the global business environment

7/28/2019 The Global Business Environment

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Globalization has changed us into a company that searches the world, not just to sell or to source, but to fnd

intellectual capital - the worlds best talents and greatest ideas.

Jack Welch, ormer General Electric CEO

We are moving toward a global economy. One way o approaching that is to pull the covers over your head.Another is to say: It may be more complicated - but thats the world I am going to live in, I might as well be

good at it.

Phil Condit, ormer CEO and Chairman o Boeing

The global economy has undergone a vast transormation in the past 20 years:

Economic linkages among countries are growing rapidly. Since World War II, the growth rates o both

trade and cross-border investment have consistently exceeded the growth o economic output at the

global and regional levels, and or nearly all countries.

Since the late-1980s, economic liberalization has spread around the world. Ater decades o economic

isolation, countries such as China, India, Russia, Brazil, Egypt, Mexico, and others have joined the

global economy (see Figure 1 on page 5 or a graphical depiction o this phenomenon).

Nearly hal o global Gross Domestic Product (GDP) growth is projected to occur in developing countries

in the next 25 years (see Table 5 on page 7). In a recent study, Goldman Sachs projected that China,

India, Russia, and Brazil will all be among the worlds six largest economies by 2050 (this study is

discussed in more detail below).

The past decade has witnessed the rise o developing country-based multinational rms in sectors

as diverse as pharmaceuticals, brewing, banking, white goods, and inormation technology. Until

recently, nearly all global rms were based in the United States, European Union, or Japan (see the

Going Global case series or several examples).

Globalization is now occurring rapidly in service activities. Globalization has traditionally been

concentrated in the natural resources and manuacturing sectors, which employ about 16% o U.S.

workers. The services sector provides 78% o employment. (See Exhibit 3 or a depiction o costsavings rom moving an activity oshore.) The globalization o services is causing rms to actively

reengineer their global operations to better access and leverage global resources.

To provide context, Exhibits 1 and 2 present world maps scaled by, respectively, economic output and

population. The patterns evident in these maps indicate the challenge and opportunity that globalization

The Global Business Environment

Proessor Robert E. Kennedy developed this note. 2008, Robert E. Kennedy.

note1-428-65107 August 2004

THEWILLIAM DAVIDSON INSTITUTE


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The Global Business Environment 1-428-651

creates or managers. For example, the United States has only 4.6% o the worlds population but produces

about 26% o global economic activity. At the other extreme, India has about 16.5% o the global population,

but produces only about 1.4% o global output. As India enters the global economy through closer trade and

investment linkages, it will aect the global economy in many ways. Its customers represent vast potential

markets. Its workers are skilled and very low cost. And its rms will create tremendous pressures or global

industries to restructure. These eects will unold over decades and will have a proound impact on nearly

all sectors o the economy and every prominent managers career.

This note provides a brie prole o the global business environment. It is organized into our sections.

The rst discusses how economic perormance is measured and presents comparative gures or a sample

o countries. The second reviews why rms trade and invest across borders and why governments generally

encourage such activity. The third section discusses global economic trends. The ourth presents several

projections or how the global economy will evolve in the next ew decades.

Measuring Economic Performance

Economic perormance is oten discussed using a concept called Gross Domestic Product (GDP). GDP is

dened as the total value o all nal goods and services produced within a country during a specied period(most commonly one year).

GDP is dened as:

GDP = consumption + investment + government expenditures + (exports imports)

GDP measures current economic activity within a country. A closely related concept is Gross National

Product (GNP), which measures economic activity by a countrys actors o production (people and capital).

In practice, the measures track closely or most countries.

GDP is by no means a perect measure o well being. It measures only currently produced goods and

services exchanged in market transactions. It ignores non-market events that may improve or subtract rom

the quality o lie. Examples include childrearing, enjoying nature, depleting natural resources, and religiousobservances.

