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National Differences in Political Economy

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2 National Differences in Political Economy
2 chapter National Differences in Political Economy McGraw-Hill/Irwin Global Business Today, 5e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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INTRODUCTION This chapter explores how the political, economic, and legal systems of countries differ Together these systems are known as the political economy of a country

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POLITICAL SYSTEMS A political system is the system of government in a nation Political systems can be assessed according to: the degree to which they emphasize collectivism as opposed to individualism the degree to which they are democratic or totalitarian

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Classroom Performance System The political, economic and legal systems of a country are called Political systems Economic systems Legal systems Political economy Classroom Performance System Answer: d

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Collectivism and Individualism Collectivism refers to a system that stresses the primacy of collective goals over individual goals When collectivism is emphasized, the needs of the society as whole are generally viewed as being more important than individual freedoms

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Socialism Communists generally believed that collectivism could only be achieved though revolution and totalitarian dictatorship, while social democrats worked to achieve the same goals by democratic means Privatization is the movement toward free market economies by selling state-owned enterprises to private investors

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Individualism Individualism is a political philosophy that an individual should have freedom over his or her economic and political pursuits. Individualism focuses on: guaranteeing individual freedom and self-expression letting people pursue their own self-interest in order to achieve the best overall good for society

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Classroom Performance System Individuals who believe socialism can be achieved only through revolutions and totalitarian dictatorship are called Social democrats Communists Individualists Representative democrats Classroom Performance System Answer: b

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Democracy and Totalitarianism Democracy is a political system in which government is by the people, exercised either directly or through elected representatives Totalitarianism is a form of government in which one person or political party exercises absolute control over all spheres of human life, and opposing political parties are prohibited

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Democracy The most common form of democracy today is representative democracy, where elected representatives vote on behalf of constituents

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Totalitarianism The four major forms of totalitarianism are: communist totalitarianism: advocates achieving socialism through totalitarian dictatorship theocratic totalitarianism: political power is monopolized by a party, group, or individual that governs according to religious principles tribal totalitarianism: a political party that represents the interests of a particular tribe monopolizes power right wing totalitarianism: individual economic freedom is allowed but individual political freedom is restricted in the belief that it could lead to communism

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Classroom Performance System Which system emphasizes individual freedom and self-expression? Individualism Collectivism Theocratic totalitarianism Tribal totalitarianism Classroom Performance System Answer: a

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ECONOMIC SYSTEMS A free market system is likely in countries where individual goals are given primacy over collective goals State-owned enterprises and restricted markets are common in countries where collective goals are dominant

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Three broad types of economic systems can be identified-a market economy, a command economy, and a mixed economy. Market Economy In a pure market economy the goods and services that a country produces, and the quantity in which they are produced is determined by supply and demand

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Command Economy In a pure command economy the goods and services that a country produces, the quantity in which they are produced, and the price at which they are sold are all planned by the government Mixed Economy A mixed economy includes some elements of a market economy and some elements of a command economy

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Classroom Performance System Which of the following is not one of the three broad types of economic systems? Market economy Command economy Mixed economy Free economy Classroom Performance System Answer: d

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LEGAL SYSTEMS The legal system of a country is the rules, or laws, that regulate behavior, along with the processes by which the laws of a country are enforced and through which redress for grievances is obtained. The legal environment of a country is important because a country's laws regulate business practice, define the manner in which business transactions are to be executed, and set down the rights and obligations of those involved in business transactions Differences in the structure of law can impact the attractiveness of a country as an investment site and/or market

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Different Legal Systems The common law system (based on tradition, precedent, and custom) is found in most of Great Britain’s former colonies, including the United States The civil law system is based on a very detailed set of laws organized into codes and is found in over 80 countries, including Germany, France, Japan, and Russia Islamic law is the most widely practiced theocratic law system (based on religious teachings) in the modern world

