Chapter 2 The Global Economic Environment PowerPoint by Kristopher Blanchard North Central University

Introduction to Chapter Market definition – People or organizations with needs and wants; both have the willingness and ability to buy or sell The global economic environment plays a large role in the development of new markets for organizations

The World Economy – An Overview The new realities: Capital movements have replaced trade as the driving force of the world economy Production has become uncoupled from employment The world economy, not individual countries, is the dominating factor The first change is the increased volume of capital movements. The dollar value of world trade in merchandise is running at roughly $9.2 trillion per year. However, the London foreign exchange market turns over $450 billion each working day; overall, foreign exchange transactions are running at approximately $1.5 trillion per day worldwide—far surpassing the dollar volume of world trade in goods and services. The second change concerns the relationship between productivity and employment. Although employment in manufacturing remains steady or has declined, productivity continues to grow. The third major change is the emergence of the world economy as the dominant economic unit. Company executives and national leaders who recognize this have the greatest chance of success. For example, the real secret of the economic success of Germany and Japan is the fact that business leaders and policy makers focus on world markets and their respective countries’ competitive positions in the world economy. This change has brought two questions to the fore: How does the global economy work, and who is in charge? Unfortunately, the answers to these questions are not clear cut.

The World Economy – An Overview The new realities continued: 75-year struggle between capitalism and socialism has almost ended E-Commerce diminishes the importance of national barriers and forces companies to re-evaluate business models The fourth change is the end of the Cold War. The demise of communism as an economic and political system can be explained in a straightforward manner: Communism is not an effective economic system. The overwhelmingly superior performance of the world’s market economies has given leaders in socialist countries little choice but to renounce their ideology. Finally, the personal computer revolution and the advent of the Internet era have in some ways diminished the importance of national boundaries. Two-thirds of American households have PCs; worldwide, an estimated 500 million personal computers are installed in homes and businesses. In the so-called Information Age, barriers of time and place have been subverted by a transnational cyber-world that functions “24/7.”

Economic Systems 4 main types of economic systems Market Capitalism Centrally planned socialism Centrally planned capitalism Market socialism

Economic Systems Resource Allocation Market Command Centrally Private Planned Capitalism Private Resource Ownership State Market Capitalism This classification is based on the dominant method of resource allocation (market versus command) and the dominant form of resource ownership (private versus state). Centrally Planned Socialism Market Socialism

Economic Freedom Rankings of economic freedom among countries Ranges from “free” to “repressed” Variables considered include such things as: Trade policy Taxation policy Banking policy Wage and price controls Property rights

Economic Freedom Free Repressed Hong Kong Singapore Ireland New Zealand United States United Kingdom Netherlands Australia Switzerland Repressed Bosnia Vietnam Laos Iran Cuba Iraq Libya North Korea Congo

Stages of Market Development World Bank has defined four categories of development High-income countries Upper-middle income countries Lower-middle income countries Low-income countries Based upon Gross National Product (GNP) Although the income definition for each of the stages is arbitrary, countries within a given category generally have a number of characteristics in common. Thus, the stages provide a useful basis for global market segmentation and target marketing.

Stages of Market Development

Big Emerging Markets China India Indonesia South Korea Brazil Mexico Argentina South Africa Poland Turkey These countries are known as Big Emerging Markets (BEMs) because of the incredible growth potential within each market. Each one has experienced rapid economic growth during the past decade. These BEMs cut across the four stages of economic development; per capita income ranges from $10,879 in South Korea to $489 in India. China is the largest, with a population of 1.3 billion people; Argentina is the smallest, with a population of 38 million people. Despite these contrasts, experts predict that the BEMs will be key players in global trade even as their track records on human rights, environmental protection, and other issues come under closer scrutiny by their trading partners. The BEM government leaders will also come under pressure at home as their developing market economies create greater income disparity.

Marketing Opportunities in LDCs Characterized by a shortage of goods and services Long-term opportunities must be nurtured in these countries Look beyond per capita GNP Consider the LDCs collectively rather than individually Consider first mover advantage Set realistic Deadlines One of marketing’s roles in developing countries is to focus resources on the task of creating and delivering products that are best suited to local needs and incomes. Appropriate marketing communications techniques can also be applied to accelerate acceptance of these products. Marketing can be the link that relates resources to opportunity and facilitates need satisfaction on the consumer’s terms.

Influencing the World Economy Group of Seven (G-7) Organization for Economic Cooperation and Development The Triad

Marketing Implications of the Stages of Development Product Saturation Levels The percentage of potential buyers or households that own a particular product Graph shows that in India a private phone is owned by 1% of the population

Balance of Payments Record of all economic transactions between the residents of a country and the rest of the world Current account – record of all recurring trade in merchandise and services, private gifts, and public aid between countries trade deficit trade surplus Capital account – record of all long-term direct investment, portfolio investment, and capital flows

Balance of Payments U.S. balance of payments statistics for the period 1999 to 2003

Overview of International Finance Foreign exchange makes it possible to do business across the boundary of a national currency Currency of various countries are traded for both immediate (spot) and future (forward) delivery Increases the risk to organizations that are involved in global marketing

