International Business 9e By Charles W.L. Hill McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Political Economy and Economic Development Chapter 3 Political Economy and Economic Development

What Determines A Country’s Level Of Economic Development? Gross national income (GNI) per person measures the total annual income received by residents of a nation Japan, Sweden, Switzerland, and the U.S. have high GNI China and India have low GNI GNI can be misleading because it does not consider differences in the cost of living need to adjust GNI figures using purchasing power parity (PPP) LO1: Explain what determines the level of economic development of a nation. Japan, Sweden, Switzerland, and the United States rank among the highest on GNI.

How Do Countries Compare On GNI? Economic Data for Select Countries

What Determines A Country’s Level Of Economic Development? Official figures can also be misleading because they do not account for black economy transactions In addition, GNI and PPP data are static and do not consider economic growth rates So, while China and India are currently categorized as being poor they are growing more rapidly than many developed nations and are expected to become among the largest economies in the world It is estimated that black market transactions in India could account for as much as 50 percent of GDP.

How Do Countries Compare On Growth Rates? Economic Data for Select Countries LO2: Identify the macro-political and economic changes taking place worldwide.

What Determines A Country’s Level Of Economic Development? Nobel-prize winner Amartya Sen argues economic development should be seen as a process of expanding the real freedoms that people experience the removal of major impediments to freedom like poverty, tyranny, and neglect of public facilities the presence of basic health care and basic education Amartya Sen also claims that economic progress requires the democratization of political communities to give citizens a voice The Nobel prize-winning economist Amartya Sen has argued in his theory of social development that development should be assessed less by material output measures such as GNI per capita/GDP per capita and more by the capabilities and opportunities that people enjoy. According to Sen, development should be seen as a process of expanding the real freedoms that people experience. Hence, development requires the removal of major impediments to freedom: poverty as well as tyranny, poor economic opportunities as well as systematic social deprivation, neglect of public facilities as well as the intolerance of repressive states. In Sen’s view, development is not just an economic process, but it is a political one too, and to succeed requires the “democratization” of political communities to give citizens a voice in the important decisions made for the community. This perspective leads Sen to emphasize basic health care, especially for children, and basic education, especially for women.

What Determines A Country’s Level Of Economic Development? The United Nations used Sen’s ideas to develop the Human Development Index (HDI) which is based on life expectancy at birth educational attainment whether average incomes are sufficient to meet the basic needs of life in a country Sen’s influential thesis has been picked up by the United Nations, which has developed the Human Development Index (HDI) to measure the quality of human life in different nations. The HDI is based on three measures: life expectancy at birth (which is a function of health care), educational attainment (which is measured by a combination of the adult literacy rate and enrollment in primary, secondary, and tertiary education), and whether average incomes, based on PPP estimates, are sufficient to meet the basic needs of life in a country (adequate food, shelter, and health care).

How Do Countries Compare on Economic Development? Economic Data for Select Countries

How Does Political Economy Influence Economic Progress? Innovation and entrepreneurship are the engines of long-run economic growth innovation includes new products, new processes, new organizations, new management practices, and new strategies entrepreneurs commercialize innovative new products and processes Innovation and entrepreneurship help increase economic activity by creating new markets and products that did not previously exist innovation in production and business processes result in more productive labor and capital further boosting economic growth rates A country’s economic development is a function of its economic and political systems. Economic freedom associated with a market economy creates greater incentives for innovation and entrepreneurship than either a planned or a mixed economy. The Opening Case: Revolution in Egypt explores the recent bloodless revolution in the country that has opened the door to economic progress.

How Does Political Economy Influence Economic Progress? Innovation and entrepreneurship require a market economy there is little incentive to develop new innovations in planned economies because the state owns all means production and therefore, the gains There is a strong relationship between economic freedom and economic growth the six countries with the highest ratings of economic freedom from 1975 to 1995 were also among the highest for economic growth Hong Kong, Switzerland, Singapore, the United States, Canada, and Germany LO3: Describe how transition economies are moving towards market based systems. Innovation and entrepreneurship require strong property rights.. Without strong property rights protection, businesses and individuals run the risk that the profits from their innovative efforts will be expropriated, either by criminal elements or by the state. There is debate on the kind of political system that best achieves a functioning market economy with strong protection for property rights. People in the West tend to associate a representative democracy with a market economic system, strong property rights protection, and economic progress. Building on this, we tend to argue that democracy is good for growth. However, some totalitarian regimes have fostered a market economy and strong property rights protection and have experienced rapid economic growth. Four of the fastest-growing economies of the past 30 years—South Korea, Taiwan, Singapore, and Hong Kong—had one thing in common at the start of their economic growth: undemocratic governments!

How Does Political Economy Influence Economic Progress? Innovation and entrepreneurship require strong property rights without strong property rights, individuals and businesses risk having their innovations and potential profits stolen Economist Hernando de Soto claims that inadequate property protection in many developing nations limits economic growth While it is possible to argue that democracy is not a necessary precondition for a free market economy in which property rights are protected, subsequent economic growth often leads to establishment of a democratic regime.

How Does Political Economy Influence Economic Progress? Democratic regimes are probably more conducive to long-term economic growth than dictatorships, even the benevolent kind property rights are only secure in well-functioning, mature democracies Subsequent economic growth leads to the establishment of democratic regimes South Korea Taiwan Country Focus: Emerging Property Rights in China explores the implications of a new property law that took effect in China in 2007. In China, all land belongs to the state. Land is leased to urban users for 40-70 years, and to rural users for 30 years. Under the new law, urban and rural land lease holders now have the right to automatically renew their leases, or be fairly compensated if the land needs to be used for other purposes. Consequently, lease holders now have some protection against large scale appropriation by the state.

