INTERNATIONAL

UNIT 2 SECTION 4 THE POLITICAL OR LEGAL ENVIRONMENT

BUSINESS Unit 2, section 4: The Political or Legal Environment

Politics and laws play a critical role in international business. Even the best
multinational can pack bag and baggage and leave the host country as a
result of unexpected political or legal influences. But the failure to anticipate
these factors can be the undoing of an otherwise successful business
venture. Of course, a single international political or legal environment does
not exist. The business executive has to be aware of the political and legal
forces on a variety of levels on the international scene.

For example, while it is useful to understand the complexities of the home

country’s legal system, such knowledge may not protect against sanctions
imposed by the host country. The firm, therefore, has to be aware of
conflicting expectations and demands in the international arena, and work
together with governments to maintain viable international business
practices.

Government policies both impose strategic constraints and provide

opportunities. The government can affect business opportunities through tax
laws, economic policies, and international trade rulings. One example of
restraint on business action is the government’s standards regarding bribery.
In some countries bribes and kickbacks are common and expected ways of
doing business; but for the U.S and most western-oriented countries, these
are illegal practices, which can result in the prosecution of employees.

By the end of this Section, you should be able to;

 explain the concept of political environment in international business
 differentiate between the political and legal environment
 explain the differences between the various forms of sanctions and
embargos
 identify the various export controls available to a country.

Now read on.....

The Host-Country Perspective

No manager can afford to ignore the rules and regulations of the country
from which he or she conducts international business transactions. Many of
the laws and regulations may not specifically address international business
issues, yet they can have a major import on a firm’s opportunity abroad.
Minimum wage legislation for example, has a bearing on the international
competitiveness of a firm using production processes that are highly labour
intensive. The cost of domestic safety regulations may significantly affect
the pricing policies of international firms.

Other legal and regulatory measures, however, are clearly aimed at

international business and some may be designed to help firms in their
international efforts. For example, governments may attempt to aid and

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protect the business efforts of domestic companies facing competition from

abroad by settling standards for product content and quality.
The political environment in most countries tends to provide general support
for the international business efforts of firms headquartered within the
country. For example, a government may work to reduce trade barriers or to
increase trade opportunities through bilateral and multilateral negotiations.
Such actions will affect individual firms to the extent that they improve the
international climate for free trade.

Often, governments also have specific rules and regulations that restrict
international business. Such regulations are frequently political in nature,
and are based on governmental objectives that override commercial
concerns. The restrictions are particularly sensitive when they address
activities outside the country. Such measures challenge the territorial
sovereignty of other governments and raise the issue of extra-territoriality,
meaning a nation’s attempt to set policy outside it territorial limits. Yet
actions implying such extra-territorial reach are common, because nations
often argue that their citizens and products maintain their nationality
wherever they may be, and they therefore continue to be subject to the rules
and laws of their home country. Three main areas of governmental activity
are of major concern to the international business manager. They are
embargoes or trade sanctions, export controls, and the regulation of
international business behaviour.

Embargoes and Sanctions

Sanctions and embargoes refer to governmental actions that distort free flow
of trade in goods, services, or ideas for decidedly adversarial and political,
rather than economic purposes. Sanctions tend to consist of specific
coercive trade measures such as the cancellation of trade financing, or the
prohibition of high technology trade. Embargoes are usually much broader,
in that they prohibit trade entirely. For example, the US and EU imposed
trade sanctions on Russia in March, 2014 with the invasion of eastern
Ukraine by Russian President Putin. Again, the US can sanction some
countries by prohibiting the export of all items to them as is against Cuba,
Syria, and North Korea when everything, but humanitarian trade, has been
banned.

Trade embargoes have been used quite frequently and successfully in times
of war, or to redress specific grievances against hostile countries. Economic
sanctions and embargoes have become a principal tool of the foreign policy
of many countries. Often, they are imposed unilaterally in the hope of
overthrowing a country’s government at best, or at least changing its
policies.

