Chapter 4 The political, legal, economic and technological environment

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1 Slide 4.1 Chapter 4 The political, legal, economic and technological environment

2 Slide 4.2 Political risk Uncertainty that stems, in whole or in part, from the exercise of power by governmental and nongovernmental actors (Zonis, M. 2000).

3 Slide 4.3 Types of political risk Macropolitical risks: affect all firms in the country, e.g. war, inflation Micropolitical risks: affect only certain firms in the country, e.g. legislation preventing smoking in public places.

4 Slide 4.4 Analysing political risks Type Inflation Currency devaluations/depreciation Currency revaluations/appreciation Increased taxation Impact on firms Higher operating costs Reduced value of repatriated earnings Less competitive in overseas markets and in competing against imports in home market Lower after-tax profits

5 Slide 4.5 Quantifying political risk (1) Can give a score to a particular political risk, high score meaning greater political risk E.g. legal requirements regarding environmental pollution might be given a range of scores from 4 to 8 Some legislation is inevitable (4 minimum score), worst case is still more legislation (8 maximum score).

6 Slide 4.6 Quantifying political risk (2) Can use expected value (EV) EV = n i 1 px where p i = probability of outcome i (as a decimal) x i = value of outcome i n = number of possible outcomes. i i

7 Slide 4.7 Quantifying political risk (3) Firm estimated a 60% probability of a strike occurring so that profits are 10 million and a 40% probability of a work to rule occurring so that profits are 20 million. The expected value (EV) of a labour dispute : EV ( m) = ( ) + ( ) = 14 m. A change in the firm s assessment of the probabilities of these events occurring or the value of their impact would change the expected value calculation.

8 Slide 4.8 Prioritising political risk (1) Figure 4.1 Prioritising (political) risk

9 Slide 4.9 Prioritising political risk (2) Responses to political risks Improve relative bargaining power Adopt integrative techniques Adopt protective and defensive techniques Drivers of political risk External Interaction Internal.

10 Slide 4.10 Improve relative bargaining power MNEs may seek to develop a stronger bargaining position than that of the host country itself. E.g. MNE creates a situation in which the host country loses more than it gains by taking action against the company. MNE may threaten to leave the host country if the company is forced to meet certain governmental regulations (with significant job losses) to avoid such regulations.

11 Slide 4.11 Adopt integrative techniques Integrative techniques ensure that the subsidiary is as fully integrated as possible with the local economy, so that it becomes part of the host country s infrastructure. Helps generate host country commitment to the success of the MNE.

12 Slide 4.12 Adopt protective and defensive techniques MNE seeks to limit, in advance, the costs to the MNE should the host government interfere in its activities. Little local manufacturing Locates R & D outside the host country Hires only essential local personnel Manufactures the same product in many other countries Etc.

13 Slide 4.13 International legal environment Types of legal system Common law Statutory law Code law Religious law Bureaucratic law.

14 Slide 4.14 Common law Legal system in the UK and its former colonies, including the USA, Canada, Australia, India, New Zealand, and much of the Caribbean Essentially unwritten, developed over long periods of time and is founded on the decisions reached by judges over the years on different cases When a judge makes a decision, a legal precedent is then established Such case law has evolved over the centuries, which means that there will obviously be legal variations between countries E.g. manufacturers of defective goods are more liable to litigation in the USA than they are in the UK.

15 Slide 4.15 Statutory law Involves legislation, i.e. the laws passed by government. This can also be a source of legal variation between countries. E.g. the US Freedom of Information Act is more far reaching than similar UK legislation, so that transactions between the government and companies have to be more transparent in the USA than in the UK.

16 Slide 4.16 Code law This is the world s most common system. It is an explicit codification in written terms of what is and what is not permissible. Such laws can be written down in criminal, civil and/or commercial codes. When a legal issue is in dispute, it can then be resolved by reference to the relevant code. Most continental European countries, together with their former colonies, follow this type of legal system.

17 Slide 4.17 Religious law Based on rules related to the faith and practice of a particular religion. A country that works in this way is called a theocracy. E.g. Iran where mullahs (holy men) determine what is legal or illegal depending on their interpretation of the Koran, the holy book of Islam. May pose problems for firms operating in these countries, e.g. the Koran says that people should not charge others interest as this is an unfair exploitation of the poor. Thus banks charge up-front fees, and owners of bank deposits are given shares of the bank s profits rather than interest. In countries relying on religious laws there is often an absence of a due process and appeals procedure.

18 Slide 4.18 Bureaucratic law This occurs in dictatorships and communist countries when bureaucrats largely determine what the laws are, even if these are contrary to the historical laws of the land. MNEs operating in such countries have often found it difficult to manage their affairs as there tends to be a lack of consistency, predictability and appeals procedures.

