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Chapter 2: Understanding Politics, Laws, and Economics
Chapter Outline
LO1: Identify two types of institutions.
1. Key Concepts
Institutions are popularly known as the “rules of the game.” Building on the “rules of the
game” metaphor, Douglass North, a Nobel laureate in economics, more formally defines
institutions as “the humanly devised constraints that structure human interaction.” An
institutional framework is made up of both the formal and informal institutions governing
individual and firm behavior. Richard Scott, a leading sociologist, identifies three pillars that
support these institutions: regulatory, normative, and cognitive. Formal institutions include
laws, regulations, and rules. On the other hand, informal institutions include norms, cultures,
and ethics.
2. Key Terms
3. Discussion Exercise
In the scenarios listed below, have students identify whether they are influenced by formal
institutions or informal institutions.
LO2: Explain how institutions reduce uncertainty.
1. Key Concepts
While institutions do many things, their key role is to reduce uncertainty. Specifically,
institutions influence the decision-making process of both individuals and firms by signaling
what conduct is legitimate and acceptable and what is not. Uncertainty surrounding
economic transactions can lead to transaction costs, which are the costs associated with
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Chapter 2: Understanding Politics, Laws, and Economics
2. Key Terms
Opportunism: The act of seeking self-interest with guile
Transaction costs: Cost associated with economic transactions or, more broadly, the cost
of doing business
3. Discussion Exercise
Since the previous section refers to institutions as “rules of the game,” have students
participate in an exercise in which they have to invent a game. Have students form small
LO3: Identify the two core propositions underpinning an institution-based view of global
business
1. Key Concepts
How do institutions matter? The institution-based view suggests two core propositions (see
Exhibit 2.3). First, managers and firms rationally pursue their interests and make choices
within institutional constraints. Second, while formal and informal institutions combine to
govern firm behavior, informal constraints play a larger role in reducing uncertainty and
providing constancy for managers and firms in situations where formal constraints are
unclear or fail.
2. Discussion Exercise
The importance of institutions to the conduct of business can be seen in recent attempts by
world governments to stem the global financial downturn through various policy changes. In
areas as diverse as lending, taxation, and infrastructure, the governments of several nations
have passed substantial legislation intended to stimulate economic growth. These policies
provide a first-hand account of how institutions affect the conduct of business around the
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Chapter 2: Understanding Politics, Laws, and Economics
LO4: List the differences between democracy and totalitarianism
1. Key Concepts
A political system refers to the rules of the game on how a country is governed politically. At
the broadest level, there are two primary political systems: democracy and totalitarianism.
This section first outlines these two systems and then discusses their ramifications for
political risk.
2. Key Terms
3. Discussion Exercise
Changes in a nation’s government represent significant opportunities or crises to
multinational enterprises (MNEs) because of their impact on these businesses. For 24 years,
the nation of Iraq was a single-party, totalitarian state under the control of Saddam Hussein.
In 2003, he was overthrown during the invasion of the U.S.-led coalition. Totalitarian rule
was replaced in 2004 with a U.S.-sponsored Coalition Provisional Authority, and this was
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Chapter 2: Understanding Politics, Laws, and Economics
LO5: List the differences among civil law, common law, and theocratic law.
1. Key Concepts
A legal system refers to the rules of the game on how a country’s laws are enacted and
enforced. By specifying the do’s and don’ts, a legal system reduces transaction costs by
minimizing uncertainty and combating opportunism. Laws in different countries typically
are not enacted from scratch but are often transplanted—voluntarily or otherwise—from
three legal traditions (or legal families): civil law, common law, and theocratic law.
2. Key Terms
LO6: Articulate the importance of property rights and intellectual property rights.
1. Key Concepts
One fundamental economic function that a legal system serves is to protect property rights,
which are the legal rights to use an economic property (resource) and to derive income and
benefits from it. While the term “property” traditionally refers to tangible pieces of property
such as land, intellectual property (IP) specifically refers to intangible property that is the
result of intellectual activity (such as the content of books, videos, and websites). Intellectual
property rights (IPR) are legal rights associated with the ownership of intellectual property.
IPR primarily include rights associated with patents, copyrights, and trademarks. IPR need
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Chapter 2: Understanding Politics, Laws, and Economics
2. Key Terms
3. Discussion Exercise
LO7: List the differences among market economy, command economy, and mixed
economy.
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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Chapter 2: Understanding Politics, Laws, and Economics
1. Key Concepts
An economic system refers to the rules of the game on how a country is governed
economically. A pure market economy is characterized by the “invisible hand” of market
2. Key Terms
LO8: Explain why it is important to understand the different institutions when doing
business abroad.
