 billion followers, Islam with 1 billion,
Hinduism with 750 million and Buddhism with 350 million followers. Although
Confucianism is more a set of guiding principles than a religion, it also has an
important ethical influence on culture and behaviour in certain parts of Asia.
Christianity has three main branches which are Roman Catholic, Orthodox and
Protestant. According to the German sociologist Max Weber, Protestant ethics
emphasises on the importance of individual hard work, achievement and
frugality for the glory of God. They strive constantly for efficiency, savings and
reinvestment of profits for future productivity, all of which are necessary in a
capitalist economy and entrepreneurial activity.
Hinduism and Buddhism stress the afterlife and spiritual achievement rather
than involvement in this world. Hinduism believes that the way to achieve
spiritual perfection is by leading a severe ascetic lifestyle of material and physical
self-denial. However, Buddhism does not support the Hindu caste system and
may be more encouraging towards entrepreneurial activity than Hinduism.
While Islam supports entrepreneurship, it strongly prohibits exploitation and

discrimination. The role of women managers in business may also be limited
compared to Western countries and products have to abide by the halal ruling.
Islam also regards interest payment as usury. However, these restrictions have
also revealed opportunities as evidenced by the successful marketing of non-
alcoholic beverages and interest-free banking products.
Confucianism has 150 million followers throughout Asia. It has been characterised
more as a code of conduct rather than a religion with the emphasis on loyalty and
relationships. The economic success of Japan, South Korea, Singapore and China
could be a result of loyalty to central authority and placing the good of the group
before that of the individual.
The impact of religion on international business varies from country to country,

depending on the similarity of religious beliefs and tolerance of other religious
view points.

2.1.4 Values and Attitudes
Values are the principles and standards that have been internalised and
accepted by members of a society.
Attitudes are the thoughts, feelings and actions resulting from those values.
Thus, cultural attitudes towards time, age and status may reflect these values and
influence the opportunities available to international business in a given society.
(a) Time
Attitude towards time differ greatly among cultures. In western cultures,
time means an opportunity to produce more and increase ones income and
is not to be wasted. In Latin America, it is not unusual if meetings begin 45
minutes late and meetings may be interrupted by the host entertaining
unscheduled visitors like family and friends. Westerners may wrongly
interpret the hospitality of the host as a sign of rudeness and disrespect.
In other cultures like the Japanese and the Arabs, meetings may start on
time but initial meetings would focus on establishing relationships and
determining whether the parties can trust and work with each other
comfortably. In contrast, Westerners expect to get down to business
immediately after exchanging a few pleasantries and follow a set agenda.
(b) Age
While youthfulness is considered a virtue in a society like the United States
and may send young high achievers to negotiate with international
partners, the Asian and Arab cultures respect age and correlates a
managers stature with age. Similarly, the Chinese would prefer to deal
with older and more senior members of a firm and may feel offended when
dealing with young counterparts.
In the Japanese culture where group-based decisions are important, senior

managers will not approve projects unless they have obtained a consensus
among junior managers. Foreign firms often commit the mistake of
focusing their attention in negotiations to the senior managers, when they
should be persuading the junior managers.

(c) Status
Values and attitudes towards the means by which a person achieves
his/her status also vary across the different cultures. In some societies,
status may be inherited through the wealth or rank of a persons ancestors,
such as the noble class in some European countries. In the United States,
however, hard working entrepreneurs are held in high regard and their
children would not be similarly respected if they fail to match their parents
achievements.
In Japan, a persons status is linked to the status of the group to which he or

she belongs. Thus, attending elite universities such as the Tokyo University
or employment in elite organisations such as Toyota Motor Corporation or
the Ministry of Finance would grant a high status.
2.1.5 Language
Language shapes the way people perceive the world and helps define culture. In
countries with more than one language, we may also find more than one culture,
such as the English-speaking and the French-speaking cultures in Canada.
Language may be verbal and messages are conveyed by the words used and how
they are spoken, for example, the tone of the voice. Messages may also be
communicated through non-verbal means by way of gestures, body position and
eye contact.
In international business, language serves four important purposes which are:
(a) Information Gathering and Evaluation

Language is important in information gathering and evaluation. Market
intelligence is best obtained by becoming part of the market rather than
observing it from the outside. The capable manager is therefore personally
able to see and hear what is going on, rather than relying on the opinions of
others.
(b) Easier Access to Society

Language is also able to provide the manager with easier access to society.
The ability to speak the local language means better acceptance and higher
willingness of the locals to openly communicate with the manager, at the
same time fostering cordial relationships.

