Chapter 2 Political, Economic and Legal Environments: Diversity or Growing Uniformity? 2.1. Introduction Of course you know that political, economic, and legal systems of countries differ; but you may not know what these differences are, the degree of difference (are countries actually becoming similar?) and how and why these differences are important to companies that do business in foreign markets, In practice, firms operating abroad should have a thorough understanding of the formal institutions of each country they are in, or are thinking of entering, In this chapter, we are going to explore these institutions and related systems—known collectively as the ‘political economy’ of a country—and what they mean for businesses operating internationally. In doing so, we are going to introduce something called ‘an institution-based perspective’. The key functions of institutions are to reduce uncertainty, reduce transaction costs, and constrain opportunism. As we shall see, political, economic, and legal institutions establish the formal ‘rules of the game’ for operating in a particular country. We will look at the equally and sometimes more important informal rules in. the next chapter. In this chapter we also look at international institutions that are important contextual features of international business. Here we consider the roles of organised regional blocs, using examples in Europe, Americas, and Asia Pacific, and the institutions of the international monetary and trading system. 2.2. An Institution-Based View of International Business Peng, Wang and Jiang (2008) and Peng and Meyer (2019) argue that, esentilly, a country’s institutions establish the formal and informal rules of the game for operating in that country. 41i ents «.- ical, Economic and Legal Envi ronm because the ‘ules differ berwen count, and what is not possible. Institutions ca, formal institutional framework lay ly need to know these, what can be achieved, focus on thi Js individual and firm behaviout, AS We shal ye compliance to varying degrees. In the ney, ethics shaped by culture, religion, and ody, Firms operating international and because they shape greatly be formal or informal. In this chapter we regulations, and rules—of country, that contro different governments have regulatory power to coerce chapter we will look at informal rules—norms, values, social forces. What do institutions do? Essentially their key role isto reduce uncertainty; and limiting the rane ave developed over time because the potential, adv of acceptable actions does this. Institutions hi if you were trying to do business in consequences of uncertainty can be devastating. For example, the Middle East in 2021—say in Egypt; United Arab Emirates; Israel; Qatar; or Lebanon—imagine the immense difficulties of just understanding the business context, let alone deciding what to do. Uncertainty increases transaction costs, a term made highly popular by Oliver Williamson, a Nobel Economic prizewinner (Williamson, 1985). Transaction costs are the costs associated with carrying out an economic transaction or, in short, the costs of doing business—for example search, negotiation; getting to contract; monitoring supplier performance, Transaction costs will increae if others behave opportunistically, defined rather nicely by Williamson as ‘self-interest seeking with guile’. Institutional frameworks can reduce the potential for such opportunistic behaviour. This is important for international business, because if transaction costs become prohibitively high ina country, people may choose not to undertake trade in that country at all. Institutions are evolving all the time and international business managers need to keep up with these changes. For example, in the last 20 years, China, Poland, Russia, and Vietnam have been sometimes moving from central planning to market competition—though each in different ways and at different speeds—and sometimes these processes have been reversed. ‘These are often called ‘transition economies’. Institutional transition can be defined as fundamental and comprehensive changes to the formal and informal rules of the game that affect organisations as players. In summary, Peng and Meyer (2019) argue convincingly that, for international business, institutions matter, They suggest that at the heart of an institution-based view there are two CO propositions. Firstly, managers and firms rationally pursue their interests and make choices witht the formal and informal constraints of a given institutional framework. Secondly, although for and informal institutions combine to govern firm behaviour 3 fi fail or are unclear, informal constraints will play a lar constancy to managers and firms. More on informal now ifyou want: Take an organisation you are fail in situations where formal constrain get role in reducing uncertainty and providing Constraints in Chapter 3, but try this out ar with—a workplace, a university, 2 hospi 42Political, Economic and Legal Environments ..- maybe. There are formal ways of getting things done, for example assigning a task to someone with a deadline, What are these formal ways? What happens if they do not work? The chances are that it will be a mixture of formal and informal institutions that prevail to get the task assigned and the person to agree, and perform. 2.3. Political Systems ‘A political system represents the rules of the game on how a country is governed politically. Ie is helpful co think of political systems as having two dimensions: firstly, the degree to which they emphasise collectivism as opposed to individualism, and secondly, the degree to which they are totalicarian or democratic. Collectivism versus individualism Collectivism refers to a system that stresses the primacy of collective goals over individual goals. In other words, in a collectivist society, the needs of a society as a whole are generally viewed as being more important than individual freedoms. In modern times collectivism has been equated with socialism, and state ownership of the basic means of production, distribution, and exchange. During the late 1970s, communism, with strong command economies, was a dominant force in the world. Think of the former Soviet Union for example, and its Eastern European neighbours, like Poland, Czechoslovakia, and Hungary. Think also of ' ‘China, Cambodia, and Vietnam, and of ‘Angola and Mozambique, Cuba, and Nicaragua. By 2000, the world was a very different place, The Soviet Union for example, had been replaced by 15 republics that were structured as democracies. China, though it stil limited political freedom, was moving away from its strict communist ideology, though in recent years it has moved towards blending communism with confucianism, while centralising more state power. Today, only a few fringe states like Cuba and North Korea still practise a strong brand of communism. Social democracy, which incorporates belief in a mixed economy of central planning, state, and private enterprises has also been retreating, though at differene speeds depending on the country. For example, countries like the UK, France, and the means of production and have seen Germany have placed less emphasis on state-ownership of moves towards privatisation—selling state-owned enterprises to the private sector. individualism suggests that individuals should have freedom over theit economic and political Milton Friedman and Friedrich von sursuits. People and economists such as Adam Smith, fayek have championed this philosophy. Individualism is based on two key concepts: firstly, that sdividual freedom and self-expression are guaranteed, and secondly, that people are allowed to achieve the best overall good for ursue their own selfinterests (within the rule of law) in order to there is a debate about how important individualism and the sciety. For international companies 43al, Economic and Legal Environments ... less environment, related idea of free market economics are for creating a favourable b and who gains from applying these concepts in international trading environments, Abou, Clearly collectivism and individualism conflict as creeds, and this has often fuelled tensions between different countries for example, most notably, between the USA, Western Europe ang the Soviet Union during the so-called Cold War, and may help to explain something of the tr tensions between USA and China in recent years. = Totalitarianism You can think of totalitarianism and democracy as being at opposite ends of a political dimension. At one end you have totalitarianism, where one person or political party exercises absolute control over all spheres of life, and opposing political parties are forbidden; and at the other end there is democracy—a political system in which government is by the people, and i exercised either directly or through elected individuals. While we generally think of democracy as going hand-in-hand with individualism, and totalitarianism being associated with collectivism, Brey areas do exist. For example, China is still under totalitarian rule, but has adopted free marker Policies that tend to be associated with individualism (though in recent years commentators have Pointed to some return to greater communist party control). In recent years Russia has become increasingly totalitarian, while still holding to some democratic forms, e.g. elections. The world has seen four major forms of totalitarianism: Communist totalitarianism. This system advocates achieving socialism through totalitarian dictatorship. While this form of totalitarianism has been declining worldwide, countries like Vietnam, Cuba, and North Korea still follow the philosophy. Theocratic totalitarian is a system whereby political power is monopolised by a party, group, or individual that governs according to religious principles. You can think of countries like Saudi Arabia or Iran when you think of this type of system. Both countries are greatly influenced by the principles of Islam, and both countries restrict political and religious freedom. Tribal totalitarian. This system is where a political party that represents the interests of a particular tribe, monopolies power. This type of system has occurred, for example, in some African nations like Zimbabwe, Uganda and Tanzania. In Kenya there are some 40 tribes, but the Kikuya tribe has been persistently best represented politically in government, ° Right wing totalitarian is a system that may allow individual economic freedom: 44Political, Economic and Legal Environments ... but individual political freedom is restricted to avoid forms of socialism. A nation’s military often backs this declining type of system; although you might recall its presence in Germany and Italy during the 1930s and 1940s. Military dictatorships were frequent in Latin America, e.g. Brazil (1964-1985) and Chile under General Pinochet. They could also be found at various times in Asian countries like Taiwan, Indonesia, Philippines and South Korea, though these have since become more democratic. Democracy A pure democracy is based in the belief that people should be directly involved in decision making. ‘The most common form of democracy today, however, is representative democracy, where elected representatives vote on behalf of constituents. Some of the embraced characteristics of democracies include freedom of expression, free media, regular elections, a fair court system, and free access to state information, ‘The political system is governed by institutions. ‘The rules are usually laid down in a constitution, determining things like how elections are organised, how votes are translated into representation in a parliament, and how much power elected officials and representatives have. ‘There are notable variations in representation methods, including: Proportional representation versus first-by-the-post. Countries such as Germany and Denmark have systems whereby all votes are added up and seats allocated to political parties in proportion to the number of votes they gained. Countries like India, USA, and UK have a first-past-the-post system where each constituency elects one representative based on who in the election wins the most votes. Direct versus indirect elections of government, Some countries have direct lections for certain posts, e.g, citizens of France and the USA directly elect their presidents with executive power to appoint ministers. In most countries citizens elect representatives who then, on the citizens’ behalf, elect and monitor government and ministers. Representative versus direct democracy. \n most countries citizens elect representatives to act on their behalf. Centralisation of power. There are variations between countries in the degree of power held by central, regional and local governments. For example, in federated countries like Australia and the USA, states wield quite a lot of power. In the UK central government has devolved quite a lot of functions to Scottish, Welsh, and Northern Irish assemblies. 