7-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Global Business Today 1e by Hill. Slides...

Chapter 7

Economic Environment 7

Lecture/Chapter Topics

• Economic Endowments • Macroeconomic Stability• Economic Development• Economic Systems• Economies in Transition• Managerial Implications

Economic Endowments• A preliminary assessment of the potential of a country as either

a location for production or a market for a firm’s product would consider the economic variables of its:

– Size

– Natural and created resource endowments associated with its geography

– People

– Infrastructure

– Competitiveness

Economic Endowments• Size

– The size of an economy is a basic measure of the market potential for a firm’s product.

– Two general measures of the size of an economy are its population and level of national income and production.

Economic Endowments• Size (Cont’d)

– Gross National Income (GNI) GNI is the value of a nation’s income, that is the income

earned by the residents of the nation. GNI measures the value of the incomes of residents, no

matter where the income is earned, in the domestic market or a foreign market.

GNI equals GDP plus net income from abroad. GNI per capita is a common measure of economic

development.

Economic Endowments• Size (Cont’d)

– Gross Domestic Product (GDP) GDP measures the value of production and the income

earned from that production that occurs within a nation’s boundaries.

GDP measures the production in the country no matter who owns the factors of production, be they a domestic or a foreign resident.

GDP is a measure of the size of an economy.

Economic Endowments• Geography

– The natural resources and features of a country affect the level and patterns of market demand and production.

– Geographic features such as the endowments of accessible mineral deposits, climatic patterns, the distribution of soil types and the topography of a region provide or limit business opportunities.

Economic Endowments• Geography (Cont’d)

– A country’s location can in itself, either geopolitically or physically, be a valuable business resource.

– Geographic proximity has been a factor in the formation of trading agreements.

– Geography is a factor that drives the development of an economy and its economic system.

Economic Endowments• People

– The population characteristics of a country help define its market potential or its potential as a location for production.

– Market analyses of population size and growth and population distributions can provide general indicators of the potential market size for a firm’s product.

Economic Endowments• People (Cont’d)

– Population distribution information looks at how a population is divided into various categories such as gender, age and location.

– Income distribution information focuses on what proportion of the population receives what proportion of the total income.

– Sufficient people with sufficient income to spend are the foundations of a potentially viable market for a firm’s product.

Economic Endowments• People (Cont’d)

– Population density influences market potential.– An educated and skilled population — an outcome of

investment in education and training — represents the human capital of a nation.

– Education emerges as an important determinant of economic development.

Economic Endowments• Infrastructure and Institutions

– Infrastructure refers to the collection of the nation’s assets and institutions that facilitate and support economic activity.

– Infrastructure includes the physical, economic and commercial structures and institutions.

– From a firm’s point of view, infrastructure comprises those facilities and services external to the firm that facilitate and enhance the competitiveness of its marketing and production operations.

Economic Endowments• Infrastructure and Institutions (Cont’d)

– A key element of the commercial infrastructure is a well developed financial system.

– Institutions in this sector include banks, non-banks (e.g. insurance firms, superannuation funds), markets (e.g. stock exchanges) and supervisory authorities (e.g. the reserve bank of a country).

– Two roles of the financial system are the provision of a stable payments system and financial intermediation between savers and investors.

Economic Endowments• Competitiveness and Productivity

– Competitiveness refers to the quality possessed by a nation or a business that enables it to maintain an economic advantage in a marketplace.

– Source of competitiveness Internal sources: Product differentiation, new products,

process redesign and innovative organisational arrangements

Economic Endowments• Competitiveness and Productivity (Cont’d)

– Source of Competitiveness (cont’d) External sources: Quality infrastructure, country of origin

effects, and external economies arising from the firm’s operation in a large and successful industry or cluster of successful industries in a country or region

– A firm’s competitiveness depends on three key elements: price of inputs, productivity and the foreign exchange rate.

Economic Endowments• Competitiveness and Productivity (Cont’d)

– Productivity is the ratio of output to the factors of production.– A worst case scenario would be a combination of high labour

costs, low productivity and an appreciation of the domestic currency in the foreign exchange rate.

