The Interplay of Political Economy, Ethics, and International Business

Posted on Aug 20, 2024 in Law & Jurisprudence

POLITICAL ECONOMY

Culture, predominantly the cultural determinant of social organization, is the foundation upon which the political economy is built. The political economy includes a country’s political, economic, and legal systems. These systems are collectively referred to as the political economy and as such suggests that these systems are interdependent—meaning they interact and influence each other. In order to understand the parts, we will take each and address them separately.

Political System

Refers to the system of government (national level) in a country. The system can be assessed by addressing two dimensions:

  1. Assesses the basic unit of social organization – the degree to which collectivism or individualism is emphasized.
  2. Assesses the country’s political ideology – the degree to which the country practices democracy or totalitarianism.

Collectivism vs. Individualism

Collectivism: Refers to a political system that stresses the primacy of the collective over individualistic needs. Therefore, the needs of society as a whole are more important than individual freedoms.

  • Today in a political compact, the political collectivist philosophy has been assumed by socialists.
  • Socialism: State-owned enterprise (business)—specifically so that enterprise benefits society as a whole rather than benefiting individual capitalists.
  • Karl Marx: Argued that individualist capitalists exploit workers—not pay them for their full value of their labor. He argued that to ensure workers don’t get exploited and instead get fully compensated consistent with their value, that the government should own and operate the means of production.

Socialism has bifurcated into 2 camps:

  • Communism: Believe socialism can be achieved and supported through war (revolution) and the resulting political ideology is totalitarianism.
  • Social Democrats: Believe socialism can be achieved by democratic means (citizens elect) and accordingly the resulting political ideology is democracy.
  • Communist form of socialism: Soviet Union (former), China, Cuba, N. Korea
  • Social Democratic form of Socialism: Norway, Sweden, India, Australia, Brazil.

Over time, there are fewer countries that support the communism form of socialism because Karl Marx was wrong. Countries learned that state-owned (government and national level) enterprises perform very poorly. They are ineffective and inefficient often resulting in low quality/high priced goods/services and then in order to compensate for poor performance, citizens were asked to pay higher taxes. As a result, some governments decided to privatize some of the enterprises – selling the enterprise to private interests. They held on to a handful of enterprises: healthcare, transportation, energy.

Individualism: Refers to the philosophy that an individual should have freedom in his/her political and economic pursuits. Individualism stresses the interests of the individual over the interests of the collective (group). Individualism is built upon two central tenets:

  1. Guarantee of individual freedom and self-expression.
  2. Welfare of society is best served by letting individuals pursue their own economic self-interest.

The central message of individualism is that individual political and economic freedoms are the ground rules upon which society is built, laws are made, and according to which people live by. Individual freedoms are outlined in the country’s constitution.

Democracy vs. Totalitarianism

Democracy refers to a system whereby citizens elect people to represent them. Most citizens vote for individuals they believe to have a similar value system. There is a correlation between individualism and democracy meaning that for countries that emphasize individualism they have a democratic form of government.

  • For countries that are collectively organized they can support either a democratic or totalitarian form of government.
  • In a democracy, the constitution states that citizens are politically and legally equal and are guaranteed:
    • Right to freedom of expression, speech, thought, opinion, and organization.
    • Free media
    • Free and fair elections held regularly
    • Fair court system
  • The defining characteristic of all democracies = freedom.

Totalitarianism: Form of government in which a “single agent” has absolute political control—monopolizes political power and thereby subordinates individual citizens to the collective interests of “the state” (government).

  • The “single agent”: Military leader, religious leader, a single party, royal family, individual.
  • The single agent uses their power to regulate/dictate all aspects of a citizen’s life—this could include what religion can be practiced, what occupation/income you can have, where you are in the family structure based on gender (male/female).
  • The government does not tolerate any ideas, interests, or activities that contradict or threaten the state. The agent will go so far as to suppress/eliminate dissent through: surveillance, prosecution/jail, torture, death, censorship, propaganda, violence.
  • Individual freedoms are denied to citizens.

Pseudo-democracies: Countries that claim to be democracies, but exhibit political behavior consistent with totalitarianism = democracies in name only. Pseudo-democracies can be assessed and identified by looking at the extent to which freedom actually exists. Freedom House looks at:

  1. Are free and fair elections held?
  2. Are individual citizens’ freedoms guaranteed?
  3. Does the Rule of Law exist?
  4. Freedom of the press?

