02 - Formal Institutions: Political, Economic and Legal System

Question 1

Institutional Perspectives on International Business

Answer 1

the institutional framework, governing a particular context is made up of formal and informal institutions governing individual and firm behavior

Question 2

Transaction costs

Answer 2

• costs associated with economic transactions or the cost of doing business
• costly to organize transactions using market mechanisms and as a consequence economic actors organize themselves in less costly ways, e.g. firms

Question 3

Institutions can be classified according three “pillars”

Answer 3

• regulatory: coercive power of governments
• normative: mechanisms through which norms influence individual and firm behaviour
• cognitive: internalized, taken for granted values and beliefs that guide individual and firm behavior

Question 4

What do Institutions do?

Answer 4

• reduce uncertainty through signaling what conduct is legitimate and what is not
  
  • Political uncertainty (e.g. expropriation)
  • Economic uncertainty (e.g volatile exchange rates)
  • Behavioral uncertainty (e.g. partner does not carry out obligations)
• reduce potential for opportunistic behavior by establishing rules of the game
  
  • e.g. risk of failure to fulfill a contract mitigated by formal courts

Question 5

Two core propositions of the institution based view

Answer 5

• Managers and Firms rationally pursue their interests and make choices within the formal and informal constraints in a given institutional framework
• Although formal and informal institutions combine to govern firm behaviour, in situations in which formal constraints are unclear or fail, informal constraints will play a larger role in what managers do

Question 6

Formal institutions examples

Answer 6

• laws
• regulations
• rules

Question 7

Informal institutions examples

Answer 7

• norms
• cultures
• ethics

Question 8

Formal institutions

Answer 8

• political systems
• economic systems
• legal systems

Question 9

Political system

Answer 9

rules of the game on how a country is governed politically

Question 10

Types of political system

Answer 10

• Democracy
• Totalitarianism

Question 11

Political risk

Answer 11

is the risk associated with political changes that may negatively impact domestic and foreign firms

Question 12

Democracy definition

Answer 12

System in which citizens elect representatives to govern the country on their behalf

Question 13

Totalitarianism definition

Answer 13

System in which one person or party exercises absolute political control over the population

Question 14

Why are political elections - even in other countries - important for business?

Answer 14

• political systems determine who sets the rules, and whose interest may be reflected in the rules
• political systems also determine where and how businesses may be able to influence legislative processes through lobbying (mostly legal) or corruption (mostly illegal)
• influence how frequently the rules of the game are changed, a major source of political risk

Question 15

Market economy

Answer 15

• characterized by the “invisible hand” of market forces
• government takes a hands-off, or laissez faire, approach
• all factors of production are privately owned

Question 16

Command economy

Answer 16

• government taking the “commanding height” in the economy
• all factors of production are government- or state owned and controlled
• all supply, demand, and pricing are planned by the government

Question 17

Varieties of Capitalism

Answer 17

scholarly view suggesting that economies have different inherent logics on how markets and other mechanisms coordinate economic activity

Question 18

Varieties of Capitalism: Liberal Market economy

Answer 18

A system of coordination primarily through market signals

Question 19

Varieties of Capitalism: Coordinated Market Economy

Answer 19

System of coordination through a variety of other means in addition to market signals

Question 20

Civil law

Answer 20

a legal tradition that uses comprehensive statutes and codes as primary means to form legal judgments

Question 21

Common law

Answer 21

• a legal tradition that is shaped by precedents and traditions from previous judicial decisions
• case law: rules of the game that have been created by precedents of cases in court

Question 22

debates provoked by formal institutions

Answer 22

• property rights
• corporate governance
• political risks

Question 23

property rights

Answer 23

legal rights to use an economic property resource and to derive income and benefits from it

Question 24

intellectual property rights

Answer 24

rights associated with the ownership of intellectual property

Question 25

patents

Answer 25

legal rights awarded by government authorities to inventors of new technological ideas, who are given exclusive (monopoly) rights to derive income from such inventions through activities such as manufacturing, licensing or selling

Question 26

copyrights

Answer 26

the exclusive legal right of authors and publishers to publish and disseminate their work

Question 27

trademark

Answer 27

exclusive legal rights of firms to use specific names, brands and designs to differentiate their products from others

Question 28

Institutions and political risk

Answer 28

• Business prefer institutional environements, which make it easier to plan for the long term
• Changes in law such as new taxation or regulation are common around the world and represent a mild form of political risk
• Even small changes can shift the playing field between foreign and local players
• More serious political risk arise from military embargoes or trade sanctions
• Other sources of political risk include civil wars, riots, protests and breakdowns of public order; which can cause major lossess to businessers
• The most extreme risk is nationalization (expropriation) of foreign assets