After World War I, the League of Nations set a precedent for the legal
justification of economic sanctions or trade embargoes by subscribing to a
covenant that contained penalties or sanctions for breaching its provision.

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The members of the League of Nations did not intend to use military or
economic measures separately, but the success of the blockades of World
War I fostered the opinion that “the economic weapon conceived into as an
instrument of war is a means of peaceful pressure”, which became the
greatest discovery than most previous Sessions of the League. The basic
idea was that economic sanctions could force countries to behave peacefully
in the international community.

A problem with sanctions is that frequently, their unilateral imposition has

not produced the desired result. Sanctions may make the obtaining of goods
more difficult or expensive for the sanctioned country, yet their purported
objective is almost never achieved. For it to work, sanctions need to be
imposed multilaterally to affect all the goods and services that are vital to
the sanctioned country – goals that are clear but difficult to implement.
Sometimes, global cooperation must be the driving force for sanctions to be
achieved. For example, when Iraq invaded Kuwait in August 1990, virtually
all members of the United Nations condemned this hostile action, and joined
a trade embargo against Iraq.

Sanctions imposed by the government usually mean the loss of business by

the international firm. But the issue of compensating these domestic firms
and industries affected by these sanctions are very slow, thus making them
less competitive. The end result is the inability to ease the burden on these
firms, which undercut their ultimate chance for success. The international
manager is often caught in this political web of events, and loses business as
a result.

Export Controls
Nations have export control systems, which are designed to deny or at least
delay the acquisition of strategically important goods and services by
adversaries. Export control systems are based on export administration.
Export administration in most countries control the export of all goods,
services, and ideas from one country to another. The determinants for
control are national security, foreign policy, short supply, and nuclear non-
proliferation.

For any export to take place, the exporter needs to obtain an export license
from the appropriate governmental agency – usually the Ministry of Trade
or the Department of Commerce. In consultation with other governmental
agencies such as Defence, Agriculture or Energy, the Ministry of Trade or
Commerce Department has to draw up a list of commodities whose export is
considered sensitive to the home country.

In addition, a list of countries differentiates nations according to their

political relationship with the exporting country. Finally, a list of individual
firms that are considered to be unreliable trading partners because of past
trade diversion activities exist for each country.

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After an export licence application has been filed, specialist in the

department of commerce match the commodity to be exported with the
critical commodity list – a file containing information about products that
are either particularly sensitive to national security or controlled for other
purposes. The product is then matched with the country of destination and
the recipient firm or company. If no concerns regarding any of the above-
stated issues exist, then an export license is issued.

This process may sound extremely cumbersome but it does not apply in
equal measure to all exports. Many international business activities can be
carried out with a general licence, which provides blanket permission to
export. Under such a license, which is not higher than the price of paper,
exports can be freely shipped to most trading partners provided that neither
the product nor the country involved is considered sensitive.

However, the process becomes more complicated and cumbersome when

products incorporating light level technologies and countries not friendly to
the exporting country are involved. The exporter must then apply for a
validated export license, which consists of written authorisation to send a
product abroad.

The international business repercussions of export controls are important. It

is one thing to design an export control system that is effective and which
restricts those international business activities subject to important national
concerns. It is, however, quite another thing when controls lose their
effectiveness, and one country’s firms are placed at a competitive
disadvantage with firms in other countries whose control systems are less
expensive or even non-existent.

Regulating International Business Behaviour

Home countries may implement special laws and regulations to ensure that
the international business behaviour of firms headquartered within them is
conducted within moral and ethical boundaries considered appropriate. The
definition of appropriateness may vary from country to country and from
government to government. The international manager must walk a careful
line, balancing the expectations held in different countries.

One major area in which nations attempt to govern international business

activities involves boycotts. For example, Arab nations developed a
blacklist of all international companies that deal with Israel and vice-versa.
Further, Arab customers frequently demand assurance that products they
purchase are not manufactured in Israel, and that the supplying company
does not do any business with Israel. The goal of this action clearly is to
impose a boycott on business with Israel. Such a policy has automatic
retaliatory consequences from Israel, or those who are sympathetic to the
Israeli cause.

