A Plea for more Politics in the
International Business Research Agenda
by
Christian Harm
University of Münster
March 2001
Abstract
This paper suggests that current research on international business should provide for a more prominent role of Politics in its analysis. International research examines transactions that reach across national borders, yet nations and their borders have so far not been sufficiently operationalized to be integrated into a more comprehensive analysis. I draw on an existing paper by Charap and Harm (2000) that integrates rudimentary political structures into a generalized economic calculus. There, it is argued that Politics can be defined as rent-seeking, and that political regimes merely differ according to the nature of rent-seeking activities. This paper uses some stylized notions of political decision-making in dictatorial and democratic regimes to draw inferences on political attitudes towards international trade, direct
investment, and regional business clusters. An outlook for management policies towards political decision-makers is provided.
Outline
1 Introduction ... 3
2 International vs. Interregional Economic Activity... 5
3 An Economic Definition of Politics: Rent-seeking ... 8
3.1 Combat and Dictatorship ... 8
3.2 Gangs as a successful adaptation to the anarchy game ... 10
3.3 Predatory Hierarchies... 11
3.4 The Economics of Dictatorship ... 12
3.5 Towards “civilization”... 14
3.6 Rent-seeking democracies ... 15
3.7 Politics and the Law... 16
4 InterNATIONal Economic Activity... 17
4.1 Dictatorships... 18
4.2 Mature Democracies... 20
4.3 Weak Democracies ... 23
4.4 Summary of the economic effects of the political regime ... 25
5 Managing the Firm-Government interface... 25
6 Conclusions ... 28
1 Introduction
Notwithstanding the fact that Witold Henisz (1998) received the 1999 AIB Dissertation award for his work on Political Risk and Direct Investments, a casual survey of the leading Journals in the area of International Business reveals that the issue of Political Risk covers somewhat less than 5% of the publications, while Politics in general is hardly dealt with. The message that this paper wishes to convey is as simple as it is (hopefully) convincing:
International Business deals with economic transactions that transcend national borders.
National borders are defined by Politics. Thus, Politics as a phenomenon deserves to be an integral part of International Business research, at least to a greater extent than what the academic record shows at the moment.
Also, the issues raised with political content usually refer to a notion of political risk, which generally stands for adverse, or at least more volatile, shifts in attitudes of host governments with respect to international trade and foreign direct investments. A more general study of the political environment could lead to a more proactive view of management policies towards host country governments, including both issues of diverging and converging interests. For that, it is mandatory to describe the incentive structure of political actors in various regimes.
Hill (1999) describes in a text book setting the emerging attitude of governments towards foreign direct investment as “pragmatic nationalism”. What is that?
Depending on whether we look to modern industrialized democracies or semi-tribal dictatorships, the answer is likely to change. What is nationalism? The problems of
economists in defining an aggregate welfare function translate into obscurity when describing national objectives. Pragmatism on this level is thus unlikely. Much more promising, on the
other hand, is an approach to treat politicians as individuals facing certain incentives and constraints. Such individuals have objectives which we may assume they follow
pragmatically.
In order to put more structure into this analysis, we need to classify political regimes and describe for each the incentives and constraints faced by the political leadership. First and foremost, however, we need to integrate politics at least loosely into a generalized economic calculus in order to understand the role of politics in an economy, and derive its objectives with respect to the economy. Thereafter, we may also analyze the behavior of management versus politicians in a more structured way.
Describing the incentive structure of politicians is not such a novel idea. It has been at the core of Public Choice theory, which is part of the economic profession since decades.
However, that part of the literature has largely been concentrating on understanding
democracies, and in particular, the incentives of politicians inside US congress. I deviate from this setting by starting out with the paper by Charap and Harm (2000), which analyzes
“primitive” political structures in warlord economies or dictatorships. Here, politics is equated with rent-seeking. This definition of politics is then carried over to more mature regimes, where I argue that the nature of politics continues to be rent-seeking, albeit in a more
“civilized” setting.
Understanding politics in this way opens the floor to understanding the objectives of politicians as redistributive activities, whoever the beneficiaries may be. The attitudes of politicians towards international economic transactions then follow as a consequence.
The paper will progress as follows. Chapter 2 will briefly review some major theories of international trade and direct investment to argue that such theories can hardly distinguish international and interregional economic activities. The chapter ends by putting the existing theories into a context with recent research on the geographic distribution of economic activity and suggests that a “truly international” theory should study, how the introduction of a political border alters trade and investment flows over a geographic sphere.
