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—Russian proverb

OBJECTIVES After studying this chapter, you should be able to

1. Discuss the philosophies and practices of the political environment

2. Profile trends in contemporary political systems

3. Describe current trends in political ideologies and their implications to MNE’s choices

4. Explain political risk management

5. Compare the relative benefits and drawbacks of proactive versus passive political risk management

6. Discuss the principles and practices of the legal environment

7. Profile trends in contemporary legal systems

8. Identify and describe key legal issues facing international companies

CHAPTER 3 Governmental and Legal Systems

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economic growth has reduced the number of poor by more than a half-billion since 1981. Hundreds of millions more, though poor, see a brighter future. In 2010, 91 percent of Chinese citizens saw their economic situation as “good,” compared to 52 percent in 2002.3 Most domestic markets are in early high-growth stages. Many MNEs that came for low-cost workers stay for increasingly well-off shoppers.4

Market Performance Rapid economic development catapulted China from an also-ran in 1980 to the world’s second largest economy in 2012; analysts see it becoming the world’s larg- est sometime between 2016 and 2036.5 Growing income spurs consumer spending. During the U.S. and British indus- trialization in the nineteenth century, real incomes per capita doubled in 50 years. China’s did the same in nine years. Said a China expert, “Never before in history has so much wealth been created in such a short time.”6

Infrastructure In a multiyear program, China is investing trillions of renminbi on housing, offices, highways, airports, seaports, waterways, dams, power grids, high-speed trains, and communication networks. Despite tremendous progress, it has far to go. For example, it lags in the number of airports with paved runways: 452, compared to 713 in Brazil and 5,194 in the United States. Moreover, 44 Chinese cities popu- lated by more than a million people still have no mass-transit system other than buses.7

Resources China’s well-educated population creates an immense pool of productive labor. Wage rates for unskilled labor are less those in many other countries—perhaps 5 percent of comparable costs in the United States, Japan, and Europe and a third of those in Mexico and Turkey.8 Besides efficient factory workers, China boasts a large and growing number of productive, lower-cost brainworkers. In 2013, it added another $250  billion to its university infra- structure, and after doubling its number of universities over the previous decade, it plans to produce 195 million college graduates by 2020. China’s current five-year economic plan directs millions to study alternative energy, energy efficiency, environmental protection, biotechnology, advanced informa- tion technologies, and high-end equipment manufacturing.9

Strategic Positioning China represents the biggest growth opportunity in the history of capitalism. The country is experi- encing roughly ten times the economic acceleration, on more

From 1949 to the late 1970s, China was autarkic, cham- pioning a self-sufficient economy that relied entirely on its own resources. Leaders of the governing Communist Party believed that interaction with foreigners would corrupt China’s politics and pollute its culture; hence, they prohibited FDI and restricted foreign trade. Near the end of the 1970s, however, China’s leaders began rethinking this strategy. Realizing it was lagging the world, China enacted the Law on Joint Ventures Using Chinese and Foreign Investment in 1978 and effectively began building a socialist market economy that opened the country to the global market.

Since then, Chinese economic policy has been marked by steady market liberalization that has fueled its acceler- ating global trade and investment. Undeniably, the Chinese Communist Party (CCP) maintains its absolute monopoly on political power. As one Beijing scholar observed, “The Party (CCP) is like God. He is everywhere. You just can’t see him.”2 Free market principles, however, increasingly shape the country’s business environment.

Transformation has yielded astonishing results. Over the past three decades, China has prospered more from globalization than any other country, outsmarting and outper- forming many on the world stage. Many of its citizens have moved from mud huts to high rises. Companies have turned from woeful enterprises into world-class multinationals. The country has accumulated the greatest financial reserves in the world. Consequently, many see its ascendency as a global event without parallel.

THE SIREN CALL OF CHINA

Compelling incentives attract foreign investors to China. Since the 1980s, MNEs have maintained a veritable gold rush there, ranging from manufacturing ventures and export processing to licensing agreements and service relationships. Total FDI in China—representing more than 600,000 ventures opened by companies from around the world—was nearly $1.7 tril- lion in 2012, while literally nonexistent in 1980. Why have so many rushed to China? Quite simply, they see stunning opportunities:

Market Potential With 1.34 billion citizens, China resets conventional analytics. Consider that the Walt Disney Corporation is building a $4.4 billion theme park and resort in Shanghai where 330 million people—more than the population of the United States—live within a three-hour drive or train ride. China’s market scope steadily expands. Its

China—Complicated Risks, Big Opportunities1CASE

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CHAPTER 3 Governmental and Legal Systems 131

than 100 times the scale, resulting in an economic transformation that carries over 1,300 times the force of change than seen during the Industrial Revolution. MNEs are responding in kind: Ford plans to double its production capacity in China to 1.2 million vehicles by 2015, its most rapid expansion anywhere in 50 years; GE relocated its 115-year-old X-ray division from Wisconsin to Beijing; Yum! now looks to China for half its global sales and 40 percent of its operating profits. Bluntly put, “You are not a global player unless you are in China.”10

THE COMPLICATION OF REALITY

Notwithstanding the hype and its hyperactive performance, complications tarnish China’s appeal. Its political and legal systems make business operations a nebulous, frustrating process. In a nutshell, China practices “State Capitalism” whereby the government manipulates market activities to achieve political goals. Consequently, MNEs doing business in China often find themselves at a disadvantage. Ambitious Western firms such as Exxon Mobil, ABB, Caterpillar, and Vodafone purchased big stakes in Chinese com- panies. Political problems and legal difficulties short-circuited their plans. Eventually, like many others, they sold their stakes and reset their strategies.11

China’s rapid emergence aggravates long-running idiosyncrasies. The resulting mix of ancient and contemporary outlooks creates many grey areas. Some observers argue that, when it comes to doing business in China, the number one rule is to throw away the rulebook. Sage foreign investors abandon the notion that Western ideas automatically work in China. The principle of forming a corporation “for any valid business purpose” does not exist there. Incorporating in China requires telling the government—in

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MAP 3.1 China: The Inscrutable Market With more than 1.3 billion consumers and a labor force of just over 800 million workers, China is attractive to foreign investors. One of every five people in the world lives in China, but the population is unevenly distributed. Approximately 50 percent of Chinese citizens live on just 8.2 percent of the country’s total land. Even so, maintaining centralized control over the nation’s political and legal affairs has traditionally been difficult. The vast distances between seats of authority helps local officials evade the watchful eye of faraway bosses.

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132 PART 2 National Environmental Differences

excruciating detail—who you are, what you want to do, how you plan to do it, how much you intend to invest, and how many jobs you will create. MNEs endure protracted negotiations in obtaining permission to open local operations. At each stop of the long march, national, provincial, and local officials ask how the investment encourages capital formation, promotes exports, creates jobs, and transfers technology. If you hit the right targets, only then does the government green-light your project.

DRAGONS AND SNAKES

As in China, centralized governments worldwide determine the path and pace of local economic develop- ment. China, however, poses a particularly tough case given that its political and legal systems impose many time-consuming tasks. Moreover, China tends to stack the odds against foreigners who are bold enough to forge ahead in the face of an elaborate government bureaucracy and a fledgling legal system.12 “If the great invention of European civilization was a legal system,” quipped an observer, “then China’s was bureaucracy.”13

Exasperated investors blame China’s treacherous terrain on a bureaucratic system that regulates activity based more on arbitrary agendas than objective standards. Connections, not competencies, often matter more. Those who believe that economics should determine the efficient means of generating prosperity see this as illogical. Still, it is utterly logical to Chinese leaders who regard state control of busi- ness activity as the most reliable path toward harmonious prosperity—and, one mustn’t forget, staying in charge of the show.

Foreign investors navigate often-mysterious political channels. The long-running conflict between central and local Chinese authorities further confuses issues. The vastness of the country means that local officials, whether headquartered in the smallest village or the largest city, are often left alone by their comrades in Beijing. Certainly, there are national laws, but how they move from Beijing to the provinces is a different story. “The center,” notes one observer, often “has no control over the provinces. When it sends people to investigate illegal pirating of CDs, local governors block access to the factories.”14 As Chinese folklore warns, “The mightiest dragon cannot crush the local snake.” This proverb captures the spirit of the enduring power struggle within China. Essentially, even though the central authorities in Beijing may appear to be all-powerful, the politics of powerful local fiefdoms often subvert their authority.

PRECISE LAWS OR AMBIGUOUS GUIDELINES?

China had no formal legal system in 1978 when it launched one of the greatest campaigns of legal reform in history. Ongoing developments have stabilized what had been an unpredictable, periodically chaotic legal environment. Still, China faces such ongoing challenges as legislative gaps, hazy interpretation, lax enforcement, and philosophical disagreements. Legislation is chock-full of ambiguities, says one Beijing- based lawyer, who thinks it will take 10 to 15 years to iron out many wrinkles.15 Some are less optimistic, comparing the state of the Chinese legal system with that of the United States in the 1920s—then an antiquated composite of statutes and codes that took several decades to modernize.

Others note that, in the case of the Chinese system, even bigger problems reflect a difference in the concept of legality in that society. Western legal systems rest on the rule of law and its doctrine of legiti- mate regulations transparently administered by public officials who are held accountable for their just enforcement. In contrast, China practices the philosophy of the rule of man, seeing the right of the “man” (once in the person of the Emperor, today in the form of the CCP) to act free of checks and balances. Besides being the law, the CCP is seen as above the law and given the legitimacy bestowed upon it by its ostensible “mandate from heaven.”16 Rarely does the Chinese criminal court end with anything other than a guilty verdict. Rather, explained an FBI Special Agent and legal attaché at the U.S. Embassy in Beijing, “there is really no rule of law here . . . they (CCP) make a decision ahead of time to make a point.”17

THE LEGALITY OF ILLEGALITY

China’s legal practices combined with the growing pains of its novel legal institutions and evolving politi- cal norms challenges MNEs. A sensitive tripwire is the theft of intellectual property—patents, trademarks, copyrights, and so on. MNEs complain that relentless, widespread, and sophisticated robbery of their

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CHAPTER 3 Governmental and Legal Systems 133

intellectual property fuels China’s economic surge. Aggressive estimates link nearly a third of the Chinese economy to piracy.18

The FBI estimates that American companies lose hundreds of billions annually to counterfeiting. China continues to be the number one source country for counterfeit and pirated goods seized; in just the U.S., Chinese counterfeits accounted for 62 percent or $124.7 million of the total domestic value of seizure.19 U.S. authorities, noting the rarity of legal punishment, charge Chinese officials with tolerating, if not encouraging, pirates.20 Still, countries wage battle. The United States, for instance, has frequently appealed to various transnational institutions about China’s “inadequate enforcement” of intellectual prop- erty regulations.21

What accounts for China’s status as the world’s premier counterfeiter? Analysts point to a mix of its quest to catch the West, collectivist orientation, rule-of-man legacy, and dubious enforcement of ambigu- ous laws—conditions that create a political and legal morass. Noted an observer, “We have never seen a problem of this size and magnitude in world history. . . . There’s more counterfeiting going on in China now than we’ve ever seen anywhere.”22 Problems threaten to escalate. Government policies have “left a deep impression on companies that intellectual property is there for anyone to use it.” Local and provin- cial authorities rely heavily on pirates to power local economic growth. Moreover, China excels in making high-quality knockoffs. As some say in Shanghai, “We can copy everything except your mother.”23

WHERE TO NOW?

Inevitably, investors question how an opaque single-party political system bolstered by a murky legal environment can protect their rights. Some believe that external institutions will improve transparency. China’s 2001 ascension to the WTO, for example, required it to accept rules on all sorts of business mat- ters, including tariffs, subsidies, and intellectual property. And, granted, China has steadily amended its legal codes to comply with WTO standards. However, the struggle is not a shortage of regulations. Rather, China’s sluggish enforcement, even in cases of outright violation, is the primary problem.

Despite intimidating political difficulties and confusing legal questions, legions of foreign investors fall sway to the siren call of China. Whether driven by bright forecasts, confidence in continued progress, or desperation to ride this megatrend, companies leave the sanctuary of predictable markets for the distinc- tive ways of the Middle Kingdom. Then, once they clear immigration and cross the modern-day Rubicon, they face the daunting task of interpreting China’s political and legal systems. ■

QUESTIONS

3-1. Identify three compelling economic reasons to invest in China. Then identify three compelling political r easons to avoid doing so. Recommend a criterion one could use to trade off the oppor- tunities of operating in China versus the risks of doing so.

3-2. What sort of operational safeguards would you advise a company to adopt in order to better manage the risks of China’s legal environment?

INTRODUCTION Chapter 2 showed that the cultural issues facing international businesses differ from those facing domestic firms. This chapter carries the analysis forward, emphasizing that once a company leaves its home country it operates in markets with different political and legal systems. Some countries are similar; Australian companies would not find many surprises in New Zealand, for instance. In other cases, the differences are profound; an ill-prepared U.S. company would encounter shocks in Russia. Navigating among countries requires that MNEs study how political and legal circumstances overlap and differ. Determining where, when, and how to adjust business practices without undermining the basis for success is an enduring challenge.

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134 PART 2 National Environmental Differences

Consider that a domestic company operates in a single national environment in which institutional policies are reasonably predictable. Operating internationally exposes its man- agers to diverse and conflicting pressures from wide-ranging groups in different nations. Variations increase the challenge of interpreting different philosophies, laws, and attitudes on political freedom, property rights, and legal responsibility. Consequently, effective managers begin with the realization that when it comes to politics and laws, countries’ different ideas result in different political and legal environments. They position themselves to compete by understanding these differences, rather than ignoring or, worse, resisting them.

No matter where an MNE goes, the prevailing politics and laws affect its options and operations. China’s political and legal environments, for example, require MNEs to rethink the best ways to acquire resources, make investments, adapt operating modes, and manage risk. Figure 3.1 identifies the political principles and legal outlooks that define a nation’s business environment. This chapter will discuss how they influence the prevailing political ideology, shape the role of government, moderate the degree of political risk, and define the legal system.

THE POLITICAL ENVIRONMENT Our opening profile of China shows that its evolving political and legal systems create a thriv- ing business environment. Tens of thousands of foreign investors have entered its market, opened operations, managed activities, and earned profits. Still, the political system imposes hardships while the legal system complicates attempts to right wrongs. This situation is not unique to China. The interplay of political ideologies, conceptions of political freedom, legacies of legality, presumptions of fairness, and exercise of power makes for challenging political environments around the world.

Consider Russia, home to 142 million people. The world’s largest country in terms of territory, it possesses vast natural resources and has a government that looks to foreign MNEs to help modernize its energy-dependent economy. Still, foreign investors face high hurdles. An executive at Swedish retailer IKEA explained that the Russian political environ- ment is “a bit of a roller coaster. . . . [Y]ou don’t know exactly what will happen tomorrow.”24 The roster of horror stories features well-known names. Authorities arbitrarily confiscated products of Motorola, charged PwC Russia with tax evasion on flimsy evidence, and argu- ably expropriated Yukos.25 Doing business in Russia means you had better be “big enough to defend yourself against bureaucratic attacks [and] . . . ready to hold your nose when elections are rigged and political opposition is crushed.”26 Ironically, Prime Minister Vladimir Putin has promised a “dictatorship of the law,” an approach that appeals to the majority of Russians

EXTERNAL INFLUENCES

PHYSICAL AND SOCIAL FACTORS

COMPETITIVE ENVIRONMENT

Political policies and legal practices Cultural factors Economic forces Geographic influences

OPERATIONS

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Role of government in society Political ideologies Political risk Legal environment Operational and strategic legal issues

FIGURE 3.1 Political and Legal Factors Influencing International Business Operations The political and legal environments are broad-stroke concepts that defy straightforward classification. Nevertheless, managers emphasize key points, principally those identified here, to develop useful perspectives.

Managers study political and legal environments in order to adjust company activities to local circumstances.

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CHAPTER 3 Governmental and Legal Systems 135

who prefer strong leadership to vibrant democracy.27 Others, however, see Russia trapped in lawlessness and legal nihilism. Accordingly, Transparency International rated Russia 133 out of 176 nations in its Corruption Perceptions Index.28

These sorts of situations require executives evaluate, monitor, and forecast the dimen- sions and dynamics of foreign political environments. They study how government officials exercise authority, legislate policies, regulate enterprise, and punish wrongdoers. They moni- tor how politicians are elected and whether and how they depart. They assess whether the rule of law or of man prevails. They gauge whether freedom is a practical ideal or a wishful abstraction. Then, based on their analyses, they forecast business scenarios, always mindful that political stability rewards investment while political uncertainty penalizes it.29

Whether targeting Afghanistan, Zimbabwe, or any of the more than 200 markets in-between, managers study a nation’s political system—namely, the structural dimen- sions and power dynamics of the government that (1) specify institutions, organizations, and interest groups and (2) define the norms and rules that govern political activities. The mission of a political system is clear-cut: integrate different groups into a functioning, self- governing society. Likewise, its test is sustaining society in the face of divisive viewpoints. Success supports peace and prosperity, as we see in Sweden, Botswana, and Australia. Failure leads to instability, insurrection, and, ultimately, disintegration of the sort seen in Somalia, Afghanistan, and Libya.

INDIVIDUALISM VERSUS COLLECTIVISM Explaining the similarities and differences of political systems has intrigued a long line of thinkers, beginning with Plato and Confucius and moving on to Herodotus, Machiavelli, Smith, Rousseau, Marx, Gandhi, and Friedman.30 Each wrestled with enduring philosophical issues: How should society balance individual rights versus the needs of the community to sustain a rational, righteous, and harmonious system? What is the basis of the state’s author- ity over its citizens? Should society guarantee individual freedom in the pursuit of economic self-interest? Does society fare better when individual rights are subordinated to collective goals? Should society champion equality or institute hierarchy? Are individual rights inalien- able or conferred by the collective? Engaging these and like-minded questions anchors interpretation of the political systems in terms of individualism versus collectivism.

INDIVIDUALISM The doctrine of individualism emphasizes the primacy of individual freedom, self-expression, and personal independence (think of the declaration that we all have “certain inalienable Rights, that among these are Life, Liberty and the pursuit of Happiness”).31 It champions the exercise of one’s ambitions while opposing regulations that overly constrain them. The government protects the liberty of individuals to act as they wish, as long their actions do not infringe upon the liberties of others.

The business implications of individualism are direct: every person has the right to make economic decisions largely free of rules and regulations. Countries with an individualistic orientation, such as Australia, Canada, Netherlands, New Zealand, the United States, and the United Kingdom, shape their marketplace with the idea of laissez-faire. Literally mean- ing, “leave it alone,” a laissez-faire approach holds that the government should not interfere in business affairs; rather, the market should operate according to the neoliberal principles of free market fundamentalism. Left to their own devices, people regulate themselves in promoting economic prosperity and act fairly and justly to maximize personal performance without threatening the welfare of society.

Gaps between philosophical ideals and opportunistic behaviors often fan an adver- sarial relationship between governments and businesses in individualistic societies. Recent events dramatize this circumstance. The global financial crisis of the last decade revealed

The goal of the political system is integrating the diverse elements of a society.

The test of a political system is uniting society in the face of divisive viewpoints.

Individualism champions the primacy of the rights and role of the individual. Collectivism refers to the primacy of the rights and role of the group.

CONCEPT CHECK

Chapter 2 showed that culture moderates the practices of international business. Many points of interpretation, both from an academic and managerial perspective, follow from the interplay of collectivism or individualism in a country.

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136 PART 2 National Environmental Differences

that some individuals and firms had maximized their interests at the expense of societal welfare. Long-running support of deregulation, privatization, and trade liberalization, advo- cated to maximize individual freedom of choice, ultimately proved destructive. Opportunistic behavior destabilized the marketplace and jeopardized system sustainability. In response, governments reset regulations to reduce market inefficiencies (such as deficient consumer knowledge or excessive producer power) that had given some individuals undue privilege. Ongoing market problems in such countries as Spain, Japan, Ireland, Greece, Portugal, and the United States push governments to restrain the individualism of free markets in order to protect the collective welfare.

COLLECTIVISM The doctrine of collectivism emphasizes the primacy of the collective—e.g., a group, party, community, class, society, or nation—over the interests of the individual. No matter the importance of those who comprise it, the whole of the collective is ultimately greater than the sum of its individual parts. Today, we see collectivism in a range of countries, including Argentina, China, Vietnam, Japan, South Korea, Egypt, Brazil, Taiwan, and Mexico.

Collectivism in the business world holds that the ownership of assets, the allocation of resources, the structure of industries, the conduct of companies, and the actions of managers share a common goal: improve the welfare of all members of society. Business decisions are made by the group for the benefit of the group. Political systems that exhibit a collectiv- ist orientation hold that government regulates the market to promote social equality, labor rights, income equality, and workplace democracy so that the “welfare of the nation takes precedence over the selfishness of the individuals.”32 In extreme cases, such as Venezuela or Saudi Arabia, political leaders severely limit property rights and regulate the mass media in order to control the business environment.

