The Economic Environment
! Learn the criteria for dividing countries into different economic categories.
! Learn the differences among the world’s major economic systems.
! Discuss key economic issues that influence international business.
! Assess the transition process certain countries are undertaking in changing to market economies—and how this transition affects international firms and managers.
When companies source, produce and/or market products in foreign countries, they often encounter challenging economic environments. Chapter 4 first considers the economic environments of countries in which an MNE might want to operate by describing countries by income level and type of economic system. Then it examines key macroeconomic indicators, such as economic growth, inflation and the surpluses and deficits reflected in the balance of payments. Finally, the process and progress of the transition to a market-based economy by many former centrally planned and other countries is discussed.
OPENING CASE: McDonald’s Corporation in Emerging Markets
This case exemplifies the challenges of
global expansion during times of economic uncertainty as well as the risks of
entering emerging markets. Despite enormous start-up challenges, McDonald’s has done well in
Teaching Tip: Carefully review the PowerPoint slides for Chapter 4. For an additional visual summary of key chapter points, also review text Figure 4.1—Physical and Societal Influences on International Business. Finally, note the U.S. Balance of Payments Appendix on text pages 136-137.
Understanding the economic environments of foreign countries and markets is vital to helping managers predict the ways in which trends and events will likely affect their firms’ future performance there. Questions to be addressed include both the size and the nature of the market. Answers are often complex.
II. AN ECONOMIC DESCRIPTION OF COUNTRIES
Companies do business abroad for a variety of reasons. Factor conditions (production factors) include essential inputs to the production process such as human resources, physical resources, knowledge resources, capital resources and infrastructure; they are crucial for investments made for production purposes. Demand conditions (market potential) include the composition of local demand (quality of demand), the size and growth of local demand (quantity of demand) and the internationalization of basic demand; they are crucial for market-seeking investments. Location-specific advantages incorporate the combination of factor and demand conditions, plus other relevant qualities.
A. Countries Classified by Income
Size of national
demand is indicated by Gross National Income (GNI), previously
referred to as Gross National Product (GNP). The broadest measure
of economic activity, GNI represents the market value of final goods and
services newly produced by domestically owned factors of production. Gross
Domestic Product (GDP) represents that value of production that takes
place within a nation’s borders, without regard to whether the production is carried out
by domestic or foreign factors of production. Per capita GNI is
computed by dividing GNI by a country’s population. Because nominal exchange rates
(unadjusted market rates) do not always reflect international differences in
prices, purchasing power parity (PPP) is used as an indicator of
the number of units of a country’s currency required to buy
the same amounts of goods and services in its domestic market. The World Bank
refers to low- and middle-income nations as developing countries,
which are also known as emerging countries (a term also used to
describe the capital markets in such countries). While developing countries in
Asia and Latin America are generally moving forward, those in
B. Countries Classified by Region
MNEs tend of
organize their operations along geographic lines. Major geographic regions of
the world include: East Asia and the Pacific, Europe and Central Asia, Latin
America and the Caribbean, the Middle East and
C. Countries Classified by Economic System
Every government struggles with the right mix of ownership and control of its economy. Ownership refers to the ownership of resources engaged in economic activity—the public sector (government), the private sector, or both. Control refers to the allocation and control of resources engaged in economic activity. Just as there is a relatively high correlation between economic freedom and political freedom, there is also a relatively high correlation between economic freedom and economic growth.
1. Market Economy. A market economy is one in which resources are primarily owned and controlled by the private sector. Key factors include consumer sovereignty (the right to choose what to buy), the freedom of market entry and exit and the determination of prices according to the laws of supply and demand.
2. Command Economy. A command economy (often referred to as a centrally planned economy) is one in which all dimensions of economy activity, including pricing and production decisions, are determined by central government planning authorities.
3. Mixed Economy. A mixed economy describes an economic system characterized by a mixture of market and command economies, including a combination of public and private ownership. Market socialism is characterized by the state ownership of significant resources, but the allocation of those resources comes from the market price mechanism, and prices are determined by the laws of supply and demand.
III. KEY MACROECONOMIC ISSUES AFFECTING BUSINESS STRATEGY
Macroeconomic factors can have a major impact on both the profitability and the operating strategy of MNEs. Three key issues are economic growth, inflation and surpluses and deficits.
A. Economic Growth
While history is often used to forecast future economic trends, it is certainly not perfect. Further, there exists significant differences in growth rates throughout the world. The direct impact of events such as the Asian financial crisis, terrorist activities such as 9/11 and corporate scandals such as Enron and WorldCom spreads quickly to international markets, but the effects are uneven. Thus, future growth is bound to be variable by region, even in the high-income countries.
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. Ultimately it affects interest rates, exchange rates, the cost of living and the general confidence in a country’s political and economic systems.
