CHAPTER 5

THE POLITICAL AND LEGAL ENVIRONMENT

Chapter Outline

A. Home Country Political and Legal Environment

1. Embargoes and Sanctions
2. Export Controls
3. A New Environment for Export Controls
4. Import Controls
5. Regulation of International Business Behavior
B. Host Country Political and Legal Environment
1. Political Action and Risk
2. Legal Differences and Restraints
3. Influencing Politics and Laws
C. The International Environment
1. International Politics
2. International Law
3. International Terrorism and Marketing
D. Ethical Issues
1. Corporate Governance and Responsibility
2. Intellectual Property
3. Bribery and Corruption

Chapter Objectives

This chapter intends to sensitize students to political and legal issues. A broad range of
discussion is devoted initially to home country political and legal activities. It is
highlighted how strictly domestic actions can affect the international competitiveness of
firms. The discussion of embargoes, sanctions, and export controls stress how difficult it is
to enforce such actions, particularly in a world where multilaterally coordinated efforts are
scarce in the trade arena. Import controls are evaluated in the context of their initial
objectives and their subsequent results. Frequently it is found that temporary measures
become permanent, and that actions taken to provide a temporary respite wind up as
privileged rents for vocal constituencies. The regulation of international business behavior
is addressed, with a particular focus on antitrust and bribery issues. Even though such
regulations may inhibit the activities of firms, they may be important to maintain due to a
nation's legal and ethical priorities.

The political risk in host countries is evaluated with a particular focus on expropriation,
confiscation, and domestication. Students need to understand that risk is always present
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 internationally, and that in the event of major occurrences, little government help is
available from the home country. It is therefore important to be a good corporate citizen.
However, one alternative open to firms is to try to influence politics and laws. The extent
and effect of such lobbying efforts are demonstrated.

When entering a foreign market, every company encounters an entirely new foreign legal
environment to which it must adapt in order to be successful.

Suggestions for Teaching

What has worked well for us is setting different criteria for the invocation of embargoes or
sanctions. These criteria can vary in terms of the countries that are concerned (e.g., Libya
vs. Canada or the U.K.) and the trigger factors for the sanctions (e.g., terrorism vs. worker
rights vs. differing government policies.) A natural lead-in to this topic is export controls,
where it is very useful to discuss with students which technologies are critical and how
different nations rely on trade with their trading partners to a differing degree. For example,
can one expect a nation which depends to a large extent on trade with a particular country
not amicable to the United States (e.g., Italy and Libya) to take exactly the same
international trade policy measures as the United States? It is also useful to point out
alternatives such as relying on market forces yet guiding those through concerted
government activities. However, in that context it is useful to point out the high cost of
such alternatives.

The bribery issue always has a lot of room for lively in-class discussion. Students need to
understand that it is not a question of amount, but of ethical behavior. Nevertheless, the
concurrent message to be communicated should be one of reasonableness in terms of
carrying out international business transactions. The website of Transparency International
(www.www.transparency.de.) has been helpful to us here.

A discussion can be initiated on the direct and indirect impacts of terrorism on business
activities and the markets of countries adversely affected by it. In order to make the topic
interesting, references and examples can be drawn from the recent terrorist activities across
the world.

The issue of legal differences is best understood by evaluating the effects and the cost of
litigation, students can explore what major effect these activities can have on a firm. It is
also helpful to ask students if business or service providers in their community have had to
close down or alter their method of operation due to the threat of litigation and the lack of
insurance coverage (e.g., obstetricians, horseback riding).

