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Editor's Notes
When a company wants to do business in another country, it studies conventional wealth, income, employment, and policy standards. The dynamic nature of political and economic events requires that it also anticipate new situations. Besides assessing the foreign markets in which they operate, managers also need to monitor those in which they do not. Globalization connects countries in many ways; hence, economic change in one country likely has consequences in other countries. Companies also watch economic changes in those countries where they may not operate but where competitors do. Improving economic performance or revised economic policies in a particular country may strengthen their rivals. Since the 1980s, managers enjoyed economic opportunities as countries adopted the principles of capitalism and the practices of free markets. We have recently seen the credit crisis reset expectations. Now, in the aftermath of the global meltdown, there is growing government involvement in economic affairs. Changing economic policies reveal the ambitions of the government and the likely implications to economic freedoms.
A principle of globalization is the broadening network of relationships among people, companies, countries and institutions throughout the world. Philosophically, the same principle holds for our ideas about how economies emerge and evolve. Linkages and connections among economic ideas speak to questions about markets and performance.
Research pinpoints key elements of an economic environment. These include, among many others, income, purchasing power, market size, market type, and economic freedom. Reducing the oft-overwhelming idea of an economic environment to its more easily understood elements, as this chapter shows, provides useful building blocks. Then, with that understanding in mind, we can analyze how they interact in building the economic environment. Figure 4.3 also highlights the importance of applying a systems perspective—namely, that linkages among elements mean that change in one element in the economy affects other parts. Key economic forces include: • Price stability • Capital markets • Factor endowments • Market size • Public policy
GNI can mislead managers when they compare countries. For example, economic powers like the United States, Japan, and Germany consistently claim the top rankings of countries when sorted by GNI. Therefore, the data might give the misleading impression that these top-ranked countries are far wealthier, more productive, and faster growing than lower-ranked countries. Managers improve the usefulness of GNI, GNP, and GDP by adjusting them for the number of people, grow rate of the economy, and the relative cost of living in a country. Per Capita Conversion: Managers transform GNI, as well as many other economic indicators, by the number of people who live in a country. This conversion is common sense given how unevenly the world’s population of 6.78 billion, as of October 2009, is distributed across countries. Therefore, adjusting GNI by population leads to a per capita estimator that measures a country’s relative performance. Rate of Change: Interpreting present and predicting future economic performance requires pinpointing the rate of change. Looking at countries in terms of their growth rate for GNI per capita shows a wide range. For example, between 1998 and 2002, Ireland was the fastest growing economy in the world, expanding more than 8 percent per annum. Japan, in contrast, grew by only 0.2 percent over that period. Generally, the GNI growth rate also indicates its economic potential—if GNI grows at a higher (or lower ) rate than the population, standards of living are said to be rising (or falling ). The GNI growth rate highlights likely business opportunities. For example, China has been one of the fastest-growing economies over the past 30 years, averaging high single-digit growth for the past several years. This growth, in turn, has resulted in the swiftest, most extensive rise out of poverty any nation has ever seen. Naturally, this rise has attracted immense amounts of foreign investment in anticipation of growing market opportunity powered by rising consumer demand. PPP: provides a method of measuring the relative purchasing power of different countries’ currencies for the same basket of goods and services. Human Development: GNI, including its expression in terms of per capita, growth rate, and PPP, profiles growth and development in an economy. Some argue that these indicators, by measuring growth with purely monetary indicators, misrepresent the scale and scope of a country’s level of development. Managers deal with these concerns by evaluating a country’s degree of human development to estimate its current and future economic activity. Jointly considering the degree to which economic and social indicators support human development enables managers to measure market potential in terms of the capabilities and opportunities people enjoy. The Human Development Index combines indicators