C. Surpluses and Deficits
Internal and external deficits are important indicators of a country’s economic strength and stability. Surpluses are rarely a problem. An internal deficit indicates that a government’s expenditures exceed its revenues; an external deficit indicates that a country’s cash outflows (payments) exceed its inflows (receipts).
1. The Balance of Payments. The balance of payments account records commercial transactions and other financial flows between the residents of a given country and the rest of the world.
a. The current account includes trade in goods and services and income from assets abroad and payments on foreign-owned assets in the country. The merchandise trade balance reflects a country’s deficit or surplus with respect to trade in goods. The service account reflects transactions such as transportation and other international services and royalties and fees on licensing agreements. (Unilateral transfers include government and private relief grants and income transferred abroad.)
b. The capital account records transactions in real or financial assets between residents of a given country and the rest of the world. An inflow of capital is a positive transaction; an outflow is a negative transaction. Also included in the capital account are changes in the official reserve assets of a country, such as gold, special drawing rights and foreign currencies.
2. External Debt. External debt consists of money borrowed from foreign institutions. It can be measured in two ways: the total amount of the debt and debt as a percentage of GDP. The larger these two numbers, the more unstable an economy will become and the more likely economic growth will slow.
3. Internal Debt and Privatization. Government budget deficits result from an excess of government expenditures relative to revenues and contribute to a country’s overall debt position. As countries move to reduce their deficits, the privatization of state-owned enterprises may occur, thus relieving the government of the need to subsidize inefficient operations.
IV. TRANSITION TO A MARKET ECONOMY
Many countries are undergoing the transition from command economies to market economies because of the failure of the central planning process to generate satisfactory economic growth. In general, transition implies the liberalization of economic activity, the reallocation of resources to their most efficient use, macroeconomic stabilization, the privatization of state-owned assets, budgetary constraints and the development of an institution and legal framework to protect property and individual rights.
A. The Process of Transition
process can provide significant opportunities for MNEs as markets are opened
and foreign direct investment opportunities expand. For
B. The Future of Transition
In the short-term, major challenges confronting the transition economies will include continued macro stability, economic growth, improvement in institutional and structural areas and the solution of social issues such as poverty, child welfare and HIV/AIDS. In the long-term, however, the challenges to the transition economies will virtually be the same as those of other developing economies.
ETHICAL DILEMMAS AND SOCIAL RESPONSIBILITY:
How Much Economic Assistance Is Too Much?
A major issue of economic social responsibility concerns the obligation of high-income countries to assist developing nations. There are several areas of concern. First, in order to participate in the trade process, emerging economies must have access to high-income markets, i.e., discriminatory barriers should be abolished. Second, foreign aid can be used as a tool for economic development, but not all people share that view. Third, the forgiveness of loans to developing countries by high-income governments could be part of the solution to the debt crisis. Such actions are appropriate for governments, but it is unlikely that the private sector would participate in these measures.
LOOKING TO THE FUTURE:
A Global Economy in the New Millennium
As the twenty-first century dawned, the
global economy seemed to be strengthening, but then a serious economic downturn
in 2001-2002 threatened continued growth. Because the
Teaching Tip: Visit www.prenhall.com/daniels for additional information and links relating to the topics presented in Chapter 4. Refer your students to the on-line study guide, as well as the Internet exercises for Chapter 4.
CLOSING CASE: The Daewoo Group and the Asian Financial Crisis
would you describe
into the category of “mostly free,” there is significant government intervention in the South Korean
economy. Modeled after the Japanese system,
The position one
takes with respect to this question depends upon the particular sector involved
and the reason for the investment. Many view a time of economic crisis and
currency weakness as a good time to invest if appropriate opportunities can be
found. On the other hand, others will feel that economic risk in
What are the key mistakes Kim Woo-Chung made in formulating and
implementing Daewoo’s strategy, and how did the economic crisis in
Kim Woo-Chung’s major mistake in implementing Daewoo’s strategy
was the assumption of debt, which in 1998 equaled 13 percent of
4. What risks does GM face in taking over Daewoo Motor?
GM faces major
risks in the marketplace. By selling Daewoo cars in Europe and the
Additional Exercises: Economic Realities
Exercise 4.1. Ask students to explain why per capita income is often an inadequate indicator of national wealth. Be sure they cite examples of particular countries to support their points. Then ask them to explain why a particular government would select gross domestic product (GDP) as a measure of domestic economic activity, rather than gross national income (formerly gross national product).
Exercise 4.2. Ask students to consider the following statement: “As a country’s political system changes from a more repressive to a more representative form of government, its economic system will necessarily change as well.” Then ask them to consider whether the complete privatization of all state-owned and controlled assets is necessary for an economic transition to be successful.
Exercise 4.3. In a day of global recession, many wonder if it is necessary or desirable to have national economies linked to closely together. Ask the students to consider what, if anything, a country can do to protect itself from the impact of negative global economic events. Then ask them to consider whether the impact of global recession on MNEs is necessarily the same as the impact on countries. If not, why not?