45Political, Economic and Legal Environments ... Political systems matter for international business because they: * Set the rules, and whose interests are served by the rules. * Determine whether and how businesses can influence legislative processes " through lobbying (mostly legal) or corruption (usually illegal). * Influence how frequently, and in what ways the rules of the game for business change. This can be a major source of political risk, i.e. risk associated with political ch: 5 anges that may negatively affect domestic and foreign firms. Icis important to point out that many countries have features of both democratic and more totalitarian tendencies. In such counties some democratic institutions exist but in weak form, while totalitarian traits may deny or limit such institutions as free speech, independent media, multiple political parties, civil liberties, and the rule of law. ‘This can be clearly seen in Russa, for example, where, by 2021, there were still elections and opposition parties, but independent medis and civil liberties operated within political, legal and economic power concentrated at the centre of government. Robert Mugabe and his ZANU-PF party in Zimbabwe subverted democratic institutions and established a monopoly political power there from1980 to his death in late 2019, Democracy - political system in which citizens elect representatives to govern the country on their behalf. Supports global business by preserving individuals right to freedom of expression and organisation. Totalitarianism (or dictatorship) - system in which one person or party exercises absolute political control. * Communist totalitarianism + Right-wing totalitarianism + Theocratic totalitarianism + Tribal totalitarianism {In general, totalitarianism is not as good for business as democracy. Totalitarian nations often entail higher political risk due to wars, riots, Protests, chaos and breakdowns, which can negatively impact firms. TE 46Political, Economic and Legal Environments ... 2.4. Economic Systems Keep in mind that a nation’s political system and its economic system are connected. Indeed there is a whole area of study called political economy which focuses on production and trade—their relations with law, custom and government, and with the distribution of national income and wealth. As mentioned above, in countries where individual goals are given primacy over collective goals, free market systems are likely to exist; but in countries where collective goals are dominant, markets are likely to be restricted and state-owned enterprises are common. All have implications for firms operating internationally. An economic system refers to the rules of the game on how a country is governed economically. Broadly there are three types of economic system: * Market economy. Here goods and services are privately owned and production quantities are determined by supply and demand. In a market economy, governments encourage free and fair competition and discourage monopolies. Note that, amongst countries, there have been very few pure market economies! In 2001, Hong Kong had the highest degree of economic freedom, but by 2021 there had been some noticeable government intervention its legal system and economy. ‘The 2008/2009 financial crisis, and its aftermath, saw increased government intervention in many countties across the world, and more recent moves towards protectionism (see Chapter 1). The 2020-2021 crisis saw market ‘economy ideas in flux as countries and_supra-national institutions wrestled with how to reignite economic groweh, Command economy. Here the government plans the goods and services that a country produces; the quantity in which they are produced; and the price at which they are sold, Businesses are state-owned and the government allocates resources for the good of society asa whole, Examples are the former Soviet Union, and, in 2020, North Korea. Socialist-inclined governments have sometimes moved their countries towards more government planning and state ownership—for example India and France—but in both cases these approaches have fallen into disfavour with more centrist or right wing governments coming into power. Mixed economy. Here elements of both a market economy and acommand economy are present. Governments often take control of industries that are considered vital to national interests. During the 2008/2009 financial crisis, for example, the US government took an 80 percent share in AIG to stop the company from collapsing and damaging the broader financial system. Examples of mixed economies include France, UK, and Sweden in the 1980s, though subsequently all three counties have reduced state ownership and undertaken more privatisation, India, Brazil and Italy 47Political, Economic and Legal Environments .. have also soughe, over the yeas, to reduce their large state-owned sectors, i they still retained a number of such state-owned enterprises into 2021, 8h Most countries entered the thd decade ofthe 21" century more or less as market econom, organised themselves by market forces, but also had varying depress of non-maet omy ‘The varieties-of-capitalism view (Hall and Soskice, 2001) embodies this reality, and suggests Pe due to history, culture, resources, and other factors, countries can vary enormously on hoy 4” combine market and non-market mechanisms to coordinate economic activity. Moreover the, economies will be constantly changing in the modern dynamic global environment. ‘The vig, suggests two main types of economy: * Coordinated market. ‘This operates through a system of coordinating by market signals together with a variety of other means, for example Italy, Netherlands, and Japan, Such economies may well have more employment protection, and les ability to raise capital through the stock market. In Germany, for example, employees have representatives on corporate boards (unlike in UK) and government is much more directly involved in vocational training. In Asia, many countries have embraced liberal market principles but also have a strong state providing direction and investment supporting the economic development path, e.g. South Korea, Singapore. * Liberal market. This operates through a system of coordination primarily through ‘market signals. Hall and Soskice (2001) suggest UK, USA, Canada, and Australia were examples in 2000, though it is important not to understate the extent of government involvement in economic development even in these states. For example the 2008/2009 crisis prompted the UK and US governments to nationalise some banks and tighten banking regulations. The 2020-2021 crisis also saw greater government intervention in economies to attempt to restore stability and stimulate economic growth. Indeed, the 2020-2021 pandemic and economic crisis led to a lot more government intervento? 7 5 ; the in economies worldwide. Throughout 2020 commentators speculated as to how tempor? fn measures taken would be, and the degree to which some aspects of government control W°' become more permanent. Most commentators expected quite a lot of country variation. 2.5. Legal Systems A legal system represents the formal rules that regulate behaviour, along with the processes bY ve obtained: which the laws of a country are enforced and through which redress for grievances is obt# 48Political, Economic and Legal Environments ... Why is it important for international managers to be familiar with different legal systems? Ieis because a country’s laws regulate business practice, define the manner in which business transactions are to be executed, and set down the rights and obligations of those involved in business transactions. The legal system impacts the attractiveness of a country as a business investment or a potential target market (see also Chapters 4 and 6). A country's legal system is strongly influenced by its political system, So, countries that are collectivistic, totalitarian states restrict private enterprise, while individualistic market economies support private enterprise and consumer rights, There are three broad types of legal system, though many legal systems are influenced by multiple legal traditions: * Common law is based on tradition, precedent, and custom. So, judges look at how previous cases have been treated to decide how to treat current cases. ‘Then, as new precedents are made, laws can be amended if necessary. Thus an important part of common law is case law, which is a rule of law created by precedents of cases in court. Common law is English in origin but has stretched to many English influenced countries—in Africa, Asia, South Africa, also Canada and the USA—and is based on statutes, customs and court decisions. Judges are arbiters, and juries are decision-makers. The implications for business are greater freedom to design contracts and codes of practice. Detailed contracts are needed to fill in for gaps in the legal framework; more legal disputes involving much use of lawyers; and greater legal burden, may favour the more powerful companies. * Civil law is based on a detailed set of laws organised into codes. This type of system, which is practised in more than 80 countries including Germany, Japan, and Russia, is less adversarial than common law because under civil law, judges only have the power to apply the existing law, not interpret the law. Here law is codified in books of law, and judges lead the proceedings including questioning and deciding, For businesses the implications tend to be relatively short contracts and codes of practice, and more consumer and employee protection available under the law. Businesses often complain about the bureaucracy of civil law, but civil law also often gives greater legal certainty. Examples include the French code civil, Germanic civil law and Nordic civil law. *° Religious, or theocratic law is based on religious teachings. Today, Islamic law is the most widely practised theocratic law system in the world. Example countries include Iran, Libya, Saudi Arabia, and Morocco. In practice, Islamic jurors and scholars have been struggling to apply the foundations of Islamic law to the modern world, including to commercial activities, and many Muslim countries today are 49Political, Economic and Legal Environments actually practising Islamic law combined with common law or Civil layy, tually outlaws the payment or receipt OF interest, One comple the Porn corey) ied in formal law. Shatia-compli., "4 tom, Islamic states this has been embodied in form: somplian banking about US82 tllon in size in 2015, and operated in some 105 coun, bs ae Patt bat ng in Turkeys Quran; Kuwait; Iran; UAE; Saudi Arabia; and Malaysia Why is it important for international companies to be familiar with the legal system o countries in which they operate? One key reason is because each system Approaches the enforcement of contracts in a different way. So, suppose you come froma common lay, State, you have signed an agreement with a company operating under a civil law System. Which [a should apply? In order to deal with this type of scenario, as of 2016 about the United Nations Convention on Contracts for the International Sale of Goods, or CICS, whi established a uniform set of rules governing certain aspects of the making and performance of everyday contracts between sellers and buyers who have their Places of business in different ation One problem has been that important trading nations, like India and the United Kingdom, did ng sign the convention. F the + and 83 countries had sen Issues for international businesses {eal systems are also important for dealing with Several other important issues for international businesses: * Property rights. Property tights are the legal rights over the use to which a resource is put and over the use of any income that may be derived from that resource. Asyou have probably already guessed, the lawe On property rights differ across countries. 