Key Terms

Environmental superfund: A fund to cover the costs of domestic safety regulations and
made up from fees imposed on U.S. chemical manufacturers, based upon volume of
production.
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Intellectual property rights: Safeguarding rights by providing the originators of the idea or
process with a proprietary compensation, at least, in order to encourage quick dissemination
of innovations.
Gray market: Distribution channels uncontrolled by producers; goods may enter the
market place in ways not desired by their manufacturer.
Trade sanctions: Governmental actions that inhibit the free flow of trade goods, services,
and ideas, imposed for adversarial and political purposes.
Embargoes: Governmental actions that terminate the free flow of trade in goods, services,
or ideas, imposed for adversarial and political purposes.
Export control systems: Governmental policy designed to deny or at least delay the
acquisition of strategically important goods by adversaries.
Dual-use items: Goods that are useful for both military and civilian purposes.
Export license: Written authorization to send a product abroad.
Foreign availability: Easy access to high-technology products worldwide, from many
sources.
Tariffs: Taxes imposed on imports, which subsequently increases the price of the imported
product in the domestic market.
Voluntary restraint agreements: Non tariff trade barriers in the form of self imposed
restrictions and cut backs aimed at avoiding punitive trade actions from the host country.
Quota systems: Control of imports through quantitative restrictions.
Downstream change: A change in the import composition brought about by import
controls.
Boycotts: Refusing to purchase from or trade with a company because of political or ideological
differences.
Political risk: The risk of loss when investing in a given country, caused by changes in a
country’s political structure or policies, such as tax laws, tariffs, expropriation of assets, or
restriction in repatriation of profits.
Ownership risk: Exposing property and life to political risk in another nation.
Operating risk: Exposing ongoing operations of a firm to political risk in another nation.
Transfer risk: Exposing the transfer of funds to political risk across international borders.
Expropriation: Seizure of foreign assets by a government with payment of compensation to
the owners.
Confiscation: Transfer of ownership from a foreign firm to the host country without
compensation to the owner.
Domestication: Gaining control over the assets of a foreign firm by demanding partial
transfer of ownership and management responsibility to the host country.
Overinvest: Tendency in the initial acquisition process to buy more land, space, and
equipment than is needed immediately to accommodate future growth.
Price controls: Government regulations that set maximum or minimum prices;
governmental imposition of limits on price changes particularly in sectors that are considered to
be highly sensitive from a political perspective, such as food or health care.
Theocracy: A legal perspective that holds faith and belief as its key focus and is a mix of
social, legal, and spiritual guidelines.
Common law: Based on tradition and depends less on written statutes and codes than on
precedent and custom; this law originated in England and is followed in the
U.S.
Code law: A comprehensive set of written statutes; countries with code law try to spell out
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all possible legal rules explicitly; based on Roman law and found in a majority of nations.
Antidumping laws: Laws prohibiting below-cost sales of products.
Terminology: Words and/or phrases used to describe a concept.
Lobbyists: A person who attempts to influence the legislative process; they are well-
connected individuals and firms that provide access to policymakers and legislators.
Chill effect: This phenomenon occurs when buyers become uncertain about the state of their
nation’s economy, and a sharp reduction in demand for both consumer and industrial goods
follows.
Corporate governance: The relationship among stakeholders used to determine and control
the strategic direction and performance of an organization.
Intellectual property: Refers to a legal entitlement of exclusive rights to use an idea, piece
of knowledge, or invention.
Functional lubrication: Bribes that are not imposed by individual greed, but that serve to
“grease the wheels” of bureaucratic processes; amounts tend to be small, the “express fee” is
standardized, and the money is passed along to the party in charge of processing documents.
Sarbanes-Oxley Act: Provides protection to investors by imposing the accuracy and
reliability of corporate disclosures; the act covers issues like corporate responsibility, financial
transparency and accounting oversight.

Questions for Discussion

1. Discuss this statement: "High political risk requires companies to seek a quick payback on
their investments. Striving for such a quick payback, however, exposes firms to charges of
exploitation and results in increased political risk."

A firm beginning to do business in an unstable and changing political environment may

want to establish itself quickly, generate revenues to offset the costs of organization, and
quickly gain a foothold in the market. If it approaches the host environment carefully, it
may take steps to become a beneficial influence there by hiring local employees, joining
local associations, or contributing to the community. However, if a firm is aggressive in
seeking a quick payback on its investment in a foreign country, the government and
business community might perceive it to be exploitative. This is particularly likely if a
company brings in its own employees for managerial positions or all of its other positions.

A firm needs to demonstrate that it is concerned about the host country’s society and that it
considers itself an integral part of the host country rather than simply an exploitative foreign
corporation. In order to prevent political risks, firms can adopt measures like intensive local
hiring and training practices, good pay, philanthropy, and more societally useful investment.
A company can also form joint ventures with local partners to demonstrate a willingness to
share its benefits with nationals.

