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Political Instability

Discuss about the Foundations of Global Corporate Success.

Due to increasing rate of globalization and technological advancements, commercial activities like foreign direct investments (FDI), emergence of multinational companies (MNC), and joint international ventures (JIV) as well as strategic alliances have been moving on upward trajectory. Globalization has improved interaction and foreign trade across many countries. However, a number of factors have slowed down foreign business activities. These factors are broadly compartmentalized into two: formal and informal systems. Formal systems include factors like political systems, economic systems, and legal systems and informal system, while informal system encompass cultural, social, and linguistic aspects. This paper analyses the risks, costs, and uncertainties that these factors impose towards undertaking foreign business activities.

There has been increasing academic concern on the relationship between international business and political environment. One of the most fundamental issues in this context is the type of the political risks that may hamper foreign investment. In most instances, when political risk depicts government interference with market operations. According to Ghosh (2015), political risk emanates from the government’s action to prevent or interfere with the business transactions by either changing the terms of agreement or confiscating partially of or the foreign owned business assets. Farnell and Crookes (2016) define political risk as “government or sovereign interference with the business operations.” Some scholars equate political backlash with the environmental aspects like direct violence, instability, and competition (Cavusgil et al., 2017). Ghosh (2015) identifies the dynamic feature of political environment but contends that progressive and gradual changes that are unexpected do not define the political risk. However, political uncertainties affect the business in terms of transfer— technology, people, payments, and capital uncertainties; operational— business regulation uncertainties; and control— uncertainties concerning policies that relates to the management control (Kaur and Sandhu, 2013). Operational and transfer uncertainties flow from the political-economic events to ownership-control events.

According to Ma et al (2013), political activities have great influence on the economic activities of a country, and as such, a shift in regime may dramatically transform the economy socialism to capitalism. Similarly, power concerns affect the economic policies that a country adopts. For a regime that has been installed through coup may adopt radical socialism that strip all foreign-owned companies their assets. Political expropriations may also be in form of inclusion of forceful renegotiation of contracts with public enterprises, violating the agreement on tax benefits, revisiting business regulatory rules to the detriment of the private investors, and nationalization of private assets without redress (Immarino and McCain, 2013). Uncertainty about the regime change may affect the value of the business expected returns and influence their variations. Political systems have great influence the investment strategy.

Conflicts between Host Countries and Other Countries

Countries that experience consistent political instabilities are prone to political violence and have quintessentially weak institutions. In such scenarios, the investment decisions are underpinned on the risk of asset destruction, sporadic changes in the domestic demand, and the poor infrastructure. In addition, countries that undergo political conflicts tend to have slow economic growth and low income per capita. Political instability may also result to destruction of properties and looting. In most times, political unrest culminates to the state of anarchy, which is another factor inhibits foreign investment. Political instability is the reason why most developed and emerging economies do not want to invest in countries like Somalia, Syria, and Pakistan. This is because there is more risk involved in such countries compared to the politically stable countries like China (Wild and Wild, 2018).

Like the internal conflicts, border disputes can result to a reduction in capital inflow and capital outflow, thereby blighting FDI. Conducting a business along tumultuous zones may expose the firm to high risks of asset destruction and staff insecurity. Conflict among the countries materially reduces the demand for business products (Wild and Wild, 2018). For instance, the border conflict between Russia and Ukraine over Crimea has plummeted FDI in Ukraine “from $4.5 billion in 2013 to $410 million in 2014” (Vox Ukraine, 2017)

There are four distinct types of the economic systems: traditional economy, market economy, command economy, and the mixed economy (Immarino and McCann, 2013). A command economy is an economic system where coordination of economic activities operates under direct control, directive, and regulations of the administrative systems. The economic activities are considered significant to the complex social systems that they cannot be left to operate under the context of the free market. Under this economic system, the economic agents, especially in the production organizations, take orders from high ranks within the authority in the political hierarchy. Therefore, the authorities directly undertake the firm activities, resource employment, production output, management of disturbances, and their coordination.

Essentially, the central government sets the firm production targets. Some of the activities that government regulation encompasses include price levels, budgetary control and allocation, material balance, and technical coefficients. According to White and White (2016), this kind of command authority may collide with market forces in crucial sectors of the economy hence manipulating the political direction. Some of the countries whose economies are inherently command system include Russia, China, and North Korea.