Managed Dirty Float? Definitions Float refers to the system of fluctuating exchange rates Managed refers to the specific use of fiscal and monetary policy by governments to influence exchange rates Devaluation is a reduction in the value of the local currency against other currencies

Managed Dirty Float? Definitions Dirty refers to the fact that central banks, as well as currency traders, buy and sell currency to influence exchange rates

Foreign Exchange Market Dynamics Supply and Demand interaction Country sells more goods/services than it buys There is a greater demand for the currency The currency will appreciate in value The table shows how fluctuating currency values can affect financial risk, depending on the terms of payment specified in the contract. Suppose, at the time a deal is made, the exchange rate is €1.10 = $1. How is a U.S. exporter affected if the dollar strengthens against the euro (e.g., trades at €1.25 = $1) and the contract specifies payment in dollars? What happens if the dollar weakens (e.g., €0.85 = $1)? Conversely, what if the European buyer contracts to pay in euros rather than dollars?

Purchasing Power Parity (PPP) – The Big Mac Index Is a certain currency over/under- valued compared to another? Assumption is that the Big Mac in any country should equal the price of the Big Mac in the US after being converted to a dollar price A country’s currency would be overvalued if the Big Mac price (converted to dollars) is higher than the U.S. price. Conversely, a country’s currency would be undervalued if the converted Big Mac price is lower than the U.S. price. Economists use the concept of purchasing power parity (PPP) when adjusting national income data to improve comparability. In its survey of earnings around the world, Zurich-based UBS also uses the Big Mac as a reference point. The survey assesses purchasing power around the world in terms of how long the average wage earner must work to earn enough money to pay for a Big Mac. According to its 2003 survey, employees in Zurich, Geneva, Tokyo, Luxembourg, and New York have the highest take-home pay. Workers in Nairobi, Bombay, Shanghai, Budapest, Moscow, and Manila rank at the bottom in terms of take-home pay.

Managing Economic Exposure Economic exposure refers to the impact of currency fluctuations on the present value of the company’s future cash flows Transaction exposure is from sales/purchases Real operating exposure arises when currency fluctuations, together with price changes, alter a company’s future revenues and costs

Managing Economic Exposure Numerous techniques and strategies have been developed to reduce exchange rate risk Hedging involves balancing the risk of loss in one currency with a corresponding gain in another currency Forward Contracts set the price of the exchange rate at some point in the future to eliminate some risk

Looking Ahead Chapter 3 – The Global Trade Environment: Regional Market Characteristics and Preferential Trade Agreements

Market Capitalism Individuals and firms allocate resources Production resources are privately owned Driven by consumers Government should promote competition among firms and ensure consumer protection Return

Centrally Planned Socialism Opposite of market capitalism State holds broad powers to serve the public interest; decides what goods and services are produced and in what quantities Consumers can spend on what is available Government owns entire industries Demand typically exceeds supply Little reliance on product differentiation, advertising, pricing strategy Return

Centrally-Planned Capitalism Economic system in which command resource allocation is used extensively in an environment of private resource ownership Examples: Sweden Japan Return

Market Socialism Economic system in which market allocation policies are permitted within an overall environment of state ownership Examples: China India Return

Low-Income Countries GNP per capita of $785 or less Characteristics Limited industrialization High percentage of population involved in farming High birth rates Low literacy rates Heavy reliance on foreign aid Political instability and unrest Of these, only China and India are BEMs Return

Lower-Middle-Income Countries GNP per capita between $786 and $3,125 Sometimes called less-developed countries (LDCs) Characteristics Early stages of industrialization Cheap labor markets Factories supply items such as clothing, tires, building materials, and packaged foods 3 BEMs: Poland, Turkey, Indonesia Return

Upper-Middle-Income Countries GNP per capita between $3,126 to $9,655 Characteristics Rapidly industrializing Rising wages High rates of literacy and advanced education Lower wage costs than advanced countries Sometimes called newly industrializing economies (NIEs) 3 BEMs: Argentina, Brazil, Mexico, South Africa Return

High-Income Countries GNP per capita above $9,656 Sometimes referred to as post-industrial countries Characteristics Importance of service sector, information processing and exchange, and intellectual technology Knowledge as key strategic resource Orientation toward the future Return

Group of Seven (G-7) Leaders from these high income countries work to establish prosperity and ensure monetary stability United States Japan Germany France Britain Canada Italy Return

Organization for Economic Cooperation and Development 30 nations each with market-allocation economic systems Mission: to enable its members to achieve the highest sustainable economic growth and improve the economic and social well-being of their populations www.oecd.org Return

The Triad Dominant economic centers of the world Expanded Triad Japan Western Europe United States Expanded Triad Pacific Region North America European Union The ascendancy of the global economy has been noted by many observers in recent years. One of the most astute is Kenichi Ohmae, former chairman of McKinsey & Company Japan. His 1985 book Triad Power represented one of the first attempts to develop a coherent conceptualization of the new emerging order. Ohmae argued that successful global companies had to be equally strong in Japan, Western Europe, and the United States. These three regions, which Ohmae collectively called the Triad, represented the dominant economic centers of the world. Today, roughly 70 percent of world income as measured by GNP is located in the Triad. Return