2017

MBA6243 INTERNATIONAL BUSINESS

CASE STUDY 2

By:

A. HARIS AWANG(MBA2016-04-1001)

Submitted to:

Mr. Soorianarayanan A/L NariahFaculty of Business

Asia Metropolitan University08th February, 2017

Meet the BRICsThe opening case for this chapter highlighted the accelerating success of emerging economies. The focus of attention is now squarely on the vanguard of emerging economies, the so-called BRICs: Brazil, Russia, India and China. The BRIC countries although much larger in scale and scope than other emerging markets, symbolically represents trends that are developing throughout the world. Many presume that where the BRICs go, others will follow. As we look at the emergence of the BRICs, we discuss the implications for the economic environment as well as individual company activity. Then, to close, we’ll see what threats to the BRICs might make them crumble.

At current trends and with reasonable projections, over the next few decades Brazil, Russia, India and China will become a larger, more powerful force in the world economy. By 2050, the BRICs will eclipse most of the current richest countries of the world, will encompass over 40 percent of the world’s population, and hold a combined PPP-adjusted GDP of nearly $15 trillion. Consequently, the rankings of national economies will change dramatically (See Figure 4.8).

In terms of specifics, China and India will be the dominant global suppliers of manufactured goods and services, respectively, while Brazil and Russia will become the principal suppliers of raw materials. Collectively, on almost every scale, they will become the largest entity on the global stage.

The unfolding influence of the BRICs as engines of new growth and spending power leads some to argue that these transitions may happen even sooner, especially given the aging working populations and falling productivity rates in richer nations. Experts forecast that the most dramatic transition will take place over the next 20 to 30 years.

By 2016, China’s economy will be larger than those of Japan, the United Kingdom, Germany, France, Italy, and Canada, with an eye to passing the United States as the world’s largest economy soon thereafter. India’s economy will pass Japan’s by 2030, making it the third largest in the world. Of the premier economic powers of the twentieth century, only the United States and Japan will be among the largest economies in 2050.

This trend has also shaped relationships between parties. India and China, the world’s two most populous countries, agreed to form a strategic partnership to end border dispute and boost trade in a deal marking a major shift in relations between the Asian giants. The agreement signed by the premiers of both countries, eases decades of mutual distrust between the nations as a result of a war in 1962. “India and China can together reshape the world order,” Indian Prime Minister Manmohan Singh proclaimed at a ceremony for his Chinese counterpart, Premier Wen Jiabao, at India’s presidential palace.

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Similarly, bilateral Sino-Russian trade was #33 billion in 2006, up from $20 billion in 2005, and it is expected to reach $70 billion by 2010. China is Russia’s fourth-largest trading partner; Russia is China’s eighth. They are the leading members of the Shanghai Cooperation Council, one of the most influential economic centers in the world. Indications show a strengthening of ties between these nations. In many people’s eyes, Russia, by rolling back democracy and reviving its imperialist past, is more politically aligned with the one-party state of China.

As of early 2008, no text was made public of any formal agreement to which all four BRIC nations are signatories. Still, change was afoot. BRIC leaders knew that a multilateral alliance would amplify their political, legal, economic and strategic influence. spearheading these efforts was President Putin of Russia with his goal to build “a new world economic architecture” that would reflect the rising power of emerging economies and the decline of the old heavyweights of the United States, Japan, and many European countries.

At a recent G8 summit, a forum for leading market economies, Putin condemned existing global organizations as archaic and undemocratic. “The world is changing before our very eyes,” he said. “Countries that seemed hopelessly backward only yesterday are becoming the world’s fastest-growing economies today.” Emerging economies, led by the BRICs, no longer wanted simply to be part of the world’s outdated architecture-instead, they wanted to go forward into a brave new world largely unencumbered by the past.

The diffusion of commodities, work, technology, and companies outward from the United Kingdom and fellow rich countries has changed the game of globalization. Furthermore, improving sophistication of information technology enables reorganizing production across borders, thereby opening up new production frontiers for previously non-tradable services. The steadily shrinking role of the prominent economies of the twentieth century will trigger fundamental shifts in firm strategy, consumption, and investments.