POLITICAL IDEOLOGY The orientation toward individualism or collectivism fundamentally shapes a nation’s politi- cal system and, hence, its political ideology. In theory, an ideology is an integrated vision that defines a holistic conception of an abstract ideal and its normative thought processes. For example, the ideal of freedom carries with it ideas about related principles, doctrines, goals, practices, and symbols. A political ideology stipulates how society ought to govern itself and outlines the methods by which it will do so.

In the United States, the liberal principles of the Democratic Party and the conservative doctrine of the Republican Party define their respective political ideologies—i.e., the former favors collectivist measures such as progressive taxation and strict environmental standards whereas the latter champions individualistic measures such as consumer choice and mini- mal regulation. Japan has a similar situation: its Democratic Party advocates social liberalism and its Liberal Democratic Party advocates conservatism. No matter the specific cause, an effective political ideology moves beyond describing a vision of a better, brighter future. Put simply, it specifies the means to achieve that ideal.

Japan and the United States, like many other countries, have political parties that list smaller memberships than do the main parties. Consequently, most nations are pluralistic in which different political groups champion competing ideologies.33 Pluralism also arises when two or more groups in a country differ in terms of language (Belgium), class structure (United Kingdom), ethnic background (South Africa), tribal legacy (Afghanistan), or reli- gion (India).

A pluralistic system requires that officials negotiate policies. The bargaining process between competing groups dictates that politics follow multiple, shifting lines. Multi-criteria compromise, not single-minded consensus, is the order of the day. The resulting ambiguity complicates decision making for MNEs. Pluralism requires that managers assess the interplay

Collectivism stresses that the needs of society take precedence over the needs of the individual.

A political ideology encapsulates the doctrine of political behavior and change. It outlines the procedures for converting ideas into actions.

Pluralism holds that there are multiple opinions about an issue, each of which contains part of the truth, but none that contain the entire truth. Progress depends on negotiation and compromise.

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among groups. Often, companies try to influence policy formulation. In the United States, for example, some companies fund political action committees that support preferred candidates or influence the legislative process.

SPECTRUM ANALYSIS Figure 3.2 outlines a political spectrum. By specifying a basic conceptual structure, spec- trum analysis guides the assessment of a complex issue—in this case, political ideology. Configuring ideologies along the central axis lets us model different ones relative to the others. The starting point is specifying credible ideas to anchor the endpoints. When those are reasonably set, we then position the others.

Determining the standard of “reasonably set” can prove difficult. The world exhibits a diversity of potential ideologies: anarchism, conservatism, secularism, environmentalism, liberalism, feminism, nationalism, socialism, theocracy, and so on. Cultural perspectives also moderate interpretation of such choices. From a Western perspective, for example, one commonly sees the endpoints defined as conservative versus liberal interpretations of democ- racy—i.e., Republican versus Democrat. Other endpoints command greater relevance in other contexts. A political spectrum in an Islamic country, such as Iran or Saudi Arabia, is likely bounded by theocracy versus secularism to reflect the role of the clergy in the government. In the case of Taiwan, parties that endorse Chinese reunification oppose those that champion Taiwanese independence. In Belgium, ends would reflect the ethnic and socioeconomic ten- sions between the Dutch-speaking Flanders region and the French-speaking Walloon region. In Canada, it would be inclusive nationalism versus Bloc Québécois’s call for the sovereignty of predominantly French-speaking Québec.

Although initially confusing, a common denominator integrates the diversity of political ideologies: namely, its vision of political freedom. This ideal originated in the practice of politics in ancient Greece and has since been inseparable from interpreting political action. Political freedom reflects the degree to which fair and competitive elections occur, the extent to which individual and group freedoms are guaranteed, the legitimacy ascribed to the rule of

Political freedom measures the degree to which fair and competitive elections occur, the extent to which individual and group freedoms are guaranteed, the legitimacy ascribed to the rule of law, and the existence of freedom of the press.

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FIGURE 3.2 The Political Spectrum In practice, purely democratic and totalitarian systems are exceptions. Looking around the world, one sees many variations. For example, democratic systems range from radical on one side (advocates of extreme political reform) to reactionary (advocates of a return to past conditions). Likewise, totalitarian systems emphasize different degrees of state control. Fascism aims to control people’s minds, souls, and daily existence, whereas authoritarianism confines itself to political control of the state.

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138 PART 2 National Environmental Differences

law, and the existence of freedom of expression. As ideologies differ, so too do interpretations of the ideal degree of freedom. Rather than an inalienable right, freedom is open to debate. As a result, the matters of where, how, and why a company invests and how it manages operations are alienable freedoms, subject to the ideology that anchors and influences the political system.

With these ideas in mind, Figure 3.2 sets the political spectrum, with democracy, with its call to preserve, protect, and defend political freedom, anchoring one endpoint and totali- tarianism, with its call to control, constrain, and, suppress political freedom, the other.34 The ideologies that fall between these endpoints interpret political freedom differently. Liberal ideologies, for instance, advocate the right of individuals; authoritarianism subordinates individual freedoms to the welfare of the collective. In the former, managers have many investment and operating options; in the latter, they have far fewer. Similar examples only reinforce our chief point: Freedom is the distinguishing characteristic of political ideologies. Some stress its primacy, others oppose it. Throughout all, MNEs study its implications to their decisions.

Each political ideology in Figure 3.2 is notable; we lack the space to stipulate each one here. However, understanding the ideals and means of the two endpoints, democracy and totalitarianism, helps one interpret the others.

DEMOCRACY Abraham Lincoln held that democracy is a government “of the people, by the people, for the people.” Modern-day democracies translate this ideology into the principles that all citizens are politically and legally equal, entitled to freedom of thought, opinion, belief, speech, and association, and command sovereign power over public officials.35 A democratic government protects personal and political rights, civil liberties, fair and free elections, and independent courts of law.36 These principles and practices institutionalize political freedoms and civil lib- erties that, by endorsing equality, liberty, and justice, support individualism.

Different legacies shape the performance of democracy in a nation. More practically, the scale and scope of modern society imposes logistical constraints, particularly when population size makes it impossible for all voters to participate directly. Table 3.1 shows that countries respond with different types of democracies. Notwithstanding variance, all advocate the authority of the many over the few. The future may see a resurgence of direct democracy. Evolving technologies increasingly support a virtual assembly of citizens who express their votes directly through electronic signature gathering or online polling processes.

Democracy calls for participation by citizens in a fair and just decision-making process.

TABLE 3.1 Prominent Types of Democracies

The elemental definition of democracy hails from the Greek dēmokratía: “rule by the people.” As we see here, the rule of the people is practiced in different ways.

Representative Originates in a constitution that protects individual freedoms and liberties. The law treats all citizens, both public and private, equally. Elected representatives hold ultimate sovereignty but must act in the people’s interest. Officials represent voters and, while mindful of voters’ preferences, have the authority to act as they see fit. Examples include the United States and Japan.

Multiparty A political system whereby three or more parties govern, either separately or as part of a coalition. The leadership of a single party cannot legislate policy without negotiating with opposition parties. Examples include Canada, Germany, Italy, and Israel.

Parliamentary Citizens exercise political power by electing representatives to a legislative branch referred to as the parliament. The legislature is the source of legitimacy for the various ministers that run the executive branch. Examples include India and Australia.

Social Applies democratic means to guide the transition from capitalism to socialism. The government promotes egalitarianism while also regulating capitalism’s tendency toward opportunism. Examples include Norway and Sweden.

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Business Implications In a democracy, MNEs invest and operate based on economic, not political, standards. Business environments promote commerce, expand trade, and stream- line exchange, both within and across countries. The signaling devices of market activities, not bureaucratic regulation, organize a productive business environment. Managers and consumers are free to do as they see fit. In political terms, freedom sanctions rights and lib- erties; in economic terms, it legitimizes profits and prosperity. Brazil, India, Indonesia, and Turkey provide cases in point. Their belief in central planning run by a strong state had led to stagnant if not failing economies 20 years ago. Now these countries are converting the energy of their emerging democracy into dynamic business environments.37

TOTALITARIANISM A totalitarian system subordinates the individual to the interests of the collective. A single agent in whatever form, such as an individual, a committee, an assembly, a junta, or a party, monopolizes political power and uses it to regulate many, if not all, aspects of public and private life. The agent believes it has noble intentions, protecting people from the hazards of individual choice.38 Fair game includes regulating residents’ occupation, income level, inter- ests, religion, and even family structure.39

A totalitarian government eliminates dissent through indoctrination, persecution, surveillance, propaganda, censorship, and violence. It tolerates few, if any, ideas, interests, or activities that run counter to state ideology.40 There is no alternative for the simple reason that none is allowed to exist. In extreme situations, personal survival is linked to that of the ruling regime. Collectively, these conditions merge the interests of individuals with those of the state. Table 3.2 profiles types of totalitarian systems.

The dynamics of change in a totalitarian state highlight the means used to enforce its ideology. Rejecting preceding forms of society as corrupt, immoral, and beyond reform or redemption, a single leader advocates a new society that corrects wrongs, redresses injus- tice, and supports harmony. In place of private property, the state allocates power and status to reward supporters (who often monetize privileges through corruption). It uses propa- ganda, indoctrination, and incarceration to coerce citizens. State-controlled media filters

Democracy and individualism are intrinsically related and mutually reinforcing; individualism legitimates principles of democracy and democracy supports standards of individualism.

A totalitarian system consolidates power in a single agent who then controls political, economic, and social activities.

Totalitarianism and collectivism are intrinsically related and mutually reinforcing; collectivism legitimates principles of totalitarianism and totalitarianism supports standards of collectivism.

TABLE 3.2 Prominent Types of Totalitarianism

First recorded in reference to Italian fascism, “totalitario” stood for “complete, absolute, totalitarian” control by a dictatorial one-party state that regulates every realm of life. As we see here, the ruling agent can control society to different degrees.

Authoritarianism Tolerates no deviation from state ideology. Day-to-day life reflects obedience to state authority; resistance incurs punishment. Officials regulate the political environment but pay less attention to the economic and social structure of society. Often lacks an ideology to politicize public and private life. Examples include Kazakhstan, North Korea, Chad, and Turkmenistan.

Fascism Organizes a nation based on corporatist perspectives, values, and systems. Advocates a single-party state that controls, through force and indoctrination, people’s minds, souls, and daily existence. Fascism calls for the merger of state and corporate power. There have been few fascist political systems; most prevailed during World War II.

Secular A single-party government controls elections, tolerates dissent as long as it does not challenge the state, and suppresses other ideologies. The state does not prescribe an all-encompassing ideology. It grants limited individual freedoms provided one does not contest state authority or disrupt social harmony. Examples include China, Vietnam, and Venezuela.

Theocratic Government is an expression of the preferred deity. Leaders claim to represent its interests on earth. Applies ancient dogma in place of modern principles. Strict social regulation and gender regimentation typically ensue. Examples include Iran, Afghanistan, and Saudi Arabia.

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140 PART 2 National Environmental Differences

information, state-controlled education filters ideas, and state-controlled courts, police, and security suppress dissent. The cumulative result is a “virtual mind prison” in which the leader and the state fuse—one conforms or is cast out.41

Although remote to citizens in Western democracies, forms of totalitarianism prevail throughout the world. Some 2.5 billion people—roughly one-third of the world’s popula- tion—live under such rule, with another 1.5 billion people residing in less draconian but still authoritarian political systems.42 The citizens of such countries as Madagascar, Turkmenistan, Afghanistan, China, Iran, North Korea, and Saudi Arabia have few personal freedoms and civil liberties. The reemergence of powerful, single-party states worldwide reinforces totalitarian- ism: Russia suppresses individual freedoms through arbitrary governance; Venezuela restricts media that urge dissent; Iran corrupts its electoral process. Some see the political practices powering China’s rise as endorsing authoritarianism.43 Finally, leaders of such harshly gov- erned countries increasingly display subtle finesse. Concludes Freedom House, “Our findings point to the growing sophistication of modern authoritarians. They are flexible; they distort and abuse the legal framework; they are adept at the techniques of modern propaganda.”44

Business Implications Managers in totalitarian systems face markets that are radically dif- ferent from those in democracies. Private enterprise, if permitted, supports state control of economic activities. For instance, the Chinese government, under the direction of the CCP, owns and manages large swathes of the economy. The state is the majority owner of 99 of the 100 largest publicly listed Chinese companies, 39 of which are among the 500 biggest in the world.45 Similarly, 129 huge conglomerates in finance, media, mining, metals, transporta- tion, communication, and so on answer directly to the CCP. Likewise, China’s provincial and municipal officials control thousands of medium-sized and smaller ones.46 Add it all up and you have an authoritarian system that rejects many of the practices found in a democracy.

Managers operating in such markets adjust decision making to the intricacies of political activities. Bluntly put, the government’s imperative is sustaining state power, and econom- ics and markets are handy tools with which to do so. The situation affects all companies, but typically hits foreign investors hardest. The state favors local companies at the expense of foreign competitors, providing them with favorable financial assistance, special tax programs, relaxed work regulations, and other benefits.47 The state’s intent to value and allocate resources in manipulating market outcomes for political purposes creates complicated risks and rewards. For example, China requires foreign enterprises to tolerate, if not facilitate, set- ting up Communist Party cells in their local operations—indeed, some local governments require that private companies contribute a share of their payrolls to finance Party activities.48 The cells are there to educate and supervise the companies to behave lawfully, fulfill their social responsibilities, promote harmonious labor relations, and maintain social stability.

In recourse, MNEs strike deals that would be unthinkable elsewhere. Consider General Electric’s 50–50 joint venture with Aviation Industry, a Chinese military-jet maker, to pro- duce avionics, the electronic brains of aircraft. The deal required GE to take the risky but potentially lucrative step of folding pieces of its global operations into partnerships with a state-owned enterprise. Such deals had earlier proved troublesome, souring over concerns that Chinese partners, after gaining access to Western technology and expertise, became potent new rivals.49 Even so, seeing China as its “second home market,” GE reasoned the cost of missing the fast-growing Chinese aviation industry exceeded the potential risks. As GE’s vice chairperson noted, “Staying out of China in hopes of keeping our intellectual prop- erty safe is obviously not an option.”50

THE STANDARD OF FREEDOM Freedom is a topic of enduring importance. Freedom House, an independent watchdog organization that promotes liberty worldwide, helps frame our interpretation. It stipu- lates, “Freedom is possible only in democratic political systems in which the governments are accountable to their own people; the rule of law prevails; and freedoms of expression,

CONCEPT CHECK

Recall our discussion in Chapter 2 of “Behavioral Factors Affecting Business.” These variables change as people change—or as state authority influences them. Shaping people’s behavior to support the state’s interests leads an authoritarian government to manipulate norms, including work motivation, risk taking, communication practices, and consumption preferences.

Freedom House identifies three types of political systems:

Authoritarian parties often rely on shadowy politics, skewed elections, and nefarious security agencies.

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CHAPTER 3 Governmental and Legal Systems 141

association, and belief, as well as respect for the rights of minorities and women, are guar- anteed.”51 Since 1972, Freedom House has annually assessed the state of political freedom around the world,52 applying measures derived from the Universal Declaration of Human Rights.53 It identifies three types of systems:

free” country exhibits open political competition, respect for civil liberties, independent civic life, and independent media. There are inalienable freedoms of expression, assembly, associa- tion, education, and religion. Examples include Australia, Brazil, India, and the United States.

partly free” country exhibits limited political rights and civil liberties, corruption, weak rule of law, ethnic and religious strife, unfair elections, and censorship. Often, democracy is a convenient slogan for the single party that dominates within a façade of regulated pluralism. Examples include Guatemala, Pakistan, and Tanzania.

not free” country has few to no political rights and civil liberties. The government allows minimal to no exercise of personal choice, relies on the rule of man as the basis of law, constrains religious and social freedoms, and controls a large share, if not all, of business activity. Examples include China, Russia, Saudi Arabia, Iran, and Vietnam.

Map 3.2 shows the distribution of freedom worldwide. In 2013, 90 countries were free (46 percent of all countries), 58 partly free (30 percent), and 47 not free (24 percent). Regarding population, approximately 3 billion people (43 percent of the global population) live in a free country, 1.6 billion (22 percent) partly free, and 2.5 billion (35 percent) not free.

TRENDS IN POLITICAL IDEOLOGIES The second half of the twentieth century saw the steady diffusion of democracy. Between 1950 and 2009, the number of democratic political systems grew from 22 out of 154 coun- tries (14 percent) to 90 out of 193 countries (47 percent). The number of nations that made

Nor th Atlantic Ocean

South Atlantic Ocean

South Pacific Ocean

North Pacific Ocean

North Pacific Ocean Gulf of Mexico

Gulf of Alaska Bering Sea

Beaufort Sea

Arctic Ocean

Hudson Bay Labrador Sea

Caribbean Sea

Indian Ocean

South China Sea

East China Sea

Sea of Okhotsk

Tasman Sea

Bay of Bengal

Norwegian Sea

Greenland Sea

BAHAMAS

UNITED STATES OF AMERICA

CANADA

U.S.A.

GREENLAND

ST. KITTS & NEVIS ANTIGUA & BARBUDA

DOMINICA ST. LUCIA ST. VINCENT & GRENADINES

BARBADOS TRINIDAD & TOBAGO

GUYANA SURINAME

FRENCH GUIANA

GRENADA

DOM. REP. HAITI

CUBA

JAMAICA BELIZE

HONDURAS

NICARAGUA

COSTA RICA

PANAMA

EL SALVADOR GUATEMALA

MEXICO

SAMOA

ECUADOR

PERU

VENEZUELA

COLOMBIA

BRAZIL

BOLIVIA

CAPE VERDE

GUINEA BISSAU

THE GAMBIA

SENEGAL

MAURITANIA

GUINEA

SIERRA LEONE

LIBERIA

NIGERIA

NIGER CHAD

SUDAN

ERITREA

DJIBOUTI

YEMEN

SAUDI ARABIA

OMAN

SOMALILAND ETHIOPIA

UGANDA

KENYA

SOMALIA

COMOROS

MALAWIZIMBABWE

ANGOLA

NAMIBIA

BOTSWANA MOZAMBIQUE

SWAZILAND

MADAGASCAR

MAURITIUS

SEYCHELLES

MALDIVES

SRI LANKA

BANGLADESH

INDIA

QATAR BAHRAIN

EGYPT LIBYA

ALGERIA

MOROCCO

WESTERN SAHARA

JORDAN ISRAEL

PAKISTAN NEPAL BHUTAN

BURMA LAOS

SOUTH KOREA

NORTH KOREA

MONGOLIA

RUSSIA

KAZAKHSTAN

UZBEKISTAN

TURKMENISTAN NAGORNO KARABAKH

KYRGYZSTAN

TAJIKISTAN

CAMBODIA

VIETNAM

HONG KONG

TAIWAN

JAPAN

CHINA

PHILIPPINES

BRUNEI

MALAYSIA

SINGAPORE

INDONESIA

EAST TIMOR

PAPUA NEW GUINEA SOLOMONISLANDS

TUVALU

FIJI

TONGA

NAURU KIRIBATI

MARSHALL ISLANDS

MICRONESIA

PALAU

VANUATU

AUSTRALIA

NEW ZEALAND

THAILAND

TIBET

INDIAN KASHMIR

PAKISTANI KASHMIR AFGHANISTAN

IRAN

SYRIA

TURKEY ARMENIA

GEORGIA SOUTH OSSETIA

ABKHAZIA

MOLDOVA UKRAINE

TRANSNISTRIA

BELARUSPOLAND

RUSSIA

SWEDEN NORWAY

ICELAND

FINLAND

ESTONIA LATVIA

LITHUANIA

ROMANIA

BULGARIA MACEDONIA

GREECE ALBANIA

AZERBAIJAN

GERMANY CZECH REP.

SLOVAKIA AUSTRIA

LIECHTENSTEIN LUXEMBOURG

BELGIUM NETHERLANDS

U.K. DENMARK

IRELAND

PORTUGAL ANDORRA

SPAIN

FRANCE ITALY SWITZERLAND

MONACO SAN MARINO

KOSOVO

MONTENEGRO BOSNIA & HERZ.

SERBIACROATIA SLOVENIA

HUNGARY

NORTHERN CYPRUS

CYPRUS MALTA

TUNISIA

KUWAIT

U.A.E.