As a stand-alone measure, GDP doesnt provide much insight. To understand a countrys economic

perormance, the analyst must compare either levels or growth rates across countries. To do so, a countrys

GDP must be converted to a common standard - typically the U.S. dollar - using some rate o exchange.

At market exchange rates, the United States has by ar the worlds largest GDP, with more than twice

the aggregate output o Japan (see Table 1). GDP comparisons using ocial exchange rates oer a good

indication o a countrys purchasing power and relative position as a supplier in international markets or

goods and services.

While quite logical, using ocial exchange rates can understate the eective domestic purchasing

power o the average producer or consumer in less-developed countries. This is because the relative prices

or goods and services within a country varies widely across countries. For example, compared with energy

or entertainment, domestic help is extremely cheap in India. In the United States, personal services are

relatively expensive, while energy is relatively cheap. Someone with an income equivalent to US $20,000 in

India can live very well, while that income in the United States would be near the poverty line or a amily

o our. One measure that attempts to correct or this distortion is the so-called Purchasing Power Parity

(PPP) exchange rate. The PPP exchange rate is the rate which equalizes the purchase price o a pre-dened

basket o goods. PPP rates oten vary substantially rom market rates. For example, in India, the PPP GDP

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is more than ve times GDP measured at ocial exchange rates. In very rough terms, this tells us that an

Indian worker earning the equivalent o $20,000 lives about as well as a U.S. citizen earning $100,000. When

PPP exchange rates are used to rank GDPs, China jumps rom the seventh to the second largest economy in

the world. India moves rom #12 to #4.

A nal measureperhaps most closely related to living standardsis per capita GDP. This measures

economic output per person. As the table indicates, many o the countries with the highest GDP per capita

are small, relatively specialized economies like Luxembourg, Bermuda, and the Cayman Islands. There is no

single best measure o economic perormance. Per capita GDP is a reasonable approximation o standard o

living. Market rate GDP indicates a countrys aggregate infuence in global markets. The United States isunique in that it appears near the top o all our lists. As we will see later, several prominent analysts predict

that large developing countriesspecically Brazil, Russia, India, and China (the so-called BRICs)will

become much more predominant in global GDP rankings in the next ew decades.

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Table 1

Global Rankings

Ranking Population (millions) Aggregate GDP (billion USD) PPP GDP Per Capita GDP

1 China 1,288 United States 10,881 United States 10,871 Luxembourg 55,100

2 India 1,064 Japan 4,326 China 6,435 United States 37,800

3 United States 291 Germany 2,400 Japan 3,582 Norway 37,700

4 Indonesia 214 United Kingdom 1,794 India 3,096 Bermuda 36,000

5 Brazil 176 France 1,747 Germany 2,279 Cayman Islands 35,000

6 Pakistan 148 Italy 1,465 France 1,632 San Marino 34,600

7 Russia 143 China 1,409 United Kingdom 1,606 Switzerland 32,800

8 Bangladesh 138 Spain 836 Italy 1,559 Denmark 31,200

9 Nigeria 135 Canada 834 Brazil 1,371 Iceland 30,900

10 Japan 127 Mexico 626 Russia 1,318 Austria 30,000

Luxembourg 0.45 India 586 Canada 963 Russia 8920

Bermuda 0.06 Brazil 492 Turkey 477 India 520

Cayman Islands 0.04 Nigeria 50 Nigeria 139 Nigeria 320

Source: World Bank Quick Reerence Tables

Table 2

GDP Growth Rates 1990-2002 (selected countries)

Low/Middle Income Countries (%) High Income Country (%)

China 9.7 United States 3.3

India 5.8 Germany 1.6

Poland 4.3 Norway 3.6

Argentina 2.7 France 1.9

Malaysia 6.2 Japan 1.3

South Africa 2.2 Australia 3.8

Low/Middle income countries 4.3 High income countries 2.5

Source: Global Economic Indicators


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Economic perormance over time is generally measured in terms o growth rates. As a general rule, well-

managed developing countries grow at aster rates than developed countries. This is because they can import

capital and technology and ollow a development path already blazed by more developed countries. (Table 2

summarizes 12-year growth rates or a selection o countries.)

