INTERNATIONAL MANAGEMENT Chapter 3: The Economic, Legal, and Political Environment
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Chapter 3
THE ECONOMIC, LEGAL, AND POLITICAL
ENVIRONMENT
Learning Objectives
After studying this chapter, you should be able to:
2. compare market economy to other types of economies.
4. identify Shari’a or Islamic law.
5. explain political risk.
General Teaching Suggestions
Introduce the environmental factors affecting management through an anecdote from
business history. Encourage students to express their views on the story. Request the
class to analyze the leading environmental factors affecting business in their home
country.
Opening Case Discussion Guide
This case describes the controversy pertaining to the legal battle between the native
Indians of Ecuador and Chevron company, accused of dumping millions of gallons of
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CHAPTER OUTLINE: KEY CONCEPTS AND TERMS
Sections I through IV of Chapter 3
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I. ECONOMIC ENVIRONMENT
1. Key Concepts
This section analyzes the popular views on market-driven economies and other
economic systems across the world.
• Economic Analysis Tools
Adam Smith theorized that the freedom to determine prices and competition
without the interference of the government or the guilds would result in the best
economic outcome.
David Ricardo explained why it can be beneficial for two countries to trade, even
though one of them may be able to produce all goods necessary. This theory of
comparative advantage forms the basis of modern trade theory.
Developmental economics studies how nations prosper by identifying a range of
factors that encourage economic development and the competitive advantage of
nations. Three perspectives of this approach are:
i. neoclassical theory,
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ii. geographic and location theory, and
iii. institutional approach.
The “diamond” model, developed by Harvard Business School professor Michael
Porter is particularly useful for analyzing a region’s competitive posture in a
given industry segment.
• The Diamond Model of National Competitiveness
• Other Country-Level Economic Concerns in Emerging and Transitioning
Economies
The maturity of the economic systems is an important consideration. Emergent
economies are rapidly growing economies that typically employ market-based
2. Key Terms
• Market-based economic system – Relies on individuals in the society to
determine the price of any good.
• Price – The exchange ratio for goods and services between what the seller is
II. LEGAL ENVIRONMENT
1. Key Concepts
A firm seeking to understand a market should understand not only its economic
environment but also its legal environment. An important consideration is the status
of the rule of law and whether it exists. The legal and regulatory environment not
only is important to establish how business will operate, it can in fact provide a
competitive advantage to a business.
• Legal Systems around the World
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Most of the world’s legal systems can be classified into two broad categories—
common law and civil law systems. Other legal systems that merit discussion are the
theocratic systems, of which Islamic or Shari’a law is the most important.
• International Law
• International Business and Protecting Intellectual Property
The issue of protection of intellectual property rights is discussed with reference
2. Key Terms
• Repatriation of profits – The ability of a firm to take the profits it makes in a
country out of that country.
• Common law – Legal systems primarily built on legal precedent established by
judges as they resolve individual cases; those case opinions have the force of law
and strongly influence future decisions. Common law originated in medieval
• Shari’a law – The law system inspired by the Koran, the Sunna, the Hadiths,
older Arabic law systems, parallel traditions, and the work of Muslim scholars
over the two first centuries of Islam.
• Copyright – The exclusive right to control reproduction or adaptation of creative
works, such as books, movies, music, paintings, photographs, and software.
III. POLITICAL ENVIRONMENT
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1. Key Concepts
A firm should understand the political risk as it can have an immediate and
dramatic impact on a firm. There are a variety of strategies to control political
risk.
i. Obtaining insurance.
ii. Diversify its investments.
iii. A firm may choose to enter a nation in a joint venture.
2. Key Terms
• Nationalize – When a government decides a good or factory will be owned by
the national government.
• Expropriation – When a government seizes the ownership of a private asset or
assets.
IV. CHAPTER SUMMARY
1. Key Concepts:
• This chapter has examined economic, legal, and political environments and how
they affect international management.