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Caught in a web of governmental activity, firms may be forced either to lose

business or to pay substantial fines. This is especially true, if the firm’s
products are competitive yet not unique, so that the supplier can opt to
purchase them elsewhere. The heightening of such conflict can sometimes
force international companies to search for new ways to circumvent the law,
which may be very risky, or to totally withdraw their operations from a
given country.

Anti-trust laws
Another area of regulatory activity affecting the international business
efforts of firms is anti-trust laws. These laws often apply to international
operations as well as domestic business. In many countries, antitrust
agencies watch closely when a firm pays a company, or engages in a joint
venture with a foreign firm, or makes an agreement abroad with a
competing firm in order to ensure that the action does not result in restraint
of competition.

Ethics, Bribery, and Corruption

Firms operating abroad are also affected by laws against bribery and
corruption. In many countries, payments or favours are a way of life, and “a
greasing of the palm or wheel” is expected in return for personal services
rendered, or contracts awarded. As a result, many international businesses
routinely pay bribes or do favours for foreign officials in order to gain
advantage. Even in the late 1990s, the British Chamber of Commerce
reported that bribery and corruption was a problem for 14 percent of
exporters.

Similarly in the US, the Foreign Corruption Practice Act was passed in
1977, making it a crime for US executives of publicly traded firms to bribe a
foreign official in order to obtain business. A number of US firms have
complained about the Act, arguing that it hinders their efforts to compete
internationally against companies whose home countries have no such anti-
bribery laws.

The problem is one of ethics verses practical needs, and to some extent the
amounts involved. For example, it may be hard to draw the line between
providing a generous cash tip, and paying a bribe in order to speed up a
business transaction. Many business executives believe that the United
States should not apply its moral principles to other societies and cultures in
which bribery and corruption are endemic. To compete internationally,
executives argue, they must be free to use the most common methods of
competition in the host country.

On the other hand, applying different standards to executives and firms

based on whether they do business abroad or domestically is a difficult thing
to do. Also, bribes may open the way for shoddy performance and loose

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moral standards among executives and employees, and may result in a

spreading of general unethical business practices. Unrestricted bribery could
result in firms concentrating on how to bribe best, rather than on how to best
produce and market their products.

Typically, international businesses that use bribery fall into three categories:
those who bribe to counter-balance the poor quality of their products or their
high prices; those who bribe to create a market for their unneeded goods and
services; and in the bulk of cases, those who bribe to stay competitive with
other firms who bribe. In all three of these instances, the customer is served
poorly, the prices increase astronomically, and the transactions do not reflect
economic competitiveness.

A final major issue that is critical for international business managers is that
of general standards of behaviour and ethics. Increasingly, public concerns
are raised about such issues as environmental protection, global warming
and pollution, and morale behaviour. However, these issues are not of the
same importance in every country. What may be frowned upon or even
illegal in one nation may be customary, or at least acceptable in another. For
example, the cutting down of the Brazilian rain forest may be acceptable to
the government of Brazil, but scientists, environmentalists, and concerned
consumers may object vehemently because of its global effect on climate.
Another example could be that, US tobacco products may be legal in the
US, but this may result in accusations of exporting death to developing
nations where US tobacco is patronised.

International firms must understand these conflicts and should assert

leadership in implementing change. This is because not everything that is
legally possible should be exploited for profit. By acting on existing,
leading-edge knowledge and standards, firms will be able to benefit in the
long term through consumer goodwill and the avoidance of retaliatory
recriminations.

Host Country Political and Legal Environment

Politics and laws of a host country affect international business operations in
a variety of ways. The good manager will understand these dimensions of
the countries in which the firms operates so that he or she can work within
existing parameters, and can anticipate and plan for any future changes that
may occur.