19 Slide 4.19 National laws and international business National laws may impact international business via: Trade restrictions Foreign ownership restrictions Environmental restrictions Exit restrictions Etc.

20 Slide 4.20 Law making in the EU (1) An outline of the consultation procedure for law making in the EU

21 Slide 4.21 Law making in the EU (2) EU law takes four main forms: Regulations: apply directly, no national measures needed to implement them. Directives: EU objectives must be met, but the means to achieve them is left to individual nations. Decisions: binding on all members of the EU. Recommendations: optional.

22 Slide 4.22 EU competition policy Articles 81, 82, 87 and 88 of the Treaty of Rome 1958 give the European Commission powers to control the behaviour of monopolies and dominant firms where these are found to restrict competition. European Commission can also intervene to prevent member governments using tariffs, subsidies or state aid to distort competition within the EU.

23 Slide 4.23 EU competition policy and economic efficiency No presumption in EU that mergers are against public interest. Each case can be investigated by the European Commission on its own merits. European efficiency can be broken down into two elements: Productive efficiency: larger size may reduce average costs Allocative efficiency: larger size may give market power to raise prices above marginal costs. Key issue is the net outcome of any proposed merger.

24 Slide 4.24 Settling international disputes Which country s laws apply? In which country should the issue be resolved? What techniques to use: Litigation Arbitration or mediation Negotiation?

25 Slide 4.25 Litigation The principle of comity provides for a country to honour and enforce within its own territory the decisions of foreign courts. Comity requires three conditions to be met: Reciprocity between the countries Proper notice given to the defendant The foreign court s judgment does not violate domestic statutes or treaty obligations.

26 Slide 4.26 Arbitration or mediation Court cases can be costly and time consuming, so many companies may prefer the process of arbitration. Arbitration: the two conflicting parties agree to abide by the decisions of a third party. Mediation: a third party attempts to bring the positions of the conflicting parties closer together.

27 Slide 4.27 Government disputes Sometimes a company may be in dispute with a national government, so few legal options E.g. the Foreign Sovereign Immunities Act of 1976 in the USA provides that the actions of foreign governments against US firms are beyond the jurisdiction of the US courts. If Germany, say, chose to nationalise IBM s German operation or impose taxes on IBM, there would be no redress for the company.

28 Slide 4.28 Negotiations International negotiations bring with them a whole new set of problems over and above those faced when negotiating domestically. Bargaining power of the MNE with host governments or businesses will depend on: The level of technology Nature of the goods or services Importance of its managerial expertise Value of its capital input, etc. The bargaining power of the host country depends on: The size of the consumer market The degree of economic and political stability, etc.

29 Slide 4.29 Intellectual Property Rights Patents Trademarks Copyrights TRIPS (Trade Related Intellectual Property Rights) Developed countries (since 1 Jan 1996) Developing/Transitional countries (since 1 Jan 2000) Least developed countries (from Jan 2006).

30 Slide 4.30 Patents Patent law confers ownership rights on the inventor. To qualify as the subject matter of a patent the invention must be novel, involve an inventive step and be capable of industrial application. Novel seeks to exclude granting monopoly ownership rights to something which already exists. Inventive seeks to establish that a step has been taken which would not be obvious to experts in the field. Industrial application limits such protection to specific applications of these ideas. Patents depend upon registration for their validity.

31 Slide 4.31 Trademarks Trademarks are any sign capable of being represented graphically which is capable of distinguishing goods or services of one undertaking from those of other undertakings (UK, Trade Marks Act 1994). This is sometimes referred to as the product differentiation function. Trademarks require less intellectual activity than patents or copyright to be deemed protectable, with the focus instead being on the commercial activity associated with such trademarks. As with patents, trademarks depend on registration for their validity, which gives the holder the exclusive right to use the mark in the UK for ten years, subject to further renewals in periods of ten years. Infringement occurs where others use the trademark without permission.

32 Slide 4.32 Copyrights (1) Copyright law prevents the copying of forms of work (e.g. an article, book, play, poem, music score, etc.) rather than the ideas contained within these forms. However, sometimes the copyright can be extended to the structure underpinning the form actually used (e.g. the plot of a book as well as the book itself).

33 Slide 4.33 Copyrights (2) Copyright (unlike patents and trademarks) applies automatically and does not require registration. Three key conditions: Work which is original, in the sense that the work is different from that of its contemporaries Of an appropriate description, i.e. literacy, dramatic, music, artistic, sound recordings, films and broadcasts all qualify. Even business letters can receive protection as literacy works Being sufficiently connected to the country in question, since copyright is essentially national in character. So in the case of the UK, the author (or work) must be connected to the UK by nationality, domicile, source of publication, etc. UK copyright extends to the life of the author +50 years.