How Does Geography Influence Economic Development? Countries with favorable geography are more likely to engage in trade, and so, be more open to market-based economic systems, and the economic growth they promote Jeffrey Sachs studied economic growth rates between 1965 and 1990 and found that landlocked countries grew more slowly than coastal economies being totally landlocked reduced a country’s growth rate by 0.7% per year tropical countries grew more slowly than countries in temperate zones

How Does Education Influence Economic Development? Countries that invest in education have higher growth rates because the workforce is more productive countries in Southeast Asia have offset their geographical disadvantages by investing in education Indonesia, Malaysia, and Singapore

How Is The Political Economy Changing? Since the late 1980s, two trends have emerged Democratic revolution (late 1980s and early 1990s) democratically elected governments replaced totalitarian regimes more committed to free market capitalism A move away from centrally planned and mixed economies more countries have shifted toward the market-based model Two trends are evident: first, during the late 1980s and early 1990s, a wave of democratic revolutions swept the world; second, totalitarian governments collapsed and were replaced by democratically elected governments that were typically more committed to free market capitalism than their predecessors had been.

How Is The Political Economy Changing? Trend 1: Democracy has spread over the last two decades many totalitarian regimes failed to deliver economic progress to the vast bulk of their populations new information and communication technologies have broken down the ability of the state to control access to uncensored information economic advances of the last 25 years have led to increasingly prosperous middle and working classes who have pushed for democratic reforms These changes were most dramatic in Eastern Europe, where the collapse of communism bought an end to the Cold War and led to the breakup of the Soviet Union, but similar changes were occurring throughout the world during the same period. Across much of Asia, Latin America, and Africa there was a marked shift toward greater democracy.

How Free Are Countries Politically? Political Freedom in 2010

How Is The Political Economy Changing? Author Francis Fukuyama argues that the new world order will be characterized by democratic regimes and free market capitalism But, political scientist Samuel Huntington argues that while many societies are modernizing they are not becoming more Western predicts a world split into different civilizations these civilizations will be in conflict with each other Country Focus: India’s Economic Transformation explores India’s ambitious economic reform program. The reforms, which began in 1991, were designed to help the country achieve greater economic growth through privatization, new investment opportunities, changes in import and export controls, and other policies. So far, the reforms seem to be working.

How Is The Political Economy Changing? Trend 2: The spread of market-based systems more countries have moved away from centrally planned and mixed economies toward the market-based model Command and mixed economies failed to deliver the sustained economic growth achieved in market-based countries The underlying rationale for economic transformation has been the same the world over. In general, command and mixed economies failed to deliver the kind of sustained economic performance that was achieved by countries adopting market-based systems, such as the United States, Switzerland, Hong Kong, and Taiwan.

How Free Are Countries Economically? Economic Freedom in 2010

What Is The Nature Of Economic Transformation? The shift toward a market-based system involves deregulation – removing legal restrictions to the free play of markets, the establishment of private enterprises, and the manner in which private enterprises operate privatization - transfers the ownership of state property into the hands of private investors the creation of a legal system to safeguard property rights Without a legal system that protects property rights, and without the machinery to enforce that system, the incentive to engage in economic activity can be reduced substantially.

What Does The Changing Economy Mean For Managers? Markets that were formerly off-limits to Western business are now open firms need to explore opportunities in these markets Despite being underdeveloped and poor, some markets have huge potential China -1.2 billion people India – 1.1 billion people Latin America – 400 million potential consumers LO4: Explain the implications for management practice of national difference in political economy.

What Does The Changing Economy Mean For Managers? However, the potential risks are large will democracy thrive especially in difficult economic times? will totalitarian regimes return? will a multi-polar world of different civilizations emerge? will China’s financial system be stable?

What Are The Implications Of Political Economy Differences For Managers? Countries with democratic regimes, market based economic policies, and strong property rights protection are more likely to have higher sustained rates of economic growth these markets are more attractive to international businesses the benefits, costs, and risks of doing business in a country are a function of the country’s political, economic, and legal systems

What Are The Implications Of Political Economy Differences For Managers? The benefits of doing business in a country are a function of the market’s size the purchasing power of its consumers their likely future wealth By identifying and investing early in potential future economic stars, firms may be able to gain first mover advantages (advantages that accrue to early entrants into a market) and establish loyalty and experience in a country China Example: In 1960, South Korea was an unremarkable Third World nation. Today, it is the eleventh largest economy in the world as measured by GDP. Firms that recognized the country’s potential have benefited from its stunning growth.

What Are The Implications Of Political Economy Differences For Managers? The costs of doing business in a country are a function of its political system is it necessary to pay bribes to get market access? economic level are the necessary supporting business and infrastructure in place? legal system it can be more costly to do business in countries with dramatically different product, workplace, and pollution standards, or where there is poor legal protection for property rights McDonald’s found that it needed to make numerous investments in Russia in order to ensure the quality of its supplies.

What Are The Implications Of Political Economy Differences For Managers? The risks of doing business in a country are a function of 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

How Can Managers Determine A Market’s 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 Other things being equal, the benefit-cost-risk trade-off is likely to be most favorable in politically stable developed and developing nations that have free market systems and no dramatic upsurge in either inflation rates or private sector debt

How Can Managers Determine A Market’s Overall Attractiveness? Country Attractiveness