Why Trade and Invest Across Borders?

History shows that embracing the global economy is crucial to economic growth in rich countries

and or development in poor ones. Scan the list o the worlds most successul countries over the past 50

yearsthe United States, Germany, France, Japan, China, Chile, and South Korea. In every case, encouraging

cross-border trade and investment fows has been a central element o the countrys economic strategy.

At the other extreme, countries that have resisted globalization have generally lagged their more open

neighborsor example, Burma, Tanzania, Aghanistan, the USSR prior to 1989, Venezuela, Zimbabwe ater

1997, and India prior to 1991.

Engagement in international trade and investment is integral to economic growth because it increases

the productivity o local resources, which invariably leads to higher productivity, wages, and living standards.

Free trade encourages a country to ocus on those things it does relatively well, and to stop doing things itdoes relatively poorly (economists reer to this as comparative advantage). A countrys standard o living can

rise only when the eciency with which it uses its resources (people, capital, etc.) improves. Tradealong

with education, investment, and technological progressare important drivers o productivity growth.

Trade has a second important benet. It increases the range and quality o options available to local

consumers and orces local producers to improve their oerings in order to compete more eectively. This

pressure is inconvenient or local producers but it benets consumers. Countries that have lowered their

tari barriers and increased the intensity o competition in the local market oten see rapid improvements

in productivity as local producers rush to upgrade their products and processes.

Much o the discussion around trade policy ocuses on the ate o specic workers who are displaced rom

trade-exposed industries. For example: How are North Carolina textile workers supposed to compete withSri Lankan workers making one dollar a day? Framing the issue this way ignores the wider benets o trade.

Everyone in a country benets rom the productivity improvements generated by tradeboth those engaged

in tradable activities and those in so-called non-tradable sectors such as education, security services,

healthcare, construction, hospitality, and personal services. Increasing productivity is always accompanied

by the dislocation and reallocation o productive resources, but the overall benets to the economy vastly

outweigh the costs to individual dislocated workers. Consider restaurant workers. U.S. bartenders and wait

sta earn 50-70 times more than their counterparts in India. They dont work 50 times as hard, nor are they

50 times more productive. They enjoy high wages because the overall U.S. economy is 50-70 times more

productive than Indias and a signicant portion o that wealth fows to hospitality workers, teachers, etc.

A displaced textile worker may be individually worse o, but those costs are vastly outweighed by the cost,

quality, and income improvements or society as a whole.

FDI

Foreign direct investment(FDI) also leads to an array o benets. In addition to providing capital to

und investment, direct investors (that is, those that invest directly in rms or physical assets, not publicly

traded securities) typically provide technology, links to supply and distribution chains, and management.

These actors all raise the productivity o local resources, thus raising wages and the standard o living. Much

o Chinas export growth in the past two decades has been driven by oreign-invested production acilities.

Investment capital was necessary, but other actors were just as important. Nearly all academic studies

indicate that recipient countries realize many and varied benets rom FDI.


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Many actors beyond trade infuence a countrys standard o living, including history, natural

endowments, and proximity to developed country markets. Most o these actors are xed, whereas trade and

investment policy are decision variables. Experience and numerous academic studies indicate that openness

to international trade and investment fows are critical ingredients or development.

Global Economic Trends

The global economy is in the midst o a vast transormation. Globalization can be measured in many

waysby exploring government policies, with actual trade and investment fows, or with many other

methods. Nearly every measure, however, shows that economic linkages among countries have become more

extensive. We review three measures here.

