Importance of Informal Institutions

Compared with advanced nations in which market mechanisms function effectively, “institutional voids” concept begins by clarifying the institutional problems that beset emerging nations. Accordingly, the institutional market is an important topic studied within institutional economics, though these studies only incorporate a portion of the framework and does not incorporate informal institutions such as social codes of conduct and practices. Reflecting back on our comparison of the overall economic institutions including informal institutions in China and India, let us now consider their implications in terms of global strategy.

First, we must emphasize the necessity of strengthening our understanding of institutions, including informal rules such as codes of conduct and practices in corporate economic activities, in addition to explicit rules such as economic laws that are part of economic institutions in target countries. In particular, informal rules are structured over time in the process of economic development, and reflect the historical background and political systems of that country. Thus, they are a critical factor underlying economic activities. In this regard, the desire of the government is clearly reflected in various aspects of corporate economic transactions in China. In contrast, market competition among private companies drives the rules of the game in India. However, in our discussion of “institutional voids,” India is fragmented by complex regulatory systems and markets from the aspect of market mechanism efficiency, and it indicated how far away these are from the level of advanced nations. In both China and India, reforms are underway for the creation of corporate law and regulatory systems, and both countries are working on economic systems based on global standards in accordance with the WTO rules. However, even if codified laws and guidelines change, actual economic activity will not change very easily because of entrenched informal codes of conduct. Thus, the likelihood of failure will increase if a company bases its business decisions only on codified rules.

Next, the relationship with the government is particularly important for businesses in emerging markets. China has a unique economy in which political processes that determine national leadership take place in the Communist Party, and economic development objectives are achieved through a system of “elimination tournaments” at the local government level. However, a common fact among emerging markets is that local government policies and decision-making have a significant impact on global business. India has many institutional voids, but industrial policies such as government regulations and regional revitalization rules are making actual economic activities possible by filling market mechanism voids. In emerging nations with slow development of the private sector, government is often the partner of businesses. For example, in the next chapter, we examine infrastructure businesses such as railways and water; in these businesses, even though the end consumer is the general public, the government acts as an intermediary as a B2G2C business. As such, it is important to maintain good relationships with government organizations and build business models that can accomplish a win-win relationship. In addition to revitalizing regional economies, local governments enforce policies with various goals such as providing stable living environments for citizens and improving the environment. It is important to consider business strategies that not only generate profitability but also contribute to these government objectives, or in other words, contribute to the value proposition for the government. Finally, let us discuss risk management as it relates to global strategy for emerging nations posing high levels of uncertainty. Investment decisions for a global business must consider various risks such as local macroeconomic environments, exchange rates, and other economic risks; labor relations, procured parts quality, and other operational risks; and societal risks such as opposition to foreign firms. It is possible to deal with economic risks to a certain extent using financial instruments such as futures trading and options. Most operational risks are caused by institutional voids, and JETRO and others have published examples of how best to deal with them (JETRO 2006). It is possible to forecast these risks to a certain extent, and few have great impact as to cause a cessation of business operations. The most important risk to consider under the global business strategy are risks of policy changes, as we have observed in the sudden order for a company to leave the industrial park in Shanghai's Jiading district. The risk of political instability such as a coup de'état is also great, but unlikely in our emerging nation subjects of China and India (unlike developing nations with huge institutional voids). Election results in India can impact policy direction, and it can be characterized as a policy risk in the broad sense of the term. So how should companies react in the face of policy risk? These risks exist because of sudden changes in government policy and the breadth of discretion given to governments in the administration of policy. Thus, understanding the direction and breadth of these changes is, in effect, risk management, specifically, it is to recognize the policy objectives and priorities of the national and local governments.

In China, central and local governments publicize policy decisions made at the various levels. In India, policies change depending on election results at the national and state levels. Gathering and analyzing this kind of intelligence is a necessity. Of the two countries, China carries higher risks because policy making is done by a select number of central and local leaders. On the other hand, it is easier to ascertain the general direction of the country in case of India because issues are visible in election results. However, in either case, building win-win relationships with local governments is critical, as already discussed. Local corporate social responsibility, or CSR, activities are effective responses to societal risks such as opposition to foreign firms in India and anti-Japanese sentiments in China. In any case, companies must realize the necessity for long-term investments in the countries in which they conduct business.

References

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Capelli, P., Singh, H., Singh, J., & Useem, M. (2011). The India way: How India's top business leaders are revolutionizing management. Boston: Harvard Business Press.

Grief, A. (2006). Family structure, institutions and growth: The origins and implications of Western corporations. American Economic Review, 96(2), 308–312.

JETRO. (2006, July). Chugoku business no risk management. Tokyo: Japan External Trade Organization (JETRO) (in Japanese).

Khanna, T. (2007). Billions of Entrepreneurs: How China and India are reshaping their futures and yours. Boston: Harvard Business School Press.

Khanna, T., & Palpu K. G. (2010). Wining in emerging markets: A roadmap for strategy and execution. Boston: Harvard Business School Press.

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