IM535 – International Operations
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Module Four
The Economic Systems and Market Methods
Chapter Objectives
• To communicate the importance of economic analysis
• To discuss the idea of economic freedom
• To profile the characteristics of the types of economic
systems
• To introduce the idea of state capitalism
• To profile leading indicators of economic development,
performance, and potential
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Case: Emerging Markets
The Challenge of the Comeback …
24 countries are emerging markets because of their
market development and high rate of economic growth
Source: http://www.lagodaxnian.wordpress.com
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Case: Emerging Markets make a comeback
Source: Based on Development Centre Studies, The World Economy: A Millennial Perspective, OECD Publishing, 2006.
Looking to 2060: A Global Vision of Long-Term Growth, OECD Economic Policy Papers, November 2012.
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Case: Emerging Markets
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Evolution of Earth’s Economic Center of Gravity:
1000 A.C. to 2050
The world’s center of economic gravity has
changed over the past centuries. A big jump from
Asia to Europe was due to industrial revolution.
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Analysis of the Economic Environment
• Studying an economic environment helps managers make
better investment choices and operating decisions
• Limited resources require managers to identify which
countries in the world guarantee investment as well as those
they must avoid
• Basic principals which should be considered by managers to
assess the economic environments:
– Economic System complexity
– Market dynamism
– Market interdependence
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Analysis of the Economic Environment
• To assess a country’s economic environment, IB mangers
should know:
– Countries differ in different ways
– Economic and political changes alter market circumstances
– Understand connections, change, and consequences
• UN estimates MNE’s are ≈ (22,000) firms and some are in emerging world
from China, India, and Brazil (Fortune 500)
– The challenges of the comeback
– Choices of citizens, policymakers, and institutions
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Economic Freedom
• Economic freedom is characterized by the absence of
government obligation or constraint on the production
distribution, and/or consumption of goods and services.
• People are free to work, produce, consume, and invest in the
ways they choose.
• The Economic Freedom Index approximates the extent to
which a government intervenes in the areas of free choice,
free enterprise.
• Countries ranking highest on this index tend to enjoy both the
highest standards of living as well as the greatest degree of
political freedom
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Economic Freedom Index
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Dimensions of the Economic Freedom Index
1. Property Rights: the ability of individuals to accumulate
private property, secured by clear laws that are fully enforced by
the state.
2. Freedom from Corruption: degree that corruption introduces
insecurity and uncertainty into economic relationships.
3. Fiscal Freedom: tax burden imposed by government on its
citizens.
4. Government Spending: government expenditures as a
percentage of GDP.
5. Labor Freedom: the legal and regulatory framework of a
country’s labor market (e.g. minimum wages, layoffs, hiring, and
hours worked).
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Dimensions of the Economic Freedom Index
6. Business Freedom: the ability to start, operate, and close a
business.
7. Monetary Freedom: the degree of price stability and the
extent of price controls.
8. Trade Freedom: the absence of tariff and non-tariff barrier
that affect imports and exports of goods and services.
9. Investment Freedom: ability of individuals to move resources
without restrictions into and out of activities internally and
across the country’s borders.
10. Financial Freedom: efficiency of banking and independence
of the financial sector from government control and
interference.
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Global Distribution of Economic Freedom
Source: www.heritage.org
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Economic Freedom
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Economic Freedom and the Standard of Living
• The standard of living is a general measure of economic
welfare, usually measured by per capita income, to reflect
the availability of goods and services to satisfy wants rather
than needs.
• Increases in economic freedom and the standard of living
have a strong and direct relationship.
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Free Economy and GDP per Capita
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Free Economy and Inflation Rates
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Value of Economic Freedom
• Economic freedom affects:
– Growth rates
– Productivity
– Income levels
– Inflation
– Unemployment
– Life expectancy
– Literacy
– Political openness
– Environmental sustainability
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Trends in Economic Freedom
• For the last few decades, it was assumed that economic
freedom would increase.
• But now the trend toward increased economic freedom is no
longer certain.
• The global financial crisis (2008) has made this assumption
questionable.
• Populism …
• Governments are now intervening in markets to implement
safeguards to protect against a repeat of that financial crisis.
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Types of Economic Systems
• An economic system refers to the mechanism that deals with
the production, distribution, and consumption of goods and
services.
• It has the following types:
1. Market economy
2. Command economy
3. Mixed economy
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Types of Economic Systems
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Types of Economic Systems
Market Economy
• It describes a system where individuals, rather than
government, make the majority of economic decisions.
• Key factors include consumer sovereignty, the freedom of
market entry and exit, and the determination of prices
according to the laws of supply and demand.