(c) Ability to Communicate

The capability to speak a common language within the firm or with diverse
distributors has also become increasingly important. A foreign manager
needs to communicate with employees of a subsidiary in another country
and would otherwise require an interpreter.
(d) Ability to Interpret Different Contexts of Culture

Besides the ability to communicate, language also provides the manager
with the ability to interpret different contexts of culture. For example, the
use of English in different countries carries different meanings. When the
British say Negotiations Bombed, it means it was a huge success, which
conveys exactly the opposite to the Americans.
Firms also need to exercise more care in the use of language in conveying
advertising messages. There often is a need for advertisements originally in the
language of the home country to be accurately translated into the local language
and words used have to be carefully selected to avoid difficulty in pronouncing
them.
2.1.6 Education
A countrys education system, both public and private, plays an important role in
the transmitting and sharing of culture. Countries education systems have
varying emphasis on the quality of their education, whether based on particular
skills or the overall level of the education. Japan and South Korea emphasise on
the sciences more than the Western countries and Germany on apprenticeship
programmes for craftsmen and machinists. The United States system stresses on
the development of self-reliance, creativity and self-esteem, and provides
widespread access to higher education.
In employment, the international firm has to provide employees with training

programs taking into account their educational background, skills and literacy
levels.
ACTIVITY 2.1
Which basic culture element do you think has the biggest influence on
the growth of international business?

Assess your understanding by answering the following questions.
EXERCISE 2.1
1. The Japanese culture places very high importance on:

A. Group membership
B. Individualism
C. Personal achievement
D. Individual preferences
2. Which of the following religious beliefs are most likely to support

economic development and growth?
A. Christianity and Buddhism
B. Hinduism and Buddhism
C. Confucianism and Islam
D. Islam and Christianity
3. Culture includes all the following elements, EXCEPT:

A. Language
B. Religion
C. Geography
D. Social institutions

4. Culture is a system of values and norms that are shared among a

group of people and shapes their way of life.
A. True
B. False
5. Hinduism is the most widely practised religion in the world.

A. True
B. False
6. How does education impact culture?
7. Why is knowing the local language important to the international

business manager?
2.2 POLITICS AND LEGAL ENVIRONMENT

The two subjects of law and politics are considered as a pair because they are
both intertwined in the sense that political decisions may change laws and laws
may regulate the power of politicians. The system of government in a country is
known as the political system. It brings together people of different backgrounds
and allows them to work together to govern themselves. A countrys political
system influences how business is conducted domestically and internationally.
We shall now learn about the political ideologies upon which countries base their
political systems and the risks associated with doing business in different
countries.
2.2.1 Basic Political Ideologies

Political systems can be assessed according to two related dimensions. Firstly, the
degree to which collectivism is emphasised against individualism. Secondly, the
degree to which they are democratic or totalitarian. These two dimensions are
interrelated because systems that emphasise on collectivism tend to be
totalitarian while systems that value individualism tend to be democratic. Figure
2.2 illustrates the types of political ideologies.

Figure 2.2: Types of political ideologies
(a) Collectivism
This refers to a political system that places primary importance on
collective goals rather than individual goals. The needs of society as a
whole are generally held as more important than individual freedom.
Collectivism was firstly advocated by Plato (427347 B.C), who believed
that individual rights should be sacrificed for the good of the majority,
property should be commonly owned and society should be divided into
classes with philosophers and soldiers who would rule for the benefit of all.
Modern socialism was based on the teachings of Karl Marx (18181883),

