Political Tensions Are Creating New Rules for International BusinessPublished: September 22, 2008 in Knowledge@Wharton
After more than a quarter century of expansion following the collapse of the Soviet Union, emerging economies still promise opportunity but also political risk for international businesses. Growing income disparity in rapidly developing economies (RDEs), geopolitical tensions and anti-U.S. attitudes are among the broader political trends that could shape global business in the future, according to Wharton faculty.
"Increasingly, politics will intervene and political management skills will be valuable for multinationals," says Wharton management professor Witold Henisz. "What determines who wins in China and Russia and Brazil is not necessarily the best technology or market pitch or cost. Who wins is whoever can navigate the political game -- not just today, but tomorrow."
According to Henisz, emerging market countries are going through a "counter-movement" to the mass privatization and financial liberalization policies of the 1990s that focused on driving economic growth. Now, countries are taking a closer look at how economic growth should filter out through society. "A theme in many countries I'm observing is a new form of populism," he says. Emerging markets -- especially those rich in resources -- are beginning to demand more from foreign investors in return for giving outsiders access to natural resources, labor or growing consumer markets. Governments in emerging markets are less likely now to use foreign income for extravagances such as lavish government buildings. Instead, they are funding poverty alleviation programs and infrastructure that will support growth, Henisz notes.
Philip Nichols, Wharton professor of legal studies and business ethics, says the war on terrorism has the potential to distort global economies in much the same way the Cold War stalled growth in countries that were propped up by one side or the other. Countries that aligned with a particular side were rewarded with economic support but failed to develop their own efficient economies. Ultimately, the standard of living in those countries declined. If the United States and other Western governments prop up countries as a defense against terrorism, and Islamic governments similarly align, emerging nations caught on one side or the other may never build viable economies. "The war on terror could lead to a lot of distortive behavior, and emerging economies are especially sensitive to these types of distortions. We may see regimes propped up that make no political sense and that make astonishingly bad economic decisions," Nichols says. "That's too bad because a lot of people may suffer again."
Markets Reinventing Themselves
Another broad political trend that Nichols sees influencing global business is emerging countries' reluctance to accept ideas affiliated in some way with the United States. "A lot of emerging economies are just finding and reinventing themselves," he explains. "They're assiduously trying not to pick up ideas that come from the United States." Nichols says much of the animosity stems from the way in which the war in Iraq has been carried out, which he says has eroded trust in the United States and any goodwill generated following the Sept. 11, 2001, attacks. "If the United States becomes more sensitive to multilateral rather than unilateral action -- or threat of action -- that might change. But right now, it's something to keep an eye on if you are a businessperson."
Howard Pack, Wharton professor of business and public policy, notes that emerging markets have made strides in upgrading their financial and political systems to sustain growth. Some measures indicate there is less corruption and better legal enforcement in these countries, although he cautions that these measures are subjective evaluations, often of large foreign firms. "It's very hard to know which of these accurately describes true conditions on the ground."
Many countries have managed to move toward democracy, he says. Most Latin American countries have working democracies, which is a major change from the 1970s and 1980s. Pack points out that a number of African nations are also functioning as democracies. While Russia cannot be considered a "serious democracy," many of the nations in Eastern Europe are reasonably stable democracies, he notes. However, "some of the [emerging market] democracies that seem to be functioning well are fragile.... Six months ago, who would have predicted Kenya would fall into disarray?"
An important element of political stability in emerging markets has been the rise of international commodity prices -- owing largely to Chinese and Indian demand -- which has helped raise incomes in Latin America and Africa. However, the economic slowdown in the United States will adversely affect China and, indirectly, Africa and Latin America, Pack says. In Africa, there was little change in income per person from 1960 to 2000, but in the last five to six years there has been a significant upturn, primarily as a result of commodity sales to China. In the Middle East, emerging countries did well from 1960 to 1985, but suffered when oil prices fell. In the last four to five years, economies of oil-rich countries including Saudi Arabia and Kuwait have ascended. More populous Middle Eastern countries such as Algeria, Egypt, Morocco and Tunisia have enjoyed some growth, but it has hardly been rapid, and all of these nations face the challenge of creating enough jobs to support a growing labor force.