IRAQ LEBANON

ZAMBIA

LESOTHOSOUTH AFRICA

CONGO (KINSHASA)

RWANDAGABON

BURUNDI

TANZANIA

CAMEROON CENTRAL AFRICAN

REPUBLIC SOUTH SUDAN

CÔTE D’IVOIRE

SAO TOME & PRINCIPE EQUATORIAL GUINEA

GHANA

TOGO

CONGO (BRAZZAVILLE)

BURKINA FASO

MALI

BENIN

CHILE

PARAGUAY

ARGENTINA

URUGUAY

PUERTO RICO

GAZA STRIP/ WEST BANK

Freedom Status Country Breakdown Population Breakdown

FREE 90 (46%) 3,046,158,000 (43%)

PARTLY FREE 58 (30%) 1,613,858,500 (23%)

NOT FREE 47 (24%) 001,228,673,2 (34%)

TOTAL 195 7,036,838,600

Survey Findings

MAP 3.2 Map of Freedom, 2013 Freedom House, classifying countries in terms of their degree of political freedom, identifies three types—Free, Partly Free, and Not Free. If you live in a country classified as “free,” you enjoy a broad range of political rights and civil liberties. If you are a citizen of a “partly free” nation, your share of rights and liberties ranges anywhere from average to just below average. If your homeland is “not free,” you enjoy few rights and liberties. Source: Freedom House, “Map of Freedom 2013,” at www.freedomhouse.org.

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142 PART 2 National Environmental Differences

the transition, particularly during the 1970s and 1980s, gave rise to the political phenom- enon referred to as the Third Wave of Democratization.54 During this period, more than 30  countries throughout Africa, Asia, Latin America, South America, and Eastern Europe abandoned totalitarianism for democracy. The quest for individual freedoms and civil liberties transformed the world. Societies began building fairer civic institutions, independent media, objective judiciaries, and stronger property rights.55 As a result, today nearly half the world’s population lives in a democracy of some sort. Put differently, today more people live in coun- tries with democratic governments than at any time in history.

In doubling the number of democracies in two decades, the Third Wave of Democratization helped topple the Berlin Wall in 1989, demolish the Communist Bloc, and end the Cold War. Some saw the worldwide democracy surge symbolizing the “end of history.” Specifically, the universalization of Western liberal democracy, reinforced by the market fundamentalism of capitalism, represented the endpoint of humanity’s ideological evolution and the final stage of human government.56

ENGINES OF DEMOCRACY The reluctance of totalitarian structures to fade gracefully requires powerful change agents. Beginning in the mid-1970s, a confluence of events began building several engines that pow- ered the Third Wave of Democratization. Notably:

Regime Legitimacy The failure of totalitarian regimes to deliver economic progress undermined their legitimacy. Aggrieved citizens, weary of long-declining standards of life, contested the right of officials to govern. The fall of the Berlin Wall punctuated this epic change. Formerly communist countries shifted from collectivism to individualism, thereby spurring citizens to demand greater political freedom and civil liberty.

Communication Innovations Improved communications eroded totalitarian states’ control of information. Technologies integrated disenfranchised people into the global vil- lage. Once it took weeks, if ever, for word-of-mouth of protests to spread; now, improving connections circulated news within hours.57 Images of resistance and rebellion had snow- ball effects on pro-democracy campaigns worldwide. On a micro scale, we see similar effects linking protests in Chinese factories. Specifically, labor unrest has become more commonplace in China, as factories operating in highly competitive markets press their workers to improve productivity. Workers linked via mobile phones and the Internet, increasingly aware of their rights and common cause, increasingly challenge perceived injustices.58

Freedom’s Consequences Freedom yielded economic dividends.59 The median per capita gross domestic product, a measure of the standard of living, increased nearly sevenfold for free countries compared to not free countries. Growing wealth positively influences prop- erty rights, the rule of law, education opportunities, gender equality, media vigilance, and social tolerance.60 Prosperity promoted the expansion of the middle class, whose burgeoning access to the uncensored news Thomas Jefferson’s belief that “Information is the currency of democracy.” Perhaps most critically, rising prosperity supported the political stability and faith in the future that anchors the democratic ideology.61

The multi-decade march toward greater political freedoms and expansive civil liberties fueled a belief in the inevitability of democracy—again, the so-called “end of history” sce- nario. For MNEs, this trend stabilized business environments, both at home and abroad. Growing stability encouraged them to expand their investment horizon to include markets that had previously been off-limits (notably, China, Russia, and Central and Eastern Europe). As a result, industries developed, middle classes emerged, globalization accelerated, and freedom flourished.

CONCEPT CHECK

Chapter 1 identifies the “Expansion of Technology” as a driving force of globalization. Advances in telecommunications liberated the flow of information, thereby challenging and changing political attitudes in many countries.

CONCEPT CHECK

In profiling “The Forces Driving Globalization” in Chapter 1, we noted the power of changing political situations. Until recently, we have witnessed the diffusion of democracy and the corresponding decline in totalitarianism. Growing acceptance of the legitimacy of democracy accelerated the expansion of international business.

Various forces powered past the Third Wave of Democratization:

regimes to deliver prosperity

technology

political freedom

The Third Wave of Democratization refers to the third surge of democratically governed states in the 20th century. Ultimately, as this wave crested, the number of countries led by a democratic government significantly increased.

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CHAPTER 3 Governmental and Legal Systems 143

DEMOCRACY: RECESSION AND RETREAT Democracy retains appeal worldwide—preferred by people in most countries, its allure energized by growing wealth and education, its legitimacy worldwide solidified by an expand- ing middle class.62 Troubling data, however, question its momentum. Managers increasingly qualify their interpretation of political environments with the possibility that “history,” rather than ending, is just beginning.

A few years ago, longitudinal data on the slowing momentum of democracy indicated a “democracy recession.” Now, data indicate that democracy is in retreat worldwide. In 1989, 41 percent of nations had an electoral democracy; in 1999, it was 63 percent; in 2012, down to 60 percent.63 Figure 3.3 indicates an ominous shift over the past few years. Gains in free- dom have given way to declines in freedom. Sham elections, police crackdowns, kangaroo courts, and persecution of dissidents gain traction. All speak to the stance taken by President Lukashenka of Belarus, who declared on the heels of a rigged election victory, “there will be no more mindless democracy in this country.”64 Worldwide, increasingly influential totalitarian regimes impose “forceful measures designed to suppress democratic reformers, international assistance to those reformers, and ultimately the very idea of democracy itself.”65 As a result, 2013 marked the seventh consecutive year in which political freedom declined worldwide— the longest consecutive period of setbacks in nearly 40 years.66

The State of Political Affairs The Economist Intelligence Unit (EIU) applies a broad mea- sure to assess a nation’s “texture of democracy.” It notes that democracy, narrowly defined, is easily achieved—indeed, if merely holding elections were sufficient, virtually every coun- try would qualify as a democracy. Rather, an effective democracy depends upon free and fair elections as well as supportive institutions and public attitudes that protect freedom. Assessing the “texture of democracy,” therefore, involves 60 indicators of a country’s electoral process and pluralism, civil liberties, government functioning, political participation, and political culture.67 Countries are rated as either as a full democracy, flawed democracy, hybrid regime, or authoritarian regime.

The EIU evaluates democracy in 167 countries that, combined, are home to virtually the entire population of the world.68 Analysis finds many are “democracies” in name only; just

Over the past seven years, long-running gains in political freedom have given way to wide-spread declines.

Several indicators show slowing adoption of democracy throughout the world.

Thomas Jefferson reasoned, “Information is the currency of democracy.” If so, then this satellite dish-covered exterior, atop a Kabul apartment’s facade, plays a crucial role fortifying its performance. Source: kzww/Shutterstock

▶

The Economist Intelligence Unit identifies four types of political systems:

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144 PART 2 National Environmental Differences

25 are full democracies, while 53 are “flawed democracies.” Nineteen of the full democra- cies are found primarily in the West, with the remainder scattered in Latin America, Eastern Europe, and Africa. Flawed democracies predominate in Latin America and Eastern Europe. The fragility of institutional structures, political participation, and democratic cultures within many of these countries has led to significant backsliding. Likewise, corruption, violence, and drug trafficking encourage authoritarianism.

Of the remaining 89 countries, the EIU rates 36 as “hybrid regimes” that mix democratic and authoritarian practices. Procedural irregularities often corrupt free and fair processes. Hong Kong, for example, exemplifies a hybrid regime that manifests many trappings of a democracy, including an effective judiciary, civil liberties, independent media, and political parties. Still, authoritarian tendencies are evident. Consider its electoral process. Its Chief Executive (effectively its President) is chosen not by Hong Kong’s 7 million residents but by a 1,200-person “Election Committee.” The sense of a rigged system of political freedom with- out democratic accountability radicalizes its politics.69

Finally, 55 countries are judged authoritarian regimes. In many cases, they showcase insti- tutions of democracy that are merely Potemkin designs. Day-to-day life displays the telltale marks of totalitarianism, including unfair elections, disregard of civil liberties, state-owned media, omnipresent state security, pervasive censorship, and a corrupt judiciary.

An Important Qualification Qualifying these results by demography adds some use- ful perspective. Like Freedom House, the EIU reports that about half of the world’s popu- lation lives within some sort of democratic system. However, it notes that just 11 percent reside in countries with a functioning “full democracy.” Furthermore, some 37 percent live in flawed democracies, 14 percent in hybrid regimes, and 38 percent in authoritarian regimes.70 Westerners may presume that democracy prevails throughout the world, but presently only about one of every nine people lives in one.

30

20

32

29

38

30 30

21 21

35

10

38

14

33

16

40

11

25

12

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0

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10

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20

25

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N um

be r

of C

ha ng

es

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Gains Declines

FIGURE 3.3 Freedom in the World: Gains and Declines by Country, 2003–2013 The past decade shows a disturbing trend in the momentum of political freedom worldwide. Early on, gains in freedom exceeded declines. The past seven years have seen the opposite, with growing state authority reducing individuals’ political freedom.

Source: Based on Freedom House, “Freedom in the World 2013: Democratic Breakthroughs in the Balance,” www.freedomhouse.org.

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CHAPTER 3 Governmental and Legal Systems 145

AUTHORITARIANISM’S SURGE In 1991, citizens in the former Soviet bloc countries celebrated the move from a single-party state to a multiparty political system. By 2009, support had fallen drastically, especially in poorer countries such as Ukraine, Hungary, and Lithuania.71 By 2012, belief in democracy continued deteriorating in the wake of the global financial crisis as most countries in the region saw declining democracy scores.72 Established democracies struggle as well. In the United States, the terrorist attacks of September 11, 2001, reset the standards of personal freedom, resulting in restrictions that raised questions about the moral authority of demo- cratic ideals. Europe, meanwhile, struggles to preserve political freedom in the face of harsh austerity policies and the replacement of sovereign democratic processes with financial dic- tates from leaders of the EU and the European Central Bank.73 Persistent economic struggles challenge the belief, strongly held since the fall of the Berlin Wall, that “freedom works.”

Collectively, trends throughout the world show growing confidence in the authoritarian alternative, with countries growing skeptical of the virtues of a multiparty democracy and showing increasing interest in building single-party political systems. The EIU notes:

Authoritarian trends have become even more entrenched in the Middle East and much of the former Soviet Union. Democratization in Sub-Saharan Africa is grind- ing to a halt, and in some cases is being reversed. A political malaise in east-central Europe has led to disappointment and questioning of the strength of the region’s democratic transition. Media freedoms are being eroded across Latin America and populist forces with dubious democratic credentials have come to the fore in a few countries in the region. In the developed West, a precipitous decline in political par- ticipation, weaknesses in the functioning of government, and security-related curbs on civil liberties are having a corrosive effect on some long-established democracies.74

Engines of Authoritarianism Several engines powered the Third Wave of Democratization. Likewise, the following forces promote totalitarianism today:

Political Economy of Growth Rising uncertainty questions the relationship between the level of economic development and democracy. The classic modernization hypothesis— that economic development is a pre-condition of democracy —is no longer universally accepted.75 Consider China. Its economic performance since 1980 endorses its authoritarian, one-party system as an alternative to liberal, multiparty democracies. Concurrently, its model of a “people’s democratic dictatorship” has steadily gained credibility worldwide.76 For many poverty-stricken countries, patience with the not-yet-realized dividends of the “democracy advantage” thesis has worn thin. Some point to India, noting that its more than 60 years of nearly uninterrupted democratic governance rule has failed to improve health, education, or wealth for a majority of Indians.77

Rhetoric Versus Reality Democracy setbacks in Italy, France, UK, Spain, and the US give pause to some 70 strategically significant countries at the political crossroads. If democracy can’t work there, how could it work here, they wonder.78 Charges of hypocrisy against Western countries (owing to incursions in Iraq, Libya, and Afghanistan, along with the implications of antiterrorist activities for political freedoms and civil liberties) jumble democratic ideals. Double standards in foreign policy (i.e., some autocratic countries can be friends, such as Saudi Arabia, whereas others are foes, like Venezuela) corrode the cred- ibility of democracy promoters.79 Consequently, fewer than one in five West Europeans trust political parties, while only one in three regards governments and parliaments as trustworthy.80

Economic Problems The global financial crisis has complicated matters. High unemploy- ment, slow growth, and rising debt, by threatening the middle class, has weakened belief in the effectiveness of democracy. Confidence in institutions has declined throughout the West. The International Labour Organization reports wavering belief that political policies in

Powering the resurgence of totalitarianism are

strong performance

practices of democracy

following slowing growth

meaning of democracy

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146 PART 2 National Environmental Differences

democratic states lead to a fairer and better future.81 History shows that right-wing totalitar- ian movements generally draw popular support from the middle class seeking to preserve the status quo. Those who fall into poverty are politically hazardous. In the United States, for example, the worse the economy, the more people describe themselves as “right-wing.”82 On the other hand, left-wing totalitarianism often develops from working class movements seeking to overthrow wealthy oppressors—think of the tension between the proletariat and bourgeois in Marxism. Unless reversed, unemployment, debt, and anxiety erode confidence that democracy works.83

Who Defines Democracy? The legitimacy of Western notions of democracy travels poorly to societies with different ideals and institutions. Hu Jintao, former CCP chief and China’s president, speaks of “democracy” with a different meaning from the one understood by Westerners. In his view, calls for multiparty democracy are taboo, opposition cannot offi- cially organize, reform must obey the “correct political orientation,” and “orderly” change must respect and preserve the authority of the CCP.84 Similarly, Prime Minister Vladimir Putin, proclaiming himself “a true democrat,” argues the West misinterprets the virtues of authoritarianism. He charges “some of the participants in the international dialogue believe that their ideas [of democracy] are the ultimate truth.”85 Western-style democracy, rather than promoting individual rights and civil liberties, is an ideological ruse that disguises vast inequalities. Likewise, Brazil’s former President da Silva says that the primary advocates of Western-style democracy no longer speak for the world, having lost the moral authority to dictate solutions to developing countries.86

The engines of totalitarianism, considered in the context of democracy’s retreat, raise the question: Has democracy run its course? If so, as we consider in our “Looking to the Future” box, what then might become of political ideologies and how might MNEs respond?

the global philosophical center in an America-dominated unipolar world, its idealized Consensus—promoted by executives, politicians, generals, journalists, and insti- tutions—called upon countries to reform in ways that reflected the political economy of the United States. Powering this call was a set of interrelated beliefs: right- minded reform led to economic growth, which created a middle class that supported property rights, which in turn began institutionalizing the rule of law. Making those choices and implementing the necessary poli- cies would institute, support, and sustain a legitimate democracy.

Successfully navigating this sequence, reasoned the United States, would build nations that stead- fastly championed prosperity and peace. A world of nations practicing US-style pro-peace democ- racy arguably signified the endpoint of humanity’s sociocultural evolution.88 Ironically, promoting and protecting the Washington Consensus requires a powerful military; combined defense-related spend- ing of more than $1.1 trillion in the U.S. exceeds that of all other countries combined.89

Like you, managers wonder what a political map of the world might look like in the next decade. Will democracy spread? Will totalitarianism gain more ground? Will new ideologies arise? It is tempting to regard these questions as academic straw men, best left to the folks in ivory towers. The latest data indicate they are anything but. As faltering political freedom and resurgent authoritari- anism accelerate democracy’s retreat, countries reset marketplaces and MNEs adjust strategies. Trends high- light the contemporary political ideologies competing for supremacy—namely, the Washington Consensus, the Beijing Consensus, and the Clash of Civilizations. What, pray tell, might these mean to managers?

The Washington Consensus

Named after the close of the Cold War for the free- market, pro-trade, and pro-globalization policies promoted by the United States, the Washington Consensus advocates democracy, political freedom, rule of law, and human rights.87 As Washington became

Looking to the Future Political Ideology and MNEs’ Actions

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that would inspire peaceful democracy in the region. Efforts there, as well as pro-democracy movements in Tunisia, Egypt, Afghanistan, Libya, and elsewhere, have had limited success. Moreover, Western military involvement has raised questions about the legitimacy of democratic ideals throughout the region. Faltering institutions and changes in political sentiments hin- der the transition to democracy in several Islamic nations, including Kuwait, Iran, Saudi Arabia, and the Palestinian areas.

Regional instability highlights the difficulty of pro- moting democratic political cultures, to say nothing of a functioning democracy. The discontent of the economically and politically disadvantaged, particu- larly among youth suffering extreme unemployment, mobilized the massive pro-democracy protests of the so-called Arab Spring. Although initially prom- ising, study of the determinants and consequences of democratic transitions advise caution; violent uprisings struggle to institutionalize durable demo- cratic change. Moreover, weak property rights and civil liberties continue constraining change, thereby thwarting democratic progress.95

Productive economies in the oil-rich Persian Gulf also stall the spread of democracy; it no longer appears that democracy is a necessary condi- tion for prosperity. Furthermore, oil-based revenue entrenches an autocracy by removing the need to levy taxes and thereby reducing state accountability. Consequently, moderate Arab leaders contend that the transition from totalitarianism to democracy is, at best, “a slow process.” Hardliners, meanwhile, vilify democracy.96

The reluctance of Islamic states to adopt democ- racy animates the “clash-of-civilizations” scenario. Irreconcilable cultural and religious differences between Islam and the West, goes this reasoning, will trigger a backlash against Western political ideals and their crystallization in the ideologically interventionist Washington Consensus.97 Some speculate that an epic clash between oppositional civilizations will usher in a new political ideology based on cultural and reli- gious ideals.

What’s Next, Managers Ask?

Democracy’s ongoing retreat questions long- cherished ideals. Managers study the direction that political ideologies might track. Will liberal democracy à la the Washington Consensus regain the command- ing heights? Ongoing developments worldwide, led by an expanding middle class and supported by social networking channels, support that forecast.98 Or will

The Beijing Consensus

Alternatively, rather than the end of history, some say the growing appeal of the Beijing Consensus signals the next political era.90 A euphemism for China’s self- proclaimed “people’s democratic dictatorship,” this Consensus calls for a single-party system in which elected representatives, preapproved by the ruling party, oversee a nominal democratic system whose citizens, though granted the right to vote, cannot participate in decision making.91Elections, while free, are not fair. The CCP aspires to rule by consent, pre- ferring benevolent persuasion to the iron fist. Still, it swiftly suppresses those who challenge its author- ity. Spontaneity in a single-party system, no matter how apolitical, symbolizes protest. As CCP officials explain, “Stability trumps everything.”92

Unlike the ideologically interventionist Washington Consensus, the Beijing Consensus is ideologically agnostic. It prizes economic development and international trade as the means to generate growth, create wealth, and build a harmonious society. It uses fast-growing prosperity to subvert political choice, reasoning that people value higher wages, social stability, and economic security far more than political freedom. The Beijing Consensus does not pass judgment on another country’s poli- tics; in turn, it expects not to be judged. It advocates trade “with no strings attached” (which, in the case of the Washington Consensus, are democracy, free- dom, human rights, and the rule of law). To this end, China invests throughout Asia, Africa, the Middle East, and South America free of demands for politi- cal reform.93

China’s policy of harmonious stability within a single-party state has gained credibility worldwide, particularly given its strong performance in the wake of the global financial crisis. Said one analyst, “[T] he ‘China model’ of authoritarian capitalism is gain- ing currency. Governments from Syria to Vietnam have sung its praises.”94 Some argue that state con- trol that weds liberal economics with single-party authoritarian politics, rather than the union of liberal economics and multiparty democracy, now repre- sents the superior political path to prosperity and harmony.

The Clash of Civilizations

Spreading democracy in the Arab world, which is reg- ularly rated the world’s least free region, has been a long-running goal of the West. Indeed, an aim of the Iraq War was to build the luminous “city upon a hill”

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148 PART 2 National Environmental Differences

POLITICAL RISK Politics is always and everywhere dynamic. At different times, different parties champion different ideologies that endorse different political systems, with unpredictability ensuing. Consequently, investing and operating internationally exposes MNEs to risks that arise from a country’s political system. This class of risk, referred to as political risk, is the potential loss arising from a change in government policy. More precisely, it is the risk that political deci- sions, events, or conditions will affect a country’s business environment in ways that force investors to accept lower rates of return, cost them some or all of the value of their invest- ment, or threaten the sustainability of their operation. Figure 3.5 identifies leading causes of political risk.

