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Lecture 7

AFM333 Lecture Notes - Lecture 7: Country Risk, Totalitarianism, Limited Government

7 pages73 viewsFall 2017

Accounting & Financial Management
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Chapter 7: Political and Legal Systems in National Environments
The Nature of Country Risk:
- country risk (aka political risk): exposure to potential loss or adverse effects
on company operations and profitability caused by developments in a
country’s political and/or legal environment
- immediate cause of country risk is a political/legal factor, underlying factors
may be economic, social, or technological developments
Political and Legal Environments in International Business:
- political system: a set of formal institutions that constitute a government
- political systems are constantly evolving in response to demands and the
evolution of the national and international environment
- legal system: a system for interpreting and reinforcing laws
- legal system incorporates institutions and procedures for ensuring order and
revolving disputes in commercial activities, taxing economic output, and
protecting intellectual output and other company assets
- adverse developments in political and legal systems give rise to country risk
(ex: new government, shifting values/priorities in political parties, creation
of new laws/regulations, etc)
- country risk is always present, but its nature and intensity vary over time
and amongst countries
Political Systems:
- well-known totalitarianism states: Nazi Germany, Spain, China, and the
Soviet Union
- state attempts to regulate most aspects of public and private behavior
- seek to control economic and political matters, as well as the attitudes,
values, and beliefs of citizens
- over time, many of the world’s totalitarian states have either disappeared or
shifted towards democracy and capitalism
- belief that capital and wealth should be vested in the state and used
primarily for production rather than for profit
- socialism is based on a collectivist ideology where the collective welfare of
people is believed to outweigh the welfare of the individual
- government frequently intervenes in the private sector and in business
- has become the prevailing political system in many of the world’s advanced
- characterized by two key features:
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1) private property rights: the ability to own property and assets
and to accumulate private wealth
o important because they encourage individual initiative,
ambition, and innovation, as well as the desire to
accumulate wealth
2) limited government: government performs only essential
functions that serve all citizens
o state control and intervention in the economic activities
of private individuals or firms is minimal
o by allowing market forces to determine economic
activity, the government ensures resources are
allocated with maximal efficiency
Democracy’s Link to to Economic Freedom and Openness:
- compared to totalitarianism and socialism, democracy is associated with
greater economic freedom and usually higher living standards
- economic freedom flourishes when governments support the institutions
necessary for that freedom, such as freely operating markets and rule of law
- democracy is closely related with openness (lack of regulation/barriers to
the entry of firms in foreign markets)
- absence of excessive regulations also benefits buyers because openness
increases the quantity and variety of products available
The Relationship between Political Systems and Economic Systems:
- each political system tends to be associated with a particular type of
economic system
- generally, totalitarianism is associated with command economies, democracy
with market economies, and socialism with mixed economies
Command Economy:
- makes the state a dominant force in the production and distribution of g/s
- central planners make resource allocation decisions and the state owns
major sectors of the economy
- sizable bureaucracy thrives, and central planning tends to be less efficient
than market forces in synchronizing supply and demand
Market Economy:
- market forces determine prices
- government intervention in the marketplace is limited, economic decisions
are left to individuals and firms
- the task of the state is to establish a legal system that protects private
property and contractual agreements
Mixed Economy:
- exhibits the features of both a market economy and a command economy
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