Regarding firm strategy, companies from richer countries are scrambling to reorient their operations to the BRICs. For many, there seems to be a tentative consensus that just being there, no matter the shape or form of investment, is more crucial than the product the company actually offers. Others are further along in their reorientation, some motivated by the opportunity, many motivated by the realization that “companies that don’t take a vigorous approach to China and India will face threats to their existence in coming years.”

For example, GM is going great guns in China even though it is struggling in the United States. In 2005, its sales rose 35.2 percent to a record 665,390 vehicles and by 2007; it was the biggest carmaker in China. Hyundai, the second largest selling brand of car in Russia, is in talks to build a manufacturing plant outside of St. Petersburg. Similarly, Wal-Mart and Bharti Enterprises, a leading Indian cell phone operator, plan to open hundreds of Wal-Mart superstore across India by 2010.

Other tales amplify the strategic significance of the BRICs. Cisco Systems has decided that 20 percent of its top talent should be in India within five years. In 2007, it moved one of its highest-

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ranking executive to Bangalore with the title of Chief globalization officer. More dramatically, IBM is slowly making India the company’s center of gravity. From a local labor force of 9,000 in 2003, IBM now employs 73,000 in India - meaning that almost one in five IBM workers now is in India. Having investedUS$2 billion in its Indian operation from 2003 through 2006, IBM announced it would invest an additional $6 billion by 2008. Symbolizing the growing primacy of its Indian operations is IBM’s historic decision to hold its annual Investors Day in 2007 on the grounds of the Bangalore Palace; this event had never before been held outside of the United States. But this change made perfect sense given that “India is at the epicenter of the flat world,” explained Michael J. Cannon-Brookes, vice president for business development in India and China at IBM.

In terms of consumption, the BRICs are on the verge of rapid growth in consumer products. Economic analyses advise companies to start capitalizing on this coming wave of consumption given that consumer demand takes off when GNI per capita income is between $3,000 and $10,000.

The first economy to hit those levels was Russia, China, India, and Brazil are steadily heading there. China and India, in particular, have rapidly growing middle classes whose demand aspirations are changing quickly. Analysts predict the middle class will expand from 50 million to 583 million people by 2025. More immediately, between 2005 and 2015, over 800 million people move from consuming necessities to consuming higher-priced branded goods.

By 2025, approximately 200 million people in these economies will have annual incomes above $15,000. For example, there are only 2 cars for every 100 people in China, as opposed to 50 cars per 100 Americans. By 2040, China’s car ownership will likely to rise 29 cars per 100 people. The total number of cars in China and India combined could rise from around 30 million today to 750 million by 2040, more than all the cars on the world’s roads today. Even then, however, car ownership rates in those two countries will be half those in the United States today.

Notwithstanding the spectacular economic performance and potential of the BRICs, there is some skepticism. In principle, observers note the endemic problem of “recency bias”, which is the dubious expectation that the current trend will continue into the future. Repeatedly, companies’ executives, investors, and officials extrapolating the present into the future have made mistakes.

There are also several practical threats. Despite high-octane economic growth, the BRICs face futures of widespread poverty and distorted income distributions. By 2025, the income per capita in today’s richer countries will exceed $35,000 for more than a billion people. In contrast, only about 24 million people out of the nearly 3 billion folks in the BRIC economies will hit that threshold.

Long term, income per capita in the United States is projected to reach $80,000 by 2050 while China will likely be just over $31,000 , Brazil about $26,600, and India just $17,400. With the possible exception of Russia, hundreds of millions of people in the BRICs will be far poorer on average than individuals in Germany, France, Japan, Italy, Canada, and the United States. Consequently, for the first time in history the largest economies in the world will no longer be the richest when measured by GNI per capita.

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Inevitably, many ask if the BRICs could turn into bricks their march to miracle economies. Unquestionably, governments in each country have developed economically sensible policies, opened trade and domestic markets, and begun building institutions that support free markets. Still, there is more than a passing chance that conditions in one economy, if not all, will fall out of sync for the simple fact that the transition from command-controlled economies for freer market rests on a difficult set of accomplishments. Basically, four instrumental conditions must occur, more or less concurrently, for a market economy to grow consistently:

1. Sound macroeconomic policies and a solid macroeconomic background, as seen in low inflation, prudent public finances, and supportive government policy

2. Strong political institutions that endorse transparency, fairness, and the rule of law

3. Openness to trade, capital flows, and foreign direct investment

4. High levels of education at both the primary and secondary levels

The failure to achieve these standards jeopardizes current economic performance and long-term growth potential.