1h some countries, even though there are laws protecting property, the laws are not tights can be violated through private actions and through public actions, Individuals perform Private violations, like theft, piracy, of blackmail. Keep in mind that this type of violation can take place in any countrys but in countries with weak legal systems, like Russia, itis a much bigger problem: When public officals, like Politicians and bureaucrats, violate property tights th) might use legal mechanisms Such as levying excessive taxes—as in Venemuela inthe 2000s—requiring spe ; vee I : state cial expensive licences, or even simply taking assets into control,Political, Economic and Legal Environments a A patent gives the inventor of a new product or process exclusive rights co manufacture, use, or sell the invention. A copyright is the exclusive right of authors, composers, playwrights, artists, and publishers to publish and dispose of their work as they see fit. ¢ A trademark is a design or name, which may be officially registered, that allows merchants or manufacturers to designate or differentiate their products. Protection of intellectual property rights varies by country. China and Thailand have been among the world’s biggest violators of intellectual property rights. Pirated products like Rolex watches, Levi's jeans, and computer software are widely available in both countries. In Latin America, about 68 percent ofall software is pirated, and in China some studies estimiate that the figure is 86 percent. Nearly 200 countries have signed the Paris Convention for the Protection of Industrial Property to protect intellectual property rights and are part of the World Property Organisation, but enforcement of property regulations is still lax in many countries, What can you do if your intellectual property is stolen? You can lobby your government to take action. You can also file your own lawsuit. For example, Starbucks was successful against a Chinese firm that opened stores that were virtually replicas of the traditional Starbucks store. Product safety and product liability. Product safety laws set certain standards to which a product must adhere and product liability involves holding a firm and its officers responsible when a product causes injury, death, or damage, ‘These vary greatly across countries and this often leads to an ethical dilemma for companies. ‘What should a company do if the standards in a foreign market are lower than the standards at home? Should they comply with home standards even if chis puts them at a competitive disadvantage? Corporate governance, ‘This involves the rules by which shareholders and other interested parties control corporate decision-makers, Variations across countries are closely related to differences in economic and legal systems. Generally, common law systems have evolved in ways that provide strong protection for financi investors ive, shareholders. In civil law countries, for example Germany and Denmark, the law tends to offer less protection for sharcholders and more rights to other stakeholders in the firm, for example, non-managerial employees who tend to be represented on corporate supervisory boards. 51al Environments Political, Economic and Legal Environments iene 2.6. Country Development: Political, Economic, and Legal Issues ronments oF county can havea significan impact on i i | envi sical, economic, and legal ao potential investment location or target “The polit cts of sts sronomic development, and om its attracivenss9 8 aa we tkee, Economic development levels cn be measured using gross national income per person, reading because they do not take info ACcOUNE COs of ving GNI. But GNI measures can b differences. So, we adjust these num or PPP, we can adjust the numbers to Fe country, What does this mean for companies? thar the average Indi ers by purchasing power. Using purchasing power paiy ect how far your money actually goes in a particular ‘Well, looking at a PPP adjusted GNI for India an could only consume about 6 percent of the by the average American. Should US firms have discounted India as because if we look a little deeper we would find that the country had 100 million people, which represents 2 tremendous opportunity for foreign companies. Are there other ways to measure economic development? Nobel-prize winning economist Amartya Sen argues that rather than si imply focusing on material output sures, like GNI per capita, we should consider the capabilities and opportunities people enjoy when measuring economic development. Sen (1999) believes that economic progress includes to freedom—such as tyranny, poverty, and the neglect of public in decisions. in 2007, we would conclude goods and services consumed a potential market then? No, an emerging middle class of about things like removing impediments facilities —and a democratisation of political communities so thar citizens have a voice ic health care and education is essential for economic So Sen argues, for example, that providing basi or HDI, which growth, The UN has incorporated Sen’ ideas in its Human Development Index, measures the quality of life in different countries. HIDI is based on life expectancy at birth, ‘educational attainment, and whether average incomes in a country are sufficient to meet the basic needs of life in that country. ‘Why do some countries succeed in economic development while others fail? Some argue that investment and technological progress explain capital accumulation, higher productivity and thus increasing economic success. Many policy makers and scholars contend that innovation and entrepreneurship are the engines of long-run economic growth, and that furthermore innovation and entrepreneurship require some form of market economy. In other words, new products and busines processes can increase the productivity of labour and capital ‘Think of some of the innovations by Microsoft, Apple, Samsung or Dell—all of which were formed by entreprencuss— and how they have changed not only the way of doing business, but also how many people live today. Similan inovason and entrepreneurship probably require strong property rights. The innovations by Microsoft were not given protection, there would have been litle incentive for the company to continue to develop new software and other products. Oth hi ical i ers argue that human capital is the key to prosperity, so developing countries must invest 52Political, Economic and Legal Environments ... in higher education. Others relate success to market friendly macro-economic policies by government, including low inflation; stable exchange rates; low trade barriers; and low government budget deficits. Peng and Meyer (2019) line up with the argument of North (2005) and see political, economic, and legal institutions as the basic determinants of a national economic performance because these influence incentives, and the costs of doing business: * Institutions ensure that firms are able to make gains from trade. * Lack of strong formal market-supporting institutions force firms to trade on a much more ‘ion basis, incurring political, legal and economic risks in conditions of instability, and an over-dependency on informal relationships. * Emerging formal market-supporting institutions support foreign firms moving into complicated long-distance trade with a country because they can see reasons for specialisation and growth in size, and making long-term commitments to international trade there. © If property rights are protected, this will fuel innovation; entrepreneurship; more economic growth; and increased inward investment. 2.7. Beyond the Nation State: Regional Economic Integration “The idea behind regional economic integration is that, without trade barriers, member countries will be better off, However, there is some concern that as more countries become involved in regional agreements, the trading blocs will begin to compete against each other. We can observe across the world five levels of economic integration: 1. A free trade area removes all barriers to the trade of goods and services among member countries, but members determine their own policies toward nonmembers. ‘The European Free Trade Area (EFTA) between Norway; Iceland, Liechtenstein, and Switzerland, is the most enduring free trade area. Another well-known free trade area is the North American Free Trade Area or NAFTA, though this was subject to major change during 2019-2020 (see below). ‘A.customs union climinates trade barriers between members, and adopts a common. ard non-members. The EU began as a customs union, but, as we will policy tow: discuss late, it has moved beyond this level of integration, The Andean Pact between Bolivia, Columbia, Ecuador, and Peru has been an example of a customs union. 3, A common market has no barriers to trading between members; has a common 53ind Legal Environments ... Political, Economic ai policy toward non-members; and allows free movement of the factors of production, ‘This is a significant step up from a customs union, and requires members to cooperate on fiscal, monetary, and employment policies. The EU was a common market for many years before moving to the next level of integration. Eventually, MERCOSUR, an agreement between Brazil, Argentina, Paraguay, and Uruguay, had hopes of becoming a common market. “The next level of economic integration is the economic union which involves the free flow of the factors of production between members; the adoption of a common external trade policy; a common currency; harmonisation of tax rates; and a common monetary and fiscal policy. So, again, this is a significant increase in integration from the previous level. The EU is currently an imperfect example of an economic union, For example, not all members have adopted the common currency (though the UK, with its pound sterling, formally left the EU in January 2020) and there are still differences in tax rates across the countries. 