International Business Chapter Four The Economic Environment International Business 10e Daniels/Radebaugh/Sullivan 2004 Prentice Hall, Inc4-1

2004 Prentice Hall, Inc Chapter Objectives Learn differences among the world ’ s major economic systems Learn differences among the world ’ s major economic systems Learn criteria for dividing countries into economic categories Learn criteria for dividing countries into economic categories Discuss economic issues that influence international business Discuss economic issues that influence international business Assess the transition process for market economies Assess the transition process for market economies 4-2

2004 Prentice Hall, IncIntroduction Managers need to understand economic environments to predict trends that might affect their company’s performance. A country’s economic policies are a leading indicator of the government’s goals and its planned use of economic tools and market reforms. The subject of economic development is important to citizens, managers, policymakers, and institutions,

2004 Prentice Hall, Inc Economic Issues for International Businesses What type of economic system does the country have? What type of economic system does the country have? What is the size, growth potential, and stability of the market? What is the size, growth potential, and stability of the market? Is the company ’ s industry in that country ’ s public or private sector? Is the company ’ s industry in that country ’ s public or private sector? If public, does the government allow private competition?If public, does the government allow private competition? If private, is it moving towards public ownership?If private, is it moving towards public ownership? 4-3

2004 Prentice Hall, Inc Economic Issues for International Businesses, cont Does the government view foreign capital as competition with or in partnership with public or local private enterprises? 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 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? How much of a contribution is the private sector expected to make in assisting the government formulate overall economic objectives? 4-4

2004 Prentice Hall, Inc Key Economic Forces General economic framework General economic framework Economic size and stability Economic size and stability Existence and influence of capital markets Existence and influence of capital markets Factor endowments Factor endowments Indicators Indicators GrowthGrowth InflationInflation SurplusesSurpluses DeficitsDeficits Market Size Market Size Availability of economic infrastructure Availability of economic infrastructure 4-5

2004 Prentice Hall, Inc Factor Conditions Inputs to the production process Inputs to the production process Human resourcesHuman resources Physical resourcesPhysical resources KnowledgeKnowledge CapitalCapital InfrastructureInfrastructure Factor conditions are especially critical for the production of goods Factor conditions are especially critical for the production of goods 4-6

2004 Prentice Hall, Inc Demand Conditions Market potential Market potential Composition of home demand (nature of buyer needs)Composition of home demand (nature of buyer needs) Size of home demandSize of home demand Growth of home demandGrowth of home demand Internationalization of demandInternationalization of demand Demand conditions are Demand conditions are especially critical for especially critical for market-seeking market-seeking investments investments Composition? Size? Growth? Internationalization? 4-7

2004 Prentice Hall, Inc Gross National Income Tool to measure one country against another Tool to measure one country against another SizeSize DemandDemand Gross National Income (formerly the Gross National Product) Gross National Income (formerly the Gross National Product) GNI is the market value of final goods and services newly produced by domestically owned factors of production. GNI is the market value of final goods and services newly produced by domestically owned factors of production. Countries with high populations and high per capita GNI are most desirable in terms of market potential Countries with high populations and high per capita GNI are most desirable in terms of market potential 4-8

2004 Prentice Hall, Inc Gross Domestic Product GDP: the value of production that takes place within a nation ’ s borders, without regard to whether the production is done by domestic or foreign factors of production GDP: the value of production that takes place within a nation ’ s borders, without regard to whether the production is done by domestic or foreign factors of production Example - Example - Both a Ford and a Toyota manufactured in the United States counts towards US GDP.Both a Ford and a Toyota manufactured in the United States counts towards US GDP. A Ford produced in Mexico would not.A Ford produced in Mexico would not. 4-9

2004 Prentice Hall, Inc Importance of Per Capita GNI Low Income 755 or less (in 2000) Developing/Emerging Country High Income 9,266 or more Developed/Industrial Country Upper Middle Income 2,996-9,265 Developing/Emerging Country Middle Income 756-9,265 Developing/Emerging Country Lower Middle Income 756-2,995 Developing/Emerging Country World Bank Category Per Capita GNI ($) Common Name 4-10

2004 Prentice Hall, Inc Purchasing Power Parity PPP is the number of units of a country ’ s 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 the number of units of a country ’ s 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 PPP is a useful measure since it accounts for international differences in price Example: China has a higher PPP than JapanExample: China has a higher PPP than Japan 4-11

2004 Prentice Hall, Inc Countries Classified by Region From Map

Human Development human development A country ’ s degree of human development, in terms of both economic and social factors, us studied in order to estimate its current and future economic activity. Complementing economic indicators by also analyzing the overall quality of life in a country. The Human Resource Index The Human Resource Index: Longevity: life expectancy at birth. Knowledge: adult literacy rate and primary, secondary and tertiary gross enrollment ratio. Standard of Living: GNI per capita measured expressed in PPP.

Features of an Economy 1. Inflation: 1. Inflation: the pervasive and sustained increase in the aggregate level of prices as measured by a cost of living index. Results when aggregate demand grows faster than aggregate supply (too many people trying to buy too few goods; prices increase faster than incomes) High inflation leads to: - - setting higher interest rates - - Installing wage and price controls - - Imposing protectionist trade policies and currency controls.

The Consumer Price Index (CPI) measures the average change in consumer prices over time in a fixed market basket of goods and services. 2. Unemployment: represents the number of workers who want to work but do not have jobs. The unemployment rate is: The number of unemployed workers / The total civilian labor force (all those wiling and able to work for pay) The Misery Index The Misery Index: the sum of a country ’ s inflation and unemployment rates.

