International Business Environments & Operations Chapter 4 The Economic Environments Facing Businesses Daniels ● Radebaugh ● Sullivan International Business Environments and Operations 15e by Daniels, Radebaugh, and Sullivan

Introduction Managers assess a country’s economic environment knowing Countries differ in different ways Economic and political changes alter market circumstances It is important to understand connections, change, and consequences The challenges of the comeback Choices of citizens, policymakers, and institutions Managers study economic environments to estimate how market trends and government policy influence the performance of their companies. A country’s economic policies are a leading indicator of a government’s goals and its planned use of economic tools and market reforms. Managers should study a country’s economic environment to assess its development, explain its performance, and estimate its potential. Managers do this knowing countries differ in different ways, economic and political changes alter market circumstances, that it’s critical to make connections between events and predict the consequences of changes, the challenges of the comeback, and choices of citizens, policymakers, and institutions.

International Economic Analysis A universal assessment of economic environments is difficult because of: System Complexity Identifying proper indicators is difficult Market Dynamism New economic circumstances Market Interdependence Markets influence each other Data Overload Complicates decision-making Difficult to specify definitive set of economic indices that estimate performance and potential of an economy New challenges when interpreting relationships between estimators in other economic environments Determining which countries warrant investment is not easy. It’s very difficult to assess the potential of a country because any type of assessment relies on behavioral assumptions as well as more scientific principles. There are some 208 discrete economic environments in the world today. Managers need to narrow them down and identify exactly which countries offer the greatest potential return for the least risk.

International Economic Analysis Economic Factors Affecting International Business Operations This Figure shows the economic factors affecting international business environments. The Figure highlights the importance of applying a systems perspective - linkages among elements mean that change in one element in the economy affects other parts.

Elements of the Economic Environment Different measures used to assess performance and potential Begin with monetary values of total flow of goods and services Refine by considering growth rate, income distribution, inflation, unemployment, wages, debt, balance of payments Gross national income (GNI) Income generated both by total domestic production as well as the international production activities of national companies value of all production in the domestic plus the net flows of factor income (rents, profits, and labor income) from abroad during a one-year period The market value of final goods and services prodcued by domestically owned factors of production the broadest measure of economic activity for a country One way managers can assess markets is by looking at gross national income or GNI which measures the value of all production in the domestic economy together with the income the country receives from other countries, less similar payments it has made to other countries. Managers can also look at gross national product or GNP. Conceptually, world GNI and world GNP are the same. Gross domestic product or GDP allows managers to assess countries in which the output of multinationals represents a significant share of activity.

Elements of the Economic Environment Gross domestic product (GDP) the total value of all final goods and services produced within a nation in a particular year (both domestic and foreign owned companies produce) Technically, GDP plus the income generated from exports, imports, and the international operations of a nation’s companies equals GNI GDP is an essential part of GNI GNI data should be adjusted for the growth rate of the economy the number of people in a country the local cost of living

Improving the power of GNI Per Capita Conversion Transform GNI and other economic indicators by the number of people who live in a country Per capita GNI is converting the GNI into a standard currency (at prevailing market rates) and divide by its population Rate of change When GNI grows at higher rate than the population, standards of living are said to be rising Purchasing Power Parity (PPP) Simple conversion of per capita is misleading Adjust GNI per capita for a country in terms of its local PPP: The number of units of a country’s currency required to buy the same amounts of goods and services that one unit of income would buy in the other country

Performance and Potential of a Country Degree of Human Development Greater access to knowledge, better nutrition and health services, secure livelihood, security against crime and violence, political and cultural freedom, recreations UN Human Development Index measures achievements on three dimensions: longevity, knowledge, and standard of living Other indexes: Gender development, gender empowerment, human poverty Green economics Economic performance in terms of the effect of current choices on long-term sustainability meet the needs of the present without compromising the ability of future generations to meet their own needs Green net national product, Genuine progress indicator, Gross national happiness, Happy planet Happynomics importance of emotional prosperity in addition to financial prosperity In addition to looking at GNI, GNP, and GDP, managers also need to consider sustainability and stability. Green economics allows managers to consider the social and ecological costs of their decisions. The goal should be to create an enabling environment for people to enjoy long, healthy, and happy lives. There is growing criticism of traditional GNI figures as a measure of performance. Research shows that people in rich countries are not significantly happier than people in poor countries. Happynomics focuses on the importance of emotional happiness as a measure of a country’s performance and potential.

Inflation Inflation A general, sustained rise in prices measured against a standard level of purchasing power A measure of the increase in the cost of living Measured by comparing two sets of goods at two points in time and computing the increase in cost that is not reflected by an increase if the quality of good Results when aggregate demand grows faster than aggregate supply Chronic inflation decreases confidence in a country’s currency Deflation when prices for products go down not up Reflation increase the money supply and reduce taxes to accelerate economic activity Chronic inflation usually plagues countries where prices have been rising for prolonged periods of time. Deflation occurs when the general price level of goods and services falls. It’s often caused by a reduction in the money supply or a reduction in credit.

Unemployment Unemployment rate Number of unemployed workers seeking employment for pay relative to the total civilian labor force Misery index the sum of a country’s inflation and unemployment rates Inflation depresses economic growth, create social pressures, and increases political uncertainty The unemployment rate measures the number of workers who want to work but do not have jobs. High unemployment is a warning sign for managers because it symbolizes a government’s ineptitude in managing domestic affairs. Underemployment occurs when people work fewer hours per day than they would prefer or when they work below the level for which they have been trained.

