Importance of Political Stability for International Business

2500 words (10 pages) essay in Economics

06/10/17 Economics Reference this

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Economic growth and political stability are deeply interconnected as many examples in history suggest. For example an economic crises in the 1920 in Europe and the USA and the resulting political instability in many countries can be seen as one of the factors leading to World War II.

While growth and stability reinforce each other in terms of economic development, stability seems to be a necessary condition for investments from a business point of view. The purpose of this paper is to examine the importance of political stability to international business. Large investments are often made by multinational companies in the process of entering the foreign market. Such investments are usually made with different objectives, which are important to differentiate because of the differing ways that political stability plays into the decision making. This paper will distinguish between three different objectives: 1) the foreign market is of interest to companies for access to consumer markets, which would relate to the sale of products and services in the particular market. 2) the access to the natural capital is of primary interest to extract resources for export. 3) access to human labour might be of interest to firms, as to get cheap labor inputs (labour as factor of production). With the nature of business as outlined above, risk involved with regards to instability differs which will become important for more detailed discussion. Multinational enterprises may well engage in several of these types of investment at the same time.

Of general importance, however, is of course the risk involved with making such investment decisions. Companies engaging in Foreign Direct Investment (FDI), for instance, make overseas investments either by setting up a subsidiary or associate company in the foreign country, through a joint venture or merger, or simply by acquiring shares of an overseas company. To examine the importance of political stability to international business in form of FDI or other cross-border activities, it must first be understood what its absence means: Alesina et. al. (1996) define political instability as ‘the propensity to a government collapse’. In international business, however, the influence of political instability is felt far before a government is about to collapse. In fact, any policy or governmental change can negatively as well as positively affect operations. Political risk is thus intrinsic to international business. Political stability is one factor of risk that affects the the business in different ways.

When looking at political stability one should not neglect the importance of type of governmental representation, i.e. are democratic systems more favourable to politcal stability than, for instance, authoritatian regimes? A democracy can be defined as ‘a political system based on majority rule, in which all citizens are guaranteed participatory rights to influence the evolution of government’ (Issitt, 2013). This evolution of government ensures checks and balances on elected officials. For businesses this is important because it reduces arbitrary government intervention and the risk of policy reversal while protecting generally property and ownership rights (Asiedu and Lien 2011; Li, 2009). This kind of protection granted by democratic governments ensures a credibility for the enforcement of contracts and law and would thus provide a low risk environment that businesses prefer, resulting in attraction of FDI. Conversely, in authoritarian regimes, guidelines as these are less likely to be followed. Indeed, the World Investment and Political Risk 2011 published by the World Bank concluded that authoritarian political regimes are associated with an increased risk of expropriation (World Bank, 2012). This risk of expropriation is central to investment decisions. Furthermore, Feng (1997) argues that the existence of a democratic system can be related to stability in the political environment reducing government change that is not intended by the constitution. At the same time a democratic regime provides the opportunity for major government change within the political system, i.e. constitutional changes that should result in no or less political instability.

However, although some researcher have found democracies to be more stable than non-democratic forms of government, from a business perspective, the latter is not necessarily a risk factor for stability per se. Indeed, depending on the type of business the Multi-National Enterprise (MNE) is intending to conduct in the foreign market, an investment in an autocratic country might be preferable (Asiedu & Lien, 2011). Democracies, unlike autocratic governments tend to be unaccountable to their electorates . Consequently, more generous incentive packages may be provided to prospective investors, along with protection from labour unions (Li and Resnick, 2003) In addition, it is easier for firms to exploit their oligopolistic or monopolistic positions when they operate in autocratic countries (Li and Resnick, 2003). This is particularly true to the above defined companies (2) involved in primary resource acquisition as FDI in natural resource exporting countries tends to be concentrated in extractive industries. Moreover, businesses engaged in extractive industries favour a stable policy evironment because the exploration and extraction of minerals involve initial large amounts of capital, long gestation periods and a high degree of uncertainty. As democratic countries generally have more frequent changes of government officials, autocratic regimes might be more favourable to those particular MNEs. For example the German governing coalition had decided to ban the reprocessing of German nuclear fuel beyond the first of January 2000, which resulted in a loss of billions of dollars in future business to British and French nuclear fuel clients (Financial Review, 28 January 1999). These types of government policy changes are less likely to occur in an autocratic system.

In addition to the point made above, access to natural resources in the host nation is a main driver of FDI in extractive industries, and the resources are financially, politically and strategically important to the host nation. Consequently, the control of FDI of respective resources lies very much with the government. This means that access to invaluable production input can be enhanced through close ties with the government. (Asiedu & Lien, 2011). These ties and relationships are easier to foster in autocratic than in democratic regimes. To conclude, it is important to understand that a democratic system facilitates FDI in countries where the share of natural resource in total export is low, but has a negative effect on FDI in economies where exports are largely dominated by natural resources. Evidence for this can be inferred from the fact that democratic government is positively linked to FDI only if the share of natural resources in total exports is low (Asiedu and Lien, 2011).