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Differences in Contract Law Contract law is the body of law that governs contract enforcement A contract is a document that specifies the conditions under which an exchange is to occur and details the rights and obligations of the parties involved The United Nations Convention in Contracts for the International Sales of Goods (CIGS) establishes a uniform set of rules governing certain aspects of the making and performance of everyday commercial contracts between sellers and buyers who have their places of business in different nations By adopting CIGS, a nations signals to other nations that it will treat the Convention’s rules as part of its law Country Focus: Corruption in Nigeria Summary This feature describes the corruption that has characterized Nigeria’s economy over the last 40 years. When the country initially gained its independence from Britain in 1960, expectations were high that Nigeria would become an economic heavyweight in Africa. With abundant natural resources and a large population, it seemed the stage was set for success. However, despite earnings of more than $300 billion from oil sales during the period 1970 to 2000, the country still suffered from extreme poverty, illiteracy, and high debt. Several factors have been blamed for Nigeria’s troubles including political instability and corruption. Suggested Discussion Questions 1. What is meant by corruption? Explain how a corrupt political system affects the well being of a country. 2. With its huge oil reserves and large population, Nigeria was expected to emerge as a major player in Africa. Yet today the country is extremely poor with little expectation for an economic turnaround any time in the near future. Explain how Nigeria came to be in such a sad state. 3. Clearly, Nigeria’s corrupt government has been a major factor in the country’s demise. In contrast, other countries including Finland and Canada expressly prohibit corruption. In your opinion, would Nigeria be better off following the example of countries like Finland and Canada? Why or why not?

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Classroom Performance System Which type of legal system is based on a very detailed set of laws organized into codes? Contract law Civil law Common law Theocratic law Classroom Performance System Answer: b

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Property Rights and Corruption Property rights (the legal rights over the use to which a resource is put and over the use made of any income that may be derived from that resource) are very important for the functioning of business, but can be violated by either private action or public action

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Private Action refers to theft, piracy, blackmail, and the like by private individuals or groups Public Action and Corruption occurs when public officials extort income or resources from property holders using various legal mechanisms including excessive taxation, requiring expensive licenses or permits from property holders, or taking assets into state ownership without compensating the owners

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Foreign Corrupt Practices Act The Foreign Corrupt Practices Act makes it a violation of the United States’ law to bribe a foreign government official in order to obtain or maintain business over which the foreign official has authority, and requires all publicly traded countries to keep detailed records so that it is clear whether a violation of the act has occurred or not

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The Protection of Intellectual Property Intellectual property is property, such as computer software, a screenplay, or the chemical formula for a new drug, that is the product of intellectual activity Internet Extra: Focus on Intellectual Property Rights is the U.S government’s web page on intellectual property rights. The site is at {http://usinfo.state.gov/products/pubs/intelprp/}. 1. Click on Discuss Intellectual Property. List some examples of intellectual property. 2. Next, click on The Cost of Developing a New Drug. What protections do you feel should be awarded to pharmaceutical firms? Why? 3. Last, click on Taking Action. How are countries fighting intellectual property rights violations?

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Intellectual Property rights include: patents -- documents giving the inventor of a new product or process exclusive rights to the manufacture, use, or sale of that invention copyrights -- exclusive legal rights of authors, composers, playwrights, artists, and publishers to publish and dispose of their work as they see fit trademarks -- designs and names, often officially registered, by which merchants or manufacturers designate and differentiate their products Internet Extra: Focus on Intellectual Property Rights is the U.S government’s web page on intellectual property rights. The site is at {http://usinfo.state.gov/products/pubs/intelprp/}. 1. Click on Discuss Intellectual Property. List some examples of intellectual property. 2. Next, click on The Cost of Developing a New Drug. What protections do you feel should be awarded to pharmaceutical firms? Why? 3. Last, click on Taking Action. How are countries fighting intellectual property rights violations?

