Chapter 3
National Differences in
Economic Development
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Introduction
 Chapter 2 described how countries differ with regard to
their political systems, economic systems, and legal
systems.
 This chapter builds on this material to explain how these
differences influence the level of economic development of
a nation and, thus, how attractive it is as a place for doing
business.
 Also How economic, political, and legal systems are
changing around the world and what the implications of this
are for the future rate of economic development of nations
and regions.
 The final section of this chapter explores how differences in
political, economic, and legal institutions affect the benefits,
costs, and risks of doing business in different nations.
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Determinants of Economic Development
 Different countries have dramatically different levels of
economic development.
 A country’s level of economic development affects its
attractiveness as a possible market or production
location for firms.
 One common measure of Economic Development is a
country’s gross national income (GNI) per head of
population.
 GNI measures the total annual income received by
residents of a nation.
 GNI per person figures can be misleading because they
don’t consider differences in the cost of living.
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 To account for differences in the cost of living, one can
adjust GNI per capita by purchasing power. Referred to
as a purchasing power parity (PPP) adjustment.
 A purchasing power parity (PPP) adjustment allows for a
more direct comparison of living standards in different
countries.
 The base for the adjustment is the cost of living in the
United States. The PPP for different countries is then
adjusted (up or down) depending on whether the cost of
living is lower or higher than in the United States.
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 The GNI and PPP data give a static picture of
development. They tell us, for example, that China is
much poorer than the United States, but they do not tell
us if China is closing the gap.
 To assess this, we have to look at the economic growth
rates achieved by countries.
 Table 3.1 gives the rate of growth in gross domestic
product (GDP) per capita achieved by a number of
countries between 2007 and 2016.
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Table 3.1
Economic Data for Select Countries
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Broader Conceptions of Development
 The Nobel Prize–winning economist Amartya Sen - Sen
has argued that development should be assessed less
by material output and more by the capabilities and
opportunities that people enjoy.
 According to Sen, development should be seen as a
process of expanding the real freedoms that people
experience.
 Hence, development requires the removal of major
impediments to freedom: poverty as well as tyranny,
poor economic opportunities as well as systematic social
deprivation, and neglect of public facilities as well as the
intolerance of repressive states.
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 The United Nations created the Human Development
Index (HDI) to measure the quality of human life in
different nations.
 The HDI is based on three measures:
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 gauges a country’s economic
development and likely future growth rate
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Political Economy and Economic Progress
Question: What is the relationship between political
economy and economic progress?
Answer:
 It is often argued that a country’s economic development
is a function of its economic and political systems.
 Innovation and entrepreneurship are the engines of longrun economic growth.
 new products, new processes, new organizations, new
management practices, and new strategies
 Entrepreneurs first commercialize innovative new
products and processes.
 Economic freedom in a market economy creates greater
incentives for innovation and entrepreneurship than in
either a planned or mixed economy.
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Political Economy and Economic Progress
 Strong legal protection of property rights is another
requirement for a business environment conducive to
innovation, entrepreneurship, and economic growth
 Democratic regimes are more conducive to long-term
economic growth than a dictatorship, even one of the
benevolent kind
 Subsequent economic growth leads to establishment of
democratic regimes
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Political Economy and Economic Progress
 Other factors influencing a country’s rate of economic
development including Geography and Education:
 Geography - influences economic policy, and thus economic
development.
 countries with favorable geography are more likely to engage in trade
which can promote economic growth
 Adam Smith for example, argued that a country’s geography can also
influence its economic growth.
 Harvard economist, Jeffery Sachs has expanded this idea to suggest
that countries that are lucky enough to have favorable geographic
situations are more likely to be open to and develop market economies.
 So, landlocked economies tend to grow more slowly than coastal
economies that have easy access to trading routes.
 Similarly, countries with poor climates or soil conditions are less likely to
grow than those with more favorable conditions.
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Political Economy and Economic Progress
 Education levels:
Education emerges as another important determinant
of economic development.
nations that invest more in education will have higher
growth rates because an educated population is a
more productive population.
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States in Transition
 Since the late 1980s, two trends have been evident:
First, during the late 1980s and early 1990s, a wave
of democratic revolutions swept the world. Totalitarian
governments fell and were replaced by democratically
elected governments that were typically more
committed to free market capitalism than their
predecessors had been.
Second, there has been a move away from centrally
planned and mixed economies and toward a more
free market economic model.
 Let’s talk about each of these, beginning with the spread
of democracy.
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The Spread of Democracy
Democracy has spread to new countries because
 many totalitarian regimes failed to deliver economic
progress to the majority of their population
 new information and communication technologies have
broken down the ability of the state to control access to
uncensored information
 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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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
 Geopolitical forces can affect how companies operate in
certain countries
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The Spread of Market-Based Systems
 Since the late 1980s there has been a transformation
from centrally planned command economies to marketbased economies
command and mixed economies failed to deliver the
sustained economic performance achieved by
countries that had adopted market-based systems
many countries shifted to a market-based system
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The Nature of Economic Transformation
 The shift toward a market-based economic system involves:
1. Deregulation – involves removing legal restrictions on the free play
of markets, the establishment of private enterprises, and the
manner in which private enterprises operate
2. Privatization - transfers the ownership of state property into the
hands of private investors
 because private investors are motivated by potential profits
to increase productivity, privatization should increase
economic efficiency
3. Legal system - that protects property rights and the machinery to
enforce that system
 many countries have made significant strides toward
creating a strong legal system, but more work is necessary
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Implications of a Changing Economy
 Markets that were formerly off-limits to Western business
are now open
China (population of 1.2 billion) could be a bigger
market than the U.S., the EU, and Japan combined
India (population 1.1 billion) is also a potentially huge
market
 However, just as the potential gains are large, so are the
risks
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Implications for Managers
Question: What are the implications of the political
economy for international businesses?
Answer:
There are two main implications:
1. the political, economic, and legal systems of a country
raise important ethical issues that have implications for the
practice of international business
2. 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
 The benefits of doing business in a country are a
function of market size, and current and future consumer
purchasing power
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)
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Costs
 Firms must be prepared to deal costs of doing business
in foreign markets
1. Political costs - include the cost of paying bribes or
lobbying for favorable or fair treatment
2. Economic costs - relate primarily to the
sophistication of the economic system, including the
infrastructure and supporting businesses
3. Legal costs - can be higher 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
 Doing business in foreign markets involves risk
Political risk - 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 - 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 - 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
Generally, the costs and risks are lower in
economically developed and politically stable markets
However, the potential for growth may be higher in
less developed nations.
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