• Producers are driven by the profit motive, while consumers
determine the relationship between price and quantity
demanded.
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Types of Economic Systems
Market Economy
• Examples of market economy:
– Hong Kong
– Singapore
– Australia
– Switzerland
– Canada
– USA
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Means and Methods of a Market Economy
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Types of Economic Systems
Command Economy
• Also known as centrally-planned economies, are built upon
the government ownership and control of the factors of
production.
• Central planning authorities determine what products will be
produced in what quantities and the prices at which they will
be sold.
• Most often, the totalitarian aims of communism gave the
highest priority to industrial investments and military
spending at enormous expense to the consumer sector.
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Types of Economic Systems
Command Economy
• Examples of Command economy:
– Soviet Union
– China
– India (prior to economic reform)
– North Korea
– Cuba
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Types of Economic Systems
Mixed Economy
• It falls between the extremes of market and command
economies.
• While economic decisions are largely market-driven and
ownership is largely private, government nonetheless
intervenes in many economic decisions.
• The extent and nature of such intervention may take the form
of government ownership of certain factors of production, the
granting of subsidies, the taxation of certain economic
activities, and/or the redistribution of income and wealth.
• Democracy calls for market economy, communism calls for a
command economy. Likewise, socialism calls for a mixed
economy.
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Types of Economic Systems
Mixed Economy
• Examples of Mixed economy:
– Denmark
– Sweden
– South Africa
– Japan
– Austria
– France
– Brazil
– Germany
– India
• They mostly fall in the mostly and moderately free categories
of the economic freedom index
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State Capitalism:
Detour or Destination?
• State capitalism is an economic system whereby political
officials decide how assets are valued and when and where
they are used.
• The state encourages national companies, manage trade
relations and exchange rates to promote exports and
discourage imports.
• It is like mixed economy but it is different that government
manipulates market outcomes for political purposes.
• Foreign companies restricted from strategic industries.
– For instance, 99 out of 100 Chinese publicity companies are owned
by the Chinese government.
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Measures of Economic Performance
• Gross National Income (GNI) is the total market value of all
production (goods and services) in the domestic economy
plus the income received from other countries minus similar
payments made to other countries.
• Per capita GNI is computed by dividing GNI by a country’s
population.
• Countries with high populations and high per capita GNI are
most desirable in terms of market potential.
• For example, all production value of Saudi companies in Saudi
Arabia and the production value of all Saudi companies
abroad (e.g. Saudi companies in Egypt, France, UK, etc.)
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Gross National Income and Gross Domestic Product
• Gross Domestic Product (GDP) is the total market value of
output produced within a nation’s borders whether generated
by a domestic or foreign owned company.
• For example, all production value of Egyptian and non
Egyptian companies operating in Egypt (e.g. Saudi, French,
Canadian companies, etc.)
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Gross National Income and Gross Domestic Product
• Example – GNI:
– Value of a Ford car manufactured in the United States and the
portion of the value of a Ford car manufactured in Mexico using US
capital counts in US GNI.
– Portion of the value of a Toyota car manufactured in the US using
Japanese capital is NOT counted in US GNI; however, it is counted in
Japan GNI.
• Example – GDP:
– Both a Ford and Toyota cars manufactured in the United States
counts towards the US GDP.
– A Ford car produced in Mexico would not; however, it counts
towards Mexico’s GDP.
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Purchasing Power Parity (PPP)
• Nominal exchange rates do not always reflect international
differences in prices.
• PPP is the number of units of a country’s currency required to
buy the same amount of goods and services in the domestic
market that $1 would buy in the United States.
• Sometimes referred to as the Hamburger standard.
• PPP is a useful measure since it accounts for international
differences in price.
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The 10 Largest Economies by GNI, 2018
GNI, Atlas Method (Current US$)
Rank
Country
GNI ($ Billions)
% of World Total
1
United States
20,636
24.4%
2
China
13,181
15.6%
3
Japan
5,227
6.2%
4
Germany
3,905
4.6%
5
United Kingdom
2,777
3.3%
6
France
2,752
3.3%
7
India
2,728
3.2%
8
Italy
2,038
2.4%
9
Brazil
1,915
2.3%
10
Canada
1,666
2.0%
Source: http://data.worldbank.org/
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Adjusting Analytics
• Economic Growth Rate
– Growth rate of GNI indicates a country’s economic potential
Growth Rate (%) =
• GNI per Capita
– GNI per capita is supposed to be an indicator for the standard of
living between countries
• Purchasing Power Parity (PPP)
– PPP is an adjustment (conversion) to the GNI per capita to reflect the
cost of living in different countries with US as the base.