1. Key Concepts
Debate: Emerging Markets/Ethical Dilemma
Is Democracy Good for Economic Development?
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Chapter 2: Understanding Politics, Laws, and Economics
1. Key Concepts
Democracy is good. Dictatorship is bad. Although crude, these two statements fairly
accurately summarize the political sentiments in many parts of the world. Compared with
dictatorships, on average, democracies are richer, less corrupt, and less likely to go to war.
However, according to the Economist, democracy is “going through a difficult time.” In new
Closing Case Discussion Guide
Carlsberg Confronts Political Risk in Russia
In the early 1900s, Danish firms rushed to invest in Czarist Russia, building engine factories,
cement plants, and slaughterhouses. Then came the Russian Revolution of 1917, and all was lost
as these businesses were expropriated. When Soviet rule came to an end in 1991, Danish firms
rushed in again. The world’s fourth largest beer maker, Carlsberg was particularly successful,
building a 38 percent market share and becoming the undisputed leader in Russia.
In the 1990s, when Russia was experimenting with democracy, the economy collapsed. While
brewing is not a politically sensitive industry, institutional transitions still had a profound impact
on Carlsberg. The selling of alcohol in street kiosks was banned, which traditionally enjoyed 26
percent of off-trade sales (retail sales other than those in restaurants, bars, and hotels) of beer in
Russia.
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Chapter 2: Understanding Politics, Laws, and Economics
Video Case
Watch “Entering the Chinese Market” by Eric Tarchoune of Dragonfly Group, Ltd
1. In what ways did Tarchoune’s knowledge of the Chinese language contribute to
his success? Why was it particularly important given the areas of China he visited?
2. Western businesses depend on documents and written contracts. What challenge
did Tarchoune encounter and how did he cope?
3. What did Tarchoune mean when he said that the rules were “not written on the
wall”? What does that suggest when doing business in other countries and cultures?
4. In many parts of Asia, respect is gained with age, but Tarchoune was quite young
when he went to China. If a young foreign manager were to be sent to China, what could
he or she do to improve his or her managerial effectiveness in that country?
5. Tarchoune indicated that there would be some differences in doing business in the
larger modern cities of China as compared to where he went. To what extent do you think
that such might be the case in other parts of the world? Do you think that Western business
people may have a preference for cities that may cause them to ignore opportunities in
rural areas? Why?
Additional Discussion Material
(From Prep Cards
Critical Discussion Question
1. Without looking at any references, please identify the top three countries with the most
significant change in political risk in the last five years. Why do you think so?
Students’ answers will vary. They should provide explanations for their answers.
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Chapter 2: Understanding Politics, Laws, and Economics
2. On Ethics: As a manager, you discover that your multinational’s products are
counterfeited by small family firms that employ child labor in rural Bangladesh. You are
aware of the corporate plan to phase out these products soon. You also realize that once
you report to the authorities, these firms will be shut down, employees will be out of work,
and families and children will be starving. How do you proceed?
Students’ answers will vary. They should provide explanations for their answers.
3. On Ethics: Your multinational is the largest foreign investor and enjoys good profits in
(1) Sudan, where government forces are reportedly cracking down on rebels and killing
civilians; and (2) Vietnam, where religious leaders are reportedly being persecuted. As a
country manager, you understand that your firm is pressured by activists to exit these
countries. The alleged government actions, which you personally find distasteful, are not
directly related to your operations. How would you proceed?
Review Question
1. Name the one pillar that supports formal institutions and the two additional pillars that
support informal institutions.
2. Explain the two core propositions underpinning the institution-based view of global
business.
3. How does political risk affect global business?
Political risk is a risk associated with political changes that may negatively impact
domestic and foreign firms. The most extreme political risk may lead to nationalization
(expropriation) of foreign assets. It is hardly surprising that foreign firms are frustrated and
would rather go to “greener pastures” elsewhere.
4. Describe the differences among the three types of legal systems.
The three types of legal systems are as follows: civil law, common law, and theocratic law.
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Chapter 2: Understanding Politics, Laws, and Economics
Civil law uses comprehensive statutes and codes as a primary means to form legal
judgments. Common law is shaped by precedents and traditions from previous judicial
decisions. Theocratic law is a legal system based on religious teachings.
5. Name and describe the three economic systems. Which economic system is the most
common?
6. Generally, what is the result of strong, effective, market-supporting formal institutions?
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