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The protection of intellectual property rights differs greatly from country to country. The Paris Convention for the Protection of Industrial Property is an agreement signed by 96 countries to protect intellectual property rights The Trade Related Aspects of Intellectual Property Rights (TRIPS) requires WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years Management Focus: Starbucks Wins Key Trademark Case in China Summary This feature focuses on intellectual property laws in China. When Starbucks entered China in 1999, the company was quickly challenged by a look-alike competitor, Xing Ba Ke. Not only did the name Xing Ba Ke mimic the Starbucks name, but Xing Ba Ke’s stores were virtual replicas of those operated by Starbucks. In 2003, Starbucks sued Xing Ba Ke for trademark violations. In 2006, Starbucks won its case, and Xing Ba Ke was fined $62,000 and ordered to stop using its name. The case was seen as a break through of sorts, a signal that China was finally caving to pressure from other nations and the World Trade Organization to respect intellectual property rights. Today, Starbucks operates over 200 stores in China and expects the market to become second only to the U.S. Suggested Discussion Questions 1. Discuss the concept of property rights protection and why it is so important to companies. What does he court ruling against Xing Ba Ke mean for other companies that are already doing business in China, or are considering entering the market? 2. How important is the Chinese market to Starbucks? Does the presence of look-alike companies like Xing Ba Ke deter firms from entering the market? Teaching Tip: To explore Starbucks in more depth, go to the company’s web site at {http://www.starbucks.com/default.asp?cookie%5Ftest=1}. Click on “International” to explores individual country sites.

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Product Safety and Product Liability Countries have different product safety and liability laws that may require foreign companies to customize products to adhere to local standards If product standards are lower in other countries, firms must decide whether to produce products only of the highest standards even if this puts them at a competitive disadvantage relative to other producers and results in not maximizing value to shareholders, or whether they should produce products that respond to local differences, even if that means that consumers may not be assured of the same levels of safety in different countries

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THE DETERMINANTS OF ECONOMIC DEVELOPMENT Differences in Economic Development One common measure of economic development is a country’s gross national income per head of population (GNI) A purchasing power parity (PPP) adjustment allows for a more direct comparison of living standards in different countries A drawback of both GNI and PPP data is that they provide only a static picture of development

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The GNI per capita of the world’s nations in 2004 is shown in Map 2.1.

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Broader Conceptions of Development: Amartya Sen Nobel Prize winning economist Amartya Sen argued that development should be assessed less by material output and more by the capabilities and opportunities that people enjoy the Human Development Index (a United Nations developed index based on life expectancy, education attainment, and whether average incomes are sufficient to meet the basic needs of life in a country) reflects Sen’s ideas and was developed to gauge a country’s economic development and likely future growth rate

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Political Economy and Economic Progress What is the relationship between political economy and economic progress? This question has been the subject of a vigorous debate among academics and policy makers. Innovation and Entrepreneurship Are the Engines of Growth: there is broad agreement that innovation and entrepreneurship are the engines of long-run economic growth Innovation and Entrepreneurship Require a Market Economy: it has been argued that economic freedom associated with a market economy creates greater incentives for innovation and entrepreneurship than either a planned or mixed economy

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Innovation and Entrepreneurship Require Strong Property Rights: strong legal protection of property rights is another requirement for a business environment conducive to innovation, entrepreneurship, and economic growth The Required Political System: it seems likely that democratic regimes are more conducive to long-term economic growth than a dictatorship, even one of the benevolent kind Economic Progress Begets Democracy: it seems evident that the subsequent economic growth leads to establishment of democratic regimes

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Geography, Education, and Economic Development Geography can affect economic development Countries that invest more in the education of their young people develop faster economically

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STATES IN TRANSITION Since the late 1980s, a wave of democratic revolutions has swept the world, and many of the previous totalitarian regimes collapsed There has been a move away from centrally planned and mixed economies towards free markets

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Spread of Democracy The spread of democracy has occurred because: many totalitarian regimes failed to deliver economic progress to the vast bulk of their population new information and communication technologies have broken down the ability of the state to control access to uncensored information in many countries the economic advances of the last quarter century have led to the emergence of increasingly prosperous middle and working classes who have pushed for democratic reforms

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Political freedom around the world in 2005 is charted in Map 2.5.

