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Instructor Manual
Chapter 2: Formal Institutions: Political, Economic and Legal
Systems
(Prepared by Klaus E. Meyer, March 2019)
Introduction to the Topic
Learning Objectives
1. Explain the concept of institutions and their key role in reducing uncertainty
2. Explain the basic differences between political systems
3. Explain the systemic differences between economic systems
4. Explain the basic differences between legal systems
5. Participate in three leading debates on institutions in international business
6. Draw implications for action
General Teaching Suggestions
This chapter introduces the first part of the institution-based view underpinning this book,
namely the formal part of the institution-based view. We do so by reviewing the economic,
political and legal institutions that underpin modern economies, and that explain variations
between them – and in consequence present challenges for those engaging in business across
borders.
The Debates and Extensions at the end of the chapter may give you some ideas for the
development of debate teams. If you regularly read national or international newspaper, you
will likely find something that might be used as a tool to bring out some aspects of this
chapter and might be effective simply because the topic is current.
Opening Case Discussion Guide
Turkey is in many ways similar to other European economies (e.g. the presence of major
businesses), yet in important ways it is not. Changes in a society and an economy can
sometimes occur through natural forces and the use of persuasion but that may take a long
time as opposed to making something happen now by simply passing laws or replacing ruling
party. The Turkish government has sought to use laws as a means of achieving what it views
as economic and social process: In the early 2000 when the focus was on economic reforms,
this brought Turkey closer to shared European rules, more recently social change initiative
have widened the gap. In the global economy where firms around the world can shift where
they do business, the rules of the game in any given country are issues that are of concern.
A particular feature of the opening case is the introduction of a variety of measures of
institutions, with data for Turkey and as benchmarks other Southern European or emerging
economies. Table 2.1 illustrates the challenges of classifying countries by institutional
development: The choice of indicators influences the outcome. It also provides a basis for
discussing the range of institutions included in the concept of formal institutions and thus
included in the Chapter.
The discussion of this case can be opened by asking, Is Turkey an emerging or mature
economy? In which ways does Turkey resemble EU countries, and which ways does it not?
The case can also be combined with the Integrative Case ‘Beko washes clothes across
Europe’, which focuses on a company expanding from Turkey across Europe.
Chapter Outline, Section by Section
Section 1: An institution-based view of IB
Key Ideas
This section introduces the key concepts related to the ’institution-based view, which is
mainly grounded in institutional economics (Douglass North) and organizational sociology
(Richard Scott). However, the intellectual underpinnings of this line of thought are closely
related those by European thinkers in the 19th and 20th century – the text mentions Max
Weber and Walter Eucken as examples.
The key functions of institutions are identified as to reduce uncertainty, curtail transaction
costs, and combat opportunism. The main insights of the institution-based perspective are
summarized in two propositions: Proposition 1: Managers and firms rationally pursue their
interests and make choices within formal and informal institutional constraints in a given
institutional framework. Proposition 2: When formal constraints are unclear or fail, informal
constraints will play a larger role.
Key Concepts
institutions
Formal and informal rules of the game.
institutional framework
Formal and informal institutions governing individual and firm behaviour.
institution-based view
A theoretical perspective in international business suggesting that firm performance is, at least in part,
determined by the institutional frameworks governing firm
transaction costs
The costs of organising economic transactions.
formal institutions
Institutions represented by laws, regulations, and rules.
informal institutions
Rules that are not formalized but exist in for example norms, values, and ethics
regulatory pillar
The coercive power of governments.
normative pillar
The mechanism through which norms influence individual and firm behaviour.
cognitive pillar
The internalized, taken-for-granted values and beliefs that guide individual and firm behaviour.
opportunistic behaviour
Seeking self-interest with guile.
institutional transition
Fundamental and comprehensive changes introduced to the formal and informal rules of the game that
affect organizations as players.
Section 2: Political Systems
Key Ideas
This section has been reorganized from the in the 3rd edition. The main focus is on decision
making within democratic systems, and their impact on businesses. This is a topic that I feel
particularly passionate about because of my experience of having lived in the UK and in
continental European countries. A lot of the differences in public life and politics can be
explained by the way political representatives are elected. It also explains certain differences
in decision making processes that can see within organizations, such as universities.
Instructors may use the structure of In Focus 2.1 to add other recent elections in their own
countries to emphasize these differences.