Types of Economic Systems

On the other hand, traditional economy is the type of economy in which “customs, traditions and believes prescribe the principles of economic organization for production of goods and services is built up around traditions, according to which a particular society lives” (Ghosh, 2015). Technology and other innovations are discouraged to enable the traditional systems that have been embedded on the economic systems over the years to remain. Most countries that adopt this system of the economy are usually agricultural-dependent and rural-based. The economy is quintessentially subsistence characterized by barter trade. Economic activities are rarely commercial, and is dominated by activities like hunting and gathering, cultivations, small-scale fishing, without any modern form of technology.

Verbeke (2013) attests the amount surplus produced under the traditional economy is very little. The traditional system of economy is popular in the developing countries and the emerging markets, particularly among the aboriginal population. Another feature of such economy is that the families train their children concerning the traditional customs about resource allocation in the community. Underdeveloped parts of Africa, Asia, and South America still apply this system of the economy. One of the merit of this kind of economy is that it encourages inclusivity. Every person has a specified role to undertake in the growth of the economy, hence strengthening social bonds. Another benefit is that the n basic needs are met. The kind of life in this system appreciates basic items instead of the luxury lifestyle. However, this type of the economy is rigid to change and inhibits high standards of living.

Market economy refers to the type of economic system where forces of market demand and supply inherently controls the economic activities (Verbeke, 2013). This means that there is no government intervention or regulation. The state only offers security to buyers and sellers by protecting their individual lives and property against criminals. An absolute free market economy involves full ownership of the resources by individuals. Similarly, individuals without government involvement undertake the decisions of the market. Ideally, producer produces the amount the like and sets prices for their products. Owners of factors of production also have the discretion on what to pay the employees. However, such decisions are implicitly under the market demand and supply forces, which is inbuilt. The market forces determine how much the producer will produce and for how much the producer will sell. The economic decisions in the market economy vest on the buyers and the sellers. The market economy promotes competition, which enhances efficient use of the economic resources (Beugelsdijk and Mudambi, 2013).


In the mixed economic system, the government undertakes part of planning and production activities while private enterprises control some of the production activities (Beugelsdijk and Mudambi, 2013). Most importantly, the public systems operate in a coordinated fashion to ensure that there is partly free and partly centralized. Usually, the government undertakes the investment activities that involves huge capital outlay and are unattractive to the private investors due to the low profit margin and high degree of the risks are involved. Examples of such investments include electricity, provision of water and health services. Mixed economy has both characteristics of command and market economy.

The economy is compartmentalized into four sectors: private sector, which owns and controls resources; the public sector, which engages in production of essential goods and services. Joint sector is where the private sectors collaborate with the public sector to undertake economic activities and in the cooperative sector, small-scale producers collaborate in production activities to achieve the economies of scale (Beugelsdijk and Mudambi, 2013). Another fundamental feature of the mixed economy is the maximum social wellbeing. The mixed economy system has regulations to ensure that the private sectors engage in the production activities in a sustainable manner. Therefore, the government can impose quotas, tariffs, and labour laws to promote sustainability and social welfare. The government also ensure that there is equal distribution of wealth through taxation and investment models. Similarly, while the market forces of demand and supply determines the prices, they are also under government control. The government may establish price ceiling, fix price, or impose value added tax to control the consumption of certain products. 

The economic system that mostly favours doing business is the mixed economy (Wild and Wild, 2018). The traditional system may be detrimental to foreign investment since the inhabitants are rigid to change. On the other hand, the command system encourages state regulation, which may stifle completion and eventually affect the growth and the profitability of the business. The free market economy encourages competition, specialization, but it is prone to civil unrest and market failure, which may hamper business operations. Due uncertainties that characterize command economy, countries like Russia have experienced decline in inward FDI (Wild and Wild, 2018). However, socialist economies are marked political instability due to one-party state factor. For instance, the FDI in Vietnam registered a 96% increase in the number of FDI projects, from $5075 billion in 2015 to $18103 billion in 2016 (Hanh et al., 2017). The economic system has been favourable hence attracting MNC like Toyota, Unilever, and Canon.