As a result of this assessment, Freedom House publishes every year a Map of Political Freedom and as a result of the 4 questions, they group countries into 1 of 3 categories:

  • Free: U.S., Canada, EU, Australia
  • Partly-free: Mexico, Pakistan
  • Not free: Russia, Iran, Saudi Arabia, China

Economic System

All economic systems determine how goods/services will be produced, distributed, and consumed. Broadly speaking, there are 3 types of economic systems:

  • In countries where the emphasis is primarily individualism, you’ll likely find a democratic political ideology and a market-based economy.
  1. Market-based economy: Is where the means of production are predominantly privately-owned (as opposed to state-owned). Production is determined by the interaction of supply-demand and the prices consumers are willing to pay to receive the goods/services they want/need. Producers, motivated by profit, respond to consumers—offer goods/services consumers demand and consumers are willing to pay. Market economies are rooted in the philosophy of capitalism.
  2. Command-based economy: The means of production are predominantly owned by the state, the state decides what will be produced, in what quantities, and what prices consumers will be required to pay. All dimensions of economic activity are “centrally-planned” meaning, by the state. The underlying philosophy is communism.
  3. Mixed economies: By definition, most economic activity is market-driven; means of production are privately-owned. The government controls the means of production in a few specific industries the government deems to be important to offer for the good of society: healthcare, transportation, and energy.

Legal System

The legal system of the country refers to the laws that regulate behavior along with the process by which laws are enforced and grievances will be addressed. The legal system regulates business practice/activity and affects the attractiveness and risk of doing business in any foreign country. The legal system is inextricably-linked to the political system.

  • For countries that are individualistic and democratic you expect the legal system to be common/civil law and rule of law whereas countries that are collective, totalitarian, that Rule of Man is likely to exist.

In evaluating any country’s legal system—look at two qualifying distinctions:

  1. Type of legal system?
  2. Basis of Legal Rule?

Types of Legal Systems

A) Common law: System of law based on tradition and precedent—legal history and rulings on cases from before are applied to legal issues/cases presently. Judges interpret the law and apply it to the circumstances of the case they are presiding over. Each decision sets a precedent that other lawyers and judges will use in trying future cases. Judges hold a great deal of legal power.

B) Civil Law: Based on a detailed set of laws that are organized into legal codes. Judges rely on these codes and have very little flexibility in interpreting the codes—judges apply the codes, they don’t interpret them. Political officials create and modify codes—therefore holding most legal power. (80+ countries = most prevalent type of legal system globally)

C) Theocratic Law: Laws are based upon religious teachings. Islamic law is the most widely practiced theocratic legal system, where the foundation for what is legal/illegal is pulled from the Koran and the Sunnah (decisions and sayings of the Prophet Mohammed). There is no separation between church and state. It is problematic to apply theocratic law to international business activity, accordingly, countries where theocratic law prevails, the government has adopted either common or civil law for commercial transactions.

Contract Law

Contract: A legally binding document between parties that outlines the specific details of the exchange—what is to be exchanged, obligations, responsibilities of each party, etc. The contract will specify the legal system (civil or common) that will be applied if there is a dispute.

Contract Law: The body of law that governs contract enforcement. Contracts that apply common law tend to be very detailed. All possible contingencies tend to be spelled out, especially true for a company coming from a civil law system agreeing to common law. Contracts tend to be shorter and less specific if civil law is applied because all issues have been incorporated into the codes.

Basis of Legal Rule

A) Rule of Man (ROM): The political ruler (single agent) commands legal authority but is above the law himself/herself. Instrumental in totalitarian political systems as well as in countries that are identified as pseudo-democracies. The single agent will use the legal system to buttress their political power and suppress any threats to their authority. Justice is absent, it is arbitrary. You don’t know what to expect.

B) Rule of Law (ROL): Hallmark of democracy—so, if the country’s political ideology is democratic, then the rule of law must exist. Democracy and ROL are inextricably-linked; they must both be present if democracy is going to be able to thrive—no individual is above the law—laws are specified, understood, and commonly enforced—justice is blind, the same laws are applied to everyone.

