Chapter 1 An Overview of Financial Management and the Financial E.docx

Chapter 1: An Overview of Financial Management and the
Financial Environment Mini Case
Book Title: Financial Management: Theory and Practice
Printed By:) © 2017 Cengage Learning, Cengage
LearningChapter Review
Mini Case
Assume that you recently graduated and have just reported to
work as an investment advisor at the brokerage firm of Balik
and Kiefer Inc. One of the firm’s clients is Michelle DellaTorre,
a professional tennis player who has just come to the United
States from Chile. DellaTorre is a highly ranked tennis player
who would like to start a company to produce and market
apparel she designs. She also expects to invest substantial
amounts of money through Balik and Kiefer. DellaTorre is very
bright, and she would like to understand in general terms what
will happen to her money. Your boss has developed the
following set of questions you must answer to explain the U.S.
financial system to DellaTorre.
a. Why is corporate finance important to all managers?
b. Describe the organizational forms a company might have as it
evolves from a start-up to a major corporation. List the
advantages and disadvantages of each form.
c. How do corporations go public and continue to grow? What
are agency problems? What is corporate governance?
d. What should be the primary objective of managers?
1. Do firms have any responsibilities to society at large?
2. Is stock price maximization good or bad for society?
3. Should firms behave ethically?
e. What three aspects of cash flows affect the value of any
investment?
f. What are free cash flows?
g. What is the weighted average cost of capital?
h. How do free cash flows and the weighted average cost of

capital interact to determine a firm’s value?
i. Who are the providers (savers) and users (borrowers) of
capital? How is capital transferred between savers and
borrowers?
j. What do we call the cost that a borrower must pay to use debt
capital? What two components make up the cost of using equity
capital? What are the four most fundamental factors that affect
the cost of money, or the general level of interest rates, in the
economy?
k. What are some economic conditions that affect the cost of
money?
l. What are financial securities? Describe some financial
instruments.
m. List some financial institutions.
n. What are some different types of markets?
o. Along what two dimensions can we classify trading
procedures?
p. What are the differences between market orders and limit
orders?
q. Explain the differences among dealer-broker networks,
alternative trading systems, and registered stock exchanges.
r. Briefly explain mortgage securitization and how it
contributed to the global economic crisis.
Chapter 1: An Overview of Financial Management and the
Financial Environment Mini Case
Book Title: Financial Management: Theory and Practice
Printed By: Kristina Mack ([email protected]) © 2017 Cengage
Learning, Cengage Learning
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GOVERNMENTS AS MARKET PLAYERS:
STATE INNOVATION IN THE GLOBAL
ECONOMY
Giselle Datz
Financial innovation emanating from the public sector is not a
new phenomenon.The literature and practice of financial
regulation is filled with instances in which
the public sector understood and tried to contain financial
excesses and attempted to
maximize opportunities for economic growth via private
investment. Hardly studied,
however, have been cases of financial innovation that are not
primarily related to
regulation of private or public financial flows. This paper
focuses on how govern-
ments in emerging markets are acting increasingly as financial
market players,
enacting strategies that are not simply those of a risk-averse
welfare maximizer (in a
formal modeling description), but that of a high(er) yield
seeking investor.
The public realm in which states operate is symbiotic. It
encompasses two dual-
ities: one between public and private activity and authority, and
the other between
demand and supply for financial innovation. In continuing with
its transformative
process, the state in emerging markets is undergoing a process
of further hybridiza-
tion, applying private methodologies to serve public goals
(however politically

insulated) and engaging as both a supplier and consumer of
financial innovation in
more aggressive ways. This hybridization shapes a new
relationship between states
and financial risk. However, the extent to which sovereigns can
act as private players
is limited by the understanding that they are inescapably tied to
strategic public
"interests that will take precedence over profit maximization."'
The ability to grasp the broadened investment room to move
emerging market
governments, as well as the new constraints they face,
ultimately requires an under-
standing of the state as a heterogeneous category. In other
words, the heterogeneity
that exists within financial markets in terms of strategies used
and instruments
available, can be found within the state with its diverse time
horizons, functions and
strategies.2 Therefore, understanding the role of states demands
unpacking various
layers of public and private mechanisms that manipulates them,
which together
determine their clout in the global economy.
Journal of International Affairs, Fall/Winter 2008, Vol. 62, No.
1. F A L L / W INTER 2008 | 35
© The Trustees of Columbia University in the City of New York
Giselle Datz
T H E PUBLIC AS A SYMBIOTIC ENTITY

The public realm encompasses a symbiotic relationship in
financial innovation
that is not simply concerned with regulating private activity,
sponsoring privatiza-
tions or leaving room for private authority to emerge. Instead, it
is actually assuming
"private-like behavior" through risk management activities
regarding liability (debt)
management and asset (reserves) diversiflcation.3 This is
translated in the work of
relatively new and autonomous debt-management offices and of
sovereign wealth
funds (SWFs). Within these can be detected a pervasive private
strategy in actions
ranging from the hiring of uniquely qualified financial
professionals at market-
competitive rates to the expansion of return-related operations.''
A second symbiosis is also at play. Governments that have
always behaved as
suppliers of financial assets—most notably sovereign bonds—by
catering to the
needs of institutional investors, are now playing a different role
by providing
demand for financial innovation and financial assets.
Increasingly, states in emerg-
ing markets are becoming net exporters of capital rather than
importers. Emerging
market governments, especially in the Persian Gulf and Asia-
Pacific regions, are less
content to leave large volumes of excess foreign reserves to be
invested in risk-free
assets with low return. More and more, there is a flight to risk
through more auda-
cious investments made by sovereign wealth funds—relatively
autonomous and,

thus far, secretive institutions.
Indeed, since the late 1990s, the globalization literature has
been keen on
parceling out the role of the state. Studies that claimed that the
state was withering
away gave way to more focused analyses of states as negotiators
trying to intersect
national law with foreign actors, especially through competitive
deregulation or
reregulation linked to the preferences or imperatives of foreign
capital.5 A key para-
doxical relationship between states and global capital was
identified. Although the
scope of states' autonomy to control monetary and fiscal
policies was constrained by
economic globalization, in order to realize the material gain
from this process, as
James Mittelman suggested, the state increasingly facilitated its
development acting
as its agent. 6 This facilitation operated not only at the level of
political infrastruc-
ture, but particularly at the level of legal infrastructure. For Leo
Panitch, states
authored a regime that defined and guaranteed the global and
domestic rights of
capital through international treaties with constitutional effect.''
Hence, the role of
states was not only one of internalizing, but especially of
mediating adherence to
international capitalist competition.
Eric Helleiner's analysis of the Bretton Woods system provided
a historical
understanding of how states were indeed proactive in the
development of financial

globalization, initially restricted by the pervasiveness of the
embedded liberalism
compromise, e.g. economic liberalization accompanied by
domestic welfare policies.8
36 I JOURNAL OF INTERNATIONAL AFFAIRS
Governments as Market Players
Incrementally, however, the tenants of neoliberalisn: as both a
political project and
a set of ambitious economic reforms, promoted the abolition—
even if not univer-
sally—of capital controls in favor of freer international
financial flows.^
Governments recognize the importance of international
coordination in monetary
policy. Furthermore, central bank independence remains an
important tool for signaling
credibility to markets. However, transforming key
administrative functions within states
and financial innovations lay beyond both pillars.lo States
endured internal changes as
a consequence of their renewed engagement with global capital.
Saslda Sassen suggests
that the "internal structuration of states" is in fact an element of

analyses of the state
and globalization that has been neglected." In her view, state
participation in imple-
menting its global economic agenda entailed the ascendance of
what became strategic
agencies within the government apparatus that were most
directly connected to this
agenda, namely central banl«, treasuries and regulatory
agencies. 12
This discussion leads to an analysis of what Sassen calls the
"restructuring of the
private-public divide," where "forms of authority once exclusive
to the public
domain are now shifting to or being constituted in the private
sphere of markets
with the corresponding normative recording."'3 More
specifically, Sassen refers to
cases of expansion of the private sphere, particularly through
privatization and
marketization processes launched in the 1980s. In other words,
she sees economic
actors seeking to privatize public regulatory functions in a way
that increases their
authority over matters once exclusive to the public domain,

such as commercial arbi-
tration, property rights and the regulation of trade and capital
markets.
This analysis of the privatization of forms of authority, however
insightful, still
does not fully account for a parallel process marking a different
trend. Privatization
often means that public functions and authority cease to be
exercised solely by a
public entity and become a private venture undertaken by
private agents who
usually follow efficiency-maximization criteria and remain far
from any mandate to
provide public goods. In this sense, what is privatized is no
longer publicly managed.
Nevertheless, these processes do not fit this kind of
transformation: Sovereign debt
and asset management are not functions that have become
privatized. The private
in this discussion has to do with how, not who. These functions
are still a responsi-
bility of the state, yet are conducted almost as private-
investment operations insofar
as they: (a) count on highly specialized professionals with

