978-1337406826 Chapter 2 Solution Manual

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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

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

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

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

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.

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?

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.

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.

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.

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?