of real purchasing power, education, and health to give a more comprehensive measure of economic development. The U.N. Human Development Index: The HDI measures a country’s achievements on three dimensions: • Longevity, as measured by life expectancy at birth • Knowledge, as measured by the adult literacy rate and the combined primary, secondary, and tertiary gross enrollment ratio • Standard of living, as measured by GNI per capita expressed in PPP for U.S. dollars Green Measures: Concern for the ecological welfare of the world spurs calls for green measures of growth. Green economics hold that a country’s economy is a component of, and dependent on, the natural world within which it resides. Consequently, GNI, GNP, and GDP measures of narrowly defined economic performance make them misleading indicators of a country’s long-term economic health and performance. Specifically, measuring the quantity of market activity without accounting for the associated social and ecological costs mismeasures performance. Presently, there is no consensus on how to adjust GNI, GNP, or GDP for green concerns. Current candidates include the following: Green Net National Product Genuine Progress Indicator Gross National Happiness Happy Planet Index
Inflation: a measure of the increase in the cost of living Cost of Living: Hyperinflation is a rapidly accelerating rate of inflation that, if unchecked, leads to money losing value and markets moving to barter transactions. Chronic Inflation: Chronic inflation occurs when a country experiences high inflation for a prolonged period of time. Price Indexes & Measurement Problems: price indexes are sensitive to decisions about their scope, the formulas by which they are calculated, and other factors decided by the agencies that disseminate them. Deflation: a decrease in the general price level of goods and services, is often caused by a reduction in the supply of money or credit.
Unemployment is a measure of the number of workers who want to work but do not have jobs. Underemployed occurs when individuals work fewer hours a day than they would prefer or when individuals work below the level for which they have been trained. Problems in Measuring: As with inflation, measuring the number of unemployed workers actually seeking work in various countries is difficult, given various assumptions and exclusions. Variation in Public Support: The unemployment rate means different things in different countries due to different social policies. Some countries, such as France and Germany, provide generous unemployment protection, whereas other countries, like China, Kenya, or Jordan, offer little to no support. The Pension Problem: Growing unemployment is causing strains on public and private pensions systems, threatening to turn the financial crisis into a perilous social crisis. Technically, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment; effectively, a pension is an investment fund built up during working life and then used to provide continuing income upon retirement. Demographics indicate that the world’s 65-and-older population will triple by midcentury to one in six people, leaving many countries, especially wealthier ones like the United States, Japan, and Germany, struggling to support the out-of-work in addition to the elderly.
Poverty is the state of having little or no money and few or no material possessions. The World Bank defines extreme poverty as living on less than $1.25 per day (PPP) and moderate poverty as less than $2 per day (PPP). This standard shows that, in 2008, 1.4 billion lived on less than $1.25 a day. Poverty of this scale and scope impacts economic environments. Throughout the world, people struggle for food, shelter, clothing, clean water, and health services, to say nothing of safety, security, and education. Failure to obtain such results in suffering, malnutrition, mental illness, death, epidemics, famine, and war. For example, 100 percent of Canadians have access to clean water, whereas only 13 percent of the people in Afghanistan do .International companies facing such situations assess implications that impact virtually every feature of the economy. The Potential of the Poor Despite the daunting gap between the rich and poor, managers monitor the potential of today’s poor consumers. The Bottom of the Pyramid is the largest, but poorest socioeconomic group in the world; some see these 4 billion plus people, as the next market frontier.
Companies refine their interpretation of economic performance and potential costs by considering productivity —specifically, the amount of output created per unit input used. In terms of labor, productivity is the quantity produced per person per labor hour. Productivity growth allows an economy to grow at high rates without causing wage or price inflation.
BOP is a system of recording all of a country’s economic transactions with the rest of the world over a period of one year. Companies monitor the balance of payments to watch for factors that could lead to currency instability or significant change in government policy.
