Politico-Legal Environment in International Business

Besides national and international trade rules, the political and legal environment also has
an important role in international business. A company must consider both home and host
country’s political and legal conditions to operate successfully abroad.

8.1 Concept of Political Environment

8.1.1 Political Diversity and Political Similarity

●​ The political situation in a country results from the influence of different interest
groups like households, firms, politicians, and bureaucrats.​

●​ The stronger the group, the more its ideas shape the country’s politics.​

●​ In federal countries, different states may have different political views at the same
time.​

●​ The central government’s political scene may also change with a shift in dominant
groups.​

●​ On the other hand, some countries share similar political ideologies due to common
ethnicity, language, or religion.​

●​ Example: Serbs from nearby regions united under a political idea called Greater
Serbia.​

●​ Therefore, political environments show both diversity (differences within or between

countries) and similarity (common ideologies across countries).​

Democracy Versus Totalitarianism

Political systems range between two extremes: democracy and totalitarianism.

Democracy

●​ In democracy, citizens are involved in policy making.​

●​ Based on the idea: “of the people, for the people, by the people.”​

●​ In early democracy (like ancient Greece), all citizens participated directly.​

●​ Over time, direct involvement became difficult, leading to representative

democracy, where elected leaders make decisions.​

●​ People enjoy freedoms and civil rights.​

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 ●​ Two main types:​

1.​ Parliamentary democracy – influenced by many interest groups.​

2.​ Presidential democracy – more centralized, with an elected head of

government.​

Totalitarianism

●​ Power is held by one person or group, with no opposition.​

●​ Citizens have no constitutional rights.​

●​ Policies are controlled by rulers.​

●​ Examples: Hitler’s Germany, Stalin’s USSR; today’s Cambodia, China, Cuba, DR

Congo, Myanmar.​

Forms of Totalitarianism:

1.​ Secular Totalitarianism​

○​ Based on military or bureaucratic control.​

○​ Communism: State controls economy and politics (e.g., former East

European countries).​

○​ Tribal Rule: One ethnic group dominates (e.g., Kenya, Rwanda).​

2.​ Theocratic Totalitarianism​

○​ Religious leaders rule (e.g., Iran, Taliban-led parts of Afghanistan).​

Mixed Political Systems

●​ Pure democracy or totalitarianism rarely exists.​

●​ Most countries have a mix of both systems.​

●​ Example:​

○​ UK and USA: Democratic but may take restrictive decisions.​

○​ China: Totalitarian in structure but allows free foreign investment in special

zones.​

●​ More democracy in the mix = more political freedom.​

●​ More totalitarianism = less freedom.​

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Country Classifications by Freedom (Karatnycky, 1995)
●​ Free countries: Australia, Canada, Belgium, Chile, etc.​

●​ Partly free countries: Brazil, Cambodia, Burkina Faso, etc.​

●​ Not free countries: China, North Korea, Algeria, Nigeria, etc.​

Home Country Perspective

●​ Companies prefer countries with stable political and simple legal systems, but the
home country’s environment also influences international business decisions.​

Supportive Environment

●​ Home governments may promote international business by:​

○​ Giving incentives.​

○​ Easing procedures.​

○​ Encouraging exports.​

●​ Example: Indian government policies support Indian firms in going global.​

Restrictive Environment

●​ The home country may also create barriers to international business.​

Embargo

●​ Embargo means a complete ban on trade with a particular country.​

●​ It is a political move meant to force peace or discipline.​

●​ Example: Many embargoes were placed between 1971 and 1983.​

Sanctions

●​ Sanctions are limited restrictions (not as broad as embargoes).​

●​ They may block trade finance, advanced technology exports, etc.​

●​ Both sanctions and embargoes negatively affect trade.​

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Other Export Restrictions

●​ Some products are placed on a prohibited or restricted export list, often for
national security.​

●​ What counts as “security-sensitive” differs by country.​

○​ Example: Germany sees Patriot missile parts as exportable; others may not.​

Business Restrictions Beyond Trade

●​ Anti-trust laws may stop firms from expanding abroad if it reduces competition.​

●​ Some home countries ban bribery by their firms in foreign countries, affecting deals
where bribery is common.​

