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Chapter Four: Economic Systems and Market Methods Dr. Hadeel Abdellatif International Economic Analysis In the IB era, cultural, political, and legal systems influence a company’s decision on where, when, and how to do business. This chapter completes our profile of the environmental domains of IB,...
Chapter Four: Economic Systems and Market Methods Dr. Hadeel Abdellatif International Economic Analysis In the IB era, cultural, political, and legal systems influence a company’s decision on where, when, and how to do business. This chapter completes our profile of the environmental domains of IB, evaluating how economic systems shape a market. Studying an economic environment helps managers make better investment choices and operating decisions. Resource constraints require managers to identify which countries in the world to invest in and those they must avoid. Various principles help managers better assess economic environments, including: System Complexity. Economic environments are dynamic systems. 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. Market changes can make today’s valid measures dubious tomorrow. Evolving circumstances, compounded by disruptive situations and puzzling trends, generate anomalies and exceptions that convert comebacks into collapses. Market Interdependence. Just as no one is an island, no country is isolated. The consequence of cross-national connections means actions here influence outcomes there. Types of economics Developed Economies generally have high-income levels, extensive industrialization, advanced technological infrastructure, and high standard of living. Developed economies steadily shift to diversified, service-oriented activities that rely on information and technology to support product and process innovation. Manufacturers in developed economies have outsourced many activities to low-cost factories in the emerging economies. Developing Economies generally have low-income levels, slight industrialization, incomplete infrastructure, and lower standards of living. Significant gaps exist in economic and social characteristics between developed and developing economies. Some argue that developing countries have strong communities and social ties, extraordinary self-sufficiency, and admirable work ethics. Alternatively, one regularly finds higher infant mortality, shorter life expectancy, lower literacy levels, poorer public hygiene, insufficient health care, and inadequate nutrition in developing countries relative to their developed counterparts. Economies in Transition/Emerging Economies. At the high end of developing economies, we find faster growing, quickly industrializing countries such as China, Mexico, Indonesia, and the Philippines. Emerging economies are experiencing accelerating growth in productivity, manufacturing, exporting, and per capita income, resulting in material improvements achieved in years, rather than decades. Their financial systems, political institutions, and market infrastructure steadily modernize. Market liberalization promotes foreign investments and growing exports, deregulation and privatization improve business efficiency, and expanding economic freedoms encourage entrepreneurialism. Prosperity and progress support a growing middle class, whose economic aspirations fuel a revolution of rising expectations, thereby spurring society and the state to improve living standards. When one speaks of the emerging economies, many point to Brazil, Russia, India, and China Economic freedom Economic freedom holds that one has the right to work, produce, consume, save, and invest in the way that one prefers. It measures the absence of government coercion or constraint on the production, distribution, or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty. The Economic Freedom Index estimates economic freedom in a particular nation. The ultimate score ranges from zero (no freedom) to 100 (full freedom); hence, the higher the index for a particular nation, the higher its degree of economic freedom. Countries ranking highest on this index tend to enjoy both the highest standards of living as well as the greatest degree of political freedom. Types of Economic Systems An economic system is the set of structures and processes that guide the allocation of scarce resources and shapes the conduct of business activities in a nation. The spectrum of systems is anchored on one end by capitalism and on the other by communism. Free-market (capitalistic) economies are built upon the private ownership and control of the factors of production, while communism is based on state ownership of economic activity. The Market Economy describes the system where individuals, rather than government, make the majority of economic decisions. Key factors include consumer sovereignty, the freedom of market entry and exit, and the determination of prices according to the laws of supply and demand. The Command Economy also known as centrally planned 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. Most often, the totalitarian aims of communism gave the highest priority to industrial investments and military spending at enormous expense to the consumer sector. Mixed Economy 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. Assessing Economic Development and Performance Monetary Measures: looks at the total flow of goods and services in the economy of a nation. Gross National Income (GNI) measures the value of all production in the domestic economy together with the income that the country receives from other countries (in the forms of profits, interest, and dividends), less the same sorts of payments that it has made to other countries. Among monetary aggregates, GNI provides the broadest measure of economic performance. Gross Domestic Product (GDP) is the total market value of goods and services produced by workers and capital within a nation’s borders; it provides the truest measure of national economic activity. Technically, GDP plus the income generated from exports, imports, and the international activities of a nation’s companies equal its GNI. Gross National Product (GNP) is the total value of all final goods and services produced within a nation in a particular year. (income earned by the citizens of the country present within or outside the country) Example of how GNP is different to GDP If a Japanese multinational produces cars in the UK, this production will be counted towards UK GDP. However, if the Japanese firm sends £50m in profits back to shareholders in Japan, then this outflow of profit is subtracted from GNP. UK nationals don’t benefit from this profit which is sent back to Japan. If a UK firm makes a profit from insurance companies located abroad, then if this profit is returned to UK nationals, then this net income from overseas assets will be added to UK GNP. Note, if a Japanese firm invests in the UK, it will still lead to higher GNP, as some national workers will see higher wages. However, the increase in GNP will not be as high as GDP. Improving Economic Analytics GNI, GDP, and GNP estimate an economy’s absolute performance. Despite strengths, they can distort country comparisons. 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. A larger population base provides the opportunity for greater productivity, but can also create additional challenges for an economy. An analyst must review the population size and determine GNI per capita to establish a true picture of a nation’s standard of living. Purchasing Power Parity. While exchange rates define the number of units of one currency that are required to purchase one unit of another currency, they do not determine what a unit of currency can buy in its home country, i.e., exchange rates do not incorporate differences in the cost of living. Purchasing power parity (PPP) 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. The Shadow Economy Sometimes called the black, gray, or parallel market, or the informal economy, 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., drug-slinging, illicit gambling, cigarette and alcohol smuggling, product piracy) that fall beyond official statistics. All countries experience the effects of the shadow economy; they are particularly influential in developing economies. Some countries are moving to include shadow activities when measuring production in their economy. Sustainability and Stability Sustainability and stability perspectives hold that the objective of economic activity is to create an environment for people to enjoy long, healthy, and happy lives. Sustainability. Green economics holds that an economy is a component of, and dependent on, the natural world. Green measures gauge economic performance in terms of the effect of current choices on long-term sustainability. Estimators of economic progress toward improving happiness includes: Net National Product (NNP) measures the depletion of natural resources and degradation of the environment that result from making and consuming products 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. Human Development Index (HDI). Estimating a country’s degree of human development, in terms of the physical, intellectual, and social standards that shape its overall quality of life, helps managers measure market potential. The UN translates this view into the HDI and its components: 1. Longevity, measured by life expectancy at birth; 2. Knowledge, measured by the adult literacy rate and the combined primary, secondary, and tertiary gross enrollment ratio; 3. and Standard of Living, measured by GNI per capita (PPP). Stability. Rather than assessing an economy’s potential for increasing affluence, 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. Estimators of economic progress toward improving happiness include: 1. Your Better Life Index (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. 2. Gross National Wellness Index (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. 3. Happy Planet Index (HPI): The HPI holds that the fundamental logic of monetary metrics are misaligned, overly emphasizing growth at all costs while downplaying its costly, destabilizing, and often destructive externalities. In the realm of the HPI, progress is defined not in terms of economic development, but through success in achieving a sustainable well-being for all. Discussion Discuss the implications of the emergence of the emerging economies for careers and companies in your country? Select a developed economy such as Japan, the United Kingdom, France, or Germany, and select one of the emerging (Brazil, Russia, India, and China). Then compare the key elements of those two economic systems. Be sure to discuss the interaction between politics and economics in the two countries.