who believed that in a capitalist society where individual freedom is not
restricted, the few will benefit at the expense of the many. Therefore, to
correct this situation he advocated that the state should own all enterprises
and means of production, and ensure that workers are fully compensated
for their labour.
In the 20th century, the socialist ideology can be divided into the
communists, who believed that socialism can be achieved only through
violent revolutions and totalitarian dictatorship, and the social democrats,
who strived to achieve socialism by democratic means. Communism has
weakened with the collapse of the Soviet Union and in the countries of
Eastern Europe in 1989, as well as other nations such as Cambodia, Laos,
Vietnam, Angola and Mozambique. Many believe that it is now only a
matter of time before communism in China will also collapse. In Great
Britain, France, Germany, India and Brazil, social democratic parties have
held power from time to time, where private companies in certain
industries have been nationalised into state-owned enterprises to be run for
the good of the public. However, it has been shown that state-run
companies performed poorly and has become inefficient, counter to public

interest. As a consequence, many social democratic parties were voted out

of office and the state-owned enterprises were sold to private investors.
Britains Conservative Party and Germanys Christian Democratic Party are
more committed to private ownership and free market economics.
(b) Individualism
Individualism refers to a philosophy that the individual should have the
freedom to pursue his or her own economic and political beliefs. It stresses
that the interest of the individual should take precedence over the interest
of the state. This ideology can be traced to another Greek philosopher,
Aristotle (384322 B.C.). He argued that private property receive the
greatest care and is therefore more highly productive.
The central message of individualism is that individual economic and

political freedoms should be the ground rules upon which society should
be based. It emphasises the importance of individual freedom and self-
expression, and believes that the welfare of society is best served by letting
people pursue their own self interest. These ideas can also be found in the
writings of economists Adam Smith and John Stuart Mill.
Individualism can be viewed as advocating democratic political systems

and free market economies championed by the United States, and
collectivism as championed by the now defunct communist Soviet Union.
(c) Democracy
Democracy refers to a political system by which a country is governed by
the people, exercised directly or through elected representatives. It goes
hand-in-hand with individualism.
In ancient Greece, the pure form of democracy was practised with the
citizens direct involvement in government decision making. However, the
large populations of modern societies have made this impractical. Todays
democratic countries practise what is known as representative democracy,
where the citizens elect individuals to represent them in government. If the
elected representatives fail to perform his/her job adequately, they will be
voted out at the next election. An ideal representative democracy is
indicated by the following basic characteristics:

(i) An individuals right to freedom of expression, opinion and freedom

to organise;
(ii) Free of the press;
(iii) A regular election in which all eligible citizens are allowed to vote;
(iv) Universal adult suffrage;
(v) Limited terms for elected representatives;
(vi) A fair court system that is independent of the political system;
(vii) A non-political state bureaucracy;
(viii) A non-political police force and armed service; and
(ix) Relatively free access to government information.
(d) Totalitarianism
Totalitarianism is a form of government in which one person or one
political party exercises absolute control over all areas of human life and
prohibits opposing political parties. The individuals right to freedom of
expression and organisation, free media and regular elections are denied to
the citizens.
There are four major forms of totalitarianism in the world today. Up to the
demise of the Soviet Union, the most widespread form was communist
totalitarianism, which is a version of collectivism advocating that socialism
can only be achieved through totalitarian dictatorship.
The second form is called theocratic totalitarianism, where political power

is controlled by a party or individual who governs according to religious
principles. This is practised in Iran and Saudi Arabia based on Islamic
principles and freedom of political and religious expression is limited.
Thirdly, tribal totalitarianism, which arose in the African countries such as

Zimbabwe, Tanzania, Uganda and Kenya. A typical country consists of
several different tribes and one political party, which is not always the
majority tribe, that represents the interest of a particular tribe monopolising
power.
The fourth major form is known as right-wing totalitarianism, which

generally allows some individual economic freedom but restricts individual
political freedom in order to prevent the rise of communism. They are

hostile to socialist or communist ideologies and many are backed by the

military. Some examples of right-wing totalitarianism were the fascist
regimes of Germany and Italy during 1930-1940 and the right-wing
dictatorships in Latin America. Most of these countries, however, are now
multi-party democracies.
Although collectivism and individualism are at the opposite ends of

political systems, as is democracy and totalitarianism, there are also gray
areas that exist in between. Democratic nations may practice collective
values, while totalitarian nations may allow some degree of individualism.
China, for example, is a totalitarian state but is economically moving
towards greater individual freedom.
ACTIVITY 2.2
Visit Chinas web site at www.chinatoday.com and Taiwans website at

www.sinica.edu.tw/taiwan/. Study and compare these two nations
who share a common history and tradition yet have opposing political
ideologies. Discuss the similarities and the differences in their approach
to business.
2.2.2 Political Risks

