Economic Systems and Development

Chapter Objective Discuss the decline of centrally planned economic systems Describe mixed economies and privatization Explain how a market economy functions and the role of each primary feature Identify ways to measure economic development Describe economic transition and the remaining obstacles to companies

Economic Systems Centrally Planned Mixed Market Government ownership of economic resources and state planning Mostly private (individual or business) ownership of economic resources Government and private ownership of economic resoures split rather evenly

Centrally Planned Economy Asia Central Europe Eastern Europe Latin America Russia (1917) China (1949) Cuba (1959) Government owns most land, factories and other economic resources and plans nearly all economic activity Welfare of the group is paramount Economic and social equality is the goal “Communist” system is needed

Decline of Central Planning Central planning failed to: Create economic value Provide incentives Achieve rapid growth Satisfy consumer needs

Chinese characteristics: Focus on China Socialism with Chinese characteristics: Communist after civil war ended in 1949 Agricultural reforms began in 1979 Township and Village Enterprises legal in 1984 Aggressive reform since that time Challenges ahead: Political problems and social unrest Unemployment and migrant labor Eventual(?) reunification with Taiwan Advanced entrepreneurial and management skills

Quick Study 1 1- What is meant by economic system? Explain the relation between culture and economics. 2- What is a centrally planned economy? Describe the link between central planning and communism. 3- Identify several factors that contributed to the decline of central planned economies.

Mixed Economy Noble goals: But stagnant: Government and private parties share ownership of land, factories and other economic resources rather evenly Noble goals: But stagnant: Low unemployment and poverty Steady economic growth Equitable distribution of wealth State-owned businesses uncompetitive Prices and taxes higher, living standards mixed Privatized state firms to boost competitiveness

Market Economy Supply Demand Private parties (individuals or businesses) own vast majority of land, factories and other economic resources Supply Quantity of a good or service that producers are willing to provide at a specific selling price Demand Quantity of a good or service that buyers are willing to purchase at a specific selling price

Laissez-Faire Economics Less government interference in commerce Free choice Consumers choose freely from alternative purchase options Free enterprise Firms decide which products to sell and markets to enter Price flexibility Most prices follow the forces of supply and demand

Government’s Role in a Market Economy Enforce antitrust laws Preserve property rights Provide fiscal and monetary stability Preserve political stability

Enforce Antitrust Laws Encourages development of industries with as many competing businesses as market will sustain Keeps consumer prices in check Prevents growth-stunting monopolies

Preserve Property Rights Encourages risk-taking by people and business as claims to assets and future earnings are protected Market economy needs strong property rights Entrepreneurs start new businesses Firms create new technologies and products

Provide Fiscal & Monetary Stability Encourages commerce in a nation because it improves its reputation as a place to do business Fiscal policies (taxation, government spending) Monetary policies (money supply, interest rates) Reduces overall uncertainty Improves business forecasts Holds inflation and unemployment low

Preserve Political Stability Encourages businesses to engage in activities without fear of disrupted future operations Promotes economic growth generally Reduces worries of terrorism / kidnapping Improves chances for business survival

Economic Freedom & Wealth

Quick Study 2 1- What is a mixed economy? Explain the origin of mixed economies. 2- Explain why the mixed-economy ideal is in decline and the key role of privatization? 3- Define what is the meant by market economy and identify its three required feature? 4- Explain government role in a market economy. What is the relation between economic freedom and standard of living?

Economic Development Economic well-being of one nation’s people relative to another nation’s people Economic output (agricultural, industrial, service) Infrastructure (communications, transportation, power) People (physical health, education level) Productivity is key Ratio of outputs (that created) to inputs (resources used to create output)

National Production GDP is the value of goods and services that a nation produces during a one-year period (GNP adds international activities) Potential problems Purchasing power parity Overlooks certain transactions Ignores economic growth rates Averages disguise regions May ignore purchasing power Relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries

National Wealth at PPP PPP Estimate of GDP per Capita GDP per Capita Country (U.S. $) (U.S. = 100) United States 36,100 36,100 Switzerland 37,400 30,500 Canada 23,100 30,300 Australia 20,700 28,100 United Kingdom 26,400 28,000 Japan 31,300 27,000 Czech Republic 6,800 15,100 Hungary 6,400 13,900 Mexico 6,300 9,200 Turkey 2,600 6,400

Quick Study 3 1- What is meant by economic development? Explain how productivity (and information technology) helps improve standards of living. 2-Describe three measures of economic development and list their advantages and disadvantages. 3- Explain the concept of purchasing power parity. What are its implications for a nation's relative income per capita?

Human Development Index

Classifying Countries Developed Country Emerging Market Newly Industrialized Country Developing Country Highly industrialized, highly efficient and whose people enjoy a high quality of life Newly industrialized countries plus those with potential to be newly industrialized Recently greater national production and exports from industrial operations Poor infrastructure and extremely low personal income

Quick Study 4 1- Explain the value of the Human Development Index (HDI) in measuring a nation's level of development. 2- How are communicable diseases devastating human and economic development in some poor nations? 3- Identify the main characteristics of: (a) developed countries, (b) newly industrialized countries, and (c) developing countries. 4- Name three countries that fall into each of the three country classifications.

Economic Transition Fundamental reorganization of an economy and the creation of new free-market institutions Reforms include: Reduce budget deficits and expand credit Allow the “price mechanism” to determine prices and economic activity Legalize private firms and privatize state-owned assets within a property rights framework Remove barriers to trade and investment and eliminate currency controls Ensure social-welfare system to ease transition

Obstacles to Transition Capital shortage Lack of managerial expertise Environmental degradation Cultural differences

Focus on Russia Operated under a staunchly communist system for about 75 years Underwent a rough transition of simultaneous economic and political reform But government tax revenues are increasing and foreign investment is returning Challenges include developing managerial talent and fostering political and social stability

Quick Study 4 1- What are several of the reform measures involved in undergoing economic transition to a market economy? 2- Describe some of the remaining obstacles to businesses in transitional economies. 3- Explain Russia’s experience with economic transition. What are some tips for people wishing to do business in Russia?

Chapter Summary This chapter introduces different economic systems and examines the effect of economics on international business. Business transactions depend on a nation’s economic system—the structure and processes that a country uses to allocate its resources and conduct its commercial activities. A centrally planned economy is a system in which land, factories, and other economic resources are owned by the government, which plans nearly all economic activity. In a mixed economy, ownership of land, factories, and other economic resources are more equally split between private and government. In a market economy, the majority of land, factories, and other economic resources are privately owned. The forces of supply and demand determine who produces what and the prices of products, labor, and capital. Development can be measured using four alternative methods: the volume of a nation’s annual production using such figures as gross domestic product and gross national product; purchasing power parity—the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries; and a nation’s level of human development—a measure of the extent to which a government satisfies the broader needs of its people. Economic transition creates new free-market institutions.

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