Rule of Thumb for companies is that if the rule of man exists in any given country, then there will be an amount of unpredictability = more risk. However, countries are aware of the risks and will in some cases continue to pursue international business activity in countries where ROM exists. They do so with the plan that the opportunities that exist will outweigh the risk. So much so, in recent years, companies have increasingly pursued international business activity in countries where ROM exists.

The Political Economy: Implications for International Business

Culture is the foundation upon which the political economy is built. The political economy influences the overall attractiveness of the country as a:

  1. Potential market for goods/services.
  2. Opportunity for potential supplier relationships and/or
  3. Potential location for investment activities (subsidiary/Joint Venture).

The potential costs/risks and benefits/opportunities of doing business internationally is a function of the political economy of the country in question. / x = independent variable = political economy /// y = dependent variable = attractiveness of IB in a foreign country.

y = f (political economy) y = f(x). y depends on being able to identify, accurately, the costs/risks and benefits/opportunities that the political economy presents; All other things being equal from a US business perspective, a foreign country with an emphasis on individualism, with a democratic political ideology, a market-based economic system with ROL presents a more attractive opportunity for international business activity as compared to collective, totalitarian, command-based, and ROM. +The reality is that US companies will still choose to pursue international business activity in countries that present as collective, totalitarian, command-based ROM companies pursue based upon a strategy that weighs short-term costs/risks that are outweighed by long-term benefits/opportunities.

ETHICS AND INTERNATIONAL BUSINESS

Ethics: Accepted principles of right and wrong that govern the behavior of individuals. Individuals represent companies and therefore represent the company in its international business activity. Most ethical issues in international business are rooted in the fact that cultures and political economies differ from country to country. Therefore, what is considered to be “ethical” according to one country may be distinctly different from what is considered to be ethical in another country. When faced with a choice between two opposing alternatives—referred to as an ethical dilemma. In the context of ethics, in order to make informed, responsible, decisions we need to:

  1. Be aware of our own, individual value system.
  2. As an employee or representative of companies, be aware of the Corporate Code of Conduct (CCC). *In any differences between 1 and 2, be aware #2 wins out.
  3. In representing companies in their international business activity, what are the ethical considerations from the foreign country’s perspective? Apply what we learned, in part, about legal systems to ethics. Remind ourselves that in most instances what is legal/illegal in any country is often a function of what is considered to be ethical/unethical which is a function of culture. There is NO body of international law where countries from around the world collectively agree to what is considered to be legal/illegal, ethical/unethical. As a result, companies must abide by the legal system of each foreign country they operate in. Don’t take US law and apply it to international business activity in foreign countries.

When confronted with an ethical dilemma, decisions are usually made applying 1 of 2 approaches:

  1. Teleological approach: The decision to behave in a specific way is based upon the known consequences of the alternative behaviors.
  2. Deontological approach: The decision to behave in a specific way is based upon the individual’s personal belief that the actions are either right or wrong. It is independent of consequences.

From an international business perspective, most apply the teleological approach to decision-making.