Key Concepts
political system
A system of the rules of the game on how a country is governed politically.
democracy
A political system in which citizens elect representatives to govern the country on their behalf.
proportional representation
Election system that allocates seats in parliament in proportion to the votes received by each party
(usually subject to minimum threshold).
first-past-the-post system
Election system by which in each constituency the candidate with the relative majority of votes gets the
seat.
authoritarianism
A political system in which power is concentrated in the hands of one person or a small elite.
lobbying
Making your views known to decision makers with the aim of influencing political processes.
corruption
The abuse of public power for private benefits.
political risk
Risk associated with political changes that may negatively impact domestic and foreign firms.
Section 3: Economic Systems
Key Ideas
A pure market economy is characterized by laissez faire and total control by market forces. A
pure command economy is defined by government ownership and control of all means of
production. Most countries operate mixed economies with a different emphasis on market
versus command forces.
Beyond the traditional distinction between capitalism and socialism, we provide the ‘varieties
of capitalism’ perspective, which allows a differentiated discussion of market economies by
distinguishing liberal market economies and coordinated market economies (also see Figure
2.2).
In Focus 2.2 pushes the ‘European’ roots of the institutional thinking further by introducing
an economist whose work was very influential in Germany in the 1950s and 1960s; but who
is hardly acknowledged in the Anglo-Saxon literature that is usually cited as foundation of
the ‘institution-based view’.
This example illustrates also the danger of adopting Anglo-Saxon intellectual tradition rather
than local ones when shifting to English as a medium of instruction. I hope instructors using
this textbook will take a critical view on this issue, and introduce local traditions from their
own community to complement what we introduce in the book.
Key Concepts
economic system
Rules of the game on how a country is governed economically.
market economy
An economy that is characterized by the “invisible hand” of market forces.
command economy
An economy in which all factors of production are government- or state-owned and controlled, and all
supply, demand, and pricing are planned by the government.
varieties of capitalisms view
A scholarly view suggesting that economies have different inherent logics how markets and other
mechanisms coordinate economic activity.
liberal market economy (LME)
A system of coordination primarily through market signals.
coordinated market economy (CME)
A system of coordinating through a variety of other means in addition to market signals.
Apprenticeship system
Vocational training system for crafts and professions
Section 4: Legal Systems
Key Ideas
Another key difference among developed economies is the foundation of their legal system.
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. These
differences impact both the content of laws, but also important legal processes. We elaborate
these important differences in greater detail that other textbooks because my own experience
suggests that indeed they are very important for how people engage in business.
Key Concepts
legal system
The rules of the game on how a country’s laws are enacted and enforced.
civil law
A legal tradition that uses comprehensive statutes and codes as a primary means to form legal
judgments.
common law
A legal tradition that is shaped by precedents and traditions from previous judicial decisions.
case law
Rules of law that have been created by precedents of cases in court
legal certainty
clarity over the relevant rules applying to a particular situation
.
Section 5: Debates and Extensions
Key Ideas
This is the first ‘debates and extensions section’ as you will find it in all subsequent chapters
as well. This one focuses on three questions at the interface of legal and economic systems
that are hotly debated in scholarly circles, namely (1) property rights, (2) corporate
governance, and (3) political risks.
These debates introduce also important concepts that students may be familiar with from
other classes, but that merit review. On property rights, we also offer two In Focus boxes that
introduce internationally controversial issues likely to trigger a lot of debate, namely
intellectual property rights, and the extend of copyright.
Key Concepts
property rights
The legal rights to use an economic property (resource) and to derive income and benefits
from it.
intellectual property rights
Rights associated with the ownership of intellectual property.
patents
Legal rights awarded by government authorities to inventors of new technological ideas, who
are given exclusive (monopoly) rights to derive income from such inventions.
copyrights
Exclusive legal rights of authors and publishers to publish and disseminate their work.
trademarks
Exclusive legal rights of firms to use specific names, brands, and designs to differentiate their
products from others.
corporate governance
rules by which shareholders and other interested parties control corporate decision makers
Section 6: Implications for Practice
Key Ideas
The concluding section emphasizes the need to study and understand the (formal) institutions
of any foreign country where one is considering to do business.
Key Concepts
No new concepts
Review Questions
Review questions are provided to students on the website accompanying the book. They
directly ask to summarize the material provided in the text. Instructors may also use the
questions to structure their lectures or review sessions.
