International Business Environment

conf. univ. dr. Radu Mușetescuradu.musetescu@gmail.com

The mixed economy(= interventionism):

• the quasipresent economic systems around the word today• a combination of private property and state property• the state limits the free exercise of private property in certain activities or sectors

Market versus the public sector

• the market = a social and economic system based on private property in which the social transactions are voluntarily concluded among participants

• the public sector = a monopoly of legal enterprise (rule making and enforcement) = the core issue in the public sector is the compulsory character of the social transactions with the state (such as taxation) or of observing the rules of the exchange among the member of the society

Franz Oppenheimer (a German sociologue)

= there are two possibilities of acquiring economic goods by an individual:

- the economic means = involvement in market transactions → the satisfying customers

- the political means = the use of the state as a mechanisms for acquiring resources

The problem of „economic freedom”

• several innitiatives to assess the economic freedom: Heritage Foundation (www.heritage.org/index) and others• different criteria such as:Business Freedom, Trade Freedom, Fiscal Freedom, Government Spending, Monetary Freedom, Investment Freedom, Financial Freedom, Property Rights, Freedom from Corruption, Labor Freedom;

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Economic freedom around the world, 2011, Heritage Foundation

The freest economies

• 1. Hong Kong,• 2. Singapore,• 3. Australia,• 4. New Zeeland,• 5. The Netherlands,• 6. Canada,

The least free economics• 174. Burma• 175. Venezuela,• 176. Eritreea,• 177. Cuba,• 178. Zimbabwe,• 179. North Korea,• unrated (Afganistan, Iraq,

Liechtenstein, Sudan)

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89 țări = fără libertate sau în principal lipsite de libertate90 țări = libere sau în principal libere

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The impact of economic freedom:

• freer an economy, more prosperous the society → the firms have the liberty to engage in those activities of production which are focused on satisfying consumers

• more interventionist an economy:– More resources are allocated by government for “government

consumption”, observing public regulations, etc.– Satisfying consumers is not a priority any more;– The arbitrariness of public servants (corruption, taxation, etc.) and

additional costs

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World Economic Forum – 2011- how burdensome are public regulations?The least burdens on private

companies:

1. Singapore2. Hong Kong3. Rwanda4. Georgia5. Gambia6. Qatar7. Estonia8. Oman

The most burdensome:98. Romania

133. Italy134. Hungary135. Venezuela136. Croatia137. Angola138. Puerto Rico139. Brazil

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Economic freedom versus political freedom

• are the countries with political freedom the countries with also economic freedom?

→ fundamentally, both liberties start from the basic rights of individuals = property rights are among the basic right of individuals → these two dimension are usually in direct relation

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However:

– countries with significant political freedom but with a reduced economic freedom = while democratic, government intervention is massive (such as Brazil în anii 60,70, Argentine in the 2000’) – countries with a low political freedom but with significant economic freedom = examples from Middle East (United Arab Emirates, Qatar, so on)– sometimes, countries differentiate between local companies and foreign companies

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Time preference of governments

Besides the attitude towards private property rights, there are also differences in the time horizon of governments: • shorter the time horizon, higher intervention and arbitrariness (e.g. the electoral cycles in democracies)• longer the time horizon on which a government operates, stronger the incentive to increase prosperity (Singapore, Taiwan, South Korea, etc.)

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Why the state intervenes in the economy? = a tradition debate in political economy

• supplying public goods (security, defense, justice, infrastructure)• correcting the market failure (monopolies, cartels, etc.)• redistribution (in favor of certain social groups which are disadvantaged)• rent-seeking (special interest)• Etc.

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The size fo the government budget in an economy(= government expenditure / Gross Domestic Product)–

2007, 160 states (http://anepigone.blogspot.com)

The largest ependiture (%):1. Iraq = 87,3%2. Cuba = 81,4%3. Slovakia = 66,4%4. East Timor = 65,5%5. ROMANIA = 65,5%6. Moldova = 63,4%7. France = 61,1%8. Seychelles = 60,3%9. Hungary = 59,1%

Cele mai mici cheltuieli (%):

136. Poland = 21,2%149. Brazil = 17,3%150. Hong Kong = 17%155. Singapore = 16,3%157. Cambodgia = 13,3%158. Bangladesh= 12,6%159. Turkmenistan = 9,6%160. Afganistan = 9,2%