Two Common Ethical Concerns in International Business

  1. Employment practices: Outsourcing and offshoring by US companies are attractive because it affords US companies the opportunity to lower their cost structure—increase profitability. Today companies can do this without sacrificing quality. Offshoring and outsourcing are being done by US companies in developing countries. Relative to developed countries, like the US, developing countries do not yet have the same degree of labor laws that exist today in the US. Three employment practices that are relevant here are:
    1. Wages
    2. Working conditions
    3. Child labor
    These conditions in developing countries are much lower and therefore, is in part what affords US companies the opportunity to exploit the differences that exist between the legal systems regarding employment practices. In doing so, companies are not doing anything illegal as they are abiding by the legal standard of the developing country. However, public perception, often fed by media scrutiny, suggests US companies are behaving unethically, that US companies should not exploit the differences and instead apply US legal standards to their outsourcing/offshoring activities. If and how companies respond to the perception of unethical behavior is going to be a function of the potential consequences to a company’s primary stakeholders: customers and shareholders. All consequences boil down to potential implications to profitability. For customers: if the brand is tarnished and the customer is not buying, then it leads to a decrease in sales, revenue, and then, profitability as a result. This will lead to a decrease in shareholder value. The stock price falls and shareholders start to sell.
  2. Bribery/corruption: Defined, not necessarily illegal. (d) payments of cash or anything of value that is offered in exchange for specific consideration in return. What is expected is understood by the giver and the receiver of the bribe. Corruption is described as dishonest behavior, typically by those in positions of power. Most acts of bribery are not illegal. For most businesses, they have an intimate understanding of laws that restrict bribery and accordingly figure out ways around the law. Need to understand acts of bribery that are considered to be illegal so informed decisions can be made regarding behavior. Illegal acts of bribery are indicated in the US FCPA (Foreign Corrupt Practices Act)—US Law *US Government, with this Law requires US companies to abide by this law as they conduct business in foreign countries. **Summarize the summary of the US FCPA (reading assignment) The US FCPA makes it illegal for: US individuals (US citizens)/US companies/US employees of US companies/-shareholders of US companies/-individuals acting as agents of US companies…to use the mail (snail mail) or any other means of interstate commerce (for example wire transfers) to make payments (in foreign countries) to: -foreign officials -political parties -party officials -political candidates…In order to help the US company obtain or retain business. /. US FCPA exceptions: payments are not illegal according to the US FCPA. Payments made specifically for the purpose of expediting or securing the performance of a “routine government action” as long as the payment is provided directly to the person responsible for performing the routine government action. Also known as speed payments or grease payments. The government refers to these payments in the US FCPA as “facilitation” payments. *US FCPA also applies to any foreign company that is publicly-traded on any US stock exchange. Quiz FCPA:
    1. Under whose jurisdiction does the US FCPA fall? The Department of Justice
    2. The giver of the bribe
    3. FCPA perceived by US companies, the basis to oppose this law? Companies continued to use bribery despite the law, they just did it more carefully. Companies said that they were at a competitive disadvantage doing business abroad because others weren’t abiding by the law and continued to use bribery.
    4. OECD (Organization for Economic Cooperation & Development) anti-bribery treatment: The Anti-Bribery Convention reflects what is said in the US FCPA, brought to the OECD by the Department of Justice.
      1. Why did the US approach the OECD to pursue the treaty? There was a conflict with an anti-bribery rule with big US companies, soon they transferred the idea into the hands of the OECD in hopes to get some compliance.
      2. Why did individual member countries of the OECD agree to sign the treaty? Refraining from signing the treaty made it seem like they opposed the treaty and were supportive of bribery.
      3. Is the treaty effective? No, it was not effective because not all of the countries who signed the treaty passed laws in their own country that supported the treaty.
    5. Two reasons why the UK justified bribing? They justified it by saying that the absence of the activities cost the UK thousands of jobs and that it helped with a vital, strategic relationship in fighting terrorism.
    6. 11th: Don’t get caught

GOVERNMENT POLICY AND INTERNATIONAL TRADE

Free Trade

Free trade refers to a situation in which a government does NOT restrict what can be bought and sold from other countries. Free trade does not exist anywhere, in any country. Some governments are nominally committed to free trade, but in reality, all governments intervene in international trade primarily to protect/support the interests of politically important groups and/or to promote/support the economic interests of domestic producers. When governments do this it is referred to as “protectionism”. = is antithetical to market economies-/market economies by definition are to be free of government intervention.

When governments practice protectionism, what are the 3 most common instruments that are employed?