Review Questions
(as provided to students on the website)
Material in the Book
1. Explain what “institutions” are!
2. What are the differences between formal and
informal institutions?
3. Explain the concepts of regulatory, normative and
cognitive pillars of institutions as introduced by
Richard Scott.
4. How do institutions reduce transaction costs?
5. How do institutions alter the potential for
opportunistic behaviour?
6. What is institutional transition?
7. Explain two core propositions of the institution-
democracy?
9. Explain four variations in the procedures by which
democratic countries take major political decisions!
10. What are the consequences of proportional
11. What are the implications of a country adopting a
more authoritarian political system.
12. Why should businesses be concerned about
political systems?
13. Explain the key differences between a market
why it should be classified as CME or LME, and
how this classification may have changed over
time.
16. Outline the key differences between civil law and
common law countries!
17. What are the historical origins of respectively civil
19. Why are property rights, from a business
perspective, an essential element of any legal
system?
Page 32-34
Page 33
Page 33-34
Page 33-35
Page 33-34
Page 34
Page 35
Page 36-39
Page 36 and 37 (In Focus
Page 38
Page 39
Page 42-43
Page 43-45
Page 44-46 (incl. Tables 2.4
Page 46 and In Focus 2.3
Page 47-48
20. What are intellectual property rights, and what are
the main obstacles to their enforcement?
21. Why are corporate governance laws, from a
business perspective, an essential element of any
legal system?
22. What is political risk?
23. How does the institutional framework affect
political risk?
24. Why should managers study the formal and
informal institutions of a country before embarking
in business there?
Page 49
Page 49-50
Page 50
Page 51-52
Critical Discussion Questions
At the end the chapter, we provide discussion questions that aim to stimulate students
thinking beyond memorizing the material learned in the chapter. They are designed to be
used at a basis for in-class discussions, group work, or individual assignments. Below, we
provide some indicative answers of issues that may be raised in response to these questions.
Discussion Questions
(as provided in the book)
Indicative Responses
1. What are the relative merits of a
coordinated market economy (CME) and
a liberal market economy (LME)? Would
you rather work / study / retire in a CME
or an LME?
2. What is in your view the most legitimate
way to select student union
family firms that employ child labour in
rural Bangladesh. You are aware of the
corporate plan to phase out these products
investor and enjoys good profits in (1)
elections fail to meet normal European
standards. As a country manager, you
1. Key issues to discuss here are the
freedom for business – and hence the
opportunities – but also the risks
associated with a CME. An LME
provides greater stability and security
for those less capable of high
achievement.
likely, most are going to defend their
own country’s traditional system, and
should be challenged to appreciate the
corporations would presumably be
do all they can to try and stop it.
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?
4. The debate here is whether sanction
are a) legitimate and b) effective as a
means to put pressure on political
regimes deemed hostile to human
rights agendas.
My personal view is that, firstly,
historically economic sanctions have
never been effective in achieving
anything other than strengthening the
opposition against outside interference
(Turkey, Opening Case, being a
possible exception), and secondly,
businesses can achieve a lot through
the way they operate in these
countries – i.e. respecting and
advancing human rights in their own
operations and their suppliers – but
them getting involved in high politics
is creates more problems than it
solves.
Q3 & Q4 are ethical questions where the
students’ answer is not as important as the
thought process and the ability to clearly
articulate.
Closing Case
The closing case provides further opportunities to apply ideas and concepts learned in this
chapter in a real world setting. The Closing Case for this Chapter is “Carlsberg faces political
risk in Russia” and focuses on the challenges of doing business in a politically and
economically volatile environment. Starting from events around World War I, the case at the
expropriation or trade boycotts) that have arisen over the recent two decades.
Below are some indicative responses to the case discussion questions.
political risks?
3. If you were a board member of
Carlsberg, would you vote ‘yes’
or ‘no’ for a new project to
acquire a local company in
Russia?
availability of natural resources. For
example western companies often have
advanced technologies while Russia has
huge potential market. It depends on the
business proposal presented and the legal
protections in place at the time, among
other considerations.
3. The answer to question 3 depends on the
foregoing analysis. In view of the EU
sanctions regime, there may be
opportunities for ‘cheap’ acquisitions, but
since Carlsberg already has overcapacity
and political risk remains high, it will be
challenging to convincingly argue for a
‘yes’ vote.
Further Learning Activities
In addition to the cases and discussion questions provided in the book, instructors may want
to use any of the following activities to further engage students with the material.