●​ Environmental laws may stop companies from operating in countries with weaker
environmental protections.​

○​ Example: US firms may be restricted from working in Brazil due to rainforest

cutting.​

Host Country Perspective

●​ Firms know their home country environment but may be unfamiliar with different
host countries' political and legal conditions.​

●​ This creates political risk in international business.​

●​ Studying the host country's environment is mainly about evaluating and managing
political risk.​

Meaning and Definition of Political Risk

Definition:​
Political risk refers to the sudden and unanticipated changes in the political setup of the
host country that cause unexpected disruptions in the business environment and affect a
company's performance. (Thunell, 1977)

●​ Example:​

○​ If a rightist party comes to power → policies become liberal → positive for

MNCs.​

○​ If a leftist party comes to power → restrictive policies → negative for MNCs.​

●​ MNCs are more concerned with the negative effects of political risk.​

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Broad Forms of Political Risk
Earlier, political risk mainly meant expropriation. Now, it includes:

●​ Ethnic, racial, religious, or civil strife​

●​ Political corruption​

●​ Blackmail​

Types of Political Risk

Czinkota’s Classification (1999):

1.​ Ownership Risk – Threat to company property and life.​

2.​ Operating Risk – Government interference in business operations.​

3.​ Transfer Risk – Difficulty in transferring funds across countries.​

Kobrin’s Classification (1982):

1.​ Macro Risk (Country-specific) – Affects all foreign firms in a country.​

○​ Expropriation, ethnic conflict, currency inconvertibility, debt refusal​

2.​ Micro Risk (Firm-specific) – Affects a specific firm or industry.​

○​ Conflict with host government’s goals or corruption in business dealings.​

Host Country Perspective – Political Risk (Simplified Notes)

Macro Political Risk

●​ Affects all foreign companies in a country.​

●​ Caused by:​

○​ Government taking over assets (expropriation)​

○​ Civil or ethnic conflicts​

○​ Currency issues​

○​ Non-payment of debts​

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Micro Political Risk

●​ Affects specific companies or industries.​

●​ Caused by:​

○​ Conflict between company goals and host government policies​

○​ Corruption in host country​

🔹 Expropriation and Confiscation (Simplified Notes)

Definition:

●​ Expropriation is when the government takes over (seizes) private property owned
by a foreign company. If the government gives payment for the seized property, it is
called expropriation. If no payment is given, it is called confiscation. Although
international law says compensation must be paid, the process is usually long and
complicated. Companies want full value for future profits, but governments often pay
less, based on older book value. Expropriation usually happens due to political
reasons like a change in government or ideology. For example, after communism
took over in China and Eastern Europe, many private businesses were nationalized.
Sometimes, economic reasons also cause expropriation—like in Sweden, where the
ship-building industry was taken over during a recession.

✅ Summary Box:
Term Meaning Compensation?

Expropriation Govt. takeover of

private
✅ Yes
property

Confiscation Govt. takeover

without legal
❌ No
payment

🔷📘Currency Inconvertibility​
Currency inconvertibility means when a government restricts the conversion of its

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🔹
local currency into foreign currency or blocks the transfer of money out of the country.
This happens when the host government passes laws that prohibit foreign

the host country's currency for other currencies. 💰

companies from taking their money or profits abroad or prevent them from exchanging

📊 It is a financial form of political risk.

The reasons for such actions are both economic—such as solving balance of

political change. 📍
payments problems—and political, which can arise due to internal instability or drastic
For example, the Government of Nigeria had imposed such currency
restrictions in the past to fulfill its economic and political objectives.

🔷📘3.Definition:
Credit Risk​
Credit risk arises when a country refuses to honor financial contracts or
repay debt owed to foreign companies or lenders.

✨Credit
Meaning:​

🔹 risk occurs when the host country:​

🔹 Breaks a financial agreement made with foreign entities.

Refuses to pay back loans or dues to foreign companies.​

📊 Type: Financial form of political risk.

🌀💰Reasons:​
🛑 Economic – Example: Mexico declared inability to repay its debt in the 1980s.​
Political – Example: After Khomeini came to power in Iran, the government refused to
repay loans, stating they were taken during the Shah’s regime.

