2.7: Implications of Changing Political Economy Flashcards
Transition to Market-Based Economy
Transitioning to a market-based economic system, particularly in post-communist
Eastern European states, has often been accompanied by economic and political chaos.
Liberalization of economies, privatization, and competition led to some inefficiencies, state support for failing enterprises, budget deficits, and hyperinflation.
Successful Transition Policies
“Shock therapy” economic policies, characterized by quick liberation of prices and trade, tight monetary policy to control inflation, and rapid privatization, were successful in Eastern European states like the Czech Republic, Hungary, and Poland.
These policies correlated with faster economic growth compared to countries that implemented reforms more slowly.
Implications for International Business
The end of the Cold War and the global shift towards free markets and democracy have opened up previously closed markets in Eastern Europe, Latin America, Africa, and Asia.
These markets, though still undeveloped, are potentially enormous and offer significant opportunities for international businesses.
Associated Risks
Despite the potential gains, there are substantial risks involved in doing business in these new market economies. T
he future of democracy in Eastern Europe is uncertain, and there’s a possibility of economic setbacks.
The world may shift from a bipolar to a multipolar structure dominated by different civilizations, leading to conflicts and challenges for international investments.
Companies must consider these risks while exploring opportunities in these markets.
Implications for International Business
The implications for international business from the material discussed in this chapter fall into two main categories.
The first category relates to how a country’s political, economic, and legal environment influences its attractiveness as a market or investment site.
This includes assessing the benefits, costs, and risks associated with doing business in that country.
Attractiveness
A country’s overall attractiveness for international business is determined by balancing the long-term benefits, costs, and risks associated with doing business in that country.
Several factors contribute to these determinants, which affect a company’s decision to enter or invest in a particular market.
Benefits of Doing Business in a Country
The long-term monetary benefits of doing business in a country depend on factors such as the size of the market, the purchasing power of consumers, and the country’s future economic prospects.
While some countries may have a large population, low living standards can limit their economic market size.
However, assessing a country’s future potential is crucial, as rapid economic growth can transform a seemingly impoverished nation into a significant market.
Early Entrants vs. Late Entrants
Early entrants into potential future economic stars may gain advantages such as **building brand loyalty, gaining experience in the country’s business practices, and achieving substantial first-mover advantages. **
In contrast, late entrants may face disadvantages, including the challenge of competing with established players.
Economic System and Property Rights
A country’s economic system and property rights regime can serve as reliable indicators of its economic prospects.
Free market economies with strong property rights tend to experience higher economic growth rates compared to command economies or those with weak property rights.
Therefore, a country’s economic system and property rights, combined with market size, can provide insights into the potential long-term benefits of doing business there.
Political Factors Affecting Costs
In some countries, the costs of doing business can increase due to the need to pay off politically powerful individuals or entities in exchange for market access.
This need to pay essentially bribes is more prevalent in closed totalitarian states compared to open democratic societies.
Economic Factors Affecting Costs
The sophistication of a country’s economy is a critical economic factor influencing the costs of doing business.
Less developed economies may lack necessary infrastructure and supporting businesses, potentially forcing international firms to provide their own, thus raising costs.
McDonald’s Example in Russia
McDonald’s decision to open its first restaurant in Moscow required vertical integration backward to ensure product quality.
The company had to establish its own dairy farms, cattle ranches, vegetable plots, and food processing plants within Russia to meet quality standards, increasing the cost of doing business in Russia.
Legal Factors Impacting Costs
Legal factors influencing the cost of doing business include strict standards and regulations related to product safety, workplace safety, and environmental pollution.
Inadequate business contract laws in some countries can lead to difficulties in resolving contract disputes, resulting in substantial losses for international firms
Additionally, countries with weak intellectual property protection can lead to the unauthorized use or theft of an international business’s intellectual property.
This, in turn, can result in lost income and increased costs for businesses operating in such countries.
Political Factors Affecting Risks
Political risk refers to the likelihood of political forces causing significant changes in a country’s business environment that can negatively impact a business enterprise’s profitability and goals.
Political risk tends to be higher in countries experiencing social unrest, disorder, or factors that increase the likelihood of such unrest
Social Unrest as a Form of Political Risk
Social unrest often manifests as strikes, demonstrations, terrorism, and violent conflicts, all of which can disrupt business operations.
