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International Business
Chapter Four
The Economic Environment
Chapter Objectives
• To appreciate the importance of the economic analysis
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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
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Introduction
All countries differ in terms of:
-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.
4-3
Key Economic Forces
• The general economic framework of a
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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
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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.
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Fig. 4.1. Physical and Societal
Influences on
International Business
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Gross National Income
Gross national income (GNI): the market
value of all final goods and services
produced by a country’s domesticallyowned firms in a given year
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ECONOMIES RANKED BY 2003 GNI
United States 11,012,597
Japan
4,360,824
Germany
2,085,464
United Kingdom 1,680,069
France
1,521,613
China
1,416,751
Italy
1,243,168
Canada
773,943
Source: World Bank Development Indicators 2003
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[$US MILLIONS]
Spain
Mexico
South Korea
India
Brazil
Australia
The Netherlands
Russian Fed.
700,475
637,159
576,426
570,760
479,515
436,470
425,556
374,810
4-7
Map 4.2: The World’s Wealth
Measured in Per Capita GNI
4-8
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.
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Map 4.3: The World’s Wealth
Measured in Terms of
Purchasing Power Parity
4-10
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.
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Map 4.4: The Human
Development Index
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Second-order Indicators of Economic
Development and Potential
• Inflation
• Unemployment rate
• Debt
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– 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.
4-13
The Balance of Payments
• reports the total of all money flowing into a
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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.
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The Balance of Payments:
Key Components
• Current Account
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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
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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 environment and potential economic policies.
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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
N. Korea
Cuba
Free-market
China
Russia
Vietnam
Brazil
India
S. Korea
Japan
Germany
France
USA
Canada
UK
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Types of Economic Systems
• Market Economy: a free-market (capitalistic)
economy built upon the private ownership and
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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
4-18
Fig. 4.3: Relationships between the
Control of Economic Activity and the
Ownership of Production Factors
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The Economic Freedom Index
• approximates the extent to which a government
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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
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The Economic Freedom Index:
Determining Factors
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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
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Map 4.5: Countries Ranked
According to Economic Freedom
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Map 4.6: GDP Per Capita
Growth Rate
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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.
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Policies That Shape the
Economic Transition Process
• Privatization: the sale and/or legal transfer of
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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]
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• Fiscal and monetary reform: the reliance upon
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market-oriented instruments to achieve
macroeconomic stabilization, the setting of
strict budgetary limits, and the use of marketbased 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
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Fig. 4.4: Reforms and
Economic Progress
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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]
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• 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.
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