private experience or
outsource some services to the private sector in serving a public
purpose; (b) involve,
in the case of asset management by SWFs, a mix of "opaque
operations and invest-
ments" such as acquisition equity (making sovereign states
shareholders in private
businesses abroad); and (c) utilize models of risk management
through hedging akin
to that of private financial players. Together such functions
entail competitive strate-
gies among different sovereign debt and asset managers for the
most lucrative deals,
FALLAVINTER 2008 I 37
Giselle Datz
taldng the understanding of a "competitive state" to yet another
level of specializa-
tion and interaction. 14 In all of these areas, we see a
rearticulation ofthe relationship
between states and financial risk. At stake is a more welcoming
engagement with the
motto, "no risk, no reward."
Sassen aptly suggests that understanding the global economy
may entail the

blurring, rather than the neat segmentation, of "longstanding
dualities in state schol-
arship, notably those concerning the distinctive
QlStinCtlOn spheres of influence of respectively the national
and
l i c ^^ global, of state and non-state actors, and of the
orirl -rkfixT-o+o i o private and the public."'^ In this sense, my
argument
«mu. p r i v a t e IS ., o , , . . .
j ^ , merges with Sassen s notion that globalization is
QcLerinineQ Oy producing within states a form of authority
that is a
tlie kinds of hybrid, "neither fully private nor fully public,
neither
constraints that ^"'̂ ^ national nor fully global."'^ I argue that
the
. , t" . 1 distinction between public and private is then not
states as rinancial
determined by passive versus active investment and
y p e t and
players risk management, but by the ldnds of constraints that
subject to. states as financial market players are subjected to.
More than a hybrid, the state is a heterogeneous cate-
gory that entails a symbiotic relationship between private and
public strategies,
obstacles and methodologies.
For Geoffrey Underhill, a neat separation of state and market is

not realistic as
there is a latent interdependence between the two, one which is
evidently not new,
but rather endogenous to governance and the process of
economic competition.!''
Such interdependence is not welcoming of a market and
government conceptual
dichotomy (seeing markets as exchange and governance as
coercion), but rather
more conducive to the idea of a "state-market condominium."
Under this condo-
minium, public regulation and supervision of market forces is
more than the result
of an antagonistic relationship between the public and the
private. Instead, "it is
systematic evidence of the ways in which market interests and
state policy processes
are integrated."is In this view, the transformation of markets
goes hand-in-hand with
the transformation of the state. Yet more than a reciprocal
relationship, a symbiotic
interaction between public and private in the heart of the state
is apparent. The case
of SWFs that purchase stakes in important Western firms has
led to a series of reac-
tions by official sectors in developed countries. The complexity
of the situation is
well illustrated by U.S. Securities and Exchange Commission
Chairman Christopher
Cox, to whom the increasing involvement of governments as
both owners of compa-
nies and investors in securities can be seen to challenge the
classical (liberal)
understanding of states as proposed by Adam Smith and Milton
Friedman, who

Governments as Market Flayers
emphasize minimal intervention at a fundamental level.'^
Underlining this unfolding policy confusion is the reality of
"embedded neolib-
eralism," which is, as Philip Cerny suggests, a system of
production and
private-public interaction—not simply via state, but also via
civil society networks—
multifaceted and impressively fungible.20 That is, the current
phase of capitalism,
based on a combination of tenants from neoclassical economic
theory targeting
global economic integration, has become increasingly "what
actors make of it."
What states have been making of it goes beyond setting up
firewalls; it now involves
a closer understanding of risk and how some exposure to it may
be worth the ride.
DEBT MANAGEMENT
Sovereign debt management has gone through important
changes in both devel-

oped and developing countries. In the European Union (EU),
political integration
was a product of an important process of economic
harmonization, which entailed,
among other initiatives, balancing budgets along the lines of
accountable and trans-
parent debt management. From this emphasis came the initiative
to make debt
management a more autonomous function of entities located
inside the Ministry of
Finance, yet behaved separately from it in a more specialized
fashion. For example,
the Ministry of Finance defines the medium-term strategy for
debt management
according to its risk preferences and the macroeconomic
constraints of the country,
while the Debt Management Office (DMO) implements that
strategy and adminis-
ters the issuance of domestic and foreign-currency debt.2 '
At the macroeconomic level, the logic for this separation of
tasks is analogous to
investor-signaling arguments made by students of central bank
independence.22

Sovereign debt management that is independent of monetary
policy would signal to
financial markets and domestic constituencies that governments
are indeed commit-
ted to the transparent and accountable management of debt
policy. That could lower
the government's borrowing costs, indicating that the country is
much less likely to
engage in risky strategies, such as irresponsible indebtedness, in
order to suit
political goals.
At the microeconomic level, an autonomous debt agency
functions much like
private fund administrators in the sense that it tries to attract
professionals who are
knowledgeable in the intricacies of global financial markets. In
an International
Monetary Fund (IMF) report. Marcel Cassard and David
Folkerts-Landau explain
that a great advantage of an autonomous DMO is that it "can be
given a clearly
defined objective, without being hampered by either the
management of structure or
pay scale of the public sector. "23 A flexible pay structure is

seen as an important mech-
anism to attract qualified staff. Translated into practice,
performance criteria was
developed for debt managers, which made their daily work,
accountability structures
Giselle Datz
set aside, a risk management operation of liabilities. If they
were in charge of manag-
ing assets, their work would not differentiate much from that of
private mutual or
pension fund managers. After all, the logic goes that "debt
management could be
significantly improved if it was entrusted to portfolio managers
with knowledge and
experience in modern risk management techniques, and if their
performance was
measured against a set of criteria defined by the Ministry of
Finance."24
Indeed, the perceived necessity to attract these kinds of
professionals was a
reason for Ireland, Sweden and Denmark to develop separate
debt management
offices placed outside of the Ministry of Finance and staffed
with financial experts
with experience in portfolio risk management. It was then
assumed that funding
operations would be carried out more aptly because those in

charge "followed private
sector, market-oriented principles and that, since they did not
have to comply with
bureaucratic procedures, they would create an environment
appropriate for quick
decision making. "25 Philip Anderson stresses the fact that
recruitment and retention
of staff with appropriate skills is often a challenge in the public
sector.26 Yet, creative
solutions are increasingly being discovered, such as providing
staff with training
opportunities, contracting skilled and experienced staff on
fixed-term assignments
and allowing for placements of private sector personnel in the
debt management
unit or for the use of long-term advisors with specialist skills.27
Furthermore, bench-
marks for debt management are set in accordance with the risk
tolerance of each
government, which is, in turn, a function of the size of the
public debt, its currency
composition and maturity.28 Sovereign debt managers, like
private pension and
hedge or mutual funds managers, are held accountable for their
actions if they
perform below benchmark targets set in terms of the foreign
currency market.
Increased competitiveness is another goal of DMOs, further
linking public poli-
cies to private methodologies. For example, France's Debt
Management
Office—^Agence France Tresor—was created to reduce the cost
of debt for the French
taxpayer and "to help investors better identify French debt
securities within the range

of sovereign debt products available in European and world
markets."29 Catering to
investors' demands and preferences is an effective way to gain
terrain among competi-
tors. In this effort, sovereign debt management institutions are
increasingly issuing
inflation-indexed bonds as well as long-maturity bonds that
appeal to investors inter-
ested in cushioning growing inflationary pressures
worldwide.^o
W^hat we see then are two important transformations having
taken place. Not
only was more autonomy given to DMOs and equivalent
agencies, but also a private
rationale for conducting business was inserted in the system via
increased competi-
tion among these agencies. The Financial Times reported in
2002 that, although
"European finance ministers are not usually at the forefront of
innovation in capital
markets," the picture is definitely changing. The newspaper
went on to report that,
as "competition for funding from investors intensifies in the
wake of the euro, newly-
styled and aggressive debt management agencies are getting
more creative and more
opportunistic in meeting their governments' borrowing
requirements." If, in the

