Business in the Global Political Environment

1. Ayush&Parekh&
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Index
Sr.!No.! ! ! Topic! Page!No.!
1.! Introduction! 3!
2.! Global!Political!Environment! 3!
3.! Types!of!Political!System!! 5!
4.! Political!Interdependence!! 6!
5.! Government!Intervention!in!Trade! 7!
6.! Political!Factors!affecting!Business! 9!
7.! Political!Risk! 10!
8.! Measuring!Political!Risk! 13!
9.!
The Perils of Political Instability and
Uncertainty!
16!
10.! The!Contrasting!examples!of!India!and!China! 17!
11.!
Why!Businesses!like!a!stable!MacroP
Environment!
18!
12.!
Political!Strategies!for!Conduction!
International!Business!
19!

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

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to one based on knowledge industries
• Demographic shifts
• The development of a global economy
• Increased trade liberalization
• Advances in communication technology
• Increased threat of global terrorism
• An era without a dominant economic, political, or
military power
Globalization creates a turbulent global socio-political
environment characterized by competing political actors,
shifting power relations, and politically driven changes in
national economies around the world. Businesses work to
find opportunity and profit to be had from these political
and economic changes. The political turbulence and
upheaval has resulted in a move from centralized
economies to a decentralized global economy and has
created numerous emerging markets. These emerging
markets refer to the capital markets of developing
countries that have liberalized their financial systems to
promote capital flows with nonresidents and have
become broadly accessible to foreign investors.
Business opportunities, including international
investments and joint ventures, in the global economy
are increasingly tied to trade pacts such as the North
Countries are privatizing many state-owned industries
and allowing foreign investors to purchase pieces of
them through joint ventures or allowing local operations
to participate in these projects (Stites, 1995).
Emerging markets, often occurring in countries
experiencing political upheaval, will continue to increase
in the expanding global market. Businesses, participating
in the new global economy, will continue to seek out
new manufacturing and sales opportunities in foreign

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

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

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In “Coca-Colonization” powerful multinationals can
exert considerable economic and cultural power over
local people. Today, pressure groups and populist
movements demonstrate against this and protest against
the WTO.
How Do Governments Intervene in Trade?
While the past century has seen a major shift toward free
trade, many governments continue to intervene in trade.
Governments have several key policy areas that can be
used to create rules and regulations to control and
manage trade.
• Tariffs. Tariffs are taxes imposed on imports. Two
kinds of tariffs exist—specific tariffs, which are
levied as a fixed charge, and ad valorem tariffs,
which are calculated as a percentage of the value.
Many governments still charge ad valorem tariffs as
a way to regulate imports and raise revenues for
their coffers.
• Subsidies. A subsidy is a form of government
payment to a producer. Types of subsidies include
tax breaks or low-interest loans; both of which are
common. Subsidies can also be cash grants and
government-equity participation, which are less
common because they require a direct use of
government resources.
• Import quotas and VER. Import quotas and
voluntary export restraints (VER) are two strategies
to limit the amount of imports into a country. The
importing government directs import quotas, while
VER are imposed at the discretion of the exporting
nation in conjunction with the importing one.

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• Currency controls. Governments may limit the
convertibility of one currency (usually its own) into
others, usually in an effort to limit imports.
Additionally, some governments will manage the
exchange rate at a high level to create an import
disincentive.
• Local content requirements. Many countries
continue to require that a certain percentage of a
product or an item be manufactured or “assembled”
locally. Some countries specify that a local firm
must be used as the domestic partner to conduct
business.
• Antidumping rules. Dumping occurs when a
company sells product below market price often in
order to win market share and weaken a competitor.
• Export financing. Governments provide financing
to domestic companies to promote exports.
• Free-trade zone. Many countries designate certain
geographic areas as free-trade zones. These areas
enjoy reduced tariffs, taxes, customs, procedures, or
restrictions in an effort to promote trade with other
countries.
• Administrative policies. These are the bureaucratic
policies and procedures governments may use to
deter imports by making entry or operations more
difficult and time consuming.

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Political factors affecting business
• Bureaucracy
• Corruption level
• Freedom of the press
• Tariffs
• Trade control
• Education Law
• Anti-trust law
• Employment law
• Discrimination law
• Data protection law
• Environmental Law
• Health and safety law
• Competition regulation
• Regulation and deregulation
• Tax policy (tax rates and incentives)
• Government stability and related changes
• Government involvement in trade unions and
agreements
• Import restrictions on quality and quantity of
product
• Intellectual property law (Copyright, patents)
• Consumer protection and e-commerce
• Laws that regulate environment pollution

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

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influence the society and government?
• Is there demographic stability?
• Are there internal social, ethnic or religious tensions
that could lead to a civil war or unrest?
• What is the country's trade credit history?
• What is the level of unemployment among citizens?
Political risk, as a general, global category, is
characterized by three factors: catastrophic events,
business environment, and public policy (Dugan, 1999).
• Catastrophic events: catastrophic events refer to the
political developments that can affect operations of
all foreign firms in a country. Theoretical examples
include racial and ethnic unrest, civil strife,
terrorism, civil war, international conflict, and
systemic failure. Real word examples include
former Yugoslavia's ethnic unrest, civil war, and
international conflict.
• Business environments: business environment risks
faced either by all foreign businesses in a region or
industry specific risks (related to government
corruption, labor strife, and the judicial system).
Examples include labor and elections. Labor
organizations through much of the world are closely
tied to political organizations. This connection
between labor and politics brings foreign companies
into the midst of political struggles and issues.
Foreign elections, which seldom influence foreign
business operations directly, do influence public
policy. Elections may bring in new officials who
alter or shift the business environment to match the
new regime. For example, new officials may change
the tax code or structure.