5. Ina political union, independent states are combined into a single union where the economic, social, and foreign policy of members is coordinated. An example is the USA. ‘The EU has also headed toward this level, but some members have wanted limits placed on these ambitions. Countries integrate for both economic and political reasons. We know, from our discussion of trade theory in Chapter 1, that free trade can be beneficial to countries. We will see that, for various reasons, trade barriers still exist despite the efforts of the World ‘Trade Organisation (WTO). Regional economic integration offers countries a way to achieve the gains from free trade, at least on a limited basis, more quickly than would be possible under the processes offered by the WTO. ‘The political case for integration has two main points. Firstly, by linking countries togethers making them more dependent on each other; and forming a structure where they regularly have t0 interact, the chances of violent conflict and war decrease. Secondly, economic integration gives the bloc of countries greater power and makes them much stronger politically when dealing with other countries than if they were to act independently, Fintegration is beneficial, why does it not occur more often? ‘Two key issues limit integration. Firstly, while a nation as a whole benefits from integration, some groups may actually lose. Critics of NAFTA, for example, were concerned about the potential for job loss in the USA if companies shifted production to take advantage of Mexico's low cost labour. From 2016, the US administration has been more aggressive on these and other trade issues relative to Canada and Mexico. By 2020 it had renegotiated the treaties between the three countries. Secondly, countries that integrate their economies lose some degree of national sovereignty. Integration requires that 54Political, Economic and Legal Environments ... countries give up some control over monetary policy, fiscal policy, and trade policy. For example, most of the countries belonging to the EU have given up their currencies and adopted the euro instead. Some economists point out that integration only makes sense when the amount of trade it creates is greater than the amount that it is diverting. Trade creation occurs when low cost producers within a free trade area replace high cost domestic producers, while trade diversion occurs when higher cost suppliers within a free trade area replace lower cost external suppliers. 2.8, Regional Integration in Europe ‘As we said, faced with the inevitable limitations of global institutions, many countries have chosen to organise themselves into regional blocs to pursue joint economic and sometimes political objectives. In this section we will look at some of the major economic blocs as examples only, remembering that there are many such blocs, though none as large as the ones described here. In Europe, there is the European Union (EU), which is the world’s most integrated group of countries with 27 members (the United Kingdom formally left in early 2020). ‘The EU Single Market is based on freedom of movement of goods, capital, people, and services. This is implemented though harmonisation of regulation in some sectors, and mutual recognition of national regulation in others. The EU aims to facilitate free movement of people within the union, particularly to enable people to take up a job in another country. ‘The euro has become a common currency in 16 countries that have transferred their monetary policy to the European Central Bank. EU competition policy aims to ensure that a competitive environment is maintained in cases of mergers and acquisitions, cartels, collusion and state aid. Formal political structures of the EU resemble a government, yet national governments wield power through the Council. ‘The decision- making processes in the EU are based on democratic principles, yet they are often far removed from the individual citizens in member countries. Enlargement creates not only benefits but also costs for existing EU members, who thus may be less enthusiastic to admit further members. While a member, the UK had an ambiguous relationship with the EU, grounded in its history and its political culture, For example, like several other European counties, it refused ro have the euro as its currency, Today, The European Union consists of many countries. The original agreement between Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands was expanded in 1973 to include Great Britain, Ireland, and Denmark. In 1981, Greece joined, then Spain and Portugal in 1986, and Austria, Finland, and Sweden in 1986. ‘Ten more countries joined in 2004, and three more in 2007. ‘The European Community was founded in 1957 by the Treaty of Rome. This became the European Union in 1993, after the Maastricht Treaty was ratified, extended political cooperation, and committed members to adopt a single currency by 1999. This created the single 55al, Economic and Legal Environments .. largest currency zone inthe world after che US dollar. Euro notes and coins started ci 2002. However, three members, Britain, Denmark, and Sweden opted out of the euroz0; institutions govern the EU: Poli lating in Me, Five * The European Council resolves major policy issues and sets policy directions, * The European Commission is responsible for implementing EU law and mon member states to ensure they are in compliance. * The Council of the European Union is the ultimate controlling authority, + The European Parliament debates legislation proposed by the commission and forwarded to it by the council. + The Court of Justice acts as the supreme appeals court for EU law. itoring For our purposes, the most relevant aspect of the EU is the institutional framework it provides for business. Four aspects of EU policy shape greatly how international business can be done: * The ‘single market”. The EU has created an institutional framework that establishes many of the rules by which businesses compete. It has removed most internal trade barriers between member countries. Internal customs and passport controls have been abolished. A prime focus has been on establishing the four freedoms—free movement of people, goods, services, and capital amongst member countries. A common external tariffis applied to all imported goods across the customs union. The EU has attempted to harmonise— create common rules, standards and regulations on the free movement of goods—and has made considerable headway, but this has been a difficult and complex political process, with national ot local regulations sometimes being allowed to stand if deemed more effective than EU stipulation. ‘The single market for services has been even more difficult to implement. Service sectors like banking and telecommunications have complex regulatory regimes. Services always have some local component and common standards may be difficult to apply across different cultures, and customers with differing expectations. Moreover, and a bigger point for goods and services, harmonisation represents liberalisation and threatens protectionism in local markets. * The free movement of people. People from EU member states are fice 10 work in other EU countries, but there can be barriers. ‘The EU has moved t0 guran mutual recognition of professional experience, qualifications, and training across P| countries. It has also encouraged the movement of EU students and the advancement of higher education across EU countries. The Schengen Agreement laid the basis 9 56Political, Economic and Legal Environments ... passport-free travel across member states, but also tightened regulations and policing for non-EU state citizens arriving at EU borders—the so-called Schengen area. European competition policy. The European commission regulates for competition issues such as over-dominant players, or illegal collusion, but only in cases involving multiple countries. National authorities are the regulators where only a national market isaffected. The EU commission also looks to regulate mergers and acquisitions, including foreign mergers, if they seem to represent a substantial impediment to effective competition within the EU. Note that the EU also regulates governments, for example, when ‘state aid’ or subsidies are being offered to subsidise companies or protect local jobs, or make attractive a particular location to a multinational looking to make a foreign direct investment. Competition policy has numerous exceptions however, not least during the 2008/2009 financial crisis, when governments bailed out their home country banks. ‘The euro as a common currency, Having one currency, rather than several, is easier for companies and individuals. The same currency is used across the bloc, so companies will save the cost and risks of converting currencies. Having a single currency will also make it easier to compare prices across Europe. Adopting a single currency will make it easier to do the same thing in Europe, and force companies to lower prices. The lower prices should then encourage producers to look for ways to reduce their production costs in order to maintain their profit margins. So, by adopting a common currency, we should sce greater efficiency. Another benefit of the euro is that it should boost the development of a highly liquid pan-European capital market. Finally, the capital market will provide a greater range of investment options to individuals and institutions. While there are many benefits of adopting the euro, there are also some disadvantages. A major cost involved in adopting a common currency is that individual countries lose control over monetary policy. ‘The three countries that opted out of the eurozone did so because they did not want to give up this autonomy. A second disadvantage of the euro is that the EU is not an optimal currency area; or an area where similarities in the underlying structure of economic activities make it feasible to adopt a single currency and use a single exchange rate as an instrument of macro-economic policy. In other words, because of differences in member economies—take Portugal and Finland for example—they might react differently to external shocks. So, a change in the euro exchange rate that helps Finland might actually hurt Portugal. Some critics have argued that instead of establishing the euro and then moving toward political union, the EU should have achieved political union status first. 