International Business Chapter Four The Economic Environment

Chapter Objectives To appreciate the importance of the economic analysis of foreign markets To identify the major dimensions of international economic analysis To compare and contrast the economic indicators of countries To profile the characteristics of the types of economic systems To discuss the idea of economic freedom To profile the idea, drivers, and constraints of economic transition

Introduction All countries differ in terms of: -economic performance -levels of economic development -economic performance -economic potential A firm’s managers must understand the economic environments of those countries in which it operates, as well as those of countries in which it does not, in order to predict how trends and events the world over will likely affect firm performance.

Key Economic Forces The general economic framework of a country Its degree of economic stability The existence and role of capital markets The presence of factor endowments Market size The existence of economic infrastructure

Factor Conditions Factor conditions: a nation’s inputs into the production process, such as human, physical, knowledge, and capital resources and infrastructure Not only is it difficult to specify a definitive set of economic indicators that precisely assess the performance and potential of a nation’s economy, but it is also difficult to understand the systematic relationship of one variable to another.

Fig. 4.1. Physical and Societal Influences on International Business

Gross National Income Gross national income (GNI): the market value of all final goods and services produced by a country’s domestically-owned firms in a given year ECONOMIES RANKED BY 2003 GNI [$US MILLIONS] 1. United States 11,012,597 9. Spain 700,475 2. Japan 4,360,824 10. Mexico 637,159 3. Germany 2,085,464 11. South Korea 576,426 4. United Kingdom 1,680,069 12. India 570,760 5. France 1,521,613 13. Brazil 479,515 6. China 1,416,751 14. Australia 436,470 7. Italy 1,243,168 15. The Netherlands 425,556 8. Canada 773,943 16. Russian Fed. 374,810 Source: World Bank Development Indicators 2003

Map 4.2: The World’s Wealth Measured in Per Capita GNI

Purchasing Power Parity Purchasing power parity: the number of units of a country’s currency required to buy the same amount of goods and services in the domestic market that one unit of income would buy in another country. Purchasing power parity [PPP] is estimated by calculating the value of a universal “basket of goods” that can be purchased with one unit of a country’s currency.

Map 4.3: The World’s Wealth Measured in Terms of Purchasing Power Parity

The Human Development Index Is designed to capture long-term progress rather than short-term changes Measures longevity, knowledge (adult literacy rates), and standards of living Combines indicators of real purchasing power, education, and health The human development index provides a more comprehensive measure that incorporates both economic and social variables.

Map 4.4: The Human Development Index

Second-order Indicators of Economic Development and Potential Inflation Unemployment rate Debt Internal external Income distribution Poverty rate Balance of payments The Consumer Price Index (CIP) measures the average change in consumer prices over time in a fixed market basket of goods and services; the misery index represents the sum of a country’s inflation and unemployment rates.

The Balance of Payments reports the total of all money flowing into a country less all money flowing out of that country to any other country during a given period of time records a country’s international transactions amongst companies, governments, and/or individuals during a given period of time The Balance of Payments [BOP] is officially known as the Statement of International Transactions.

The Balance of Payments: Key Components Current Account Value of merchandise exports and imports Value of services exports and imports Value of income receipts and payments Net value of unilateral transfers Capital Account Value of capital inflows and outflows Value of financial inflows and outflows Net change in official reserve assets

Surpluses and Deficits A trade surplus indicates that the value of exports exceeds the value of imports. A trade deficit indicates that the value of imports exceeds the value of exports. Trends in balance of payments data can reveal important strategic implications with respect to a country’s economic environ- ment and potential economic policies.

Economic System Defined Economic system: the set of structures and processes that guides the allocation of scarce resources and shapes the conduct of business activities in a nation Spectrum of Economic Systems Centrally-planned Free-market N. Korea China Brazil Japan USA Cuba Russia India Germany Canada Vietnam S. Korea France UK

Types of Economic Systems Market Economy: a free-market (capitalistic) economy built upon the private ownership and control of the factors of production Command Economy: a centrally-planned economy built upon government ownership and control of the factors of production Mixed Economy: an economy in which economic decisions are largely market-driven and ownership is largely private, but significant government intervention is still evident

Fig. 4.3: Relationships between the Control of Economic Activity and the Ownership of Production Factors

The Economic Freedom Index approximates the extent to which a government intervenes in the areas of free choice, free enterprise, and market-driven prices for reasons that go beyond basic national needs classifies countries as: -free -mostly free -mostly unfree -repressed

The Economic Freedom Index: Determining Factors Trade policy The fiscal burden of the government The extent and nature of government intervention Monetary policy Capital flows and investment Banking and financial activities Wage and price levels Property rights Other government regulation Informal market activities

Map 4.5: Countries Ranked According to Economic Freedom

Map 4.6: GDP Per Capita Growth Rate

Economic Transition The shift from a command or mixed economy to a freer market economy largely depends on a government’s ability to: -dismantle features such as central planning -create features such as consumer sovereignty. The success of the transition process depends upon the government’s ability to liberalize economic activity, to reform business practices, and to establish legal and institutional frameworks.

Policies That Shape the Economic Transition Process Privatization: the sale and/or legal transfer of government-owned resources to private individuals and/or entities Deregulation: the relaxation or removal of restrictions on the free operation of markets and business practices Property rights: the protection of real (tangible) and intellectual (intangible) property [continued]

Fiscal and monetary reform: the reliance upon market-oriented instruments to achieve macroeconomic stabilization, the setting of strict budgetary limits, and the use of market-based policies to manage the money supply Antitrust legislation: laws designed to maintain and promote market competition, i.e., to prohibit the anticompetitive behavior of monopolies

Fig. 4.4: Reforms and Economic Progress

Implications/Conclusions The benefits of doing business in a given country are directly influenced by the size of the market, the wealth of consumers, and the openness, the stability, and the growth potential of the economy. [continued]

The power of economic analysis is a function of identifying the best possible indicators and then understanding how they work both in isolation and interactively. The type of economic system is a strong predictor of a nation’s present economic performance and its future economic prospects.