Chapter 1

Chapter 6The Political Environment:A Critical Concern1IntroductionInternational law recognizes the sovereign right of a nation to grant or withhold permission to do business within its political boundaries and to control where its citizens conduct business.

Sovereignty of NationsA sovereign state is independent and free from all external control enjoys full legal equality with other states governs its own territoryselects its own political, economic, & social systemshas the power to enter into agreements with other nations.A citizen is subject to the states laws even outside the countrys borders. Nations can and do abridge specific aspects of their sovereign rights to coexist with other nations. The European Union and NAFTA are examples of agreements between nations to give up their sovereignty for free trade and other common benefits. Some countries view the WTO as a threat to sovereignty, the fear of relinquishing their nations rights for a common goal that might not benefit them or be detrimental to their goals. Foreign investment is also viewed as a threat to sovereignty, for example it took many years after the NAFTA was passed for the Mexican government to allow foreign companies to invest in the energy and banking sectors which were government controlled monopolies until then.3Sovereignty of NationsSovereignty refers to both the powers exercised by a state in relation to other countries and the supreme powers exercised over its own membersA state:Sets requirements for citizenshipdefines geographical boundariescontrols trade and the movement of people and goods across its borders.

A citizen is subject to the states laws even outside the countrys borders. Nations can and do abridge specific aspects of their sovereign rights to coexist with other nations. The European Union and NAFTA are examples of agreements between nations to give up their sovereignty for free trade and other common benefits. Some countries view the WTO as a threat to sovereignty, the fear of relinquishing their nations rights for a common goal that might not benefit them or be detrimental to their goals. Foreign investment is also viewed as a threat to sovereignty, for example it took many years after the NAFTA was passed for the Mexican government to allow foreign companies to invest in the energy and banking sectors which were government controlled monopolies until then.4Nations can and do abridge specific aspects of their sovereign rights to coexist with other nations.The European Union & North American Free Trade Agreement (NAFTA) represent examples of nations voluntarily agreeing to give up some of their sovereign rights to participate with member nations for a common, mutually beneficial goal.

Sovereignty of NationsStability of Government PoliciesThe ideal political climate for a multinational firm is a stable, friendly government. Unfortunately, governments are not always stable and friendly, nor do stable, friendly governments always remain so. For foreign firms, the ideal situation is a stable government in the country they are operating in. Unfortunately, this is not always the case. A change in government, whether by election or coup, does not always mean a change in the level of political risk. Conversely, radical changes in policies toward foreign business can occur in the most stable governments as well (Coke in India is an example). The political changes in Mexico in 2000, a change after many years of the PRI party to the PAN party helped open up the Mexican market to foreign investment and a more liberal government trade policy. The newly elected President of Mexico in 2012, Enrique Pea Nieto is planning a major upgrade of the 1994 U.S.-Canada-Mexico free trade deal, that is, he wants NAFTA to expand just beyond the current three country deal if this region is to compete effectively with China and its neighboring countries. He is also proposing greater collaboration with the United States. 6Stability of Government PoliciesRadical shifts in government philosophy can occur when:An opposing political party ascends to powerPressure from nationalist and self-interest groupsWeakened economic conditionsBias against foreign investment or conflicts between governments

For foreign firms, the ideal situation is a stable government in the country they are operating in. Unfortunately, this is not always the case. A change in government, whether by election or coup, does not always mean a change in the level of political risk. Conversely, radical changes in policies toward foreign business can occur in the most stable governments as well (Coke in India is an example). The political changes in Mexico in 2000, a change after many years of the PRI party to the PAN party helped open up the Mexican market to foreign investment and a more liberal government trade policy. The newly elected President of Mexico in 2012, Enrique Pea Nieto is planning a major upgrade of the 1994 U.S.-Canada-Mexico free trade deal, that is, he wants NAFTA to expand just beyond the current three country deal if this region is to compete effectively with China and its neighboring countries. He is also proposing greater collaboration with the United States. 7Instability of Governments and Policies: Political ReasonsSome forms of government seem to be inherently unstableChanges in political parties during elections can have major effects on trade conditions NationalismAnimosity targeted toward specific countriesTrade disputes

Instability can be caused for various reasons, some governments are inherently unstable. An example would be where there are too many political parties that a coalition government has to be formed and is weak and therefore can be ousted by opposition parties. India and Italy are prime examples of coalition governments that have been unstable. When Lucent Technologies sold cellular phones for the first time in India many years ago, they had a huge sale of cell phones that resulted in millions of dollars. However, within six months of this, the Indian government changed and the new political party in power imposed a special tax on all cell phone owners, and this resulted in many giving up their cell phones. The current government in India has a liberal policy on cell phones and therefore there is once again a large penetration of cell phones in the country at all economic and social class levels. Being very nationalistic can be a reason for instability as well as having historical feelings of dislike towards certain countries can lead to specific policies. And, as described at the beginning of the chapter, trade disputes such as the banana wars can lead to specific policies as well.8Forms of GovernmentDemocracy or market directed government ideologyCommunist governmentsTheocratic RepublicIslamic Law countries where political parties can exist but have little powerThe religious leader controls government and all governmental decisions