57ironments ... Political, Economic and Legal Envi dom became the fist member state to leave the EU, ingdo ; a rin feds mention to leave and egotited a wth agg In January 2020, the United Ki 2016 referendum, the UK signi! be ina transitional phase until at least 31 December 2020, during which The UK was to be ina ad sabject to EU law and part ofthe EU single market and customs union, Before remained subject to his on itories of member states had left the EU or its forerunners. hy itor three ter Lo spower—even without the UK. Containing in 2099, oe Fe 4 aes eee In 2017, the BU (including the United Kingdom) ta eee noitl gos dames roduc (GDP oF aound US820 lion, conn approximately 25 percent of global nominal GDP. Additionally, all EU countries have avery high Human Development Index, according to the United Nations Development Programme, ‘Thro, the Common Foreign and Security Policy, the EU has developed a role in external relations and defence. The union maintains permanent diplomatic missions throughout the world and represents itself at the United Nations, the World Trade Organisation, the G7 and the G20, 2.9. Regional Integration in the Americas ‘We will now look at just three trade blocs in the Americas, and assess their levels of success: ‘The North American Free Trade Agreement (NAFTA) ‘This became law in 1994. Under NAFTA, tariffs on 99 percent of the goods traded between Mexico, Canada, and the USA were aboli ished, and so were most of the restrictions on the cross-border flow of services. The agreement also protected intellectual property, removed most restrictions on Foreign Direct Investment between the three countries, and allowed each country ‘ maintain its own environmental standards. In addition, two commissions were established to intervene when environmental standard o1 legislation involv inimum wages, ee ns * legislation involving health and safety, mini ‘What are the benefits of NAFTA? NAFTA’ supporters argued that it would provide economic Bains to all members, Mexico sho are ; ; uld benefit from mi USA acon suho ate adamape st BF0W economically, with the country looking to get preferent ‘Pons. Inthe USA and Canada, consumes would benefit some from Mexico, and companies would benefit not onl having access toa large and more ™ as companies from Canada and the labour. ‘The jobs would help Mexico tial treatment for 80 percent ofits from the lower-priced products that from low cost labour, but also fromPolitical, Economic and Legal Environments ... They also raised concerns that pollution would increase as companies shifted production to take advantage of Mexico's more lax environmental regulations. In addition, some critics raised concerns that Mexico would lose its sovereignty, as the country became dominated by US firms that were not really committed to helping the economy grow, but rather just saw it as a cheap assembly location. [After the first decade of NAFTA, most people agreed that both the critics and the supporters of the agreement were probably guilty of exaggeration, By most statistical measures NAFTA had been a success, with trade between the countries and FDI into Mexico growing very fast indeed. For example, studies showed that the concern over jobs turned out to be a non-issue. Jobs in Mexico boomed while job losses in USA were very small. Some US firms persevered because most components in Mexican assembly plants used US-made parts, unlike Asian-based assembly plants. One positive that came from the agreement was increased political stability in Mexico. This, of course, may also be beneficial to the USA and Canada. Some Mexican critics pointed out that job gains have stagnated as USA and Canadian multinationals shifted more work to China rather than Mexico. The future may well see some enlargement with several other Latin American countries, including Chile indicating that it would like to join. But NAFTA’s more recent history has been more problematic, partly because of the more aggressive negotiating stance adopted by the US administration elected in 2016. After US President Donald ‘Trump took office in January 2017, he sought to replace NAFTA with a new agreement, beginning negotiations with Canada and Mexico. In July 2017, the US administration provided a derailed lise of changes that it would like to see vo NAFTA. ‘The top priority was a reduction in the United Seates trade deficit, The administration also called for the climination of provisions that allowed Canada and Mexico to appeal duties imposed by the United States and limited the ability of the United States to impose import restrictions on Canada and Mexico. The list also alleged subsidised state-owned enterprises and currency manipulation, From June to late August 2018, Canada was sidelined as the United States and Mexico held bilateral talks. On 27# August 2018, Mexico and he United States announced they had reached a bilareral understanding on a revamped NAFTA rade deal that included provisions that would boost automobile production in the US According san article in The Economist, on 30% August 2018, the deal put the Mexican car industry nto a raightjacket.’ For example, Mexico agreed to increase the rules of origin threshold, which would lean that 75 percent, as opposed to the previous 62.5 percent, of a vehicle's components must be dein North America to avoid tariffs. The deal also included a 10-year data protection period ainst generic drug production on an expanded list of products chat benefits pharmaceutical mpanies—particularly US makers producing high-cost biologic drugs, There was also a ‘sunset 1use’—a 16-year expiration date with regular 6-year evaluations, 10 possibly renew the agreement 59ical, Economic and Legal Environments ... for additional 16-year terms; and an increased de minimis threshold in which Mesig ry minimis value to $100 from $50 regarding online duty- and tax-free purchases, (The de, + the de threshold refers o the value of imported goods below which no duty or taxis collecreg. is customs declaration is very simple.) band the Negotiations with Canada followed. According to an August 2018 article in the Ottawa Gi key issues under debate included supply management; pharmaceuticals cultural exernpeg the sunset clause; and de minimis thresholds. In September 2018, the United States, Men, and Canada reached an agreement to replace NAFTA with the United States-Mexico-Cany ‘Agreement (USMCA). NAFTA remained in force, pending the ratification of the USMca\ In January 2020, the revised agreement was signed into law in the USA. A range of trade experts have said that changing trade relations would have a range of ‘unintended consequences for the US, including reduced access to the US's biggest export markets a eduetng in economic growth; and increased prices for gasoline, cars, fruits, and vegetables, The worst affected sectors would be textiles, agriculture and automobiles. According to Chad P. Bown, senior fellow at che Peterson Institute for International Economics, “a renegotiated NAFTA that would re-establish trade barriers is unlikely to help workers who lost their jobs—regardless of the cause—take advantage of new employment opportunities.” Others have suggested that repealing NAFTA will not lead to increased car production in the USA. ‘Was NAFTA so bad for the USA? The new agreement certainly saw a move towards trade barriers and protectionism by the USA. In a 2015 report, the Congressional Research Service summarised multiple studies as follows: “In reality. NAFTA did not cause the huge job losses feared by the crites or the large economic gains predicted by supporters. The net overall effect of NAFTA on the US economy appears to have been relatively modest, primarily because trade with Canada and Mexico accounts for a small percentage of US GDR However, there were worker and firm adjustment costs as the three countries adjusted to more open trade and investment among their economies.” Andean Community and Mercosur Te is useful to look at regional blocs that are less successful. The Andean Pact between Bolivia, Chile, Ecuador, Columbia, and Peru was formed in 1969, and modelled on the EU. However by the mid-1980s, it was clear that the Pact had more or less failed to achieve any of its goals. In the lave 1980s though, many Latin American countries began to adopt free market policies, and 1990 the Andean Pact was re-launched, and operated as a customs union. In 2003, the poe Community signed an agreement with MERCOSUR to work toward a free trade area. You"! recall chat Mercosur is South American trade bloc. It established by the Treaty of Asuncién iP © and Protocol of Ouro Preto in 1994. Full members are Argentina, Brazil, Paraguay and Urs 60 eeePolitical, Economic and Legal Environments ... Mercosur began in 1988 as a free trade agreement between Brazil and Argentina, It was expanded to include Paraguay and Uruguay in 1990, and has been makin, the coun However, some critics have argued that, establishing high tariffs to outside countries, that companies in these industries would be ig Progress toward free trade between rather than creating trade, Mercosur, by is actually diverting trade in some industries, and unable to compete in global markets. In recent years, the furure of this group has been unstable, not least because of politics. Venezuela pulled out of the Andean Community in protest against Colombia and Peru signing trade deals with the USA. Uruguay demanded the right to sign a separate trade deal with the USA despite being a Mercosur member. The central problem has been that members of both trade blocs actually trade very little with each other but mainly with the USA. Other economic blocs have been proposed but seem hard to organise and sustain in the difficult political disunity of the continent, ‘With the cooperation agreement with Mercosur, the Andean Community gained four new associate members: Argentina, Brazil, Paraguay, and Uruguay. ‘These four Mercosur members were granted associate membership by the Andean Council of Foreign Ministers. ‘They met in an enlarged session with the Commission (of the Andean Community) on 7 July 2005. This move reciprocated the actions of Mercosur, which granted associate membership to all the Andean Community nations by virtue of the Economic Complementarity Agreements (Free Trade Agreements) signed between the CAN and individual Mercosur members. Mercosur’s purpose is to promote free trade and the fluid movement of goods, people, and currency. As you can see, since its foundation, Mercosu’s functions have been updated and amended many times; it currently confines itself to a customs union, in which there is free intra- zone trade and a common trade policy between member countries. The official languages are Spanish, Portuguese, and Guarani. ‘The bloc comprises a population of more than 270 million people, and the combined Gross Domestic Product of the full-member nations is in excess of US$3.0 trillion a year (US$3.393 trillion in 2018) making Mercosur the fifth-largest economy in the World. It is the fourth-largest trading bloc after the European Union. ‘The working of Mercosur has not met with universal approval within interested countries. Chile has, o a certain extent, preferred to pursue bilateral agreements with trading partners, and there have been calls from Uruguayan politicians to follow this example. Mercosur signed free trade agreements with Israel in December 2007; with Egypt in August 2010; the State of Palestine in December 2011; and Lebanon on 18 December 2014. In 2016, Brazilian presidents, Dilma Rousseff, and later Michel Temer, along with Argentine 61Political, Economic and Legal Environments President Macti began to place pressure to negotiate a free trade agreement between Me, ther Latin American nations. In June 2019, the Earopen O Unio, ne and the European Union and o ‘ ‘Mercosur Free Trade Agreement was confirmed. ‘The bilateral trade deal opens 109 ercen, trade and 90 percent of Mercosur trade. ‘The deal, however, has taken a long time to be mee 2.10. Regional Integration in Asia Pacific One of the most important efforts in Asia Pacific isthe Association of South East Asian Nat, ASEAN. ASEAN was formed in 1967 with five founding nations, later increased t010, ins” Brunei; Cambodia; Indonesia; Laos; Malaysia: Myanmar; The Philippines: Singapore; Thala and Vietnam. ‘There are two observer nations: Papua New Guinea and Timor Leste. ASEAN, goals are co promote fice trade between members and achieve cooperation on industrial polis, but so far, it has made only slow progress. However, a new agreement between the six orginal members came into effect in 2003 to create a free trade area, with the creation of the ASEAN Economic Community by 2015. Across all nations of ASEAN, there is a population of over 622 million people. ‘The region has one of the largest economies in the world, and itis believed that by 2050, it will have the 4ch-largest economy in the world. It also has one of the largest labour forces in the world, falling behind only India and China. ‘The total region stretches across over 1.7 million square miles. The organisation focuses on boosting economic and trade growth, with all member states having a free trade agreement. Travel within the region is also easier for member states. All member states have signed a treaty against the development of nuclear weapons. Most have also signed on to a counter- terrorism pact. Technical and research cooperation is also promoted across the member states. Initiatives include overseeing the protection of the environment and wildlife through the Centre for Biodiversity. ASEAN has suffered because members’ main trading partners—USA, Japan, China, and Europ¢— are outside the ASEAN bloc. On average intra-ASEAN trade has represented only 27.6 percent of ASEAN country exports. Size of intra-ASEAN trade also varies from country to country $° benefits of membership are unevenly distributed. Furthermore, ASEAN experiences internal the EU: political tensions, and much more economic, religious, and cultural diversity than, says or groups However ASEAN does act as a group in negotiating agreements with other countries, 5 like the EU for which it is an important trading partner. It has signed free trade agreements ee Korea, Japan, Australia, and New Zealand; and the ASEAN China Free Trade Agreement 62Political, Economic and Legal Environments ... 