A market economy is a system in which individuals, rather than government, make the majority of economic decisions. A market economy gives individuals the freedom to decide where to work, what to do and for how long, how to spend or save money, and whether to consume now or later. This view is anchored in the principle of laissez-faire and its notion that a market is best left to its own internal dynamics. Unfettered by government regulation, a free market efficiently determines the relationships among price, quantity, supply, and demand. Because individuals make economic decisions, a market economy depends on individuals and companies, rather than the government, owning and controlling resources. Private ownership means that a market economy allocates factors of production. A market economy calls for as few government restrictions as possible—the more visible the “hand” becomes due to government intervention, the less efficiently the market works. Nonetheless, the invisible hand is not infallible, given the need for some public goods (like traffic lights or national defense) and precautions (such as environmental regulations) that preempt those inclined to maximize personal gain at the expense of society’s welfare. Therefore, a free market relies on government action to enforce contracts, protect property rights, ensure fair and free competition, regulate certain sorts of economic activities, and provide general safety and security. A command economy, also known as a centrally planned economy, is a system whereby the government owns and controls all resources. Hence, the government commands the authority to decide what goods and services a country will produce, the quantity in which they are produced, and the price at which they are sold. Centrally planned economies have telltale principles. The collectivist philosophy anchors the practice of public investment, public wealth, and public enterprise. In addition, governments manipulate market outcomes for political purposes. This predisposition sacrifices the efficiency of economics for the effectiveness of state control of the flow of ideas, information, capital, and products within the domestic market and across international borders. Command economies can appear to perform well for short periods. By controlling everything and everybody, the state can mobilize idle resources to generate bursts of growth. Performance can be impressive as long as the main source of growth is putting unemployed resources (principally labor) to work. Similarly, command economies typically develop large-scale, capital-intensive production systems that rarely achieve marginal rates of efficiency in making products. A mixed economic system combines elements of the market and command economic systems; both government and private enterprise influence production, consumption, investment, and savings. Proponents of the mixed economy concede that an economic system must aspire to achieve the efficiencies, productivity, and innovativeness found in free markets. An economic system, they reason, must also prevent individualism from harming the welfare of society (e.g., the opportunism of leading culprits of the global credit crisis). Furthermore, a fair and just economy defends the weak by supporting low unemployment, helps the impoverished by promoting the equal distribution of wealth, stabilizes the system by responding to market failures, and protects society by limiting abuses of market power.
The scale, scope, and swiftness of the global economic crisis, in contesting the usefulness of market fundamentalism, have revitalized the reexamination of the role of government in the economic system. Sorting through the fallout of the global credit crisis, societies debate the degree to which the state should regulate the market, stabilize panics, safeguard citizens, redistribute wealth, and sustain flagging demand. The Allure of Market Economies: The past few decades showed that market economies outperformed their mixed and command counterparts in terms of productivity, income, and wealth. Market economies had higher rates of long-term economic growth and enjoyed more prosperity than mixed or command economies. Case after case indicated that liberating the factors of production from government control spurred innovation and entrepreneurship. The resulting efficiencies improved resource usage, and the greater effectiveness of individual decision making had far-reaching benefits. A free market is a theoretical term that describes a market that is free from government intervention. Large and growing majorities believe that people’s lives are better off under capitalism than state control. Even after acknowledging that capitalism means some people will be rich and others poor or that there will be severe ups and downs from time to time, people still strongly support free markets. Surveys show that majorities in 39 of 47 prominent economies (such as the United States, Germany, China, and India) believe that a free-market economy supports higher quality of life for most people. Correspondingly, 17 of 35 countries showed rising support for free markets since 2002; 5 countries showed declining support. In the formerly communist nations of Eastern Europe, capitalism receives mixed reviews but overall support. In Latin America, views are also somewhat mixed, but the trend is in favor of free markets in Brazil, Argentina, Mexico, and Chile. Economic freedom is the individual liberty to produce, trade, and consume any goods and services acquired without the use of force, fraud or theft. Transition to a market economy involves liberalizing economic activity, reforming business activity, and establishing legal and institutional frameworks that increase economic freedom.