Two trends increase political risk worldwide. First, many fast-growing emerging markets are rife with flashpoints. Arbitrary legal systems, fragile institutions, volatile societies, and corrupt regimes fan instability. Many firms in these countries are state-run, pursuing politi- cal goals that complicate economic situations. Aggravating matters is the fact that political risks differ from market to market. In Venezuela, managers face economic nationalism; in Brazil, a manager needs to understand Congress’s multi-party alliances; in China, the task is interpreting the power and play of the CCP; in Saudi Arabia, a manager must make sense of the internal relations of the ruling family. Hence, operating in these markets is quite differ- ent from the comparatively more predictable politics in Western democracies. Analytics that work in one country often travel poorly to others.

Second, the aftermath of the financial crisis aggravates political risk in both developed and developing markets. When the Berlin Wall collapsed, globalization steadily standardized the inconsistencies of politics across markets. Certainly, countries evolved at different rates. However, as many developed in the broad context of the Washington Consensus, managers could reasonably assume that the principles of Western-style political economy, not local quirks, would shape national affairs. The global credit crisis reset the equation. Now, local politics influence the performance of global markets and the actions of MNEs on a scale not seen in decades. If the crisis continues testing people’s faith in democracy, companies face growing public challenge and political constraint.

ideological war between Washington and Moscow. Hence, the question arises: Are we once again facing a cycle of transition and consolidation?101

Whatever the answer, only the ill-advised under- estimate political change. If the Washington Consensus proves resilient, managers must adjust operations to the growing pains of countries that champion freedom, advocate human rights, and adopt the rule of law. Prosperity may come with dif- ficulty, but there will be prosperity for many. If the Beijing Consensus predominates, managers must rethink business in a world that uses state con- trols to generate economic growth at the price of freedom. Prosperity may come easily, but its price will include individual freedoms. If ideologies trans- form as civilizations clash, the resulting social and religious orders will reset systems. Prosperity may prove a wild card as oppositional ideologies battle for the commanding heights. ■

the one-party trademark of the Beijing Consensus set political standards? China’s growing involvement in receptive countries worldwide supports that projec- tion. To that end, when recently asked, “How satis- fied are you with the country’s direction?” 83 percent of Chinese reported satisfaction versus 31 percent in the United States, 19 percent in France, 15 percent in Britain, and 7 percent in Japan.99 Finally, if countries bypass the American Way or the Chinese Path, might a clash of civilizations give rise to new ideas of political freedom?100 Ongoing tensions in hotspots worldwide do not bode well.

Whatever the scenario, history reminds us that it matters. The first and second waves of democratiza- tion (1828–1926 and 1943–1962, respectively) were followed by periods of freedom backlash, democracy retreat, and backslides into authoritarianism. The end of the second wave saw more than 20 countries revert from totalitarianism, symbolized by the ensuing

Political risk refers to the threat that decisions or events in a country will negatively affect the profitability and sustainability of an investment.

CONCEPT CHECK

Chapter 1 notes that some interest groups fear that globalization fatally weakens national sovereignty—that is, growing external control restricts a nation’s right to act in its own interests. Here, we observe that this attitude often intensifies political risk. Foreign investors face higher risks when a host government becomes increasingly sensitive to threats to its sovereignty.

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CLASSIFYING POLITICAL RISK The evaluation of political risk often applies a macro-micro criterion. Macro risks affect all companies in a given country; micro risks are project-specific actions that affect individual, usually foreign-owned, companies. Figure 3.4 applies this approach but further qualifies the macro-micro division with the intensity level of the type of risk. We develop these charac- teristics in terms of the resulting classes of political risk: systemic, procedural, distributive, and catastrophic.

CLASSES AND CHARACTERISTICS OF POLITICAL RISKS The political risks of international business have telltale characteristics. Here, we see that they vary in terms of the intensity of their impact on company operations, belong to various classes, typically follow from the imposition of certain sorts of regulations, and have distinc- tive outcomes.

Systemic Political Risk As a rule, a country’s political processes aim not to punish specific companies arbitrarily. If they did, few would hazard the investment. More often, investors face political risk that follows from shifts in public policy. New political leaders, for instance, may adopt policies that differ from their predecessors’—say, reducing the individual benefit of business activity by increasing tax rates to improve collective welfare. In that case, new regulations will alter the macro environment for all. Similarly, a government may target an economic sector that it sees dominated by foreign interests, such as Venezuela’s program to nationalize energy and media companies.102 In both situations, politically motivated polices alter the macro environment, thereby creating systemic political risks that affect all firms. If democracy continues faltering, the likely rise in corruption, weakened property rights,

Scale Class Type Outcome

Micro Financial Anomalies or arrange overseas loans.

Systemic Competing Perspectives The host government’s policies on, for instance, human rights, labor conditions, or environmental sustainability, create public relations problems for a foreign company at home.

Unilateral Breach of Contract The host government repudiates a contract negotiated with a foreign company or approves a local firm’s doing the same.

Procedural Tax Discrimination

Restrictions on Profit Repatriation

Regulatory policies that make it difficult for the company to get credit

A foreign company is saddled with a higher tax burden than a local competitor.

foreign company can remit from its local operations to the home office. The host government arbitrarily limits the amount of profit that a

Distributive Destructive Government Actions Unilateral trade barriers, often via local-content requirements, interfere with the distribution of products to local consumers.

Harmful Action Against People Local employees of a foreign company are threatened by kidnapping, extortion, or terrorist actions.

Catastrophic Expropriation/Nationalization The host government or a political faction seizes a company’s local assets. Compensation, if any, is usually trivial. Resurgent totalitarianism and resource nationalism increase this risk.

Macro Civil Strife, Insurrection, War Military action damages or destroys a company’s local operations.

FIGURE 3.5 Classes and Characteristics of Political Risk The political risks of international business have telltale characteristics. Here, we see that they vary in terms of the intensity of their impact upon firm operations, belong to various classes , typically follow from the imposition of certain sorts of regulations, and have distinctive outcomes.

The primary types of political risk, from least to most disruptive, are

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150 PART 2 National Environmental Differences

unpredictably enforced laws, and freedom constraints will increase systemic political risk in many countries.

Systemic risks do not necessarily reduce potential profits. In fact, elections and policy shifts can create opportunities for foreign investors. In the past few years, for example, newly elected governments in Vietnam, Malawi, Estonia, and Guinea deregulated and privatized their previously state-controlled economies. Investors who accepted the risk of a public policy reversal and pursued the emerging opportunities prospered as freer markets developed in these countries. Our opening case traces a similar market pattern in China. Political trends encouraged pro-market reforms that reduced risks and created opportunities. Still, taking advantage of such opportunities, whether in China or elsewhere, calls for tough-minded analysis of the risk-return relationship.

Procedural Political Risk Around the clock, people, products, and funds move from point to point in the global market. Each move creates a procedural transaction between subsidiar- ies, companies, or countries. Political actions sometimes impose frictions that slow or stop these transactions. The repercussions of, say, public fraud or a partisan judicial system can raise business costs. Corrupt officials might pressure a foreign firm to pay additional monies to clear goods through customs or obtain a permit to open a factory. For example, Nigeria’s notoriously challenging business environment is rife with procedural risks. “The entire state machinery exists to siphon off cash,” said one observer. “Many functions of government have been adapted for personal gain. . . . A universe of red tape engulfs the economy. . . . In some Nigerian states, governors must personally sign off on every property sale; many demand a fee.”103 Politically motivated interference escalates expenses, thereby lowering returns. Procedural political risk is a micro risk—that is, it affects some but not all companies. Monitoring industry developments, minding the relative contribution of their firms to the local economy, and promoting solid citizenship help MNEs manage their exposure.

Distributive Political Risk Countries see successful foreign investors as agents of innova- tion and sources of prosperity. Often, as MNEs generate greater profits in the local economy, the host government may question whether it is getting its “fair” share of the rewards. In some

FIGURE 3.4 Today, a Question of Where Fiction Stops and Fact Starts

Source: Robert Mankoff/New Yorker Cartoon Bank/www.cartoonbank.com

Systemic political risks, by influencing the macro business environment, affect the operation of all firms.

Procedural political risk institutes impediments that constrain the flexibility of local operations.

The dynamic of distributive political risk is the gradual elimination of the local property rights of foreign companies.

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CHAPTER 3 Governmental and Legal Systems 151

situations, change is immediate. For example, rising silver prices led the Bolivian government to “dismantle the privatization model” governing its mining industry and expropriate all assets owned by private, largely foreign-owned mining companies.104 Foreign MNEs, like Coeur d’Alene Mines and Pan American Silver, besides watching their share price plummet on the news, were given two weeks to prepare for state takeover of their Bolivian mines.

More often, officials launch programs of creeping expropriation whereby they slowly take a bigger share of the rewards. Methods vary, such as increasing barriers to transferring personnel into or profits out of the country. Gradually, through such techniques, the host government eliminates MNEs’ local property rights. Generally, vigilance helps MNEs mini- mize exposure. Many also fight back, building global supply chains that diversify operations.

Chrysler, for example, deterred creeping expropriation in Peru because its local factory made about half the parts needed to assemble a car; importing the rest meant the local facil- ity was useless if the government interfered with operations. Likewise, Japan’s escalating tension with China (notably, consumer boycotts of Japanese products, anti-Japanese riots, and foreboding military confrontations) pushes Japanese MNEs to hedge their political risk. Some apply a “China-plus” approach whereby they backstop their supply chains, once anchored in China, with a shadow hub in another Asian market such as Thailand, Vietnam, or the Philippines. Although inefficient, alternative locations safeguard the Japanese firms’ Asian operations in the event political hostilities flare.105

Sometimes the importance of the market leaves MNEs with few options. The United States, for instance, is not generally considered a hotbed of distributive political risk. If you’re in the cigarette business, however, you’re aware that the U.S. carries high degrees of politi- cal risk.106 Its government battles cigarette makers (both domestic, like Philip Morris, and foreign, like British American Tobacco) on matters of taxation, regulation, business practice, and liability. Preserving market access requires that companies accept hard operational limits.

Catastrophic Political Risk Catastrophic political risk includes political developments that adversely affect the operations of every firm in a country. It typically arises from macro flash- points—ethnic discord, illegal regime change, civil disorder, insurrection—that disrupt soci- ety. Anti-state activities in Egypt in early 2011, for example, paralyzed its economy. Foreign commerce and domestic business all but halted, markets seized up, and supplies of all sorts vanished. Auspiciously, Egypt pulled back from the brink. In other situations, such as in failed states like Chad, Afghanistan, or Zimbabwe, spiraling disruptions triggered political conflicts that devastated the business environment for all firms.107 By the fall of 2013, however, Egypt fell into a similar downward spiral. MNEs responded by suspending operations.

Catastrophic political risk devastates companies and countries.

Yes Companies take politics seri- ously, fully aware that the actions

of host governments affect the business environment. Consequently, MNEs face threats that demand political risk management strategies. All have a choice: They can apply a proactive or passive approach. Those who advocate active political risk management reason that the best defense is a good offense. In my opinion, they’re right. Taking charge, predicting political problems, and controlling risks is the ticket to success.

WHAT TO DO Seasoned managers pull this off through two battle-tested tactics. First, they apply state-of-the-art statistical modeling to quantify political risks. Second, they stress-test their models, consulting experts on the political

maneuverings in a particular country. This two-pronged approach, like good management in general, applies hard analysis and objective interpretation. It begins with the thesis that neither positive nor negative political events in any country are independent or chance events. Civil strife, creeping expropriation, regime change, ethnic tension, ter- rorism, and the like do not happen randomly. They unfold in observable patterns that bright folks applying sharp analytics can study to estimate the odds of future out- comes. An objective model that detects, measures, and frames scenarios moves a company ahead of the curve, preparing it to manage its political risk exposure.

WHAT TO WATCH Measuring the right set of discrete events is the key precondition of modeling political risk.

Proactive Political Risk Management: The Best Approach

Point Point

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152 PART 2 National Environmental Differences

Specifically, this approach requires identifying valid indi- cators that one can measure reliably. Research identifies useful indicators: the number of military officers hold- ing political office, pace of urbanization, frequency of government crises, degree of literacy, ethno-lingual frac- tionalization, and so on. Evolving methods fortify analyses. For example, sentiment analysis identifies emotionally charged words and phrases used in online communica- tions. Comparing the relative frequency of positive and negative words used in millions of exchanges, feeds, and posts on the Internet produces a national as well as global map of how people “feel.” Sentiment analysis, for example, indicated that people’s resentment of autocratic rule was crossing critical thresholds in Egypt and Libya weeks before violence erupted.108 Moreover, sentiment analysis confirms that the challenge is not identifying indi- vidual measures, but rather identifying the right mix. Once done, skillful statistical modeling can objectively estimate risk exposure.

WHAT TO ADD We concede a proactive approach has limits. Spreadsheet estimation, no matter how rigorous or extensive, carries analysis only so far. Reaching this limit

need not halt analysis, however. One can complement quantitative measures with in-depth, country- specific qualitative indicators. Enriching interpretation requires per- spectives and perceptions that intuitively understand a country’s political drama in ways that numbers struggle to represent.

How do we apply this approach? A popular tactic is surveying country experts. Besides being mindful of quan- titative factors, specialists add an understanding of the subtle intricacies of secondary data. They enhance analy- ses with their expertise on the subjective conditions in a country, adding a bit of wisdom to interpret what appears to others as idiosyncratic circumstances but, in their eyes, is a systematic pattern of political activities.

Integrating expert assessments into your political risk strategy is straightforward. Begin by running standard- ized interviews with experts to assess a country’s political environment. If stuck, a useful starting point is the Internet; searching “political risk management” generates resources. Collectively, they support projecting realistic scenarios and logically assigning probabilities to reasonable outcomes— the hallmarks of proactive political risk management.

No Unquestionably, a proactive approach exhibits the hallmark of

good management—enterprising, confident, and control- ling. However, it fails to explain why many MNEs do the exact opposite, choosing to manage political risk passively by treating it as an unpredictable hazard of the business environment. They reason that no model, regardless of how brilliantly it has been conceptualized, how system- atically it has been specified, and how precisely it has been administered, can consistently predict political risk. Granted, shrewd models extrapolate meaningful insights from economic, political, and social reports about who may take office, what polices may pass, and how these sorts of political events affect the business environment. Unquestionably, these insights make the political system and its risks understandable. They do not, however, make it predictable.

WHAT TO HEDGE Insights do not qualify as predictions precisely because of the intrinsic impossibility of reliably measuring messy, ill-structured situations. The political world is complex, its inalienable feature is ambiguity, and its tendency to change is absurdly high. Complicating matters are the innumerable variables and their interaction

that shape a political system. This situation becomes more difficult as companies venture

into emerging markets, each with its own political pecu- liarities. Going from the United States to Mexico may be a stretch, but that pales in comparison to expanding from the United States to, say, Saudi Arabia, Kazakhstan, Latvia, or Rwanda. No matter how powerful the spreadsheet or insightful the expert, the dimensions and dynamic of a political environment defy precise specification. Certainly, developing broad frameworks that anticipate unpredict- able hazards makes good business sense. However, prudently  managing political risk starts by rejecting the delusion that  one can. The objective is protection, not prediction.

HOW TO HEDGE This, of course, raises the ques- tion: How do I hedge my company’s exposure? Typically, MNEs applying a passive approach outsource the political risk-management process. They reason the best shield is buying political risk insurance—essentially, the best offense is a good defense. Consider the flexibility they get through this approach. They can purchase coverage that protects operations from an array of political risks, includ- ing government expropriation, involuntary abandonment,

Proactive Political Risk Management: The Best Approach Counterpoint

Counterpoint

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CHAPTER 3 Governmental and Legal Systems 153

THE LEGAL ENVIRONMENT As political ideologies differ among countries, so do legal systems. Thus, a key aspect of the international business environment is how a country develops, interprets, and enforces its laws. Businesspeople, understandably, champion consistency in laws from country to coun- try. Uniform, transparent laws make it easier to plan where to invest and, once there, how to compete on competencies, not connections.

In theory, legitimate rules that apply without prejudice to individual or institutional behavior, regardless of political, cultural, or economic status, anchor an effective legal envi- ronment. Done justly, individuals and companies can make lawful decisions that support peace and prosperity; done arbitrarily, all suffer. “To distrust the judiciary,” reasoned Honoré de Balzac, “marks the beginning of the end of society.”

The legal system specifies the rules that regulate behavior, the processes by which laws are enforced, and the procedures used to resolve grievances. Legal systems differ across countries due to variations in tradition, precedent, usage, custom, or religious precepts. Moreover, with the exception of the members of the European Union, countries rarely rec- ognize the legitimacy of legal practices or court judgments from other nations. Concluded a legal scholar, “Products move very easily across borders. Legal judgments, not so much.”109

All things being equal, every legal system institutes rules that support business formation, regulate transactions, and stabilize relationships. Successfully doing so ensures that a society can pursue economic development and, when disagreements arise, resolve them without resorting to lawlessness. Modern legal systems share three components: (1) constitutional law, which translates the country’s constitution into an open and just legal system, setting the framework for government and defining the authority and procedure of political bodies to establish laws; (2) criminal law, which safeguards society by specifying what conduct is criminal, and prescribing punishment to those who breach those standards; and (3) civil and commercial laws, which ensure fairness and efficiency in business transactions by stipulat- ing private rights and specific remedies in order to regulate conduct between individuals

and damage from political violence. Furthermore, com- panies are not limited to a few carriers. A range of public agencies, international organizations, and private compa- nies offer a variety of coverage options.

financial institutions funded and owned by member governments that promote growth in member countries by providing financial incentives to potential investors. Reducing the capital at risk encourages firms to ex- pand into otherwise unacceptably risky environments. Examples are the African Development Bank, the Asian Development Bank, and the World Bank Group.

encourages U.S. investment projects overseas by pro- tecting ventures against various forms of risk, including civil strife, expropriation, and currency inconvertibility. Increasingly, OPIC promotes investments in emerging markets that support U.S. foreign policy priorities.

protection. Many cover “routine” distributive and pro- cedural risks that involve property and income, such

as contract repudiation and currency inconvertibility. Private insurers are reluctant to cover catastrophic risks that result from civil strife, insurrection, or war.

WHAT TO REALIZE Ultimately, we have no quarrel with the notion that prediction and control are touchstones of professional management. Still, politics are anything but predictable and controllable. Indeed, few, if any, predicted the political turmoil of the Arab Spring and the surpris- ingly swift collapse of the Mubarak regime in Egypt. And who would have called democracy’s retreat a decade ago, especially when leading analysts were celebrating the “end of history?” Not to put too sharp an edge on it, but if one cannot predict these mega-events, then exactly what can one predict? Therefore, it just makes more sense—and, we might add, more cents—to resist the delusion of proactive management and opt for the practicality of passively man- aging political risk.

3-3. Given the choice between a proactive versus a passive risk management strategy, which approach would you recommend? Specify three reasons to justify your rec- ommendation.

The legal system is the mechanism for conceiving, stipulating, interpreting, and enforcing the law in a formal jurisdiction.

Modern legal systems evidence three components:

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154 PART 2 National Environmental Differences

and/or organizations. No single legal component in and of itself guarantees a functioning legal system. Success depends on the collective effectiveness of all in promoting philosophi- cal integrity, procedural justice, and personal security.

Aspects of each type of law bear upon MNEs’ actions in a host country.110 Our opening case, for example, shows how China’s legal traditions and practices attract, retain, and deter foreign investment. Whereas Western investors are accustomed to transparent bankruptcy laws that protect creditors, Chinese law presently protects debtors. Likewise, one in six busi- ness practitioners in Russia has been prosecuted for alleged economic crime over the past decade; most cases have no plaintiff, acquittals are rare, and company assets are often expro- priated by the state.111 Russian law, contends critics, “is the property of those who enforce it, and written exclusively for them.”112

TYPES OF LEGAL SYSTEMS The type of legal system in a country determines the conduct of business transactions, the rights and obligations of those doing business, and the legal redress open to those who believe they have been wronged. Understanding the nuances of the system pushes execu- tives to assess a variety of issues: Are laws based on abstractions or practicality? Do judges or juries pass judgment? Is justice based on objective principle or seen as the province of divinity? Do personal connections trump case facts? Peculiar as these questions sound, inter- national business puts managers into different situations wherein different interpretations of these issues result in different standards that regulate the legality of their actions.

The globalization of business drives the standardization of laws across countries. Still, enduring philosophical outlooks and practical orientations result in different types of legal systems around the world. Map 3.3 identifies the primary types that prevail worldwide, namely: common law, civil law, theocratic law, customary law, and mixed systems.113

Managers face five types of legal systems in the world today:

Civil Law

Common Law

Muslim Law

Customary Law

Mixed System

MAP 3.3 The Wide World of Legal Systems Managers operating internationally face legal environments anchored in a variety of philosophies and principles. Here we see the world organized by predominant types of legal systems. Source: University of Ottawa, “World Legal Systems,” retrieved 4/15/2013 from www.juriglobe.ca/eng/index.php.