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The New World Order and Global Terrorism The end of the Cold War and the “new world order” that followed the collapse of communism in Eastern Europe and the former Soviet Union, taken together with the collapse of many authoritarian regimes in Latin America, have given rise to intense speculation about the future shape of global geopolitics.

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The Spread of Market-Based Systems In general, command and mixed economies failed to deliver the kind of sustained economic performance that was achieved by countries adopting market-based systems Since the late 1980s there has been a transformation from centrally planned command economies to market-based economies

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Economic freedom around the world is summarized in Map 2.6.

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The Nature of Economic Transformation The shift toward a market-based economic system typically involves at least three distinct activities: deregulation privatization legal enforcement of property rights

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Deregulation Deregulation involves removing restrictions on the free operation of markets Privatization Privatization transfers the ownership of state property into the hands of private investors

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Legal Systems Without a legal system that protects property rights, and without the machinery to enforce that system, the incentive to engage in economic activity can be reduced substantially by private and public entities that expropriate the profits generated by the efforts of private sector entrepreneurs. Implications of Changing Political Economy Markets that were formerly off-limits to Western business are now open, however, just as the potential gains are large, so are the risks Country Focus: Building a Market Economy in India Summary This feature describes the changes in India’s political economy since the country gained independence from Britain in Until the early 1990s, India followed a mixed economy system that was characterized by a large number of state-owned enterprises, centralized planning, and subsidies. The system failed to deliver significant growth and in 1991 India’s government implemented a series of reforms designed to foster increased privatization, inward investment, and exports. While initially successful, economic reform stalled by the later 1990s, and poverty was widespread. Suggestion Discussion Questions 1. What makes India an attractive destination for foreign firms? 2. Since its reform program began in 1991, India has seen a significant turnaround in its economy. What factors might threaten this turnaround? 3.The Indian Embassy maintains a web site that provides useful information about doing business in India. The site is {http://www.indianembassy.org/newsite/Doing_business_In_India/FDI_Policy_Procedures.asp}.

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IMPLICATIONS FOR MANAGERS political, economic, and legal systems of a country raise important ethical issues that have implications for the practice of international business the political, economic, and legal environment of a country clearly influences the attractiveness of that country as a market and/or investment site

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Benefits By identifying and investing early in a potential future economic stars, firms may be able to gain first mover advantages (advantages that accrue to early entrants into a market) and establish loyalty and experience in a country

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Costs Political costs include the cost of paying bribes or lobbying for favorable or fair treatment Economic costs relate primarily to the sophistication of the economic system, including the infrastructure and supporting businesses It can be more costly to do business in countries with dramatically different product, workplace, and pollution standards, or where there is poor legal protection for property rights

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Risks Political risk is the likelihood that political forces will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise Economic risk is the likelihood that economic mismanagement will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise Legal risk is the likelihood that a trading partner will opportunistically break a contract or expropriate property rights

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Overall Attractiveness The overall attractiveness of a country as a potential market and/or investment site for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country. Internet Extra: The U.S. State Department produces a series of annual "Country Reports“. The site is {http://www.state.gov/travelandbusiness/}. 1. Click on Doing Business in International Markets. Discuss the ways the State Department helps American companies doing business in other countries. 2. Next, click on More Business Information and then on Investment Climate Statements. Compare the investment climate in several countries. Where would you invest? Which countries would you avoid?

