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International Business

Sixteenth Edition

Chapter 4

The Economic Environments Facing Business

Learning Objectives

4-1 Explain the value of economic analysis

4-2 Differentiate the types of economic environments

4-3 Explain the idea of economic freedom

4-4 Differentiate the types of economic systems

4-5 Interpret indicators of economic development, performance, and potential

4-6 Profile elements of economic analysis

Learning Objectives for Chapter Four.

Economic Systems and IB

Objective 4-1

Principles used to assess economic environments

System Complexity

Market Dynamism

Market Interdependence

Learning Objective 1: Explain the value of economic analysis.

In the IB realm, cultural, political, and legal systems influence a company’s decision on where, when, and how to do business. This chapter will address economic influences in IB.

Various principles help managers better assess economic environments, including:

• System complexity: Economic environments are dynamic systems. The intricacy of the simplest economic system defies straightforward specification. Stipulating models that definitively represent a country’s economic performance and potential as well as work reliably in all types of economic environments is difficult.

• Market Dynamism: Evolving circumstances, compounded by disruptive situations and puzzling trends, generate anomalies and exceptions that convert comebacks into collapses.

• Market Interdependence: Cross-national interdependencies moderate the forces of supply, demand, and their pricing signals. Adjusting analysis for actions and reactions across an expanding scope of markets complicates interpretation.

Economic Factors Affecting Business

Objective 4-1

Figure 4.2 Economic Factors Affecting International Business Operations

Learning Objective 1: Explain the value of economic analysis.

This chart shows that managers must be able to navigate type of economic environment, degree of economic freedom, drivers of economic performance, and orientation of economic systems.

Types of Economic Environments

Objective 4-2

Types of economics

Developed

Developing

Economies in transition

Degrees of development

Learning Objective 2: Differentiate the types of economic environments.

Types of economies:

Developed: A developed economy has a robust economic environment marked by wide-ranging activities, efficient capital movement, stable institutions, extensive infrastructure, international trade and investments, advanced technologies, and higher economic freedom.

Developing: Generally, a developing economy has an uneven economic environment that is marked by narrow market activities, inefficient capital movement, resistance to foreign ownership, trade restrictions, imperfect competition, unstable institutions, limited infrastructure, sketchy technologies, and lower economic freedom.

Economies in transition: Great range marks the economic performance among developing economies precisely because different economies experience different levels of development at different rates. At the low end, countries marred by fragile political institutions, heavy indebtedness, poorly performing markets, and ongoing conflict (e.g., Afghanistan, Democratic Republic of Congo, or Timor Leste) average per capita incomes in the low hundreds (US$).

In absolute terms, globalization expanded the economy for all. In relative terms, though, many countries prospered, some more than others, and a few not at all. Different reasons explain different levels of economic development in different countries. Analysis directs attention to the economic, political/legal, and cultural moderators of development

(see Table 4.2—next slide).

Forces Affecting Degrees of Development

Objective 4-1

Table 4.2 Moderators of Economic Development

Learning Objective 2: Differentiate the types of economic environments

These factors assist in a countries economic development.

Activity minute:

Which do you think is the most valuable in terms of economic development? You can pose this question to the class or ask them to discuss in small groups.

Emerging Economies

Objective 4-2

Map 4.1 Emerging Economies of the World

Learning Objective 2: Differentiate the types of economic environments.

This map shows the emerging economies of the world.

Economic Freedom

Objective 4-3

What is economic freedom?

Economic Freedom Index

Learning Objective 3: Explain the idea of economic freedom>

Economic freedom is the “absolute right of property ownership, fully realized freedoms of movement for labor, capital, and goods, and an absolute absence of coercion or constraint of economic liberty beyond the extent necessary for citizens to protect and maintain liberty itself.”

Economic freedom can assist in economic development.

Economically free countries support activities that create income and generate wealth. Successful entrepreneurs map paths that others follow to build better lives.

Economic freedom does not signify the absence of government. Ultimately, freedom requires protection.

Economic Freedom Index estimates economic freedom in a particular nation. In principle, this index measures the degree that a nation accepts Adam Smith’s thesis that “basic institutions that protect the liberty of individuals to pursue their own economic interests result in greater prosperity for the larger society

Chart on Economic Freedom and Standard of Living

Objective 4-3

Figure 4.4

Economic Freedom and the Standard of Living

Source: Adapted from Terry Miller and Anthony Kim, “Why Economic Freedom Matters | 2015 Index of Economic Freedom Book.” 2016.

Accessed April 15. http://www.heritage.org/index/book/chapter-2. Used by permission.

Note: GDP is adjusted for PPP.

Learning Objective 3: Explain the idea of economic freedom

This chart shows the greater the economic freedom, the higher standard of living

Economic Freedom Classifications

Objective 4-3

Table 4.4 Economic Freedom: Classification and Characteristics

Source: Adapted from “Methodology | 2015 Index of Economic Freedom Book.” Accessed December 8, 2015. http://www.heritage.org/index/book/methodology.

