CHAPTER 3
POLITICAL ECONOMY AND ETHICS
LEARNING OBJECTIVES:
3.1 Describe the key features of each form of political system.
3.2 Explain how the three types of economic systems differ.
3.3 Summarize the main elements of each type of legal system.
3.4 Outline the global legal issues facing international firms.
3.5 Describe the main issues of global ethics and social responsibility.
CHAPTER OUTLINE:
Introduction
Political Systems
Totalitarianism
Theocratic Totalitarianism
Secular Totalitarianism
Doing Business in Totalitarian Countries
Democracy
Representative Democracy
Doing Business in Democracies
Economic Systems
Centrally Planned Economy
Origins of the Centrally Planned Economy
Decline of Central Planning
Failure to Create Economic Value
Failure to Provide Incentives
Failure to Achieve Rapid Growth
Failure to Satisfy Consumer Needs
Mixed Economy
Origins of the Mixed Economy
Decline of Mixed Economies
Move toward Privatization
Market Economy
Origins of the Market Economy
Laissez-Faire Economics
Features of a Market Economy
Government’s Role in a Market Economy
Enforcing Antitrust Laws
Preserving Property Rights
Providing a Stable Fiscal and Monetary Environment
Preserving Political Stability
Economic Freedom
Legal Systems
Common Law
Copyright © 2016 Pearson Education, Inc.
Civil Law
Theocratic Law
Global Legal Issues
Intellectual Property
Industrial Property
Copyrights
Product Safety and Liability
Taxation
Antitrust Regulations
Ethics and Social Responsibility
Philosophies of Ethics and Social Responsibility
CSR Issues
Bribery and Corruption
Labor Conditions and Human Rights
Fair Trade Practices
Environment
Bottom Line for Business
A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 3.
These slides and the lecture outline below form a completely integrated package that simplifies the
teaching of this chapter’s material.
Lecture Outline
I. INTRODUCTION
This chapter considers the basic differences between political and legal systems around the
world. Disputes grounded in political and legal matters affect business activities, but companies
can manage the associated risks.
II. POLITICAL SYSTEMS
A political system includes the structures, processes, and activities by which a nation governs
itself. A nation’s political system derives from its history and culture, and includes such factors
as population, age, race composition, and per capital income.
The political system also allows for Participation, which occurs when people voice opinion,
vote and show general approval or disapproval of the system.
A. Totalitarianism is the belief that every aspect of people’s live
Must be controlled in order for a political system to be effective. Anarchism is the belief
that only individuals, and private groups should control a nation’s political activities.
Pluralism is the belief that private and public groups belong in politics. Individuals
govern without the support of the people, the government tightly controls people’s lives,
and do not tolerate opposing viewpoints. These governments share three features:
imposed authority, lack of constitutional guarantees, and restricted participation.
1. Theocratic totalitarianism: political system under the control of totalitarian
religious leaders.
2. Secular totalitarianism: political system in which leaders rely on military and
bureaucratic power. It takes three forms: Communist, tribal and right wing.
a. Communism: obtain social and economic equality only by establishing an
all-powerful Communist Party and by granting the government
ownership and control over all types of economic activity, and by
instituting socialism, a system in which the government owns and
controls all types of economic activity
b. Tribal totalitarianism: one ethnic group imposes its will on others with
whom it shares a national identity.
c. Right-wing totalitarianism: government endorses private ownership of
property and a market-based economy but grants few (if any) political
freedoms. Leaders strive for economic growth but oppose left-wing
totalitarianism, or communism.
4. Doing business in totalitarian countries: Companies need not be concerned with
political opposition outside the government. It can be risky because the law
is vague or nonexistent, and people in powerful government positions can
interpret laws at will.
B. Democracy – a political system in which government leaders are elected directly by
wide participation of the people or their representatives.
1. In representative democracies, citizens elect individuals from their groups to
represent their political views.
2. Representative democracies strive to provide: freedom of expression; periodic
elections; full civil and property rights; minority rights; and nonpolitical
bureaucracies.
3. Doing business in democracies: Democracies tend to maintain stable business
environments through laws protecting individual property rights. Participative
democracy, property rights, and free markets encourage (not guarantee)
economic growth.