Economic freedom is the individual liberty to produce, trade, and consume any goods and services acquired without the use of force, fraud or theft. Operationally, the Economic Freedom Index estimates the extent to which the government of a country constrains free choice and free enterprise for reasons that go beyond the need to protect property, liberty, citizen safety, and market efficiency. Practically, this index grades a country on 50 indicators that are organized into 10 dimensions (see Table 4.5). Operationally, the higher the score on a factor, within the range of 0 to 100 percent, the lower the level of government interference in the economy and the higher the degree of economic freedom. The standard of living is a general measure of economic welfare, usually measured by per capita income, to reflect the availability of goods and services to satisfy wants rather than needs. In this profile, we see that increases in economic freedom and the standard of living have a strong, direct relationship.
Now, buffeted by the crisis, we see countries facing hardships that push them to ratchet down economic forecasts as well as deal with growing political and social unrest. Critics of freer markets maintain that a free market cannot protect social values and skews income distribution. Furthermore, a free market encourages the accumulation of vast wealth and powerful self-interests that threaten social liberties and political rights. Hence, they argue, the benefits of a market economy, when fully measured, fall short of the benefits provided by a strong government regulating a mixed economy. Free market advocates are quick to point out that government-provided stability is not free. Relying on big brother to safeguard standards of living comes with a heavy price—namely, a sacrifice of freedom, a slowness to innovate, and the peril of slow growth. Certainly, history shows that government-directed economies can often perform well. Over time, however, the power of their typical advantages—cheap labor, large-scale production facilities, artificially cheap capital, low R&D investment—fade in the face of improving management systems and production processes in free markets. More fundamentally, history also shows that government control decreases the risk-affinitive behavior of entrepreneurs and companies. For decades, capitalist critiques had rung true. The reliance in mixed and command economies on expanding regulations had created sclerotic economies badly in need of free-market reforms. However, the global economic crisis and its threat to systemic stability—precisely because of too little regulation, too little social concern, and too little government—have put free-market advocates on the defensive. Dealing with the fallout of the economic meltdown and installing safeguards that prevent its recurrence, goes the reasoning, demands more government involvement in the economic affairs of the state, not less.
Changing marketplace conditions and unfolding political trends signal uncertainty about the types of economic environments facing managers. No longer can managers safely presume, as they have for the past few decades, that markets will adopt reforms that increase economic freedom. Profiles of the market, mixed, and command types of economic environments give managers a framework to interpret change to marketplace philosophy. In addition, managers also monitor key indicators that provide an early-warning system on the direction and dynamic of transition from one type of economic environment to another. Most notably, these key indicators include a government’s efforts to regulate the economy, its inclination to protect individual ownership and property rights, its ideas about fiscal and monetary policies, and its willingness to enforce antitrust regulation. Privatization is the process of changing something from state to private ownership or control. Privatization is an essential element of a market economy, not just for improving general efficiency but also because an unfettered private sector better regulates supply and demand, thereby leading to better production and consumption decisions. Hence, the ambition to move toward a market economy requires a government to disengage from the economy by privatizing state-owned enterprises. Regulation: The issue of regulation involves imposing restrictions on the free operation of markets and business practices. In principle, regulations prevent companies from maximizing efficiency, given that they sacrifice productivity in complying with regulations. Moreover, government regulations are regarded as the antithesis of economic freedom, given their systematic reduction of individual choice. A property right is the exclusive authority to determine how a resource is used. This protection supports a competitive economy by assuring investors and entrepreneurs that they, not the state, will prosper from their hard work. If lacking or arbitrarily applied, entrepreneurs and companies face a high risk of contract or property rights violations. Fiscal and Monetary Reform: Economic decision making by political officials often leads governments to adopt tax or spending policies that slow growth and increase interest rates, inflation, and unemployment. Mixed economies typically impose higher tax rates, spend more on social programs, and regulate executive compensation levels more aggressively than commonly seen in market economies. Antitrust legislation promotes free competition in the market place by outlawing monopolies. Liberalizing an economic system requires a government to legislate antitrust laws that encourage the development of industries with as many competing businesses as the market can sustain. In such industries, prices are kept low by the forces of competition. By enforcing antitrust laws, governments can prevent monopolies from exploiting consumers and restraining market growth.
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