Chapter 3: National Differences in Economic Development Source: © Toonman/Shutterstock.com Listening to changing customer demands and monitoring your environment allow you and the firm to identify potential growth opportunities.  Chapter 3: National Differences in Economic Development

Learning Objectives LO 3-1 Explain what determines the level of economic development of a nation. LO 3-2 Identify the macropolitical and macroeconomic changes occurring worldwide. LO 3-3 Describe how transition economies are moving toward market-based systems. LO 3-4 Explain the implications for management practice of national differences in political economy.

Introduction Differences in political, economic, and legal systems influence the level of economic development and its attractiveness for doing business There has been a general move toward more democratic forms of government, market-based economic reforms and adoption of legal systems that better enforce property rights

Differences in Economic Development 1 of 3 A country’s level of economic development affects its attractiveness as a possible market or production location for firms A common measure is gross national income (GNI) – value of all final goods and services produced in the country in a year. A purchasing power parity (PPP) adjustment provides a more direct comparison of living standards in different countries LO 3-1 Explain what determines the level of economic development of a nation.

Jump to Appendix 1 long image description Map 3.1 GNI per Capita 2014 Jump to Appendix 1 long image description

Table 3.1 Economic Data for Select Countries Country GNI per Capita 2014 $ GNI PPP per Capita 2014 $ Annual Average GDP Growth Rate 2005-2014 % Size of Economy GDP 2014 $ billions Brazil $11,530 $15,590 3.41% $2,346 China 7,400 13,170 9.99 10,355 Germany 47,640 46,480 1.32 3,868 India 1,570 5,630 7.69 2,049 Japan 42,000 37,920 0.61 4,601 Nigeria 2,970 5,710 6.04 569 Poland 13,690 23,930 3.84 545 Russia 13,220 24,710 3.46 1,861 Switzerland 90,680 59,610 2.09 701 United Kingdom 43,430 39,040 1.34 2,989 United States 55,200 55,860 1.58 17,419 Source: World Development Indicators Online, 2016.

Map 3.2 GNI PPP per Capita 2014

Gardner: Ratio of GNI at PPP to GNI at market exchange rate, related to GNI at market exchange rate, 2015

Differences in Economic Development 2 of 3 Official figures can be misleading Unrecorded cash transactions can be significant India’s black or shadow economy may be around 50% of GDP The EU estimates that the shadow economy accounted for 10% of GDP in the UK and France in 2012, 24% in Greece, and 32% in Bulgaria

Map 3.3 Average Annual Growth Rate in GDP % 2005-2014

Differences in Economic Development 3 of 3 Broader Conceptions of Development Amartya Sen - development should be assessed less by material output and more by the capabilities and opportunities that people enjoy The UN created the Human Development Index based on life expectancy, education attainment, and whether average incomes are sufficient to meet the basic needs of life in a country Reflects Sen’s ideas and gauges a country’s economic development and likely future growth rate

Map 3.4 Human Development Index 2014

Human Development Index Related To GNI per capita at PPP

Political Economy and Economic Progress 1 of 6 Innovation and Entrepreneurship are the Engines of Growth For a country to sustain long term economic growth, the business environment needs to be conducive to innovation and entrepreneurial activity Innovation - new products, new processes, new organizations, new management practices, and new strategies Entrepreneurs first commercialize innovative new products and processes

Political Economy and Economic Progress 2 of 6 Innovation and Entrepreneurship require a Market Economy Countries with high economic freedom have high economic growth and richer citizens Hong Kong, Switzerland, Singapore, the U.S., Canada, and Germany Countries that lack economic freedom also fail to achieve respectable economic growth

Political Economy and Economic Progress 3 of 6 Innovation and Entrepreneurship require Strong Property Rights Individuals and businesses must have the opportunity to profit from innovative ideas Hernando de Soto – developing world will not benefit from capitalism until property rights are better defined and protected

Political Economy and Economic Progress 3 of 6 Gardner: The Washington Consensus 10 economic policy prescriptions in a "standard" reform package promoted by institutions such as the IMF, World Bank, and US Treasury Department. The term was coined in 1989 by the English economist, John Williamson Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP; Redirection of public spending from subsidies toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment;

Political Economy and Economic Progress 3 of 6 Gardner: The Washington Consensus (continued) Tax reform, broadening the tax base and adopting moderate marginal tax rates; Interest rates that are market determined and positive (but moderate) in real terms; Competitive exchange rates; Trade liberalization: liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs; Liberalization of inward foreign direct investment; Privatization of state enterprises;

Political Economy and Economic Progress 3 of 6 Gardner: The Washington Consensus (continued) Deregulation: abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions; Legal security for property rights. Gardner – Expanding on point 6 - Trade Policy – Import Substitution versus Export Promotion

Political Economy and Economic Progress 4 of 6 The Required Political System Democratic regimes tend to be more conducive to long- term economic growth than dictatorships – even the benevolent kind Limiting human freedom also suppresses human development and therefore limits progress

Political Economy and Economic Progress 5 of 6 Economic Progress Begets Democracy Democracy is often a consequence of economic growth South Korea and Taiwan This has contributed to the attitude of many Western governments towards human rights violations in China If China establishes a free market system, it is hoped that greater individual freedom and democracy will follow

Political Economy and Economic Progress 6 of 6 Geography, Education, and Economic Development Geography - influences economic policy, and thus economic development Favorable geography facilitates trade which can promote economic growth Gardner – Geography and colonialism (Acemoglu, Johnson, Robinson) Education levels Investment in education promotes faster economic development The belief that geography can influence economic policy, and hence economic growth rates, goes back to Adam Smith. Education emerges as another important determinant of economic development (a point that Amartya Sen emphasizes).