Debt Debt the total of a government’s financial obligations; measures the stats borrowing from its population, from foreign organizations, foreign governments, and international institutions internal debt: results when a govt spends more than it collects in the revenues Reasons: imperfect tax system, costs of security or social programs exceed available tax revenues, state-owned enterprises run deficits external debt: results when a govt borrows money from foreign lenders Managers can look at a country’s debt to gauge how much a country borrows from its citizens, foreign organizations, foreign governments, and international institutions. When total debt is high the more uncertain an economy’s performance and potential.

DEBT Growing public debt signals tax increases reduced growth rising inflation increasing austerity (governess)

Income Distribution Income distribution estimates the proportion of the population that earns various levels of income GNI or PPP per capita report how much income the average person earns but everyone is NOT an average Gini Coefficient measures the extent to which the distribution of resources deviates from a perfectly equal distribution Assess the degree of inequality in the distribution of income in a country Uneven income distributions exists in almost every country Urban versus Rural income Distribution Managers should also look at income distribution to better understand a market’s performance and potential. One trend that is affecting markets across the globe is the growing gap between rich and poor. Managers can estimate inequalities in income distribution using a Gini coefficient. A score of one indicates that one person has all the income. Most countries range between 25 and 60 percent.

Poverty Poverty the state of having little or no money and few or no material possessions ~ condition in which a person or community is deprived of, or lacks the essentials for, a minimum standard of well being in life The essentials can be food, safe drinking water, shelter; social resources such as education and access to information, healthcare, and social status; opportunity to develop meaningful connections with other people in the society extreme poverty less than $1.25 per day moderate poverty less than $2.00 per day (over 3 billion people) Today the world population is 80% poor, 10% middle income, and 10% rich Poverty shapes economic environments. While the number of people in extreme poverty in the world has fallen, this figure is misleading because much of the drop has been in a single country, China. Poverty continues to be a problem with as many as 1.2 billion people in poverty. The growth of business and economic progress is dependent on ending poverty. Keep in mind though, that despite being poor, there may still be a market for goods. Some 80 percent of Indians live on less than $2 per day for example, yet there are 700 million cell phone subscribers in the country. The Base of the Pyramid is the largest, but poorest, socioeconomic group in the world who live on less than $2.50 per day. This group may in fact be the future of the global economy prompting the development of frugal engineering which focuses on the needs of poor consumers as a starting point for developing functional, economic products.

Labor Costs and Productivity Labor Costs: The cost of labor is a key element of total costs Consider labor cost for a factory worker across countries Productivity: Amount of output created per unit input used Quantity produced per person per labor hour

Balance of Payments Balance of payments Officially known as Statement of International Transactions Reports a country’s trade and financial transactions with the rest of the world (usually over one year) Current account: Tracks all trade activities in merchandise Capital account: Tracks both loans given to foreigners and loans received by citizens A country’s balance of payments is a system of monitoring all of a country’s economic transactions with the rest of the world. It reports the country’s trade and financial transactions with the rest of the world. A current account surplus occurs when exports exceed imports, while a current account deficit occurs when imports exceed exports.

Economic Freedom Economic freedom – people have the right to work, produce, consume, save, and invest the way they prefer measured across business freedom, monetary freedom, fiscal freedom, investment freedom, freedom from corruption, property rights, trade freedom, government size, financial freedom, and labor freedom So, it’s important for managers to monitor a range of economic issues, but perhaps most important is an assessment of economic freedom, or what a manager has the freedom to do. Economic freedom reflects the absence of government coercion or constraint on the production, distribution, or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty. In some countries these freedoms are taken for granted, while in others they are rare. Economic freedom advanced in 2011. As you might expect, it tends to be higher in Western countries and lower in Eastern countries.

Types of Economic Systems An economic system refers to the mechanism that deals with the production, distribution, and consumption of goods and services Set of structures and processes that guides the allocation of resources and shares the conduct of business activities in a country Spectrum analysis gives a range of economic systems in the world with capitalism and communism on two ends Major difference between economic systems is in terms of their implications for economic matters such as ownership and control and freedom of prices to balance supply and demand Managers can explore a country’s economic system to understand how the host government regulates the economy, protects property rights, sets fiscal and monetary policies, and enforces antitrust regulation. There are three main types of economic systems: market, command, and mixed economies.

Types of Economic Systems This Figure shows the different types of economic systems.

Capitalism vs Communism Capitalism: free market system built on private ownership and control Owners of capital have property rights Communism: centrally planned system built on state ownership of all economic factors of production and control of all economic activity

Market Economy: Capitalism In a market economy individuals rather than governments make most economic decisions Capitalism private ownership of capital Laissez-faire governmental noninterference in economic affairs In market economies private interests own resources, and prices determine supply and demand. While there is generally an attitude of laissez-faire the invisible hand does become more visible at times because of the need to provide public goods and protect society. Market economies maximize economic freedom.

Command Economy: Communism In a command economy the visible hand of the state supersedes the invisible hand of individuals Government owns and controls resources determines prices In a command economy, governments plan what goods and services will be produced, the quantity in which they are produced, and the price at which they are sold. Command economies constrain economic freedom.

Mixed Economy There are rarely pure capitalist or communist countries now Most economies are mixed economies fall between market and command economies Socialism regulate economic activity with a focus on social equality and a fair distribution of wealth In a mixed economy, both government and private enterprise influence production, consumption, and savings. This type of economy supports socialism and the notion that the partly visible hand of the government commands and controls some factors of production. Therefore, economic freedom in a mixed economy is regulated.

Economic Development, Performance, and Potential Broad classes of countries include developing countries largest number of countries low per capita income emerging economies fast growing, relatively prosperous BRICs – Brazil, Russia, India, and China developed countries high per capita income and standard of living like the U.S., Japan, France, Australia Managers need to assess a country’s level of economic development, performance, and potential. Countries can be classified as developing countries, emerging economies, and developed countries.