International Business 10e

By Charles W.L. Hill

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 3

Political Economy and Economic Development

3-3

What Determines A Country’s Level Of Economic Development?

Gross national income (GNI) per person measures the total annual income received by residents of a nation Japan, Sweden, Switzerland, and the U.S.

have high GNI China and India have low GNI

GNI can be misleading because it does not consider differences in the cost of living need to adjust GNI figures using purchasing

power parity (PPP)

3-4

How Do Countries Compare On GNI?

Economic Data for Select Countries

3-5

What Determines A Country’s Level Of Economic Development?

Official figures can also be misleading because they do not account for black economy transactions

In addition, GNI and PPP data are static and do not consider economic growth rates So, while China and India are currently

categorized as being poor they are growing more rapidly than many developed nations and are expected to become among the largest economies in the world

3-6

How Do Countries Compare On Growth Rates?

Economic Data for Select Countries

3-7

What Determines A Country’s Level Of Economic Development?

Nobel-prize winner Amartya Sen argues economic development should be seen as a process of expanding the real freedoms that people experience the removal of major impediments to freedom like

poverty, tyranny, and neglect of public facilities the presence of basic health care and basic

education Amartya Sen also claims that economic

progress requires the democratization of political communities to give citizens a voice

3-8

What Determines A Country’s Level Of Economic Development?

The United Nations used Sen’s ideas to develop the Human Development Index (HDI) which is based on life expectancy at birth educational attainment whether average incomes are sufficient to

meet the basic needs of life in a country

3-9

How Do Countries Compare on Economic Development?

Economic Data for Select Countries

3-10

How Does Political Economy Influence Economic Progress? Innovation and entrepreneurship are the engines

of long-run economic growth innovation includes new products, new processes,

new organizations, new management practices, and new strategies

entrepreneurs commercialize innovative new products and processes

Innovation and entrepreneurship help increase economic activity by creating new markets and products that did not previously exist innovation in production and business processes

result in more productive labor and capital further boosting economic growth rates

3-11

How Does Political Economy Influence Economic Progress? Innovation and entrepreneurship require a

market economy there is little incentive to develop new innovations in

planned economies because the state owns all means production and therefore, the gains

There is a strong relationship between economic freedom and economic growth the six countries with the highest ratings of economic

freedom from 1975 to 1995 were also among the highest for economic growth Hong Kong, Switzerland, Singapore, the United States,

Canada, and Germany

3-12

How Does Political Economy Influence Economic Progress? Innovation and entrepreneurship require

strong property rights without strong property rights, individuals and

businesses risk having their innovations and potential profits stolen

Economist Hernando de Soto claims that inadequate property protection in many developing nations limits economic growth

3-13

How Does Political Economy Influence Economic Progress? Democratic regimes are probably more

conducive to long-term economic growth than dictatorships, even the benevolent kind property rights are only secure in well-functioning,

mature democracies Subsequent economic growth leads to the

establishment of democratic regimes South Korea Taiwan

3-14

How Does Geography Influence Economic Development?

Countries with favorable geography are more likely to engage in trade, and so, be more open to market-based economic systems, and the economic growth they promote

Jeffrey Sachs studied economic growth rates between 1965 and 1990 and found that landlocked countries grew more slowly than coastal

economies being totally landlocked reduced a country’s growth

rate by 0.7% per year tropical countries grew more slowly than countries in

temperate zones

3-15

How Does Education Influence Economic Development?

Countries that invest in education have higher growth rates because the workforce is more productive countries in Southeast Asia have offset their

geographical disadvantages by investing in education Indonesia, Malaysia, and Singapore

3-16

How Is The Political Economy Changing?

Since the late 1980s, two trends have emerged 1. Democratic revolution (late 1980s and early

1990s) democratically elected governments replaced

totalitarian regimes more committed to free market capitalism

2. A move away from centrally planned and mixed economies more countries have shifted toward the market-

based model

3-17

How Is The Political Economy Changing?

Trend 1: Democracy has spread over the last two decades many totalitarian regimes failed to deliver economic

progress to the vast bulk of their populations new information and communication technologies

have broken down the ability of the state to control access to uncensored information

economic advances of the last 25 years have led to increasingly prosperous middle and working classes who have pushed for democratic reforms

3-18

How Free Are Countries Politically?

Political Freedom in 2012

3-19

How Is The Political Economy Changing?

Author Francis Fukuyama argues that the new world order will be characterized by democratic regimes and free market capitalism

But, political scientist Samuel Huntington argues that while many societies are modernizing they are not becoming more Western predicts a world split into different civilizations these civilizations will be in conflict with each

other

3-20

How Is The Political Economy Changing?

Trend 2: The spread of market-based systems more countries have moved away from

centrally planned and mixed economies toward the market-based model

Command and mixed economies failed to deliver the sustained economic growth achieved in market-based countries

3-21

How Free Are Countries Economically?

Economic Freedom in 2013

3-22

What Is The Nature Of Economic Transformation?

The shift toward a market-based system involves deregulation – removing legal restrictions to

the free play of markets, the establishment of private enterprises, and the manner in which private enterprises operate

privatization - transfers the ownership of state property into the hands of private investors

the creation of a legal system to safeguard property rights

3-23

What Does The Changing Economy Mean For Managers? Markets that were formerly off-limits to Western

business are now open firms need to explore opportunities in these markets

Despite being underdeveloped and poor, some markets have huge potential China -1.3 billion people India – 1.2 billion people Latin America – 600 million potential consumers

3-24

What Does The Changing Economy Mean For Managers? However, the potential risks are large will democracy thrive especially in difficult

economic times? will totalitarian regimes return? will a multi-polar world of different civilizations

emerge? will China’s financial system be stable?

3-25

What Are The Implications Of Political Economy Differences For Managers?

Countries with democratic regimes, market based economic policies, and strong property rights protection are more likely to have higher sustained rates of economic growth these markets are more attractive to international

businesses the benefits, costs, and risks of doing business in a

country are a function of the country’s political, economic, and legal systems

3-26

What Are The Implications Of Political Economy Differences For Managers?

The benefits of doing business in a country are a function of the market’s size the purchasing power of its consumers their likely future wealth

By identifying and investing early in potential future economic stars, firms may be able to gain first mover advantages (advantages that accrue to early entrants into a market) and establish loyalty and experience in a country China

3-27

What Are The Implications Of Political Economy Differences For Managers?

The costs of doing business in a country are a function of its political system is it necessary to pay bribes to get market access?

economic level are the necessary supporting business and

infrastructure in place? legal system it can be more costly to do business in countries

with dramatically different product, workplace, and pollution standards, or where there is poor legal protection for property rights

3-28

What Are The Implications Of Political Economy Differences For Managers?

The risks of doing business in a country are a function of Political risk - the likelihood that political forces will

cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise

Economic risk - the likelihood that economic mismanagement will cause drastic changes in a country's business environment that adversely affects the profit and other goals of a business enterprise

Legal risk - the likelihood that a trading partner will opportunistically break a contract or expropriate property rights

3-29

How Can Managers Determine A Market’s Overall Attractiveness? The overall attractiveness of a country as a

potential market and/or investment site for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country

Other things being equal, the benefit-cost-risk trade-off is likely to be most favorable in politically stable developed and developing nations that have free market systems and no dramatic upsurge in either inflation rates or private sector debt

3-30

How Can Managers Determine A Market’s Overall Attractiveness?

Country Attractiveness