International Dollar has the same purchasing power of 1$ has in USA
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Country Classification
• Developing Countries
•
•
Largest number of countries
Low per capita income
• Emerging economies
•
•
Fast growing, relatively prosperous
BRICS: Brazil, Russia, India, China, South Africa
• Developed Countries
• High per capita income and high standard of living
• USA, UK, Japan, France, Australia
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World Bank Country Classification
Common Name
GNI Per Capita
World Bank
Number of
Classification Countries
Developing
Country
$1,025 or less
Low Income
Developing
Country
$1,026 to $3,995
Lower Middle 47
Income
Developing
Country
$3,996 to $12,375
Upper Middle 60
Income
Developed and
OECD Country
$12,376 or more
High Income
31
80
OECD: Organization for Economic Cooperation and Development (36 Countries)
OECD Members GNI per capita = $40,095
Source: https://data.worldbank.org/indicator/NY.GNP.PCAP.CD?view=chart
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GNI per Capita, 2020
Source: https://data.worldbank.org/indicator/NY.GNP.PCAP.CD?view=map
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GNI per Capita Measured Two Ways, 2018
Country
Current US$ PPP (Current International $)
Algeria
3,920
13,600
Bangladesh
1,750
4,057
Belgium
45,910
46,860
Brazil
9,140
14,068
Canada
44,940
43,632
Denmark
60,140
49,565
Egypt
2,800
10,743
France
41,080
40,458
Ghana
2,130
3,943
Japan
41,310
40,344
Nigeria
1,960
5,142
UK
41,770
39,979
PPP is an adjustment
in GNI per capita to
reflect differences in
the cost of living
PPP is the number of
units of a country’s
currency required to
buy the same amount
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.
Source: http://data.worldbank.org/indicator/NY.GNP.PCAP.CD/countries
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The 10 Largest Economies, 2018
GNI, Adjusted for PPP (current international $)
Rank
Country
GNI ($ Billions) % of World Total
1
China
25,303
18.7%
2
United States
20,837
15.4%
3
India
10,393
7.7%
4
Japan
5,616
4.1%
5
Germany
4,524
3.3%
6
Russian Federation
3,950
2.9%
7
Brazil
3,320
2.4%
8
France
3,106
2.3%
9
United Kingdom
3,016
2.2%
10
Italy
2,555
1.9%
Source: http://data.worldbank.org/
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Economic Analysis
1. Inflation
2. Unemployment
3. Debt
4. Income Distribution
5. Poverty
6. Balance of Payments
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Inflation
• The inflation rate represents the percentage increase in the
change in prices from one period to the next, usually a year.
• A common indicator of inflation is the consumer price index
(CPI), which measures the cost of a fixed basket of goods and
services and compares the price from one period to the next.
• Inflation occurs because aggregate demand is growing faster
than aggregate supply.
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Inflation
• Inflation directly impacts:
– Interest rates (increase with increase in inflation).
– Exchange rates (weaker currencies as inflation increase).
– Cost of living and the general confidence in a country’s political and
economic systems.
• Inflation is a measure of the increase in the cost of living
• Deflation is the opposite of inflation where prices go down,
not up.
• Reflation is a process where the government increase the
money supply and reduce taxes to accelerate economic
activity
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Unemployment
• The unemployment rate represents the number of
unemployed workers divided by the total civilian labor force
in a given country.
• The misery index represents the sum of a country’s inflation
and unemployment rates.
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Unemployment
• The Pension Problem
– Many countries’ aging populations rely heavily on pension income
and the availability of sufficient funds in these systems are in real
danger.
• The impact of less people working and reductions in returns in
the investments held by these pension systems are two large
drains to the available resources counted on by the aging
sector of the population.
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Debt
• Debt is the sum total of a government’s financial obligations;
it measures the state’s borrowing from its population, from
foreign organizations, from foreign governments, and from
international institutions.
• Internal and External Debt
– Internal debt results when a government spends more than it
collects in revenues; the subsequent pressure to revise government
policies often leads to economic uncertainty.
– External debt results when a government borrows money from
foreign lenders.
• Growing debt can often be an early warning for tax increases,
reduced growth, rising inflation, and increasing austerity.
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Income distribution
• Income distribution describes what share of a country’s
income goes to various segments of the population.
– 20% of the Brazilians (35 millions) receive 60% of the income. GNI is
$ 1.4 trillion. GNI per capita is $2,710.
– 20% of American receives 46% of the GNI.