past, the supply of European sovereign bonds was relatively
predictable, now supply
for bonds is a major mover of financial markets. So much so
that "some of the
elements of the corporate bond market are beginning to
influence the shape of the
government market. "31
Since 2001, the World Bank and the IMF have been advocating
for the estab-
lishment of quasi-independent agencies to manage the public
debt of emerging
market countries, emphasize the benefits of lower cost for
public credit, create trans-
parency and accountability, especially regarding the
development of accurate and
comprehensive debt data, implement of cost effective cash
management policies that
"minimize government liquidity and repayment risks"; and
provide consistency in
the development of governments' securities market.32 The
crucial difference between
emerging market economies and Organisation for Economic Go-
operation and
Development (OECD) economies is not the level of
indebtedness, which has been
positively altered by high levels of reserve accumulation in the
developing countries,
but how governments' balance sheets are exposed to external
shocks, given their low
level of investment diversification and amount of debt issued in
foreign currency.33
The Nigerian Debt Management Office, for example, was
established in 2000 in
order to consolidate the management of public debt in a semi-

autonomous agency.
Its goals were to reduce debt stock and cost, link debt
management to effective fiscal
and monetary policies and to project and promote the "good
image of Nigeria as a
disciplined and organized nation, capable of managing its assets
and liabilities."34
The Nigerian DMO has been able to deliver on its mandate to
reduce the debt stock
and, perhaps more importantly, lead the way in the much needed
development of
Africa's debt markets. A crucial achievement of Nigeria's DMO
has been the
country's exit from the Paris and London clubs through effective
negotiations and
debt buybacks.35
Autonomous DMOs operating in developing countries are still
relatively rare,
even if the notion of increased strategic debt management has
been prevalent since
the 1990s. Where no major institutional change was carried out,
evident moves have
been made in most countries in terms of methodological
assessments and updates in
risk management practices. In countries where the central bank
is responsible for
domestic debt, it has been hard to transform this responsibility
to a different agency,
as in the cases of Costa Rica, Nicaragua and Sri Lanka. Pakistan
has set up a coor-
dination office and Gosta Rica a coordination committee. These
are layers of
"complex arrangements" politically and financially when it
comes to debt manage-
ment in a context of volatile financial flows.36 In addition,

developing countries have
Giselle Datz
focused on creating domestic public debt markets. For example,
in Brazil these debt
markets have been a component of the country's debt
management strategy^?
With varying degrees of depth, more private-like approaches to
public debt
management are changing in important ways the channels
through which govern-
ments do business with public and private financial players,
both as demand for high
yield and supply of new investment tools.
SOVEREIGN WEALTH FUNDS
After decades of severe indebtedness, many developing
countries are now able
to accumulate foreign reserves, make early repayments of their
debts to the IMF
and buy back foreign-currency debts. This has to do with
learning curves from the
1997 Asian crisis, which made it evident that reserve
accumulation was an imper-
ative to buffer sudden instability. As Ben Thirkell-White puts
it, "the build up of
reserves in the post-crisis Asia suggests that the need for
finance is not so desper-
ate that countries are prostrate in the face of market

pressure."38 Indeed, the tide
has turned. Developing countries are consolidating their
positions as capital
exporters.39 That is a critical change in the configuration of
capital flows. The
salience is no longer that of the private sector, nor is it that of
the public sector in
developed countries exporting money to developing countries.
Rather, a structural
shift is underway, marking a "dramatic redistribution of
international wealth"
according to which large flows of publicly-owned funds are
moving from countries
that "historically have not been major players in international
finance" to those who
used to play this role. Therefore, governments, not private
players, are in control of
"the new international wealth."40
A large volume of this wealth is held by sovereign wealth funds
(SWFs), govern-
ment investment vehicles funded by foreign reserve exchange
assets that are
managed separately from the official reserves of the central
bank and reserve-related
functions of the finance ministry.^i According to recent
estimates, there are fifty-four
SWFs (pension and non-pension funds) in operation today. They
are linked to
thirty-seven different countries and hold approximately US$5.3
trillion in assets.42
Sources of funding and hence strategies of investment and time
horizons differ
among SWFs. Some are funded through central bank reserves
(as in the case of the
giant funds from China and Singapore). Others are funded

through export revenues
of state-owned resources (Abu Dhabi, Kuwait), taxation from
exports (Russia), fiscal
surpluses (Korea, New Zealand) or privatization receipts
(Malaysia, Australia).
According to the IMF, there are five types of SWFs based on
policy objectives.
There are stabilization funds set up by countries rich in natural
resources to cushion
volatility in commodity prices, savings funds that "transfer non-
renewable assets
into a diversified portfolio of international financial assets to
provide for future
generations," funds that operate as reserve investment
corporations pursuing poli-
cies with higher returns, development funds that allege priority
to socioeconomic
projects and sovereign funds that are, in effect, pension
funds.''^
Having existed for over three decades, SWFs are not new; what
is new is the
number of funds and their sheer current and predicted sizes. In
2007, sovereign
funds invested US$92 billion in equity transactions, compared
to US$3 billion in
2000. Moreover, the trend seems to be accelerating as these
funds' investments

during the first quarter of 2008 alone reached US$58 billion,
which exceeds their
combined total for the years 2000 to 2005.44
Such growth is linked to the accumulation of sovereign reserves
in emerging
markets through trade surpluses "unequalled as a percentage of
the global economy
since the beginning of the 20th century," which have made
official reserves held by
some governments become "astronomically high." The key here
is that SWFs do not
simply represent saving for a rainy day, but strategic investing
for the long term.45
They mark a departure from the trend to invest foreign reserves
in liquid assets such
as short-term U.S. Treasury bills and government securities
issued by other devel-
oped countries to investment in high-return equities. After all,
as Nouriel Roubini
puts it, "Why hold U.S. T-bills with a meager 5 percent return,
German Bunds with
a 4 percent return, or Japanese government bonds with a 0.5
percent return when
you can acquire foreign firms, invest in real assets, stock
markets, or higher-yielding
corporate bonds? "46 Indeed, there is pressure on governments
with surpluses to earn
better returns through different and riskier investment avenues.
One of the key financial developments of the turbulent period of
late 2007 and
early 2008 was the way in which emerging market governments,
through their
SWFs, acted as stabilizers of key commercial and investment
banks plagued by ever-

increasing losses from the sub prime crisis. For example, the
Chinese Investment
Corporation (CIC) invested US$5 billion in Morgan Stanley,
acquiring a 9.9 percent
share in the company. This happened despite CIC's losses in a
previous US$3 billion
deal with Blackstone whose initial public offering price dropped
over 50 percent
after the deal was concluded. The Government of Singapore
Investment
Corporation (GIC) and an undisclosed investor from the Middle
East invested
US$12 billion in the Swiss UBS. Abu Dhabi Investment
Authority injected US$7.5
billion into Citigroup late in 2007.
Sovereign wealth funds are not only investors in large Western
financial institu-
tions, but also clients. Investment banks have been keen on
creating the
infrastructure to attract sovereign investment. For example,
HSBC Investments has
hired a new "global head of sovereign and supranational," and
Morgan Stanley
Investment Management has announced the appointment of a
"managing director
and head of central banks and sovereign wealth funds."
According to the person who
FALL/WINTER 2008 I 43
Giselle Datz
assumed this latter position, his role is to "help improve the

firm's coverage of these
increasingly important clients." In his own words: "It's about
engaging with the
clients to understand their needs and then providing tailored
investment solutions."
Another asset manager in charge of dealing with sovereign
funds states that "one of
the reasons why sovereign funds are important...is because it's
new business, it's new
money."'"' That entails managing funds on behalf of SWFs,
many of which outsource
mandates when in-house expertise is lacking, as in the case of
Abu Dhabi Investment
Authority whose assets—between 70 and 80 percent—are
managed outside the
country. Norway's Government Pension Fund has about 28
precent of its assets
managed by fewer than fifty third-party bond and equity asset
managers. As
expected, competition for the business of SWFs is stiff. Wall
Street firms are increas-
ing their focus on sovereign funds by selling services that range
from advice on
merger and acquisitions to structured services.48
The liaison between Wall Street and some emerging market
governments
should not recall the time Citibank—despite being "too big to
fall"—lent money to
Latin American countries only to witness the default of these
loans en masse in the
1980s. This is a different kind of relationship. It is a private
investment firm
serving the sovereign client, helping it generate higher yield for
public monies, and,
expectedly, collecting handsome fees in return. Not only is the

public-private
symbiosis within the state a case in point, but the renewed ways
in which Wall
Street deals with and in some ways relies on sovereign wealth
from emerging
markets adds more depth to what Richard Gnoddle calls the
"new ecosystem of
global capital."49
Sovereign wealth funds retreated from Wall Street as the U.S.
financial crisis
worsened in the early fall of 2008. Yet, …
The Meaning and Role of Entrepreneurship
Education for School Students in
the Global Economy
Christina Wai Mui YU
The Hong Kong Institute of Education, China
Abstract
This paper aims to clarify the meaning and role of
entrepreneurship educa-
tion (EE) from a competence-based perspective in order to
prepare school
students to work and live better in the global economy. After a
critical review
on entrepreneurship and EE, it was found that there is a shift
from a narrow
business-oriented process to a generic competence-driven
process in defin-
ing entrepreneurship. The ultimate roles and goals of EE for