4. Capitalism: belief that ownership of the means of production belongs in the
hands of individuals and private businesses.
III. ECONOMIC SYSTEMS
Economic system: structure and processes a country uses to allocate its resources and conduct
its commercial activities. No economy reflects a completely individual or group orientation but
displays a blend of individual and group values.
A. Centrally Planned Economy
Land, factories, and other economic resources are owned by the government, which
plans nearly all economic activity. Ultimate goal is to achieve political, social, and
economic objectives through complete control of production and distribution of
resources.
1. Origins of the centrally planned economy
a. Group welfare is more important than individual well-being, and thus
strives to achieve economic and social equality.
b. Karl Marx in the 1800s argued the economy must be overthrown and
replaced with an equitable “communist” system.
c. By the 1970s, central planning was the economic law in lands stretching
across Central and Eastern Europe (Albania, Bulgaria, Czechoslovakia,
East Germany, Hungary, Poland, Romania, and Yugoslavia), Asia
(Cambodia, China, North Korea, and Vietnam), Africa (Angola and
Mozambique), and Latin America (Cuba and Nicaragua).
2. Decline of central planning
a. In the late 1980s, nation after nation began to dismantle communist
central planning in favor of market-based economies. Shortly after the
former Soviet Union implemented its twin policies of glasnost (political
openness) and perestroika (economic reform), its totalitarian government
crumbled. Communist governments in Central and Eastern Europe fell
soon after, and today countries such as the Czech Republic, Hungary,
Poland, Romania, and Ukraine have republican governments. There are
far fewer communist nations than there were two decades ago, although
Cuba and North Korea remain hard-line communist nations. These
nations dismantled central planning in favor of market-based economics
for several reasons.
b. Failure to create economic value: Central planners failed to produce
quality products efficiently.
c. Failure to provide incentives: Government ownership limited incentives
to maximize benefits from resources, which lowered economic growth
and living standards.
d. Failure to achieve rapid growth: Leaders realized their nations were
falling quickly behind other nations (lack of innovation).
e. Failure to satisfy consumer needs: Consumers’ basic needs were not
being met.
B. Mixed Economy
Land, factories, and other economic resources are more equally split between private
and government ownership. Government controls economic sectors important to
national security and long-term stability. Generous welfare system supports unemployed
and provides health care.
1. Origins of the mixed economy
a. Successful economy must be efficient and innovative, but also protect
society. Goals are low unemployment, low poverty, steady economic
growth, and an equitable distribution of wealth.
b. Mixed economies are modernizing to be more competitive.
2. Decline of mixed economies
Mixed economies are converting to market-based systems. Government
ownership means less efficiency, innovation, responsibility, and accountability;
higher costs; slower growth; and higher taxes and prices.
a. Move toward privatization
i. Selling government-owned economic resources to private
companies and individuals.
ii. Increases efficiency, cuts subsidies to state-owned firms, curtails
appointment of managers for political reasons.
C. Market Economy
Most land, factories, and other economic resources are privately owned, either by
individuals or businesses. Price mechanism determines:
Supply: Quantity of a good or service that producers are willing to provide at
a specific selling price.
Demand: Quantity of a good or service that buyers are willing to purchase at
a specific selling price.
1. Origins of the market economy
Individual concerns are above group concerns. The group benefits when
individuals receive incentives and rewards to act in certain ways.
a. Laissez-faire economics: French for “allow them to do [without
interference].” Individualism fosters democracy as well as a market
economy.
2. Features of a market economy
a. Free choice: individuals have purchase options.
b. Free enterprise: companies can decide what to produce and which
markets to compete in.
a. Price flexibility: prices rise or fall reflecting supply and demand.
3. Government’s role in a market economy
Little direct involvement, but plays four important roles:
a. Enforce antitrust laws
i. Goal of antitrust (antimonopoly) laws is to encourage the
development of industries with as many competing businesses as
the market will sustain.
ii. Prevent trade-restraining monopolies and combinations that
exploit consumers and constrain commerce.
b. Preserve property rights
i. Encourage individuals and firms to take risks such as technology
investments, new product invention.
ii. Legally safeguard claims to assets and future incomes they
generate.
c. Provide a stable fiscal and monetary environment
i. Influence inflation and unemployment rates through effective
fiscal and monetary policies.
ii. Stability improves company forecasts and reduces risks
associated with future investments.
d. Preserve political stability
i. Market economy depends on a stable government.
ii. Helps companies avoid worrying about political risk.