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END-OF-CHAPTER GUIDE
* MANAGERIAL GUIDELINES
* OPENING VIGNETTE DISCUSSION QUESTIONS
MANAGERIAL GUIDELINES
2. Michael Porter’s Diamond of Competitive Advantage is an excellent model to
understand country competitiveness.
4. Legal systems are connected to the culture of a given country. The legal systems
5. There are business opportunities that exist for business people from the legal
6. Political risk and corruption are realities that the businessperson must understand
and monitor.
7. Even if the environment is quite corrupt, a firm must remember that the actions of
firms from mature markets are limited by laws, such as the Foreign Corrupt
Practices Act.
OPENING VIGNETTE DISCUSSION QUESTIONS
1. How does a firm protect itself against political risk in a situation like Texaco
Chevron, who is being sued for activities conducted a relatively long time ago?
Student responses may vary. According to the text, there are a variety of
strategies to control political risk.
i. Obtaining insurance.
ii. Diversify its investments.
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2. Why do you think the Ecuadorians used the U.S. court system rather than their
own? What do you think of this?
The case had been filed originally in the U.S. due to the stronger rule of law and
DISCUSSION QUESTIONS
1. It is currently against the law for businesses in the U.S. to sell oil equipment to
Iran. However, many firms still do so through their European or Caribbean
subsidiaries. What do you think of this type of activity? Should governments
enforce their political goals through limitations on business?
Student responses may vary. The obvious attempt to circumvent the spirit of the
2. Do you see increasing standardization of the environment for business as the
power of the WTO, EU, and others increases?
3. What issues do you see that legally could impact international firms in the future
that are not currently major topics of concern?
4. Is it a market opportunity or a limitation when dealing with a nation that has a
large Muslim population that follows Shari’a law even though it isn’t the law of
the land?
Student responses may vary. It is important to realize that Muslims will often be
guided by Shari’a-based law even if they do not live in a country that is governed
IN-CLASS EXERCISES
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1. After being largely ignored for long periods of time, Islam has become a potent
force influencing today’s world. Discuss the current role of Islam. Identify some
of the unique characteristics you understand about Islam and what questions you
have about the religion. After discussing these issues, what are the challenges that
foreign firms face in doing business in a majority Muslim nation?
2. What evidence is there to support the view that a common business culture is
spreading throughout the world? Consider factors such as economic and political
3. At first glance, the Diamond model only seems to be useful to describe a
country’s national competitive environment of a firm. Is there any way a firm can
use the Diamond model to improve its competitiveness? Give two example of
4. As the assistant to vice-president of Colgate’s toothpaste division, you have
conducted an initial survey of consumer tastes and preference across a cross–
section of the Chinese market. Based on your findings, what would you
recommend to your boss about how to proceed with evaluating the environment in
China for selling Colgate toothpaste there? Are there any initial observations you
will make that can help to guide your strategy later?
TAKE-HOME EXERCISES
1. Research the international oil industry. Focus on what are referred to as the major
oil companies. Give an assessment of the general environment facing these firms.
Is it favorable? How is it changing? How should a major firm such as Exxon
respond to the political changes and new environmental demands on its main
businesses?
2. Research the country of Brazil. Pick an industry that is globally competitive.
Conduct a diamond of national competitiveness analysis of that industry.
Student observations may vary based on their industry choice. Some of the major
3. If you wanted to conduct business in a country like Somalia, what are the legal
and political issues you might face? Briefly research the country and develop the
outlines for an international company that moves there.
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Republic of Somalia is a country located in the Horn of Africa. Somalia’s
4. Read about Shari’a law and identify a new potential business that might serve the
needs of this religious community.
SHORT CASE QUESTIONS
1. In approximate terms, what do you think will be the exchange rate between the
U.S. dollar and the Chinese RMB?
2. What would be the best strategy for a large multinational when faced with the
steep decline of the U.S. dollar?
3. Why do you think some politicians talk so positively about the dollar’s decreasing
value?
4. What is the long-term outlook for the U.S. dollar?
The US trade deficit; interest rates; global economic environment along with the