Chapter 3 reviews the paper by Charap and Harm (2000) to classify political regimes, and derive some implications for the motivation of political actors. In chapter 4, I will merge the insights generated in chapters 2 and 3 to derive some preliminary implications for
international trade and direct investment, and the regional agglomeration of businesses. In chapter 5, I will then sketch out some insights relevant for managers of multinational enterprises. Chapter 6 serves to summarize and conclude.
2 International vs. Interregional Economic Activity
A brief, and necessarily incomplete, history of theories of international economic
transactions might start with mercantilism, which was later shown to be not an equilibrium concept: maximizing exports to accumulate gold creates inflation, which eventually restores the country’s trade balance. This logic could be equally applied to the Protestant work ethic, where people work a lot, and consume little, which is not an equilibrium either. Mercantilism is thus a concept applied to the relation among nations, but is equally applicable to smaller economic units, and thus has no special “international” focus.
An international focus could be generated by recognizing the political cast as a central agent in this setting. Recognizing mercantilist theories as contemporary to more or less predatory
aristocratic nations could open the question, whether the theorists might only have been talking about trade in goods, and that the political rulers were using the earned gold to finance foreign mercenaries in military conflicts1, which would restore equilibrium to the balance of payments. Recognizing mercenaries as imported services would render a policy of
maximizing the export of commercial goods “pragmatic nationalist” for an international regime characterized by ongoing predatory conflicts.
Leaving mercantilism, we arrive at Adam Smith’s concept of absolute advantage, to have goods produced in those nations that can produce them best. All would gain by trading.
Naturally, this concept of trade through the division of labor is applicable to individuals, groups, regions, as well as nations so that again there is no particular “international” element.
This holds also for Ricardian comparative advantage, which recognizes that some people or nations would do nothing since they do nothing best, and that this would be a waste of
resources. Still, the concept applies at all levels of aggregation, and has no particular
“international” dimension.
This century may be described at trying to identify the sources of comparative advantage.
Heckscher and Ohlin looked at capital and labor endowments of nations in a world, where the movement of both was rather restricted. Even inside a nation, however, workers do not move frictionlessly, and to some extent, the logic of trade driven by factor endowments can be translated to the interregional level. Today, where at least inside the EU there are but a few political impediments to the movement of labor or capital, the situation between and within
1 For casual evidence regarding the use of foreign mercenaries in conflicts the reader is referred to the excellent account of Fernao Mendes Pinto (1627, 1990) of either regional wars in 16th century Burma, or the futile struggle of Mongolia to conquer China in the same period, where the Chinese in part defended themselves by buying out the soldiers of the aggressor.
member states is identical, and displays that there is no truly “international” component of Heckscher and Ohlin.
Market power in a monopolistic or oligopolistic setting can be a source of comparative advantage, which is the basis of Vernon’s product life cycle theory, or Krugman’s new trade theory. With few alterations, Vernon’s theory can be applied to an East Coast producer, who develops his local market, starts “exporting” to the West Coast, and finally opens a production location there once the market has become large enough – a direct investment, but foreign?
Krugman’s logic may equally be translated to competition for monopolists by local tax authorities. The welfare effects are generated for the national as well as the regional level, depending on which unit of analysis is applied.
Finally, Porter’s diamond examines a wealth of factors that influence the competitiveness of nations and determine the competitive and comparative advantage of nations in certain
sectors. However, Porter’s (1998) recent work extends the logic formerly applied to nations to explain regional agglomeration of industries in clusters2. Again, there is nothing special about the international dimension.
The interplay of theories is illustrated in Figure 1. The regional agglomeration of industries in clusters as described by Porter leads to regional specialization and trade. Organization theory as for example put forward by Williamson (1985) can explain, why organizational boundaries may span across clusters3. Market power arguments may be similarly applied. The crucial
2 See also, for example, Dunning (1997).
3 Similarly, Calvet (1981) had argued that theories of foreign direct investment ultimately need to resort to organization theory to explain, why there is not a simple trade relation between economic agents in the respective countries.
question is, what the impact of the introduction of a national border would be on trade and direct investment patters as well as the location of industrial clusters.
Figure 1: Agglomeration, trade, and direct investment domestically and internationally
3 An Economic Definition of Politics: Rent-seeking
To introduce Politics to the above analysis, I will review the paper by Charap and Harm (2000), which discusses the internal dynamics of autocratic regimes in an economic context.