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Classroom Performance System Which type of risk involves the likelihood that a trading partner will opportunistically break a contract or expropriate intellectual property rights? Contract risk Economic risk Legal risk Political risk Classroom Performance System Answer: c

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CRITICAL THINKING QUESTIONS 1. Free market economies stimulate greater economic growth, whereas state-directed economies stifle growth! Discuss. Answer: In a market economy, private individuals and corporations are allowed to own property and other assets. This right of ownership provides a powerful incentive for people to work hard, introduce new products, develop better advertising campaigns, invent new products, etc., all in the hopes of accumulating additional personal capital and wealth. In turn, the constant search on the part of individuals and corporation to accumulate wealth enriches the entire economy and creates economic growth. In contrast, in a command economy, private individuals and corporations are not allowed to own substantial quantities of property and other assets. The objective of a command economy is for everyone to work for “the good of the society.” Although this sounds like a noble ideal, a system that asks individuals to work for the good of society rather than allowing individuals to build personal wealth does not provide a great incentive for people to invent new products, develop better advertising campaigns, find ways to be more efficient, etc. As a result, command economies typically generate less innovation and are less efficient than market economies.

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CRITICAL THINKING QUESTIONS 2. A democratic political system is an essential condition for sustained economic progress. Discuss. Answer: This question has no clear-cut answer. In the West, we tend to argue that democracy is good for economic progress. This argument is largely predicted upon the idea that innovation is the engine of economic growth, and a democratic political system encourages rather than stifles innovation. However, there are examples of totalitarian regimes that have fostered a market economy and strong property rights protection and experienced rapid economic growth. The examples include four of the fastest growing economies of the past 30 years – South Korea, Taiwan, Singapore, and Hong Kong – all of which have grown faster than Western economies. However, while it is possible to argue that democracy is not a necessary precondition for the establishment of a free market economy, it seems evident that subsequent economic growth leads to establishment of democratic regimes. Several of the fastest-growing Asian economies have recently adopted more democratic governments.

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CRITICAL THINKING QUESTIONS 3. What is the relationship between corruption (i.e., bribe taking by government officials) in a country and economic growth? Is corruption always bad? Answer: Economic evidence suggests that high levels of corruption significantly reduce the economic growth rate in a country. By siphoning off profits, corrupt politicians and bureaucrats reduce the returns to business investment, and hence, reduce the incentive that both domestic and foreign businesses have to invest in that country. The lower level of investment that results has a negative impact on economic growth. However, while most students will probably agree that corruption is bad, some may point out that the U.S., despite its Foreign Corrupt Practices Act, does allow “grease payments” to expedite or secure the performance of a routine governmental action. According to Congress, “grease payments” while technically bribes are not being used to obtain or maintain business, but rather are simply made to facilitate performance of duties that the recipients are already obligated to perform.

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CRITICAL THINKING QUESTIONS 4. The Nobel prize-winning economist Amartya Sen argues that the concept of development should be broadened to include more than just economic development. What other factors does Sen think should be included in an assessment of development? How might adoption of Sen’s views influence government policy? Do you think Sen is correct that development is about more than just economic development? Explain. Answer: Sen has argued that development be assessed less by material output measures such as GNP per capita, and more by the capabilities and opportunities that people enjoy. Sen suggests that development be seen as a process of expanding real freedoms that people experience, and as such, that development requires the removal of major impediments to freedom. Governments influenced by Sen might ensure that basic health care and education programs are available especially for women. Many students will agree with Sen and the notion that development is not just an economic process, but a political one too, and that to succeed citizens must be given a voice in the important decisions made for the country.

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CRITICAL THINKING QUESTIONS 5. You are the CEO of a company that has to choose between making a $100 million investment in either Russia or the Czech Republic. Both investments promise the same long-run return, so your choice of which investment to make is driven by considerations of risk. Assess the various risks of doing business in each of these nations. Which investment would you favor and why? Answer: When assessing the risks of investment, one should consider the political, economic, and legal risks of doing business in either Russia or the Czech Republic. At this time (Fall 2002), the risk in Russia would probably be considered higher than the risk in the Czech Republic. The Czech Republic has just been accepted as a future member of the EU, and as such gains the benefits and stability offered by the EU. Russia, by contrast, is still many years away from even being in a position to be considered by the EU for membership. Depending upon when you are using the book, this situation could be different. (You also may want to substitute other countries into this question depending on current events and the countries with which you feel your students will be most familiar.)