The political climate in a foreign country may change and affect the viability of a
firms operations. Tax and minimum wage laws affect the firms profitability and
the cost of labour respectively, and environmental protection laws affect the
production technology and the cost of waste disposal. Civil wars, kidnappings of
foreign personnel and government take-over of foreign assets may threaten
foreign operations.
Most political risks can be divided into three categories:
(a) Ownership risks, whereby the property of the firm is threatened through
expropriation or confiscation.
Expropriation is the taking-over of foreign-owned properties by the

government with compensation being provided. However, these
compensations are often unsatisfactory to the owners. Confiscation also
means the taking over of foreign-owned assets, but it does not involve
compensation for the firm.

(b) Operating risks, in which changes in laws, environmental standards, tax

regulations, terrorism and armed uprisings threaten the ongoings of the
firm and the safety of its employees.
(c) Transfer risks, when the government interferes with a firms ability to shift
funds into and out of the country.
Political risks may be the result of government actions through passing of laws. It
may also arise from non-governmental actions, such as kidnappings, extortion
and terrorism. Although political risks may occur in democratic as well as in
totalitarian political regimes, they are more likely to happen in totalitarian
countries.
2.2.3 Types of Legal Systems

An international firm faces a complex task of not only having to obey the laws of
its own home country but also the laws of all the host countries in which it
operates. Laws determine which markets firms can enter, the prices of their
products or services, and the cost of labour, raw materials or technology.
Managers, therefore, need to be aware of the different countries legal systems,
which may differ in terms of the nature of the system and the degree the
judiciarys independence from the political system.
Legal systems differ based on their historical, cultural, political and religious
backgrounds. There are three basic systems of law:
(a) Common Law

It is a system of law that relies on the rulings of previous cases (called
precedents), custom and traditions, and common usage as the basis for
court decisions. Its origins can be traced to England hundreds of years ago.
It is now found in the United States and most of the United Kingdoms
former colonies, such as Hong Kong.
(b) Civil Law

The civil law system, sometimes known as code law, is a compilation of
laws organised into codes. It has its origins in the Roman code of law
dating back to 450 B.C. More than 70 countries, including Germany, France,
Japan and Russia operate with a civil law system.
Common law and civil law differ because the former is based on the courts
interpretation of events, whereas civil law is based on how the law is
applied to the facts of the case. For example, contracts in a common law
country tend to be detailed, with all the terms and conditions spelled out. In
a civil law country, they tend to be shorter and less specific because many
of the issues detailed in a common law contract are already included in the
civil code. The courts will interpret civil law with reference to these codes.
(c) Theocratic Law

A theocratic law system is based on the established rules governing the
faith and practice of a particular religion. Although both Hindu and Jewish
laws are still being practised, Islamic law is the most widely implemented
legal system in the modern world. Islamic law, or the Syariah, is based on
the Holy Quran, and the Sunnah, or decisions and teachings of the Prophet
Muhammad.
Islamic law not only concerns moral behaviour but it also extends to cover
commercial activities. It is intended to govern all aspects of life. Several
Islamic countries such as Iran, Sudan, Pakistan and Saudi Arabia, for
example, have adopted Islamic banking systems and banned traditional
commercial banking. They have pronounced interest to be non-Islamic and
illegal. Banks therefore cannot charge interest or benefit from interest and
instead structure fees into their loans to allow them to make a profit.
The underlying principle is that money can earn a return by being

employed productively, but not by being earned in financial markets.
ACTIVITY 2.3
Different countries have different kinds of legal systems in relation to

business operations. List down and discuss the importance of law in
international businesses.
2.2.4 The Legal Profession

As international trade expands, legal services are increasingly required by firms,
such as in the area of contract negotiations and intellectual property protection.
As such, the legal profession itself is also experiencing internationalisation.
However, the international practice of law is not without barriers. Cultural and
political differences between countries which influence the law still remain.
Apart from the law itself, rules and procedures pertaining to the practice of law
also varies from country to country. There are different professional codes
governing lawyers standards of conduct regarding issues such as confidentiality,
fees, conflicts of interest and publicity.