2010—fundamentally converting a major rival into a potential partner in raising exports and GDP forall parties. ‘Asa region, ASEAN has undeniably grown in importance, Southeast Asia is quickly establishing itself as an Industry 4.0 hub. Geopolitically, it has become a valuable site of contention with ‘major powers such as the USA and China looking to establish their influence over the region. In 2018, in response to US President Donald Trump’ more insular policies, ASEAN proposed a trade agreement of its own: The Regional Comprehensive Economic Partnership (RCEP). The RCEP could be one of the biggest trade deals in history as it would encompass 25 percent of global gross domestic product (GDP); 45 percent of the toral population; 30 percent of global income; and 30 percent global trade. Other countries involved in this trade agreement are India; China; Japan; South Korea; Australia; and New Zealand. But passing the agreement has been a challenge on its own, In 2018, ASEAN and the countries involved missed its fourth deadline to sign the deal, despite having negotiations for more than a year. It was reported in November 2019, however, that Southeast Asian countries were committed to signing the mega Asia Pacific trade pact in 2020. ASEAN Secretary-General Lim Jock Hoi had also said that ASEAN leaders, together with their counterparts from the five RCEP participating countries had agreed to push forward and sign the trade pact in 2020. 2.11. The Multilateral Monetary and Trade Systems We have looked at formal institutions operating at country and regional level, but firms operating internationally also have to bear in mind the influence and impact on the business environment of two international institutions—the International Monetary Fund (IMF) and the World Trade Organisation (WTO). Both have their supporters and detractors. The International Monetary Fund ‘The IMF is a multilateral organisation promoting international monetary cooperation and. providing temporary financial assistance to countries with balance of payments problems. It has three primary activities on behalf of its 189 member countries: 1. Monitoring the global economy. 2. Providing technical assistance to developing countries. 3. Lending to countries in financial difficulties. 63Political, Economic and Legal Environments , as long as it meets a few requirements. These include proy; untry can apply to richer the country, the higher its quota. The ‘The IMF’ lending activity focuses on helping countries with severe balance of paymeng a ‘The IMF acts asa lender of last resort, with loan repayments typically expected within ones years. As one example, IMF bailouts in 2008/2009 were ro Hungary (US$15,7 billion, a (US$2.1 billion); Ukraine (US$16.4 billion); Romania (US$17.1 billion); Lawvia(Us$2.4 ai Georgia (US$0.75 billion); Armenia(US$0.54 billion); Belarus (US$2.6 billion); Past cuss billion); and Serbia (US$0.53 billion). ‘There have been quite a few more since! ‘These loans an mainly funded by quota subscriptions. In 2018, Argentina received the largest loan in the Mp, history at US$57billion. ‘The IMF can lend its members a total amount of US$ 1tillion, IMF loans come with strings attached. IMF conditionality typically imposes conditions that require ‘belt-tightening’ by pushing governments to embark on reforms that they probably would nor have undertaken otherwise. To attack inflation and government deficits, the IMF ‘ypically looks for cuts in government expendicure, amongst other things, in agreement with that government. In principle the conditions imposed are designed to also ensure the country can repay its IMF loans. In the 1990s and early 2000s the IMF often went into action in emerging economies including Mexico; Russia; Indonesia; South Korea; Turkey; and Brazil, ‘The financial ctisis of 2008 and subsequent events, for example the financial crises in Greece, Spain, Ireland, and Portugal in 2010-2012, led to renewed debates around the pros and cons of IMF conditionaliry, Criticisms include: * The IMF's lack of accountability. It has very few officials, who are not elected and do not always have deep knowledge of the country being bailed out. ‘The IMF's ‘one-size-fits-all’ economic strategy may be inappropriate. Some economists argue that balancing the budget may not be the best policy; that deficit spending has been a successful policy for pulling countries out of crisis; that cutting spending in more vulnerable developing countries undergoing a major economic ctisis to balance the budget may make matters much worse, not better. On the other hand, some critics have argued that the IMF has sometimes not been tough enough, allowing countries to run up deficits not sustainable in the medium and long term. * Bear in mind, of course, that it is difficult to say whether IMF policies are bens worse than the alternatives, becausé itis difficult to know what would have happem if a country had not adopted IMF recommendations. 64Political, Economic and Legal Environments ..- * A major limitation identified in the 2008-2013 crisis is that the IMF has no power over countries that do not need its loans despite having large budget or current deficits. Notable cases are the USA and the EU, ‘The IMF continued operations throughout 2020-2021. Trade tensions, weak economic growth, a slowdown in manufacturing and companies’ debts, and the impact of the coronavirus pandemic, were big topics throughout 2020. Through the fund and other activities, such as the gathering of statistics and analysis; surveillance of its members’ economies; and the demand for particular policies, the IMF continued to work to improve the economies of its member countries. The organisation's objectives stated in the Articles of Agreement are: to promote international monetary co-operation; international trade; high employment; exchange-rate stability; sustainable economic growth; and making resources available to member countries in financial difficulty. IMF funds come from two major sources: quotas and loans. Quotas, which are pooled funds of member nations, generate most IMF funds. ‘The size of a member's quota depends on its economic and financial importance in the world. Nations with larger economic importance have larger quotas. “The quotas are increased periodically as a means of boosting the IMF's resources in the form of special drawing rights. ‘What are the achievements of the IMF? The IMF is often described as a ‘lender of last resort’, In times of crisis, countries look to it for financial assistance. Economists like Harvard University’s Benjamin Friedman have said it’s difficult to measure the organisation's success because we can't know if its policies are “worse than whatever the alternative would have been”. However, some praised the Fund's role in supporting Mexico after it declared it would be unable to repay its debts in the early 1980s. More recently, Brazil obtained IMF loans in 2002 to avoid defaulting on its debts. ‘The government was able to turn the economy around relatively quickly, and pay off its entire debt two years ahead of schedule. What are the main criticisms? The conditions the IMF imposes on countries to which it lends money have sometimes been described as ‘harsh’, In the past, these have included lower government borrowing, cutting corporate taxes and opening up their economies to foreign investment. It was in Greece that the eurozone financial crisis started back in 2009, and Greece was the hardest-hit economy. After it received bailout loans from the IMF, Greece had to make some changes, Critics said the austerity—intended to get government borrowing needs down— was excessive and did damage to the economy and society. The unemployment rate in Greece still remained high at 17 percent in 2020, down from a peak of over 27 percent in 2013. 65Political, Economic and Legal Environments ... ‘Any country can apply to join, as long as it meets a few requirements. These include provi information about its economy and paying in a sum of money called a quota subscription, The richer the country, the higher its quota. ‘The IMPs lending activity focuses on helping countries with severe balance of payment problems “The IMF acts as a lender of last resort, with loan repayments typically expected within one o ye years. As one example, IMF bailouts in 2008/2009 were to Hungary (US$15.7 billion); Iceland (US$2.1 billion); Ukraine (US$1644 billion); Romania (US$17.1 billion); Latvia(US$2.4 billion), Georgia (US$0.75 billion); Armenia(US$0.54 billion); Belarus (US$2.6 billion); Pakistan(Usg7 ¢ billion); and Serbia (US$0.53 billion). ‘There have been quite a few more since! These loans are mainly funded by quota subscriptions. In 2018, Argentina received the largest loan in the IMF's history at US$57billion. The IMF can lend its members a total amount of US$1uillion, IMF loans come with strings attached. IMF conditionality typically imposes conditions that require ‘belt-tightening’ by pushing governments to embark on reforms that they probably would not have undertaken otherwise. To attack inflation and government deficits, the IMF typically looks for cuts in government expenditure, amongst other things, in agreement with that government. In principle the conditions imposed are designed to also ensure the country can repay its IMF loans. In the 1990s and early 2000s the IMF often went into action in emerging economies including Mexico; Russia; Indonesia; South Korea; Turkey; and Brazil. ‘The financial crisis of 2008 and subsequent events, for example the financial crises in Greece, Spain, Ireland, and Portugal in 2010-2012, led to renewed debates around the pros and cons of IMF conditionality. Criticisms include: * The IMF's lack of accountability. It has very few officials, who are not elected and do not always have deep knowledge of the country being bailed out. * The IMP’ ‘one-size-fits-all’ economic strategy may be inappropriate. Some economists argue that balancing the budget may not be the best policy; that deficit spending has been a successful policy for pulling countries out of crisis; that cutting spending in more vulnerable developing countries undergoing a major economic ctisis to balance the budget may make matters much worse, not better, On the other hand, some critics have argued that the IMF has sometimes not been tough enough, allowing countries to run up deficits not sustainable in the medium and ong term. * Bear in mind, of course, that itis difficult to say whether IMF policies are better oF worse than the alternatives, because