3. Risk from Ethnic, Religious, or Civil Strife:​

Definition: This is a macro political risk that arises due to violence, war, and internal
conflicts like racial, ethnic, religious, or civil unrest.​
Examples:

●​ Slaughter in Bosnia and Herzegovina​

●​ Breakdown of authority in Somalia and Rwanda​

●​ Rise of Islamic fundamentalism in Algeria and Egypt​

These conditions create major risks for MNCs operating in such countries.​

4. Conflict of Interest:​
Definition: This is a micro political risk arising from the difference in goals between
MNCs and the host government.

●​ MNCs focus on maximizing corporate wealth.​

●​ Host governments focus on economic and social welfare.​

Causes of Conflict:​

●​ MNCs may transfer funds affecting money supply, leading to inflation or deflation.​

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 ●​ Use of transfer pricing may reduce tax revenue.​

●​ High royalty payments may worsen balance of payments.​

●​ Non-economic conflicts may also occur, e.g., for national security.​

Example:​

●​ U.S. government blocked Japanese purchase of Fairchild Industries due to

national security.​

5. Corruption:​
Definition: Corruption in host countries causes problems for MNCs by increasing costs
and complications.​
Examples:

●​ In Cambodia, bureaucrats created obstacles for foreign firms.​

●​ In Kenya, foreign companies had to sell equity to local politicians.​

Fact:​

●​ Transparency International ranks 85 countries on Corruption Perception Index.​

●​ In 1999, 34 OECD and 5 other countries signed a convention to ban bribery in

international business.​

Evaluation of Political Risk

Definition:​
Before entering a foreign market, a firm must assess the level of political risk.

●​ If risk is high → firm may avoid operating in that country.​

●​ If risk is moderate/low → firm may operate with a risk management strategy.​

●​ To build any strategy, risk must be assessed either qualitatively or quantitatively.​

1. Qualitative Approach​
Definition: This approach uses inter-personal contact, expert judgment, and analysis of
events to assess political risk.

Sources of Insight:

●​ Internal: Employees posted in the foreign country.​

●​ External:​

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 ○​ Academic experts​

○​ Government foreign offices​

○​ Journalists or correspondents​

○​ Specialized consultants​

Example:

●​ Gulf Oil hired experts from government and universities to assess investment
safety in Angola—turned out successful even under a Marxist regime.​

Methods Used:

●​ On-the-spot study by a team (after initial positive review)​

●​ Examination of secondary data (historical and trend analysis)​

●​ Future risks are forecasted from past trends (Kramer, 1981).​

Special Practice:

●​ Some firms, like Exxon, create exclusive risk analysis divisions.​

●​ Build relations with local influence groups (e.g., politicians, unions, military).​

2. Quantitative Approach
Definition:​
Quantitative models use statistical tools, formulas, variables, and indexes to measure
political risk numerically. These methods aim to predict political instability and its effects on
investment.

1. Primary Risk Investment Screening Matrix (American Can)

●​ Uses around 200 variables, reduced to 2 indexes:​

○​ Index of economic viability​

○​ Index of political stability​

●​ Variables include:​

○​ Frequency of government changes​

○​ Level of violence​

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 ○​ Armed conflicts​

○​ International disputes​

○​ Inflation rate, external deficits, growth rate​

2. Decision Tree Method (Robert Stobaugh, 1969)

●​ Analyzes probability of nationalization step-by-step​

●​ Considers various event branches with assigned probabilities​

●​ Example:​

○​ Govt change = 50%,​

○​ Nationalisation = 40%,​

○​ Inadequate compensation = 40%​

○​ Final probability = 0.5 × 0.4 × 0.4 = 0.08​

3. National Propensity to Expropriate (Harald Knudsen, 1974)

●​ Uses measurable variables like:​

○​ Urbanisation​

○​ Literacy rate​

○​ Labour unionism​

○​ Natural resource endowment​

○​ Infant survival rate, calorie intake​

○​ Civic amenities access, per capita GNP​

●​ Successfully predicted nationalisation in Latin America​

4. Risk Rating Scale (Haner, 1979)

●​ Rates political risk on a scale of 0–7 for each factor​

●​ Internal Factors:​

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 ○​ Political and social fractionalisation​

