QUESTION 1.2-INTERNATIONAL BUSINESS

MGMK 4710

INTERNATIONAL BUSINESS

Chapter 4. ECONOMIC ENVIRONMENTS

Look at the following link:

www.heritage.org/index

I. INTRODUCTION

Chapter 3 discussed how cultural environments affect the political environments. In turn, political/legal environments have huge implications economic environments. High-income (developed) economies tend to be democratic nations. Low to middle income (developing) economies are likely to have a totalitarian system.

II. ECONOMIC SYSTEMS

An economic system is the set of structures and processes that guides the allocation of scarce resources and shapes the conduct of business activities in a nation. There are three main economic systems: market economy, command economy, and mixed economy

A. Market economy

It is an economic system in which productive activities are privately owned and operated. Credited to Adam Smith, the laissez-faire principle, i.e., nonintervention by government in a country’s economic activity, states that producers are driven by the profit motive, while consumers determine the relationship between price and quantity demanded. The high standards imposed by a market economy are based on some preconditions, including sound macroeconomic policies, fair and transparent political institutions, open trade and high levels of education.

Main characteristics:

- Private property rights: policies protect rights of individuals to own property

- Pricing system: interaction of supply and demand determines prices of goods and services

- Production: market determine the quantity of goods and services to be produced

- Consumption: individuals freely make buying decision

- State: hands off system of laissez-faire, limited regulation so market operates properly

- Capitalism: private ownership of means of production

- Resources: supply-demand interactions determine how resources are distributed and used

B. Command economy

It is an economic system in which productive activities are planned and owned by the state. Also known as planned economies, command 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.

Main characteristics:

- Private property rights: policies prohibit individuals from owning property

- Pricing system: government regulates prices of goods and services

- Production: government decides which quantity of which goods and services to be produced

- State: hands on system of government control of production, consumption and prices

- Socialism: state ownership of means of production

- Resources: state distributes and decides how to use resources

C. Mixed economy

It is an economic system in which private ownership (capitalism) and state ownership (socialism) co-exist. Mixed economies fall 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.

Main characteristics: features of market economy and command economy are combined:

- State: substantial government intervention in production and pricing

- Market: sizable public sector alongside dominant private sector

- Production: government controls production and resources in key sectors

III. ECONOMIC INDICATORS

MNEs’ managers need to look at various indicators (measures) to assess the

level of a country’s economic performance and potential. There are several

indicators that managers can use:

A. Gross Domestic Product (GDP)

Gross Domestic Product measures the value of goods and services generated by both domestic and foreign-owned firms within a nation’s borders in a given period, usually a year. The concepts of Gross National Income (GNI) and Gross National Product (GNP) are sometimes used, but they are similar to GDP. Even though GDP provides the size of a country’s economy, managers should closely examine GDP growth rate.

B. Other economic indicators

To better understand a country level of economic development, managers need to study other GDP-related measures:

- Population: it can determine the size of a particular market

- Per capita income: besides the size of an economy (GDP), and that of its population, the capacity of a country’s individuals to make purchases is determined by the per capita income. Per capita income is obtained by dividing GDP by population. Per capita income is the measure used by international institutions (World Bank, International Monetary Fund, etc.) to classify countries (rich vs poor countries, developed vs developing countries, high-, middle-, or low-income countries, etc.)

- Purchasing power parity: it represents the number of units of a country’s currency required to buy the same amount of goods and services in the domestic market that one unit of income would buy in another country. PPP is estimated by calculating the value of a universal “basket” of goods that can be purchased with one unit of a country’s currency.

- Inflation: it is the pervasive and sustained rise in the aggregate level of prices as measured by a cost of living index. When aggregate demand grows faster than aggregate supply, i.e., when prices rise faster than incomes, the effects can be dramatic. Some countries have high inflation rates (i.e. prices go up faster). There are however instances where prices go down (a phenomenon called deflation)

- Unemployment rate: it represents the number of unemployed workers divided by the total civilian labor force in a given country.

- Debt: it 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. A country’s government has revenues as well as spending (budget). Budget surplus exists when revenues are higher than spending. When revenues are lower than spending, the government has a budget deficit, and this will force the government borrow, resulting in debt.

- Income distribution: it describes what share of a country’s income goes to various segments of the population. Uneven income distribution occurs in virtually every country with the U.S. having the largest inequality compared to other industrialized nations.

- Poverty: it is a condition in which a person or community is deprived of, or lacks the essentials for a minimum standard of well-being and life. According to the World Bank, globally, the world is about 80 percent poor, 10 percent middle income, and 10 percent rich. The reduction of the number of people in poverty has been concentrated in a few countries like China, but poverty appears to be growing worldwide.

IV. IMPACT OF POLITICAL ENVIRONMENTS ON ECONOMY

Political and legal environments affect economic environments. Political risk is a crucial factor MNEs’ managers consider before making the decision of whether to invest in a country. It is no surprise that MNEs invest more in stable countries and less in unstable nations.

- Democracies and market economy: because democracies involve freedom of economic organization (i.e. to start a company), most democratic countries tend to also have a market economic system. In addition, the legal system in democratic nations tends to have and enforce laws that protect private ownership (i.e. property rights) which promotes economic growth. Not surprisingly, most high-income economies are democratic nations

- Totalitarianism and command economy: because totalitarianism prohibits freedom of economic organization, most totalitarian countries tend to adopt the command economic systems. Also, the legal system in totalitarian nations has laws that do not allow private ownership, which does not promote economic prosperity. Most totalitarian countries are low income economies.

- Transition toward democracy and market economy: unable to improve living standards of their populations, several totalitarian nations are undergoing political transformations by increasingly carrying out democratic reforms. Often, these reforms are the result of political pressures from the bottom (i.e. by the people). Many countries have been transitioning toward democracy and market economy have also experienced economic hardship, income disparity, and therefore social discontent and often political instability.