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4. Comparison of Economic Institutions in China and India

4.1 Introduction

Global business strategies must conform to business environments in target countries and regions. As repeatedly expressed herein, while the world is becoming flatter, there still are significant barriers in the form of national borders. Chapter 2 discussed ideas and strategies to understand the differences in business environments because of these barriers. According to the CAGE distance framework, the differences in business environments due to national borders are wide-ranging and consist of cultural, administrative, geographical, and economic factors. These differences may be observed in the languages, religions, economic systems, and living standards present in each country. This chapter discusses a more fundamental principle of “institutional theory” in the context of differing business environments between nations, and examines its relationship to global strategy.

The 1993 Nobel laureate in economics, Douglas North, developed a theory that countries not only have codified “formal” institutions such as laws, but also have just as important and implicitly presented “informal” institutions such as the code of conduct and practices. North expounded on the relationship of these institutions to economic performance (North 1990). Among economic theories based on market transactions, such as product and labor markets, the field of “institutional economics” as developed by North, which studies the relationship between economic activities and informal constraints such as the code of conduct and practices, continues to be researched.

The behaviors of corporations and individuals within an economic society do not necessarily abide by the formal institutions, but they are often determined by informal restraints such as taboos and customs. This tendency is particularly apparent in developing nations such as China and India because these nations have been slow to enact various rules regarding economic transactions (corporate law, contract law for private transactions, property law including intellectual property, etc.). Even when laws have been codified, the enforcement of these rules has often been insufficient.

For example, China has made three major revisions to its patent laws since their enactment in 1985, and intellectual property institutions are being strengthened because of calls for “indigenous innovation.” However, the state of intellectual property protection in China is far removed from the country's tough patent system. China also implemented antimonopoly laws in 2008. However, its enforcement makes it appear like the objective is to protect domestic industry and limit foreign corporations.

It would appear that these countries are conforming to global standards by integrating modern legal structures from foreign countries and codifying them into rules; however, because the inertia of informal rules of economic transaction practices and societal behaviors is so strong, the enforcement of rules are quite literally all over the map. With the help of the WTO and regional economic partnership agreements, an international alignment according to formal economic rules is shaping. However, informal rules such as country-specific societal norms and customs do not change easily, and some doubt the hypothesis of converging into one global system. A concept often used within institutional economics is that of “path dependency.” The thinking goes that because practices and rules for economic transactions are formed during a country's process of achieving economic development—a process that is determined by differing historical backgrounds and economic developments depending on a country—there exists several equilibriums. For example, some countries drive cars on the right side of the road, whereas others drive on the left. There are various theories as to why this difference exists; one of them is that the position of doors in horse-drawn carriages differed in England and France, but whatever the case, there is some historical background for this phenomenon. However, once a practice like this is set, it is extremely expensive to change and things remain in a state with several equilibriums. Incidentally, there is a field of study called “comparative (or historical) institutional analysis” that uses game theory to model path dependency and a state of multiple equilibriums to explain differences in institutions among countries (Aoki 2010; Grief 2006).

Institutions in various countries, including informal institutions, can be characterized as game rules for conducting economic activities. An examination of global business strategy cannot be engaged in without an understanding of these game rules. In Chap. 2, we discussed the state of global strategy considering primarily codified formal institutions. In this chapter, we progress one step further and consider the impact of institutions in economic society, including unwritten rules, on global strategy. Chapter 1 featured a company in an industrial park in Shanghai's Jiading district that was suddenly ordered by the government administration to exit the park. Codified rules granted contractual authority to companies within this industrial park to use the property for a specific length of time. However, the decision by the government administration can overturn this contract. These rules are not explicitly codified, but they nonetheless exist. Property rights in many regions of India are vague, and when discussions with local farmers in Tata Motor's appropriation of land in West Bengal did not go well, Tata made the decision to pull out of its planned factory construction.

Once events like these occur, they become difficult to solve. Thus, it is important to increase our understanding of institutions, including their informal rules in countries, where a corporation is expanding, to understand possible strategies to avoid risk, or at least to keep losses from risks to a minimum. In this chapter, we compare and contrast China and India as we consider the relationship between economic societal institutions and global business. First, we examine foreign investment policy differences between the two countries. We then explicate institutional differences that arise because of the differences in each country's political and economic systems. Further, we examine views on global strategy on the basis of the institutional differences in India and China. In doing so, we also explain risk management as it applies to global business.

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