• Urban versus Rural Income Distribution
– There is a particularly strong relationship in skewed income
distributions and growth in per capita income between those who
live in urban settings, where growth is accelerating, and those who
live in rural settings, where growth is nearly stable.
• There is a growing gap between the rich and poor in every
country in the world.
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Income distribution
• The main reason is that 200 years ago everyone was poor.
• Increasing income inequality isn't just an issue of social
justice, but also one of economic efficiency.
• Gini coefficient
– Measure the extent to which the distribution of resources deviates
from a perfect equal distribution.
– A score of Zero means perfect equality.
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Poverty
• Poverty is the state of having little or no money and few or no
material possessions
– Extreme poverty: less than $1.25 per day
– Moderate poverty: less than $2.00 per day
• According to the World Bank, globally, the world is about 80
percent poor, 10 percent middle income, and 10 percent rich.
• Poverty impacts economic development, and the way
businesses do business.
• International companies must deal with issues such as the
lack of market systems, infrastructure deficiencies, criminal
behavior, and bad government.
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Balance of Payments
• The balance of payments (BOP), officially known as the
Statement of International Transactions, records a country’s
international transactions among companies, governments,
and/or individuals.
• It reports the total of all money flowing into a country less all
money flowing out of that country to any other country
during a given period.
• Current and Capital Accounts. The two primary accounts are:
– (a) the current account, which tracks all trade activity (exports and
imports) in merchandise and services.
– (b) the capital account, which tracks long and short-term capital
flows whether loans given to foreigners or loans received by citizens.
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Components of a Country’s Balance of Payments
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Balance of Payments
• A trade surplus indicates that the value of exports exceeds
the value of imports.
• A trade deficit indicates that the value of imports exceeds the
value of exports.
• The statistical discrepancy reflects the difference between the
sums of the credits and debits.
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Current Account Balances: The Top and Bottom Five
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Key Components of Economic Analysis
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Beyond Economic Development
• The Shadow Economy
• Sustainability and Stability
• Sustainability Measures
–
–
–
–
Green Economy
Net National Product (NNP)
Genuine Progress Indicator (GPI)
Human Development Index (HDI)
• Stability Measures
–
–
–
–
–
Sufficient Resources
Happynomics
Your Better Life Index (YBLI)
Gross National Wellness Index (GNWI)
Happy Planet Index (HPI)
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The Shadow Economy
• Legal and illegal business that fall beyond official
measurement
• Government’s efforts to collect economic data are
complicated by the shadow economy (black, grey, parallel
market, informal economy).
• It includes extra legal-activities (e.g. driving an unlicensed taxi,
street trading, or unregistered day car center, housekeeping
etc.)
• Developed economies tend to have a smaller shadow
economy than developing economies.
• In some developing countries the shadow economy ran from
55% to 73% of GDP.
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The Shadow Economy
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Size of the Shadow Economy, % of GDP
Source: https://knoema.com/mekpaig/world-shadow-economy-map
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Sustainability and Stability
• GNI and GDP, even after adjusting for growth rates and
purchasing power, partially evaluate a country’s economic
performance and potential.
• Monetary measures miss other costs of externalities like air,
water, or noise pollution; which are the by-products of
economic activity.
• The performance of an economy should consider the
information beyond monetary measures such as data
provided by; Sustainability and Stability.
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Sustainability: Green Economy
• Sustainability aims at complementing monetary metrics by
assessing economic performance in terms of “meeting the
needs of the present without compromising the ability of
future generations to meet their needs”.
• Top world country rankings for sustainability:
– Sweden, Switzerland, Norway, UK, and New Zealand.
• Green Economy
– Measures economic performance in terms of the effect of current
choices on long-term sustainability.
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Sustainability: Green Economy
• Several proposals outline paths to “greenify” GNI and GDP.
Current candidates include the following:
– Net National Product (NNP)
– Genuine Progress Indicator (GPI)
– Human Development Index (HDI)
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Sustainability: Net National Product (NNP)
• Measures the depletion of natural resources and degradation
of the environment that result from making and consuming
products.
• Just as a company depreciates its tangible and intangible
assets when making a product, so too should countries.
• NNP does so by depreciating the country’s assets when
generating growth.
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Sustainability: GNI and NNP Comparison
Country
GNI ($ Billions)
NNP ($ Billions)
United Stated
19,830
16,740
China
12,134
9,106
Japan
5,038
3,944
Germany
3,750
3,123
United Kingdom
2,634
2,257
India
2,630
2,247
Canada
1,630
1,347
Finland
254
208
Nigeria
364
306
Egypt
230
209
Algeria
165
134
Source: https://data.worldbank.org/indicator/
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Sustainability: Genuine Progress Indicator (GPI)
• The GPI indicator takes everything the GDP uses into account
but considers other figures that represent the cost of the
negative effects related to economic activity (such as the cost
of crime, cost of reduced environmental quality, health and
hygiene, security, free time, resource depletion, and
educational attainment).