In addition, political uncertainties and social assumptions in each country limit their economic potential. Brazil’s economic potential has been anticipated for decades, but it has struggled to achieve expectations due to problems in income equality, productivity, and education. Likewise the population count of Russia is declining, and the country’s uncertain government, environmental degradation, and crumbling infrastructure confound growth projections. India, in addition to other pressing economic and political challenges, has many poor people. China’s particular interpretation of the rule of law, rights of citizens, environmental sustainability, and principles of democracy posses problems. Too, China faces a closing window of opportunity; by 2020 China will have the largest number of both old and very old people on earth.

Finally, so-called green constraints shadow the bright futures of all. The emergence of the BRICs will challenge the well-being and sustainability of the global environment. Global warming, diminishing raw materials, and escalating pollutions suggest there is a finite limit to much the BRICs can develop before exceeding the capacity of the global economy to supply them and of the environment to support them. More worrisome is the Worldwatch Institute report that if China and India, to say nothing about Russia and Brazil, were to consume resources and produce pollution at the current U.S per capita level, it would require two planet Earths just to sustain their two economies.

In summary, the emergence of the BRICs suggests that the next generation of economic development of the global economy will be a fascinating yet bumpy ride. No matter what, coming anywhere close to reaching their apparent potential will redefine the structure of economic environments, patterns of growth, and dynamics of economic activity worldwide.

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Question 1Map the proposed sequence of evolution of the economy of the BRICs. What indicators might companies monitor to guide their investments and organize their local market operations?

ANSWER:

In 2001, Jim O’Neill who worked at Goldman Sachs, in his paper “Building Better Global Economic BRICs” coined the term BRICs which included 4 economies namely Brazil, Russia, India and China. Later on, Wilson & Purushothaman (2003) mapped out the BRICs economic growth by projecting GDP growth, income per capita and currency movements until 2050.

GDP GrowthThe projections of GDP in US$ are relative to long-term projections for the G6 (US, Japan, UK, Germany, France and Italy) as in figure 1 below. The figure suggests that India’s economy could be larger than Japan’s by 2032, and China’s larger than the US by 2041 (and larger than everyone else as early as 2016). The BRICs economies collectively could be larger than the G6 by 2039.

Figure 1. Source: Goldman Sachs (2003).

Figure 2 shows the growth of share of GDP of each group relative to the total for both groups. India has the fastest growth potential over the next 30 and 50 years.

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Figure 2. Source: Goldman Sachs (2003).

The largest economies is shown in figure 3. It is projected that China will be the largest in 2050 followed by the US and India.

Figure 3. Source: Goldman Sachs (2003).

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Income per CapitaDespite of the growth, individuals in the BRICs are poorer that those in the G5 by 2050. China’s per capita income may be similar to where the developed economies are now (about US$30,000 per capita). By 2030, China’s income per capita could be roughly what Korea’s is today. On the other hand, income per capita in the US by 2050 could reach $80,000.

Currency MovementsCountries can grow richer with their appreciating currencies. As productivity rises, currencies tend to rise.

Figure 4. Source: Goldman Sachs (2003).

Apart from the three indicators described above, companies also might want to monitor other factors like political stability, competition and monetary policies by the local government. Foreign firms may also want to monitor major economic indicators such as GNI (Gross National Income), PPP (Purchasing Power Parity), and the Human Development Index, as well as developments in the cultural, and legal environments of those nations in order to guide their investments and organize their local market operations.

Question 2What are the implications of the emergence of the BRICs for careers and companies in your country?

ANSWER:

The implications of the emergence of BRICs are described according to each country’s involvement in Malaysia.