Note: Given that this is a Mercator projection, the scale approximates east-west distance at the equator; however, the farther you move from the equator, the more the east-west distance is distorted.

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CHAPTER 3 Governmental and Legal Systems 155

Common Law A common law system relies on tradition, judge-made precedent, and usage. It respects established case law in resolving disputes. Judicial officials refer to statu- tory codes and legislation, but only after considering the rules of the court, custom, judicial reasoning, prior court decisions, and principles of equity. The doctrine of stare decisis is a distinguishing feature of the common law system—it obliges judges to respect the precedent established by prior court rulings.114 The common law system has Anglo-American legacies; it prevails in, among others, Canada, the United States, India, Hong Kong, England, New Zealand, and Australia.

Civil Law A civil law system relies on the systematic codification of accessible, detailed laws. It assigns political officials, rather than government-employed judges, the responsibility to translate legal principles into a compendium of regulatory statues. Rather than create law, as they do in the common law system, judges apply the relevant statues to resolve disputes. In contrast to stare decisis, judicial officers in a civil law system are not bound by precedent. Precisely stipulated statutory codes, however, constrain their authority to interpret the law. Similarly, notaries public play minor roles in common law countries but are important gate- keepers as well as regulators of contracts and certificates in civil law systems. Civil law is the most widespread type of legal system in the world. It is used in various forms in approxi- mately 150 countries, including Germany, France, Mexico, and Japan.

Theocratic Law A theocratic law system relies on religious doctrine, precepts, and beliefs. Ultimate legal authority is vested in religious leaders, who regulate business transactions and social relations based on their interpretation of a sacred text. For instance, Iran’s president, Hassan Rouhani, defers to the final say of Iran’s supreme leader, Ayatollah Ali Khamenei. Theocratic laws see no separation of church and state; government, law, and religion are one. The most prevalent theocratic system, Muslim or Islamic law (or Shari’a), is based on the Qur’an, the Sunnah (decisions and sayings of the Prophet Muhammad), the writings of Islamic scholars, and the consensus of legal communities in Muslim countries.115 Muslim law prevails in the Middle East and northern Africa. However, modernists (e.g.,  Turkey, Indonesia), traditionalists (e.g., Kuwait, Malaysia), and fundamentalists (e.g.,  Iran, Saudi Arabia) advocate different interpretations of Shari’a.

Customary Law A customary law system reflects the wisdom of daily experience or, more formally, enduring spiritual legacies and time-honored philosophical outlooks. It anchors legal systems in many indigenous communities, defining the rights and responsibilities of members. Legitimacy follows not from the stamp of a powerful person or sanctification by an institution, but from individuals recognizing the benefits of complying with community stan- dards. Offenses are treated as torts—i.e., private wrongs or injuries rather than crimes against the state or society. Customary law prevails in many developing countries, particularly those in Africa.116 Few nations operate under a wholly customary legal system. Instead, this type often plays a role in countries that have a mixed legal system.

Mixed System A mixed legal system emerges when a nation uses two or more of the preceding types. In a sense, legal pluralism results when two or more legal systems apply cumulatively or interactively. Map 3.3 shows that one finds most mixed legal systems in Africa and Asia. The Philippines, South Africa, and Guyana, for instance, follow a blend of civil and common law. Nigeria, Malaysia, and Kenya mix common, theocratic, and custom- ary law. Bangladesh, Singapore, and Pakistan blend common and theocratic law. Indonesia, Djibouti, and Oman, conversely, blend theocratic law with civil codes.

TRENDS IN LEGAL SYSTEMS As the Third Wave of Democratization spread, the philosophy of individualism supplanted that of collectivism. Legally, this change promoted individual legal rights and instituted practices of due process. The law became more transparent, courts became more impartial,

Common law is developed by judges through the decisions of courts.

Civil law is based on strict application of statutory laws.

Theocratic law is based on the inspirations and instructions of religious teachings.

Customary law is based on norms of behavior that gain legitimacy through long-term practice.

CONCEPT CHECK

As we saw in Chapter 1, business environments vary. Granted, there are points of convergence, but conducting international business calls for recognizing the existence of fundamental differences across countries. Here, we stress that legal systems differ on a variety of principles and practices.

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and officials became more accountable in many countries. Presently, democracy’s retreat, by signaling the rise of strong states advocating collectivism, pushes managers to pinpoint likely changes in legal systems. Managers begin by accepting that authoritarian govern- ments use the legal system to regulate business activity so that it unconditionally supports and sustains the state. There is no separation of law and state; the state uses the law to control public and private matters. Bluntly put, justice is not blind but arbitrary, oppressive, and state-serving.

Recall earlier observations on legal affairs in China. Doing business there, said an observer, means dealing with “a society that had . . . plenty of rules, but they were seldom enforced. China appeared to be run by masterful showmen: appearances mattered more than sub- stance, rules were there to be distorted.”117 Moreover, the CCP’s official status above the law further complicates determining what is right and what is wrong. China is not the exception. The Russian legal code is laced with ambiguities. Businesses, caution legal analysts, “cannot even keep track of the law, let alone decide whether to follow it.”118 Besides confusion, ambi- guity renders the law as less about protecting the citizenry and more a tool of arbitrary and abusive state power.

The Basis of Rule Once relegated to the periphery of the global economy, emerging mar- kets steadily command center stage. Their expanding markets increasingly frame managers’ interpretation of legal trends. Most notably, the strong performance of emerging economies pushes managers to reassess the prevailing philosophical basis of law in order to understand how local officials will regulate the business environment. Specifically, the rise of emerging economies, along with their dissimilar conceptions of legality, requires that managers ask, “What is the basis of rule in a given country?” This question inevitably directs attention to the rule of man versus the rule of law.

The Rule of Man The rule of man holds that ultimate authority resides in a person whose word and whim, no matter how unfair or unjust, is law. For much of history, rulers and law were one and the same—the law was the will of the ruler, whether that ruler was called king, queen, lord, emperor, empress, shogun, czar, raj, chief, caliph, etc.119 Today, these titles have largely given way to others, such as chairman, emir, comandante, generalissimo, dictator, supreme leader, or, in the case of North Korea, “Dear Leader.” In whatever form and with whatever title, the rule of man defines a legal system in which the sovereign leader’s actions are not restricted by a constitution, regulated by criminal codes, or open to opposition. For example, Saddam Hussein, former President of Iraq, imperiously declared that the “law is anything I write on a scrap of paper.”120 In China, furthermore, top-ranked party members accused of wrongdoing answer to the CCP first, not to the law of the land, precisely because “the Party sits outside, and above the law.”121

The rule of man is an instrumental device of totalitarianism. In effect, the sovereign leader creates the law, officials are the followers of the law, and the citizens its subjects. In such systems, the state uses the legal system to suppress threats to, and reward support for, its authority. Constitutional issues are discretionary, criminal law is arbitrary, and opportunism taints commercial and civil matters. The law is an apparatus of the state. Rather than defi- cient, justice is absent.

The Rule of Law The rule of law holds that no one, whether a public official or pri- vate citizen, is above the law. Thomas Jefferson, for instance, wrote in the Declaration of Independence that “all men are created equal” to hold forth that everyone, from kings to peasants, is subject to the same laws.122 More symbolically, in front of courthouses worldwide stands a statue of a woman, carrying a sword and measuring balances, sometimes wearing a blindfold, sometimes with eyes closed. Her sword stands for the power of the court, her scales for the competing claims of the petitioners, and her blindfold signifies that justice is meted out objectively, without fear or favor, regardless of identity, power, or weakness. Justice is blind so that justice is impartial.

CONCEPT CHECK

As developed in Chapter 2, a country’s cultural orientation toward standards of accountability, equity, and fairness influences the prevailing principles in its legal environment.

The rule of man holds that the ruler, in whatever form, commands authority that is above the law.

The rule of man anchors the legal system in totalitarian states.

The rule of law holds that no individual is above laws that are clearly specified, commonly understood, and fairly enforced.

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The rule of law holds that governmental authority is legitimately exercised in accordance with written, publicly disclosed laws. In such a system, citizens regard constitutional prin- ciples as legitimate, criminal codes as fair, and commercial/civil matters as just. Operationally, laws are clear, publicized, and protective of fundamental rights; they are developed, adminis- tered, and enforced transparently; all citizens have access to a competent, independent, and ethical judiciary; and all officials are accountable to the law of the land.123 Rather than absent, justice is omnipresent.

Absent the rule of law, democracy struggles.124 Operationally, it constrains state power and safeguards lives, liberty, and property. Instituting objective legal standards creates stability that encourages investment and growth. Finally, the rule of law defines the core of a just society and fortifies liberty. Protecting people from abusive and arbitrary government is vital, given that, as John Locke warned some three centuries ago, “Wherever law ends, tyranny begins.”

IMPLICATIONS FOR MANAGERS Originating in the Magna Carta of 1215, the concept of the rule of law anchored the legal evo- lution of many developed economies, most notably Great Britain, the United States, France, and Germany. Besides instituting a just political environment, the rule of law guarantees the enforceability of commercial contracts and business transactions while safeguarding property rights. Investors and companies rely on it to validate laws, codes, and statutes.

For example, in the West, property rights—namely, the exclusive authority to determine how one’s property is used—are so taken for granted that they rarely cross our minds. We cannot say the same for many countries in Asia, Africa, the Middle East, and South America. There, the historic centrality of the rule of man makes the principles and practices of the rule of law odd abstractions. It has, at best, a negligible legacy in the legal traditions of many long- developing, now-emerging countries. As a result, property rights in countries like China, Venezuela, Saudi Arabia, Russia, and Vietnam are so arbitrarily protected that they are an enduring concern.125 The rule of thumb for MNEs is straightforward: In countries where the rule of man is the basis of law, acceptable marketplace behavior is unpredictable. Managers stay alert to trumped-up charges, solicitation of bribes, and favoritism of local rivals.

Map 3.4 indicates that the rule of law prevails in wealthier, westernized countries— i.e., the United States, Canada, Japan, New Zealand, Australia, and most of Europe.126 In contrast, the countries that fall in the long crescent that starts in northern Russia, cuts south- ward through China, circles down to South East Asia, moves on toward the Middle East, and extends through Africa over to South America show the far greater pervasiveness of the rule of man. Conclusion? The rule of man anchors the legal systems of many of today’s emerging countries. Managers, eyeing these fast-growing markets, realize that where there is no formal law officially in place, society typically defaults to the rule of man.

THE CONFOUND OF DEMOCRACY’S RETREAT The tendency toward totalitarianism in many developing countries complicates legal circum- stances. Again, look at Map 3.4. Every country that Freedom House rates as “Partly Free” or “Not Free” lies along the “rule of man crescent.” The same goes for countries rated as Hybrid or Authoritarian states by the EIU. Uncertainty about the basis of law and the goals of gov- ernment in much of the world creates a disconcerting situation for managers. Operating in Western economies grants them the benefit of a consistent application of legitimate laws. Few developing countries offer such safeguards.

In Germany, for example, action taken by foreign firms against local companies that counterfeit their products consistently proves decisive. Violators are restrained and punished. In Belarus or Kazakhstan, however, the same sorts of legal actions typically prove point- less. There, as in other rule-of-man systems, writs, injunctions, and lawsuits are trapped in a slow-grinding legal machine that answers to the leader, not to legitimate legal standards.127

Uncertainty about the basis of law in a particular country complicates decision making in the MNE.

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Violators in the good graces of the “man,” whether Alexander Lukashenko of Belarus or Nursultan Nazarbayev of Kazakhastan, flourish.128

Certainly, a prudent MNE could opt to avoid such markets. In fact, this strategy had long been the case. Until 2000 or so, the question of the basis of law in developing countries was largely inconsequential. Markets in the West provided a wealth of opportunities for produc- tive, profitable activity. Developing markets were on the periphery of the global economy, serving mainly as sources of raw materials. The occasional dispute between the adventur- ous Western company and the locals was typically resolved in the favor of the former. Now, slowing growth in the West, aggravated by the aftermath of the financial crisis, moves the fast-growing emerging economies to the center of the global market. Their supply of inex- pensive, productive resources along with accelerating local demand is a siren call few MNEs can resist. As GE’s CEO reasoned, “We’ve globalized around markets . . . Today we go to Brazil, we go to China, we go to India because that’s where the customers are.”129 Going forward, the McKinsey Global Institute reports that 400 midsize emerging-market cities— many unfamiliar in the West—such as Sanaa, Ibadan, Ouagadougou, Chittagong, Kinshasa, and Bamako, will generate nearly 40 percent of global growth over the next 15 years. As a result, and as suggested in our opening profile of China, MNEs long accustomed to the rule of law increasingly operate in markets anchored in the rule of man.

WHICH RULE WHEN? Some hypothesize that developing countries, especially fast-growing emerging economies like China, Argentina, Russia, Nigeria, Peru, Saudi Arabia, Thailand, and Malaysia, will follow the precedent of developed countries and eventually accept the legitimacy of the rule of law.

0th–10th Percentile

90th–100th Percentile

75th–90th Percentile

50th–75th Percentile

25th–50th Percentile

10th–25th Percentile

MAP 3.4 The Worldwide Practice of the Rule of Law The rule of law holds that government authority is legitimate only when it is exercised according to written laws and established enforcement procedures. The coding of this map is based on the degree a country does so. Therefore, for example, the United States at the 90th percentile indicates the pervasiveness of the rule of law. Conversely, Venezuela’s classification below the 10th percentile indicates the pervasiveness of the rule of man. Source: Based on World Bank, Governance Matters VI: Governance Indicators for 1996–2011, retrieved April 15, 2013 from http://info.worldbank.org/governance/wgi/worldmap.asp See also Kaufmann D., A. Kraay, and M. Mastruzzi (2010), The Worldwide Governance Indicators: Methodology and Analytical Issues, retrieved April 15, 2013 from info.worldbank.org/governance/ wgi/pdf/WGI.pdf. http://info.worldbank.org/governance/wgi/worldmap.asp

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As Western countries moved from agrarian to industrial economies, their societies increas- ingly saw the need to sanction and protect property rights. Ongoing economic development, in turn, required a legal system that no longer appealed to the “man” in power but to the written law for guidance and resolution. Therefore, extrapolating from Western history, some presume that the shift from agrarianism to industrialism in developing countries will acceler- ate their adoption of the rule of law. The Third Wave of Democracy, with ideological change anchored in the Washington Consensus, bolstered this scenario.

Recent circumstances, however, complicate the projected progression. Democracy’s retreat has slowed, if not reversed, progress precisely because the rule of law is antithetical to totalitarianism—one cannot be the “man” if one must answer to the law. More practically, China’s economic performance tests the thesis that a positive relationship exists between the rule of law, economic growth, and prosperity.130 China’s status as the world’s largest recipient of foreign investment over the past few decades, notwithstanding corruption within a system of crony capitalism administered by the absolute authority of the CCP, questions the necessity of the rule of law. Similar situations in Russia, Venezuela, Saudi Arabia, and Turkmenistan, among others, require foreign investors to qualify their forecasts. Now, the more plausible scenario is one in which emerging economies will arguably migrate from one basis of rule to another—that is, from rule of man to “rule by law” and its implicit notion that even the ruler is subject to the law. Growing cries from expanding middle class for stronger property rights, by improving the accountability of public officials, will then lay the founda- tion for society to accept the legitimacy of the rule of law.

Then again, in order to advise folks in emerging economies, one must qualify this inter- pretation in light of national legacies. The forecast of the rule of law as the inevitable end- state presumes that the particular legal philosophies of the West apply to countries through- out the world. Instead, some argue that the “West does not know best,” reasoning that the

Lady Justice, here seen at Römer Square in Frankfurt, Germany, is an allegorical personification of the moral force of the rule of law. Source: klickable/Fotolia

▶

CONCEPT CHECK

Chapter 1 suggests that democratic political systems grant MNEs the freedom to engage in their preferred modes of international business. Note, however, that democracy’s retreat creates uncertainty about operating in particular countries. Nations use their legal systems to encourage, regulate, or prohibit certain modes.

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efficiency and stability of a progressive, autocratic ruler are often more important than the liberty and freedom of a messy democracy. Said one Western analyst, “One-party autocracy certainly has its drawbacks. But when it is led by a reasonably enlightened group of people, as China is today, it can also have great advantages.”131 Indeed, throughout its storied 5000-year history, Chinese civilization has never practiced democratic governance based on the rule of law. Instead, while dynasties periodically changed, each adopted authoritar- ian governance that imposed the rule of man. Consequently, managers watch and learn as changing economic environments, which we profile more precisely in Chapter 4, influence the basis of law.

LEGAL ISSUES IN INTERNATIONAL BUSINESS Differences in political ideologies often pose operating problems. The fact that countries use diverse legal principles to regulate the business environment aggravates this situation. Moreover, new forms of business activity along with changing patterns of trade and invest- ment put MNEs in uncertain legal situations. In the following, we profile legal aspects of day-to-day decision-making in the MNE.

OPERATIONAL CONCERNS MNEs obey local laws on starting, running, and closing a business. Activities such as hiring workers, obtaining credit, protecting investors, paying taxes, trading across borders, and enforcing contracts must comply with applicable laws. In theory, business regulations are efficiently designed, easily accessible, and straightforwardly administered. Moreover, simple, well-designed work rules discourage corruption by removing the incentive to bribe regula- tors. The World Bank, along with the World Economic Forum, concludes that better business conditions consistently boost economic growth, job creation, and trade.

Despite these virtues, big companies and individuals often experience the opposite. Wal-Mart has run into a firestorm of controversy over its bribery practices in Mexico. In defense, Wal-Mart held that the convoluted, often contradictory Mexican legal code pushed it to protect its competitiveness with well-placed bribes.132 Similarly, at the micro level, a Brazilian entrepreneur recalled his experience in starting up his first company in his home country, where obtaining authorizations, licenses, and permits to start a new business—from seven different ministries—took about 150 days. When he started a U.S.-based business, however, “within a week I had formed an LLC (limited liability corporation), incorporated in Delaware, and set up bank accounts.”133

The globalization of markets progressively standardizes legal systems. Attracting foreign investors requires positive reputations and records. Memberships in international organi- zations accelerate this trend. The European Union requires all member countries to satisfy standards for the rule of law; the World Bank requires borrowers to agree to legal reforms; the WTO imposes a raft of legal obligations. Despite this convergence, enduring variability differentiates how countries regulate basic business operations. The World Bank evaluates several features of the business environment, studying how the role of regulation influences economic performance. Table 3.3 provides a cross-country snapshot of some of the variation involved in starting, running, and closing a business.

Getting Started Starting a business involves activities such as registering a name, choosing the appropriate tax structure, obtaining licenses and permits, arranging credit, and securing insurance. Some countries expedite this process; others do not. For example, start-up is a straightforward process in Australia, requiring one registration procedure that encompasses tax, labor, and administrative declarations. Conversely, India imposes 13 procedural require- ments, including regulations for bank deposits, court registration, health benefits, and so on. The upshot: it takes about two days to start a business in Australia but about 30 days in India.

CONCEPT CHECK

A theme of the text is the linkages among individuals, companies, countries, and institutions. Here, we emphasize the importance of relationships between ideas and ideals, namely the interplay among a country’s type of political system, its organizing legal philosophy, and its prevailing doctrine of law. Making these connections helps managers assess the systemic nature of the country’s business environment.

Operational concerns that managers face worldwide include

contracts.

The growing confidence of emerging economies increasingly questions the long-running presumption that “the West knows best.”

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At least one can take comfort in avoiding the same in Suriname— starting up there involves 13 procedures spanning 694 days.

For the sake of clarity, we restrict our discussion primarily to first-order effects of day- to-day operations for a small to medium-size enterprise. Keep in mind that activities, such as a business start-up, can be quite complicated for large MNEs. For instance, when enter- ing India, multi-brand foreign chains, such as Wal-Mart, Carrefour, IKEA, and Tesco, face a battery of regulations. Notably, they must operate as joint ventures, have no higher than a 51 percent ownership share, direct at least half of their capital investments into processing infrastructure, and open outlets only in cities that have at least 1 million residents.134

Making and Enforcing Contracts Once up and running, companies enter and enforce contracts with buyers and sellers.135 The sanctity of a contract is vital to business transac- tions. The United Nations Convention on Contracts for the International Sale of Goods sets guidelines for negotiating and enforcing contracts. Still, standards vary across different legal systems. Countries using a common law system, for instance, encourage precise, detailed contracts, whereas those with a civil law system encourage less specific agreements.

Similar tendencies show up in contract-enforcement policies. Australia, Norway, and the United Kingdom impose the fewest number of enforcement procedures. Burundi, Angola, Bolivia, Cameroon, El Salvador, Mexico, and Panama require many procedures. Singapore needs 150 days to enforce a contract, the United States about 300 days, and Timor-Leste some 1,800 days. On average, across 185 countries, a firm is looking at 615 days to settle a contract dispute.