○​ Use of force to retain power​

○​ Xenophobia​

○​ Socio-economic conditions​

○​ Radical left strength​

●​ External Factors:​

○​ Dependence on hostile power​

○​ Negative regional influences​

●​ Scoring Interpretation:​

○​ ≤19 → Minimal risk​

○​ 20–34 → Acceptable risk​

○​ 35–44 → Very high risk​

○​ 44 → Not advisable to invest​

​

5. Euromoney Risk Rating (1993)

●​ Uses 3 indicators with weighted scores:​

○​ Economic (40%): Debt service ratio, current account deficit, external debt​

○​ Credit (20%): Debt service record, ease of rescheduling​

○​ Market (40%): Bond market access, sell-down of short-term papers, forfeiting

access​

●​ Countries are ranked:​

○​ Highest score = least risk​

○​ Lowest score = most risk​

○​ Formula: Weighted proportional scoring​

6. Early Warning System (Simon, 1982)

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 ●​ Predictive method using lead indicators​

●​ E.g., Protests and riots may signal regime overthrow​

●​ Can be country-specific or industry-specific​

●​ Helps management take preventive actions​

8.3.3 Management of Political Risk

Two Main Approaches (Gregory, 1989)

1.​ Defensive Approach​

○​ Aim: Protect the firm by reducing dependence on the host country​

○​ Measures:​

■​ Borrow from host country​

■​ Get host government guarantees​

■​ Limit local nationals in management​

■​ Do R&D in home country​

■​ Use a single global trademark​

2.​ Integrative Approach​

○​ Aim: Blend the foreign unit into the host country​

○​ Measures:​

■​ Hire local staff​

■​ Build ties with political leaders​

■​ Use local distributors/professionals​

General Practice

●​ Global firms → Prefer Defensive Approach​

●​ Multi-domestic firms → Prefer Integrative Approach​

●​ Most companies use a mix of both approaches​

Strategy Depends On

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 ●​ Type and level of political risk​

●​ Timing of action:​

○​ Before investment​

○​ During the project​

○​ After expropriation​

Management Prior to Investment – Detailed but Simple Notes

Political risk should be managed before investing in a foreign country. There are five key
methods to handle this risk:

1.​ Including Political Risk in Capital Budgeting​

○​ Political risk is factored into the investment decision by increasing the

discount rate.​

○​ This helps assess whether the project is still profitable under risky conditions.​

○​ Drawback: It reduces the value of early cash flows, while political risk is
usually higher in the later years.​

2.​ Reducing Investment Flow from Parent Company​

○​ Instead of sending large amounts of money from the parent company, use
local borrowing in the host country.​

○​ This reduces exposure if political problems arise.​

○​ Disadvantage: Local funds may be more expensive.​

○​ The company must choose between higher financing cost and lower
political risk.​

3.​ Negotiating Agreements with Host Government​

○​ Before making any investment, the company can sign formal agreements
with the host government.​

○​ These agreements cover investment terms, operations, protections, etc.​

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 ○​ Once signed, the host government is legally bound to follow them, reducing
the chance of future issues or policy changes.​

4.​ Planned Divestment Strategy​

○​ The company plans to gradually transfer ownership and control to local

shareholders.​

○​ This is often agreed upon with the host government from the beginning.​

○​ It builds trust with the local government and reduces the risk of expropriation
(forced takeover).​

5.​ Political Risk Insurance​

○​ The company can buy insurance to protect against losses from political risks
like expropriation, war, or currency issues.​

○​ Insurance can be obtained from:​

■​ Governmental agencies​

■​ Private financial service firms​

■​ Property-focused insurers​

○​ Insurance types:​

■​ Bilateral (between two countries) – e.g., OPIC (Overseas Private

Investment Corporation – USA)​

■​ Multilateral (involving multiple countries or global institutions)​

Multilateral Political Risk Insurance – MIGA (Simplified Notes)

1. What is MIGA?

●​ MIGA stands for Multilateral Investment Guarantee Agency.​

●​ Created in 1988 as part of the World Bank Group.​

●​ Provides insurance against non-commercial (political) risks.​

2. Risks Covered by MIGA:​

MIGA protects investors from losses due to:

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 ●​ Currency transfer restrictions​

●​ Expropriation (forced takeover by government)​

●​ War and civil disturbance​

●​ Breach of contract​

MIGA also helps resolve disputes early—before they become claims—and supports
project financing by giving confidence to banks.