1. In Focus 2.1 on elections around the globe provide an opportunity to discuss and
interpret any recent election discussed in the media. If the election in – say UK 2015 –
had been held by the rules of France, USA, India, Germany, how would the result have
been different? Students will be surprised to find how often the winner by one set of rules
would not actually have been the winner had another European country’s rules been
applied. Sadly, very few journalists seem to recognize that.
2. The Integrative Case “Xiaomi Challenges Global Smartphone Leaders” has been
written specially to discuss the fast-paced development of firms in emerging economies
(which likely will surprise many students in Europe), and thus the rapidly evolving role of
emerging economies in the global economy (Chapter 1). The case allows to highlight the
complementarity of the institutions-based (Chapter 2&3) and resource-based views
(Chapter 4) in explaining MNEs. It also provides leads into a discussion of the early
stages of internationalization (Chapter 11).
3. The Integrative Case “Tackling Corrupt Practices: GSK in China” brings together the
themes of corruption (Chapter 3), social responsibility in foreign countries (Chapter 10)
and headquarter-subsidiary relationships (Chapter 14). GSK has globally announced high
4. The Integrative Case ‘Just Another Move to China?’ has been written to discuss the
challenges faced by expatriates and their families as they cope with unfamiliar
environments, and have to make decisions over their international careers (Chapter 16). It
also allows to further deepen the discussion on how and why differences in formal and
informal institutions (Chapters 2 and 3) matter for international business.
5. Evaluating political risk is an important element of country risk analysis. In fact, your
personal interest relates to countries in the Middle East and North Africa region that have
a high political risk. Provide a brief overview of the region and the reasoning behind
assessing these countries that have been assessed with high political risk. From this list,
which country has the highest overall country risk?
One resource which can be used is “A.M. Best Country Risk Ratings”. This website
can be found by entering the search term “country risk analysis” at the globalEDGE™
Resource Desk search box located at http://globaledge.msu.edu/resourceDesk/. Once
at the A.M. Best Country Risk Ratings website, click on the “AMB Country Risk
6. Since you work for a diversified multinational corporation, economic risk across different
sectors of the world economy is an integral part of analysis as it indicates the future
business prospects for specific industries. Evaluate the risk assessment of three industry
sectors that are available to analyze. Prepare a report and provide a recommendation
concerning which industry and region would be most beneficial to your company.
One resource which can be used is “@rating”. This website can be found by entering
the search term “different sectors” at the globalEDGE™ Resource Desk search box
East/North Africa, CIS, Japan, Emerging Asia, and Latin America), and
Pharmaceuticals (Emerging Asia, North America, Western Europe, and Latin
Further Readings
At the end the chapter, suggested further readings are provided. The primary aim is to
provide students a starting point for further work, for example when preparing a class
assignment or dissertation. These references also are recommended for instructors not
familiar with the topic and wishing to ‘get ahead of the students’ before lecturing on a topic.
P.A. Hall & D. Soskice, eds, 2001, Varieties of Capitalism, Oxford: Oxford University Press – an
introduction and discussion of the varieties of capitalisms view.
T. Kostova & V. Marano, 2018, Institutional theory perspectives on emerging markets, in: R. Grosse &
K.E. Meyer, Oxford Handbook of Managing in Emerging Markets – summarizes three traditions of
theory on institutions with special focus on emerging economies.
D.C. North, 1991, Institutions, Journal of Economic Perspectives 5(1): 97-112 – the foundation of
contemporary institutional economics.
M. W. Peng, D. Wang & Y. Jiang, 2008, An institution-based view of international business strategy,
Journal of International Business Studies 39: 920-936 – an introduction to institutional perspectives
on international business topics.
M.A. Witt & G. Redding, eds., 2014, The Oxford Handbook of Asian Business Systems, Oxford: Oxford
University Press – in depth descriptions and analysis of how Asian economies work, and how they
differ from each other.
K. Zweigert & H. Kötz, 1999, An Introduction to Comparative Law, 3rd ed., Translated by T. Weir,
Oxford: Oxford University Press – a systematic overview of the main legal systems around the
world.
A reading to be added to this list is our recent paper reflecting over the development of the institution-based
view over the past decade:
K.E. Meyer & M.W. Peng (2016). Theoretical Foundations of Emerging Economy Research,
Journal of International Business Studies, 47(1): 3-22.