Social unrest is more likely in countries with multiple ethnic nationalities, competing political ideologies, economic mismanagement (e.g., high inflation), or those situated near fault lines between civilizations.
Economic Impact of Social Unrest
Social unrest can lead to sudden changes in government policies and even abrupt changes in government, affecting business operations.
Prolonged civil strife resulting from social unrest can have detrimental economic consequences, such as the seizure of assets without compensation or the collapse of local economies.
Examples of Political Risk Impact
After the 1979 Islamic revolution in Iran, the new Iranian government seized the Iranian assets of numerous U.S. companies without compensation.
The violent breakup of the Yugoslavian federation into warring states like Bosnia, Croatia, and Serbia led to economic collapse and reduced profitability for investments in those countries.
Business Costs of Protests in Chile and Hong Kong
The 2018 and 2019 protests in Chile and Hong Kong resulted in significant business costs, including the closure of roads, ports, stock exchanges, hotels, customs points, and airports.
These disruptions made it increasingly difficult for businesses to continue their operations, affecting various sectors, including academia, as seen in the relocation of the Academy of International Business annual meeting.
Economic Risk Due to Government Mismanagement
Economic risk arises when government mismanagement of a country’s economy leads to significant changes in the business environment, negatively impacting the goals and profitability of businesses.
While economic risks often correlate with political risks, they are treated as a distinct category because economic mismanagement does not always directly result in social unrest.
Indicators of economic mismanagement include a country’s inflation rate and the level of debt, both in the business and government sectors.
Asian Financial Crisis of 1997-98
Point 1: Rapid increase in business debt in Asian countries like Indonesia, Thailand, Malaysia, and South Korea during the 1990s was encouraged by the government for “strategic importance” industries.
Point 2: Overinvestment led to excessive industrial and commercial capacity, resulting in many uneconomic investments.
Point 3: Inability to generate profits for debt payments led to a surge in nonperforming loans for banks, and foreign investors began pulling their money out of these countries, triggering the 1997-98 financial crisis in Southeast Asia.
Point 4: The crisis included a severe decline in Asian stock markets, currency devaluation, reduced local demand, and prolonged economic recession.
Government Intervention During the 2008-09 Financial Crisis
Point 1: During the 2008-09 worldwide financial crisis, governments in countries like the United States intervened in various ways to address the crisis.
Point 2: Interventions ranged from bailouts and acquisitions of struggling financial companies (e.g., Bear Stearns, Lehman Brothers, AIG) to providing financial aid to non-financial companies like General Motors.
Point 3: These interventions demonstrated that even governments committed to free-market principles were willing to take an activist role in managing their economies and supporting specific companies during crises.
Impact of Financial Crisis on Countries
Point 1: Financial crises have widespread effects on countries, not limited to individual companies.
Point 2: Countries often borrow money to support their spending, and during crises, their tax base shrinks due to declining property values, reduced consumer spending, and higher unemployment.
Point 3: Different countries experience financial crises in different ways, with varying impacts on their economies.
Legal Risks in International Business
Legal risks arise when a country’s legal system lacks sufficient safeguards against contract violations and property rights violations.
Point 2: Weak legal safeguards can lead firms to break contracts or expropriate intellectual property opportunistically.
Point 3: High legal risks in a country may deter international businesses from entering into long-term contracts or joint ventures with local firms.
Point 4: Organizations like the European Commission and the World Justice Project assess countries’ legal systems and their performance in upholding the rule of law.
Overall Attractiveness of a Country for International Business
The attractiveness of a country for international business depends on evaluating the benefits, costs, and risks associated with doing business there.
Point 2: Generally, costs and risks are lower in economically advanced, politically stable democratic nations and higher in less developed, politically unstable nations.
Point 3: Future economic growth rates play a crucial role in determining the long-term benefits of doing business in a country.
Point 4: Economies with free market systems and growth potential are likely to offer a more favorable benefit-cost-risk trade-off.
Point 5: In contrast, politically unstable, mixed or command economies, and nations with speculative financial bubbles may have less favorable trade-offs for international businesses.