– Productivity is one element over which the firm has some control but there is still considerable influence from external factors.

Economic Endowments• Major Productivity Determinants

Macroeconomic Stability• Developing countries of the world would seem to offer the

best opportunities for international business but such business is accompanied by many risks.

• Policy uncertainty, macroeconomic instability, tax rate and corruption were found to be the four most significant obstacles out of fourteen based on the UN’s survey of 26000 firms operating in 53 countries.

• Policy uncertainty and macroeconomic instability are the major obstacles to realising business and investment opportunities in developing countries.

Macroeconomic Stability• Economic Stability

– Macroeconomic stability occurs when an economy grows without persistent and major fluctuations in the levels of economic activity, inflation rates, unemployment and balance of payments.

– This measure focuses more on the state of the current economic conditions of an economy.

– Current economic conditions reflect the stage of the business cycle.

Macroeconomic Stability• Economic Stability (Cont’d)

– ‘Business cycle’ refers to the tendency of economies to move in sequence through phases of expansion and contraction of economic activity in a somewhat regular pattern.

– In pursuit of social, political and economic goals, national governments attempt to stabilise the economy.

Macroeconomic Stability• Business Cycle and Stabilisation Policy Goals

Macroeconomic Stability• Economic Stability (Cont’d)

– Fiscal (or budget) policy and monetary policy are the main instruments of policy that national governments use to stabilise the economy.

– Fiscal policy involves making adjustments to government expenditures and taxes to stimulate or slow down economic activity.

– Monetary policy involves the manipulation of interest rates and the money supply by the nation’s central bank for similar purposes.

Macroeconomic Stability• Economic Growth and Fluctuations

– Economic growth refers to an increase in the productive capacity and national output of a country, measured by the rate of increase of GDP.

– Real GDP is a measure of the dollar value of GDP after taking into account changes in value owing to price changes.

Macroeconomic Stability• Economic Growth and Fluctuations (Cont’d)

– Sources of Economic Growth In the longer term, the sources of economic growth include:

• the availability of more resources; and• the factors that lead to the more productive use of those resources

such as increased labour skills, new technologies, innovative products and expanding markets and scale economies

Macroeconomic Stability• Inflation

– Inflation is an increase in the general price level over time. It becomes a matter of concern to management and policy makers when the increases are persistent and sizeable.

– Quarterly and annual percentage changes in the Consumer Price Index (CPI) are common measures of inflation.

– The CPI in essence is derived from the average price of a fixed sample or basket of consumer goods and services purchased at different times.

Macroeconomic Stability• Inflation (Cont’d)

– The GDP deflator is another common basis for measuring inflation.

– The GDP deflator takes account of the price changes of a larger and more varied set of goods and services than that contained in the consumer’s basket.

– In periods of high and volatile inflation rates, expectations of continuing inflation persist and uncertainty rises.

Macroeconomic Stability• Inflation (Cont’d)

– Interest rates are likely to rise with inflation.– High inflation can lead to the depreciation of the value of a

currency, which implies consequences not just for international business but also for the global employee.

– High rates of inflation can hinder the long-term development performance of an economy.

Macroeconomic Stability• External Viability and the Balance of Payments

– The external viability of a country is an important variable for business to monitor when assessing the economic conditions of a country.

– Whether or not a country is able to pay its way internationally can affect the market or investment potential of the country.

(Cont’d)– A country’s international financial transactions are

summarised in the country’s balance of payments (BOP) statement.

– The statement consists of three main accounts: the Current Account, the Capital Account and the Financial Account.

(Cont’d)– The Current Account records the ‘current’ expenditures on

transactions. – The Capital Account records international capital transfers.– The Financial Account records the financial flows and

balances arising from capital transactions.

Macroeconomic Stability• Balance of Payments Summary

(Cont’d)– A second set of accounts that records the investment

outcome of cross-border transactions and is related to the BOP is the International Investment Position (IIP) account.

– The IIP records a nation’s stock of foreign assets and liabilities at a particular point in time.