Hiring and Firing No matter where you are operating, you will have to hire and, when necessary, fire workers. One would think that common sense would guide legally appropriate

TABLE 3.3 The Rules of the Game

The World Bank tracks micro-level characteristics of the regulatory frameworks in 185 economies. Comparative information on the rules of the game encourages officials to streamline their legal systems, thereby improving the efficiency of national business environments. Here we highlight data for a subsample of countries in terms of opening, running, and closing a business.

Economy Starting a Business Enforcing Contracts Closing a Business

Number of Procedures1

Time (Days)

Cost (% of income per

capita) Number of

Procedures2 Time3 (Days)

Cost* (% of Claim)

Recovery rate (C on the $)

Time (Years)

Cost5 (% of Estate)

Australia 2 2 0.7 28 395 21.8 80.8 1 8 Brail 13 119 5.4 45 731 16.5 17.1 4 12 Canada 1 5 0.4 36 570 22.3 90.7 .8 4 Chad 11 55 175.5 41 743 45.7 0 4 6 China 14 38 3.6 37 406 11.1 36.1 1.7 22 France 5 7 0.9 29 390 17.4 45.0 1.9 9 Germany 9 15 6 30 394 14.4 82.7 1.2 8 Guatemala 12 37 52.5 31 1459 26.5 27.5 3 15 India 12 29 46.8 46 1420 39.6 27.6 4.3 9 Japan 8 23 7.5 30 360 32.2 92.7 .6 4 Korea, Rep. 8 14 7.5 35 230 10.3 82.3 1.5 4 Russian 8 29 2.3 36 281 13.4 41.5 2 9 United States 6 6 1.4 32 300 14.4 81.5 1.5 7 United Kingdom 6 13 0.7 28 399 24.8 88.5 1 6

Source: Compiled from “Doing Business 2012,” The World Bank.

Notes 1 Number of procedures to complete before starting a business. 2 Number of procedures that require interaction between the parties to the dispute or between them and the judge or court officer. 3 Average number of days from when the plaintiff files the lawsuit in court until settlement. 4 Average cost incurred during dispute resolution, including court fees and attorney fees. 5 Average cost of bankruptcy process, including court costs, insolvency practitioners’ costs, and associated expenses.

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decisions. Legal standards around the world, however, are rarely straightforward. Moreover, local laws cover virtually every aspect of employment—how workers are hired, what they are paid, how many hours they can work, and whether they can be fired.

Singapore, New Zealand, and the United States are among the countries with the most flexible labor-regulation statutes. China provides the most flexibility in hiring and firing and the greatest discretion in setting employment conditions (work hours, minimum wages, and benefits). In contrast, Angola, Belarus, and Paraguay restrict firing employees and impose generous severance payments.

Slow-moving bureaucracies often complicate business regulation. Mexico last overhauled its labor law in the 1970s; hence, sacking a worker after a year of employment costs three times as much as in Chile, and eight times more than in Brazil. Mexico’s higher severance costs further constrain firms’ flexibility.136 Regarding bureaucracy, India’s national govern- ment imposes 55 labor laws while its various states add another 150 or so. Its Industrial Disputes Act, for example, requires any company employing 100 or more workers to obtain state permission before firing anyone, even if it has hit hard times.137

Getting Out or Going Under Closing a business involves more than padlocking the doors. In the United States, for example, the Internal Revenue Service requires reporting the sale of assets, payments to subcontractors, and termination of retirement plans. In the West, the bankruptcy process is anchored in the English bankruptcy law of 1732, the first modern law to address this issue, and its progressive revision, beginning in 1800, by the United States.

Ireland, Japan, Canada, and Hong Kong make closing the doors both fast (between four to eight months) and cheap (between 1 and 10 percent of the estate). The situation differs in developing countries. India’s lack of a comprehensive bankruptcy code complicates deal- ing with creditors, officials, and courts, which in turn discourages bankruptcy. Consequently, only four of every 10,000 firms go bankrupt in India, compared with 350 per 10,000 firms in the United States.138 Bankruptcy in Indonesia, Vietnam, and Ecuador is slow (between five to eight years) and expensive (between 10 and 30 percent of the estate). Several countries, including Burundi, Sudan, Cambodia, Afghanistan, Guinea-Bissau, and Dominica, stipulate no standards to govern dissolution.

A KEY RELATIONSHIP: WEALTH AND REGULATION Data indicate an inverse relationship between a nation’s general wealth and its regula- tion of business activity. In a nutshell, richer countries regulate less and poorer countries regulate more. In high-income countries (e.g., the United States, France, Japan), starting a business requires an average of 6.28 procedures, spans 18 days, and costs 7 percent of per capita income. Doing the same in middle-income countries (e.g., Mexico, Poland, Malaysia, China, India, South Africa), requires an average of 7.8 procedures, spans 36 days, and costs 28 percent of per capita income. Lastly, in low-income countries (e.g., Bangladesh, Ethiopia, Nepal), one is facing 7.5 procedures, a 90-day span, and 37 percent of per capita income. Furthermore, legal systems in wealthier nations tend to regulate operational activities more consistently than do those in poorer countries—as one would expect, given the prevalence of the rule of law in the former and the rule of man in the latter.139

Table 3.4 identifies the top-ranked and bottom-ranked countries whose legal policies enact the most or least supportive business environments. In terms of the former, Singapore has developed a comprehensive legal code that fosters the most favorable business environment in the world. Conversely, the Central African Republic’s legal shortcomings create the world’s least favorable business environment. These rankings confirm an important relationship: most of the top-ranked countries in Table 3.4 have a democratic political system and a common or civil law legal system anchored in the rule of law. In contrast, most of the bottom-ranked countries exhibit authoritarian politics and a mixed legal system anchored in the rule of man.

CONCEPT CHECK

Chapters 1 and 2 note that income and wealth influence the actions that countries, both rich and poor, take to develop their business environments. Correspondingly, these factors also influence countries’ approach to regulating MNEs local operations.

Richer countries typically regulate business activities less. Poorer countries typically regulate more.

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STRATEGIC CONCERNS Routine concerns focus managers’ attention on the day-to-day operations of opening, running, and closing a business. Strategic concerns direct their attention to long-term issues that shape the competitiveness, profitability, and sustainability of the firm. A country’s legal environment influences each aspect, shaping an MNE’s strategic decisions on making a prod- uct, marketing it, and safeguarding its proprietary features. Let’s inspect some key concerns.

COUNTRY CHARACTERISTICS National laws affect the flow of products across borders. To determine charges for the right to import a product, host governments devise laws that consider the product’s country of origin—the country where it was grown, produced, or manufactured. Some countries apply this policy to product labels, under the title COOL (country-of-origin labeling), to inform consumers and support local producers. National security concerns also shape country- of-origin regulations. Suspicion about the espionage capabilities of their communication products dog Huawei and ZTE. Both China-headquartered companies are marked by opaque governance and tight linkages with the Communist Party of China. National security con- cerns have led Australia, Canada, and US authorities to exclude their network equipment products from public contracts.140

Politicians also enact regulations to protect jobs, appease voters, placate special inter- ests, and preserve tax revenue. Not surprisingly, host governments prefer that MNEs make the greatest possible portion of their product(s) locally. Besides boosting local enterprise, technology transfers and knowledge spillovers support domestic innovation. To spur reluctant companies, governments enforce local content regulations. Brazil, for instance, levies a 30 percent tax increase on imported cars with less than 65 percent local content.141 Likewise, Brazil requires foreign energy firms to spend 1 percent of gross revenue on local R&D.

TABLE 3.4 Easy Here, Hard There: Doing Business in Various Countries

The World Bank ranks 185 countries on their respective ease of doing business—the higher the score, the more favorable the business environment. Technically, the ease of business index averages the country’s percentile rankings on ten dimensions: starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, and enforcing contracts. Here we see the best and worst performers.

Country Ranking Country Ranking Singapore 1 Niger 176 Hong Kong SAR, China 2 Côte d’Ivoire 177 New Zealand 3 Guinea 178 United States 4 Guinea-Bissau 179 Denmark 5 Venezuela 180 Norway 6 Congo, Dem. Rep. 181 United Kingdom 7 Eritrea 182 South Korea 8 Congo, Republic 183 Georgia 9 Chad 184 Australia 10 Central African Republic 185

Source: Doing Business 2013, The World Bank, Retrieved August 15, 2013.

Strategic concerns that managers face worldwide include

content.

protection.

CONCEPT CHECK

Recall from Chapter 2 that culture influences attitudes toward the development and ownership of ideas. Certain attitudes, particularly those toward workplace motivation and relationships, influence entrepreneurial behavior in a country. Likewise, attitudes toward collective and individual priorities shape a nation’s competitive environment.

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PRODUCT SAFETY AND LIABILITY Countries regularly impose product-safety and liability laws that require an MNE to adapt a product or else forsake market access. As a rule, wealthier countries impose stringent standards, whereas poorer countries, reflecting developing legal codes and rule-of-man legacies, apply inconsistent ones. The European Union’s product-liability directive shapes global standards.142 It outlines the legal responsibility of manufacturers and stipulates the process of product-liability compensation claims. Then again, some MNEs proactively preempt the risk. The Danish toy maker Lego, for instance, noted consumers’ fear of the possible toxicity of plastic toys made in China and did not open a factory there. Instead, Lego opted for factories in comparatively more expensive but less worrisome Mexico and Eastern Europe.143

LEGAL JURISDICTION Countries stipulate the criteria for litigation when agents—whether legal residents of the same or of different countries—are unable to resolve a dispute. Usually, in the face of a cross-national dispute, each company petitions its home-country court to claim jurisdiction in the belief that it will likely receive more favorable treatment. This situation is especially pressing when a MNE from a rule-of-law system has legal difficulties in a rule-of-man environment. Worry about legal proceedings in certain legal systems leads MNEs to specify a choice-of-law clause in contracts that stipulates whose laws, if necessary, govern dispute resolution. Importantly, it obliges both parties to negotiate a compromise in the event the law changes. Without bind- ing arbitration agreements, companies and consumers travel in legal limbo. Unless the foreign company has local operations, determining legal jurisdiction does not hold it accountable to a nation’s legal system.

INTELLECTUAL PROPERTY In Adam Smith’s time, countries drew strength from their agricultural prowess. Later, smokestack industries defined a nation’s prosperity and power. Now countries look to their brainpower to create might, prestige, and wealth. We call the output of this brainpower intellectual property (IP)—the creative ideas, innovative expertise, or intangible insights that create a competitive advantage for an individual, company, or country. The growing power of ideas in the global economy has made the protection of intellectual property a flashpoint of controversy.

Mainstream thought holds that the right to claim ownership of intellectual property stimulates innovation. Transnational institutions—notably, the World Intellectual Property Organization (WIPO), along with governments and industry associations—push for stronger protection. The primary safeguard is an intellectual property right (IPR) that grants the registered owners of inventions, literary and artistic works, and symbols, names, images, or designs the right to determine the use of their property. In other words, an IPR grants the registered owner of a copyright the legal authority to decide who may use the property and under what circumstances. Essentially, an IPR constitutes a legally enforceable but limited monopoly granted by a country to the innovator. It specifies a period during which other parties may not copy an idea so that the innovator can commercialize it. MNEs invest great effort to safeguard intellectual property, relying on tools like patents, trademark registrations, and copyrights.

The pervasiveness of piracy worldwide testifies to the difficulty of enforcing IPRs. Our closing case, “It’s a Knockoff World,” profiles these problems. Weak enforcement in some countries, particularly those marked by a rule of man bias and authoritarian politics, impose obstacles. Other problems arise because not all countries support the various agreements that

Product safety regulations set by the European Union shape standards worldwide.

The addition of a choice-of-law clause to contracts between different parties in different countries is an effective legal safeguard.

Intellectual property rights refer to the right to control and derive the benefits from writing (copyright), inventions (patents), processes (trade secrets), and identifiers (trademarks).

The predominant share of counterfeit products is made in countries in which the rule of man prevails.

Intellectual property is the general term for creative ideas, expertise, or intangible insights that grant its owner a competitive advantage.

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protect IPRs—primarily, the Paris Convention for the Protection of Industrial Property and the Berne Convention for the Protection of Literary and Artistic Works, both created in the 1880s and updated periodically. The WTO’s Trade-Related Aspects of Intellectual Property Rights (TRIPS) broadens protection while, more recently, the EU is moving toward a “unitary patent” recognized automatically in all member countries.

Matters of jurisdiction complicate protection. A U.S. patent, for example, establishes IPR only in the United States and its territories and possessions; it does not extend to foreign markets. Further, there’s no shortcut to worldwide protection; companies can- not register a “global” patent, trademark, or copyright. Although an IPR sounds secure, enforcing it often proves difficult. For example, in the United States, companies can go after the makers and sellers, not users, of counterfeit goods.144 Worldwide, governments claim to abide by these agreements and enforce IPRs. However, piracy increasingly threatens popular or pricey products.

THE BASIS OF POLITICAL AND LEGAL DIFFERENCES A key theme of this chapter is that inalienable differences exist between countries regarding political practice and legal regulation. Students new to the study of international business often find it helpful to understand the historical, economic, and cognitive basis for these dif- ferences. As we just saw, IP is a critical component of the development of any economy, no matter how rich or poor. Whereas some countries steadfastly affirm strong protection, others are less inclined. Still others turn a blind eye, informally sanctioning piracy. Making sense of the differences in attitudes and outlooks, as would be the case for other political or legal issues, follows from making sense of the effects of historical legacies, economic conditions, and cultural orientations.

HISTORICAL LEGACIES Most counterfeit goods are made in markets in which the rule of man is the de facto legal system. A return trip to China, given its legal tradition, its influence, and its sluggishness in protecting IP, highlights the scope of the problem. Officially, China has a battery of laws that comply with international standards for market access, nondiscrimination, and transpar- ency. However, many Chinese citizens and officials question the legitimacy of laws passed by foreign governments. Hence, foreign-made laws are inconsistently enforced in the local marketplace. This gap between domestic traditions and foreign standards, explained a Chinese jurist, means that its IP laws “exist to protect Chinese IP from foreign IP.”145 This situation is not unique to China. The Asian Development Bank evaluated the performance of Indonesia, Malaysia, the Philippines, South Korea, and Thailand relative to the rest of the world on measures of good governance: accountability, political stability, government effec- tiveness, regulatory quality, control of corruption, and rule of law. Over the past decade, their performance has deteriorated on nearly every dimension.146

Calls for China (as well as Vietnam, Russia, Chad, India, Malaysia, to name just a few of the many with similar records) to protect IP in the context of the rule of law may even- tually prove successful. Still, few anticipate quick progress. Advised a partner of Jones Day Shanghai, the “trend in China is toward more transparency, but it’s likely to be a 20-year process. . . . even then, it will be far from the standards in the United States.”147 For China, the legal legacy of two millennia of the rule of man—or, in its current form, the rule of the CCP—suggests that such a change may be “one of the largest social infrastructure projects in the history of mankind.”148

Countries that observe the rule of law, as opposed to the rule of man, more aggressively protect intellectual property rights.

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ECONOMIC CIRCUMSTANCES The vigor of IP protection often reflects a country’s stage of economic development. Just as poorer countries regulate less rigorously than richer countries, so too do they more weakly protect IP.149 In the case of developed countries, folks reason that protecting IP is the best way to energize innovation. “If the stuff you create can be misappropriated,” noted an ana- lyst, “your incentive for continuing to create valuable IP diminishes significantly.”150 Strong protection has created extensive IP in the West. Individuals and companies from developed countries control virtually all IP rights: Presently, they hold nearly 95 percent of all patents worldwide. In addition, 80 percent of patents granted in developing countries belong to resi- dents of wealthy countries.151

The evolving world economy, especially the market moves powered by emerging econo- mies, alters transnational institutional structures and legal outlooks.152 Popular perspectives in developing countries advocate less-stringent protection, arguing that IP rights are better interpreted as predatory, monopoly privileges that impose costs by:

advance.

existing knowledge.

and lessen the efficiency gains of free trade.

only from wealthy nations.

and slow the diffusion of innovations.

In sum, goes this reasoning, property rights are a state-created privilege that impoverishes the majority in order to concentrate wealth and power among the privileged.153 For example, in practical terms, critics in poor countries charge their rich counterparts with promoting strong IP protection to camouflage their intent to dismantle their generic drug industries.

This debate will twist and turn for many years. In the meantime, hard economics is likely the key determinant of a country’s protection of IPRs. Poor people have little money to spend on necessities, let alone for expensive branded goods sold by foreign companies. In Kenya, where the average annual income is about $1,800, it should not come as a surprise that many Kenyans “think you have to cheat to survive.”154 One means of survival is buying pirated copies of products that improve productivity (i.e., software), fight illness (medicines), or pro- vide relief (consumer products).

CULTURAL ORIENTATION Different attitudes toward IP protection reflect cultural orientations. Individualist countries such as the United States and Australia regard personal property rights as intrinsically legit- imate: if you create something, you should have the right to say who can use it or copy it for any given purpose. In contrast, collectivist countries such as South Korea, Thailand, and China extol the virtue of sharing over individual ownership: if you create something, it should improve the welfare of society. Asked about piracy in his country, for example, a South Korean diplomat explained, “Historically, Koreans have not viewed intellectual discoveries or scientific inventions as the private property of the discoverers or inventors. New ideas or technologies [are] ‘public goods’ for everybody to share freely. Cultural esteem rather than material gain [is] the incentive for creativity.”155

Similarly, countries often interpret and enforce intellectual protection differently. For example, 2013 saw India’s Supreme Court reaffirm Indian drug makers’ right to apply a

Critics of intellectual property protection argue that granting monopoly rights imposes hardships, creates inefficiencies, and slows innovation.

Generally, poorer countries protect intellectual property less vigilantly than do wealthier countries.

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process that differed from that recorded by the registered owner to produce and sell drugs patented in other countries; in other words, Indian patent law protects only the “processes” by which drugs are made, not the drugs themselves.156 Hence, Indian drug companies make copycat versions of many of the world’s best medicines and sell them for far less. For exam- ple, leukemia treatment Gleevec, developed by Switzerland-based Novartis, costs patients up to $70,000 per year; the Indian generic versions run about $2,500 annually. Not surprisingly, India is the world’s leading exporter of generic medicine. It, along with China, makes more than 80 percent of the active ingredients of all drugs used in the United States.157

Today, technologies challenge the influence of individualism and collectivism in the use and abuse of IP. Among some demographics, whether in collectivist China or individualist United States, piracy is an increasingly mainstream behavior. On one hand, hard economics spurs theft; more poor people seek affordable options, egality notwithstanding. Alternatively, the prevalence of piracy among teenagers and young adults in rich and poor countries alike reflects evolving attitudes and technological opportunism. Said the general counsel for NBC Universal, speaking of illegal file downloading, “Young people, in particular, conclude that if it’s so easy, it can’t be wrong.”158 Improving technologies, by making piracy cheaper and easier, accelerate the violation of IP rights.

THE POTENTIAL FOR CROSS-NATIONAL CONVERGENCE Convincing countries to protect IP confronts a potent mix of legal legacies, economic condi- tions, and cultural orientations. Institutional initiatives try to expedite stronger enforcement. The WTO, for example, gives wealthy countries a year to comply with its latest rules on IP but grants poorer countries five- to 10-year grace periods. Longer grace periods, the thinking goes, acknowledges economic realities while building awareness of the benefits of protecting IP. Rising piracy rates suggest these programs struggle to make a difference.

Ironically, calls for stronger protection hinge on the future success of companies in currently lax countries. History shows that countries that create IP—no matter their legal legacy, economic status, or cultural orientation—ultimately enforce property rights.159 As countries evolve from idea consumers to idea creators, they invent products based on their own IP. At some point, countries cross the threshold where the benefits of protection exceed the gains from piracy. Observers note that the United States, today a staunch defender of IPRs, copied other countries’ intellectual property when it was a developing country in the eighteenth century. Said one analyst, “American political independence was founded on the notion of economic self-sufficiency. And technology piracy became the premier tool to industrial development.”160 Inventing its own IP eventually led the United States to endorse the Paris and Berne Conventions, both of which originated in the 1880s. From then on, the U.S. has steadfastly advocated strong IP rights.

Trends in China signal the start of this process. Long the factory floor of the world, China aims to be the new product lab. Presently, its patent office leads the world in patent applica- tions; of the 2.14 million patent applications filed worldwide in 2011, 526,000 were filed in China, followed by the U.S. with 504,000, Japan with 343,000, and South Korea at 179,000. Although many Chinese patents file minor modifications, a growing share registers signifi- cant “invention” patents that grant the holder 20 years of protection (the same as in the West). Going forward, the Chinese government has a goal of 2 million domestic patent applica- tions annually by 2015, with the aim of being one of the top two patent-owning countries by 2020.161 Already, we see Chinese firms such as Huawei and ZTE battling each other over patent violations. Tension will likely escalate as Chinese firms, intent on protecting their expanding IP, demand the legal system police pirates. Right now, the signals from Chinese officials and companies are confusing—increasing piracy yet increasing patent activity.162 The resolution of this conundrum—will China stay a pirate’s paradise or become a property protector?—will shape IP practices throughout the world.163

Cultural attitudes influence the protection of intellectual property rights. Individualist societies are more vigilant than collectivist societies.