school students
cover both the possession of (1) entrepreneurship for self-
employment and
economic growth, and (2) enterprising skills for individual life
growth. More
importantly, on top of the traditional entrepreneurial
competencies and capa-
bilities, both ethical and social competencies are suggested in
EE in order to
balance individual and public interest.
Key Words: Entrepreneurship Education, Enterprise Education,
Entrepreneur-
ial Competencies/Capacities, School Students, Global Economy
Introduction
Entrepreneurship Education (EE) has drawn an increasing
interest and made
remarkable progress to become a field of academic study over
the past four
decades (Garaven & O’Cineide, 1994; Gibb, 1993 & 2011; Hytti
& O’Gorman,
2004; Jamieson, 1984; Mwasalwiba, 2010; Pittaway & Cope,
2007; Vesper &
Gartner, 1997). EE stakeholders believe that learners are able to
cope with chal-
lenging jobs or start new business ventures (self-employment)
after receiving
EE (Gibb, 1993; Hytti & O’Gorman, 2004; Jack & Anderson,
1999). Policy-
makers can then release their burdens on meeting the needs in
job market
and economic development (Kirby, 2004; Matley, 2005;
McKeown, Millman,

7
8 International Journal of Vocational Education and Training
Vol. 22 No. 2
Sursani, Smith & Martin, 2006; McMullan & Long, 1987; Rae,
2010). Moreover,
academicians are more motivated to invent programs and
activities for the
building of an enterprising society (Mwasalwiba, 2010).
Therefore, EE is one
of the possible key drivers of sustained social development and
economic re-
covery, which draws an increasing interest from multi-
stakeholders in public,
private, academia and non-profit sectors (Volkmann et al.,
2009).
The current movement of EE is becoming ‘a mainstream
education com-
ponent’ across disciplines at university and school levels in
many countries
(Cherwitz & Sullivan, 2002; Gibb, 2011; Mclarty, Highley &
Alderson, 2010;
Volkmann et al., 2009). For example, many entrepreneurship
incubation cen-
tres are being set up at universities (European Commission,
2008) and EE is a
key consensus area for development in Asia-Pacific countries
(United Nations
Educational, Science and Cultural Organisation, Asia-Pacific
Programme of
Educational Innovation for Development, 2013). EE appeals to
all students no
matter what career paths they will have (European Commission,

2008; Gibb,
2002, 2007 & 2011; Mclarty, Highley & Alderson, 2010).
However, EE is facing many challenges including a confusion
of the defi-
nition, and a lack of evidence and empirical study on its impacts
on trans-
forming the graduates to be entrepreneurs, despite EE has
impacted graduates’
intentionality. Moreover, at policy making level, there is no
concrete policy
on how to spread EE to mainstream education, even though EE
is said to be
needed by all students. Gibb (2011) also highlighted some other
challenges EE
has had such as the intra-disciplinary challenge, assessment,
and strategic and
operational capacity building. Yu (2013) shared strategies for
capacity build-
ing to advance EE at individual, institutional and societal
levels. Amongst the
existing challenges in EE, clarifying the meaning and role of EE
for imple-
mentation is most crucial since different understandings of EE
would lead to
different objectives, contents, target audiences, teaching
methods, assessment
indicators and resource implications (Mwasalwiba, 2010). For
example, EE is
mainly understood as a promising way to lower unemployment
rate in Main-
land China when it faces more than one million of college
graduates each year.
Differently, some western countries may view EE as an
individual empower-
ment to meet the ever-changing needs of employment and life.
In such a way,

the purpose of EE can range from covering either a narrow
focus on business
venturing (Volkmann et al., 2009) or a wide range of
enterprising ‘soft’ skills
(Davies, 2002).
Therefore, in this paper, a literature review on the meaning of
entrepre-
neurship and EE as well as a discussion on the significant role
of EE to today’s
school students will be critically shown in the first three
sessions. Afterwards,
a detailed review and discussion on the entrepreneurial
competencies and ca-
pabilities for school students, including those traditional and
neglected ones
The Role of Entrepreneurship Education for Students in the
Global Economy 9
will be presented. Finally, the acquisition of entrepreneurial
competencies and
capacities will be proposed.
Entrepreneurship
Scheumpeter (1934) suggested a classical function which
constitutes entrepre-
neurship concept as ‘innovation’ – carrying out changes through
creation of
new products, new production methods, new markets and new
forms of or-
ganization. Wealth is then created when such innovation exists.
Furthermore,
Drucker (2006) claimed that true entrepreneurs seek to

minimize risk and ex-
ploit change to achieve purposeful innovation. Entrepreneurship
is therefore a
process which involves the creation of an innovative economic
organization for
the purpose of gain or growth under condition of risk and
uncertainty (Doll-
inger, 2001). Entrepreneurship refers to business-oriented
activities that closely
relates to the intersections of creativity, innovation,
management, opportunity
seeking, risk taking and striking for growth (Vanderwerf &
Brush, 1989).
However, Shefsky refers to entrepreneur as someone who is
able to identify
opportunity, take up the opportunity in time and manage the
opportunity to
function as a success (Singer, 1995). It symbolises that an
entrepreneur is not
necessarily referring to someone who is associated with
business, but could
also be referring to those who possess enterprising attributes to
set up and run
a specific task because their psychological characteristics are
basically identi-
cal (Caird & Johnson, 1988; Gibb, 1987). Hence, the
Commission of the Euro-
pean Communities (CEC 2005, p. 4) defined entrepreneurship
as:
… an individual’s ability to turn ideas into action. It includes
creativity, in-
novation and risk taking, as well as the ability to plan and
manage projects
in order to achieve objectives. This supports everyone in day-
to-day life at

home and in society, makes employees more aware of the
context of their
work and better able to seize opportunities, and provides a
foundation for
entrepreneurs establishing a social or commercial activity.
According to the definition of entrepreneurship given by CEC
(2005), entre-
preneurship no longer refers to business-oriented activities
solely but also to
individual’s ability of actualizing his/her own idea through the
same cross-
ings of creativity, innovation, risk taking, management,
opportunity seeking and
striking for sustainable development in different aspects of life.
As can be seen,
there is a shift from a narrow business-oriented process for
economic growth
to a generic competence-driven process for individual growth in
defining en-
trepreneurship. Such a shift not only draws a significant impact
on under-
standing the nature and use of entrepreneurship, but also on EE.
Vol. 22 No. 2
Entrepreneurship Education (EE)
The terms ‘entrepreneurship education’ and ‘enterprise
education’ are used
interchangeably to describe EE in a wide range of programs,
courses and or
initiatives found at varied educational levels. Gibb (1993) has

stated that the
two terms are conceptually identical but contextually different.
Garavan and
O’Cinneide (1994) have further distinguished the two,
explaining that entre-
preneurship education aims to create an attitude of self-reliance,
while enter-
prise education seeks to create opportunity-seeking individuals.
In fact, no
matter what exactly the terms is used, EE covers the aspects of
both entre-
preneurship and enterprising behaviour (Seikkula-Leino,
Ruskovaara, Ika-
valko, Mattila, & Rytkola, 2010). Moreover, EE not only
applies to business
ventures but also more broadly to life (Bridge, Hegarty, &
Porter, 2010; Gibb,
2011). Many authors have suggested that entrepreneurship
education which is
more economic focused, fits advanced students in university,
while enterprise
education which is more generic in nature, suits younger
students in basic
schooling (e.g., Jones & Iredale, 2010; Leffler, 2009; Pepin,
2012). Schools and
universities should prepare young people to work in a dynamic,
rapidly chang-
ing entrepreneurial and global environment. Therefore,
providing an analyti-
cal perspective on the meaning and role of EE for school
students in the global
economy context is needed.
Role of EE to School Students

Education systems have traditionally focused on providing basic
skills and
ensuring individuals can secure future jobs. Meanwhile
globalization has
changed the nature of work, including (1) the relocation of
offices, factories
and staff to countries where operation costs are cheaper, (2) the
rapid tech-
nological development towards labour-saving production and
business pro-
cesses, (3) the lower cost of travel to encourage job mobility
and (4) an advent
of “virtual” companies outsourced to freelancers or offshore
workers (Fien,
Maclean & Park, 2009; Velde, 2009). Amidst highly uncertain
economic and
labour market conditions, employers are likely to be cautious
and hesitant
about expanding their enterprises and hiring new employees,
particularly in-
experienced school students. Even when school students have a
more stable
and secured job, they may only be able to barely sustain their
living and even
live in poor households. The rise of in-work poverty comes to
be the most
dramatic outcomes in industrialized countries over the past 30
years due to
globalization and technological advancements (Hellier &
Chusseau, 2013).
Under such circumstances, traditional education seems no
longer able to help
employment and poverty in today’s global economy.
Contrastingly, EE is in-