The form of government greatly dictates the extent of government interference in business activities. Most governments in the world are democracies that allow participation of the countrys citizens in electing their leaders. There a few communist governments in existence, China and Vietnam being prime examples where the rules and regulations for foreign companies can be determined/changed by the government at will in order to benefit that country and its industries. Russia on the other hand moved to a democracy after the break-up of the former USSR, but continues to struggle with the change, corruption is pervasive particularly for foreign investors, and the Russian government is aware of the problem. The other form of government would be countries where religious leaders and religion dictates government, Shariah Law prevails in Islamic countries. Even though political parties are allowed to exist, they have very little power.9

The CIA has classified countries based on government type as illustrated in Exhibit 6.1.10Political PartiesBe knowledgeable about the philosophies of all major political parties & their attitudes towards trade

In Great Britain, for example, the Labour Party traditionally has been more restrictive regarding foreign trade than the Conservative Party. The Labour Party, when in control, has limited imports, whereas the Conservative Party has tended to liberalize foreign trade when it is in power. Portraits of Ayatollah Ali Khamenei (the Supreme Leader) and the late Ayatollah Ruhollah Khomeini loom over Iranian women lined up to vote at a mosque south of Tehran. As mandated by law, women and men waited in separate lines at polling places with more than one ballot box. The current government also specifies the public dress of the women pictured.

11NationalismNationalism refers to feelings of national pride and unity Feelings of nationalism are manifested by: Disaster (e.g. 9/11)WarRecessionCall to buy our countrys products onlyRestrictions on imports, restrictive tariffs, and other barriers to tradeNationalism is an awakening of a nations people to pride in their country. This pride can take lead to anti foreign business sentiment in the nation. Feelings of nationalism can be manifested in a variety of ways such as the reaction of the American people and busineses towards Muslim nations following 9/11. War or recession can create feelings of nationalism as well. Other ways that nationalism can manifest itself is in trade policies such as restrictions on imports from certain countries (imposition of tariffs on shrimp imports from Vietnam, Thailand and India in 2005 to project the U.S. shrimp farmers in the Gulf region), restrictive tariffs (such as the once France imposed on South American Bananas), and other barriers such as specific product standards or health standards that only the countrys industries are able to comply with.12Targeted Fear and/or AnimosityWhen the French tried to thwart Americas plans to oust Iraqi leader Saddam Hussein in 2003 during the Bush era, the United States called for a boycott of French products, especially wine. This was a targeted animosity specifically towards one country. The historical relationship and dispute over the region of Kashmir between India and Pakistan from the time of the British rule still creates feelings of animosity that has an impact on trade between the two countries.13Trade Disputes: ExamplesUndervalued Chinese currency Ban on beef imports into JapanChinese subsidies in apparent violation of WTO rules Farm subsidies in developed countriesAIRBUSBoeing battle over subsidies

14Economic RisksInternational firms face a variety of economic risksGovernments can impose restraints on business activity to:Protect national security Protect an infant industry To conserve scarce foreign exchangeRaise revenue Retaliate against unfair trade practices

Economic risks can be encountered for reasons of national security, to protect an infant industry, to conserve scarce foreign exchange, to raise revenue, or to retaliate against unfair trade practices.

15Economic RisksExchange Controls - when a nation faces shortages of foreign exchange and/or a substantial amount of capital is leaving the country, controls may be levied over all movements of capital to conserve the supply of foreign exchange for the most essential uses. Local Content Laws - countries often require a portion of any product sold within the country to have local content, that is, to contain locally made parts.

