The Economic The Economic EnvironmentEnvironment

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Chapter ObjectivesChapter Objectives

Learn differences among the world’s Learn differences among the world’s major economic systemsmajor economic systems

Learn criteria for dividing countries Learn criteria for dividing countries into economic categoriesinto economic categories

Discuss economic issues that Discuss economic issues that influence international businessinfluence international business

Assess the transition process for Assess the transition process for market economiesmarket economies

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Economic Issues for International Economic Issues for International BusinessesBusinesses

What type of economic system does the What type of economic system does the country have?country have?

What is the size, growth potential, and What is the size, growth potential, and stability of the market?stability of the market?

Is the company’s industry in that country’s Is the company’s industry in that country’s public or private sector?public or private sector?• If public, does the government allow private If public, does the government allow private

competition?competition?• If private, is it moving towards public If private, is it moving towards public

ownership?ownership?

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Economic Issues for International Economic Issues for International Businesses, contBusinesses, cont

Does the government view foreign capital Does the government view foreign capital as competition with or in partnership with as competition with or in partnership with public or local private enterprises?public or local private enterprises?

How does the government control the How does the government control the nature and extent of private enterprise?nature and extent of private enterprise?

How much of a contribution is the private How much of a contribution is the private sector expected to make in assisting the sector expected to make in assisting the government formulate overall economic government formulate overall economic objectives?objectives?

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Key Economic ForcesKey Economic Forces General economic frameworkGeneral economic framework Economic size and stabilityEconomic size and stability Existence and influence of capital marketsExistence and influence of capital markets Factor endowmentsFactor endowments IndicatorsIndicators

• GrowthGrowth• InflationInflation• SurplusesSurpluses• DeficitsDeficits

Economic transitionsEconomic transitions Availability of economic infrastructureAvailability of economic infrastructure

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Economic SystemEconomic System

Structure and processes that a country Structure and processes that a country uses to allocate its resources and conduct uses to allocate its resources and conduct commercial activities.commercial activities.

Connection between political ideology and Connection between political ideology and

economic systemseconomic systems • Countries where individual goals are given primacy Countries where individual goals are given primacy

free market economic systems are fosteredfree market economic systems are fostered• Countries where collective goals are given primacy Countries where collective goals are given primacy

there is marked state control of marketsthere is marked state control of markets

Economic SystemsEconomic Systems

Market economyMarket economy:: what is produced & what is produced & in what quantity is determined by in what quantity is determined by supply/demand and signaled to supply/demand and signaled to producers through a price systemproducers through a price system

Command economyCommand economy:: planned by planned by governmentgovernment

Mixed economyMixed economy:: a balance of both of a balance of both of the abovethe above

Economic SystemsEconomic Systems

Market EconomyMarket Economy: resources are primarily : resources are primarily owned and controlled by the private owned and controlled by the private sector, not the public sectorsector, not the public sector• Consumer sovereignty is the right of Consumer sovereignty is the right of

consumers to decide what to buyconsumers to decide what to buy• Companies have the ability to decide what to Companies have the ability to decide what to

produce and in which market to competeproduce and in which market to compete• Prices are determined by supply and demandPrices are determined by supply and demand

Laissez-Faire EconomicsLaissez-Faire Economics

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Government Role in Government Role in Market EconomyMarket Economy

Preserving PropertyRightsPreserving PropertyRights

EnforcingAntitrustLaws

EnforcingAntitrustLaws

Providing a Stable Fiscal& MonetaryEnvironment

Preserving PoliticalStability

Enforcing Antitrust LawsEnforcing Antitrust Laws

The goals of antitrust (or The goals of antitrust (or

antimonopoly) laws is to encourage antimonopoly) laws is to encourage

the development of industries with the development of industries with

as many competing businesses as as many competing businesses as

the market will sustainthe market will sustain

Preserving Property RightsPreserving Property Rights

By preserving and protecting By preserving and protecting individual property rights, individual property rights, governments encourage individuals governments encourage individuals and companies to take risks such as and companies to take risks such as investing in technology, inventing investing in technology, inventing new products, and starting new new products, and starting new businesses.businesses.