4. Economic freedom
a. Connection between political freedom and economic growth is very
uncertain.
b. Greater economic freedom tends to coincide with higher living standards.
IV. LEGAL SYSTEMS
Set of laws and regulations, including the process by which laws are enacted and enforced and
the ways in which courts hold parties accountable for their actions. It is influenced by cultural
variables, including class barriers, religious beliefs, emphasis on individualism or conformity,
and the political system. Totalitarian governments favor public ownership and enact laws
limiting entrepreneurial behavior. Democracies encourage entrepreneurial activity and protect
businesses with property-rights laws.
A. Common Law
Tradition: Country’s legal history
Precedent: Past cases that have come before the courts
Usage: How laws are applied in specific situations
1. Originated in England in the eleventh century and adopted in its territories
worldwide.
2. Business contracts tend to be lengthy because they consider many contingencies
and possible interpretations in case of dispute. Common law systems are
flexible, taking into account particular situations and circumstances.
3. Practiced in Australia, Britain, Canada, Ireland, New Zealand, the United States,
and some nations in Asia and Africa.
B. Civil Law
1. Based on a detailed set of written rules and statutes that constitute a legal code.
Can be traced to Rome in the fifth century B.C. and is the oldest and most
common legal tradition.
2. Can be less adversarial than common law because it is not interpreted according
to tradition, precedent, and usage. Because laws are codified and concise, parties
are concerned with the explicit wording of the code; obligations, responsibilities,
and privileges follow the relevant code.
3. Practiced in Cuba, Puerto Rico, Quebec, Central and South America, most of
Western Europe, and parts of Asia and Africa.
C. Theocratic Law
1. Legal tradition based on religious teachings (e.g., Islamic, Hindu, and Jewish
law).
2. Islamic law is the most widely practiced theocratic legal system today. It was
initially a code governing moral and ethical behavior and was later extended to
commercial transactions. It restricts investments and sets guidelines for business
conduct.
3. Firms operating in countries with theocratic legal systems must be sensitive to
local values and beliefs. They must evaluate business activities, including hiring
practices and investment policies, to ensure compliance with the law, local
values, and beliefs.
V. GLOBAL LEGAL ISSUES
Companies must adapt to dissimilar legal systems in global markets because there is no clearly
defined body of international law that all nations accept. There is a movement toward
standardizing the interpretation and application of laws in more than one country, but this does
not involve standardizing entire legal systems. Enduring differences, therefore, can force
companies to continue the costly practice of hiring legal experts in each country where they
operate.
A. Intellectual Property
1. Results from intellectual talent and abilities such as graphic
designs, novels, computer software, machine-tool designs, and secret formulas.
2. Property rights are the legal rights to resources and any
income they generate. Intellectual property can be traded, sold, and licensed in
return for fees or royalty payments.
a. Industrial property is often a firm’s most valuable asset. Laws protecting
industrial property reward inventive and creative activity.
i. Patent is a right granted to the inventor of a product or process
that excludes others from making, using, or selling the invention.
The WTO grants patents for 20 years.
ii. Trademarks are words or symbols that distinguish a product and
its manufacturer. Trademark protection lasts indefinitely,
provided the word or symbol continues to be distinctive (e.g.,
Xerox).
b. Copyrights give creators of original works the freedom to publish or
dispose of them as they choose.
i. Holder can (1) reproduce the copyrighted work, (2) derive
new works from it, (3) sell or distribute it, (4) perform it, and (5)
display it publicly.
ii. Protected under the Berne Convention and the 1954 Universal
Copyright Convention.
B. Product Safety and Liability
1. Product liability holds manufacturers, sellers, and others, including individual
company officers, responsible for damage, injury, or death caused by defective
products.
2. Developed nations have the toughest product liability laws. Less-developed and
emerging countries have weaker laws.
C. Taxation
1. Tax revenues needed to pay government salaries, build military capacity, and
shift earnings from people with high incomes to the poor.
2. Consumption taxes: indirect taxes that help pay for consequences of using a
particular product and to make imports more expensive.