Exchange Controls This happens when there is a shortage of foreign exchange in the country and the government restricts the spending in foreign currency. This may result in the imposition of differential exchange rates for different products entering the countryLocal Content Laws All countries and regions may have local content laws, for example NAFTA has a 62.5% local content requirement for cars originating from the NAFTA region, the EU has a 45% local content requirement so that it forces companies to use local components.Import Restrictions Countries may impose import restrictions to protect local farmers or industries, but this may be detrimental to the local economy if it interrupts production in certain industries.Tax Controls Taxes that are imposed on foreign companies but not on domestic companies and caused their products to be more expensive in the country because it is passed on to the consumer.Price Controls Countries can impose price controls on foreign companies selling essential products such as food or gasoline, especially during inflationary periods.Labor Problems Unionism and labor laws are different in different countries and there are especially strict rules for laying off employees by foreign companies. Chinas new labor laws have been revamped and require foreign companies to provide a lot more benefits as well as lifelong employment after a certain number of years of service.16Economic RisksImport Restrictions - selective restrictions on the import of products are fairly common strategies to force foreign industry to purchase more supplies within the host country and thereby create markets for local industry. Tax Controls can be used as a means of controlling foreign investmentsExchange Controls This happens when there is a shortage of foreign exchange in the country and the government restricts the spending in foreign currency. This may result in the imposition of differential exchange rates for different products entering the countryLocal Content Laws All countries and regions may have local content laws, for example NAFTA has a 62.5% local content requirement for cars originating from the NAFTA region, the EU has a 45% local content requirement so that it forces companies to use local components.Import Restrictions Countries may impose import restrictions to protect local farmers or industries, but this may be detrimental to the local economy if it interrupts production in certain industries.Tax Controls Taxes that are imposed on foreign companies but not on domestic companies and caused their products to be more expensive in the country because it is passed on to the consumer.Price Controls Countries can impose price controls on foreign companies selling essential products such as food or gasoline, especially during inflationary periods.Labor Problems Unionism and labor laws are different in different countries and there are especially strict rules for laying off employees by foreign companies. Chinas new labor laws have been revamped and require foreign companies to provide a lot more benefits as well as lifelong employment after a certain number of years of service.17Economic RisksPrice Controls - essential products that command considerable public interest, such as pharmaceuticals, food, gasoline, and cars, are often subjected to price controls.Labor Problems - in many countries, labor unions have strong government support that they use effectively in obtaining special concessions from business. Exchange Controls This happens when there is a shortage of foreign exchange in the country and the government restricts the spending in foreign currency. This may result in the imposition of differential exchange rates for different products entering the countryLocal Content Laws All countries and regions may have local content laws, for example NAFTA has a 62.5% local content requirement for cars originating from the NAFTA region, the EU has a 45% local content requirement so that it forces companies to use local components.Import Restrictions Countries may impose import restrictions to protect local farmers or industries, but this may be detrimental to the local economy if it interrupts production in certain industries.Tax Controls Taxes that are imposed on foreign companies but not on domestic companies and caused their products to be more expensive in the country because it is passed on to the consumer.Price Controls Countries can impose price controls on foreign companies selling essential products such as food or gasoline, especially during inflationary periods.Labor Problems Unionism and labor laws are different in different countries and there are especially strict rules for laying off employees by foreign companies. Chinas new labor laws have been revamped and require foreign companies to provide a lot more benefits as well as lifelong employment after a certain number of years of service.18Political Sanctions: Examples from the U.S.Cuban crisis of the 1960sThe Iranian revolution in the 1980sThe Persian Gulf War in the 1990s The consequences of the U.S. embargo of Cuba: A relatively new Chinese Chery Q, and one of the newest American cars you can find on the island, a 1957 Chevy.

Political and Social ActivistsThe impact of political and social activists (PSAs) can also interrupt the normal flow of trade. PSAs can range from those who seek to bring about peaceful change to those who resort to violence and terrorism to effect change. Political and Social Activists

French farmers tossed tomatoes and such at McDonalds; theyve also lobbed lamb chops at their own trade ministers.Violence, Terrorism & WarViolence and terrorism may be closely related to politicsIn the past 30 years, 80 percent of terrorist attacks against the United States have been aimed at American businesses. War-torn regions are areas of concern for foreign businesses to operate inSeptember 11, 2001 and the attack on the twin towers had numerous consequences, including increasing security measures, the creation of Homeland Security that increased the cost of doing business both domestically and internationally. When there is violence and war as witnessed post September 11th, the target of the violence is usually U.S. businesses as evidenced by companies like McDonalds and Pizza Hut.23Cyberterrorism & CybercrimeCyber terrorism is in its infancyThe internet provides a vehicle for terrorist and criminal attacksInternet Virus attacks can disrupt businessesI Love You MelissaSlammerGoner WormAssessing Political VulnerabilityNo specific guidelines to determine a products political vulnerabilityCountries seeking investments in high-priority industries may well excuse companies from taxes, customs duties, quotas, exchange controls, and other impediments to investment.Firms either marketing products not considered high priority or that fall from favor for some other reason often face unpredictable government restrictions.Firms either marketing products not considered high priority or that fall from favor for some other reason oft en face unpredictable government restrictions. Indias example with Lucent Technologies and cellular phone sales followed by a tax imposition by the Indian government on cell phone users leading to cell phone users giving up their cell phones is a prime example. What Lucent thought was a sale did not turn out to be very profitable because of all the lost customers due to the new tax.

25Politically Sensitive Products and IssuesPolitically sensitive products include those that have an effect on:the environment, exchange rates national and economic security public health, e.g., genetically modified (GM) foods Ban on hormone treated beef in Europe. Closing of a KFC restaurant in India because of the spotting of two flies. (This was mainly because KFC did not enter the country by building a good relationship with the Indian government and their commercials unknowingly mocked the poverty in the country).26Forecasting Political RiskDecide if risk insurance is necessaryDevise an intelligence network and an early warning systemDevelop contingency plans for unfavorable future political eventsBuild a database of past political events for use in predicting future problemsInterpret the data gathered by a companys intelligence network in order to advise and forewarn corporate decision makers about political and economic situations

Risk assessment is used to estimate the level of risk a company is assuming when making an investment and to help determine the amount of risk it is prepared to accept. For example, doing business with India may not bring immediate returns for businesses, but in the long run it may be a profitable decision.27

Top 20 States in Danger of Failing (2011)Foreign Policy magazine uses 12 criteria to rank countries on its Failed States Index.28Lessening Political VulnerabilityLessening Political Vulnerability6-30