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CRITICAL THINKING QUESTIONS 6. Read the Country Focus on India in this chapter and answer the following questions: a. What kind of economic system did India operate during ? What kind of system is it moving towards today? What are the impediments to completing this transformation? b. How might widespread public ownership of businesses and extensive government regulations have impacted (i) the efficiency of state and private businesses, and (ii) the rate of new business formation in India during the time frame? How do you think these factors affected the rate of economic growth in India during this time frame? c. How would privatization, deregulation, and the removal of barriers to foreign direct investment affect the efficiency of business, new business formation, and the rate of economic growth in India during the post-1990 time period? d. India now has pockets of strengths in key high technology industries such as software and pharmaceuticals. Why do you think India is developing strength in these areas? How might success in these industries help to generate growth in other sectors of the Indian economy? e. Given what is now occurring in the Indian economy, do you think that the country represents an attractive target for inward investment by foreign multinationals selling consumer products? Why? Answer: a. The economic system that developed in India after 1947 was a mixed economy characterized by a large number of state-owned enterprises, centralized planning, and subsidies. In 1991, India’s government embarked on an ambitious economic reform program. Much of the industrial licensing system was dismantled, and several areas once closed to the private sector were opened. In addition, investment by foreign companies was welcomed, and plans to start privatizing state-owned businesses were announced. India has posted impressive gains since 1991, however there are still impediments to further transformation. Attempts to reduce import tariffs have been stalled by political opposition from employers, employees, and politicians. Moreover, the privatization program has been slowed thanks to actions taken by the Supreme Court. Finally, extreme poverty continues to plague the country. b. The mixed economy that developed in India after 1947 was characterized by a large number of state-owned enterprises, centralized planning, and subsidies. This system not only constrained the growth of the private sector, but it also consequently limited the effects of competition that typically promote efficiency and productivity in a free market system. The system even limited the actions of private companies, requiring them to get government approval for routine business activities. Production quotas and high import tariffs also stunted the development of a healthy private sector, as did restrictive labor laws that made it difficult to fire employees. Foreign exchange restrictions, limitations on foreign investment, controls on land use, and managed prices further exacerbated the situation. It would appear that India’s rate of economic growth was negatively affected during this time frame. By 1994, India’s economy was still smaller than Belgium’s despite having a large population. Both GDP and literacy rates were very low, and some 40 percent of the population lived in poverty. c. In 1991, India’s government embarked on an ambitious economic reform program. So far, the response to the program has been impressive. The economy expanded at an annual rate of about 6.3 percent from 1994 to Foreign investment is up from $150 million in 1990 to $6 billion in Certain sectors of the economy including information technology and pharmaceuticals have done particularly well. Still, problems persist. Actions taken by the government continue to limit efficiency gains for private companies and the country’s high rate of poverty is still a major problem. d. India’s gains in information technology and pharmaceuticals are impressive. The country has emerged as a vibrant global center for software development, and India’s pharmaceutical companies have taken a strong global position by selling low cost generic versions of drugs that have come of patent in the developed world. As these industries continue to prosper, other sectors of the economy should also see the benefit of spillover effects. e. Foreign investment is up in India. In fact, foreign investment rose from $150 million in 1990 to $6 billion in However, whether India is an attractive destination for foreign multinationals selling consumer products remains to be seen. Certainly, the large population will serve to attract some companies, but the fact that some 40 percent of the population is living in abject poverty will scare other companies away. Moreover, it is still not easy to run a company in India thanks to laws limiting everything from who can be fired to who can which products.


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