The Economic Environment

4-1

Chapter Objectives

Learn differences among the worlds major economic systems Learn criteria for dividing countries into economic categories Discuss economic issues that influence international business Assess the transition process for market economies
4-2

Economic Issues for International Businesses

What type of economic system does the country have? What is the size, growth potential, and stability of the market? Is the companys industry in that countrys public or private sector?
If public, does the government allow private competition? If private, is it moving towards public ownership?
4-3

Economic Issues for International Businesses, cont

Does the government view foreign capital as competition with or in partnership with public or local private enterprises? How does the government control the nature and extent of private enterprise? How much of a contribution is the private sector expected to make in assisting the government formulate overall economic objectives?
4-4

Key Economic Forces

General economic framework Economic size and stability Existence and influence of capital markets Factor endowments Indicators
Growth Inflation Surpluses Deficits

Economic transitions Availability of economic infrastructure

4-5

Economic System

Structure and processes that a country uses to allocate its resources and conduct commercial activities. Connection between political ideology and economic systems
Countries where individual goals are given primacy free market economic systems are fostered Countries where collective goals are given primacy there is marked state control of markets

Economic Systems

Market economy: what is produced & in what quantity is determined by supply/demand and signaled to producers through a price system Command economy: planned by government Mixed economy: a balance of both of the above

Economic Systems

Market Economy: resources are primarily owned and controlled by the private sector, not the public sector
Consumer sovereignty is the right of consumers to decide what to buy Companies have the ability to decide what to produce and in which market to compete Prices are determined by supply and demand

Laissez-Faire Economics
4-14

Government Role in Market Economy

Enforcing Antitrust Laws Preserving Political Stability Providing a Stable Fiscal & Monetary Environment Preserving Property Rights

Enforcing Antitrust Laws

The goals of antitrust (or antimonopoly) laws is to encourage the development of industries with as many competing businesses as the market will sustain

Preserving Property Rights

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

Providing Stable Fiscal & Monetary Environment

Encourages commerce in a nation because it improves its reputation as a place to do business

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

Preserving Political Stability

A market economy depends on a stable government for its smooth operation and, indeed, for its future existence. Political stability helps businesses engage in activities without worrying about terrorism, kidnappings, and other political threats to their operations.

Command Economy (Centrally Planned Economy): all dimensions of economic activity, including pricing and production decisions, are determined by a central government plan
Government owns and controls all resources Prices are determined by government Welfare of the group is paramount Economic and social equality is the goal
4-15

Decline of Central Planning

Central planning failed to:

Create economic value Provide incentives Achieve rapid growth Satisfy consumer needs

Mixed Economy: Some degree of government ownership and control

The goal is to achieve low unemployment, low poverty, steady economic growth and equitable distribution of wealth.

No economy is purely market or command Economic systems are along a spectrum of freedoms Most command economies are moving towards a market economy
4-16

CLASSIFICATION OF THE COUNTRIES

Countries Classified by Economic System
Economic systembased on governments mix of ownership and control of the economy Ownershipwho owns the resources engaged in economic activity Most countries are a mixture of public and private ownership state-owned enterprisesownership by public sector Most countries with significant state-owned enterprises are moving toward less, not more, public ownership privatization

Factor Conditions

Inputs to the production process

Human resources Physical resourcesweather, existence of waterways, availability of mineral and agricultural products

Knowledge - research and development Capital - availability of debt and equity capital Infrastructure - roads, port facilities, energy, and
communications

Factor conditions are especially critical for the production of goods

4-6

Demand Conditions

Market potential
Composition of home demand (nature of buyer needs) Size of home demand Growth of home demand Internationalization of demand

Demand conditions are especially critical for market-seeking investments

Combination of factor and demand conditions contribute to the locationspecific advantage that a country has to offer domestic and foreign investors

4-7

Economic Development
Economic well-being of one nations people relative to another nations people
Economic output (agricultural, industrial, service) Infrastructure (communications, transportation, power) People (physical health, education level)

Productivity is key
Ratio of outputs (that created) to inputs (resources used to create output)

Differences in Economic Development

Different countries have dramatically different levels of economic development Two common measurements of economic development
Gross National Income (GNI) superseded Gross National Product or GNP Purchasing Power Parity (PPP) which accounts for differences in the cost of living

Gross National Income

Tool to measure one country against another Gross National Income (formerly the Gross National Product) GNI is the market value of final goods and services newly produced by domestically owned factories of production. Countries with high populations and high per capita GNI are most desirable in terms of market potential
4-8

Size Demand

Gross Domestic Product

GDP: the value of production that takes place within a nations borders, without regard to whether the production is done by domestic or foreign factors of production Example Both a Ford and Toyota manufactured in the United States counts towards our GDP A Ford produced in Mexico would not
4-9

Importance of Per Capita GNI

Common Name Per Capita GNI ($) World Bank Category

Developing/Emerging Country
Developing/Emerging Country Developing/Emerging Country Developing/Emerging Country Developed/Industrial Country

755 or less (in 2000)

756-2,995 756-9,265 2,996-9,265 9,266 or more

Low Income
Lower Middle Income Middle Income Upper Middle Income High Income
4-10

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

26

Purchasing Power Parity

PPP is the number of units of a countrys currency required to buy the same amounts of goods and services in the domestic market that $1 would buy in the United States PPP is a useful measure since it accounts for international differences in price
Example: China has a higher PPP than Japan

4-11

Differences in Economic Development: Purchasing Power Parity

Country GNI per Capita GNI PPP per Capita GDP Growth Rate 1993-2003(%)

Brazil China Germany

$2,710 $1,100 $25,250

$7,480 2.6% $4,990 9.3% $27,460 1.2%

India
Japan Nigeria Poland Russia Switzerland United Kingdom United States

$530
$34,510 $320 $5,270 $2,610 $39,880 $28,350 $37,610

$2,880 6.1%
$28,620 1.2% $900 3.1% $11,450 4.8% $8,920 0.1% $32,030 0.9% $27,650 2.8% $37,500 3.2%

Big Mac index

The Economist's Big Mac index is based on the theory of purchasing-power parity (PPP), the idea that exchange rates should move to equalize the prices of a basket of goods and services across different countries. Our basket is the Big Mac. For example, the cheapest burger in the chart is in China, at $1.26, compared with an average American price of $3. This implies that the yuan is 58% undervalued relative to its Big Mac dollarPPP. On the same basis, the euro is 25% overvalued, the yen 17% undervalued.

Economic Factors International Businesses Must Address

Economic Growth Inflation Surpluses Deficits Balance of Payments External Debt Internal Debt Privatization
4-17

Key Macroeconomic Issues Affecting Business Strategy

Global economy can affect company profits and operating strategies Management must learn to scan the environment Economic 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 32

Key Macroeconomic Issues (cont.)

Inflationa condition in which aggregate demand grows faster than aggregate supply Inflation ratethe 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
33

Key Macroeconomic Issues (cont.)

External deficit countrys cash outflows exceed its inflows Balance of paymentsrecord of a countrys international transactions current accountcomprised of: trade in goods and services and income from assets abroad merchandise trade balancecountrys trade deficit or surplus exports considered to be positive imports considered to be negative Servicestransactions such as travel, passenger fares, other transportation income receiptspayments on assets unilateral transfersgovernment and private relief grants and income transferred by guest workers
34

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 debtresults 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

35

Key Macroeconomic Issues (cont.)

Internal debt result of an excess of government expenditures over revenues Internal deficitsexcess 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 Privatizationthe 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 36

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 Transition
Lack of managerial expertise Capital shortage

Environmental degradation

Cultural differences