Law firms also face barriers in extending their services due to government
restrictions on foreign firms from hiring local lawyers, forming partnerships with
local law firms or entering the country to practice law. Other countries may allow
foreigners to open offices within their borders to offer their services. For
example, until 1986 the Japanese market for legal services was closed to foreign
lawyers who wanted to practise in Japan. Germany blocks the practice of foreign
lawyers and the establishment of foreign firms within their country until very
recently. Hong Kong and Singapore, however, welcome foreign law firms, while
the European Community (EC) countries are beginning to relax their rules for
lawyers from other EC member countries.
For the international business firm, its need for legal services can be obtained
through several ways. The larger firms may set up its in-house legal department
by recruiting trained lawyers. When it is necessary to have local representation,
they may choose a law firm that has overseas connections who can represent
them through their foreign branch offices, affiliates or correspondent
relationships. However, smaller international business firms still rely on outside
legal counsel for their needs.
EXERCISE 2.2
1. More than 70 countries, including France, Germany and Japan,

operate on this legal system.
A. Common law system
B. Theocratic law system
C. Civil law system
D. Socialist law system
2. A countrys ____________ influences how business is conducted

domestically as well as internationally.
A. political system
B. economic system
C. legal system
D. financial system

3. China is an example of a ____________ totalitarian government.

A. fascist
B. theocratic
C. communist
D. tribal
4. In theocratic totalitarianism, the government imposes law and order

through the use of military power.
A. True
B. False
5. Common law is based on customs and traditions, usage and

precedents.
A. True
B. False
6. What are the three types of political risks? How may they affect the
international business firm?
7. Describe the various sources on which Islamic theocratic law is

based.
2.3 ECONOMIC ENVIRONMENT

In connection with the political system, we are more likely to find free market
economic systems where individualism is given prominence. In collectivist
political systems, the government may have control over enterprises and markets
may be more restricted.
The international managers ability to anticipate economic trends and events in

foreign countries may affect the firms future performance. Important dynamic
issues such as the size, growth potential, market stability, how governments view
foreign competition and their economic objectives may assist firms to assess their
viability of doing business.

2.3.1 Economic Systems

Let us now learn about the three broad types of economic systems. They are:
(a) Market Economy/Capitalism

In a pure market economy, resources and all productive activities are
owned and controlled by the private sector. Production is determined by
the interaction between supply and demand through the price system. If
demand for a product exceeds supply, prices will rise encouraging
producers to produce more. If supply exceeds demand, prices will fall and
producers will produce less. In this system, consumers are sovereign, which
means that consumers decide what to buy, and companies face no
restrictions in how they operate.
The role of the government in a market economy is to encourage

competition and efficiency between producers. Private ownership ensures
that entrepreneurs have the right to earn profits for their efforts, which
provides the incentive for them to find better ways to serve consumer
needs. This constant striving for improvement in products and processes
can be considered as a major positive impact on economic growth and
development.
In most market economies, monopolies are against the law, such as the anti-
trust laws in the United States. Monopolies emerge when they are allowed
to restrict supply. Rather than increasing output when demand increases,
the monopolist restricts output and let prices increase. Since they have no
competitors, they have no incentive to look for better ways to lower their
production costs. Although this situation is good for the monopoly firm, it
is bad for consumers and society as a whole.
(b) Command Economy/Socialism

Command economies can be found in the communist countries, such as
Myanmar and North Korea. It is also known as centrally planned
economies, whereby all economic activities such as goods and services that
the country produces, the quantity produced and the prices at which they
are sold, are all planned by the government. In pure command economies,
all enterprises are owned by the state, the rationale being that the
government can direct investments in the best interest of the nation.
Other socialist-inclined governments like France and India also practice

some elements of a command economy, although it has declined.