3. Value added tax (VAT): levied on each party that adds value to a product
throughout its production and distribution.
D. Antitrust Regulations
1. Antitrust (antimonopoly) laws are designed to prevent companies from fixing
prices, sharing markets, and gaining unfair monopoly advantages. Such laws
help ensure a wide variety of products at fair prices.
2. The United States and European Union have strict antitrust regulation and are
strict enforcers. In Japan, the Fair Trade Commission enforces antitrust laws, but
it is often ineffective.
3. In strict antitrust countries, companies see a disadvantage against competitors
whose home countries condone market sharing, whereby competitors agree to
serve only designated market segments.
VI. ETHICS AND SOCIAL RESPONSIBILITY
International managers are exposed to different conceptions of ethical behavior and guidelines
for socially responsible behavior. Child labor, human rights, the environment, and plant
closings are the heart of debates over impact of multinationals.
Ethical Behavior: personal behavior in accordance with guidelines for good conduct
or morality. No right or wrong decisions, but alternatives, each of which may be equally
valid depending on one’s perspective.
Corporate Social Responsibility: practice of companies going beyond legal
obligations to actively balance commitments to investors, customers, other companies, and
communities.
Three layers of CSR activity: (1) company works toward a specific social cause; (2)
company follows a code of conduct and operates with greater transparency; and (3)
company builds social responsibility into its core operations to create value and build
competitive advantage.
A. Philosophies of Ethics and Social Responsibility
1. Friedman View: company’s sole responsibility is to maximize profits for its
owners (or shareholders) while operating within the law.
a. Example: managers would applaud a company moving pollution-
generating operations from a strict country to a lax country.
b. Many disagree with this argument against socially responsible activities.
Today the discussion is not whether a company has CSR obligations, but
how it will fulfill them.
2. Cultural Relativist View: company should adopt local ethics wherever it operates
because all belief systems are determined within a cultural context.
a. Sees truth, itself, as relative and argues that right and wrong are
determined within a specific situation.
b. “When in Rome, do as the Romans do” captures the essence of cultural
relativism.
3. Righteous Moralist View: company should maintain its home-country ethics
wherever it operates because the home-country’s view of ethics and
responsibility is superior to others’ views.
a. Example: company headquarters instructs subsidiary managers to refrain
from bribing local officials and, thereby, imposes its righteous moralist
view on local managers.
4. Utilitarian View: company should behave in a way that maximizes “good”
outcomes and minimizes “bad” outcomes wherever it operates.
a. A utilitarian manager asks the question “What outcome should I aim
for?” and answers, “That which produces the best outcome for all
affected parties.”
b. Example: manager pays a bribe based on calculations that more people
will benefit than will be harmed by the outcome.
B. Bribery and corruption
1. Corruption leads to the misallocation of resources, hurts economic development,
distorts public policy, and damages the integrity of “the system.”
2. Enron’s failure sent a shockwave around the world. Energy trading markets were
in chaos and many lost jobs worldwide.
3. In 2002, Congress passed the Sarbanes-Oxley Act, which set more stringent
accounting standards and reporting practices.
C. Labor conditions and human rights
1. Managers must monitor behavior of themselves, employees, and business
partners.
2. Governments, labor unions, consumer groups, and human rights activists force
apparel companies to implement codes of conduct and monitoring principles in
international production.
D. Fair trade practices
1. Fair trade products: involve companies working with suppliers in more
equitable, meaningful, and sustainable ways.
2. Fair Trade USA (www.fairtradeusa.org) certifies that a product embodies fair
prices, fair labor conditions, direct trade, democratic community development,
and environmental sustainability.
E. Environment
1. Companies pursue “green” initiatives to reduce their toll on the environment and
to reduce operating costs and boost profit margins.
2. Carbon footprint: environmental impact of greenhouse gases (measured in units
of carbon dioxide) that results from human activity.
VIII. BOTTOM LINE FOR BUSINESS
Differences in political and legal systems present both opportunities and risks for international
companies. Understanding differences in culture, politics, and law is the first step for any
company that hopes to manage the risks of doing business in unfamiliar environments.
Managers of international companies also need to understand how global legal issues, including
intellectual property, product safety, and antitrust laws, affect operations and strategy.