3.1 Combat and Dictatorship
The paper takes off by discussing theories that start from a green field: a society of anarchy with no Law or politics, but individuals that possess production as well as combat
technologies4. People in such a world can either produce or steal after having won combat.
Equilibria are different depending on the endowment of resources of the (two) players, and the decisiveness of combat technology. With equal endowments, players invest more when
4 Skaperdas (1992), Hirshleifer (1991a).
combat technology becomes more decisive. With low combat decisiveness, the players do not invest in combat and “peacefully coexist”5.
With unequal endowments and decisive combat technology, the weak player acquiesces, and is thrown into slavery. With indecisive combat technology, the weak “risk all”, and – at least in probability – appropriate wealth from the strong: the Paradox of Power6. Social output is higher in the equilibrium of slavery.
These combat equilibria are compared to theories of dictatorship7. Here, dictators tax peasants and hire them as soldiers, while peasants work as farmers, soldiers, or
revolutionaries that intend to overthrow the dictator. Insights gained are that strong dictators impose less taxes, there is less combat activity in equilibrium, and thus economic output is higher than with a weak dictator. The weak dictator has to accelerate consumption, since he won’t be in office for long.
A comparison between theories of dictatorship and combat theories exposes that they are much alike, except that the dictator has a tax rate that enters the optimization calculus, while the combat situation is an all-or-nothing game. The strong dictator represents the equilibrium of slavery, while the weak dictator comes closer to the Paradox of Power.
This exposes the weakness of dictator theories in that they do not really describe a process of social aggregation. Rather, they are indistinguishable from two-player games. Thus, the
5 Skaperdas (1992).
6 Hirshleifer (1991b).
7 e.g. Grossman (1991) .
important problem of a palace revolution is not captured in these models8. This is where the paper of Charap and Harm (2000) takes off.
3.2 Gangs as a successful adaptation to the anarchy game
Once economies of scale in combat technology are introduced, people band together to try and usurp others. The gang leader’s problem is to find a sharing rule with gang members that maximizes his expected income. A larger share for gang members reduces the likelihood of a palace revolution. A constraint in this setup is the size of the territory controlled: the larger the territory controlled, the more income can potentially be generated through theft, but the larger the probability of a peasant revolution.
There is thus an optimal size of territory as well as an optimal size of the gang, since more gang members increase the controllable territory, but also the chance of a palace revolution.
If the controlled territories cannot be “fenced off”, there is always a chance that neighboring gangs collide in clashes over territory. The problem is, what to do after a won combat.
Integration of the defeated gang increases gang size beyond optimal limits, while integration of the territory expands the territory beyond optimal size. Without further alternatives, gang warfare has no winners.
This type of equilibrium of constant battles without gain in a gang or warlord economy is represented for example by naval traders in the middle ages. Pinto (1627, 1990) describes the situation among Portuguese and Asian traders in Asia of the 16th century, which permanently
8 Kirsch (1996) talks about dictatorships with reference to the „not so dangerous masses“ versus „the dangerous few“.
switched roles between peaceful traders and pirates. Similarly, Hanse traders and pirates in the Baltic Sea of the 14th and 15th centuries were battling each other on an ongoing basis.
3.3 Predatory Hierarchies
Whilst gangs are more successful than individuals at achieving an equilibrium of slavery under anarchy, resulting in higher social output, resources are still wasted in combat. The solution offered in Charap and Harm (2000) is the subjugation of defeated gangs. In this way, a hierarchy inside the predatory structure is created. A necessary condition for the hierarchy to be stable is that the subjugated gang has less resources than the “central” gang, has lesser combat power, and needs to pass a part of its predatory gains upstream to the central gang. A central gang could thus control a number of gangs that subjugate peasants.
Subjugation thus represents an organizational innovation that increases the optimal size of the territory controlled. The stability of the hierarchy depends on the allocation of power between center and periphery as well as the distribution of income to keep both the
opportunity as well as the incentives for a revolt from lower gangs in check. Once one such level of hierarchy is created, it is a simple leap of faith to extend this logic to more levels: a predatory hierarchy is created as a successful innovation to the game of anarchy, the ancient Roman concept of “Divide et Impera”.
Similarities of such reasoning are for example found in the literature on organized crime9. Indeed, mafias can be then regarded as the nucleus of the state. For example, Skaperdas and Syropoulos (1995) describe the rudimentary constitutional role of predatory teams and liken them to “primitive states.”