(c) Mixed Economy

In reality, there is no purely market or completely command economy
being practised. Most market economies have some degree of government
ownership and control. At the other end of the spectrum, command
economies are shifting to a more market oriented economy.
Between free market economies on one hand, and command economies on

the other, are mixed economies. In mixed economies, governments may
tend to take ownership of troubled firms which are considered vital to
national interests. Renault, the automobile company, was at one time taken
over by the French government to prevent its collapse and the resulting
unemployment. Some governments may own significant resources, but it
allows supply and demand to set prices, while other countries without
much resources levy high taxes for funds. Governments may also control
economic activity through their fiscal policies.
ACTIVITY 2.4
What type of economic system does Malaysia practise? Explain your

answer.
2.3.2 Differences in Economic Development

Different countries have different levels of economic development, which
international business firms should be aware of in making their expansion and
investment decisions or strategies.
(a) Economic Classification by Income

In measuring economic development, a countrys Gross Domestic Product
(GDP) is commonly used as a yardstick. GDP is the final value of goods and
services produced by a certain country within a certain period of time. This
value includes goods and services produced by the citizens and people of
other nationalities living in the country. Per capita income is the total
income of an individual in a country. Table 2.1 summarises the GDP (PPP)
per capita growth rate of some of the worlds nations in the year 19902014.

Table 2.1: List of Countries by GDP (PPP) Per Capita Growth Rate from 19902014
GDP Growth Rate

GDP Per Capita GDP Per Capita
Country (%)
(USD) in 1990 (USD) in 2014
19902014
Brazil 6,622 15,893 140.0
China 980 13,206 1247.62
Germany 19,033 46,401 143.79
India 1,146 5,701 397.43
Japan 19,230 36,619 90.43
Nigeria 1,959 5,911 201.8
Poland 5,996 25,262 321.33
Russia 8,013 22,990 186.91
Switzerland 26,734 59,540 122.71
United Kingdom 17,446 40,233 130.61
Source: World Bank, World Development Indicators (19902014)
From Table 2.1, among the richest countries are Japan, Switzerland,
Germany and the United Kingdom 5,701% respectively. Switzerland, one of
the worlds richest nations had a GDP per capita (per head of population)
of USD59,540 (2014), whereas Mozambique (not shown in table), with a
GNP per capita of only USD1,129 (2014), is one of the worlds poorest.
Large countries such as India and China are among the poorest and very
dynamic countries. Large nations such as China and India achieved
USD13,206 and USD5,701 with 1247.62% and 397.43% GDP growth rates
respectively from 19902014.
GDP per capita figures, however, can be misleading because it does not
consider the differences in the cost of living between countries. For
example, although the GDP of Switzerland showed USD59,540 (2014)
exceeding that of the United States at USD54,629 (2014) (not shown in
table), the higher cost of living in Switzerland meant that American citizens
could actually afford more goods and services than the Swiss.
The Purchasing Power Parity (PPP) method adjusts the GDP of countries
with the cost of living and allows a more direct comparison of living
standards between countries. Let us use the cost of living in the United
States as a base for comparison with India. While the GDP per capita for
India was USD5,701, the PPP per capita was USD5,610 (2014) (not shown in

table). This may indicate that the cost of living in India was lower than in
the United States, and that USD5,701 in India could buy as much as
USD5,610 worth of goods and services in the United States, as much as
USD55,837 (2014) and PPP as USD55,140 (2014).
The above figures further suggest that the standard of living among
countries also differ drastically. The average Indian citizen can afford to
consume only about (5,610 55,140 100%) 10.17% of the goods and
services that the average US citizen can. Therefore, despite having a
population of 1 billion, India does not appear to be an attractive market for
consumer goods. This conclusion, however, may not be accurate because
India has a wealthy middle class, although the majority may be poor.
The GDP and PPP figures are also a static picture of a countrys economic
development. We will need to further rely on the rate of growth in Gross
Domestic Product (GDP). For example, India may be shown as poorer than
the United States, but it does not tell us whether the income gap is closing.
They may currently be poor but it is growing at a much quicker rate than
the advanced countries. With their potential, they may in future become
more advanced and be huge markets for the international firms products.
Currently, they may contribute little to revenues, but their future
contributions could be much higher and firms may want to gain a foothold
in the market now.
Another wider approach to measuring development is called the Human

Development Index (HDI) which was developed by the United Nations and
used to measure the quality of human life in different countries. The three
criteria used are:
(i) Life expectancy at birth, which depends on the quality level of health
care accorded;
(ii) Educational attainment, which is measured through combining the

adult literacy rate and enrolment in primary, secondary and tertiary
education; and
(iii) Average incomes, which are based on PPP estimates, to measure

whether incomes are sufficient to meet the basic life necessities in a
country such as food, shelter and health care.