Countries that generate intellectual property are strong advocates of ownership rights.

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CASE I stride toward ground zero of counterfeiting—the notorious Silk Market of Beijing. As do more than 10 million people a year, I enter a 35,000-square-meter, seven- level piracy temple, packed with nearly 2,000 small stalls staffed by thousands of hard-charging, take-no-prisoner vendors offering cheap knockoffs of the leading branded products in the world. Navigating a surreal bazaar gone wild, I scan stalls boldly displaying bogus Louis Vuitton luggage, Prada purses, Hugo Boss shirts, and Hermes scarves; depending on how well you negotiate, each can be had for an absurd fraction of the price of the genuine version. Moving on, stall after stall offers infamous “copywatches,” Nike gear, Sony Jump Drives, Wii Remotes, Gillette razors, UGG footwear, Oakley sunglasses, Zeiss binoculars, Nikon lenses, North Face jackets—one after another, in a seemingly endless procession of premier brand names. Despite spot-on cosmetic resemblance, virtually all is counterfeit. Moving around, I come to digital zones, finding copies of software, music, games, and movies. Rack upon rack displays products from some of the best and the brightest minds of the world, now selling for ludicrously low prices—Microsoft Windows for about a buck, Microsoft Office for $0.75, Call of Duty or Wii Guitar Hero for a buck, Photoshop for two bucks, AutoCAD for five dollars. Each stall is packed with an ever-changing collage of customers—Germans, Indians, Canadians, Brazilians, British, Americans, and on and on—each getting past the initial shock, and many buying multiple titles.

—Daniel Sullivan’s ramble through the Silk Market, Beijing, March 2012

Companies are dogged by piracy—the illegal imitating, copying, or counterfeiting of their reg- istered products. It’s a tense issue given that it cuts to issues of innovation, history, culture, politics, and prosperity. Making matters worse is that pirates, besides being everywhere, come in every form: individuals making unauthorized copies at work, imitators laboring in dingy sweatshops, and hardened criminals running global networks.

The problem, basically, is this: IP in the form of books, music, product designs, brand names, process innovations, software, film, and the like is tough to conceive but remarkably easy to copy. Moreover, notwithstanding moral shortcomings, pirates do not lack initiative or imagina- tion. In our knockoff world, if it’s being made, it’s being faked. Counterfeiters leave no product category untouched. Fair game includes virtually everything—from the humble aspirin to the flashy Ferrari.164 And, for the kicker, knockoffs sell for a fraction of the price of the real thing to eager buyers worldwide.

Big Money, Big Risks IP theft is big business.165 Globalization and the Internet fuel the perfect storm, the former moving much of the world’s manufacturing to countries with poor IP protection, the latter providing cheap, easily accessible marketing platforms and distribution channels. The costs of counterfeit IP—e.g., lost sales, eroded consumer confidence, diminished brand repu- tation, dangerous products, enforcement expenses, and legal costs—is staggering. The International Anti-Counterfeiting Coalition (IACC) estimates that international trade in illegiti- mate goods runs more than US$600 billion a year—approximately 5 to 7 percent of world trade. ASIS International adds that the annual value of stolen corporate IP at $300 billion in the United States and over $1 trillion worldwide. Not surprisingly, piracy has grown more than 10,000 percent in the past three decades—it was $5.5 billion in 1982.166

Piracy grows because counterfeiting is astoundingly profitable; gross margins of 500 to 5,000 percent are common.167 Counterfeit medicines are more profitable than heroin, copywatches may run a couple of bucks to make but sell for $20 in Beijing’s Silk Market and $250 on Internet sites, and sales of high-end counterfeit software rival the return from cocaine trafficking.168

It’s a Knockoff World

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The lucrative rewards of piracy entice even notorious drug cartels to diversify. Mexico’s La Familia and Los Zetas, for example, generate hundreds of millions of dollars selling counterfeit DVDs. Their expanding operations have made Mexico the pirate capital of Latin America. The cartels export so many bootleg movies to Central America, for example, that some studios have stopped shipping their products there. Also, whether buying it in Cancun, Cozumel, Monterrey, or Tijuana, the bootleg DVD more than likely bears a stamp indicating it was distributed by La Familia (a butterfly) or Zetas (a stallion).169 Similarly, the cartels pirate software. La Familia sells counterfeit Microsoft software through kiosks, markets, and stores in the Michoacán region. Adding insult to injury, it stamps counterfeit Office discs with its “FMM” logo.170

Microsoft’s predicament in China highlights common problems. Copies of the latest versions of Microsoft’s Office and Windows programs are peddled in market stalls for a few dollars, a fraction of their retail price. Rampant software piracy means Microsoft’s revenue in China in 2011 was just 5 percent of its U.S. sales—even though personal-computer sales in the two countries are almost equal. Explained its CEO, Microsoft’s total revenue in China, with its population of 1.34 billion, is less than what it collects in the Netherlands, a country of fewer than 17 million.171 This situation is not Microsoft’s particular problem; thousands of companies in dozens of coun- tries struggle with the same challenge.

Nothing Is Off Limits Most think piracy is the problem of snobbish, expensive brands. Certainly, counterfeits target high-end brands—the top 10 brands counterfeited are Microsoft, Nike, Adidas, Burberry, Louis Vuitton, Sony, Lacoste, Reebok, Viagra, and Benson & Hedges. Luxury fakes, however, are just 4 percent of the counterfeit problem. The remaining 96 percent include every-day products. Nothing is off-limits; “If it’s making money over here in the U.S., it’s going to be reverse-engineered or made overseas.”172

Increasingly, counterfeiting threatens global health and safety—counterfeit medicines annu- ally kill tens of thousands and it’s anyone’s guess how much fake medicine is floating around the world today. Evidence indicates that the drug supply chain is a pirate’s paradise. The Food and Drug Administration estimates that counterfeits account for 10 percent of all drugs sold in the United States. Studies of anti-infective treatments in Africa and Southeast Asia peg up to 70 percent as fake.173 The United Nations estimates that half of the anti-malarial drugs sold in Africa are counterfeits. Imitations of Pfizer’s best-selling drugs have been found in the legitimate supply chains of at least 44 countries.174

Waging a Multifront War Companies, industry associations, and governments use a battery of weapons to wage war on counterfeiters. An enduring approach relies on dispatching squads of lawyers to search and destroy. Big companies lawyer-up to train customs officials on the nuances of their products, monitor the Web, prod Internet providers to take down copycat sites, and file injunctions against illegal sellers. UGG Australia began enforcing its IP upon realizing the prevalence of counterfeit boots. The company has shut down thousands of websites selling fake UGGs and blocked many thousands more online listings. Liz Claiborne Inc., owner of the Juicy Couture and Kate Spade brands, fight legions of websites selling counterfeits; it removed 27,000 auction listings of counterfeits in just a few months.

Some companies prefer high-tech assault. One approach embeds radio frequency identi- fication (RFID) chips in the product packaging to allow precise tracking; IBM, 3M, and Abbot Laboratories are pacesetters. Others, like Oracle, provide software programs that track products from factories to consumers. In Ghana, mPedigree lets consumers use their mobile phones to check if the product is genuine or fake; buyers call in a special code embossed inside the pack- age to the vendor, who then verifies its authenticity.175 Moving forward, some anticipate weaving microscopic markers into the product’s packaging.

Governments, fearful of losing tax revenues as well as pressures from legitimate businesses, aggressively enact tougher protection. The European Union ranks IP theft as a high priority.176

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The United States has elevated software piracy from a misdemeanor to a felony (for 10 or more illegal copies made within a six-month period with a worth more than US$2,500) and boosted enforcement efforts by threatening to sanction notorious pirates with records of “onerous and egregious” IPR violations (including countries such as China, Russia, Argentina, India, Thailand, Turkey, and Ukraine). Likewise, its Federal Drug Administration has opened offices in China, India, South Africa, and Mexico, among others, in effect taking the fight to the frontier. On other fronts, rhetoric escalates. The U.S. Trade Representative, for instance, declared, “We must defend ideas, inventions, and creativity from rip-off artists and thieves.”177

MNEs, officials, and trade associations lobby transnational institutions to devise stronger weapons. Industry associations, like the International Anti-Counterfeiting Coalition, spearhead efforts to toughen laws. Governments worldwide provide global services in public policy, busi- ness development, and consumer education. WIPO fortifies IP treaties and spurs members to bolster antipiracy efforts. Likewise, the WTO applies TRIPS to regulate enforcement, which requires all member nations of the WTO to protect and enforce IPRs according to global, not local, standards.

This fusillade of legal assaults, novel technologies, smarter investigations, diplomatic efforts, industry initiatives, consumer education, stronger IP policies, aggressive law enforcement, and concerted political, commercial, and institutional action, one would think, should prove more than sufficient. Then, to make things a bit more interesting, add in the firepower of the global reach of vigilant MNEs, high-profile legal proceedings, increased government coopera- tion, criminalization of piracy, and tougher trade agreements. Such a shock-and-awe campaign should devastate the pirates, right? Surprise, surprise: Piracy continues to grow at an increasing rate. For instance, in January 2009, Pfizer found counterfeit versions of 20 of its medicines in 81 countries. In July 2012, it found 60 such fakes in 106 countries.178

“The Bandits Are Everywhere” The global cat-and-mouse game between MNEs and pirates, far from winding down, esca- lates. Booming piracy in big, fast-growing emerging markets like China and India spells big, fast-growing trouble. As more people enter the global market, many of them are eager to consume Western brands despite income constraints. Experts warn that the resulting quest for low prices turbocharges piracy.

In addition, crafty pirates quickly overcome IP defenses. They crack licensing codes, dupli- cate holograms, falsify email headers, set up anonymous post office boxes, and devise crypto- currencies like bitcoins. Staying one step ahead of the IP police is a widespread competency. “Like drug trafficking, the counterfeiting problem is so massive [that] you don’t know how to get a handle on it. The bandits are everywhere.”179 Worrisomely, successful pirates evolve into sophisticated entrepreneurs. “When you are dealing with high-end counterfeits, you are talking about organizations that have a full supply chain, a full distribution chain, a full set of manufac- turing tools all in place and it is all based on profits.”180 Lamented one analyst, “Counterfeiting is like a balloon filled with water. You push it on one side but when you remove your hand, it bounces back even stronger.”181

Piracy gets a huge boost from the increasing availability of counterfeit goods through Internet channels, such as P2P file-sharing sites, mail order sites, or auction sites. Outgunned and out- foxed, some companies surrender. Foley & Corinna, a high-end handbag maker, explained that as it noticed more and more Internet fakes, it stopped looking altogether. “It’s just too frustrating. You can try to do something, but it’s so big and so fast.”182 Then again, there are those who treat IPR as the price of doing business. Despite everyday piracy of his products in the Chinese market, an executive reasoned that the profitability of his legal sales more than offset the losses due to counterfeits.183

Is Piracy Inevitable? The pervasiveness of piracy, in the face of aggressive lawyering, sophisticated tracking and tagging technologies, database software, and security controls, poses profound questions

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for protecting IPRs. Some worry that different legal legacies and political ideologies among countries complicate basic issues. TRIPS, by standardizing codes and norms, should have settled such troublesome issues. Legal and operational boundaries have limited its impact.

Others fear that the antipiracy war may already be lost. Evidently, a not-too-small num- ber of consumers and businesses around the world have few ethical qualms about using counterfeits. Take software, for instance. Global software piracy is rampant. In 2011, the worldwide PC software piracy rate hit 42 percent. Put differently, of all the packaged software installed on PCs worldwide, 42 percent was obtained illegally, at a cost of US$63.4 billion in lost revenue (up from losses of $29 billion in 2003). For many nations, such as Armenia, Libya, Ukraine, Bolivia, China, and Zambia, software piracy rates top 80 percent. Even the best-behaved nations, like the United States and Japan, report software piracy rates north of 20 percent.184 Consequently, Microsoft’s biggest rival is not another software company—it is counterfeiters.

The global financial crisis has pushed more people to seek counterfeits. Similarly, some in collectivist cultures reason that IP holders should honor society by abandoning their profit- maximizing business models. Sharing knowledge, not protection, is the moral imperative. But, counter others, without protection, ultimately there will be no IP to share or, for that matter, steal.

QUESTIONS

3-3. Collectivism and individualism, democracy and totalitarianism, rule of law and rule of man: What do these concepts say about IPRs and the legitimacy of protection?

3-4. What is the relationship among governments, transnational institutions, and MNEs fighting piracy? Do they share similar or different motivations?

3-5. Can MNEs stop piracy without government help? Why would they prefer greater government assistance? Why would they oppose it?

3-6. Do you think consumers in wealthier countries versus those in poorer countries justify piracy with similar rationalizations? Why?

3-7. Can you envision a scenario where developers and consumers of IP develop a relationship that eliminates the profitability of piracy?

3-8. Put yourself in the place of a poor individual in a poor country struggling to improve the quality of your life. What thoughts might shape how you interpret the legality of IPRs?

SUMMARY

terms of guiding principles and practical routines.

degree to which it emphasizes individualism vs. collectivism and the degree to which it is democratic vs. totalitarian.

political, economic, and cultural realms. It champions the inter- ests of the individual over those of society.

the needs of the individual. It encourages state intervention to improve the welfare of the group at the expense of the individual.

- passing role in a collectivist society. They play a comparatively limited role in an individualistic society.

- petitive elections occur, the extent to which individual and

group freedoms are guaranteed, the legitimacy ascribed to the rule of law, and the existence of freedom of the press.

A democratic government protects personal and political rights, civil liberties, fair and free elections, and independent courts of law.

many. The government exercises control over many to all aspects of life, the individual is subordinated to the state, and opposing political and cultural expression is suppressed.

Democracy’s retreat coupled with growing stagnation of free- dom signals resurgent authoritarian governance.

or conditions will affect a country’s business environment in ways that (1) cost investors some or all of the value of their

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172 PART 2 National Environmental Differences

investments, (2) force them to accept lower-than-projected rates of return, and (3) threaten the sustainability of local activities.

processes that enforce the laws of a country, and the procedure used to resolve grievances.

- tutional law that institutes an open and just political order, a system of criminal law that safeguards the social order, and a system of civil and commercial laws that promote fairness.

usage, and interpretation by the courts; a civil law system relies on a systematic collection of codes and statues that judges must follow; a theocratic legal system is based on religious precepts; a customary legal system follows the wisdom of daily experi- ence; and a mixed legal system combines elements of the other systems.

KEY TERMS choice-of-law clause (p. 164) civil and commercial law (p. 153) civil law (p. 155) collectivism (p. 135) constitutional law (p. 153) common law (p. 155) country of origin (p. 163) criminal law (p. 153) customary law (p. 155) democracy (p. 138)

individualism (p. 135) intellectual property (IP) (p. 164) intellectual property rights (IPR)

(p. 164) laissez-faire (p. 135) legal system (p. 153) local content (p. 163) mixed legal system (p. 155) pluralism (p. 136) political freedom (p. 137)

political ideology (p. 136) political risk (p. 148) political spectrum (p. 137) political system (p. 135) rule of law (p. 156) rule of man (p. 156) theocratic law (p. 155) Third Wave of Democratization

(p. 142) totalitarian system (p. 139)

ENDNOTES 1 Sources include the following: Michael Sylvester, “Flaming Hoops,”

Corporate Counsel: Market Report China (2004): 171; “A Disorderly Heaven,” The Economist (March 20, 2004): 12, U.S.; “Bulls in a China Shop,” The Economist (March 20, 2004): 10; “China Slams US Piracy Complaint,” BBC News (April 10, 2007); The Economist, Country Briefings: China, retrieved January 20, 2013 from www.economist. com/countries/China/ ; U.S. Department of State, Background Note: China, retrieved January 13, 2013 from www.state.gov/r/pa/ ei/bgn/18902.htm Central Intelligence Agency, World Factbook, www.cia.gov/library/publications/ the-world-factbook/geos/ch.html (January 12, 2013). The pace of change in China’s business environ- ment makes any discussion of it hazardous. Regard this case as a set of educated generalizations about the kinds of problems encountered by would-be foreign investors in China from the 1990s to date.

2 Richard McGregor, The Party: The Secret World of China’s Communist Rulers (Harper Collins, 2010): 1.

3 Pew Global Attitudes Project, Country’s Economic Situation. Specific query: “Is the country’s economic situation good or bad?” www. pewglobal.org/database/?indicator=5&survey=12&response=Good& mode=chart (Retrieved April 21, 2011).

4 Mark McDonald, “Disney to Asian Pirates: Knock It Off,” New York Times, (July 11, 2012): C-1.

5 For example, the IMF and Nobel Prize winner Robert Fogel pegs 2016, Angus Madison of the OECD targets 2020, Price Waterhouse Cooper claims 2025, Goldman Sachs targets 2027, and the National intelligence Council of the United States targets 2036.

6 Erich Follath and Wieland Wagner, “Murder, Sex and Corruption: Beijing’s Difficult Transition of Power,” Spiegel Online, Retrieved January 17, 2013, from www.spiegel.de/international/world/murder- sex-and-corruption-beijing-s-difficult-transition-of-power-a-861837. html.

7 Gordon Orr, “What’s in Store for China in 2013?” McKinsey Quarterly, January 2013.

8 “International Comparisons of Hourly Compensation Costs in Manufacturing, 2011” United States Bureau of Labor Statistics, Released December 19, 2012; “Manufacturing in India: The Masala Mittelstand,”The Economist, (August 11, 2012):55. In addition, Monthly Labour Review of the US Bureau of Labour Statistics shows that in 2009, compensation of Chinese manufacturing workers was only $0.81 per hour in 2006—just 2.7 percent of comparable costs in the US, 3.4 percent of those in Japan, and 2.2 percent of compensa- tion rates in Europe. While dated, they underscore the magnitude of the gap between China and the developed world. Moreover, as of May 2011, Apple has contracted with Foxconn to make their iPad 2s in China, where employees are reportedly paid 1,200 Yuan/month, or about $185 at current exchange rates (y/$ = 0.154), or, if we assume an average 8-hour/day, 250-day/year, (probably unrealistic assumptions), $1.11/hour. In contrast, the average U.S. manufacturing/mining/ construction compensation is $32.53/hour as of December 2010, according to the Bureau of Labor Statistics.

9 Keith Bradsher, “China’s Ambitious Goal for Boom in College Graduates,” New York Times, (January 17, 2012): A-1. Martin

by public officials who are held accountable for their just admin- istration. Operationally, no one is above the law.

- ual who commands the power to impose them. Operationally, the leader(s) is above the law.

- dency to regulate the various elements of the business environment.

safety and liability, marketing practice, rule of origin, jurisdic- tion, and IP protection.

intangible insights that give an individual, company, or country a competitive advantage. The strength of IPR protection within a country is moderated by its legal legacies, economic develop- ment, and cultural orientation.

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CHAPTER 3 Governmental and Legal Systems 173

Dewhurst, Jonathan Harris, and Suzanne Heywood, “The Global Company’s Challenge,” McKinsey Quarterly, retrieved December 31, 2012 from www.mckinseyquarterly.com/ The_global_companys_challenge_2979.

10 Personal Conversation, Daniel Sullivan and Peter Leung, Director, Nalco China, Beijing, March 1, 2011.

11 “Foreign Investment in China: Even Harder Than It Looks,” The Economist, (March 23, 2011):64.

12 Chinese Negotiation: The Long Kiss Goodnight, retrieved May 14, 2009 from www.chinesenegotiation.com/page/2/.

13 “A Survey Of Business In China: A Disorderly Heaven,” The Economist, retrieved March 24, 2011 from www.economist.com/ node/2495184.

14 Ibid. 15 The goal is not judicial independence. Rather, the Chinese chief justice

advocates out-of-court mediation as a favored means of settling civil disputes in ways that enhance social harmony. Criminal defendants, for example, have limited access to legal counsel, few rights to call their own witnesses, or even opportunities to contest testimony. Willy Lam, “Beijing Tightens Control over Courts,” Asia Times, retrieved August 4, 2011 from atimes.com/atimes/China/MF25Ad02.html.

16 The notion of the “mandate of heaven” is a Chinese philosophi- cal concept concerning the legitimacy of rulers. It is similar to the European concept of the divine right of kings. Both seek to legitimize rule from divine approval; however, unlike the divine right of kings, the Mandate of Heaven is predicated on the conduct of the ruler in question. It postulates that heaven blesses the authority of a just ruler, as defined by the Five Confucian Relationships, but disfavors a despotic ruler and would withdraw its mandate, leading to the over- throw of that ruler. The Mandate of Heaven would then transfer to those who would presumably rule best and the cycle would restart. Conveniently, the overthrow of the leader confirms that he had already lost his Mandate of Heaven (Source: en.wikipedia.org/wiki/ Mandate_of_Heaven).