Global Economy 11
tended to develop a culture of enterprise among a younger
generation within
the society that emphasizes on the value of competitiveness,
innovation and
creativity (Robertson & Collins, 2003). EE can play a
significant role in em-
powering school students to possess entrepreneurial
competencies and capa-
bilities to meet challenges in employment and or self-
employment. Of course,
life planning education and career counselling should go
alongside with EE
through a concerted effort of stakeholders in the community
too.
Moreover, investment in human capital not only enables
individuals to
increase their future earnings and enhance their experience in
the labour
market, but also enables individuals to become better citizens
on top of being
better workers (Lister, 2003). Schools should strive to make
students become
knowledgeable about contemporary issues, be able to work
independently and
collaborate with others, and possess personal dispositions that
value cultural
diversity (Learning & Teaching Scotland, 2002). They are
critical for school
students to become active citizens regardless of the economic
background they
have had and the career path they are to take (Deuchar, 2008).
For example,

those individuals who are in poverty could be empowered by EE
to regain
their economic and social dignity; while those individuals who
are rich could
be educated by EE to see how they can enjoy their life uniquely
through self-
employment. If every individual respects and cares about others
as well as the
global issues, a more enjoyable life is achievable for everyone.
Erkkila (2000),
on her comparative study between United States, United
Kingdom and Fin-
land, suggested that the belief of having both societal and
individual improve-
ments always supports the provision of EE.
There are two main features of EE to school students: (1)
developing those
personal attributes and transferable generic skills that form the
basis of an
entrepreneurial mind-set and behaviour; (b) raising learners’
awareness of
self-employment and entrepreneurship as possible career
options (European
Commission, 2009). These understandings incorporate both the
know-how
and know-why knowledge and skills as well as an emphasis on
the learning
process of entrepreneurship. However, the achievement of EE
depends very
much on what entrepreneurial competencies and capabilities are
identified for
the learning process.
Entrepreneurial Competencies and Capabilities
for School Students

Entrepreneurs need both entrepreneurial and managerial
competencies to
support the different stages and contexts of business growth
(Capaldo, Ian-
doli & Ponsiglione, 2004; Hayton & McEvoy, 2006).
Entrepreneurial compe-
tence, therefore, encompasses not only behavioural competence
(knowledge
Vol. 22 No. 2
of how to behave) but also cognitive competence (work-related
knowledge
and understanding) and functional competence (job-related
skills, know-
how) (Delamare Le Deist & Winterton, 2005; Lans, Hulsink,
Baert & Mulder,
2008). Moreover, competence-related motivational attitudes like
self-efficacy
and self-confidence should be regarded as important conditions
for entrepre-
neurial competence (Lans et al., 2008). Indeed, many authors
have agreed on
such an integrated view of competence in entrepreneurship (e.g.
Hayton &
Kelley, 2006; Markman, 2007).
Lum (2009) further noted that the possession of skills and
competencies
can lead learners to underestimate the capacities required in the
real world,
necessitating that broader and more concrete learning content
should be pro-
vided to them. Hence, developing individuals’ capacity of

knowing how to seek
for opportunities (Baron & Ensley, 2006), that is ‘be
enterprising’ (enterprise
capacity), may be more important particularly in view of the
need to meet the
ever-changing demands through lifelong learning in today’s
knowledge-based
society. The European Commission (2006) named such
enterprise capabili-
ties as ‘new basic skills’ for school students in order to improve
international
competitiveness. Mclarty, Highley and Alderson (2010, p. 33)
echoed and de-
fined enterprise capability in this way: ‘Enterprise capability
[includes] innova-
tion, creativity, risk-management and risk-taking, a can-do
attitude and the
drive to make things happen’. This concept of enterprise
capability provides a
clear guidance for the nurturing of active citizens to enable
them to develop
a mind-set of ‘you can if you want to’ (Mclarty, Highley &
Alderson, 2010).
Perhaps EE can indeed give school students courage to strive
for excellence in
their pursuit of dreams with a highly optimistic attitude.
However, it may also
possibly encourage young people to do whatever they want
without a concern
of others. ‘Be considerate before you act’ and “you can if you
want” should go
hand-in-hand in developing an enterprising mind-set for school
students.
Pepin (2012) pointed out that there are some negative effects of
entrepre-
neurship on school students such as individualism, marginality

or difficulty
dealing with authority, which have been inadequately addressed
in education.
Also, Caird (1990) indicated that the strong motivation of
entrepreneurs is
governed by a high need for achievement, power and autonomy,
and a low
need for affiliation. It is reasonable to expect that entrepreneurs
who have
confidence in their ability to control the events would be more
motivated to
actively seek new business opportunities (Lee & Tsang, 2001).
Hence, in re-
ality, it is quite true that most entrepreneurs work in isolation,
which may
easily lead them unwilling to listen to others and act
opportunistically and
ruthlessly in their will to succeed. An emphasis of opportunity
seeking may
possibly lead someone to become an opportunist without a
proper concern of
others. Hence, it is necessary to seek for a balance between the
individual and
Global Economy 13
societal interests in the provision of EE in order to protect and
nurture school
students in a healthy and positive development. Therefore,
ethical and social
competencies and capabilities are called upon in EE.
The Need of Ethical and Social Competence in EE

Ethical competence refers to the possession of certain personal
and profes-
sional values that can underpin the moral reasoning, decision
making and ac-
tion taking on specific events (CEC, 2005). Yu and Man (2009)
found that
the desirability for entrepreneurship lies in an attitudinal change
in entre-
preneurial characteristics, where more in-depth conceptual
understanding
of entrepreneurship is recommended. To strengthen individual
participants’
conceptual understanding of entrepreneurship and attitudinal
change, the
advancement of individual character building can be viewed as
a condition
for enabling individuals to engage in the ‘process of learning
and adapting to
change’ properly. As such, displaying an understanding of the
importance of
cultivating strong ethical character development through the
business-run-
ning (learning) process of entrepreneurship is crucial.
In defining key competence for all students, Kennedy (2005)
pointed out
that key competence should include the full range of skills and
competencies
relevant to one’s life span instead of employment solely.
Education should en-
able young people to become local and global citizens. Self-
interest particu-
larly takes priority in an individuals’ life in today’s
increasingly fragmented
world, however it does not mean that we can ignore needs of
others and do

whatever we want from local and/or global citizenship points of
view (Ken-
nedy, 2005). In response to the breakdown of social principles,
values and po-
litical engagement among young people, there has been a
renewed interest
in promoting ethics and moral education in citizenship
(Deuchar, 2006). Ac-
cording to Kennedy (2005, p. 44), “Young citizens must first be
taught to value
values”, it is not to indoctrinate but to allow young local and
global citizens to
distinguish between right and wrong, to recognize it in the
behaviour of others
and to take appropriate action, although it may not be easy to
find a common
value in the 21st century. In order to protect young people from
over-dressed
individualism, we need to educate them in striking a good
balance between
personal and common interest in decision makings throughout
their life. EE
possibly provides a platform to help young people to value
values as a cen-
tral part of the life experience. Deuchar (2006 & 2007) explored
the views of
teachers and students on enterprise and citizenship education in
ten primary
schools and seven secondary schools in Scotland and found that
teachers and
students were increasingly focused more on “enterprise” as
being framed upon
a model of social renewal and civic responsibility within a
global and moral