(b) Economic Classification by Regions

World Bank reports on developing countries are usually provided
according to geographical regions. International corporations find this
classification important because their activities tend to be organised along
geographical lines as well.
The major regions are as follows:
(i) East Asia and the Pacific countries such as Korea, China and Japan;
(ii) Latin America and the Caribbean, such as Brazil, Argentina and Chile;
(iii) The Middle East and North African countries such as Saudi Arabia,
Egypt, Algeria and Libya;
(iv) South Asia includes countries on the Indian continent;
(v) Sub-Saharan Africa such as Ethiopia, Sudan, Nigeria, Mozambique,

Namibia and South Africa; and
(vi) Eastern Europe and Central Asia, such as the Czech Republic,
Ukraine, Poland and the countries of Russia.
The regions of North America, Western Europe and Australia, and Japan
are categorised as high income countries, or members of the Organisation
for Economic Cooperation and Development (OECD) countries.
It is also important to note that although these countries are located within
similar regions, they may be very different from each other in terms of
ethnic origin, history, politics and economics.
Figure 2.3 provides a clearer picture of these regions.

Figure 2.3: Regions of the world
ACTIVITY 2.5
What is the difference between Economic Classification by Income

and Economic Classification by Regions?
2.3.3 The Emerging Market Economies

Since the late 1980s, two trends have radically changed the worlds government.
Firstly, a wave of democratic revolutions took place when totalitarian
governments in Eastern Europe and the Soviet Union collapsed and were
replaced by democratically elected ones. Secondly, there has been a strong shift
from centrally planned or mixed economies to a more free market system. Many
countries in Asia, Latin America and Western Europe begun selling state-owned
enterprises to private investors and deregulated their economies to promote
greater competition. These are the so called emerging economies of the world
today.
The major underlying reason for economic transition was that command and
mixed economies have revealed weaknesses that generally failed to deliver the
kind of economic achievement that was achieved by free market-based systems,
such as the United States, Switzerland and Taiwan.

The process of shifting towards a free market-based system requires several steps
as shall be explained in the paragraphs that follow.
(a) Deregulation
In the command economies, deregulation of the markets means the
removing of legally imposed restrictions to allow the free play of market
forces, the formation of private enterprises and how they operate, uplifting
controls over prices and outputs and international trade.
In the mixed economies where the role of the government is more limited,
deregulation is much easier to implement because a private sector already
exist. India, for example, has reformed their industrial licensing system that
made it difficult for new private enterprises to be established and opened
up sectors such as electricity generation, steel making, air transport and
some areas of the telecommunications industry to the private sector. India
has also removed limitations placed on foreign ownership of Indian assets
and lowered the barriers to international trade.
(b) Privatisation
Privatisation is the transfer of ownership of state-owned properties to
private individuals. It was first implemented by the British government in
1979 when 20 state firms were converted into privately owned companies.
This is an economic strategy usually used by the government as a way to

reduce their burden of the cost of operating these enterprises. Funds raised
from the effort can then be utilised to finance other government projects. At
the same time, the companies can become more productive, efficient and
innovative, and can expand the choices for the private sector. Privatisation
is also intended to attract new foreign capital into their countries.
For international firms, a countrys privatisation exercise may offer

opportunities to acquire the properties for sale at a low cost and allow the
expansion of their operations from an established base provided by these
properties.
(c) Legal Systems

Many countries that are the emerging from the communist bloc, where all
properties were government-owned, lacked the legal structure needed to
protect private property rights and enforcement of contracts that are
required for the smooth functioning of a market economy.

Foreign capital may be hesitant due to the weak system of law which
cannot offer adequate protection for their investments. In the event of
contract disputes, procedures for resolving them are either insufficient or
poorly developed.
In the long-term, major changes in the flow of trade and investments will take
place as these emerging economies continue their effort to become major players
in global trade.
EXERCISE 2.3
1. Which of the following is NOT a developing country?