3. Reinsurance by MIGA (Since 1997):​

To handle large projects and expand its capacity, MIGA:

●​ Uses reinsurance (shares its risk with others).​

●​ Partners with private and public (re)insurance companies.​

●​ Has two main programs:​

○​ Facultative Reinsurance – project-by-project basis​

○​ Cooperative Underwriting Program (CUP) – group effort with insurers​

💡 Results:
●​ Got over $2 billion capacity via facultative reinsurance​

●​ Got $0.6 billion through CUP​

4. Technical Support:

●​ MIGA also offers technical help to improve projects so they meet investor
standards.​

5. Performance (1990–June 2009):

●​ 952 guarantees issued​

●​ Covered 99 countries​

●​ Total investment value insured: $20.9 billion​

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6. MIGA Guarantees (2005–2009):

Year No. of Projects Guarantee Gross

Guarantees Covered Amount ($ bn) Exposure ($
bn)

2005 62 41 1.2 5.1

2006 46 41 1.3 5.4

2007 45 29 1.4 5.3

2008 38 21 2.1 6.5

2009 30 26 2.4 7.3

Conclusion:​
MIGA plays a major role in reducing political risk for investors in foreign countries. Its
insurance, reinsurance partnerships, and technical assistance help promote safer
international investments.

Risk Management during the Life Time of the Project – Simplified Notes

Even after investment, political risk continues, so it must be managed during the project’s
operation phase. There are four main methods:

1. Joint Venture and Concession Agreement

●​ In joint ventures, local shareholders are included.​

○​ These locals often have political influence, which helps protect the project
by pushing the government to support it.​

●​ In concession agreements (common in mineral exploration):​

○​ The host government owns the resource but gives the investor a lease to
use it.​

○​ The government earns from this deal, so it's less likely to cancel it.​

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 ●​ Limitations:​

○​ Not a permanent safeguard.​

○​ When technology becomes standard, the government might cancel the

agreement.​

○​ If a new government comes to power, it might not honor the previous

agreements.​

Risk Management during the Life Time of the Project

Definition:​
Management of risk during the pre-investment phase reduces the intensity of political risk,
but does not eliminate it. Therefore, the risk management process must continue even
during the operation of the project in the foreign country.

There are four ways to manage risk in this operational phase.

1. Joint Venture and Concession Agreement

Definition:​
In a joint venture, local shareholders are included in the project. These locals often hold
political power and can influence the host government’s decisions in favor of the enterprise.​
In concession agreements, mainly used in mineral exploration, the host government
retains ownership of the property and grants a lease to the producer (the company). The
government benefits financially and usually does not cancel the agreement.

Limitations:

●​ Not permanent — agreement can be cancelled when:​

○​ New government comes to power, or​

○​ Technology becomes common, and government no longer needs the

foreign firm.​

2. Political Support
Definition:​
Sometimes, international companies serve as a medium to fulfill political needs of the
host government. As long as the company continues to receive political support from its
home country, its assets remain secure.

Limitations:

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 ●​ If there is a change in political leadership, either in the host or home country, this
political alliance may break, increasing the risk.​

3. Structured Operating Environment

Definition:​
This means creating a dependency link between the firm’s operations in a high-risk
country and its operations in other countries.​
The high-risk unit depends on its sister units abroad for technology, raw materials, or
marketing. This discourages nationalisation because the local unit cannot operate
independently.

Example:

●​ International oil companies used this approach in the Middle East.​

●​ But once local governments acquired the required skills, they nationalised the
companies.​

4. Anticipatory Planning (Crisis Planning)

Definition:​
Also called crisis planning, this method involves preparing in advance for possible
political problems. Even before anything goes wrong, the company starts watching
political signs and planning safety steps.

Example:

●​ In the Philippines under Marcos, foreign companies predicted regime change and
took early actions to protect themselves before the 1986 revolution.