Learning Objective 3: Explain the idea of economic freedom.

After we review the definitions listed here for economic freedom classification and characteristics, we will review a map that shows the level of economic freedom. Do you think the US will have a “free” classification?

Map of Economic Freedom

Objective 4-3

Map 4.2 The Presence and Prevalence of Economic Freedom

Source: Terry Miller and Kim Holmes, 2016 Index of Economic Freedom, (Washington, DC: The Heritage Foundation and Dow Jones & Co., Inc., 2016).

Learning Objective 3: Explain the idea of economic freedom.

This map shows the world in terms of economic freedom. Remember, when we talk about economic freedom, we are discussing the extent to which the government regulates individual economic choices.

Activity Minute:

Are you surprised New Zealand and Australia rank higher than the US? Why?

Types of Economic Systems

Objective 4-4

Why is the understanding of economic systems important in IB?

Market economics

Command economies

Mixed economies

Learning Objective 4: Differentiate the types of economic systems.

Wherever they go, managers question how the host government might regulate the market, authorize property rights, implement fiscal and monetary policies, and interpret the standards of economic freedom. Evaluating the particular type of economic system in a country enhances analysis.

Types of economies:

Market economy (anchored by the values of capitalism): economic system whereby individuals, rather than the government, make most decisions is a market economy. It is anchored in the doctrine of capitalism and its thesis that private ownership confers inalienable property rights that legitimize the profits earned by one’s initiative, investment, and risk. Optimal resource allocation follows from consumers exercising their freedom of choice and producers responding accordingly.

Command Economy: In theory, communism champions state ownership of resources and control of economic activity. Nominally a political ideology, communism calls for an egalitarian, classless, and ultimately stateless society based on the government’s command of the economy (the instrumentality of attaining the Marxian mandate, “From each according to his ability, to each according to his need”). Implementing this system requires the state adopt a command economy in which it owns and controls the factors of production.

Mixed economies: Most economies, broadly labeled mixed economies, fall between the market and command types. A mixed economy is a system in which economic decisions are principally market driven and ownership is largely private, but the government intervenes, from a little to a lot, in valuing assets, allocating resources, regulating activities, and organizing markets. Put simply, the state reasons that it is the government’s responsibility to make strategic decisions about strategic industries.

Chart Explaining Economic Systems

Objective 4-4

Figure 4.5 Types of Economic Systems

Learning Objective 4: Differentiate the types of economic systems.

This chart further explains the types of economic systems.

Assessing Economic Development, Performance, and Potential

Objective 4-5

Ways to measure an economy

Monetary

GNI (Gross National Income)

GDP (Gross Domestic Product)

GNP (Gross National Product)

Learning Objective 5: Interpret indicators of economic development, performance, and potential.

Comprehensive, single-item monetary measures are incisive indicators of whether an economy (1) is expanding or contracting, (2) needs a boost or should be constrained, and (3) is threatened by inflation or recession.

Gross National Income (GNI) is the broadest measure of a country’s economic performance. It has four components: personal consumption, business investments, government spending, and net exports of goods and services.

Gross Domestic Product (GDP) is the total market value of all output produced within a nation’s borders, no matter whether it is generated by a domestic or foreign-owned enterprise, over a fixed period of time.

Gross National Product (GNP) begins by estimating the market value of goods and services produced in a given year by the labor, assets, and capital supplied by the resident of a country. It then adds the income that its citizens earned working abroad, but removes the income earned by foreigners working domestically (the latter counts toward their home nation’s GNP).

Improving Economic Analytics

Objective 4-5

Other economic analytics

Rate of economic growth

Population size

Purchasing Power Parity

Shadow economies

Learning Objective 5: Interpret indicators of economic development, performance, and potential.

While GDP, GNI and GNP can be good indicators, it may not always be the best indicator of performance. Other measures are used, such as:

Rate of economic growth: Monetary aggregates take a static snapshot of an economy at a point in time. Hence, they do not capture its rate of change. Interpreting present and forecasting future performance prompts considering an economy’s growth rate.

Population size: Managers routinely adjust indicators by the number of people who live in a country.88 This conversion is sensible given how unevenly the world’s population of 7,514,656 is distributed (e.g., from a high of 1.383 billion in China to a low of 56 in the Pitcairn Islands).89 Adjusting GNI by population, therefore, lets managers qualify a country’s performance for its demographics.

Purchasing Power Parity (PPP) The prices of goods and services vary from country to country due to, among other things, differing factor endowments, productivity rates, and regulations

Shadow economies: Found anywhere and everywhere, the shadow economy includes the extra-legal activities (e.g., driving an unlicensed taxi, street trading, or unregistered day care center) as well as well as illegal doings (e.g., prostitution, drug-slinging, illicit gambling, cigarette and alcohol smuggling, product piracy) that fall beyond official statistics. Besides conducting business in hard-to-track cash, shadow players typically go to great lengths to hide illicit transactions or dodge taxes. The off-the-books activities of the shadow economy evade and, therefore, confound official performance estimates

The Ten Largest Economies

Objective 4-5

Table 4.7 The 10 Largest Economies, GDP Adjusted for Purchasing Power Parity, 2014

Source: World Bank Development Indicators 2015.

