Download International Business

The Economic
Environment
4-1
Chapter Objectives
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Learn differences among the world’s
major economic systems
Learn criteria for dividing countries
into economic categories
Discuss economic issues that
influence international business
Assess the transition process for
market economies
4-2
Economic Issues for International
Businesses
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What type of economic system does the
country have?
What is the size, growth potential, and
stability of the market?
Is the company’s industry in that country’s
public or private sector?
• If public, does the government allow private
competition?
• If private, is it moving towards public
ownership?
4-3
Economic Issues for International
Businesses, cont
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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 much of a contribution is the private
sector expected to make in assisting the
government formulate overall economic
objectives?
4-4
Key Economic Forces
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General economic framework
Economic size and stability
Existence and influence of capital markets
Factor endowments
Indicators
•
•
•
•
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Growth
Inflation
Surpluses
Deficits
Economic transitions
Availability of economic infrastructure
4-5
Economic System
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Structure and processes that a country
uses to allocate its resources and conduct
commercial activities.
Connection between political ideology and
economic systems
• Countries where individual goals are given primacy
free market economic systems are fostered
• Countries where collective goals are given primacy
there is marked state control of markets
Economic Systems
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Market economy: what is produced &
in what quantity is determined by
supply/demand and signaled to
producers through a price system
Command economy: planned by
government
Mixed economy: a balance of both of
the above
Economic Systems
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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 buy
• Companies have the ability to decide what to
produce and in which market to compete
• Prices are determined by supply and demand
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Laissez-Faire Economics
4-14
Government Role in
Market Economy
Enforcing
Antitrust
Laws
Preserving
Political
Stability
Preserving
Property
Rights
Providing a
Stable Fiscal
& Monetary
Environment
Enforcing Antitrust Laws
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The goals of antitrust (or
antimonopoly) laws is to encourage
the development of industries with
as many competing businesses as
the market will sustain
Preserving Property Rights
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By preserving and protecting
individual property rights,
governments encourage individuals
and companies to take risks such as
investing in technology, inventing
new products, and starting new
businesses.
Providing Stable Fiscal & Monetary
Environment
 Encourages commerce in a nation
because it improves its reputation as a
place to do business
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To reduce high inflation and
unemployment, governments can help
control inflation through effective fiscal
policies (policies regarding taxation and
government spending) and monetary
policies (policies controlling money supply
and interest rates).
Preserving Political Stability
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A market economy depends on a
stable government for its smooth
operation and, indeed, for its future
existence.
Political stability helps businesses
engage in activities without worrying
about terrorism, kidnappings, and
other political threats to their
operations.
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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
resources
• Prices are determined by government
• Welfare of the group is paramount
• Economic and social equality is the goal
4-15
Decline of Central Planning
Central planning failed to:

Create economic value
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Provide incentives
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Achieve rapid growth
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Satisfy consumer needs
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Mixed Economy: Some degree of
government ownership and control
• The goal is to achieve low unemployment, low
poverty, steady economic growth and equitable
distribution of wealth.
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No economy is purely market or command
Economic systems are along a spectrum of
freedoms
Most command economies are moving
towards a market economy
4-16
CLASSIFICATION OF THE COUNTRIES
Countries Classified by Economic System
Economic system—based on government’s mix of
ownership and control of the economy
Ownership—who owns the resources engaged in economic
activity
• Most countries are a mixture of public and private
ownership
– state-owned enterprises—ownership by public
sector
• Most countries with significant state-owned
enterprises are moving toward less, not more, public
ownership
– privatization
Factor Conditions
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Inputs to the production process
• Human resources
• Physical resources-
weather, existence of
waterways, availability of mineral and agricultural products
• Knowledge - research and development
• Capital - availability of debt and equity capital
• Infrastructure - roads, port facilities, energy, and
communications
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Factor conditions are especially
critical for the production of goods
4-6
Demand Conditions
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Market potential
• Composition of home demand (nature of buyer
needs)
• Size of home demand
• Growth of home demand
• Internationalization of demand
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
Demand conditions are especially critical
for market-seeking
investments
Combination of factor and demand conditions
contribute to the location—specific advantage
that a country has to offer domestic and foreign
investors
4-7
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)
Differences in Economic
Development
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Different countries have dramatically
different levels of economic development
Two common measurements of economic
development
• Gross National Income (GNI) superseded
Gross National Product or GNP
• Purchasing Power Parity (PPP) which
accounts for differences in the cost of living
Gross National Income