17 Personal Conversation, Daniel Sullivan and Kathy Stearman, Beijing (March 4, 2011).

18 “Oded Shenkar, The Chinese Century, (Upper Saddle River, NJ: Pearson Prentice Hall, 2006).

19 IPR Seizure Statistics, 2011, U.S. Customs and Border Protection- Trade, retrieved January 18, 2013 from www.cbp.gov/xp/cgov/trade/ priority_trade/ipr/ipr_communications/seizure/.

20 Steven Weisman, “Before Visit to China, a Rebuke,” New York Times (December 12, 2006): A-1.

21 Ibid. 22 “The World’s Greatest Fakes,” 60 Minutes, quote by Dan Chow, www.

cbsnews.com/stories/2004/01/26/ 60minutes/main595875.shtml, retrieved June 15, 2006.

23 “The Sincerest Form of Flattery,” The Economist (April 4, 2007): 67. 24 “Business in Russia: Dancing with the Bear,” The Economist (February

1, 2007): 23. 25 “BP in Russia: Dancing with Mr. Putin,” The Economist,

retrieved February 14, 2011 from www.economist.com/ node/17967066?story_id=17967066.

26 “Business in Russia: Dancing with the Bear,” The Economist. 27 “Russia’s Weakened Democratic Embrace,” Pew Global Attitudes

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28 “Crocodile Tears,” The Economist, (April 28, 2007): 44. Andrew Osborn, “Russia’s Rule of Lawlessness,” WSJ.com, retrieved January 20, 2011 from online.wsj.com/article/SB123758426519199313.html Corruption Perceptions Index 2012, retrieved from www.transparency.org/ cpi2012/results, January 15, 2013.

29 Daniel Kaufmann, Art Kraay, and Massimo Mastruzzi, “Governance Matters IV: Governance Indicators for 1996–2004,” World Bank Policy Research Working Paper Series No. 3630 (May 2005).

30 Alan Ryan, On Politics: A History of Political Philosophy from Herodotus to the Present, London: Allen Lane, 2012.

31 Statement from the Declaration of Independence of the United States of America.

32 In Germany, before the adoption of liberal western economic ideas, its economic policy, so named “Gemeinnutz geht vor Eigennutz,” held that that “the welfare of the nation takes precedence over the selfishness of the individuals” (www.stephenhicks.org/tag/ gemeinnutz-geht-vor-eigennutz/).

33 Pluralism rests upon ideas drawn from the sociology of small groups. Translated to the level of a society, these ideas interpret the relation- ships and interactions between and within groups as they champion and contest political ideologies.

34 Hannah Arendt, “Totalitarianism,” Part Three of The Origins of Totalitarianism (New York: Houghton Mifflin Harcourt, 1968), p. 164.

35 Practically, the ideology of democracy anchors a political system that grants voters the power to alter the laws and structures of govern- ment, to make decisions (either directly or through representatives), and to participate directly in elections.

36 More specifically, a democracy accepts the legitimacy of (1) freedom of opinion, expression, press, religion, association, and access to infor- mation; (2) free, fair, and regular elections; (3) majority rule coupled with protection of individual and minority rights; and (4) subordina- tion of government to the rule of law.

37 Patrick French, India: A Portrait, (London: Allen Lane, 2011). 38 The philosophy of Apple’s founder Steve Jobs fit this outlook as well;

he rejected the notion that individuals were rational, believing “con- sumers don’t know what they want.”

39 In China, for example, the One Child Policy prohibits a family from having more than a single child; a couple that has a second child may be fined the equivalent of $1,300—a steep penalty in rural areas where most annual incomes are a fraction of that sum.

40 “China’s Future: Rising Power, Anxious State,” The Economist, (June 25, 2011): 3; for example, bookstores in China stock works approved by the CCP.

41 Anne-Marie Brady, Marketing Dictatorship: Propaganda and Thought Work in Contemporary China (Lanham, MD: Rowman & Littlefield, 2007).

42 “Freedom in the World 2013: Middle East Gains Provoke Intensified Repression,” Freedom House, retrieved January 20, 2013 from www. freedomhouse.org/article/freedom-world-2013-middle-east-gains- provoke-intensified-repression.

43 “China’s Future: Rising Power, Anxious State,” The Economist, Special Report: China (June 25, 2011): 3.

44 “Freedom in the World 2013: Middle East Gains Provoke Intensified Repression,” Freedom House.

45 “The Long Arm of the State,” The Economist, Special Report: China (June 25, 2011): 14.

46 Willy Lam, “China’s State Giants too Big to Play with,” Asia Times Online, retrieved May 26, 2011 from www.atimes.com/atimes/China_ Business/MA22Cb01.html.

47 Keith Brasher, “Solar Panel Maker Moves Work to China,” NYTimes. com, retrieved February 11, 2011 from www.nytimes.com/2011/01/15/ business/energy-environment/15solar.html?pagewanted=2&hpw.

48 “Chinese Politics and the WTO: No Change,” The Economist, (December 10, 2011): 46.

49 “China Squeezes Foreigners for Share of Global Riches,” WSJ. com retrieved December 29, 2010 from online.wsj.com/ article/SB10001424052970203731004576045684068308042. html?mod=rss_whats_news_us_business.

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50 “Corporate Espionage: Who Needs Cyber-spying?,” The Economist, (February 21, 2013):44.

51 Extracted from Mission Statement, Freedom House, retrieved June 28, 2009 from www.freedomhouse.org/template.cfm?page=2. For exam- ple, classical liberal philosophy holds that freedom is the absence of coercion of one person by others; jurisprudence holds that one has the right to determine one’s own actions autonomously; environmen- talism advocates constraints on the use of ecosystems in any defini- tion of freedom. Others take a more abstract approach, discussing notions of positive versus negative freedom (the right to fulfill one’s own potential vs. freedom from restraints).

52 Adrian Karatnycky, Freedom in the World 2001–2002: The Democracy Gap (New York: Freedom House, 2002), retrieved February 11, 2011 from www.freedom house.org.

53 Specifically, on December 10, 1948, the General Assembly of the United Nations adopted the Universal Declaration of Human Rights and has since called on all member countries to publicize the text and “to cause it to be disseminated, displayed, read, and expounded prin- cipally in schools and other educational institutions, without distinc- tion based on the political status of countries or territories,” For the full text of the Declaration, go to www.un.org/Overview/rights.html.

54 Samuel P. Huntington, The Third Wave: Democratization in the Late Twentieth Century, (Norman: University of Oklahoma Press, 1991).

55 Ibid. 56 Francis Fukuyama, The End of History and the Last Man (New York:

Free Press, 1992). 57 “Sledge Hama,” The Economist, (July 9, 2011):45. 58 “Angry Workers Push Back in Revolt over 2-minute Toilet Breaks,”

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59 The Economist Intelligence Unit’s Index of Democracy 2008, retrieved June 24, 2009 from graphics.eiu.com/PDF/Democracy percent 20Index percent 202008.pdf.

60 Ronald Bailey, “Does Disease Cause Autocracy?” Reason Magazine (June 1, 2011).

61 Christian Haerpfer, Patrick Bernhagen, Ronald Inglehart, and Christian Welzel (eds.), Democratization (Oxford: Oxford University Press, 2009); “Two Billion More Bourgeois,” The Economist (February 14, 2009): 18.

62 “Most Muslims Want Democracy, Personal Freedoms, and Islam in Political Life � Pew Global Attitudes Project,” retrieved January 15, 2013 from www.pewglobal.org/2012/07/10/most-muslims-want- democracy-personal-freedoms-and-islam-in-political-life/; Tang Ming, “Chinese Want Democratic Reform First, Official Poll Shows,” Epoch Times,” retrieved January 15, 2013 from www.theepochtimes. com/n2/china-news/chinese-want-democratic-reform-first-official- poll-shows-316896.html.

63 “Freedom in the World: The Annual Survey of Political Rights and Civil Liberties,” Freedom House, retrieved February 11, 2011 from www. freedomhouse.org/template.cfm?

64 Arch Puddington, “Freedom in the World 2011: The Authoritarian Challenge to Democracy,” Freedom House, freedomhouse.org: Freedom in the World 2011 Survey Release,” retrieved April 21, 2011 from www.freedomhouse.org/template.cfm?page=594.

65 “Freedom in the World 2011,” 48-49. 66 Arch Puddington, “Freedom in the World 2012,” Freedom House,

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67 “Democracy Index 2010: Democracy in Retreat, “Economist Intelligence Unit,” retrieved February 7, 2011 from www.eiu.com/public/topical_ report.aspx?campaignid=demo2010; Laza Kekic, “A Pause in Democracy’s March,” The Economist, The World in 2007 (Annual Review, 2007): 59–60.

68 Technically, the EIU evaluated 165 independent states and two territories.

69 Similarly, just over half the 70 seats in Hong Kong’s Legislative Council are determined by popular vote; the remainder is decided by groups of industry and professional associations. Add it all up and you have what some see as “the most convoluted election system on the planet.” “Streets, not seats”, View of Suzanne Pepper, a fellow at the Chinese University of Hong Kong; The Economist, (September 15, 2012): 42; “Banyan: Post-merger integration,” The Economist,” October 13, 2012; also “Monsoon of their Discontent,” The Economist, (July 9, 2011): 40.

70 “World” population refers to the total population of the 167 countries covered by the index. Since this excludes only microstates, this is nearly equal to the entire actual estimated world population in 2010. Economist Intelligence Unit.

71 “Public Opinion in Eastern Europe: The Glow Fades,” The Economist, retrieved January 31, 2011 from www. economist.com/research/articlesBySubject/displaystory. cfm?subjectid=7933596&story_id=14792427.

72 Paul Krugman, “Central European Shadows,” The New York Times, retrieved January 16, 2013 from krugman.blogs.nytimes. com/2011/12/11/central-european-shadows/.

73 Amartya Sen, “The Crisis of European Democracy,” New York Times, (May 22, 2012): A-8.

74 “Democracy Index 2010: Democracy in Retreat, “Economist Intelligence Unit,” retrieved February 7, 2011 from www.eiu.com/public/topical_ report.aspx?campaignid=demo2010;

75 Julian Wucherpfennig, “Modernization and Democracy: Theories and Evidence Revisited, Living Reviews in Democracy (2009): 1.

76 “On The People’s Democratic Dictatorship,” Selected Works of Mao Tse-tung, retrieved January 15, 2013 from www.marxists.org/refer- ence/archive/mao/selected-works/volume-4/mswv4_65.htm).

77 Pushkar, “India Waits for Democracy with Benefits,” Asia Times Online, retrieved January 16, 2013 from www.atimes.com/atimes/South_Asia/ NK03Df01.html.

78 “Countries at the Crossroads,” freedomhouse.org, retrieved April 18, 2011 from www.freedomhouse.org/template. cfm?page=139&edition=9

79 Scott Shane, February 5, 2011 “America’s Journeys with Strongmen,” NYTimes.com,” retrieved February 7, 2011 from www.nytimes. com/2011/02/06/weekinreview/06shane.html?_r=1&ref=us.

80 “Democracy Index 2011,” Economist Intelligence Unit” retrieved January 20, 2013 from www.eiu.com/public/topical_report.aspx?campaignid= DemocracyIndex2011.

81 ILO, “World of Work Report 2010. From One Crisis to the Next?” retrieved February 7, 2011 from www.ilo.org/global/publications/ books/WCMS_145259/lang–en/index.htm.

82 Richard Florida, “The Conservative States of America,” The Atlantic, retrieved March 30, 2011 from www.theatlantic.com/politics/ archive/2011/03/the-conservative-states-of-america/71827/.

83 “The Global Crisis and the Poor,” The Economist (March 14, 2009): 62–64.

84 “Democracy? Hu Needs It,” The Economist (June 28, 2007): 44; “A Warning for Reformers,” The Economist (November 17, 2007): 67.

85 “‘I am a True Democrat:’ G-8 Interview with Vladimir Putin,” Spiegel Online, retrieved June 4, 2007 from www.spiegel.de/international/ world/0,1518,486345,00.html.

86 “Brazil’s President Lula Says G7 Nations No Longer Speak for the World,” The Telegraph (March 16, 2009): A-1.

87 Roger Cohen, November 11, 2006. “China vs. U.S.: Democracy Confronts Harmony. Stay Tuned.” New York Times, retrieved February 7, 2011 from select.nytimes.com/iht/2006/11/22/world/IHT- 22globalist.html.

88 “Freedom in the World-2011,” 48-49.

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89 “Military budget of the United States,” Wikipedia, retrieved January 15, 2013 from en.wikipedia.org/wiki/Military_budget_of_the_United_ States; “Military spending: Defence costs,” The Economist, retrieved June 8, 2011 from www.economist.com/blogs/dailychart/2011/06/ military-spending.

90 James Mann, The China Fantasy: Why Capitalism Will Not Bring Democracy to China, (London: Penguin 2007); Eamonn Fingleton, In the Jaws of the Dragon: America’s Fate in the Coming Era of Chinese Hegemony (New York: Thomas Dunne Books, 2008); Martin Jacques, When China Rules the World: The End of the Western World and the Birth of a New Global Order (London: Penguin Press, 2009); Stefan Halper, The Beijing Consensus: How China’s Authoritarian Model Will Dominate the Twenty-First Century (New York: Basic Books, 2010).

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95 Matteo Cervellati, Piergiuseppe Fortunato, and Uwe Sunde, “Democratization and Civil Liberties: The Role of Violence during the Transition,” IZA DP No. 5555 (March 2011).

96 Hassan Fattah, “Democracy in the Arab World, a U.S. Goal, Falters,” New York Times (April 10, 2006): C-1.

97 Samuel Huntington, The Clash of Civilizations and the Remaking of World Order (New York: Simon & Schuster, 1996); Huntington, Who Are We? The Challenges to America’s National Identity (New York: Simon & Schuster, 2004).

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108 “Science: Getting in the Mood,” The Economist: The World in 2012, (November 17, 2012):152.

109 Andrew Martin, “Turning Point for Suits over Chinese Drywall,” The New York Times, (October 12, 2012): A-7.

110 For example, consider the legal concept of due diligence, which requires that the statements in a firm’s security-registration forms be true and omit no material facts. Companies rely on due diligence to manage the risk of cross-border acquisitions; it enacts a legally bind- ing process during which a potential buyer, say an Indian software designer, evaluates the assets and liabilities of a potential acquisition in say, Germany. Hence, due diligence is often the difference between success and failure—provided the local legal codes permit the full examination of operations and management and the verification of material facts. In the European Union, data protection rules can interfere with assessing important elements of a potential acquisi- tion, such as managers’ physical or mental health, patterns of trade union membership, and criminal histories. Hence, prudent companies considering cross-border acquisitions pinpoint issues, the country or countries involved, and the citizenship and identity of people involved from the pre-due-diligence phase to the close of the deal. These decisions inevitably reference aspects of constitutional law, (i.e., what philosophies anchor ownership rights?), criminal law, (i.e., what are the procedures and penalties for malfeasance?), and civil/com- mercial law, (i.e., do regulations promote disclosure and verification of information?). Similar situations arise with respect to discovery and with other aspects of the legal process. With respect to discovery, for example, language, culture, volume, and local law influence the right to demand documents relative to the case from the other party; “Translating and the law: Legal language,” The Economist, (November 10, 2012): 66.

111 “Russia: The Long Life of Homo Sovieticus.” The Economist” (December 10, 2011): 27-30.

112 “Russian Politics: Fear and Loathing,” The Economist, (September 22, 2012): 60.

113 See Juriglobe World Legal Systems, www.juriglobe.ca/eng/. 114 Stare Decisis: Latin, “to stand by that which is decided.” 115 Denis Wiechman, Jerry Kendall, and Mohammad Azarian, “Islamic

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116 Andorra and the Guernsey and Jersey Islands, both of which belong to the United Kingdom, apply customary law only. The codification of civil law developed out of legal customs that evolved in particular communities and, over time, were collected and recorded by local jurists.

117 “A Disorderly Heaven,” The Economist (March 20, 2004): 75. 118 “Russian Politics: Fear and Loathing,” The Economist. 119 Ian Morris, Why the West Rules . . . For Now (New York: Farrar, Strauss

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123 “Rule of Law Index,” World Justice Project,” retrieved February 8, 2011 from worldjusticeproject.org/rule-of-law-index.

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176 PART 2 National Environmental Differences

124 Paul Collier, Wars, Guns, and Votes: Democracy in Dangerous Places (New York: HarperCollins, 2009).

125 Hernando De Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (Basic Books, 2000).

126 See profile of the World Justice Project, reported in “The Paper Chase,” The Economist, (June 25, 2011): 40.

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129 “Big US Firms Shift Hiring Abroad,” Wall Street Journal (April 19, 2011): B1.

130 Louise Arbour, “The Rule of Law,” New York Times (September 26, 2012): A-8; “Economics and the Rule of Law: Order in the Jungle,” The Economist (March 13, 2008): 43-48.

131 Tom Friedman, “Our One-Party Democracy,” New York Times, (September 8, 2009): A-8.

132 David Barstow and Alejandra Xanic Von Bertrab, “How Wal-Mart Used Payoffs to Get Its Way in Mexico” NYTimes.com, retrieved April 15, 2013 from ww.nytimes.com/2012/12/18/business/walmart-bribes- teotihuacan.html?pagewanted=all&_r=0.

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135 A contract is a binding legal agreement that formalizes promises between parties, the breach of which triggers legal action.

136 “Reform in Mexico: Labour pains,” The Economist, (November 3, 2012): 37.

137 “Economics Focus: The Himalayas of Hiring,” The Economist (August 7, 2010): 76.

138 “Improving the Investment Climate in India,” South Asia Region and Investment Climate Unit,” World Bank, Washington DC, 2005; Laura Alfaro and Anusha Chari, “India Transformed? Insights from the Firm Level 1988-2005,” Harvard Business School, Working Paper 10-030, 2009.

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141 “Brazil’s Trade Policy: Seeking Protection,” The Economist, (January 14, 2012):35.

142 Duncan Fairgrieve and Geraint Howells, “Is Product Liability Still a Global Problem?” Managerial Law 49:1/2 (2007): 6–9.

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164 Items commonly counterfeited include books, printer cartridges, music CDs, brake pads, DVDs, aircraft parts, cigarettes, wristwatches, razor blades, batteries, medicine, motorcycles, handbags, jewelry, automobiles, shampoo, pens, toys, wine, shoes, clothing, luggage, foods, beer, perfume, cleaning supplies, pharmaceuticals, and health- care supplies.

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166 “Homepage | International Anti-Counterfeiting Coalition,” retrieved February 14, 2011 from www.iacc.org/ ASIS International data reported in “Intellectual Property: Can You Keep a Secret?,” The Economist, (March 16, 2013):67.

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CHAPTER 3 Governmental and Legal Systems 177

168 Ibid. 169 William Booth, “Drug Cartels Muscle into Piracy Business,” The

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171 Owen Fletcher and Jason Dean, “Ballmer Decries Huge China Sales Holes,” Wall Street Journal, (May 27, 2011): A-1.

172 Ibid, Quote by Jonathan Erece, a trade enforcement coordinator for United States Protection.

173 “Fake Pharmaceuticals: Bad Medicine,” The Economist, (October 13, 2012): 74.

174 “Fake drugs: Poison Pills,” The Economist, retrieved February 14, 2011 from www.economist.com/node/16943895?story_id=16943895.

175 Ibid. 176 Benoit Godart, “IP Crime: The New Face of Organized Crime,” Journal

of Intellectual Property Law & Practice, retrieved February 14, 2011 from iplp.oxfordjournals.org/content/5/5/378.full.

177 “SPECIAL 301 Report, Office of the United States Trade Representative,” retrieved February 24, 2013 from www.ustr.gov/about-us/press-office/ press-releases/archives/2007/april/special-301-report.

178 “Fake Pharmaceuticals: Bad Medicine,” The Economist, (October 13, 2012): 74.

179 “Software Piracy Takes Toll on Global Scale,” Hack in the Box: Keeping Knowledge Free, retrieved April 23, 2011 from www.hackinthebox.net/ modules.php?op=modload&name=News&file=article&sid=2951.

180 “Microsoft Says Software Piracy Continues to Grow,” TG Daily, retrieved February 14, 2011 from www.tgdaily.com/hardware- brief/13603-microsoft-says-software-piracy-continues-to-grow.

181 View of Mr. Orhii reported in “Fake Pharmaceuticals: Bad Medicine,” The Economist (October 13, 2012): 74.

182 Microsoft Says Software Piracy Continues To Grow,” TG Daily. 183 “Business in China and the West: A Tale of Two Expats,” The Economist

(December 29, 2010):73. 184 “Business Software Alliance - Global Software Piracy Study,” retrieved

February 16, 2013 from portal.bsa.org/globalpiracy2011/index.html.

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