Yet, there is the question how neighboring mafias avoid conflict. Here, geography can come into play. A stable territory will suitably be defined by areas, where defensive combat
technology is stronger than offensive technology: rivers, coast lines, mountain ranges. Inside such areas, a predatory hierarchy establishes an equilibrium of slavery, between such areas we have an equilibrium of “peaceful coexistence”.
This is the birth of the nation state. Nations arise from a quest of warmongering gangs for hegemony. Baumol (1995) speculates that a fruitful approach to research would be to:
“interpret most governments in human history as gangster associations,” and he maintains that: “Governments concerned with the welfare of the governed and constrained by rule of law from arbitrary and violent measures are the rare exception in human history, perhaps most realistically interpreted as a curious aberration of a very recent period in rather limited
portions of our planet."
3.4 The Economics of Dictatorship
Taxation in such a model of dictatorship is pure rent-seeking. In order to balance revenue and security objectives of the dictator, taxes are passed through a predatory hierarchy, where the amounts that are retained become larger with each level.
The dictatorship games as represented by the paper by Grossman (1991) presume a simple tax rate to be applied to the citizenry. However, this poses three problems: first, there is a collection problem when individual incomes need to be verified. Secondly, incomes in a competitive economy would accrue to the decentralized owners of financial and human capital, which implies large collection costs. Third, the dictator prefers monopolistic
9 Franzini (1995) asked: “What is to prevent us from regarding the mafia as an organizational structure that
organization of the economy as long as he can tax the monopolies appropriately. The dictator – like the monopolist – is interested to capture the consumer surplus.
Monopolies are preferable to a competitive environment since they allow the dictator to capture consumer surplus and minimize collection cost. They are also compatible with the principle of predatory hierarchies, since managerial positions in such structures are well equipped to be part of a patronage network.
Not all aspects of an economy lend themselves to an organization as a monolithic structure.
Rather than effecting public ownership in all sections of society, the dictator can alternatively create bureaucracies in charge of demanding licenses for all sorts of businesses. The
bureaucracy then has a revenue motive, but needs to be equally a part of a patronage network to reduce the probability of a palace revolution.
This is the birth of corruption pyramids that function as a part of a predatory hierarchy in a stable dictatorship. The governments licensing monopoly serves both the direct revenue interest of the government, but also opens the way for lower level bureaucrats to exploit their monopoly to support corruption proceeds. Thus, corruption in this setting is not decentralized and coincidental, but systemic in that it supports the stability of a dictatorship as part of a patronage network10. Corruption pyramids represent an efficient form of rent-seeking for a dictator.
Examples are not hard to come by. Pinto (1627, 1990) describes also economic aspects of Chinese society in the mid 16th century. There is a detailed account of the licensing structure
protects mafia firms on the basis of the advantages it offers with respect to individual protection?”
of business, including – but not limited to – a description of how the entire value chain in the fishing industry is separated into different tasks that all need an official license. More
recently, Ferdinand Marcos of the Philippines was successful at monopolizing the scattered sugar and copra industries through so-called marketing boards that are infamous across the developing world. That Mr.Benedicto, the former head of the sugar cartel, was on the plane Marcos used to flee from Manila to Hawaii in 1986 may have been no coincidence. De Soto (1989) argues that onerous Peruvian licensing requirements for businesses were installed solely for the purpose of creating sources for corruption income.
As a corollary we can suspect that one aspect of the historic struggle against this type of government is not the elimination of the deadweight loss inherent in all monopolies, but a distributional struggle over the consumer surplus. The triumph of democracy is also a triumph of the masses to regain the consumer surplus: the majority would always vote for competition and against monopoly.
3.5 Towards “civilization”
Social progress did not end with dictatorial or aristocratic structures. Grossman and Noh (1994) motivate the development towards a more benevolent monarch by recognizing that a dictator can always renegotiate all contracts, which implies that there is a minimum credible tax rate. The more secure the dictator is, the lower this minimum tax rate, and the more likely a development to a society with solid legal foundations, which improves economic growth.
Grossman (1995) explains the development of the welfare state as an attempt to prevent more costly forms of redistribtion such as theft or revolution.
10 Correspondingly, a policy of „Zero Tolerance“ towards corruption as voiced by World Bank President James Wolfensohn deserves to be critically rethought in this context: an isolated campaign against corruption may well erode an existing government, thereby leading a country towards anarchy.
In the context of predatory hierarchies and corruption pyramids, however, this means that the corrupt bureaucracy, which previously stabilized the dictatorship, now becomes a hindrance to further economic growth. The patronage network becomes less important. The bureaucrat extorting rents for his services is now “truly” corrupt. At this point of
development, a devolution of some powers to a Parliament becomes feasible.