The size of the government budget

Largest such an indicator in GDP, more resources in such an economy are allocated by the state):→ economic inefficiency (= central allocation = lack of the test of profit and loss)→ the decrease of the market for consumer goods (through higher taxation, they have less resources to spend on consumer goods on the market)→ an increase in the possibility of bribery

„Agency Theory”

the state and private firms are legal / social entities which are not however personal (cannot “act”) → in social transactions, they are represented by agents of the owners→ agents should look for the interests of his principal (the party that delegated him the decision)

→ sometimes, however, such agents may look for their own interest at the expense of their principals = principals incur costs = “agency costs”

Corruption:

“agency costs” + massive interventionism of the state in the economy → more possibilities for corruption of the agents of the state (= public servants)

→ such agents accept material compensation for “favoring” certain parties which transact with the state (they extract “private rents”)→ from the perspective of a firm, bribery is an additional cost of dong business = in theory, ignoring other factors, the most efficient producer is ble to pay the highest bribe

However, an “adverse selection” occurs = those who follow the political means are more successful than the most efficient producers→ the allocation of resources in such an economy is altered = it is not an efficient allocation;→ the incentives to be the most efficient dissappear

Transparency International (2010)

The most corrupted countries:178. Somalia177. Myanmar176. Afganistan175. Iraq

164. Venezuela

The least corrupted countries:1. Denmark2. New Zeeland3. Singapore4. Finland5. Sweden6. Canada7. The Netherlands8. Australia

69. Romania

Additional issues in corruption:

• active / offensive bribe (bribery is offered in order to get advantages) versus passive / defensive bribe (bribery is demanded and paid in order to avoid being disadvantaged)

• public bribery (towards public servants) versus private bribery (towards private employees of companies) → in a private company, corruption is eliminated through business failure (higher costs of operation) while in the public sector, there is always the possibility of “socializing the costs” (the government is not exposed to the profit / loss test)

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Corruption in international business

= some countries punish not only domestic corruption but also bribery of national companies abroad (towards foreign public servants)

• USA = „Foreign Corrupt Practices Act” (1977) = the first legislation in this direction

• Today, several international agreements:– OECD in 1997= Convention on Combating Bribery of

Foreign Public Officials in International Business Transactions → signed by 40 states

– United Nations in 2005 = Convention Against Corruption

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Such legislation:

• put the two parties in bribery on the same footing (same punishment)

• Illegal payments are confiscated (even the entire business turnover)

• Excludes „facilitation payments” = small payments in order to facilitate the operation of business (in Brazil, „despachantes”)

• sometimes, allow competitors to sue for damages, etc.

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Corruption Cases in International Business (www.fiscaltimes.com)

1. Siemens (Germany) = 1,7 bill. USD = in Argentina2. Halliburton (USA) = 580 mil. USD = in Nigeria3. BAE Systems (UK) = 450 mil. USD = in Saudi Arabia4. Snamprogetti (The Netherlands) = 240 mil. USD = in

Nigeria5. Technip (France) = 240 mil. USD = in Nigeria...Johnson and Johnson = 70 mil. USD = Greece, Poland,

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The issue of „revolving doors”

there are cases when former public servants / employees leave their state jobs and are employed in the private sector (or vice-versa) → suspicions that they face complex conflict of interests: - once they are in public office, they may favor private firms with whom they do anticipate to have business/employment connections in the future;- once they leave the public office, they may take information and contacts that they may employ in private business;- such an issue is almost impossible to radically solve (such employees have human rights too) even if there are certain measure that can be explored (a period to avoid relating to former employment institution)

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Lobby

= an activity thourgh which private agents attempt to influence the decision making process in a democractic state (esecially in legislative matters) so as such decisions won’t negatively impact them- any citizen has the right to express opinions and advance proposals for the public legislative bodies („no taxation without representation” );- however, no legislator is obliged to support such proposals even from his own circumscription → his agenda may be prioritize by such professional lobbists who argue for the public interests- may take the form of campaign contributions (however, maximum amounts are usually enacted in mature diplomacies)

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Example: lobbying in the European Union

• there is no clearcut definition;• lobbying includes not only self declared lobby firms but also

consulting firms, legal services firms, Public Relations firms, mass media, business associations, trade unions, non-governmental associations;

• 5678 firms are registered as explicitly lobbying firms in a voluntary registrar in the European Union