Tool to measure one country against
another
• Size
• Demand
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Gross National Income (formerly the
Gross National Product)
GNI is the market value of final goods and
services newly produced by domestically
owned factories of production.
Countries with high populations and high
per capita GNI are most desirable in terms
of market potential
4-8
Gross Domestic Product
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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 • Both a Ford and Toyota manufactured in
the United States counts towards our
GDP
• A Ford produced in Mexico would not
4-9
Importance of Per Capita GNI
Common Name
Per Capita GNI
($)
World Bank
Category
Developing/Emerging
Country
755 or less (in
2000)
Low Income
Developing/Emerging
Country
756-2,995
Lower Middle
Income
Developing/Emerging
Country
756-9,265
Middle Income
Developing/Emerging
Country
2,996-9,265
Upper Middle
Income
Developed/Industrial
Country
9,266 or more
High Income
4-10
World bank
• multilateral lending institution that
provides investment capital to countries
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Uses per capita GNP as a basis for lending
policies
Goal is to provide development assistance
• Build infrastructure, promote economic growth
and stability, improve quality and quantity of
demand
26
Purchasing Power Parity
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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
• Example: China has a higher PPP than Japan
4-11
Differences in Economic Development:
Purchasing Power Parity
Country
GNI per Capita
GNI PPP per
Capita
GDP Growth
Rate
1993-2003(%)
Brazil
$2,710
$7,480 2.6%
China
$1,100
$4,990 9.3%
$25,250
$27,460 1.2%
$530
$2,880 6.1%
$34,510
$28,620 1.2%
Nigeria
$320
$900 3.1%
Poland
$5,270
$11,450 4.8%
Russia
$2,610
$8,920 0.1%
Switzerland
$39,880
$32,030 0.9%
United Kingdom
$28,350
$27,650 2.8%
United States
$37,610
$37,500 3.2%
Germany
India
Japan
Big Mac index
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The Economist's Big Mac index is based on the
theory of purchasing-power parity (PPP),
the idea that exchange rates should move to
equalize the prices of a basket of goods and
services across different countries. Our basket is
the Big Mac.
For example, the cheapest burger in the chart is
in China, at $1.26, compared with an average
American price of $3. This implies that the yuan
is 58% undervalued relative to its Big Mac dollarPPP. On the same basis, the euro is 25%
overvalued, the yen 17% undervalued.
Economic Factors International
Businesses Must Address
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Economic Growth
Inflation
Surpluses
Deficits
Balance of Payments
External Debt
Internal Debt
Privatization
4-17
Key Macroeconomic Issues Affecting Business
Strategy
Global economy can affect company profits and operating
strategies
•Management must learn to scan the environment
Economic growth
•There are significant differences in growth
rates worldwide
•Affects the degree to which investments in or sales to a
country can affect the bottom line of a company
– drop in economic growth can have detrimental
effects on investments
» new investors reluctant to bring in money
» existing investors forced to cut back operations
and may pull out
» Difficult to forecast economic growth
32
Key Macroeconomic Issues (cont.)
Inflation—a condition in which aggregate
demand grows faster than aggregate supply
• Inflation rate—the percentage increase in
the change in prices from one period to
the next
• Consumer price index (CPI)—index of
inflation
– measures a fixed basket of goods and
compares its price from one period to
the next
33
Key Macroeconomic Issues (cont.)
External deficit— country’s cash outflows exceed its inflows
Balance of payments—record of a country’s international
transactions
• current account—comprised of:
– trade in goods and services and income from assets
abroad
» merchandise trade balance—country’s trade
deficit or surplus
» exports considered to be positive
» imports considered to be negative
– Services—transactions such as travel, passenger
fares, other transportation
– income receipts—payments on assets
– unilateral transfers—government and private relief
grants and income transferred by guest workers
34
Key Macroeconomic Issues (cont.)
Balance of Payments (cont.)
• Capital account— transactions in real or financial
assets between countries
– transactions include foreign direct investments
• Companies monitor the balance of payments to
watch for factors that could lead to currency
instability or government actions to correct an
imbalance
• External debt—results from borrowing money
abroad
• Measured in two ways
– total amount of the debt
– debt as a percentage of gdp
• The greater the external debt, the more unstable
the economy
• Countries with small market conditions and political
instability must rely on external debt
35
Key Macroeconomic Issues (cont.)
Internal debt— result of an excess of government
expenditures over revenues
• Internal deficits—excess government expenditures
over tax receipts
– deficits result from:
» poorly run tax system that fails to collect all
the revenues due
» expensive government programs
» state-owned enterprises operated in the red
Privatization—the sale of state-owned enterprises to the
domestic or foreign private sector
• Helps governments reduce internal debt
• A complicated political and economic process
• Key is availability of capital
• Enable foreign companies to acquire assets and
gain access to markets through acquisition
36
Transition to a Market Economy
Most command economies are undergoing transition to
market economies
• Transition a result of the failure of central planning
• Transition implies:
– liberalizing economic activity, prices, and market
operations
– developing indirect, market-oriented instruments
for macroeconomic stabilization
– achieving effective enterprise management and
economic efficiency
– imposing hard budget constraints
– establishing an institutional and legal framework
to secure property rights, the rule of law, and
transparent market-entry regulations
Obstacles to Transition
Lack of
managerial
expertise
Capital
shortage
Environmental
degradation
Cultural
differences