Vol. 22 No. 2
framework. The teachers recognised the need for rights as well
as responsibili-
ties, ambition as well as tolerance and wealth creation as well
as charity in car-
rying out EE (Deuchar, 2007).
Furthermore, in order to address the societal needs in business
running
instead of profit-making solely, social responsibility should be
highly empha-
sised in EE for school students since democratic citizenship is
not only about
benefits but also responsibilities. The purpose of running a
business is to ben-
efit not only the individual but also society. It is important to
lead school stu-
dents to engage in a wider learning context of social interaction
and help them
to become more aware of other’s concerns and to better
understand the world
around them. This enables school students to address and
respond to the pub-
lic concerns more. Enabling young people to work on social
entrepreneurship
is a possible way to strike a balance between individual and
collective needs.
Social entrepreneurship in here is defined as a business set up
to benefit society
(someone who is enterprising to benefit society) (Young, 1983).
For example,
in Quebec, Canada, school entrepreneurial activities must stem
from and cater
for the needs of the local community (Pelletier, 2007). School

students should
be provided with relevant concepts and knowledge on social
responsibility,
and be guided to create some sort of action taken to demonstrate
their con-
cern for social responsibility. For instance, school students may
also consider
producing some products and donating a certain percent of their
total profit
(if any was made) to a chosen minority or social enterprise.
Deuchar (2008, p.
30) pointed out that one of the key performance indicators of
enterprise and
citizenship education is when school students are able to view
enterprise in a
social sense and enterprising individuals as someone not limited
in business
or academic success but “anyone who could be enterprising in
their response to
community issues if they believed in the need for justice, truth
and honesty”. In
fact, social interaction with various parties plays a significant
role in the learn-
ing process of EE (Yu & Man, 2009). Thus, promoting social
interaction and
collaboration with various stakeholders to sustain individual
and collective
development in EE is highly desirable.
Acquisition of Entrepreneurial Competencies
and Capabilities
Sandberg (1994) argued that competence is constituted by a
worker’s under-
standing of work by drawing on his interpretative findings.
Gerber and Velde

(1996) further highlighted the relational aspect in understanding
competence.
Both context and work relationships play a role in the
embedding of compe-
tence. These arguments shift the concept of competence from a
narrow to a
broader view that draws on three significant implications: first,
learner is the
Global Economy 15
departure point for the acquisition of competence instead of the
competencies
themselves; second, competence is better described as a
combination of core
components that are interdependent; third, competence needs to
be developed
through the enrichment of practical experience that benefits
learners’ holistic
development. Also, the acquisition of competence is subject to
the context, the
situation and the experience of the individual who works.
Entrepreneurship
depends upon generic forms of understanding, which require
theory be put
into real practice in shifting its focus from venture creation to
the seeking of
opportunities and innovation (Lans et al., 2008). In such a way,
EE is no longer
able to teach knowledge and skills without a consideration of
their transfer-
ability across contexts and situations.
Hence, any entrepreneurship program should be led by

‘creativity, infor-
mality, curiosity, emotion and its application to personal and
real-world prob-
lems and opportunities’ (Penaluna & Penaluna, 2008) that takes
place outside
of a formal classroom setting. Moreover, entrepreneurship
programs need to
incorporate active learning elements such as business
simulation, workshops,
counselling and mentoring, study visits, business set-ups, games
and competi-
tions (Hytti & O’Gorman, 2004). Lewis and Massey (2003) and
Jones (2010)
have also argued that student-centred learning should form the
basis of any
entrepreneurship program, with students acting as agents who
are able to learn
and apply their knowledge onto other contexts. EE also depends
on hands-on
practice and social interaction with others, such as
entrepreneurs, throughout
the learning process (Man & Yu, 2007; Yu & Man, 2009). An
ecosystem for
possible collaboration amongst business, education and
community sectors
needs to be built up for enhancing the effectiveness of EE too.
More importantly, in-depth reflection throughout the process of
entre-
preneurship learning should be emphasized (Pepin, 2012)
because reflection
is a pre-condition in becoming aware of the lack of competence
(Korthager
1999, p. 192). Furthermore, the development of the necessary
and appropriate
type of entrepreneurial competencies and capacities requires a
long-term and

comprehensive transformation of education systems and
practices at all levels.
Relevant changes in policy, curriculum development, teaching
and learning,
assessment, teacher education, career counselling, work-based
projects and
internships are considered necessary.
Conclusion and Recommendations
The definition of entrepreneurship shifts from a narrow
business-oriented
process for economic growth to a generic competence-driven
process for indi-
vidual growth, which draws a significant impact on EE for
school students - a
learning process for a possession of entrepreneurship for
employment as an
Vol. 22 No. 2
option and enterprising skills for life. Young people are facing
huge challenges
in the global economy, EE instils an entrepreneurial spirit to
young people and
plays a key role in empowering them to survive better in the
future regardless
of the career and life path to be taken. Hence, entrepreneurial
competencies
and capabilities are suggested to be embedded in the education
system as ‘es-
sential and/or core’ elements. In order to create a more

harmonious global
community for the future, ethical and social competence also
need to be em-
phasized in EE. Cultivating school students to value values,
build ethical char-
acter, balance self and public interest, take up social
responsibility, interact
and collaborate with different people through authentic learning
process are
strongly recommended. Finally, more thorough studies on
policy making and
implementation of EE at all school levels are needed.
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11
Nothing has been more important since the beginning of my
reign
than increasing the prosperity of my people. The introduction of
certain new manufacturing industries … enables thousands of
my people to gain their bread honorably, the raw material stays
in
the country … and my subjects can easily pay their taxes. While

previously money left the country, it now stays within, making
the
country richer and more populated. Leopold I, Emperor of
Austria
(1640–1705)1
We quote Emperor Leopold here because his touching concern
for his
subjects’ welfare (and their ability to pay their taxes)
communicates
a clear message: the government needs to play a big role in
expanding
his country’s economy. Instead of issuing a proclamation
encour-
aging local entrepreneurs to innovate, he instituted an active
policy,
backed by state funds, to create important new industries. The
idea
of depending solely on local entrepreneurs to build such
industries
would not have entered his head.
Leopold was neither the first nor, certainly, the last head of
state to hold such views. Rulers of his era were well aware that
build-
ing a country’s economic prosperity had the desirable side-
effect

of increasing its power in international affairs, and many acted
on that realization. In the late 1600s Sir Walter Raleigh
observed,
“Whosoever commands the sea, commands the trade, whosoever
commands the trade of the world commands the riches of the
world
and consequently the world itself.”2 As a result, the competitive
race
1 Government: Boss, financial
partner, regulator – Entrepreneurs
in mixed economies
1 J. Berenger, Histoire de l’empire des Habsbourg 1273 –1918
(Paris: Librairie
Arthème Fayard, 1990), p. 331.
2 A. Herman, To rule the waves (New York: HarperCollins,
2004), p. 150.
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EBSCO Publishing : eBook Academic Collection (EBSCOhost)
- printed on 1/26/2020 1:10 PM via UNIVERSITY OF THE
CUMBERLANDS
AN: 465765 ; Kressel, Henry, Lento, Thomas V..;
Entrepreneurship in the Global Economy : Engine for Economic
Growth
Account: s8501869.main.eds_new
Gover nment: Boss, fina ncia l pa rtner, r egulator12
to industrialize and sustain national trade advantages was a con-
stant source of international friction, sometimes leading to war.
Statesmen have been involving themselves in their countries’

economies for centuries. They know that building and
maintaining
a healthy industrial base is the key to growing national wealth
and
sustaining prosperity. They are not about to leave the outcome
of
this high-stakes game to chance. Naturally, the economic purists
who advocate totally free markets are perpetually distressed by
this
state of affairs.
But these purists ignore the lessons of history. Free enterprise
cannot prosper without the infrastructure, investments, and rule
of
law that government provides. Likewise, governments sabotage
eco-
nomic growth – and their global influence in the bargain – when
they try to impose too many controls on business, or establish
rigid
plans for its direction.
In other words, government and entrepreneurs need each other.
This does not imply that Emperor Leopold’s command-and-
control

mode of economic planning is a model for our times. Economies
have evolved toward more open, mixed systems with complex
inter-
play between the public and private sectors. Entrepreneurs may
exploit opportunities to build new companies or industries, but
gov-
ernments still play a major role in charting the overall course of
an
economy and supporting its growth. The only “pure” systems
are
failed systems. Plenty of evidence is available to back this up.
Historical antecedents
National economic development programs have historically
relied
on several stratagems:
investments in education and infrastructure;•
subsidies for exporters;•
state funding to help or even create new companies;•
erection of trade barriers to limit imports;•
establishment of local monopolies or cartels to reduce domestic
•
competition and increase the ability to export.
EBSCOhost - printed on 1/26/2020 1:10 PM via UNIVERSITY
OF THE CUMBERLANDS. All use subject to

https://www.ebsco.com/terms-of-use
Histor ica l a ntecedents 13
This is as true for free-market countries as for nations with con-
trolled economies. A nation’s official commitment to free
enterprise
has never stood in the way of a little cheating to help its
preferred
industries.
For entrepreneurs, such government involvement – or “med-
dling,” as the purists would have it – is a decidedly mixed
blessing.
Government influence over the economy can have a decisive
impact
on the success of individual ventures, and decisions made at the
highest levels can foster or stifle entrepreneurial efforts.
Problems usually start for entrepreneurs when political leaders
are looking to jump-start their country’s industrialization
process.
Politicians typically believe that national programs to promote
rapid