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BrazilVale, a Brazilian company, located in Seri Manjung, Perak opened up its iron ore distribution center in 2014. This move is also a strategy for the company to be closer to China which is one of its biggest customers. The company has created job opportunities for Malaysians and local supporting industries. The initial investment on the center was reported to be US$1.3 billion. The project has created 600 direct jobs and 1,200 other related jobs with Malaysian accounting for 90% of its permanent employees. This is quite huge especially for the economy of Perak where it also boosts other sectors such housing, trading & retail industries.

RussiaAmong the BRICs economies, Russia is known to be one of the top suppliers of raw materials such as oil, gas, coal and mineral. Its investment in Malaysia does not impact much on the job opportunities in Malaysia.

IndiaIndia has been at the forefront of the IT services industry and its impact on the Malaysia job market mostly favors people and companies specializing in IT. The impact is not as massive as the manufacturing sector.

ChinaChina was Malaysia's largest trading partner in 2015, a position maintained since 2009. Total bilateral trade in 2015 was US$100 billion. Putrajaya and Beijing signed the framework financing agreement and engineering, procurement, construction contract for the US$13.10 billion (RM55 billion) East Coast Railway Line (ECRL) project in Nov 2016. The ECRL is set to be China's single largest investment in Malaysia. The 620km ECRL is one of the high-impact projects under the 11th Malaysia Plan which the Malaysian government is optimistic for the construction project to start in early 2017. However, there does not appear to be much investment from China in the manufacturing sector, which is the real driver of employment. While the ECRL may not provide massive direct job opportunities for Malaysians, in the long run, it acts as a catalyst to the economic growth of the East Coast Economic Region (ECER) which could also lead to more job opportunities for people and companies (The Star, 2016).

For export-based Malaysian companies, the emergence of BRICs opens up new opportunities as it provides vast market potential due to its growth in terms of population, income per capita and PPP. Export activities may lead to manufacturing activities which are the major driver for job opportunities for Malaysians. The Malaysian government policies in bilateral trade are very crucial in maintaining and opening up new markets in BRICs.

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Question 3Do you think recency bias has led to overestimating the potential of the BRICs? How would you, as a manager for a company assessing these markets, try to control this bias?

ANSWER:

No, I don’t think so. The study conducted by Goldman Sachs was carefully done. Recency bias is a tendency to only consider recent events while ignoring what has happened before. It's a tendency to base one's decisions on the events or developments of the recent past since they are the easiest to remember. One also believes that these events will continue in a similar manner in the near future. Goldman Sachs went as far back as 1960 to see what they said about the future.

So, to control this bias is to:

1. Keep the mind open to the possibility that things can go wrong even if they haven't before. Be alert to the surrounding developments, and if there are indications of a sectoral or a firm's fall, accept that it can happen. Take steps to counter the effect or quit the option altogether.

2. Have a long-term perspective, instead of focusing on the immediate. Rely on statistics, such as averages, not just the latest figures, whether it is the currency exchange or stock performance, or an asset class. Follow investment rules and work systematically instead of being swayed by recent events.

3. Distance from investment decisions, and base them on the demands of the current situation. If this can't be done, get the help from a financial planner. Calculate the opportunity cost of your venture, that is, the gains you are likely to make by putting in the money in a better option.

4. Consider the big picture. Look at each event independently. Always have a plan in place before investing.

One has to look at the overall picture in assessing the market from all possible angles - historical, political, culture, statistics and business fundamental, etc. For example, one can misinterpret the fundamental of our Malaysian government simply by looking at the recent currency crisis for the ringgit against the US dollar. This is clearly a recency bias. Instead, one has to look at the history, how strong the government fundamental is, and whether the currency crisis is affecting only the ringgit or other currencies throughout the world as well.

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Question 4How might managers interpret the potential for their product in a market that is, in absolute economic terms, large but, on a per capita basis, characterized by a majority of poor to very poor consumers?

ANSWER:

One of the characteristics of emerging markets is their growing middle-class. The size of the middle-class is a good indicator of demand for products and services. For example, the income per capita for China is projected to be US$30,000 in 2050, which is what most developed economies are enjoying now. Even though it consists of many poor consumers, the middle class is a market not to be ignored. With policies for human development and economic growth in place, these poor and very poor will be moving towards the middle-class income bracket.