itis difficult to know what would have happened if a country had not adopted IMF recommendations, 64Political, Economic and Legal Environments ... + A major limitation identified in the 2008-2013 crisis is that the IMF has no power over countries that do not need its loans despite having large budget or current deficits. Notable cases are the USA and the EU. ‘The IMF continued operations throughout 2020-2021. Trade tensions, weak economic growth, a slowdown in manufacturing and companies’ debts, and the impact of the coronavirus pandemic, were big topics throughout 2020. Through the fund and other activities, such as the gathering of statistics and analysis; surveillance of its members’ economies; and the demand for particular policies, the IMF continued to work to improve the economies of its member countries. ‘The rganisation'’s objectives stated in the Articles of Agreement are: to promote international monetary co-operation; international trade; high employment; exchange-rate stability; sustainable economic growth; and making resources available to member countries in financial difficulty. IMF funds come from two major sources: quotas and loans. Quotas, which are pooled funds of member nations, generate most IMF funds. The size of a member's quota depends on its economic and financial importance in the world, Nations with larger economic importance have larger quotas. “The quotas are increased periodically as a means of boosting the IMF's resources in the form of special drawing rights. ‘What are the achievements of the IMF? The IMF is often described as a ‘lender of last resort’. In times of crisis, countries look to it for financial assistance. Economists like Harvard University’s Benjamin Friedman have said it’s difficult to measure the organisation’s success because we can't know if ts policies are “worse than whatever the alternative would have been”. However, some praised the Fund’s role in supporting Mexico after it declared it would be unable to repay its debts in the early 1980s, More recently, Brazil obtained IMF loans in 2002 to avoid defaulting on its debts. The government was able co turn the economy around relatively quickly, and pay off its entire debt two years ahead of schedule. ‘What are the main criticisms? The conditions the IMF imposes on countries to which it lends money have sometimes been described as ‘harsh’. In the past, these have included lower government borrowing, cutting corporate taxes and opening up their economies to foreign investment. It was in Greece that the eurozone financial crisis started back in 2009, and Greece was the hardest-hit economy. After it received bailout loans from the IMF, Greece had to make some changes. Critics said the austerity—intended to get government borrowing needs down— was excessive and did damage to the economy and society. The unemployment rate in Greece still aPolitical, Economic and Legal Environments ... ae ‘The World Trade Organisation In the late 1940s the world community developed several institutions to facilicare intemat, trade and politcal integration. ‘These included the United Nations, the Imetnation et Fund and World Bank, together with the General Agreement on Tariffs and Trade successor, the World Trade Organisation (WTO). Mone, arn). 7 GATT was created in 1948 to reduce the levels of tariffs amongst participating countries, Bye 1980s it had been successful but had left out trade in services and intellectual Property prota, For trade regulation there were a lot of loopholes requiting reform. Moreover GATT's Succes ig removing tariff barriers led to countries developing non-tariff barriers, and GATT. did not have effective dispute resolution mechanisms for these. In 1995 participating countries extended Gary by creating the WTO. ‘The WTO is the main multilateral organisation making rules for international trade, and resolving trade-related conflicts between nations. It has both political and economic functions Peng and Meyer (2019) suggest that in recent years it has focused on: * Handling disputes constructively. Its role here has increased in recent years, * Malking life easier for all participants. ‘This involves setting out a common set of rules for international trading partners. For example, the WTO's principle of non- discrimination means that a country cannot discriminate against some trading partners and not others. * If you lower tariffs for one WTO member country you must do so for all WTO members (regional trade groups are an exception here—see below). Raising incomes, generating jobs, and stimulating economic growth. ‘The eseni role here is cutting trade barriers, with the WTO estimating that if it helped cut trade barriers by a third, this would raise worldwide income by about US$600 billion. ‘There is a debate however, about the envi: itis conducted and who benefits, ‘The WTO has six main areas: ow ronmental impacts of more trade, and hi 1. The umbrella agreement establishing the WTO, 2, The old GATT agreement Covering international trade of goods. 3. A new agreement coverin, in 5 Trade i 8 the trade in services—General Agreement on Services. 66Political, Economic and Legal Environments ... 4, An agreement covering intellectual property rights—Trade-Related Aspects of Intellectual Property Rights. 5. Trade dispute settlement mechanisms. 6. Trade policy review for looking at an individual country’s trade policies. Clearly, the WTO does a lot more than was previously done under GATT, though developing countties often complain that agricultural policies of developed countries were not included under the WTO remit, In recent years it undertook two major initiatives: * Trade dispute settlement. The WTO has a procedure to resolve conflicts between governments over trade-related matters. You can see these at work in the cases you will look at in the Activity below. The procedure is designed to avoid the weaknesses of the old GATT system, which saw long delays, blocking by accused countries, and lack of enforcement. The WTO first facilitates negotiations between the parties, but if consultation fails, i establishes a group of experts to hear the evidence, write a report and adjudicate. All this happens within 12 months (or 15 months if there is an appeal). A limitation is that the WTO does not have its own enforcement capability. It makes a recommendation, not an order, It is up to the offending country to change its practices or not, though the WTO can authorise the winning countries to impose trade sanctions and tariff barriers to encourage compliance. * The Doha Development Agenda. Also called the Doha Round, initiated in Qatar in 2001. This was the first time the WTO participating countries established the aim of promoting economic development for developing countries. ‘The four ambitions were to (1) reduce agricultural subsidies in developed countries; (2) cut tariffs, especially in industries of interest to developing countries, eg. textiles; (3) free up trade in services; and (4) strengthen intellectual property protection. You might guess which group of countries supported which aim! However, by 2003 numerous countries had failed to deliver on their promises of 2001. The development agenda continued to be problematic into the 2020s. Agriculture has been a particular problem with developing countries demanding that Japan, the EU, and USA reduce farm subsidies, but this was rejected. Meanwhile, partly in retaliation, developing countries, led by India, refused to tighten protection on intellectual property and make concessions on service trade. By the 2006 round in Geneva there was still little movement on slobal agreements, though, outside the WTO altogether, regional and bilateral (between country) agreements were accelerating, and have been since then. One example of such an agreement is 67Political, Economic and Legal Environments .. the Autala New Zealand Closer Economic Relations Trade Agreement (ANZCERTA or cpp “The USA has signed 17 bilateral free trade and investment agreements wit counties dene Australia, Singapore, Peru, Oman, and Jordan, while three more are in the process of rtfcaton Advocates of bilateral FTAs se them as a convenient substcute for global ie trade, Cis apy they: permit countries with large markets to use their bargaining power more effectively lead ty, hhub and spoke sytem of international trade that futher strengthens the counties atthe hubs; and create fragmented rules for businesses operating in multiple countries, and increase trade diversion Here are some criticisms of the WTO: + Free Trade benefits developed countries more than developing countries, \t is argued, developing countries need some trade protection to be able to develop new industries; this is important to be able to diversify the economy. It is known as the ‘infant industry argument’. Many developed economiesused a degree of tariff protection in their development phase. Economist Ha Joon Chang argues WTO. trade rules are like ‘pulling away the ladder they used themselves to climb up” (see his book: ‘Kicking Away The Ladder ..’ (Anthem Press, 2003). Most favoured nation principle. This is a core tenet of WTO rules—countries should trade without discrimination. It means a local firm is not allowed to favour local contractors. Butt is argued chat this gives an unfair advantage to multinational companies, can have costs fr local firms, and hurt the right of developing economies to favour their own emerging industries. Failure to reduce on agriculture. Free trade is not equally sought across different industries. Both the US and EU retain high tariffs on agriculture, which hurts farmers in developing economies who face tariff protection. Diversification. Arguably developing countries that specialise in primary products (eg, agriculcural products) need to diversify into other sectors. To diversify they may need some tariff protection, at least in the short term. Many of the existing industrialised nations used tariff protection when they were developing. Therefore; the WTO has been criticised for being unfair and ignoring the needs of developing countries. Environment. Free trade has often ignored environmental consideration; €8: fe trade has enabled imports to be made from countries with the least environmental Protection, Many criticise the WTO's philosophy that the most important economic objective is the maximisation of GDP. In an era of global warming and potential environmental disaster, increasing GDP may be the least important objective Arguably the WTO should do more to promote environmental considerations. 