Macroeconomic Stability• International Investment Position

Economic Development• Economic development is a multi-dimensional

concept.• It refers to the increasing capacity of an economy

to improve and sustain the standards of living of the entire population.

• It includes notions of process, change, inherent dynamism, independence, sustainability and the long term.

Economic Development• Differences in Economic Development

– Different countries have dramatically different levels of economic development.

– One common measure of economic development is a country’s gross national income per head of population.

– Countries such as Japan, Sweden, Switzerland and the United States are among the richest on this measure, while the large countries of China and India are among the poorest.

Economic Development• Differences by Country in GNI per Capita in US

Dollars

Economic Development• Differences in Economic Development (Cont’d)

– GNI per capita figures can be misleading, because they do not consider how the income is distributed or differences in the cost of living.

– Purchasing Power Parity (PPP) is an adjustment in gross national income per capita to reflect differences in the cost of living.

– PPP allows for a more direct comparison of living standards in different countries.

Economic Development• Purchasing Power Parity in International Dollars

Economic Development• Broader Conceptions of Development

– Amartya Sen, the Nobel Prize-winning economist, has argued for a different perspective on development.

– He proposes that development should be assessed less by material output measures such as GNI per capita and more by the capabilities and opportunities that people enjoy.

– Human Development Index (HDI), developed by Amartya Sen, measures the quality of human life in different nations.

Economic Development• Broader Conceptions of Development (Cont’d)

– HDI is based on three measures: i. Life expectancy at birth (which is a function of health

ii. Educational attainment (which is measured by a combination of the adult literacy rate and enrolment in primary, secondary and tertiary education)

Economic Development• Broader Conceptions of Development (Cont’d)

– HDI is based on three measures: (cont’d)iii. Whether average incomes, based on PPP estimates, are

sufficient to meet the basic needs of life in a country (adequate food, shelter and health care)

– HDI is scaled from 0 to 1. Less than 0.5: low human development 0.5 to 0.8: medium human development Above 0.8: high human development

Economic Development• Human Development Indicators

Economic Systems• Economic systems are the set of arrangements and

institutions by which decisions are made on basic economic questions of what, how and for whom to produce.

• Types of economic systems – Market economy– Command economy– Mixed economy

Economic Systems• Market Economy

– A free market system is likely in countries where individual goals are given primacy over collective goals.

– In a pure market economy the goods and services that a country produces and the quantity in which they are produced are determined by supply and demand.

Economic Systems• Command Economy

– In a pure command economy the goods and services that a country produces, the quantity in which they are produced and the price at which they are sold are all planned by the government.

– State-owned enterprises and restricted markets are common in countries where collective goals are dominant.

Economic Systems• Mixed Economy

– A mixed economy includes some elements of the market economy and some elements of the command economy.

– Certain sectors are left to private ownership and free market mechanisms, while other sectors are characterised by significant government ownership and government planning.

Economic Systems• Economic Systems and Development

– What is the relationship between political economy and economic progress? This question has been the subject of a vigorous debate among academics and policy makers.

– No categorical answer has emerged, however; all that is possible are a few generalisations as to the nature of the relationship between systemic factors and economic development.

Economic Systems• Economic Systems and Development (Cont’d)

– Innovation and Entrepreneurship are the Engines of Growth

There is broad agreement that innovation and entrepreneurship are the engines of long-run economic growth.

– Innovation and Entrepreneurship Require a Market Economy

Economic freedom associated with a market economy creates greater incentives for innovation and entrepreneurship than either a planned or mixed economy.

Economic Systems• Economic Systems and Development (Cont’d)

– Innovation and Entrepreneurship Require Strong Property Rights

Strong legal protection of property rights is another requirement for a business environment conducive to innovation, entrepreneurship and economic growth.

– The Required Political System It seems that democratic regimes are more conducive to

long-term economic growth than dictatorships, even those of the benevolent kind.

Economies in Transition• The Spread of Market-Based Systems

– In general, command and mixed economies failed to deliver the kind of sustained economic performance that was achieved by countries adopting market-based systems.