3.6 Rent-seeking democracies
Once we have defined politics in primitive societies as rent-seeking, the concept can be extended to cover democracies. Corruption would in this setting no longer involve exploitation of a position of power for personal gain, but for party coffers to maximize reelection chances. Johnston (1997) calls this weak democracies.
Yet, even a functioning democracy may be based on rent-seeking in the form of interest groups, which elect politicians to effect redistribution in their favor. This is a classic argument in Public Choice Theory, represented for example in the work of Mancur Olson (1982). With differently motivated politicians, government programs as a whole are likely to be internally inconsistent and not geared towards growth, but the system would only change towards social welfare objectives if the redistributive legislation packages would all be transparent, and every voter would know if they are net winners or losers of existing legislation: a hopeless task in all societies.
Thus, the different political regimes can be classified into separate structures that define themselves via different modes of rent-seeking, as shown in Table 1. A historical progression from top to bottom is suggested.
POLITICAL REGIME RENT-SEEKING PATTERN
Anarchy ‘Each against All’
Warlordism / Weak Dictatorship Competitive Corruption
Strong Dictatorship Monopolistic Corruption
Benevolent Monarchy ‘True’ Corruption
Weak Democracy Political Corruption
Functioning Democracy Interest-Group Rent-seeking
Table 1: Rent-seeking patterns and political regimes
An important insight at this point would be that the direction of legislation is much harder to predict in democracies than dictatorships. Here, all issues discussed in the Political Economy literature regarding the formation of voter beliefs become relevant. Cultural values, political ideology, or short-term trends determine the composition of government, leading thus to much more variety of experiments in the democratic tradition than in dictatorial societies.
3.7 Politics and the Law
An important aspect of the political structures is the legal environment they generate. I am going to concentrate here merely on aspects relevant to economic transactions, first and foremost contract law. The issue is not so much the type and / or quality of the written law, but the enforcement of such law.
Under anarchy, there is by definition no law that is accepted and enforced. Also in a mafia / warlord economy, in which Mancur Olson (2000) calls the leader(s) the roving bandits, definition of a legal code is not sensible. Only inside gangs we observe pseudo-legal
structures. Economic agents outside the gangs would have no courts to settle contract disputes.
Dictatorships, however, have an interest to define contract law and install courts so that the economy that they tax has more growth potential. Here, however, we face an enforcement problem: as long as average citizens go to court to settle contract disputes among themselves, the law intends to be impartial and consistent in order to create an efficient economic
environment. However, as an average citizen is pitted against a member of the patronage network of the ruling elite in court, the courts must support the member of the elite. Disputes inside the elite are settled according to the position in the hierarchy.
Only as societies develop further will we see a strengthening of the courts in that people are equal before the law. In weak democracies we would see politicians trying to escape the Law through immunity provisions or similar devices. The mature democracy based on rent-seeking interest groups has a fully independent legal and court system. We have arrived at the
standard economic modeling world of functioning contract enforcement at all levels.
4 InterNATIONal Economic Activity
We now have a rudimentary theory of political structures that can be applied to the question of how political borders change trade and investment patterns or the structure and location of regional business clusters. I will start off with some issues regarding dictatorships.
4.1 Dictatorships
In a dictatorship, we expect to see crony capitalism: allies of the dictator run (state owned?) monopolies. These monopolies are necessarily inefficient and have the political power to effect import tariffs to protect them from competition from abroad. Thus, trade is only feasible in sectors that do not compete with firms that are part of the crony elite. This, however, exposes a secondary problem. Custom officials hired to secure borders against unwanted goods have themselves a power base to command corruption proceeds. Bardhan (1997) quotes sources from ancient India that have recognized the problem of corruption against the ruler’s interest. The ruler has an unsolvable problem. On the one hand, the interest of the patronage network in the (monopolized) economy need to be supported, on the other hand custom positions lend themselves well to reward loyal individuals. Krueger (1974) estimates corruption proceeds at customs in Turkey and India in the 1960’s to amount to some 10% of GDP. In general, one may presume that the weaker the dictatorship, the more open the corruption at the border, and the more open the conflict between customs and cronies.
This trade policy applies to all forms of dictatorship, including Communist systems. They may help explain, why reforming countries that still have a large sector of publicly owned monopolies go through such agony to reform their trade policy. The thorny issue of Chinese tariff reform in the Special Economic Zones in the mid 1990’s, as well as the issue of Chinese membership in the WTO fall into this category11.