Here are the simplified and detailed notes for the topic "Risk Management Following
Nationalisation"—written in clear, easy language while covering all key points and
examples from the original content:

Risk Management Following Nationalisation

Definition:​
Even after taking proper steps to avoid political risk, sometimes nationalisation still
happens—when a host government takes control of a foreign company’s assets. In such
situations, the company tries to reduce the damage using different methods.

1. Negotiation with Host Government

Explanation:

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 ●​ The company talks with the host government and shows willingness to support
its policies and programs.​

●​ Sometimes, the company gives up majority control of the business to satisfy the
host government (as per Hoskins, 1970).​

2. Political and Economic Pressure

Explanation:

●​ If negotiations fail, the company tries to use political or economic pressure.​

●​ Example: A country may impose a trade embargo.​

●​ Caution: Such actions can worsen relations, so they must be used carefully.​

3. Arbitration
Explanation:

●​ If pressure doesn’t work, the company can go for arbitration.​

●​ A neutral third party helps solve the dispute and may ask the host country to pay
compensation.​

●​ Problem: Some governments ignore the decision of the arbitrator and don’t pay.​

4. Legal Action (Court of Law)

Explanation:

●​ If arbitration fails, the company can go to court.​

●​ First, it must seek justice in the host country’s courts.​

●​ If not satisfied, it can go to the International Court of Justice (ICJ) for

compensation.​

●​ Example: The Cuban government did not pay compensation to U.S. companies
after taking over their assets in 1959–1961 (Globerman, 1986).​

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Chapter 2
Economic Environment of International Business

Forms of Economic System

●​ Three main types:​

1.​ Centrally Planned Economy (CPE)​

2.​ Market-Based Economy​

3.​ Mixed Economy​

Centrally Planned Economy (CPE)

●​ Central authority takes all decisions for production & distribution.​

●​ Focus on specific economic, social, political goals.​

●​ Government owns production means and controls sectors.​

●​ Example: Former USSR, East European countries.​

Market-Based Economy

●​ Decisions taken by private firms based on demand and supply.​

●​ Private ownership of production and resources.​

●​ Firms aim to maximize profit.​

●​ Consumers are free to choose what they want.​

●​ Government interference is minimal.​

●​ Example: USA, West European countries.​

Mixed Economy

●​ Combines features of CPE and market-based economy.​

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 ●​ Government + Private sector both play roles.​

●​ China: CPE but allows private sector in special economic zones.​

●​ USA: Free-market but some sectors regulated by government.​

●​ India: Government handles social sectors; others by private.​

●​ Commonwealth of Independent States (CIS): Shifted from CPE to market-based

economy in 1990s. Transition is still ongoing in some.​

Impact on Business Operations

●​ CPE: International trade is handled by state trading corporations.​

●​ Market-based: Trade handled by individual firms.​

●​ Mixed economy: Both types of trade systems exist.​

Business Considerations in Different Economies

●​ Procedures and trade systems differ depending on the economic system.​

●​ Example: Countertrade common in East-West trade.​

●​ Indian trade with USSR was different from trade with market economies.​

●​ Transition economies (e.g., Eastern Europe) have different challenges.​

●​ Firms consider host country’s economic system before deciding on trade or

manufacturing.

9.2 Preliminary Economic Indicators

Whenever a firm moves abroad for international business, it considers some economic
indicators of the host country at a particular time and over a specific period. These indicators
help the firm in the following ways:

●​ To assess the size of demand for its product​

●​ To estimate the cost of production and net earnings, helping determine

competitiveness​

●​ To evaluate if profit repatriation to the home country will be smooth​

Key Factors:

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 ●​ Size of Demand depends on:​

○​ Level and distribution of income​

○​ Propensity to consume​

○​ Rate of inflation​

●​ Cost of Production depends on:​

○​ Availability of human and physical resources​

○​ Infrastructure development​

○​ Fiscal, monetary, and industrial policies​

●​ Repatriation of Earnings depends on:​

○​ Strength of the external sector​

:

9.2.1 Level of Income and Its Distribution

●​ Demand size depends on the buyer's income level, so firms analyze a country’s
income before entering it.​

●​ GDP (total domestic output) and GNP (GDP + income from abroad) are general
indicators.​

