Chapter Four The Economic Environment 2004 Prentice Hall

Chapter Four The Economic Environment 2004 Prentice Hall, Inc 4 -1 International Business 10 e Daniels/Radebaugh/Sullivan International Business

Chapter Objectives n n 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 2004 Prentice Hall, Inc 4 -2

Introduction n Managers need to understand economic environments to predict trends that might affect their company’s performance. A country’s economic policies are a leading indicator of the government’s goals and its planned use of economic tools and market reforms. The subject of economic development is important to citizens, managers, policymakers, and institutions, 2004 Prentice Hall, Inc

Economic Issues for International Businesses n n n 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? 2004 Prentice Hall, Inc 4 -3

Economic Issues for International Businesses, cont n n n 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? 2004 Prentice Hall, Inc 4 -4

Key Economic Forces n n n General economic framework Economic size and stability Existence and influence of capital markets Factor endowments Indicators • • n n Growth Inflation Surpluses Deficits Market Size Availability of economic infrastructure 2004 Prentice Hall, Inc 4 -5

Factor Conditions n Inputs to the production process • Human resources • Physical resources • Knowledge • Capital • Infrastructure n Factor conditions are especially critical for the production of goods 2004 Prentice Hall, Inc 4 -6

Demand Conditions n Market potential • Composition of home demand (nature of buyer needs) Composition? • Size of home demand Size? • Growth of home demand Growth? • Internationalization of demand Internationalization? n Demand conditions are especially critical for market-seeking investments 2004 Prentice Hall, Inc 4 -7

Gross National Income n Tool to measure one country against another • Size • Demand n n n Gross National Income (formerly the Gross National Product) GNI is the market value of final goods and services newly produced by domestically owned factors of production. Countries with high populations and high per capita GNI are most desirable in terms of market potential 2004 Prentice Hall, Inc 4 -8

Gross Domestic Product n n 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 a Toyota manufactured in the United States counts towards US GDP. • A Ford produced in Mexico would not. 2004 Prentice Hall, Inc 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 2004 Prentice Hall, Inc 4 -10

Purchasing Power Parity n n 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 2004 Prentice Hall, Inc 4 -11

Countries Classified by Region From Map 4. 2 2004 Prentice Hall, Inc 4 -12

Human Development A country’s degree of human development , in terms of both economic and social factors, us studied in order to estimate its current and future economic activity. Complementing economic indicators by also analyzing the overall quality of life in a country. The Human Resource Index: Index n Longevity: life expectancy at birth. n Knowledge: adult literacy rate and primary, secondary and tertiary gross enrollment ratio. n Standard of Living: GNI per capita measured expressed in PPP.

Features of an Economy 1. n n - Inflation: the pervasive and sustained increase in the aggregate level of prices as measured by a cost of living index. Results when aggregate demand grows faster than aggregate supply (too many people trying to buy too few goods; prices increase faster than incomes) High inflation leads to: setting higher interest rates Installing wage and price controls Imposing protectionist trade policies and currency controls.

The Consumer Price Index (CPI) measures the average change in consumer prices over time in a fixed market basket of goods and services. n 2. Unemployment: represents the number of workers who want to work but do not have jobs. The unemployment rate is: The number of unemployed workers / The total civilian labor force (all those wiling and able to work for pay) n The Misery Index: Index the sum of a country’s inflation and unemployment rates. n

3. Debt: Debt the sum total of a government’s financial obligations. The state’s borrowing from its citizens, from foreign organizations, from foreign governments, and from international institutions. Internal Debt: is the portion of the government debt that is denominated in the country’s own currency and is held by domestic residents. External Debt: is the portion of the government debt that is denominated in foreign currencies and is owed to foreign creditors.

Heavily Indebted Poor Countries (HIPCs) Poor countries with large debts that are the initiatives to alleviate the severe external burdens of less developed countries, as a assisting their development. target of debt means of 4. Income Distribution: Distribution describes what share of a country’s income goes to various segments of the population (each segment’s share of GNI per capita). 5. Poverty: Poverty the state of having little or no money, few or no material possessions, and little or no resources with which to enjoy a reasonable standard of living. 2004 Prentice Hall, Inc

Poverty Globally, the world is: n n n 78% poor (ppp per capita less than $3479); 11% middle income; 11% rich (ppp per capita more than $8000) 6. The Balance of Payments: Officially known as the Statement of International Transactions, and records a country’s international transactions among companies, governments, and/or individuals. Reports the total of all money flowing into a country minus all money flowing out of that country to others, during a given period. 2004 Prentice Hall, Inc

The two primary accounts under the Balance of Payments: a. The Current Account: tracks all trade in goods and services, as well as income from assets abroad. b. The Capital Account: tracks transactions in real or financial assets between countries, as well as loans given to foreigners and loans received by citizens. 2004 Prentice Hall, Inc

Countries Classified by Economic System 2004 Prentice Hall, Inc Figure 4. 2 4 -13

Types of Economic Systems n n An Economic System is the set of structures and processes that guides the allocation of scarce resources (ownership of resources), and shapes the conduct (degree of control) of business activities in a nation. 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 • Prices are determined by supply and demand 2004 Prentice Hall, Inc 4 -14

Free-market (capitalistic) economies n n n are built upon: The private ownership and control of the factors of production. Freedom of market entry and exit. Determination of prices according to the laws of supply and demand. The Laissez-Faire Principle • Non-intervention by government in a country’s economic activity. • Results in effective and efficient allocation of resources 2004 Prentice Hall, Inc

Economic Freedom, con’t n 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 2004 Prentice Hall, Inc 4 -15

Economic Freedom, con’t n n n Mixed Economy: Some degree of government ownership and control Economic decisions are largely market-driven and ownership is largely private. Government intervenes in in many economic decisions. No economy is purely market or command Economic systems are along a spectrum of freedoms Most command economies are moving towards a market economy 2004 Prentice Hall, Inc 4 -16

The Means of Transition Central Planning Systems v. Consumer Sovereignty The success of the transition process depends on: n Government’s ability to liberalize economic activity. n Reform business practices. n Establish appropriate legal and institutional frameworks. 2004 Prentice Hall, Inc

1. Privatization: the sale and/or legal transfer of government-owned resources to private individuals. Benefits: n Reduces government debt. n Increases market efficiency. n Private enterprises must compete in open for materials, labor, and capital; thus, they succeed or fail on their own merits. 2. Deregulation: the relaxation or removal of restrictions on the free operation of markets and business. 2004 Prentice Hall, Inc

Benefits: n Allows businesses to be more productive and, thus, make investments in the innovations and activities that can lead to economic growth. 3. Property Rights: The protection of tangible and intangible property rights permits individuals to enjoy the benefits of their accomplishments. 4. Fiscal and Monetary Reform: Adopting marketoriented instruments such as interest rates and taxation policies, in order to achieve stability, reduce unemployment and inflation, which will attract investments needed for growth. 2004 Prentice Hall, Inc

Economic Factors International Businesses Must Address n n n n Inflation Surpluses Deficits Balance of Payments External Debt Internal Debt Privatization 2004 Prentice Hall, Inc 4 -17

Reforms and Economic Progress 2004 Prentice Hall, Inc Figure 4. 3 4 -18

Physical & Societal Influences 2004 Prentice Hall, Inc 4 -19

Chapter Review n n 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 2004 Prentice Hall, Inc 4 -20