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• Public policies: public policy risks include political
initiatives such as changes in the tax system,
regulatory structure, and monetary system. For
example, when a foreign government is forced to
devalue currency due to economic crisis, interest
rates rise and alter domestic spending habits. This
change in monetary policy could potentially ruin a
foreign business' investment.
A major concern for any company or an individual
before venturing on an international project is whether
the political situation in the host country will change in
such way that the operating position will deteriorate. It is
very a much subjective business-specific event. Haendel
(1979) defines it as the occurrence of events that may
change the projections for profitability of a global
business venture of a given investment. The political
actions that may affect the business or construction
operations may include governmental takeover of
properties (with or without compensation), changes in
import or export regulations, or even political
insurrections leading to other drastic changes. Failure to
analyze and fully understand these risk exposures may
seriously affect one's objectives for profit, market share,
and long-term relations.
"In the broad context of international business, political
risk is defined as the risk or probability of occurrence of
some political events that will change the prospects for
the profitability of a given investment. Macro-political
risk events include sociopolitical disorder, power group
transfer, and political corruption as well as government
interference. Other major concerns also relate to the
change of government policies toward foreign

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construction firms and the power group’s involvement or
interference in the operation of a project. Foreign
companies are extremely vulnerable to the risk
associated with changes in government policies, laws, or
regulations that could directly impact their right to
operate and ability to realize the full expected value of
their project returns. The involvement and interference of
power groups in a project may take the form of more
frequent administrative checks and political corruption.
The latter is regarded by many foreign companies as an
unavoidable fact of life on projects in certain developing
countries, especially in China and Vietnam. There is the
associated risk either of spending too much money on
corrupt officials or spending it at the wrong place or
time—all at the risk of having a government agency
subsequently turn against the firm and the project for
reasons other than cost or technical considerations."
Measuring Political Risk
• Instability: The probability of encountering political
risk in a host country is considered to be directly
related to the relative stability the country's political
system. This instability may have its roots in
different economic, political, and social factors.
Some specific causal factors may include communal
unrest, strained international relations with
neighboring countries, social unrest, newly-acquired
independence, vested interests of home country
industrial groups, proximity to armed conflict, etc.
The political instability can thus be measured as
qualitative or quantitative accounting of these
correlates. An index of political instability is often

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produced using these factors and marketed as
political risk analysis (Ashley & Bonner, 1987).
This approach of measuring political risk, however,
may not be ideal for all situations. Political
instability may not always effect all international
businesses in a country. In some situations, political
instability may lead to changes that may not be at all
critical to most construction ventures. Rather than
political stability, the direction in changes in
government may be more important in certain
situations.
• Past patterns: Past patterns of political behavior is at
times analyzed to determine political risk involved.
However, predicting political risk on the basis of
historical records has its own drawbacks. Political
situations under which risks were encountered by
companies or individuals in the past might have
changed altogether; the changed circumstances may
provide a better environment for foreign investment
(e.g. Vietnam).
• Opinion analysis: Political risk may also be
measured qualitatively by examining the views of
people engaged in governmental decision making
and people who may influence future political
events affecting business. It involves the analysis of
statements of such people to determine their views
on business in general, foreign capital investment,
the means of effecting economic changes, and their
feeling toward the host country in question. Such
statements, however, should be analyzed to
determine their "inner meanings." (Sometimes
statements are made for making emotional appeals
or merely to appease a particular interest group or

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social class.)
• Political Risk Management (Ashley & Bonner,
1987)
• Avoidance: Selecting only safe environments for
business and rejecting regions that are perceived to
have greater than average degree of political risk.
• Premium for risk: Increasing the ROI (return on
investment) or requiring shorter period of payback.
• Adaptation: Responding to the particular political
environment of the host country and structuring the
international operations accordingly (e.g. adapting
to the local methods, utilization of host country
professional expertise, joint venture, etc.).
• Transfer: Sharing of risks with other individuals or
companies or reducing the risks through transfer to
other agencies.

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

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

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

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Political Strategies for Conducting
INTERNATIONAL BUSINESS
Some of the steps that an individual or a company may
follow in order to establish political strategies:
• Identifying the issue (e.g. protectionism,
environmental standards, human rights, workers
rights, etc.)
• Defining the nature of the political issue
• Assessing the potential political action of other
firms and of special interest groups
• Identifying important institutions and key
individuals
• Formulation of strategies (objectives, alternatives)
• Determining the impact of implementation (both in
home and host countries)
• Selection of the most appropriate strategy and
implementation.