Political Action and Risk

International firms usually prefer to conduct business in a country with a
stable and friendly government, but such governments are hard to come by.
International managers must, therefore, monitor governments, their policies
and stability to determine the potential for political change that could
adversely affect corporate operations.

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There is political risk in every country, except that they vary from country to
country. Political risk is lowest in countries that have a history of the rule of
law, an independent judiciary a vibrant media, a multi-party, transparent,
free and fair elections, with stability, and consistency. Political risk tends to
be highest in nations that do not have this sort of history. There are three
types of political risk:

Ownership risk which exposes life and property.

Operating risk which refers to the interference with the ongoing operations
of a firm
Transfer risk, which is mainly encountered when attempts are made to shift
funds between countries.

A major political risk in many countries is that of conflict and violent

change through military take-over or civil disobedience. An international
manager will want to think twice before conducting business in a country in
which the likelihood of such change is high. To begin with, if conflict
breaks out, violence directed toward the firm’s property and employees are a
strong possibility. Guerrilla warfare, civil disobedience, demonstrations,
disturbances, and terrorism often take an anti-industry bent, making
companies and their employees’ potential targets.

International terrorists have frequently targeted US and western corporate

facilities, operations, and personnel abroad for attack in order to strike a
blow against the United States in particular, and capitalism in general. US
firms, by their nature cannot have the elaborate security and restricted
access of US diplomatic offices and military bases. As a result, United
States businesses are the primary target of tourists worldwide, and remain
the most vulnerable targets in the future. The methods used include
bombing, arson, hijacking and outright sabotage.

In many countries, particularly in the developing world, coup d’états can

result in drastic changes in government. The new government often will
attack foreign firms. But even if such changes do not represent an
immediate physical threat, they can lead to policy changes that may have
drastic consequences. The most drastic public steps resulting from such
policy changes are usually the expropriation and confiscation of foreign
business assets or properties.

Expropriation is the forceful seizure of the ownership of a foreign business’

assets by the host government to itself, or to a domestic entity. It has
occurred several times around the globe. It is an appealing action to many
countries because it demonstrates their nationalism, and transfer a certain
amount of wealth and resources from foreign companies to the host country
immediately. Expropriation, however, does not relieve the host government
of providing compensation to the former owners.

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Confiscation is similar to expropriation in that it results in a forceful transfer

of ownership from the foreign firm to the host country. The difference is
that it does not involve compensation to the foreign firm. Some industries
are more vulnerable than others to confiscation and expropriation because of
their importance to the host country’s economy and their lack of ability to
shift operations for this reason. Such sectors as mining, energy, public
utilities, and banking have frequently been targets of such government
actions.

Confiscation and expropriation constitute major political risk for foreign

investors. Many countries are turning from confiscation and expropriation to
more subtle forms of control such as domestication. The goal of
domestication is the same – that is, to gain control over foreign investments
– but the method is different.

Through domestication, the government demands transfer of ownership and

management responsibility. It can impose local content regulations to ensure
that a large share of the product is locally produced, or demand that a large
share of the profit is retained in the country. Changes in labour laws, patent
protection, and tax regulations are also used for purposes of domestication.

Economic Risk
Most businesses operating abroad face a number of other risks that are less
dangerous, but probably more common, than the drastic ones already
discussed. A host government’s political situation or desires may lead it to
impose economic regulations or laws to restrict or control the activities of
foreign firms.

Nations that face shortage of foreign currency will sometimes impose

controls on the movement of capital into, and out of the country. Such
controls make it difficult for a firm to remove its profits or investments from
the host country. Sometimes, exchange controls are also levied selectively
against certain products or companies in an effort to reduce the importation
of goods that are considered to be a luxury or that are sufficiently available
through domestic production. Such regulations often affect the importation
of parts, components, or supplies that are vital to production operations in
the host country.