An exploitative image may lead to severe political problems, depending on the country
involved. One of the most drastic political threats facing a foreign company is confiscation.
Confiscation involves the government takeover of a firm without compensation to the
owners. Expropriation is also a form of government takeover; however, the firm's owners
are compensated although frequently at less than market value. Domestication is another
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 risk for the foreign firm which involves the transfer of ownership and management to the
government and restricts the flow of profits out of the country. These risks are highest in
developing countries where the political environment is very volatile.

2. How appropriate is it for governments to help drum up business for their companies abroad?
Shouldn't commerce be completely separate from politics?

Commerce and politics are inevitably linked by the need for trade agreements.
Policymakers can appropriately promote firms doing business abroad by carefully
formulating domestic and international trade policies in such a way that the policies do not
create hostility toward or alienation of firms conducting international trade. International
political relations do not always have harmful effects on international marketers. In fact,
when bilateral political relations between countries improve, business can benefit.
However, there are instances when trade policies must be hostile for political reasons and
economic sanctions and embargoes are used. Also, politics must regulate trade of products
relating to national security. Trade policy can promote business abroad without direct
subsidization of companies, and has indeed done so in many countries where economic well
being and security is seen as having equal rank with national and international security.

3. Discuss this statement: "The national security that our export control laws seek to protect
may be threatened by the resulting lack of international competitiveness of U.S. firms."

Export controls are designed to control the flow of strategically important goods to certain
countries. With the end of the Cold War, the Export Commodity Control List (products for
which an export license is required) has been significantly reduced. However, concern
about terrorism has heightened the control stance of the United States. Certain measures
like restricting the flow of materials, reducing flows of technological knowledge and
financial controls help U.S. to prevent proliferation of weapons of mass destruction as well
as inhibit funding for terrorist training.

It is becoming increasingly difficult to enforce export controls as more countries now have
high-tech industries. They produce products the U.S. is trying to control, such as computer
technologies that have applications in nuclear technology, at lower prices. Small high-tech
goods are easily smuggled, and the transfer of technical knowledge is done on a one-to-one
level that is difficult to control. As a result, sensitive goods become more readily available
to adversarial countries. U.S. firms which are not allowed to export certain products may be
severely handicapped in their competitiveness if firms from other countries can do so.
Nonetheless, there are major efforts being undertaken to again harmonize control efforts.

4. After you hand your passport to the immigration officer in country X, he misplaces it. A
small "donation" would certainly help him find it again. Should you help him out? Is this a
business expense to be charged to your company? Should it be tax deductible?

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 Business people working abroad are prohibited from bribing foreign officials for business
purposes by the Foreign Corrupt Practices Act of 1977. However, revisions were made to
the 1977 legislation in the 1988 Trade Act. A distinction was made between facilitation of
routine governmental actions and governmental policy decisions. Bribery which expedites
routine processes such as obtaining of permits and licenses or processing of visas and work
permits are legal. On the other hand, bribery used to influence policy decisions is still
strictly prohibited. A 1999 agreement in the OECD has further strengthened these rules.
Payments for routine government action are usually borne by the firm. Tax deductibility of
such small payments varies across countries but is permitted in most nations.

5. Discuss the advantages and disadvantages of common versus code law for the international
marketer.

Common law, which originated in England and later used in the United States, is based
more on tradition than on written statutes and codes. Code law which originated from the
Roman Law, is used by most nations and is based on written codes that attempt to cover
every possible legal circumstance. Common law tends to be more flexible than code law.
For commerce regulations, the United States uses a well-defined code of regulations,
making that area of the law similar to code law. Under a code law system a country can
adopt rules and regulations that are specifically intended to inhibit foreign penetration of
their markets. These domestic policies can have the same effect as import restrictions in a
more subtle way. For example, strict health and safety standards for domestically consumed
goods have a restrictive effect on importers.

6. The United States has been described as a "litigious" society. How does frequent litigation
affect the international marketer, particularly in comparison with the situation in other
countries?