68Political, Economic and Legal Environments ... © Free trade ignores cultural and social factors. Debatably, a reasonable argument ig free trade is that it enables countries to maintain cultural diversity. e the WTO for enabling the domination of multinational companies, which reduce cultural diversity and tend to swamp local industries and firms. * The WTO is criticised for being undemocratic. \t is suggested that its structure enables richer countries to win what they desire; arguably they benefit the most. * Slow progress. Trade rounds have been notoriously slow and difficult to reach an agreement. * WTO has become overshadowed by TIPP agreements, which fall outside the spread of WTO rules. “There are responses to these criticisms, for example: + Failure of countries to agree tariff reduction in agriculture is not the fault of the WTO, but of countries themselves. © Free trade and growth of exports have been an important factor in raising living standards, especially in Southeast Asia, which has benefitted from the remarkable growth of world trade. + The growth of world trade has helped reduce absolute poverty. «In recent years, the WTO has made more efforts to consider the situation of developing economies. Recent rounds have put pressure on developed countries to accelerate removing restrictions on imports from the least-developing countries. «© ‘The WTO has over 160 members representing 98 percent of world trade. Over 20 countries are seeking to join the WTO. © WTO has been given credit for helping to avoid trade disputes. During 2019, and early 2020, the WTO. faced challenges on multiple fronts. The organisation’s Dispute Settlement Body (DSB) faced several systemic tests. “The first of these was the viability of the Appellate Body (AB). Due to the retirement of previous AB members, and the continued refusal of the United States to appoint new ones before its concerns over the AB are addressed by the WTO membership, there were only three sitting members on the AB. Unless WTO members agreed to appoint new members this number would fall .o one by December 2019—at which point the AB would no longer be able to function. Ac the end of 2018, the EU, China, India and nine other WTO members proposed modifications to the Dispute Settlement Understanding (DSU) that would, in their view, provide solutions to all of the issues on which the United States 69Political, Economic and Legal Environments ... TN has criticised the functioning of the AB for the previous 12 months; the United States, rejected all elements of the proposal. Some observers believed that the United States already decided to put the AB out of business at the end of 2019, and that it had no before then, of engaging with other members to try to correct the AB practices about complained. , May haye intention, Which ic hag There were multiple unsettled disputes berween countries not being resolved atthe WTO durin 2019. As just one example, WTO ruling in China’ favour on some issues, and against the Usa has led some to belive the USA would threaten to eave the WTO. Finally, despite the propoat by some members to reform the WTO in 2018 (e.g. with respect to agricultural and industri} subsidies, state-owned enterprises, etc.), members appeared to be far away from finding common ground on which to start a serious discussion—let alone an eventual negotiation—on elements of WTO reform. Director-General Roberto Azevédo continued to hold consultations on the subject in 2019, bur it appeared doubeful chat members would be able to forge agreement around a singe agenda in the near future. Other multilateral organisations While the WTO and IMF are the most important multilateral organisations, there are others—not least the United Nations, whose mission is to secure world peace. Peng and Meyer (2018) usflly organise all these in terms of three agendas driving global collaboration and negotiation. Inevitably they will all be extended as a result of the 2020-2021 pandemic and economic crises. The major initiatives are: * The economic development agenda. As two examples, the World Bank supports ‘major projects that otherwise would not get off the ground, particularly in developing economies. The European Bank for Reconstruction and Development serves transition economies, mainly in Central and Eastern Europe. ‘There are also regional development banks such as the Asian development Bank based in Manila; The Inter- American Development Bank based in Washington; and the African Development Bank based in Abidjan (Ivory Coast). Worried by traditional WTO control by USA and Europe, emerging ‘BRIC’ economies formed a ‘New Development Bank’, while China led a new development bank—the Asia Infrastructure Investment Bank— focused on infrastructure investment in Asia Pacific. Two years after its formation, 80 countries had joined its governance structure, and the bank had approved 24 projects in 11 countries. * The climate change agenda, A major global concern is the environmental impact ofhuman activity. The chief focus has been on the detrimental global warming effec 70Political, Economic and Legal Environments ... of greenhouse gas emissions. The 1997 Kyoto protocol got developed counties pledging to cut GHG emission levels by 6 percent from 1990 to 2012. Unfortunately, the USA, the leading emitter at the time, refused to sign the protocol. Nor did the protocol include India and China, which developed very fast, with China becoming by 2009 the leading source of GHG. The 2009 Copenhagen meeting of countries agreed that more action had to be taken, but sparked disagreements about exactly who had to do what by when. The result was a weak non-binding Copenhagen Accord. This remains a difficult issue on which to make global progress. In December 2015, in the Paris Agreement, many countries made substantive commitments towards creating a sustainable low carbon future. These included keeping the rise in global temperature to below 2C above pre-industrial levels, and investing US$100 billion to support this aim. By 2018, 195 countries had signed the agreement, but the USA announced its intention to withdraw. By 2021 little further progress had been made on this agenda, partly hampered by the pandemic and ensuing economic crisis. The financial sector regulation agenda, Bank crashes can harm not just the home country but can have adverse consequences internationally. A country like UK, for example, is responsible for regulating its own banks, including foreign subsidiaries, and can constrain foreign banks operating in the UK. ‘The Basel Committee for Bank Supervision disseminates minimum regulatory standards, revised in 2004, and known as Basel Il; revised again in 2011 as Basel III. This established minimum requirements for liquidity, and procedures for risk metrics. In the aftermath of the 2008 financial crisis these have been criticised as inadequate, Some argue that national regulation of international banks is not enough. However, there is, as yet, no agreement as to how global bank supervision could be carried out. ‘There are also real dilemmas in banking regulations that need to focus on basic capital requirements for a bank, and on how to assess the riskiness of a bank's investment portfolio. A bank wants to lower its financial reserves, while lending to high interest customers. Meanwhile policy objectives for the financial system would include financial stability combined with lending to encourage entrepreneurs and innovators. As a result, riskerating agencies, like Fitch and Moody's, play an important role in assigning ratings to different assets and these ratings can then indirectly affect how much equity a bank needs to hold. This can have undesirable impacts, for example causing investors to make similar decisions about a bank, thus creating a systemic impact and risk, Ratings by Moody's and Fitch of sovereign bonds issued by governments can also have impacts on a government’ ability to raise capital in the financial markets, and also influence a government's spending plans. 71Political, Economic and Legal Environments ... 2.12. Conclusion In this chapter we introduced the institution-based perspective on international business, Pointed out that there are both formal and informal institutions in countries, and that these may die, across countries. The key functions of institutions are to reduce uncertainty, reduce transaction costs, and constrain opportunism. In practice, firms operating abroad should have a thorough understanding of the formal institutions of each country they are in, or are thinking of entering ‘We detailed the main types and characteristics of political, economic, and legal systems found in the world; the debates surrounding these different systems; and pointed out the implications of these in terms of establishing the rules of the game for and challenges in conducting business internationally. We then moved on to look at a five-type model of formal institutions at the regional level. The chapter then detailed the major examples of trading blocs, the first being the political institutions of the EU, and how and why the institutional framework created by the EU is pivotal for business, We then described the advantages and disadvantages of regional and bilateral economic integration in the Americas and Asia Pacific. Finally, at cross-regional level, we assessed the multilateral institutions of the global monetary and trade systems, and their current challenges. From 2016, we saw a number of emerging trends gaining a higher profile. The United Kingdom had voted, in 2016, to leave the European Union. Whatever the outcome, this threw a lot of uncertainty into both the United Kingdom's economic position, and also that of the European member states. In January 2020 the UK formally left the EU. But the challenges for the UK and EU would not work themselves through until 2023 at the earliest. Meanwhile Donald Trump's election as US president in 2016, saw the USA fall out with several economic blocs—not least in South America and Europe, but also aggressive trade stances with China. By 2018 the pattern of political, economic and social disruption looked set to continue across the course of the first term of the presidency. Meanwhile China continued to invest in many countries on many fronts (through the so-called ‘Belt and Road’ Initiative), while stretching its national logistics routes across many parts of Central Asia and into Europe. Its ‘Made In China 2025’ plan also set out to use subsidies and protectionism to create world leaders in ten industries, covering nearly 40 percent of its manufacturing. Conflicts in the Middle East, Northern Europe, Africa, and several other parts of the globe looked set to continue to make international trade unpredictable, while populism and swings to right wing politics in many countries also unsettled trading environments. Chinese and Russian expansionism continued to add to the dynamism am unpredictability of the international business envitonment. All this has threatened the stabiliy of institutions in many countries, resulting in the need for much more thorough and regulat analysis of environmental and institutional factors on the part of international businesses. When the 72Political, Economic and Legal Environments ... coronavirus pandemic hit in early 2020, this only made institutional resilience even'more urgent, and likewise the need for international businesses to scan their environments ever more rigorously. How this resilience can be achieved will be one important storyline going forward from 2021. Clearly these national, regional, and global institutions are highly important shapers of how business can be conducted internationally. However, they are not the only—and often not the most important—tules of the game with which international business needs to contend. In the next chapter we follow the institution-based perspective through into the area of informal institutions embracing culture; social norms; religion; language; and ethics. We then consider how business organisations respond to formal and informal institutional frameworks by exploring their approaches to corporate social responsibility. References Chang, H. (2003), Kicking Away The Ladder, Anthem Press, London, UK Hall, P. and Soskice, D. (eds). (2001), Varieties of Capitalism, Oxford University Press, Oxford, UK North, D. (2005), Understanding The Process of Economic Change, Princeton University Press, Princeton, USA Peng, M. and Meyer, K, (2019), International Busines, Cengage Learning, London, UK Peng, M. Wang, D. and Jiang, Y. (2008), ‘An Insticution-Based View of International Business Strategy’, Journal Of International Business 19, 920-936. Sen, A. (1999), Development As ‘Freedom, Anchor Publishing, London, UK Williamson, ©. (1985), The Econmic Institutions of Capitalism, Free Press, New York, USA 73