Since the dictator’s objectives are largely consumption oriented, imports may well receive more legislative support than exports, although this conflicts with mercantilist trade policy.
11 In an article on possible Chinese membership in the WTO, The Wall Street Journal Europe quoted the China Business Information Times in November 1999 with the words: „China remains a country ruled by men, not Law. Cronyism remains rampant.“
The reason is that the patronage network is supported by raising the standard of living of members of the hierarchy by subsidizing imports. Weaker dictatorships are in greater need of stabilizing their regime in this manner, and are thus more likely to take action accordingly, for example through a central bank policy that keeps the domestic currency overvalued against foreign currencies.
Attitudes towards foreign direct investment in dictatorships are also motivated by rent- seeking objectives. Investments that compete with domestic crony firms are not desirable and are discouraged. On the other hand, investments that serve a previously unmet need in the recipient country may be welcome, but are likely to fall into a similar regime to the one for domestic crony businesses: the dictator wants to include them in the domestic patronage network. This can mean that market exclusivity may be granted by the government, but at the same time, a local partner of the political elite must participate in the venture. Possibly, a member of the local elite must be part of the management of the company.
This environment affects international trade and investment patterns also on a secondary level. Rents due to the monopolization of the host market can only be earned when the
company is physically present and shares profits with the local elite. Thus, a simple argument of rent protection would bias the decision of a multinational firm from trade towards direct investment. If the MNE would export its goods to the respective country, the rent stream would be earned by the importer. Yet, the value of the rent stream must be balanced against the increased political risk that is inherent in autocratic structures. The weaker the
dictatorship, the more likely a future transition of power, and with that greater possible scorn against foreign firm that supported the ousted regime – if only indirectly.
Also the location of economic clusters is affected by the logic of a dictatorial society. Since the economy is driven by the rent-seeking desire of the ruler, and since the political and economic elite relies on personal loyalties, the most likely center of economic activity is the center of political power, the capital. Since we know that clusters generate positive location externalities, even a transition of power towards a more democratic regime is not going to eliminate the political capital as a center of economic power: the “Old” European countries still host a sizeable sector of their economies in or near the capital, while this is much less visible in the “New” democracies USA, Canada, and Australia.
4.2 Mature Democracies
In mature democracies, politicians perform rent-seeking activities not for themselves or their parties, but are hired by their constituency to redistribute wealth to “their” electorate.
While the detailed interest group structure depends on the social equilibrium in each country, and may thus take many different forms, there are nevertheless a few universal truisms.
Probably most importantly, labor receives a better lobby than consumption. This may be grounded in a number of factors.
a) Many industries – particularly for consumer goods – have a small but significant size, and are thus an ideal interest group in the logic of Mancur Olson. The customers of such industries tend to be society at large, and are thus not an efficient interest group for political rent-seeking purposes. A good example would be farmers and farm product consumers. Politicians can be expected to pass legislation in favor of farmer and against consumer interests.
b) For the individual, employment is a 0-1 variable. Thus, job loss introduces significant risks to life-time consumption levels. To the contrary, each decision regarding isolated consumption goods is of marginal interest to the individual. Thus, individual risk calculations would lead employed individuals to prefer legislation guaranteeing job stability at the expense of legislation guaranteeing cheaper products.
c) The Protestant work ethic is negatively biased against consumption. Consumption oriented legislation is ‘hard to sell’.
Thus, politicians can be expected to balance legislation in favor of labor rather than consumption. At the same time, however, politicians in mature democracies are expected to pass legislation favoring economic growth and general welfare. These two opposing forces determining actual legislation can be seen as inconsistent with each other.
An illustrative example from political choices with respect to international trade can be seen inside the EU or in negotiations leading up to the WTO. The originators of policy are largely driven by the Ricardian spirit that free trade increases general welfare for all countries involved. When political leaders negotiate the details of legislation, special interests from the individual countries are assuming center stage in the international arena. When politicians return home, they may actually counter the intentions of the international agreement. Thus, the Dutch government had to be convinced by the European Court of Justice through the Van Gend en Loos ruling that the Treaty of Rome was to obeyed, which in this case prohibited the issuance of larger tariffs on individual goods in the relevant time period.