Countries may also use tax policies toward foreign investors. In an effort to
control multinational corporations and their capital, tax increases may raise
the much-needed revenue for the host country, but they can severely damage
the operations of foreign investors. This damage, in turn, will frequently
result in decreased income for the host country in the long run. The
international executive also has to worry about price controls. In many
countries, domestic political pressures can force governments to control the
price of imported products or services, particularly in sectors considered

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highly sensitive from a political perspective, such as food, health care, and
petroleum products.

Managing the Risk

International business managers face the risk of confiscation, expropriation,
domestication, or other such governmental interferences whenever they
conduct business overseas. But several ways exist to lessen these risks.
Obviously, if a new government comes into power and is dedicated to the
removal of all foreign influences in the host country, there is very little a
foreign firm can do. In less extreme cases, however, international business
managers can take actions that will reduce the risk provided they understand
the root causes of the host country’s policies.

Adverse governmental actions are usually the result of nationalism, the

deterioration of political relations between the home and host country, the
desire for independence, or opposition to colonial remnants. If a host
country’s citizens feel exploited by foreign investors, government officials
are more likely to take anti-foreigner actions.

To reduce the risk of government intervention, the international firm needs

to demonstrate that it is concerned with the host country’s society and its
citizens, and that it considers itself as an integral part of the host country,
rather than simply an exploitative foreign corporation. Several ways of
doing this include intensive local hiring and training practices, better
remuneration with incentives, contribution to charity, and constant
appreciation of corporate social responsibilities. In addition, the foreign
company can form joint ventures with local partners to demonstrate that it is
willing to share its superior technologies and gains with the host country’s
nationals.

Another action that can be taken by corporations to protest against political

risk is the close monitoring of political developments. Increasingly, private
sector firms offer such monitoring assistance, permitting the overseas
corporation to discover potential trouble spots as early as possible and react
quickly to prevent major loses. Foreign firms can also take out insurance to
cover losses due to political and economic risk. Most industrialised
countries offer insurance programmes for their firms doing business abroad.

Differences in International Law

Countries differ in their laws as well as in their use of the law. For example,
over the past decade the United States has become an increasingly litigious
society in which institutions and individuals are quick to initiate lawsuits.
Court battles are often protracted and costly, and even the threat of a court
case can reduce business opportunities. In contrast, Japan’s business
tradition tends to minimise the role of the law and lawyers. The Japanese
tend not to litigate, preferring the Alternative Dispute Resolution (ADR)

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mechanism to settle business dispute. Litigation in Japan means that the

parties have failed to compromise. A cultural predisposition therefore exists
to settle conflicts out of the court system.

The two major legal systems worldwide can be categorised into common
law and code law. Common law is based on tradition and depends less on
written statutes and codes than on precedent and custom. Common law
originated from England and is the system of law in the United States and
most English speaking countries worldwide. Code law, on the other hand is
based on a comprehensive set of written statutes. Countries with code law
try to spell out all possible legal rules explicitly. Code law is based on
Roman law and is found in majority of nations of the world.
Refer to other texts for further information on the meaning and importance
of this topic. Record your notes in your jotter for face-to-face discussion.

Summary
To sum up, we will say that there are rules and regulations governing
international business transactions. For instance the use of child labour is
prohibited by international law. Recently, the major importers of Ghana’s
cocoa threatened to boycott her cocoa because they have evidence that
Ghana uses child labour in producing cocoa. Hence, ignoring this
environment can be suicidal.

Please, refer to other texts in the references provided for further information
on the meaning and importance of this topic. Put down any important notes
you come across in the blank sheet provided below for face-to-face
discussions with your course lecturer.

Now assess your understanding of this Section by answering the following

Self-Assessment Questions (SAQs). Good luck!

Activity 2.4
 Define economic risk
 The two major legal systems worldwide are............................
 Differentiate between expropriation and confiscation.
 How many types of political risk exist? Name them.
 In what two ways can international business behaviour be regulated?

Did you score all? That’s great! Keep it up.

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