Providing Stable Fiscal & Monetary Providing Stable Fiscal & Monetary EnvironmentEnvironment

Encourages commerce in a nation because it Encourages commerce in a nation because it

improves its reputation as a place to do improves its reputation as a place to do

businessbusiness To reduce high inflation and unemployment, To reduce high inflation and unemployment,

governments can help control inflation governments can help control inflation through effective through effective fiscal policies fiscal policies (policies (policies regarding taxation and government regarding taxation and government spending) and spending) and monetary policies monetary policies (policies (policies controlling money supply and interest rates).controlling money supply and interest rates).

Preserving Political StabilityPreserving Political Stability

A market economy depends on a A market economy depends on a stable government for its smooth stable government for its smooth operation and, indeed, for its future operation and, indeed, for its future existence. existence.

Political stability helps businesses Political stability helps businesses engage in activities without worrying engage in activities without worrying about terrorism, kidnappings, and about terrorism, kidnappings, and other political threats to their other political threats to their operations. operations.

Command Economy (Centrally Command Economy (Centrally Planned Economy):Planned Economy): all dimensions of all dimensions of economic activity, including pricing economic activity, including pricing and production decisions, are and production decisions, are determined by a central government determined by a central government planplan• Government owns and controls all Government owns and controls all

resourcesresources• Prices are determined by governmentPrices are determined by government• Welfare of the group is paramountWelfare of the group is paramount• Economic and social equality is the goalEconomic and social equality is the goal

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Decline of Central PlanningDecline of Central Planning

Central planning failed to:Central planning failed to: Create economic valueCreate economic value

Provide incentivesProvide incentives

Achieve rapid growthAchieve rapid growth

Satisfy consumer needsSatisfy consumer needs

Mixed EconomyMixed Economy: Some degree of : Some degree of government ownership and controlgovernment ownership and control• The goal is to achieve low unemployment, low The goal is to achieve low unemployment, low

poverty, steady economic growth and poverty, steady economic growth and equitable distribution of wealth.equitable distribution of wealth.

No economy is purely market or commandNo economy is purely market or command Economic systems are along a spectrum of Economic systems are along a spectrum of

freedomsfreedoms Most command economies are moving Most command economies are moving

towards a market economytowards a market economy

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CLASSIFICATION OF THE COUNTRIESCLASSIFICATION OF THE COUNTRIES

Countries Classified by Economic SystemCountries Classified by Economic SystemEconomic system—based on government’s mix of

ownership and control of the economy

Ownership—who owns the resources engaged in economic activity

• Most countries are a mixture of public and private ownership

– state-owned enterprises—ownership by public sector

• Most countries with significant state-owned enterprises are moving toward less, not more, public ownership

– privatization

Factor ConditionsFactor Conditions

Inputs to the production processInputs to the production process• Human resourcesHuman resources• Physical resources- Physical resources- weather, existence of

waterways, availability of mineral and agricultural products

• Knowledge - Knowledge - research and development

• Capital - Capital - availability of debt and equity capital

• Infrastructure - Infrastructure - roads, port facilities, energy, and communications

Factor conditions are especially Factor conditions are especially critical for the production of goodscritical for the production of goods

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Demand ConditionsDemand Conditions

Market potentialMarket potential• Composition of home demand (nature of buyer Composition of home demand (nature of buyer

needs)needs)• Size of home demandSize of home demand• Growth of home demandGrowth of home demand• Internationalization of demandInternationalization of demand

Demand conditions are especially critical for Demand conditions are especially critical for market-seeking market-seeking

investments investments Combination of factor and demand conditions

contribute to the location—specific advantage that a country has to offer domestic and foreign investors

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Economic DevelopmentEconomic Development

Economic well-being of Economic well-being of one nation’s people one nation’s people relative to another relative to another

nation’s peoplenation’s people

Economic output (agricultural,Economic output (agricultural,

industrial, service)industrial, service)

Infrastructure (communications,Infrastructure (communications,

transportation, power)transportation, power)

People (physical health,People (physical health,

education level)education level)

Productivity is key

Ratio of outputs (that created)to inputs (resources used to

create output)

Productivity is key

Ratio of outputs (that created)to inputs (resources used to

create output)