  1. Tariffs: (duty, tax) it is a tax imposed on an import, product-specific, but not country-specific. The tariff (tax) is imposed on the price of the product that the consumer pays. Therefore having a direct impact on the price of the product. Congress determines it will pass legislation (law) imposing a tariff on all tires imported into the US. The determination is made by Congress as to how much the tariff needs to be so that when added to the price of the import it will be more expensive than the domestically-produced product. -Tire domestically-produced = $100/tire, 9*$100 = $900 -Tire produced by a foreign company (impact) = $85/tire, 4*$85 = $34. *Assumption: consumer demand is elastic. Congress passes legislation imposing a 40% tariff on all imported tires. /Price = $85 + 40% = $119/tire * 4 = $476 vs $400 domestic/tariff = increase in Price, decrease in Demand = decrease in Supply = domestic job protection and government support of the domestic industry.
  2. Quotas: Quantity restriction—restricting the supply of an import, product-specific *decrease in supply = increase in price/*Quotas indirectly impact price through the restriction of the supply of the imported product/* In many instances, the government will impose tariffs and quotas simultaneously. Quotas are set and tracked on an annual basis.
  3. Subsidies: Government support provided to domestic producers: 4 most common forms of subsidies:
    1. Cash: Money that is paid to the domestic producer(s). Money provided is intended to be used in a specific way, for a specific purpose, but ultimately it’s up to the producer to decide how to spend the money. Producers do not have to pay the money back.
    2. Low-interest loan: Loan proceeds provided by the government to domestic producers that are offered at an interest rate that is lower than what the producer could borrow money at in the commercial loan market. The loan must be paid back but the receiver can use proceeds however they want even though money is provided for specific use.
    3. Grants: Money provided to domestic producers for a specific purpose—money must be used for that purpose, but does not have to be paid back. Example: Boeing lobbies and receives an R&D grant from the US government to help offset R&D expenses associated with the 787. Specifically to help Boeing compete against their primary global competitor Airbus. R&D grant = decrease in R&D expenses for Boeing = decrease in the total cost of the 787 = decrease in price of the 787 relative to the Airbus alternative = increase in Demand for the 787 = increase in Supply of the 787.
    4. Tax Break.

Government Intervention – Implications for Economic Activity

(protectionism) In a market economy, by definition, economic activity is driven by consumers. Consumers decide what to buy (D), how much to buy (S), and what price (P) they’re willing to pay. Producers, motivated by capitalism and the opportunity to profit, respond to consumers. By definition, in market economies, there is no government intervention.

Implications and Consequences of Government Intervention

  1. Anti-consumer as it causes consumers to pay higher prices.
  2. Invites retaliation, promotes trade wars.
  3. Often times as a result of #2, other domestic producers are brought into a trade war. ex: tires and citrus growers.
  4. In some cases, intervention protects/supports inefficient domestic industries. ex: US steel / US auto manufacturing producers.
  5. In some cases, government support to one industry ends up hurting other domestic industries.

Government Intervention for Reasons of Foreign Policy: Sanctions and Embargoes

The US government, in particular, has intervened in international trade using sanctions and embargoes to support political, foreign policy goals. Specifically:

  1. In an effort to punish or pressure a foreign country’s government to abide by what the US believes to be international norms of behavior. ex: Iran.
  2. To force/hasten change in the political system of the foreign country, specifically from totalitarianism to democracy. ex: Cuba.

Sanction (def): Very specific, coercive trade restrictions imposed against a specified foreign country. Most often used for reason #1: Russia, Libya, Syria, Sudan, North Korea.

What is restricted?

  1. Certain types of exports (merchandise)
    1. WMD: weapons of mass destruction:
      1. Biological
      2. Chemical
      3. Nuclear
    2. HI-tech exports: cell phones, radar, satellites, GPS.
    3. “Dual-use”: any product that can potentially be used for both civilian and military purposes. Ex: fertilizer, trucks. *Products may show up on more than one of these lists A-C.
  2. Freeze US-held assets: real estate, bank accounts.
  3. Restricting travel to the US.
  4. Canceling trade financing through US financial institutions.

*Sanctions that restrict certain types of exports (#1): Specifically impact exports of products by US companies, whereas the other types of sanctions do not. US companies do not often agree with this restriction as it limits their ability to compete with global competitors.

Two ways in which sanctions can be imposed:

  1. Unilateral sanctions – imposed by an individual country.
  2. Multi-lateral sanctions – imposed via the UN, specifically the UN security council: 5 permanent members (US, China, UK, France, Russia). Very difficult to achieve as the 5 permanent members have very different foreign policy objectives relative to the individual country in question. Therefore, if multi-lateral sanctions are imposed, they tend to be “watered-down” essentially don’t amount to much of anything relative to what the unilateral sanctions are. Most of the time sanctions are unilaterally imposed. Therefore rarely produce the desired foreign policy objective intended.

Embargoes – typically used to force/hasten regime change. Prohibits trade between two countries entirely. No imports from and no exports to the foreign country in question. The US embargo against Cuba was imposed specifically to bring about regime change and force a revolution to occur, bringing down Castro’s communist government. Embargoes are never multi-laterally imposed, never produced the foreign policy objective, and further limit US companies and their ability to compete with global competitors.

h global competitors.