Learning Objective 5: Interpret indicators of economic development, performance, and potential.

The table shows size of economies when PPP is taken into consideration.

Sustainability in Economies

Objective 4-5

Green Economies

Sustainability

Net National Product (NNP)

Genuine Progress Indicators (GPI)

Human Development Index (HDI)

Learning Objective 5: Interpret indicators of economic development, performance, and potential.

Green economics holds that an economy is a component of, and dependent on, the natural world. Measuring the monetary quantity of market activity through GNI, GNP, and GDP, without accounting for the associated social and ecological costs that result from the activity that generated the growth, misestimates performance and misrepresents potential.

Sustainability endorses a broader accounting of the gains and costs of growth that fall beyond monetary metrics but help gauge an economic environment. 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 commensurate with their wear and tear in generating growth.

Genuine Progress Indicators (GPI) begin by applying the same accounting framework used to calculate GDP. It then adjusts for the corresponding costs of reduced environmental quality, health and hygiene, livelihood security, equity, free time, and educational attainment. For example, unlike GDP, GPI values voluntary and unpaid household work as paid labor and subtracts the costs of crime, pollution, and family stress. Effectively, GDP versus GPI is analogous to gross profits versus net profits—accounting for all costs converts gross to net. Accordingly, GPI will equal zero if the costs of pollution, crime, and family troubles, holding all other factors constant, equal the monetary gains from the production of goods and services.

Human Development Index (HDI) Matters of human development do not show up immediately in income or growth measures. Ultimately, the reasoning goes, they will, given that improving the human condition through better nutrition, education, health care, and hygiene improves economic performance.

Stability in Economies

Objective 4-5

Happynomics

YBLI (Your Better Life Index)

GNWI (Gross National Wellness Index)

HPI (Happy Planet Index)

Learning Objective 5: Interpret indicators of economic development, performance, and potential.

Rather than assessing an economy’s potential for increasing, perspectives like happynomics or welfare economics encourage incorporating elements of psychology, health, security, and sociology. More fundamentally, they advocate redefining the traditional performance standards of wealth, income, or profit to reflect principles of well-being, quality of life, and life satisfaction.

Your Better Life Index (YBLI): Developed by the Organization for Economic Cooperation and Development (OECD), the YBLI advocates evaluating economic performance in terms of matters that people worldwide believe are important (e.g., housing, jobs, social relationships, health, security, work–family balance, education) but that fall beyond the narrow scope of monetary measures.

Gross National Wellness Index (GNWI): Others contend that material and spiritual development occur side by side; one reinforces the other or both suffer. GNWI measures a country’s capacity to promote individual well-being in terms of mental, health, work, income, social relations, economic, retirement, political, and environmental standards.

Happy Planet Index (HPI): A utilitarian view holds that people aspire to live long, healthy, ecologically sensitive lives. How well a country helps its citizens to do so, while not infringing on the opportunity of future generations and people in other countries to do the same, fully represents its economic performance and potential.

Key Components of Economic Analysis

Objective 4-6

Table 4.8 Key Components of Economic Analysis

Learning Objective 6: Profile elements of economic analysis.

Additional key components of economic analysis are shown in this table.

Profile Elements of Economic Analysis

Objective 4-6

Other elements of economic analysis for IB managers to consider

GCI (Global Competitiveness Index)

GII (Global Innovation Index)

WCI (World Competiveness Index)

Learning Objective 6: Profile elements of economic analysis.

The Global Competitiveness Index (GCI) The World Economic Forum holds that providing increasing prosperity hinges on how well a country develops institutions, regulates activity, and uses resources to improve productivity. A country’s proficiency managing these domains determines its international competitiveness.

The Global Innovation Index (GII) Countries increasingly look to brainpower for innovations that boost productivity, fortify competitiveness, and increase prosperity. The growing power of ideas and insights in the global market makes a country’s capacity for innovation a key determinant of its economic performance and potential.

The World Competitiveness Index (WCI) The World Competitiveness Project assesses a nation’s ability to set and sustain a business environment that enables enterprises to compete, prosper, and create wealth. Four factors determine a nation’s competitiveness: economic performance, government efficiency, business efficiency, and infrastructure. Each category has sub-measures that tap dimensions such as international trade, employment, prices, business legislation, productivity, and management practices. The Where-To-Be-Born Index (WTBBI) Finally, looking a bit further into the future, the WTBBI holds that how well a country provides opportunities for a healthy, safe, and prosperous life helps explain both its current and future economic environment.