The international trade policy of mature democracies can then be described as “Neo- mercantilism”. The objective of politicians is not to maximize exports in pursuit of foreign exchange earnings (although Balance of Payments reasons are also often invoked by
politicians), but to protect employment in certain sectors in the domestic economy. Of course, politicians are equally active to promote open access to foreign markets for those products, where domestic exporters have a good lobby.
Thus, unlike in dictatorships, democracies would unilaterally favor exports over imports, which may be mirrored in a policy of currency undervaluation. The Beggar-thy-neighbor policies of the interwar years come to mind.
The policies towards incoming foreign direct investments in democracies are likely to be supportive. For one thing, inward FDI add to domestic employment, and are thus welcome.
Secondly, they contribute positively to the Balance of Payments at the time of transfer, which also comes out in favor of FDI. Actually, inward FDI may be a result of a hostile trade
environment to sidestep possibly adverse trade legislation. However, domestic employers may still constitute an efficient interest group that lobbies the government against more
competition in their home market. Typically, however, those same employers as a group seek access to foreign markets for their own subsidiaries. Thus, policies in mature democracies can be expected to come out in favor of inward FDI. At the same time, politicians can be expected to discourage the exit of domestic firms to foreign countries if this is connected to substantial job losses.
Together with a neo-mercantilist trade policy, the attitude towards FDI imply that politicians aspire a state that cannot be a Balance of Payment equilibrium. It is then not surprising that politicians in all major democracies around the globe mourn the loss of sovereignty due to increased “globalization”12, and the “dominance of markets”. We are at a loss, however, to imagine what kind of international equilibrium would materialize if
12 See for example Lipsey (1997) for a discussion of this issue.
politicians had it their way: all countries can by definition not be net exporters and net recipients of FDI13.
Also the location of successful clusters of economic activities that focus on a narrow set of industries or skills is affected by the dynamics of mature democracies. According to the (democratic) dictum that all politics is local, targeted support for the development of isolated clusters is not easy to achieve in the political process. While there is now some agreement on efficient regional policies by governments14, political dynamics are not suited for targeted regional policies. If they are, politicians would be more likely to support laggard regions, which is not conducive to the specialization of regions.
Since it is hard to encompass many different industries and accordingly different clusters in the same legislative package, packages dealing with one industry are more likely to spread government support over many regions, which is the opposite of the advocated policy.
In short, mature democracies that function according to the logic of political interest groups as argued by Mancur Olson generally have to grapple with the issue of inconsistent policies, which in equilibrium cannot match the expectation of all voters. Policies regarding
international economic transactions are no exception.
4.3 Weak Democracies
In weak democracies, much the same dynamics are at work as in mature democracies, but the system is clouded by a layer of political corruption: politicians expropriating wealth not for their own pockets, but to seek reelection. The Legal Code would typically identify such
13 Although trade statistics seem to suggest that the World as a whole has an export surplus ....
behavior as illegal, so that these activities have to be clandestine. Although few official truths regarding such activities have come to the surface, recently politicians in France, Germany, Italy, Japan and many other countries have been charged with such behavior.
The clandestine nature of the acts surrounding political corruption support the development of organized crime, since politicians would have an incentive (as much as they can) to protect the “donors” of illegal political contribution from legal persecution. Being situated outside the Law, contracts are not enforceable, and such structures have to develop their own “Law”. The relatively unimpeded activities of the Yakuza in Japan15 may find their explanation here.
Ironically, the corruptibility of politicians in a weak democracy works against precisely those pieces of legislation that describe a mature democracy, and that cannot constitute an equilibrium. We would then find countries actually being less ”neo- mercantilistic” than politicians had implicitly promised their voters: more exceptions to import restrictions, less restraint of outward FDI. In fact, the incentives for politicians to become corrupt are created in the first place by the policies that turn out to be inconsistent with an equilibrium. The practice of political corruption is, of course, determined by the strength of the Law.
Just like corruption in dictatorships, political corruption also creates rents for the businesses involved, and thereby bias the choice of trade versus FDI in the direction of FDI. On a
secondary level, however, the heightened incidence of organized crime increases political risk. Russia today is arguably the best case in point. Needless to say, such environment biases against all international economic activities, but more so against FDI. The net effect is
ambiguous.
14 e.g. Dunning (1997).
4.4 Summary of the economic effects of the political regime
This section has attempted to apply the logic contained in the paper by Charap and Harm (2000) to international economic activities. Dictatorships and democracies operate along different principles, and the attitudes of politicians towards international economic activities have been described. Since politics defines the territory of a nation and rules within, economic theories that deal with cross-border activities have to account for such behavior in order to be justly called “International”.