Debt 3. Debt: the sum total of a government ’ s financial obligations. The state ’ s borrowing from its citizens, from foreign organizations, from foreign governments, and from international institutions. Internal Debt: is the portion of the government debt that is denominated in the country ’ s own currency and is held by domestic residents. External Debt: is the portion of the government debt that is denominated in foreign currencies and is owed to foreign creditors.

2004 Prentice Hall, Inc Heavily Indebted Poor Countries (HIPCs) Poor countries with large debts that are the target of initiatives to alleviate the severe external debt burdens of less developed countries, as a means of assisting their development. 4. Income Distribution 4. Income Distribution: describes what share of a country ’ s income goes to various segments of the population (each segment ’ s share of GNI per capita). Poverty 5. Poverty: the state of having little or no money, few or no material possessions, and little or no resources with which to enjoy a reasonable standard of living.

2004 Prentice Hall, IncPoverty Globally, the world is : 78% poor (ppp per capita less than $3479); 11% middle income; 11% rich (ppp per capita more than $8000) 6. The Balance of Payments: Officially known as the Statement of International Transactions, and records a country ’ s international transactions among companies, governments, and/or individuals. Reports the total of all money flowing into a country minus all money flowing out of that country to others, during a given period.

2004 Prentice Hall, Inc The two primary accounts under the Balance of Payments: a. The Current Account: tracks all trade in goods and services, as well as income from assets abroad. b. The Capital Account: tracks transactions in real or financial assets between countries, as well as loans given to foreigners and loans received by citizens.

2004 Prentice Hall, Inc Countries Classified by Economic System Figure

2004 Prentice Hall, Inc Types of Economic Systems An Economic System is the set of structures and processes that guides the allocation of scarce resources (ownership of resources), and shapes the conduct (degree of control) of business activities in a nation. An Economic System is the set of structures and processes that guides the allocation of scarce resources (ownership of resources), and shapes the conduct (degree of control) of business activities in a nation. Market Economy: resources are primarily owned and controlled by the private sector, not the public sector. 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 buyConsumer sovereignty is the right of consumers to decide what to buy Prices are determined by supply and demandPrices are determined by supply and demand 4-14

2004 Prentice Hall, Inc Free-market (capitalistic) economies are built upon: The private ownership and control of the factors of production. The private ownership and control of the factors of production. Freedom of market entry and exit. Freedom of market entry and exit. Determination of prices according to the laws of supply and demand. Determination of prices according to the laws of supply and demand. The Laissez-Faire Principle Non-intervention by government in a country ’ s economic activity. Results in effective and efficient allocation of resources

2004 Prentice Hall, Inc Economic Freedom, con ’ t Command Economy (Centrally Planned Economy): all dimensions of economic activity, including pricing and production decisions, are determined by a central government plan 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 resourcesGovernment owns and controls all resources Prices are determined by governmentPrices are determined by government 4-15

2004 Prentice Hall, Inc Economic Freedom, con ’ t Mixed Economy: Some degree of government ownership and control Mixed Economy: Some degree of government ownership and control Economic decisions are largely market-driven and ownership is largely private. Economic decisions are largely market-driven and ownership is largely private. Government intervenes in in many economic decisions. Government intervenes in in many economic decisions. No economy is purely market or command No economy is purely market or command Economic systems are along a spectrum of freedoms Economic systems are along a spectrum of freedoms Most command economies are moving towards a market economy Most command economies are moving towards a market economy 4-16

2004 Prentice Hall, Inc The Means of Transition Central Planning Systems v. Consumer Sovereignty The success of the transition process depends on: - Government ’ s ability to liberalize economic activity. Reform business practices. Establish appropriate legal and institutional frameworks.

2004 Prentice Hall, Inc 1. : 1. Privatization: the sale and/or legal transfer of government-owned resources to private individuals. Benefits: - Reduces government debt. Increases market efficiency. Private enterprises must compete in open for materials, labor, and capital; thus, they succeed or fail on their own merits. 2. Deregulation: the relaxation or removal of restrictions on the free operation of markets and business.

2004 Prentice Hall, Inc Benefits: Allows businesses to be more productive and, thus, make investments in the innovations and activities that can lead to economic growth. 3. Property Rights: The protection of tangible and intangible property rights permits individuals to enjoy the benefits of their accomplishments. 4. Fiscal and Monetary Reform: Adopting market- oriented instruments such as interest rates and taxation policies, in order to achieve stability, reduce unemployment and inflation, which will attract investments needed for growth.

2004 Prentice Hall, Inc Economic Factors International Businesses Must Address Inflation Inflation Surpluses Surpluses Deficits Deficits Balance of Payments Balance of Payments External Debt External Debt Internal Debt Internal Debt Privatization Privatization 4-17

2004 Prentice Hall, Inc Reforms and Economic Progress Figure

2004 Prentice Hall, Inc Physical & Societal Influences 4-19

2004 Prentice Hall, Inc Chapter Review Learn differences among the world ’ s major economic systems Learn differences among the world ’ s major economic systems Learn criteria for dividing countries into economic categories Learn criteria for dividing countries into economic categories Discuss economic issues that influence international business Discuss economic issues that influence international business Assess the transition process for market economies Assess the transition process for market economies 4-20