• GPI will equal zero if the costs of pollution, crime, and family
troubles equal the monetary gains from the production of
goods and services.
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Sustainability: Genuine Progress Indicator (GPI)
GPI considers both
natural and social capital
Source: http://donellameadows.org/archives/life-beyond-growth/
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Sustainability: Human Development Index (HDI)
• HDI focuses on issues of human development that do not
show up immediately in income or growth measures (e.g.
those issues related to better nutrition, education, hygiene
and health); which improves economic performance.
• Estimating a country’s degree of human development in
terms of the physical, intellectual, and social standards that
shape its overall quality of life and helps managers measure
market potential.
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Sustainability: Human Development Index (HDI)
• The UN translates the HDI into components
HDI Component
Measure
Longevity
Life expectancy at birth
Knowledge
Adult literacy rate
Primary, secondary, and
tertiary gross enrollment ratio
Standard of Living
GNI per capita (PPP)
• High HDI countries: include Norway, Australia, Switzerland,
Denmark, and the Netherlands.
• Low HDI countries: Benin, Uganda, Rwanda, Haiti, and Togo.
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Sustainability: Human Development Index (HDI)
Source: http://hdr.undp.org/en
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Stability: Sufficient Resources
• The earth currently lacks sufficient resources to support and
sustain high consumption for 7.4 billion people.
• The question arises now is what would be the case when the
earth’s projected population reaches 9.7 billion by 2050?
• If all countries consume resources and produce pollution at
the current per capita level in the United States (a rich
country) we would require five planet Earths to meet demand
and sustain the system.
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Stability: Sufficient Resources
Fossil Fuel Consumption per Capita, United States
Source: https://ourworldindata.org/grapher/fossil-fuel-consumption-per-capita?country=USA
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Stability: Sufficient Resources
Fossil Fuel Consumption per Capita, China
Source: https://ourworldindata.org/grapher/fossil-fuel-consumption-per-capita?country=USA
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Stability: Happynomics
• Happynomics is a measure that encourages moving “from the
concept of financial prosperity to the emotional prosperity”.
• Welfare economics encourage incorporating elements of
psychology, health, security, and sociology.
• It advocates redefining the traditional performance standards
of wealth, income, or profit to reflect principles of well-being,
quality of life, and life satisfaction.
“Making citizens happier, not richer, every year” Bhutan Constitution
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Stability: Your Better Life Index (YBLI)
• There is more to life
than the cold numbers
of GDP and economic
statistics.
• This index allows you to
compare well-being
across countries, based
on 11 topics the OECD
has identified as
essential, in the areas of
material living conditions
and quality of life.
Source: http://www.oecdbetterlifeindex.org/#/11111111111:
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Stability: Your Better Life Index (YBLI)
Your housing conditions and spending
Household income and financial health
Earnings, job security and unemployment
Quality of your social support network
Your education and what you get out of it
Quality of your environment
Your involvement in democracy
How healthy you are?
How happy you are?
Murder and assault rates
How much you work? How much you play?
Source: http://www.oecdbetterlifeindex.org/#/11111111111:
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Stability: Gross National Wellness Index (GNWI)
• GNWI measures a country’s capacity to promote individual
well-being in terms of mental health, work, income, social
relations, economic, retirement, political, and environment.
• The GNWI emphasizes equitable and sustainable
socioeconomic development, preserving cultural values
elevating spirituals, conserving the natural environment, and
championing fair, just governance.
• Material and spiritual development occur side by side, one
reinforces the other or both suffer.
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Stability: Happy Planet Index (HPI)
• HPI focuses on analyzing how well a country helps its citizens
to live long, ecologically sensitive lives, healthy, while not
trespassing the opportunity of future generations and people
in other countries.
• HPI holds that the fundamental logic of monetary metrics are
misaligned, overly emphasizing growth at all costs.
• With HPI, progress is defined not in terms of economic
development, but through success in achieving a sustainable
well-being for all.
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Other Meta-Models
• IB Managers often consider meta-models to improve their
understanding of the absolute and relative potential of an
economic environment.
• Popular indices include:
– Global Competitiveness Index (GCI)
– Global Innovation Index (GII)
– Where-To-Be-Born Index (WTBBI)
The “lucky baby”
league table
(80 countries)
IM535 – International Operations
Management
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