© 2001 prentice hall4-1 international business by daniels and radebaugh chapter 4 the economic...

© 2001 Prentice Hall 4-1

International Businessby

Daniels and Radebaugh

Chapter 4The Economic Environment


ObjectivesTo learn the differences between the world’s major economic

systemsTo learn the criteria for dividing countries into different

economic categoriesTo discuss key economic issues that influence international

business

To assess the transition process certain countries are undertaking in changing to market economies—and how this transition affects international firms and managers


IntroductionWorld’s economic landscape is changing

• Company managers need to understand economic environments to predict trends

• Some countries have environments where change is rapid and unpredictable

Key economic forces• General economic framework of a country• Economic stability• Existence and influence of capital markets• Factor endowments• Market size• Availability of economic infrastructure


Cultural Influences on International Business

COMPETITIVE ENVIRONMENT

PHYSICAL AND SOCIETAL FACTORS• Political policies and legal practices• Cultural factors• Economic forces• Geographical influences

EXTERNAL INFLUENCES OPERATIONS

OBJECTIVES

MEANS

STRATEGY

• Economic size• Economic systems • Key macroeconomic indicators—growth, inflation, surpluses, deficits• Economies in transition


An Economic Description of CountriesFactor conditions—inputs to the production process

• Human resources• Physical resources—weather, existence of waterways,

availability of mineral and agricultural products• Knowledge resources—research and development• Capital resources—availability of debt and equity capital• Infrastructure—roads, port facilities, energy, and

communicationsDemand conditions (market potential)

• Quality of demand—composition of home demand• Quantity of demand—size and growth of demand• Internationalization of demand

Combination of factor and demand conditions contribute to the location—specific advantage that a country has to offer domestic and foreign investors


Countries Classified by IncomeGross National Product (GNP)

• Market value of final goods and services newly produced by domestically owned factors of production

• Per capita GNP—GNP divided by total populationGross Domestic Product (GDP)

• Value of production that takes place within a nation’s borders

• No regard for whether the production is done by domestic or foreign factors of production

World bank—multilateral lending institution that provides investment capital to countries

• 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


World Bank Per Capita Income Classifications

Low income $785 or less in 1997Middle income $786 - $9,655Lower middle income $786 - $3,125Upper middle income $3,126 - $9,655High income $9,656 or more

Developing (emerging) countries include: - low- and middle-income countries - countries with both large or small populations - countries in economic transition - found in all areas of the world - tremendous potential for business because of the

sheer size of the populationDeveloped countries include: - high-income countries - clustered in just a few geographic areas - natural places to do business because of quality

and quanity of demand


Countries Classified by Income (cont.)World Bank (cont.)

• Purchasing power parity per capita GNP (PPP)– number of units of a country’s currency required to

buy the same amount of goods and services in the domestic market as $1 would buy in the United States

– measure of a the wealth of a countryCountry GNP per capitaa PPP estimates of GNP per capitab

Brazil $4,720 $6,240China 860 3,570Czech Republic 5,200 11,380France 26,050 21,860Japan 37,850 23,400Mali 260 740Mexico 3,680 8,120Russian Federation 2,740 4,190Thailand 2,800 6,590United States 28,740 28,740

a - Dollars, 1997 b - Current International Dollars, 1997


Countries Classified by RegionWorld Bank data is provided by geographic region

• East Asia and Pacific• Europe (East and Central Europe) and Central Asia• Latin America and Caribbean• Middle East and North Africa• South Asia• Sub-Saharan Africa• High-income countries

Importance of regional groupings of countries• Similar economic conditions• Mirrors the way companies organize their firm

geographically


Countries Classified by Economic SystemEconomic system—based on government’s mix of ownership

and control of the economyOwnership—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


Countries Classified by Economic System (cont.)Control of economic activity—resource allocation and control by the

public or the private sectorHeritage Foundation—factors that determine economic freedom

• Trade policy • Taxation • Government intervention in the economy• Monetary policy• Capital flows and investment• Banking• Wage and price controls• Property rights• Black market activity

Countries with greater economic freedom have more control in the private than the public sector• Some advanced countries have significant government

interference in the economy– state capitalism


Countries Classified by Economic System (cont.)Market economy— resources are primarily owned and

controlled by the private sector• Consumer sovereignty

– the right of consumers to decide what to buy– companies free to operate in the market– prices determined by supply and demand

Command (centrally planned) economy—all dimensions of economic activity are determined by a central government plan

• Government owns and controls all resources• Government best judge of use of resources

Mixed economy—degrees of ownership and control• No economy is purely market or completely command• Market socialism—state owns significant resources, but

allocation comes from market price mechanism


Interrelationship between Control of Economic Activity and Ownership of Production Factors

Ownership of Production

Private Mixed Public

Con

trol

of

Eco

nom

ic A

ctiv

ity

Market

Mixed

Command

Market/Private*

Market/Mixed

Market/Public

Mixed/Private

Mixed/Mixed

Mixed/Public

Command/Private

Command/Mixed

Command/Public

* Control/Ownership


Key Macroeconomic Issues Affecting Business StrategyGlobal 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


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

• Affects interest rates– banks must offer high interest rates to attract money– governments raise interest rates to slow down

economic growth• Affects exchange rates

– high inflation reduces the value of currency• Affects cost of living• Affects confidence in the political and economic systems

of the country


Key Macroeconomic Issues (cont.)External deficit— country’s cash outflows exceed its inflowsBalance 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


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


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


Transition to a Market EconomyMost 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


Reforms and Economic Progress

Market-friendly environment

New investmentFurther growth

Ability to attract foreign investment

Reforms and economic progressVirtuous circle

Early pain and oppositionEarly recovery and new economic opportunities

Steady progress to open, liberal market

Spread of benefitsStrong fiscal positionConfidence in banks

Growth in output, employment,new firms

Credible and well-financed government

Steady improvement in rule of lawSufficient revenues to finance social safety net

Reforms and economic progressVicious circle

Opposition to open-entrycompetition and full liberalization

Vested interest develop

Poor rule of law

Underground andvirtual economy

Market transformation frozen

Low growth and reversalFinancial stability reverse

Opportunity for rent-seeking and corruption

Partial market reform


Transition to a Market Economy (cont.)Impact on MNEs

• With liberalization and opening doors to the outside world, MNEs have increased their exports to them

• Privatization process has provided many opportunities for foreign companies to acquire companies and enter the market through acquisition

• Russia’s transition• Both political and economic transition• Initial steps resulted in steep economic decline• Massive, although not altogether effective, privatization• Soft budgets—subsidies and other government-

supporting activities—have continued• Hard administrative constraints have disappeared• Debts and deficits remain a real challenge


Transition to a Market Economy (cont.)Eastern Europe’s transition

• Poland, Hungary, and Czech Republic (to a lesser extent) underwent serious pain in early years but have begun to recover economically

• Each European country in transition differs in terms of how it approached transition and what its starting point was

China’s transition• Chinese growth has been far stronger than for other

countries in transition• China maintained totalitarian political control while

loosening the economy• A major challenge is privatizing state-owned enterprises


Transition to a Market Economy (cont.)Future of transition

• Establish market institutions– central banks and stock markets

• Stabilize the macroeconomic environment– control inflation and currency values

• Bring internal debt into balance– improve tax collections and reduce government

expenditures• Privatize state-owned enterprises• Allow private sector firms to grow

– greater freedom from control and soft budget constraints

• Deal with environmental damage– air and water pollution– cost of cleanup is significant

• Develop human capital, esp. managerial capability