34 Slide 4.34 TRIPS The WTO Agreement on Trade-Related Aspects of Intellectual Property Rights, is based on a recognition that increasingly the value of goods and services entering into international trade resides in the know-how and creativity incorporated into them. TRIPS provides for minimum international standards of protection for such know-how and creativity in the areas of copyright and related rights, trademarks, geographical indications, industrial designs, patents, layout-designs of integrated circuits and undisclosed information. It also provides for the effective enforcement of such intellectual property rights, and provides for multilateral dispute settlement.

35 Slide 4.35 Economic systems Market economy: resources allocated through the price mechanism, with market prices being determined by the forces of demand and supply. Planned or command economy: the government makes the decisions about what is produced, how resources are allocated and how the finished products are distributed. Mixed economy: contains features of both the market and planned economic systems, with the government intervening in various ways to influence market prices and resource allocation.

36 Slide 4.36 Market economy: advantages Resources allocated automatically via money votes. Consumers are therefore sovereign in deciding what is to be produced. Producers, motivated by profit, will have incentives to respond to changes in the preference of consumers.

37 Slide 4.37 Market economy: disadvantages Those with the highest incomes have most money votes. Competition may be imperfect, so firms may gain market power (e.g. monopoly) and so limit consumer choice. Externalities: some costs or benefits to society may not be reflected in the market system as costs or benefits to private firms or individuals.

38 Slide 4.38 Command economies Prices play little or no role in resource allocation. National plan gives road map with output targets for industries and firms. Input output analysis is often used in devising the national plan. Inconsistencies in plans and failure to anticipate real consumer wants often lead to unwanted production.

39 Slide 4.39 Mixed economies Use both markets and government intervention to allocate resources Government intervention both direct (public sector) and indirect (e.g. tax, regulations) Government intervention helps correct market failures 40% of UK expenditure/output involves government.

40 Slide 4.40 The market The market for a product is not a particular place but rather any situation in which the buyer and seller communicate with each other for the purpose of exchange. May be local, regional, national or international. May have no exact location, as with exchange via the internet. Can take a number of different forms: A product market, e.g. chocolate bars A labour market where individuals with particular skills supply their services to firms who demand those skills, and so on.

41 Slide 4.41 Demand Market demand is the total amount of the product that consumers are willing and able to purchase at a particular price over a given period of time. Factors influencing demand include: Price of the product Price of other products Household income Tastes Advertising.

42 Slide 4.42 Movement along the demand curve Movement along the demand curve is the result of a rise or fall in the price of the product itself. The terminology we use to describe this movement along the demand curve is to say that there has been either an expansion or contraction in demand for the product.

43 Slide 4.43 Expansion/contraction in demand

44 Slide 4.44 Shift in demand The demand curve will shift to the right (increase) or left (decrease) if there is a change in the conditions of demand. These conditions of demand include: Price of other products Household/national income Tastes of consumers Etc.

45 Slide 4.45 Increase/decrease in demand

46 Slide 4.46 Increase in demand Shift upwards and to the right. Change in conditions of demand Rise in price of substitute Fall in price of complement Rise in real income (normal product) Fall in real income (inferior product) Change of tastes in favour of product Rise in advertising expenditure.

47 Slide 4.47 Decrease in demand Shift downwards and to left. Change in conditions of the demand Fall in price of substitute Rise in price of complement Fall in real income (normal product) Rise in real income (inferior product) Change of tastes against product Fall in advertising expenditure.

48 Slide 4.48 Demand function Q X = F (P X, P O, Y, T, A X...) Quantity demanded of product X Depends upon ( = F) P X = own price of X P O = price of other products Y = real household income T = tastes of consumers A X = advertising expenditure on X.

49 Slide 4.49 Derivation of market demand Market demand curve is the total amount that consumers demand at a particular price over a given period of time. The market demand curve is derived from summing the individual demand curves horizontally.

50 Slide 4.50 Supply Market supply is the total amount of the product that producers are willing and able to provide at a particular price over a given period of time. Factors influencing supply include: Price of the product Price of other products Costs of production Tastes of producers Tax on product Subsidy on product.

51 Slide 4.51 Supply curve

52 Slide 4.52 Movement along and a shift in the supply curve Movement along the supply curve is result of a rise or fall in the price of the product. Shift in supply is the result of: A rise/fall in the price of a substitute in production A rise/fall in the price of a complement in production A rise/fall in the price of a factor of production Change in technology Introduction of a tax or subsidy on the product.

53 Slide 4.53 Increase in supply Shift downwards and to the right. Change in conditions of supply Fall in price of substitute in production Rise in price of complement in production Fall in costs of production Change of tastes of producers in favour Tax reduction Subsidy increase, etc.