industrial development (and exports) work faster than independ-
ent entrepreneurial enterprises acting in their own perceived
best
interests.
It follows that the establishment of state-owned corporations
to address critical industrial needs has been a recurring theme in
countries that are seeking to accelerate their industrialization.
Clearly, the heads of these state-owned enterprises are
bureaucrats,
not entrepreneurs, in the context of our discussion.
But real entrepreneurs who build new industries with direct or
indirect state help have also emerged in most industrializing
coun-
tries. Entrepreneurs have learned to live with whatever hand the
government deals them and find ways to prosper, which is part
of
the definition of being an entrepreneur.
For example, during Leopold’s reign Austria began producing
textiles and arms in privately owned factories. At the start of
the
process, the country lacked the knowledge and expertise to

build
and operate these industries. So it set about attracting the talent
it
needed.
Its appeal was simple. The government promised to grant local
monopolies, place import restrictions on competitive products,
and
give business people access to some state capital to establish
their
industries. These incentives lured experienced entrepreneurs
and
skilled technicians from elsewhere to set up shop in Austria. If
you
were an entrepreneur, seventeenth-century Austria was a good
place
to be, not in spite of government meddling, but because of it.
England, the birthplace of the Industrial Revolution, may have
led

the way in the race to industrialize in the seventeenth and
eighteenth
centuries, but over the next 200 years its increasing prosperity
encour-
aged others to follow its example. France, the US, Germany,
Russia,
Japan, and other countries industrialized in turn, each at its own
pace,
and with varying degrees of government oversight and support.
Since the 1960s it has been the turn of Asian countries to join
the ranks of industrialized nations, and they have done so with a
high level of government involvement. These newcomers have
learned from history, and have no hesitation in using aggressive
national economic strategies to hasten their growth. China,
India,
South Korea, and Taiwan have all emerged as industrial powers,
with exports that compete successfully with the most
sophisticated
products of the developed world. Their emergence has
revolutionized
the world economy and trade patterns.

China has been the most closely watched of all the Asian suc-
cess stories, because of both its size and its extraordinary
industrial
progress. It launched its industrial program in earnest only in
the
late 1970s, but by 2010 it moved from the back bench to second
place
in the world economy, displacing Japan. It now has prospects of
sur-
passing even the US.
China’s industrialization process has been a forced march, con-
trolled by an omnipotent Communist Party. Individual
entrepreneur-
ship has played a minor role. The term “state capitalism” has
been
applied to the current Chinese model because of its combination
of
state and private capital. But this policy is actually a modern
form of
an old system called mercantilism. It should be seen in that
context.
Early mercantilism
Mercantilism has a long history. The term is commonly applied

to
national economic policies that encourage exports and
discourage
imports. The ultimate goal is to produce a trade surplus. Such
pol-
icies were roundly condemned as long ago as 1776 by Adam
Smith in
The Wealth of Nations.
Smith advocated free trade of complementary products among
nations. But as we have already noted, very few statesmen are
will-
ing to leave economic development hostage to the vagaries of
the free
market when vital national interests are at stake.
Mercantilism as a policy was widely practiced from the seven-
teenth to the nineteenth century, particularly as countries with

agrarian economies sought to industrialize. It protected
fledgling
domestic industries from being crushed by outside competition.
Governments would provide state support to build locally
important
industries where the market risk was very low and the
technology
well established. Once these industries had succeeded in
replacing
imported products, the state could then promote exports and
hope-
fully generate a trade surplus.
Does this sound familiar? It should. Classic mercantilism
bears a striking resemblance to policies being pursued by
developing
countries to this day, including China.
Colbert launches modern French industry
Mercantilist policy was first deployed on a large scale by Jean-
Baptiste
Colbert (1619–1683), finance minister of France for twenty-two
years
under Louis XIV.

Leopold I expressed pride in the growing prosperity of his
Austrian subjects. Whether Colbert worried much about the wel-
fare of his fellow Frenchmen is highly debatable. What is
certain is
that Colbert’s big problem was financing the aggressive wars of
his
king.3
Four years after Louis XIV personally took over the reins of
government in 1661, he chose Colbert to rescue France from
near
3 For a summary of Colbert’s career and influence, see I. Murat,
Colbert (Paris:
Librairie Arthème Fayard, 1980), pp. 225–263.
bankruptcy, mostly brought on by previous military adventures.
But
this did not stop the “Sun King” from enmeshing France in
conflicts

of his own making. In the succeeding fifty years of his reign
France
was involved in three major and two minor wars, creating a
nearly
constant need for cash.
During this era soldiers and foreign allies had to be paid in
gold and silver. Since France lacked mines for precious metals,
the
only way to accumulate bullion was by building a trade surplus,
and
the structure of the economy made that impossible. French
industry
was underdeveloped and backward, in the hands of small craft
enter-
prises that simply could not compete in international markets.
Colbert decided to fix the problem by building industries such
as glass and textile manufacturing. His plan was to restrict com-
petitive imports and promote exports of exceptionally fine
products.
In this way he could generate a trade surplus that would bring a
net
inflow of foreign gold and silver into France.

Ruthless, determined, able, and in full control of the finances of
France, he poached craftsmen and entrepreneurs from various
coun-
tries by offering highly attractive incentives to set up shop in
France.
Many of the resulting businesses were granted “Royal
Privilege,”
which meant that they received state funding, paid no taxes, and
were guaranteed government orders for their products.
Colbert expected that such new businesses would become inde-
pendent of state support as their products became commercially
suc-
cessful. But this was a slow process. He was known to complain
of
continuing demands by entrepreneurs for new funds to cover
operat-
ing losses. If you were a favored entrepreneur in Colbert’s
France, you
did very well. Why not hold onto your perks as long as you
could?
The new companies built large factories with over 1,000 work-
ers – something new in France at the time. Their workers lived

in
dormitories and were paid minimal wages. The working day was
between fourteen and sixteen hours, and the only days off were
reli-
gious holidays. Colbert complained to the Roman Catholic
author-
ities that there were simply too many of those.
Labor was cheap because France was blessed, if that is the
word, with a large population and significant unemployment in
its
rural economy. Colbert had enough foresight to ensure a
continued
supply of cheap labor by encouraging early marriages – women
were
expected to marry before the age of twenty.
Having pirated technical expertise from other countries,
Colbert worried about losing what our era calls “intellectual

prop-
erty” by the same means. He took draconian steps to prevent it.
Once
in France, skilled craftsmen could not leave the country. Severe
pun-
ishments awaited those caught fleeing – from a sentence of
rowing
in one of the King’s galleys to the death penalty.
For Colbert’s program to succeed, French products had to win
international customers. To ensure that the new industries
produced
the highest quality goods, Colbert established a corps of state-
funded
industrial inspectors who were tasked with checking the quality
of
products. Delinquent producers were penalized and publicly
pun-
ished for repeated lapses in quality.
At the same time he made sure that the industries he was build-
ing were protected from outside competition until they were
ready
to compete in the international market. For example, the
importing

of Venetian glass was forbidden in 1672. And woe to the
entrepreneur
who attempted to evade his trade and quality controls. His
techno-
crats were said to have had over 15,000 small entrepreneurs
executed
for the crime of importing or manufacturing cotton cloth in
viola-
tion of French law.
Colbert did not limit his attention to manufacturing. He was
also anxious to compete with the Dutch in international trade,
which they dominated. To that end Colbert promoted the
construc-
tion of a merchant navy, and gave preference to its ships for
French
trade. To discourage competitive transport, high fees were
placed on
foreign vessels visiting French ports.
By most measures Jean-Baptiste Colbert was a thoroughly
nasty man, widely hated within and outside France. But he
launched
the country on the path of large-scale industrialization. Under

his
compulsion French industry became renowned for its quality,
par-
ticularly in such luxury products as silk fabrics, tapestries, and
fine
glass. In these areas French products came to surpass any goods
pre-
viously available on the international market.
Many famous company names in France date from this era,
including the tapestry maker Gobelin and the glass maker Saint-
Gobain. In 1688 a Venetian ambassador wrote that “such is the
qual-
ity of the French products that they are the best in the world and
attract orders from all countries.” Colbert’s policies were
successful
in at least sustaining the finances of France in spite of the
country’s

being in an almost continuous state of warfare.
Colbert’s basic approach held sway in France for some time
after
his death. In the eighteenth century French industry benefited
from
government attempts to attract English technicians and entrepre-
neurs. France sent agents on undercover missions to England to
recruit
people and collect commercial secrets, particularly those
dealing with
production machinery and metallurgical processes. For example,
the
first English steam engines were secretly imported into France.
In 1779 the ice between France and England thawed consider-
ably as the two countries signed agreements allowing the French
to
import steam engines openly. Bilateral agreements covering
other
products were also negotiated, but true free trade was far in the
future. Entrepreneurs who followed the rules had done well
under
tight government control, but free trade was something better to