The populations and the land mass of those economies in the BRICs are enormous. Quality of growth is important. Growth that creates job, growth that enables the countries to be beneficial to the poor in growth distribution. What’s the point of having great GDP figures while most of the population suffer from malnutrition?

With quality policy and the willpower of politicians, a large portion of the poor majority crossing the poverty line where start the journey towards self-sustainability.

Example, a shoe companies may find it impossible to sell shoes if the majority of the population do not even wear shoes.

It is a common belief that the poor do not have the purchasing power to afford goods. In economic terms, the GDP may be a good indicator for the economy but in reality, there’s more people who can’t afford to even have access to treated water, good education, good nutrition and livable housing. In India 22% (264 million) of the population live below the poverty line. So in BRICs economies, with the exception of Russia, the economic measure in GDP may not be the best to reflect on the actual wellbeing of the people. However, with a quality policy, the poverty can be eradicated thus converting the poor into the middle-class toward self-sustainability.

But that is just the conventional belief of the majority of corporations throughout the world that the poor can’t afford anything thus are often ignored and cut-off from the global marketplace.

However, according to Harvard Business Review (2008), even the poorest can be a thriving market. How’s that? Let’s take a look.

Norway-based Telenor and Jamaica-based Digicel, innovative mobile phone companies found opportunities to earn profits and simultaneously improve local economic landscapes by serving the very poor people of Bangladesh, Pakistan and Haiti. They are attracted to the low-wage workforces

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and the potential for creating local consumer markets, despite of poverty. Both companies refused to accept the low-purchasing-power status quo and have been systematically building up local consumer markets by generating jobs, tax revenue, and investment. While Telenor in Pakistan offers would-be entrepreneurs in impoverished remote areas its “business in a box” solution: a subsidized phone plus training, Digicel in Haiti allows phone cards to be recharged from abroad, enabling relatives pay for their phones, many of which are used in local businesses.

These examples have encouraged other multi-national corporations to enter the poor market. Procter & Gamble sells single-use sachets of detergent and shampoo that are affordable for the poor in urban areas in India, China, and South America who are just below the middle class.

Other corporations can learn a great deal from these examples of creative ways of generating purchasing power among consumers with much lower income.

Question 5In the event that one BRIC country, if not all, fails to meet its projected performance, what would be some of the implications for the economic environment of international business?

ANSWER:

One has to look at the present state of BRICs to see if it has failed. So far, none has declared that it is a failure. However, analysts warn that the slowing down or deepening woes of key emerging countries could tip a teetering global economy into another recession. In the BRICs, the vast majority is poor. Unstable government with economic failure may lead to riots, revolts, people overthrow the government, etc. Investors may hastily exit from the country. If one BRIC fails, it may affect others and the global economy. It can also result in high unemployment and civil wars which may escalate into refugee problems. It will also cause imbalance in the world economy that was once dominated by the western world.

Table 1. BRICs economic comparison. Source: The Globe and Mail (2016).

Brazil2.8% – Share of world output$1.8-trillion (U.S.) – GDP204 million – Population$8,802 (U.S.) – Per capita GDP$5.45-billion (U.S.) – Stock market capitalization

Russia3.1% – Share of world output$1.23-trillion (U.S.) – GDP146 million – Population$8,447 (U.S.) – Per capita GDP$388-billion (U.S.) – Stock market capitalization

India7.1% – Share of world output$2.18-trillion (U.S.) – GDP1.29 billion – Population$1,688 (U.S.) – Per capita GDP1.516-billion (U.S.) – Stock market capitalization

China17.2% – Share of world output11.385-trillion (U.S.) – GDP1.375 billion – Population$8,280 (U.S.) – Per capita GDP$7.09-billion (U.S.) – Stock market capitalization

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With the addition of South Africa into the BRICs to form BRICS, their economy holds more than 30% of the world output. The impact would be devastating to the world economy especially if China or India failed.

Question 6Compare and contrast the merits of GNI per capita versus the idea of purchasing power parity, human development, and green economics as indicators of economic potential in Brazil, Russia, China, and India.

ANSWER:

GNIThe gross national income (GNI) is the income generated both by total domestic production as well as the international production activities of national companies. The GNI per capita is simply the GNI divided by the population which is the average annual income for each person in a country measured in US$ per after the currency exchange.