Differences in Economic Differences in Economic DevelopmentDevelopment

Different countries have dramatically Different countries have dramatically different levels of economic developmentdifferent levels of economic development

Two common measurements of economic Two common measurements of economic developmentdevelopment• Gross National Income (GNI) superseded Gross National Income (GNI) superseded

Gross National Product or GNPGross National Product or GNP• Purchasing Power Parity (PPP) which Purchasing Power Parity (PPP) which

accounts for differences in the cost of livingaccounts for differences in the cost of living

Gross National IncomeGross National Income Tool to measure one country against Tool to measure one country against

anotheranother• Size Size • DemandDemand

Gross National Income (formerly the Gross Gross National Income (formerly the Gross National Product)National Product)

GNI is the market value of final goods and GNI is the market value of final goods and services newly produced by domestically services newly produced by domestically owned factories of production.owned factories of production.

Countries with high populations and high Countries with high populations and high per capita GNI are most desirable in terms per capita GNI are most desirable in terms of market potentialof market potential

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Gross Domestic ProductGross Domestic Product

GDP: the value of production that GDP: the value of production that takes place within a nation’s borders, takes place within a nation’s borders, without regard to whether the without regard to whether the production is done by domestic or production is done by domestic or foreign factors of productionforeign factors of production

Example -Example -• Both a Ford and Toyota manufactured in Both a Ford and Toyota manufactured in

the United States counts towards our the United States counts towards our GDPGDP

• A Ford produced in Mexico would notA Ford produced in Mexico would not4-9

Importance of Per Capita GNIImportance of Per Capita GNI

Low IncomeLow Income755 or less (in 755 or less (in 2000)2000)

Developing/Emerging Developing/Emerging CountryCountry

High IncomeHigh Income9,266 or more9,266 or moreDeveloped/Industrial Developed/Industrial CountryCountry

Upper Middle Upper Middle IncomeIncome

2,996-9,2652,996-9,265Developing/Emerging Developing/Emerging CountryCountry

Middle IncomeMiddle Income756-9,265756-9,265Developing/Emerging Developing/Emerging CountryCountry

Lower Middle Lower Middle IncomeIncome

756-2,995756-2,995Developing/Emerging Developing/Emerging CountryCountry

World Bank World Bank CategoryCategory

Per Capita GNI Per Capita GNI ($)($)

Common NameCommon Name

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World bank

• multilateral lending institution that provides investment capital to countries

Uses per capita GNP as a basis for lending policies

Goal is to provide development assistance• Build infrastructure, promote economic growth

and stability, improve quality and quantity of demand

Purchasing Power ParityPurchasing Power Parity

PPP is the number of units of a country’s PPP is the number of units of a country’s currency required to buy the same currency required to buy the same amounts of goods and services in the amounts of goods and services in the domestic market that $1 would buy in the domestic market that $1 would buy in the United StatesUnited States

PPP is a useful measure since it accounts PPP is a useful measure since it accounts for international differences in pricefor international differences in price• Example: China has a higher PPP than JapanExample: China has a higher PPP than Japan

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Differences in Economic Development: Differences in Economic Development: Purchasing Power ParityPurchasing Power Parity

CountryCountry GNI per CapitaGNI per Capita GNI PPP per GNI PPP per CapitaCapita

GDP Growth GDP Growth RateRate

1993-2003(%)1993-2003(%)

BrazilBrazil $2,710$2,710 $7,480$7,480 2.6%2.6%

ChinaChina $1,100$1,100 $4,990$4,990 9.3%9.3%

GermanyGermany $25,250$25,250 $27,460$27,460 1.2%1.2%

IndiaIndia $530$530 $2,880$2,880 6.1%6.1%

JapanJapan $34,510$34,510 $28,620$28,620 1.2%1.2%

NigeriaNigeria $320$320 $900$900 3.1%3.1%

PolandPoland $5,270$5,270 $11,450$11,450 4.8%4.8%

RussiaRussia $2,610$2,610 $8,920$8,920 0.1%0.1%

SwitzerlandSwitzerland $39,880$39,880 $32,030$32,030 0.9%0.9%

United KingdomUnited Kingdom $28,350$28,350 $27,650$27,650 2.8%2.8%

United StatesUnited States $37,610$37,610 $37,500$37,500 3.2%3.2%

Big Mac indexBig Mac index

The EconomistThe Economist's Big Mac index is based on the 's Big Mac index is based on the theory of purchasing-power parity (PPP), theory of purchasing-power parity (PPP),

the idea that exchange rates should move to the idea that exchange rates should move to equalize the prices of a basket of goods and equalize the prices of a basket of goods and services across different countries. Our basket is services across different countries. Our basket is the Big Mac. the Big Mac.