look forward to.4
In fact, it was in 1846 that England led the way to a national
free-trade policy by removing the restrictive Corn Laws and
easing
its control of the export of advanced technology. By the 1860s
prac-
tically all restrictions on imports were gone. At that time
England
4 This presentation draws on the wealth of historical
information found in J.-C.
Asselain, Histoire économique de la France du XVIII siècle à
nos jours (Paris:
Éditions du Seuil, 1985), pp. 77–105; A. Malet and J. Isaac,
XVII and XVIII Siècle
(Paris: Librairie Hachette, 1923), pp. 190–194; and Murat,
Colbert, pp. 249–261.
Moder n merca ntilism 19
had such a huge industrial lead on other countries that it could
afford
to be generous and open its market. It did not anticipate that
imports

would ever threaten domestic industry. Other countries trying to
catch up continued to play by more restrictive trading rules –
and
are doing so still.
Modern mercantilism
You might ask why we are spending so much time on mercantil-
ism and its history in a book on the modern global entrepreneur.
The simple answer is that today’s entrepreneurs operate in a
world
where governments increasingly control economies, a defining
fea-
ture of mercantilism over the centuries and one that will not
dis-
appear quickly.
This reality shapes the economic decisions made by business
people and entrepreneurs as they seek markets and business
partners
in countries with diverse economic agendas. To fully understand
its
implications, it is necessary to see it in a historical perspective.
For the same reason we must also take some time to discuss

China, by far the most prominent of modern countries with
controlled
economies. China has the second largest – and fastest growing –
econ-
omy in the world. What happens there, in consumer or industrial
mar-
kets, has a huge impact on the direction of all global business.
Industrializing Asia
We are witnessing an economic revolution in Asia, affecting
billions
of people. Countries in that region are striving to industrialize
as
quickly as possible. Given the pressure to make rapid progress
and
the top-down structure of many of their economies, it is not
surpris-
ing that Asian countries would adopt mercantilist methods.
Indeed, we are living in the golden age of broadly defined mer-
cantilism. It is currently being practiced in a highly developed
form,
on a scale unprecedented in history, by China. The world’s most
populous country has embarked on a path to industrialization

that
in some ways mirrors the journey of France under Colbert,
using
some of the same strategies. Its astonishing success has
prompted
other countries to learn from its example and shape their trade
pol-
icies accordingly.
Long relegated to the ranks of a “third-world” country with a
primarily agrarian economy, China has vaulted into a position
of eco-
nomic leadership in just forty years. The ruling Communist
Party
still controls the land, much of the economy, the military,
foreign

policy, and whatever else is of major importance to the country.
But
the highly pragmatic Party has abandoned some communist
prac-
tices and embraced a number of capitalist methods without
relin-
quishing political control.
Perhaps the biggest difference between China and the devel-
oped West is that the state owns all of the country’s banks,
either in
part or in whole. It also controls their activities, and can
therefore
channel capital to meet its industrial objectives.5 China’s
reluctance
to allow banks to operate outside of government control is as
much a
matter of history as it is of ideology. The country suffered
through a
long period of weakness and foreign intervention, and its
government
is determined to keep it free of foreign economic domination.6
Within China the most obvious sign of the success of these pol-
icies is plain to see. Visitors are frequently amazed at the

quality and
quantity of public facilities that have been built in the past
couple of
decades. Indeed, the development of a modern infrastructure is
a key
element of comprehensive state plans for industrial
development.
Of course the government of China had some powerful advan-
tages in its rapid construction of the infrastructure to support a
modern economy. In addition to absolute control of the
country’s
5 For an excellent review of the Party’s role, see D.
Shambaugh, China’s
Communist Party: Atrophy and adaptation (San Francisco, CA:
University
of California Press, 2010). Also, R. McGregor, The Party: The
secret world of
China’s Communist rulers (New York: HarperCollins, 2010).
6 H. Jones, Chinamerica: Why the future of America is China
(New York:
McGraw-Hill, 2010) contains a good overview of Chinese
economic practices and
policies.

finances, the government owns all the land. Hence it can
develop
roads, airports, railways, and public structures without the legal
restrictions found in countries where land is in private hands. It
can
also set arbitrarily low lease rates for land to stimulate the
build-
ing of factories and other facilities wherever and by whomever
it
chooses.
China’s emergence as an economic power is not accidental. It
is based on long-term development plans drawn up by
government
authorities in order to
preserve Chinese control over key domestic industries and the
economy;•
promote exports and create a trade surplus;•
acquire modern technology; and•
build a domestic industrial base capable of innovation.•
Developing nations are watching China’s amazing progress very

closely. As more countries adopt various aspects of its
approach,
entrepreneurs in the global marketplace will have to make
adjust-
ments to economic systems in which mercantilism is flying high
and the government is in the pilot’s seat. It is worth looking
more
closely at what they face in China, and may encounter in the
other
countries that it influences.
Mixed ownership, tight control
China’s economic policy permits a mix of ownership models:
pri-
vately owned businesses, joint ventures with foreign investors
and
corporations, and businesses that are fully government owned
and
funded. Regardless of ownership, foreign trade by all of these
busi-
nesses is controlled by the government. Needless to say in a
country
where the currency is tightly regulated, access to foreign
exchange

is also strictly controlled.
Some businesses in non-strategic consumer industries,
such as textiles, services, and retail, may be fully owned by for-
eign investors, but restrictions exist on investment and cap-
ital repatriation. Large companies in industries deemed critical,
including telecommunications services and banking, are either
fully
government-owned or have majority government ownership.
Even
when these vital companies are publicly traded, the government
maintains significant ownership and ultimate control.
Fifty-four state-owned enterprises, including China Mobile,
Petro China, Sinopec, and China Electronics Corporation
(CEC), are
considered “backbone” companies. To get an idea of the scale

and
scope of these enterprises, consider the fact that CEC, which
was
established only in 1989, today has 70,000 employees.
While control remains with the parent company, CEC owns
fourteen subsidiaries that are publicly listed and have some
degree of
public ownership. These businesses cover software, computers
and
computer components, and consumer electronics products. Some
of
these companies rank among the world leaders in their product
cat-
egories. They include joint ventures with foreign companies
such
as HP, IBM, and Philips who contribute their technology. With
rev-
enues in excess of $10 billion annually, CEC is a big
technology con-
glomerate with the resources to address new business areas.
As would be expected in such an economy, exporting for the
purpose of acquiring foreign exchange is a key objective of
state plan-

ners. In this they have been markedly successful. Much to the
chag-
rin of its trading partners, China runs a large trade surplus. A
major
reason for this success is the number of foreign companies that
have
moved their production to China. The products from these trans-
planted factories are exported under their original brand names.
Like Colbert’s France, China’s government offers significant
incentives to attract foreign manufacturing: a modern infrastruc-
ture, a disciplined low-cost labor force, and significant financial
inducements for companies that locate factories in areas of the
coun-
try designated for development. It is enough to convince many
com-
panies that previously manufactured in Europe, Japan, or the US
to
move their equipment into Chinese plants.
China benefits from its new status as the world’s factory in
three ways.

Transplanted manufacturing plants churn out products for which
there •
is already worldwide demand, building exports at minimum risk.
These plants provide employment for many millions of Chinese
workers.•
Last but not least, they bring the latest technology into China,
helping •
it acquire the skills and knowledge to compete on its own in the
international market.
By some estimates as much as 70 percent of the exported
products
from China are from such transplanted manufacturing plants.
To take one prominent example, most Apple® products are
assembled in China, using imported and locally manufactured
com-
ponents. In some cases the factories where they are produced
are joint
ventures with local companies; in other cases the manufacturing
is
done by contractors such as Foxconn. Either way, it is estimated

that
over 100,000 workers are employed in manufacturing Apple
prod-
ucts alone. These wildly popular products are sold worldwide
under
the Apple brand, helping boost China’s burgeoning trade
surplus.
Foxconn, a huge company ($80 billion of annual revenues in
2009) of Taiwanese origin, exemplifies the importance of
transplants
to the development of China’s economy and its workforce.
Foxconn
is a contract manufacturer of electronic products not only for
Apple,
but for HP and other major international brands.
The company has built virtual dormitory cities for its Chinese
workers. One such location, in Shenzhen, houses over 300,000
work-
ers in a sprawling compound. Since factories draw their low-
wage
workers from rural areas, owners have to provide the workers
with
access to affordable housing near the plants.

Building domestic industries
Infrastructure, employment, exports: all are prerequisites for a
mod-
ern industrial economy. But other bricks are needed to build a
stable
industrial base. While transplants contribute to …

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