The litigious nature of the U.S. business environment increases costs for international
marketers besides causing extensive delays in marketing opportunities in the United States.
Firms must have liability insurance and legal departments to handle lawsuits and to research
potential legal problems. These insurance and legal expenses add to the operating costs of
the company. As a result, U.S. firms are less competitive than foreign firms that operate in
less litigious environments. Moreover, the tendency of judges to encourage out-of-court
settlements provides room for easy arbitration and mediation for dispute resolution.
Litigation against companies in the U.S. is often highly publicized. Negative publicity can
escalate the damage to a firm resulting from a lawsuit, further reducing its competitiveness
vis-a-vis foreign companies.

7. What are your views on lobbying efforts by foreign firms?

Answers will vary. For better or worse, American society is influenced by the lobbying
efforts of foreign firms in the American political system. The number of lobbyists for
foreign parties in the U.S. has increased remarkably. These lobbyists' primary objective is
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 not to promote U.S. trade competitiveness, expand the American employment base, or
protect sensitive technology, but rather to represent foreign economic interests. The
lobbying services range from legal assistance to public relations.

The experience and networks of lobbying firms can help in presenting corporate concerns to
decision makers. In doing so, new information and insights can be provided to policy
makers and decisions can be precipitated more rapidly.

These efforts clearly affect the decisions being made within Congress as well as influence
the American perception of foreign objectives in the United States. At the same time,
however, the right to represent one's interests to officials is a major benefit of a democracy.

8. Discuss how changes in technology have affected the effectiveness of U.S. export control
policy.

The ability of the U.S. to enforce its export control laws and gain the intended results is
increasingly challenged by technological advances. On the other hand, enforcement is more
difficult by the ease with which certain technologies, such as software, can be transferred
across borders. For example, a computer program can be sent internationally via the
Internet without detection. Other sensitive information such as blue prints, instructions,
ingredients can also be accessed unhindered on the global, unregulated Internet.

The size of electronic equipments which are exported also affects the U.S. export control
policy to some extent. For example, earlier supercomputers and high-technology items used
to be fairly difficult to hide and any movement of such products was easily detectable.
Nowadays, state-of-the-art technology has been miniaturized. The advanced technological
equipments are so small that it can fit into a briefcase, and most of them are no larger than
the luggage compartment of a car. Given these circumstances, it has become difficult for the
U.S. export control officials to closely supervise the transfer of such equipment.

Technology advances have also made more difficult the intended purpose of U.S. export
control laws - which is primarily to keep certain products out of the hands of certain groups.
As technology spreads and is communicated to more people, the number of potential
suppliers (U.S. and foreign) grows, making any attempt on the part of the U.S. to block any
particular nation from obtaining a product nearly impossible.

Internet Exercises

1. Summarize the U.S. export licensing policy towards Cuba. (Go to www.bis.doc.gov).

Export licenses must be obtained for exporting goods. For Cuba the current embargo policy
denies nearly all exports license applications with the exceptions of “medicines, medical
equipment and supplies, and the donation of food, clothing and other designated
humanitarian items.” Over time, this policy may be subject to change. This site also

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 provides detailed instruction on how to file for an export license. Students can be asked to
discover some of these details for specific products and countries.

2. What are the key components of the anticorruption agreements

passed by the European Union, the Organization of American
States, and the United Nations? (Go to www.oecd.org/ or
http://www.transparency.org)

This website briefly describes the agreements and actions taken by numerous international
organizations to combat corruption. The European Union, the Organization of American
States and the United Nations have established the Union Policy against Corruption, the
Inter-American Convention Against Corruption and the United Nations Development
Programme for Accountability and Transparency.

The EU through its Union Policy against Corruption aims to reduce all forms of corruption,
at every level, in all EU countries and institutions and even outside the EU. It also aims to
identify possible areas where the EU might be an appropriate actor to take future initiatives
in the fight against corruption. The Inter-American Convention Against Corruption passed
by the Organization of American States believes that fighting corruption strengthens
democratic institutions and prevents distortions in the economy, improprieties in public
administration and damages to the moral fiber of the society. It believes that, it is the
responsibility of the member countries to hold corrupt persons accountable in order to
combat corruption.

References are offered to books, papers and surveys that describe the nature, causes and
effects of corruption. The demand and supply sides of bribery are discussed together with
typical practices and remedies.

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