●​ Per capita income gives a better picture, especially for large-population countries
where high GDP may not mean high purchasing power.​

World Bank (2008) Classification (in 2007 USD):

●​ Low-income country: $935 or less​

●​ Lower middle-income country: $936–3705​

●​ Upper middle-income country: $3706–11,455​

●​ High-income country: $11,456 or more​

Country Groupings:

●​ Developed countries: North America, Western Europe, parts of Asia, Australia​

●​ Developing countries: Includes:​

○​ Newly industrialising countries (NICs) or emerging markets​

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 ○​ Less developed countries (LDCs)​

○​ Least developed countries (LLDCs) – 50 countries with very poor economic

indicators​

Business Decisions Based on Income

●​ Low-income countries → low purchasing power → MNCs offer low-priced goods.​

●​ Middle/high-income countries → better market for expensive goods like luxury

cars.​

Exceptions: High-Priced Goods in Low-Income Countries

●​ Reason 1: Large population + low wages = cheap labour, reducing production
costs.​

●​ Reason 2: Unequal income distribution means a wealthy minority can afford costly
goods.​

○​ Example: In a 500 million population, if 10% control 60% of income, 50 million

can buy luxury items.​

So, distribution of income is more important than just per capita income in business
decisions.

Market Segmentation
●​ MNCs can target both income groups if income is unequally distributed:​

○​ Low-priced version for low-income consumers​

○​ Premium version for wealthy consumers​

○​ Example: Seiko (low-cost) and Hittari (premium) watches in the same country​

Global Trends in Income Distribution

●​ World Bank (1996): Increasing gap between rich and poor globally.​

○​ USA: 9:1 income ratio between national average and poorest 20%​

○​ Brazil: Similar​

○​ UK: 4:1​

●​ If even the poor can maintain a decent living standard, income inequality is less of
a concern.​

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9.2.2 Inflation
●​ Inflation affects purchasing power by reducing real income, even if nominal
income remains the same.​

●​ Higher inflation = Lower purchasing power → lower demand for products.​

●​ MNCs must consider inflation rate before setting up operations in a foreign country.​

Impact on Cost of Production

●​ High inflation → Higher production cost in host country.​

●​ May not affect local market competitiveness (since all producers face same cost).​

●​ But affects exports to low-inflation countries (due to higher costs).​

●​ MNCs may prefer exporting to high-inflation countries instead of setting up

manufacturing there, if their home inflation is lower.​

Inflation and Exchange Rates

●​ Inflation's impact on trade should be viewed along with exchange rate changes, as
exchange rate shifts may cancel out inflation effects.​

Social Impact of Inflation

●​ Fixed-wage earners suffer most (lower real income).​

●​ Business community may benefit (higher profits = higher purchasing power).​

●​ MNCs can target business class with products suited to their increased purchasing
power.​

Role of Monetary Policy

●​ To control inflation, monetary authorities may raise interest rates.​

●​ This leads to higher borrowing costs, which slows down industrial growth.​

●​ May result in industrial stagnation, reducing foreign investment inflows.​

Consumption Behaviour

Consumption behaviour or the pattern of consumption affects product demand. In

low-income countries, consumers focus more on price than quality, so multinational firms
struggle to sell high-quality, high-price products, even for daily use.

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In rural areas of less developed countries, people prefer saving or investing in real estate,
which lowers their spending on general goods. A large portion of income goes to food and
housing, reducing demand for other products.

The decision to save or consume depends on the population's quality and the availability of
social security schemes. Literate populations prefer quality products, while uneducated
people are more price-conscious. Without social security, people save more, so consumption
stays low. But with such schemes, consumption increases.

When multinational firms choose a host country, they consider consumption patterns,
population quality, saving habits, and the presence of social security systems.

Availability of Human and Physical Resources

Easy access to human and physical resources lowers production costs and provides a
competitive edge. Multinational firms cannot transport all labor from home, so they hire
senior staff from their own country and local skilled manpower for the rest.

They assess the availability of technical and managerial talent before entering a host
country. Physical resources (raw materials and other inputs) are also important. For
example, Indian firms moved to Sri Lanka for rubber and Nepal for herbal products due to
abundant local resources.