Legal systems can affect the foreign investment by influencing the investors’ perception on the returns and the risks involved in an investment. Laws that are designed to raise investment cost my may discourage the foreign investors and make the remaining part to raise their demands on the return investment. The main transaction cost to foreign investment, according to Cantwell (2014), is the uncertainty risk about the commercial and legal structures, as well as the risks of breaching intellectual property laws. However, Yu et al (2013) argue that there is no need of stronger intellectual property laws when the business is operating in countries that do have the capacity to invest in technology and contravene the intangible asset laws. Other legal risks include labour laws and taxation policies. Peng and Meyer (2016) observe that absence of international legislative framework that can address such policy issues may impose a huge risk to the foreign business. Without adequate intergovernmental operations to establish mechanisms and principles that guide business operations between the two countries, investors may be exposed to legal risks and uncertainties. To reduce such risks, it is imperative that the countries implant international legal systems to promote familiarity with the foreign country’s legal system.


Another legal risk that international businesses may face is difficulty in optimum connections to address unique challenges that the international business operation presents. Farnell and Crookes (2016) observe that foreign investors may be exposed to demarcation problems when in matters of defining obligations and rights. One of the main difference between the international and domestic transactions is the existence of broader range of parties in legal relationships. Demarcation problems may spawn overlapping problems and other disputing issues. More often, contractual relationships applies to international transactions, for instance buyer and seller contract, carriage contract, insurance contract, buyer and bank contract, as well as bank and the buyer contract. Such system of transaction explicitly discourages international business firms.

In addition, money transfer across different countries usually involves legal process that blends local laws with the international arrangements. Specialized contract policies define the obligations and rights of the payee, payer, and banks facilitating the transactions. Some of the regulatory concerns that emerge are general fraud, fund misappropriation, security systems, and confidentiality issues (Cantwell, 2014). The nature of the transaction also demands that the legal systems ride in the same pace with finance and trade institutions.

Some of the aforementioned issues replicate in foreign direct investment system. Some of the legal systems give the state full control over the production firms hence making foreign investment difficult, particularly in countries that embrace “customary international laws.” in similar vein, countries that operates under command economy stipulates that the government will control the foreign businesses, which may clash with the local host laws (Ghosh, 2015). Some countries may also impose restriction requirements to protect the local enterprises. Some of such restrictions include like performance requirements, which stipulates the specifications that a company must meet to join a particular sector of production; licencing requirements, majorly administrative verification; operational requirements, and joint venture requirements, which insists on inclusion of local capital in the foreign production process (.Ghosh, 2015)

Culture refers to  “a set of shared values, assumptions and beliefs that are  learnt  through  membership  in  a  group,  and  that  influence  the  attitudes  and  behaviours  of  group  members” (Vadi, 2011) Multinational companies or businesses that engage in the direct foreign investment must observe foreign differences to succeed in a foreign environment. Failure to observe cultural differences can be detrimental to business in terms of strained relationships, poor performance, and reputation vitiation. According to White (2016), it is imperative for businesses that want to invest in foreign countries to understand how culture materializes as well as how cultural differences influence commercial activities globally. Ideally, culture is multifaceted phenomenon and exits at different categories like occupational groups, business units, organizations, industries, and geographical units. Therefore, a firm must consider all these factors before it embarks on the foreign investment.

Beugelsdijk and Mudambi (2013) observe that national cultural diversity has remain consistent over time. In another nuanced study, Ghosh (2015) asserts that there is existential resilience of cultural standards even after occurrences like immigration, globalization, technological advancements, formal education, and cross-cultural activities like games. Most Cultures like United States, Canada, and Australia vests on universal commitments, for example upholding integrity, while most cultures in the Russia, China, and North Korea emphasizes on loyalty to relationships and people. The resilience of culture values across different countries is significant to MNC that face numerous national cultures in their operations. This means that operation across the borders presents substantial complexities since it compels the multinational companies to redesign their ethics and standards in accordance with the cultural milieu that they operate. To be effective in its operation, the business must incur knowledge cost on the locals’ behaviour and understand their cultural mechanisms. To mitigate cultural uncertainties, MNC like KFC, Coca-Cola, and Unilever have been employing employees from the host countries (Ghosh, 2015)

In social norms, the individualism and collectivism is the main hurdle for the MNC. Individualism social system puts more weight on the personal preference rather than the whole community or a group. Most countries that embrace individualism like the one the United States and United Kingdom have quintessentially lose structures that emphasize on the individual rights, independence, and personal achievements and initiatives. On the other hand, collectivism social systems, like in China and North Korea, distinctions are based on the community or group fashion, and community interest comes first at the expense of individual’s interest (Beugelsdijk and Mudambi, 2013). Like in the case of cultural differences, the MNC must incur knowledge cost and uncertainty risk to operate in in a socially different setup. Asian countries like China, Singapore, Korea, and Taiwan accounts for 70% of FDI in Taiwan because their social systems are almost similar (Hanh et al., 2017) 