For example, the cheapest burger in the chart is For example, the cheapest burger in the chart is in China, at $1.26, compared with an average in China, at $1.26, compared with an average American price of $3. This implies that the yuan is American price of $3. This implies that the yuan is 58% undervalued relative to its Big Mac dollar-58% undervalued relative to its Big Mac dollar-PPP. On the same basis, the euro is 25% PPP. On the same basis, the euro is 25% overvalued, the yen 17% undervalued.overvalued, the yen 17% undervalued.

                               

      

Economic Factors International Economic Factors International Businesses Must AddressBusinesses Must Address

Economic GrowthEconomic Growth InflationInflation SurplusesSurpluses DeficitsDeficits Balance of PaymentsBalance of Payments External DebtExternal Debt Internal DebtInternal Debt PrivatizationPrivatization

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Key Macroeconomic Issues Affecting Business Strategy

Global economy can affect company profits and operating strategies

•Management must learn to scan the environmentEconomic growth

•There are significant differences in growth rates worldwide•Affects the degree to which investments in or sales to a

country can affect the bottom line of a company– drop in economic growth can have detrimental

effects on investments» new investors reluctant to bring in money» existing investors forced to cut back operations

and may pull out» Difficult to forecast economic growth

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Key Macroeconomic Issues (cont.)

Inflation—a condition in which aggregate demand grows faster than aggregate supply• Inflation rate—the percentage increase in

the change in prices from one period to the next

• Consumer price index (CPI)—index of inflation

– measures a fixed basket of goods and compares its price from one period to the next

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Key Macroeconomic Issues (cont.)

External deficit— country’s cash outflows exceed its inflows

Balance of payments—record of a country’s international transactions

• current account—comprised of:– trade in goods and services and income from assets

abroad» merchandise trade balance—country’s trade

deficit or surplus» exports considered to be positive» imports considered to be negative

– Services—transactions such as travel, passenger fares, other transportation

– income receipts—payments on assets– unilateral transfers—government and private relief

grants and income transferred by guest workers

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Key Macroeconomic Issues (cont.)

Balance of Payments (cont.)• Capital account— transactions in real or financial

assets between countries– transactions include foreign direct investments

• Companies monitor the balance of payments to watch for factors that could lead to currency instability or government actions to correct an imbalance

• External debt—results from borrowing money abroad

• Measured in two ways– total amount of the debt– debt as a percentage of gdp

• The greater the external debt, the more unstable the economy

• Countries with small market conditions and political instability must rely on external debt

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Key Macroeconomic Issues (cont.)

Internal debt— result of an excess of government expenditures over revenues

• Internal deficits—excess government expenditures over tax receipts

– deficits result from:» poorly run tax system that fails to collect all

the revenues due» expensive government programs» state-owned enterprises operated in the red

Privatization—the sale of state-owned enterprises to the domestic or foreign private sector

• Helps governments reduce internal debt• A complicated political and economic process• Key is availability of capital• Enable foreign companies to acquire assets and

gain access to markets through acquisition

Transition to a Market Economy

Most command economies are undergoing transition to market economies

• Transition a result of the failure of central planning• Transition implies:

– liberalizing economic activity, prices, and market operations

– developing indirect, market-oriented instruments for macroeconomic stabilization

– achieving effective enterprise management and economic efficiency

– imposing hard budget constraints– establishing an institutional and legal framework

to secure property rights, the rule of law, and transparent market-entry regulations

Obstacles to TransitionObstacles to Transition

Culturaldifferences

Culturaldifferences

Environmentaldegradation

Environmentaldegradation

Capitalshortage

Capitalshortage

Lack of managerialexpertise

Lack of managerialexpertise