9.2.5 Network of Infrastructure

●​ Supportive infrastructure is essential for industrial success.​

●​ Key needs: power supply, transport links (road/rail), communication systems.​

●​ Multinational firms consider infrastructure while evaluating host countries.​

●​ Historical example: US economic aid in the 1950s aimed to support infrastructure

and attract US investment.​

●​ In India, lack of infrastructure is a reason for the delay between FDI approval and
actual inflow.

9.2.6 Fiscal, Monetary, and Industrial Policies

●​ Economic policies in the host country affect the ease or difficulty of multinational
operations.​

Fiscal Policy

●​ High corporate income tax reduces net profits.​

●​ Firms may use transfer pricing to reduce tax, but it is complex.​

●​ Tax treaties between home and host countries help reduce tax burden.​

●​ Tax holidays may be offered to attract foreign investment.​

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 ●​ Excise duties increase production cost; they may be:​

○​ Based on output​

○​ Based on value addition​

●​ Import duties (tariffs) increase the price of imported goods:​

○​ Ad valorem (based on value)​

○​ Specific (based on quantity)​

○​ Mixed (both value and quantity)​

●​ In free trade areas/customs unions, no tariffs on intra-regional trade—this

encourages business.​

●​ Fiscal policy also deals with budget/fiscal deficits:​

○​ High deficits can negatively impact monetary, external, and other sectors,
affecting multinationals.​

Monetary Policy

●​ Affects money supply, inflation, interest rates, cost of credit, and financial sector
health.​

●​ Good policy = low inflation, low interest rates, strong financial institutions →
cheaper and easier credit → lower operational costs → better competitiveness.​

●​ Multinational firms benefit, though local firms do too.​

Industrial Policy

●​ Decides where foreign investment is allowed.​

●​ Restrictive policy = limited sectors for FDI.​

●​ Liberal policy = more foreign investment.​

○​ Example: India liberalized its policy in 1991, attracting many foreign investors.

Strength of External Sector

●​ Repatriation of Profits:​
Multinational firms prefer host countries where profit repatriation to the parent unit is
easy.​

●​ Liberal Policy Requirement:​

A liberal repatriation policy depends on:​

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 ○​ Strong balance of payments.​

○​ Large foreign exchange reserves.​

●​ Issues in Developing Countries:​

○​ Face current account deficits due to:​

■​ High import needs.​

■​ Demand and supply constraints on exports.​

■​ Small invisible trade.​

●​ Capital Account Flows:​

○​ In some cases, capital inflows cover the current account deficit and increase
foreign exchange reserves.​

○​ Happens when:​

■​ Incentives are given to foreign investors.​

■​ There is a stable economic and political environment.​

●​ Assessment by Multinational Firms:​

Firms check the external sector health using:​

○​ Export-import ratio​

○​ Current account balance/GDP ratio​

○​ Current receipt/GDP ratio​

○​ Import cover of reserves (in months)​

○​ External debt/GDP ratio​

○​ Debt service ratio​

●​ Conclusion:​
A stronger external sector attracts more foreign investment.​

Here are simple, concise, and relevant notes on the topic "Process of Analysing
Economic Environment", based only on the provided content:

Process of Analysing Economic Environment

1.​ Judging Economic Indicators​

○​ Firms assess economic indicators at the time of export or investment.​

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 ○​ Trend analysis over time is also essential.​

2.​ Use of Past and Future Data​

○​ Past data is easily available through historical records.​

○​ Future data is based on forecasts using past trends.​

3.​ Step 1: Data Collection​

○​ Secondary data:​

■​ Easy and low-cost.​

■​ Sources include IMF, World Bank, UN, and government agencies.​

○​ Primary data:​

■​ Collected through firms or consultants.​

■​ More expensive and faces challenges (e.g., distance, culture,

language).​

4.​ Step 2: Market Evaluation​

○​ Evaluate total market potential.​

○​ Use consumption patterns and income growth rates to forecast future

demand.​

○​ May use input-output tables to analyze sectoral or international linkages.​

○​ If country-specific data is missing, use data from similar countries.​

5.​ Goal​

○​ To determine market size in the target host country.​

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