Linguistic distance is also one of the major uncertainty risk that MNC are likely to face. For instance, when investing in Venezuela, business executives must ensure that the staffs are multicultural competent (Yu et al., 2013). This may require additional training, which is costly. In addition, due to language barriers, the business must incur knowledge cost, information asymmetry, and moral hazard cost. For business to be effectual in its operation, it must liaise with national commercial and international agencies within that country. The business must also work closely with the local inhabitants since they understand the environment better. To invest in East Africa, MNC like Unilever and Coca-Cola have to ensure that their employees are well conversant with English and Swahili languages (Ghosh, 2015)

Conclusion

Based on the aforementioned and discussed formal and informal systems, it is evident that undertaking a foreign business presents multidimensional kind of risks. Therefore, businesses that seek to invest into international markets should consider political systems, economic systems, legal systems, as well as sociocultural and language aspects before designing a strategic plan.

References

Beugelsdijk, S., & Mudambi, R. (2013). MNEs as Border-Crossing Multi-location Enterprises: The role of Discontinuities in Geographic Space. Journal of International Business Studies, 44(5), 413-426. doi:10.1057/jibs.2013.23

Cantwell, J. (2014). Location of International Business Activities: Integrating Ideas from Research in International Business, Strategic Management and Economic Geography. (Location of international business activities.) Basingstoke [u.a.: Palgrave Macmillan.

Cavusgil, S. T., Knight, G. A., & Riesenberger, J. R. (2017). International business: The New Realities. Pearson Prentice Hall.

Farnell, J., & Crookes, P. I. (2016). A New Economic Relationship in a Changing World. The Politics of EU-China Economic Relations, 3-15. doi:10.1057/978-1-137-48874-9_1

Ghosh, A. (2015). Dynamic Systems for Everyone: Understanding How Our World Works. (Dynamic systems for everyone.) Cham: Springer.

Hanh, N. P., Van Hùng, ?., Hoat, N. T., & Trang, D. T. (2017). Improving Quality of Foreign Direct Investment Attraction in Vietnam. International Journal of Quality Innovation, 3(1). doi:10.1186/s40887-017-0016-7

Henisz, W. J., Mansfield, E. D., & Von Glinow, M. A. (2010). Conflict, Security, and Political Risk: International Business in Challenging Times. Journal of International Business Studies, 41(5), 759-764. doi:10.1057/jibs.2010.11

Iammarino, S., & McCann, P. (2013). Multinationals and Economic Geography: Location, technology and Innovation.

Kaur, S., & Sandhu, M. S. (2013). Internationalisation of Born global firms: Evidence from Malaysia. Journal of the Asia Pacific Economy, 19(1), 101-136. doi:10.1080/13547860.2013.818426

Ma, X., Delios, A., & Lau, C. (2013). Beijing or Shanghai? The Strategic Location Choice of Large MNEs’ Host-country Headquarters in China. Journal of International Business Studies, 44(9), 953-961. doi:10.1057/jibs.2013.49

Peng, M., & Meyer, K. (2016). International Business EMEA. London: South Western: Cengage Learning.

Vadi, V. (2011). When cultures collide:Cultural Heritage and Foreign Direct Investment. Cultural Heritage in International Investment Law and Arbitration, 87-92. doi:10.1017/cbo9781139828598.016

Verbeke, A. (2013). International Business Strategy: Rethinking the Foundations of Global Corporate Success. Cambridge: Cambridge University Press.

Vox Ukraine. (2017, February 7). Foreign Direct Investment in Ukraine: War and Peace. Retrieved from https://voxukraine.org/en/investments-in-ukraine-en/

White, R. (2016). Cultural Differences and Economic Globalization: Effects on trade, Foreign Direct Investment, and Migration. Abingdon: Oxon ; New York, NY.

Wild, J. J., & Wild, K. L. (2018). International business: The Challenges of Globalization.

Yu, T., Subramaniam, M., & Cannella Jr, A. A. (2013). Competing Globally, Allying Locally: Alliances between Global rivals and Host-country Factors. Journal of International Business Studies, 44(2), 117-137. doi:10.1057/jibs.2012.37

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