In this section, I have merely sketched a few avenues of how a recognition of the rent- seeking nature of politics can further our understanding of international economic
transactions. It is hoped that this is an impetus to stimulate more theoretical work in this area in order to define testable implications. A such enriched understanding of the relationship between economics and politics will then enable us to provide better guidance to managers acting in the international arena. The last section will provide a few thoughts on business implications of the above arguments.
5 Managing the Firm-Government interface
As mentioned in the outset, most studies in International Business that deal with the political cast analyze “Political Risk”. However, at least to some extent, risk management implies some notion of passivity. To the contrary, this paper wishes to suggest that businesses need to address the problems cast around Politics proactively. Not in the least, this implies lobbying, but it also involves some thorny ethical issues that this paper can only touch on.
15 Milhaupt and West (1999).
Multinational businesses need to be aware that they operate in many political environments.
Their involvement in a dictatorship, for example, may not be seen independently from the political forces in their home country. During the time of Apartheid in South Africa, when sentiment in Western democracies translated into pressure for resident MNE’s, one typical defense was that the standards of hiring black workers were better than in domestic South African firms, and so was the pay level or work conditions.
In fact, it would have been rational for many reasons, if the respective firms had followed these policies. It would be both beneficial for their reputation at home during the Apartheid regime as well as for a (then only potential) regime shift.
Thus, this article is far from recommending to business leaders to engage in corrupt practices at liberty when entering a dictatorship. An issue, however, is, in how far such activities can be avoided at all. If the only way to enter a country is through a local (crony) business partner in a Joint Venture, this by itself implies a support of a predatory hierarchy that Western democracies have unilaterally branded as unethical. Yet, the issue is not clear cut as long as International Community has accepted a nation in its midst as an honorable
member. Businesses cannot be asked to judge for themselves which countries are “ethical enough” to do business in. This has to be done by the domestic political leadership.
Still, businesses will more often than not be approached for some type of support, be it only in the relatively harmless guise of a Joint Venture partner16. They are well advised to accept such a partner. Given the above analysis of the legal system in dictatorships, a court dispute
16 Former President Suharto of Indonesia was said to be represented on the Board of well over a thousand firms, which is consistent with the stronghold that the political cast in a dictatorship has over the economy. In this environment, crony business partners are more or less the only viable business partners.
with a crony business cannot be won. Only a local partner of equal standing can guarantee a modicum of a chance in such a dispute.
Also, this paper does not want to encourage MNE managers to bribe politicians in democratic countries. Rather, they are encouraged to use legitimate avenues of lobbying in order to make sure that their views are incorporated in a piece of legislation relevant to them.
Lobbying, however, needs to adapt to the political regime in the host country as well as the political culture that prevails in that country.
An example may be the EU decision-making process. A US firm used to making (legal) campaign contributions to politicians is likely to see similar efforts frustrated in an
environment where unelected lower level bureaucrats define the largest part of the respective legislation in a process that may take years of discussions and revisions. The only way to address this environment would be via a more or less permanent representation in Brussels that seeks to influence the process from early on at a low level.
Recognition of the political cast as a relevant decision-making factor not only increases the need for proactive lobbying, but also for more educational activities versus the electorate in home and host country directly – especially in highly visible consumer industries. A casual glance at the media suggests that many managers have understood this well. This paper wants to suggest that the academic debate in this area should be intensified on a more solid
theoretical basis, and that student curricula should be further enriched in this direction.
6 Conclusions
This paper has proposed to intensify the role of Politics in International Business and Economic Research. While international research studies the nature of cross border activities, so far the nature of nations and national borders have not been sufficiently instrumentalized to be incorporated into the academic inquiry. This paper suggests to use an approach developed by Charap and Harm (2000) that defines Politics as rent-seeking activity, in which nations and national borders can arise endogenously. Different political regimes are described, and it is maintained that merely the nature of rent-seeking changes between regimes, but not the issue that Politics may generally be defined as such.
The paper proceeds to suggest some implications for research in international business and economics. Issues of trade policy, attitudes towards foreign direct investment, and the topic of the agglomeration of business activities in geographic clusters are discussed in dictatorial and democratic political settings. It is suggested that testable implications for international
research can be derived, leading to a furthering of our understanding of the international economy by incorporating political decision-making more closely into the analysis. Finally, an outlook on possible implications for managers of MNE’s is provided. Many managers already perceive the importance of addressing the political sphere in their environment. It is time that academia approaches the issue in a more structured form.
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