International Business
by
Daniels and Radebaugh
Chapter 4
The Economic
Environment
© 2001 Prentice Hall
4-1
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 Hall
4-2
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
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4-3
Cultural Influences on International Business
EXTERNAL INFLUENCES
PHYSICAL AND
SOCIETAL FACTORS
• Political policies and
• Economic size
legal practices
• Economic systems
• Cultural factors
• Key macroeconomic
• Economic forces
indicators—growth,
• Geographical influences inflation, surpluses,
deficits
• Economies in
transition
COMPETITIVE
OPERATIONS
OBJECTIVES
STRATEGY
ENVIRONMENT
MEANS
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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
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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
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World Bank Per Capita Income Classifications
Low income
Middle income
Lower middle income
Upper middle income
High income
$785 or less in 1997
$786 - $9,655
$786 - $3,125
$3,126 - $9,655
$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 Hall
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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 capitaa PPP estimates of GNP per capitab
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
260
740
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
© 2001 Prentice Hall
b - Current International Dollars, 1997
4-8
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 Hall
4-9
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
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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
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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
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Interrelationship between Control of Economic
Activity and Ownership of Production Factors
Ownership of Production
Private
Control of
Economic Activity
Market
Mixed
Public
Market/Private*
Mixed/Private
Command/Private
Market/Mixed
Mixed/Mixed
Command/Mixed
Market/Public
Mixed/Public
Command/Public
Mixed
Command
* Control/Ownership
© 2001 Prentice Hall
4-13
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
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4-14
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
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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
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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
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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
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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
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Reforms and Economic Progress
Opposition to open-entry
competition and full liberalization
Poor rule of law
Underground and
virtual economy
Vested interest develop
Reforms and economic progress
Vicious circle
Opportunity for rentseeking and corruption
Market transformation frozen
Low growth and reversal
Credible and well-financed government
Financial
stability reverse
Partial market reform
Spread of benefits
Steady improvement in rule of law
Strong fiscal position
Sufficient revenues to finance social safety net
Confidence in banks
Growth in output, employment,
new firms
Reforms and economic progress
Virtuous circle
Early pain and opposition
Early recovery and new economic opportunities
Market-friendly environment
Steady progress to open, liberal market
New investment
Further growth
Ability to attract foreign investment
© 2001 Prentice Hall
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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
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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 Hall
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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
© 2001 Prentice Hall
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