• other assessments reach the 15.000 (Corporate Europe);• the most targeted sectors: pharmaceuticals, agro-business

(especially tobacco), etc. = heavily regulated industries• lobby industry = between 1.5 – 3 billion euro (EU Observer);

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However

- lobbying = can sometimes argue for the “public interest” but, in fact, follow the “purely private” interest (or “special interest”)- a widening gap between “discourse” and “reality”- lobby may be deeply connected with corruption

The problem of expropriations / nationalizations in doing business abroad

expropriation = the involuntary (forced) giving up of private ownership on certain economic goods (it includes the expropriations with “compensation”)

special problem = the case of foreign companies operating in a country (the expropriated firm “belongs” to another country)

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Expropriations (Quan Li, 2005)

1960 – 1990 = 520 major expropriations in developing countries:→ 423 = made by non-democratic governments→ 97 = made by democratic governments

But, on average:4,5 years between expropriations in a non-democracy3,3 years between expropriations in a democracy

→ democracy does not exclude expropriation

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Factors that determine expropriations:

• nationalism = especially in natural resources („resource nationalism”)• populism = governments that attempt to be more popular by redistributing resources from particular agents to the majority• govenment is less democrat, so rulers do not care about consequences (they operate on short time horizon); • the lack of an independent juidiciary that can play the role of a “veto player” = the system of „check-and-balance” that is particular to mature legal systems• public interest versus private interests• etc.

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Considerations regarding the decision to expropriate when it is taken by a government

= it is an analysis of cost-profit

•main costs = loss in reputation, especially in what regards foreign companies•main benefits = populist policies or an increase the stock of resources

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„Indigenization” policies• Some governments have explicit policies of „indigenization” of the control

in certain companies, such as the compulsion for such companies to be majority owned by local investors

• usually in certain industries (again, natural resources) but also economy wide (Zimbabwe and, to a less degree, South Africa)

Consequences:- short term redistribution (tale from „haves” and give it to „have-nots”);- distortion of economic incentives (foreign firms do not invest any more,

existing firms are losing profits, so on);- the emergence of “favored” individuals and groups, non-interested in the

economic way but only in the political way of getting resources

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The concept of “political risk”

= the probability of a negative impact on the operations of a foreign company because of events or developments in the political field in a country where it operates

= determined by the uncertainty derived from the decision of the government and the public institutions but also of certain political forces or groups (separatist forces and so on)

= the attempt to aggregate in a single expression the multiple dimension of the influence of politics on economics;

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Political risk

Dimenssions:-expropriation;-breaking contracts;-changes in legislation or regulation (because of competing lobbying, PR, corruption);-terrorism, military conflict;-social unrest (strikes, manifestations, etc.);-restrictions on the foreign exchange market (and the ability for foreigners to transfer foreign currencies), etc;

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The relative importance of different dimension of political risk

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“Hidden expropriations” (indirect)

= even without a direct and explicit expropriation of a business, certain government measures may have a strong impact on the ability of a firm to continue to operate in an economy:- renegotiation of concessions (awarded when entering an economy);- changing taxation (higher taxes);- the lack of a legal system of protecting property rights;-Etc.

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Mechanisms to deal with political risk (the perspective of firms)

• negotiation with local governments;• (informal) relationships with political leaders;• cooperation with local communities;• cooperation with local non-governmental organizations;• the hedging of operations risk (through financial contracts);• support for certain political leaders / parties = may involve

high risk;• joint-ventures with local companies.

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Concerns of international companies as regards the developing countries in the close future

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International mechanisms to deal with political risk

= the emergence of economic agents that offer insurance against political risk (associated in the Bern Union)-public institutions / financed by governmentsc: Overseas Private Investment Corporation (USA); COFACE (France); Export Development Corporation (Canada); export-import banks-multilateral institutions (African Trade Insurance Agency, Asian Development Bank, Islamic Corporation for the Insurance of Investment and Export Credit, Multilaterial Investment Guarantee Agency from the World Bank)-private companies (insurance and reinsurance):

= sums insured in 2010 for political risk = 65.8 billion USD

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Challenges

• the insurance by a state of political risk of investing abroad by national companies = may alter their prudential approach

• moral hazard = there is somebody else who is supporting the costs → firms will overinvest in such countries

• the costs may be taken over by the public budget of such a state = it may stimulate aggressive approaches towards the other state

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