Let’s say a country has a relatively high GNI per capita. What does that tell us? Is their standard of living better that others? Can they afford housing? The GNI per capita alone does not tell us anything more other than the average income of a given population. If the income disparity is large as in the BRICs, surely there will be many poor people who do not earn as much but have lesser standard of living. As an indicator of economic potential in the BRICs, it has some merits. It shows the relative performance of the countries.

PPPHowever, macroeconomic analysis relies on several different indicators to compare economic productivity and standards of living between countries and across time. One popular indicator is the purchasing power parity (PPP).

In economics, purchasing power parity (PPP) asks how much money would be needed to purchase the same goods and services in two countries, and uses that to calculate an implicit foreign exchange rate. Using that PPP rate, an amount of money thus has the same purchasing powering different countries. Among other uses, PPP rates facilitate international comparisons of income, as market exchange rates are often volatile, are affected by political and financial factors that do not lead to immediate changes in income and tend to systematically understate the standard of living in poor countries.

HDINienhuys (2013) believes that the economic growth indicator by GNI is outdated and suggests the human development index (HDI) instead.

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The Human Development Index (HDI) is a much better indicator for comparing countries than GNI (gross national income), but it only gives a ranking on a development ladder, and not a value. Bhutan for example, evaluates its national situation by considering welfare and happiness as the most important indicators.

A few billionaires and a larger group of millionaires on the one hand and many millions of people living in poverty on the other hand, as in India and China, may still produce a reasonable economic growth figure as in GNI per capita, even if the situation is not very social or democratic.

Moreover, HDI is also comparative measure of life expectancy, literacy, education, and standards of living for countries worldwide. Thus, by combining indicators of real purchasing power, education, and health, the index offers a comprehensive measure of a country’s standard of living that incorporates both economic and social variables.

Green EconomicsAs GNI indicator is too money oriented, Green economics is a methodology of economics that supports the harmonious interaction between humans and nature and attempts to meet the needs of both simultaneously. The green economic theories encompass a wide range of ideas all dealing with the interconnected relationship between people and the environment. Green economists assert that the basis for all economic decisions should be in some way tied to the ecosystem, and that natural capital and ecological services have economic value. (Investopedia, 2017).

For example, China is battling with industrial pollution due to the economic growth. If not addressed properly, economic growth can be detrimental to the planet and future generations will suffer as it becomes more and more inhabitable.

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ReferencesInvestopedia. (2017). Green Economics. Retrieved 8 February, 2017, from

http://www.investopedia.com/terms/g/greeneconomics.asp

Milner B & York G. (2016). The Crumbling BRICS. The Globe and Mail, Retrieved 8 February, 2017, from http://www.theglobeandmail.com/report-on-business/international-business/why-the-brics-failed-to-meet-lofty-expectations/article29652151/

Nienhuys, S. (2013). The Broker - Connecting Worlds of Knowledge: GNP and GNI are outdated. Retrieved 8 February, 2017, from http://www.thebrokeronline.eu/Blogs/Inequality-debate/GNP-and-GNI-are-outdated

O'Neill, J. (2001). Building Better Global Economic BRICs. Goldman Sachs Research, 66(1), 1-15.

The Malay Mail Online. (2016). After Malaysia-China’s RM144b deals, pundits say more investments possible. Retrieved 6 February, 2017, http://www.themalaymailonline.com/malaysia/article/after-malaysia-china-rm144b-deals-pundits-say-more-investments-possible#sthash.zggkyiFl.u9DyfpaR.dpuf

The Star. (2016). Najib: China Investment in Malaysia Set to Expand. Retrieved 6 February, 2017, http://www.thestar.com.my/business/business-news/2016/11/01/najib-says-china-investment-in-malaysia-set-to-expand/#fLjGPO3VtokzsZ8v.99

Warnholz, J.L. (2008). Even the Poorest Can Be a Thriving Market. Harvard Business Review, 1(1), 1. https://hbr.org/2008/05/even-the-poorest-can-be-a-thriving-market

Wilson D & Purushothaman R. (2003). Dreaming With BRICs: The Path to 2050. Goldman Sachs Research, 99(1), 1-24.

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