States in Transition 1 of 4 Since the late 1980s, a wave of democratic revolutions has swept the world, and many of the previous totalitarian regimes collapsed There has been a move away from centrally planned and mixed economies towards free markets LO 3-2 Identify the macropolitical and macroeconomic changes occurring worldwide.

Map 3.5 Freedom in the World 2016 The Freedom House Survey Team, “Freedom in the World 2016,” www.freedomhouse.org Jump to Appendix 2 long image description

States in Transition 2 of 4 The Spread of Democracy Many totalitarian regimes failed to deliver economic progress to the majority of their population New information and communication technologies have broken down the ability of the state to control access to uncensored information Economic advances of the last quarter century have led to the emergence of increasingly prosperous middle and working classes who have pushed for democratic reforms

States in Transition 3 of 4 The New World Order and Global Terrorism The end of the Cold War and the “new world order” that followed the collapse of communism, taken together with the collapse of many authoritarian regimes in Latin America, have given rise to intense speculation about the future shape of global geopolitics Fukuyama: war of ideas may be at an end and liberal democracy has triumphed Huntington saw the world split into different civilizations each with its own value systems and ideology Two decades ago, author Francis Fukuyama argued, “We may be witnessing . . . the end of history as such: that is, the end point of mankind’s ideological evolution and the universalization of Western liberal democracy as the final form of human government.”22 Fukuyama goes on to say that the war of ideas may be at an end and that liberal democracy has triumphed. In contrast to Fukuyama, Huntington envisioned a world split into different civilizations, each of which has its own value systems and ideology. Huntington predicted conflict between the West and Islam and between the West and China. As for terrorism, in Huntington’s thesis, global terrorism is a product of the tension between civilizations and the clash of value systems and ideology.

States in Transition 4 of 4 The Spread of Market-Based Systems Since the late 1980s there has been a transformation from centrally planned command economies to market-based economies Command and mixed economies failed to deliver the sustained economic performance achieved by countries that had adopted market-based systems Many countries shifted to a market-based system

Map 3.6 Distribution of Economic Freedom 2016 Source: The Freedom House Survey Team, “Freedom in the World 2016.” www.freedomhouse.org Jump to Appendix 3 long image description

The Nature of Economic Transformation Deregulation Removing legal restrictions to the free play of markets Establishment of private enterprises Removing price controls Privatization Transfers ownership of state property into the hands of private individuals Legal Systems Laws protecting private property rights and providing mechanisms for contract enforcement Without a legal system in place, little incentive to engage in economic activity LO 3-3 Describe how transition economies are moving toward market-based systems.

The Nature of Economic Transformation Gardner – Privatization Methods restitution equal-access voucher privatizations management-employee takeover auction strategic investors in a closed-bid tender offers. loans for shares auctions LO 3-3 Describe how transition economies are moving toward market-based systems.

Implications of Changing Political Economy Markets that were formerly off-limits to Western business are now open China (population of 1.3 billion) could be a bigger market than the U.S., the EU, and Japan combined. Gardner – Graham Allison on the risk of Thucydides Trap – that wars often happen, even when unwanted, when a rising power challenges an established one India (population 1.2 billion) is also a potentially huge market Latin America has 600 million potential consumers No guarantee that democracy will thrive in newer democratic states Although the bipolar world of the Cold War era has vanished, it may be replaced by a multipolar world dominated by a number of civilizations. In such a world, much of the economic promise inherent in the global shift toward market-based economic systems may stall in the face of conflicts between civilizations.

Focus on Managerial Implications 1 of 4 The overall attractiveness of a country depends upon the balance between the likely benefits of doing business in that country against the likely costs and risks Benefits Function of market size, and current and future consumer purchasing power May be able to gain first mover advantages Late entrants face late-mover disadvantages LO 3-4 Explain the implications for management practice of national difference in political economy.

Focus on Managerial Implications 2 of 4 Costs Political costs - include the cost of paying bribes or lobbying for favorable or fair treatment Economic costs - relate primarily to the sophistication of the economic system, including the infrastructure and supporting businesses Legal costs - can be higher in countries with dramatically different product, workplace, and pollution standards, or where there is poor legal protection for property rights

Focus on Managerial Implications 3 of 4 Risks Political risk - the likelihood that political forces will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise Economic risk - the likelihood that economic mismanagement will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise Legal risk - the likelihood that a trading partner will opportunistically break a contract or expropriate property rights

Focus on Managerial Implications 4 of 4 Overall Attractiveness The overall attractiveness of a country as a potential market and/or investment site for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country Generally, the costs and risks are lower in economically developed and politically stable markets However, the potential for growth may be higher in less developed nations Gardner – Willingness to take risk may vary between large and small companies, and between state-controlled and private companies. Internet Extra: The U.S. State Department produces a series of annual "Country Reports“. The site is {http://www.state.gov/travelandbusiness/}. 1. Click on Doing Business in International Markets. Discuss the ways the State Department helps American companies doing business in other countries. 2. Next, click on More Business Information and then on Investment Climate Statements. Compare the investment climate in several countries. Where would you invest? Which countries would you avoid?

Figure 3.1 Country Attractiveness Jump to Appendix 4 long image description

Summary In this chapter we have Explained what determines the level of economic development of a nation. Identified the macropolitical and macroeconomic changes occurring worldwide. Described how transition economies are moving toward market-based systems. Explained the implications for management practice of national differences in political economy.

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