54 Slide 4.54 Decrease in supply Shift upwards and to the left. Change in conditions of supply Rise in price of substitute in production Fall in price of complement in production Rise in costs of production Change of tastes of producers against Tax increase Subsidy decrease, etc.

55 Slide 4.55 Supply function Q X = F (P X, P O, C, T n, T X,T P...) Q X = Quantity supplied of product X Depends upon ( = F) P X = price of product X P O = price of other products C = costs of production T n = technology T X = tax rates (subsidy is negative tax) T P = Tastes of producers.

56 Slide 4.56 Derivation of the supply curve The market supply curve is derived from summing the individual firm supply curves horizontally.

57 Slide 4.57 Market equilibrium Equilibrium price relates to the price at which the quantity demanded equals the quantity supplied. Disequilibrium refers to a situation in which demand does not equal supply. This can lead to a situation of either excess demand or excess supply.

58 Slide 4.58 Price determination Equilibrium price and quantity

59 Slide 4.59 Free market economies Prices act as signals to both consumers and producers. Profits aid resource allocation Direct resources to the most profitable activities Reward risk taking Encourage productive efficiency (minimum costs) Provide resources (e.g. ploughed-back profits).

60 Slide 4.60 Role of price signals Price acts as signal to buyers/sellers Restoring equilibrium price and quantity in a free market

61 Slide 4.61 Increase in demand Rise in equilibrium price and quantity

62 Slide 4.62 Decrease in demand Fall in equilibrium price and quantity

63 Slide 4.63 Increase in supply Fall in equilibrium price, rise in quantity

64 Slide 4.64 Decrease in supply Rise in equilibrium price, fall in quantity

65 Slide 4.65 Maximum price A maximum price P* set below the equilibrium price P 1

66 Slide 4.66 Minimum price A minimum price P* set above the equilibrium price P 1

67 Slide 4.67 Price elasticity of demand (PED) Measures the responsiveness of the quantity demanded (QD) of a product to a change in its own price PED = % change in QD of X % change in price of X

68 Slide 4.68 PED terminology Elasticity values (ignoring sign) 0 perfectly inelastic 0 1 relatively inelastic 1 unit elastic 1 infinity relatively elastic Infinity perfectly elastic

69 Slide 4.69 Factors affecting price elasticity of demand Availability of close substitutes Whether the product is a necessity or a luxury Whether the product is habit forming The time period under consideration.

70 Slide 4.70 PED and Revenue (1) Relatively elastic demand if PED > I (ignoring sign) Fall in price: Total revenue rises Rise in price: Total revenue falls Relatively inelastic demand if PED < I (ignoring sign) Rise in price: Total revenue rises Fall in price:total revenue falls.

71 Slide 4.71 PED and Revenue (2)

72 Slide 4.72 PED and tax incidence Lump-sum tax: incidence of tax on consumer when demand is relatively inelastic and relatively elastic

73 Slide 4.73 Tax and government revenue Price elasticities of demand and government revenue from a lump-sum tax

74 Slide 4.74 Cross elasticity of demand (CED) (1) Measures the responsiveness of the quantity demanded (QD) of X to a change in the price of Y CED = % change in QD of X % change in price of Y Where X and Y are substitutes in consumption, CED is positive Where X and Y are complements in consumption, CED is negative.

75 Slide 4.75 Cross elasticity of demand (CED) (2) CED involves a shift in the demand curve (here for product A). Where A and B are substitutes in consumption, fall in price of B results in a decrease in demand for A. Where A and B are complements in consumption, fall in price of B results in an increase in demand for A.

76 Slide 4.76 Income elasticity of demand (IED) (1) Measures the responsiveness of the quantity demanded (QD) of X to a change in household or national income. IED = % change in QD of X % change in real income

77 Slide 4.77 Income elasticity of demand (IED) (2) Some goods and especially services (e.g. education, health, leisure) have high positive IEDs. IED may be negative over certain ranges of income for inferior goods and services. IED is useful in forecasting shift in demand when GDP is rising/falling.

78 Slide 4.78 Economic variables and international business Real income per head (standard of living) Economic growth (rate of increase of real income per head) Exchange rate Inflation rate Unemployment rate Tax and subsidy levels Technological change.

79 Slide 4.79 Technological environment Process innovation: new processes of production, i.e. New ways of doing things which raise the productivity of factor inputs Product innovation: new products (goods or services) which were not previously available Around 80% of technical change is process innovation.

80 Slide 4.80 Technical change and the level of employment Figure 4.4 Technical change and the level of employment

INSTITUTE OF ACTUARIES OF INDIA

INSTITUTE OF ACTUARIES OF INDIA EXAMINATIONS 2 nd November 2015 Subject CT7 Business Economics Time allowed: Three Hours (10.30 to 13.30 Hrs.) Total Marks: 100 INSTRUCTIONS TO THE CANDIDATES 1. Please