© 2001 Prentice Hall4-1 International Business by Daniels and Radebaugh Chapter 4 The Economic Environment

© 2001 Prentice Hall4-2 Objectives To learn the differences between the world’s major economic systems To learn the criteria for dividing countries into different economic categories To 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

© 2001 Prentice Hall4-3 Introduction World’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

© 2001 Prentice Hall4-4 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

© 2001 Prentice Hall4-5 An Economic Description of Countries Factor 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 communications Demand 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

© 2001 Prentice Hall4-6 Countries Classified by Income Gross 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 population Gross 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

© 2001 Prentice Hall4-7 World Bank Per Capita Income Classifications Low income$785 or less in 1997 Middle income$786 - $9,655 Lower middle income$786 - $3,125 Upper middle income$3,126 - $9,655 High 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 population Developed countries include: - high-income countries - clustered in just a few geographic areas - natural places to do business because of quality and quanity of demand

© 2001 Prentice Hall4-8 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 country Country GNP per capita a PPP estimates of GNP per capita b Brazil $4,720 $6,240 China 860 3,570 Czech Republic 5,200 11,380 France 26,050 21,860 Japan 37,850 23,400 Mali Mexico 3,680 8,120 Russian Federation 2,740 4,190 Thailand 2,800 6,590 United States 28,740 28,740 a - Dollars, 1997 b - Current International Dollars, 1997

© 2001 Prentice Hall4-9 Countries Classified by Region World 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

© 2001 Prentice Hall4-10 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

© 2001 Prentice Hall4-11 Countries Classified by Economic System (cont.) Control of economic activity—resource allocation and control by the public or the private sector Heritage 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

© 2001 Prentice Hall4-12 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

© 2001 Prentice Hall4-13 Interrelationship between Control of Economic Activity and Ownership of Production Factors Ownership of Production Private Mixed Public Control of Economic Activity Market Mixed Command Market/Private * Market/Mixed Market/Public Mixed/Private Mixed/Mixed Mixed/Public Command/Private Command/Mixed Command/Public * Control/Ownership

© 2001 Prentice Hall4-14 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

© 2001 Prentice Hall4-15 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

© 2001 Prentice Hall4-16 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

© 2001 Prentice Hall4-17 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

© 2001 Prentice Hall4-18 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

© 2001 Prentice Hall4-19 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

© 2001 Prentice Hall4-20 Reforms and Economic Progress Market-friendly environment New investment Further growth Ability to attract foreign investment Reforms and economic progress Virtuous circle Early pain and opposition Early recovery and new economic opportunities Steady progress to open, liberal market Spread of benefits Strong fiscal position Confidence in banks Growth in output, employment, new firms Credible and well-financed government Steady improvement in rule of law Sufficient revenues to finance social safety net Reforms and economic progress Vicious circle Opposition to open-entry competition and full liberalization Vested interest develop Poor rule of law Underground and virtual economy Market transformation frozen Low growth and reversal Financial stability reverse Opportunity for rent- seeking and corruption Partial market reform

© 2001 Prentice Hall4-21 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

© 2001 Prentice Hall4-22 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

© 2001 Prentice Hall4-23 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