A. China
B. France
C. India
D. Malaysia
2. Among the countries of the emerging market economies are the

countries of:
A. Argentina and Brazil
B. Russia and Eastern Europe
C. Malaysia and Thailand
D. Germany and Italy
3. Which method adjusts the national income of countries with the

cost of living and allows a more direct comparison of living
standards between countries?
A. Gross National Product (GNP)
B. Gross Domestic Product (GDP)
C. Purchasing Power Parity (PPP)
D. GDP Growth Rate

4. A centrally planned economy is one in which the countrys

resources are primarily owned and controlled by the private sector,
not the public sector.
A. True
B. False
5. Privatisation means the selling of privately owned companies to the

government to settle their debts.
A. True
B. False
6. What are the major features that differentiates between the three
economic systems of the world today?
7. What are the three steps that need to be taken by the emerging
market economies in their efforts to transform to a free market-based
system?
In this topic, we have focused on the existing issues of culture, politics, legal
and economic systems in the external environment of the international
business firm.
We have learned that although international markets are increasingly facing

globalisation, the world remained strongly multi-cultural.
Culture has a greater impact on consumer goods tastes and preferences

compared to industrial goods, which are more universal in nature.
We also learned that political and legal systems tend to differ from country to
country, even among those sharing similar political ideologies.
Based on these different systems, governments determine how businesses are

carried out in relation to their respective countries.
The area of business contracts and settlement of disputes is another

important area that gives direct impact to the international firm.

Finally, we learned about the three major economic systems practised by

countries today, which are broadly categorised as the free market system,
command economy and mixed economic system. These different systems are
also related to political systems.
The economic success of democratic countries indicates a strong positive

relationship with the free market economic system.
Thus, the desire to be as economically-developed drove many communist

countries to convert to democracies such as in Russia and Eastern Europe.
The topic ends with a discussion on these former communist countries which
are now termed as the emerging market economies.
Acculturation Market economy

Attitudes Mixed economy
Culture Norms
Collectivism Organisation for Economic
Cooperation and Development (OECD)
Command economy
Privatisation
Democracy
Politics
Deregulation
Purchasing Power Parity (PPP)
Ethics
Religion
Gross Domestic Product (GDP)
Social structure
Human Development Index (HDI)
Totalitarianism
Individualism
Value
Legal system

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Topic Cultural,

For the international business manager, an awareness of each of these external

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Finally, in this topic, the concept of culture is analysed to help us understand

2.1.1 What is Culture?

Let us look at the following terms:

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What should a business firm do to adjust itself to a specific culture in a

Figure 2.1: Elements of culture

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2.1.2 Social Structure

2.1.3 Religion and Ethics

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While Islam supports entrepreneurship, it strongly prohibits exploitation and

The impact of religion on international business varies from country to country,

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2.1.4 Values and Attitudes

In the Japanese culture where group-based decisions are important, senior

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In Japan, a persons status is linked to the status of the group to which he or

In international business, language serves four important purposes which are:

(a) Information Gathering and Evaluation

(b) Easier Access to Society

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(c) Ability to Communicate

(d) Ability to Interpret Different Contexts of Culture

In employment, the international firm has to provide employees with training

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Assess your understanding by answering the following questions.

1. The Japanese culture places very high importance on:

2. Which of the following religious beliefs are most likely to support

3. Culture includes all the following elements, EXCEPT:

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4. Culture is a system of values and norms that are shared among a

5. Hinduism is the most widely practised religion in the world.

6. How does education impact culture?

7. Why is knowing the local language important to the international

2.2 POLITICS AND LEGAL ENVIRONMENT

2.2.1 Basic Political Ideologies

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Figure 2.2: Types of political ideologies

Modern socialism was based on the teachings of Karl Marx (18181883),

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interest. As a consequence, many social democratic parties were voted out

The central message of individualism is that individual economic and

Individualism can be viewed as advocating democratic political systems

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(i) An individuals right to freedom of expression, opinion and freedom

(ii) Free of the press;

(iv) Universal adult suffrage;

(v) Limited terms for elected representatives;

(vi) A fair court system that is independent of the political system;

(vii) A non-political state bureaucracy;

(viii) A non-political police force and armed service; and

(ix) Relatively free access to government information.

The second form is called theocratic totalitarianism, where political power

Thirdly, tribal totalitarianism, which arose in the African countries such as

The fourth major form is known as right-wing totalitarianism, which

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hostile to socialist or communist ideologies and many are backed by the