In Latin America, Wharton management professor Gerald McDermott notes, growth is at a standstill and countries are highly dependent on the North American Free Trade Agreement and the U.S. economy. McDermott says that while participation in trade agreements such as NAFTA is a good first step, emerging countries must initiate deeper institutional reform to sustain long-term growth. "Not radical change," he says, "but new or deeper processes that allow all the parties to have voice and influence, and that's difficult for them."
An Important Role for the Left
The institution of social democratic politics incorporating the left is the most important political change under way in Latin America at the moment, McDermott says. For decades, the political environment was shaped by the right or populist authorities who repressed the left. The election of President Luiz Inácio Lula da Silva in Brazil is a "massively strong signal that disaffected people have a real institutional alternative and it doesn't have to be along the route of [Venezuelan President] Hugo Chavez." He points to several shaky countries -- Peru, Bolivia and Ecuador -- where Chavez's influence is growing. And he says it is important to remain aware of the power and influence China now holds in Latin America, where it has been building relationships as a result of its demand for resources.
McDermott notes that Eastern European emerging market nations have been joining the European Union at a rapid pace. "There are places that were basket cases 15 to 20 years ago and are now reasonable places," he says. The European Union has found ways to invest money efficiently in emerging markets where corruption is declining while regulatory controls and foreign direct investment are on the rise. "There's a little bit of a bubble atmosphere there." Real estate prices have soared in major cities and there is concern about how growth will smooth out, he adds.
Meanwhile, the Kremlin continues to dominate the neighboring former Soviet republics, which McDermott says remain a "no-man's land" with marginal assets. Even Ukraine and Georgia, which have undergone waves of reform and democratization, remain unstable. Russia is a quasi-capitalist country that "day by day is consolidating an authoritarian political structure." The country is benefiting from high prices for oil and natural gas, but it is unclear what would happen if commodity prices fell. "Now, Europe and NATO in general are in a bind because they are more and more dependent on Russian resources for gas and oil, and Russia plays these cards effectively," McDermott says.
India's 'Horse Race'
India is in a "horse race," Nichols says, between the growing number of people in poverty and the advancing middle class. "That race will have a tremendous influence on whether India can continue to be ever more hospitable to business or revert to the kind of populist socialism it experienced in the first decades of independence after throwing off Britain." In rural states, he says, economic development has been subverted by corruption and a difficult political environment. Meanwhile, many major cities are growing, free-market centers with prosperous knowledge-based industries. "If you are spending time in Bangalore or Hyderabad or Mumbai, you might say the race is over. But when you get to the countryside of poorer states it's not by any means," Nichols says. "One could be lulled into a sense of complacency and forget there are still half a billion poor people whose votes can be swayed against business."
The gap is widening and could lead to the kind of political change that brought Chavez to power in Venezuela. "The gap got so big [that] a populist -- and perhaps not economically savvy fellow -- essentially became the dictator." If, however, the economy lifts the entire population, he says, India has the potential to become vastly more dynamic than China, with more natural resources, better-educated people and a strong network in Europe and North America. "India has astonishing potential," he says, adding that it is important to pay attention to India's "uncomfortable" relationship with neighboring Pakistan, which "could precipitate something either great or bad."
China's Economic Power
In Southeast Asia, the most important potential political development is China's relationship with countries in the Association of Southeast Asian Nations.
While China has been courting business relationships in Africa and Latin America, it has been less involved with its neighbors. "With ASEAN, China has been assiduously hands-off politically, protecting each member's autonomy and independence, which isn't necessarily China's style or in China's interest," Nichols says. "If China uses its economic power to woo ASEAN and can start picking off ASEAN members one by one, it will change a lot of the dynamic in that particular region."
As for China itself, Wharton management professor Marshall Meyer says many economists and political scientists make the mistake of thinking of its government as a federal system. In fact, he says, there is a "constant tug of war" in China between the central government and powerful local authorities. For example, every year at the Chinese New Year the national government issues a series of decrees. This year -- and for the last five years -- the priority has been to shift land ownership to farmers with deeds and clear systems of compensation. "Will this be implemented?" Meyer asks. "It's totally unclear. Local governments, especially at the township and village level, have been making a lot of money selling farmers' land to developers and pushing the farmers off their lands. This is creating unrest."
Meyer says Elizabethan England faced the same problems and worked it out through development of a parliamentary system, but it took years. China, he says, has "telescoped time. Who knows how long it will take to sort out the internal administration of China? But the creation of a workable, more efficient system of administration and the creation of national markets are the next two big tasks."