The following two cases, will examine the influence of social unrest on extracting MNEs in Africa. In Nigeria, despite of decades of political instability culminating civil war in the 1960s, international oil companies operated successfully in the country since the resources have been discovered in the 1950s. In the early 1990s the Ogoni group acted as a non-violent opposition to the oil companies over the contamination of their region and unsatisfactory financial benefit from oil revenues. In 1995, Ogoni author and campaigner Ken Saro-Wiwa was charged with incitement to murder and executed by Nigeria’s military government. In 2009, in a settlement accusing Shell of collaborating in the execution of Saro-Wiwa and eight other tribal leaders, the oil conglomerate agreed to pay £9.6m out of court,

In another case in South Africa, police had been involved in a massacre opening fire on mine workers, where more than 30 striking miners had been killed according to the South African police ministry. Despite apartheid having ended 18 years before, the protests indicated that the nation is still struggling with inequality as well as poverty and unemployment issues. The strike and the government’s violent response show that large parts of the population are unsatisfied with slow pace of transforming South Africa’s largely white-owned business establishment, including a growing perception that the governing African National Congress (A.N.C.) and its allies have become ‘too cozy’ with international businesses.

Though any conclusions drawn from these examples should be examined carefully, the cases suggest that international businesses may exploit host government support to an extent that feed social inequalities and subsequently lead to political instability through increased risks of social unrest.

Although, particularly in Arfrican countries, political instability has been and continues to be an issue during colonialism, independence and apparent neo-colonialism’, there are also success stories as seen with the positive collaboration between international businesses and Botswana as an other extractive economy.

The example of Botswana shows how democratic political institutions, secure property rights and law enforcements as well as prudent macroeconomic policies are possible even in the poorest societies and that the political stability that comes with it can lead to sustainable external investments and hence long term economic growth. In fact, Botswana had the fastes average rate of economic growth in the world during the past four decades. While the country is very rich in diamonds it also has big non-mining industries such as cattle ranching. The countries success can mainly be justified through its excellent set of indigenous sociopolitcal institutions that prevented explotation of certain elites and thus ensured political stability. This has been complemented by good leadership qualities since diamond exploitation began in the 1970s. For example, the transferring of property rights over soil diamonds from the Bangwato tribe to the government had reduced conflict among tribes over the resources. Morever, when the political hegemony of leader’s party began to be challenged it did not engage in clientelism, but improved and expanded education in the country (Acemoglu ….)

Whereas in Nigeria, for example, some regional leaders and their followers refuse children to government-run schools, as they do not seing education as a priority, the government in Botswana seems to have found the right mix of policies, investing in education, infrastructure and healthcare that promote political stability and hence favourable business environments for MNEs and investors.

Moving on from exploitive industries to MNEs that are interested in foreign consumer markets (1), an insight into the soft-drink giant PepsiCo international business activities will be given. It will be examined how profits and reputation in the domestic market have indirectly been affected by its operations in one of its host markets, Burma (Myanmar).

Burma gained its independence from British rule after World War II. For one and a half decades it remained a demogracy until a group of military leaders established a social republic through a government coup. The newly formed military government in 1988 opened the economy gradually to foreign investment and private enterprises. PepsiCo was one of many American companies that responded favorably to the invitations of the government. In 1990 Pepsi entered the market via a franchising agreement and FDI. However, the government’s had a very negative record on human rights and its military has been knownforced hundreds of thousands, if not millions, of ordinary Burmese to “contribute” their labor, often under harsh working conditions. Soon, PepsiCo began to feel the negative effects of consorting with a censured host state, as consumers in the US including a network of students on about 100 campuses began to boycott their products. Critics claimed that, by doing business in Burma, American companies were helping prop up the repressive military government of that country through taxes and other means. After suffering from loss of business contracts in the US, Pepsi’s announced its partial pull-out from Burma in 1996, which resulted in further protests, followed by the complete pull-out in 1997. Ethics/BECG026.htm

Surprisingly, in August 2012 PepsiCo announced plans to re-enter Burma. PepsiCo stated that it will partner with UNESCO and that the two companies plan to work together 1) to provide programs focussing on managerial skills training to support the country’s development and 2) strengthen its people and 3) empower the workforce. This statement suggests that PepsiCo has learned from its previous experience in the country. Its collaboration with UNESCO aims at preventing negative perception of the general public towards its collaboration with a government that has been claimed to exploit its labour force and is associated with large-scale and bloody riots during times of economic declines.

Tayeb (2000) points out that all businesses function ‘within a globally defined non-market environment’. Thus, when evaluating political risks only on a national level, risks resulting from events in the international political community may be missed out on (Stopford, 1994) The following example will therefore look at how businesses can also be affected by political risk influenced by political tensions between two or more economies: In course of the crisis in Ukraine, the EU and USA have issued economic sanctions at Russian companies associated with Russia’s annexation of Crimea or those stirring up unrest in eastern Ukraine. In return Russia has started to indirectly sanction western companies doing business in Russia. For instance, McDonald’s business has been affected when Russian consumer protection officials declared that its sale was illegal because of “inappropriate physical-chemical parameters” earlier this year. As a consequence, 12 McDonald’s restaurants in Russia have been temporarily closed. This reaction, which is believed to be a response to the western sanctions, is a political threat to McDonald’s in particular, as it counts Russia among its top seven global markets. The current closures only appear to have a minor effect on the multi-billion dollar fast food franchise. However, it shows that when international relations sour, economic sanctions are a popular instrument of international coercion (Tayeb, 2000). In this particular case, territorial disputes were the initiator for the political instabilities. Subsequent sanctions, human right abuses, ideological differences and protectionism can also be the cause of sanctions that may have a negative impact on international business.

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