– Since the late 1980s there has been a transformation from centrally planned command economies to market-based economies.

Economies in TransitionDistribution of Economic Freedom

Economies in Transition• The Nature of Economic Transformation

– The shift towards a market-based economic system typically involves at least three distinct activities:

1. Deregulation

2. Privatisation

3. Development of institutions

States in Transition1. Deregulation

– Deregulation involves removing legal restrictions to the free play of markets, the establishment of private enterprises and the manner in which private enterprises operate.

2. Privatisation– Privatisation transfers the ownership of state property

into the hands of private individuals, frequently by the sale of state assets through an auction.

States in Transition

3. Development of Institutions– Required is the development of institutions such as the legal and

financial systems that underpin a market-based economy.– A well-functioning market economy also requires laws protecting

private property rights and providing mechanisms for contract enforcement.

Managerial Implications• Markets that were formerly off limits to Western business are

now open; however, just as the potential gains are large, so are the risks.

• Political, economic and legal systems of a country raise important ethical issues that have implications for the practice of international business.

• The political, economic and legal environment of a country clearly influences the attractiveness of that country as a market and/or investment site.

Managerial Implications• Benefits

– A business can benefit from a foreign country’s resource endowments, both created and natural and from its location, either by proximity to its markets or essential resources.

– By identifying and investing early in potential future economic stars, firms may be able to gain first mover advantages (advantages that accrue to early entrants into a market) and establish loyalty and experience in a country.

Managerial Implications• Costs

– Macroeconomic instability, as evidenced by high inflation and BOP deficits, can prove costly to business.

– High and volatile rates of inflation have an impact on business operations and strategy.

– Instability can impact on both the economic and the political environments.

Managerial Implications

• Costs (Cont’d)

– The Value of Money If the inflation rate is higher than the increases in

income then the real value or purchasing power of that

income declines.

As the cost of living rises, consumers will alter their

level and pattern of demand for goods and services.

Managerial Implications• Costs (Cont’d)

– International Competitiveness As inflation occurs, domestically produced goods and

services become more expensive and less competitive on world markets and imports become more competitive in domestic markets.

The competitiveness of businesses diminishes and remains affected as the costs of doing business rise and these rises, which feed inflationary expectations, become locked into a higher level for the period of the contract.

– Increased Tax Burden If wage and salary earners are able to negotiate

employment contracts that do allow incomes to increase in line with inflation, the real value of their income is maintained.

High marginal rates (e.g. in Australia and New Zealand) are claimed to be disincentives to work more hours or invest in education and training.

– Redistribution of Income High and persistent rates of inflation unintentionally

redistribute income and wealth. People on fixed incomes or with little bargaining power in the labour market lose real income.

Growing inequities can be a source of industrial disputes and more general political instability.

– Policy Initiatives In order to combat inflation governments may enact

policies that can be detrimental to domestic and international business activity.

Action by governments themselves can be a major source of inflation, particularly in relation to their lack of fiscal or budget discipline.

– Policy Initiatives Significant and persistent imbalances in a country’s

BOP could indicate economic conditions that increase the risk of doing business in the country.

The level of economic development in terms of economic sophistication and institutional development impacts business costs.

– Risks In addition to political and legal risks, there are

economic risks.

Economic risks arise from macroeconomic instability

and macroeconomic mismanagement by the

government of a country.

– Risks (cont’d) Economic risks can be defined as the likelihood that

economic mismanagement will cause drastic changes

in a country’s business environment that hurt the profit

and other goals of a particular business enterprise.

• 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 associated with doing

business in a foreign country are typically lower in

economically advanced and politically stable democratic

nations and greater in less developed and politically

unstable nations.

Managerial Implications• Attractiveness by Country

Summary of Main Themes

• This chapter has reviewed the economic conditions

to be considered by a firm in assessing its

business prospects in a country.• The potential benefits, costs and risks of doing

business in a country are a function of its resource endowments, its macroeconomic stability, its level

of economic development and the nature of its

economic system.

7-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Global Business Today 1e by Hill. Slides...

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