The rst explores a countrys openness to international trade and investment. First suggested by Sachs

and Warner (1994) and updated by Ghemawat and Kennedy (2000), this methodology uses seven actors

to calculate a policy openness index or 192 countries. Factors include: average tari rates, regulatory

restrictions on FDI, the presence or absence o a two-tiered oreign exchange system, etc. Figure 1 charts the

global shares o market GDP, purchasing power parity GDP, and population in countries that are considered

open to the global economy. This doesnt mean that all, or even most, citizens in these countries areengaged in global commerce, just that their national governments are not preventing them rom doing so. As

the chart illustrates, the share o global population living in open economies was airly steady rom the early

1960s through the mid-1980s. Then, starting around 1986 and accelerating in the early 1990s, dozens o

countries implemented programs o economic liberalization that deregulated domestic markets and lowered

barriers to trade and investment. In a period o just 13 years (1985 - 1998), the percentage o people living

in open economies rose rom 23% to 78%.

Global shares o GDP and PPP-GDP ollow a similar, but less dramatic pattern.

Measures o trade and oreign direct investment as a percentage o economic activity ollow a similar

pattern. Since the end o World War II, global GDP growth has averaged around 3.7%, with wide variation

across countries and regions o the world. Global trade has grown at a 7.2% compound annual rate, and

oreign direct investment fows have grown at a 9.6% rate. Measured as a percentage o country or global

economic output (see Table 3) exports and imports (not reported here) have steadily increased.

Figure 1

Global Openness Shares

0%

10 %

20 %

30 %

40 %

50 %

60 %

70 %

80 %

90 %

100%

Populat ion Market GDP PPP GDP


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A similar pattern is evident with oreign direct investment. While the year-to-year fows o FDI are quite

volatile, the cumulative stock o FDI has shown a steady increase since 1960. The rate o increase appears

to have accelerated since the early 1980s.

It is, o course, possible that these trends will reverse. But this seems unlikely. A consensus has developed

among development proessionals and the vast majority o national economic policymakers regarding how

best to help poor countries develop. This view holds that relatively ree prices, investment in education,

decentralized capital allocation, and openness to the global economy are the best paths out o poverty. Aterdecades o stop-go policy experimentation, the overwhelming majority o low- and middle-income countries

have implemented programs o economic liberalization. For those that stay the course, the uture looks

brighter than the recent past.

Projections

Over the next fve years, our experts project that eight developing countries - Brazil, China, India, Mexico,

Poland, Russia, South Korea and Thailand - will account or about 50 percent o global auto-industry

growth.

Rick Wagoner, CEO General Motors Corporation, Jan. 2003

World Bank Projections

Every year, the World Bank publishes an in-depth study entitled, Global Economic Prospects and the

Developing Countries. This book explores a variety o issues acing developing countries and, based on

current and anticipated policies, projects GDP growth by income group and region. Table 5 is adapted rom

the 2002 edition o the publication.

As o 2000, high income countries accounted or about 78% o global GDP and were orecast to grow

at their historical rate o 2.6% in the decades to come. The projections or the low- and middle-income

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Table 3

Global Merchandise Exports as a Percentage of GDP

Country 1950 1973 1992 2000

United States 3.0 5.0 8.2 11.7

Germany 6.2 23.8 32.6 34.5

Japan 2.3 7.9 12.4 10.8

China 1.2 2.1 17.5 27.6

India 2.6 4.2 9.0 11.2

World 7.0 11.2 13.5 20.1

Source: World Bank Global Economic Indicators

Table 4

World FDI Stock as a Percentage of World Output

1960 1975 1980 1985 1991 1997

4.4 4.5 4.8 6.4 8.5 11.8


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countries, however, were a revelation. The World Bank projected that low- and middle-income countries

would grow at more than twice the rate o high-income countries (5.5% vs. 2.6%) and that low-income

countries in every geographic region would outperorm the high income countries as a group. For the rst

time, the World Bank was projecting across the board convergence in income levels.

The projections indicate that nearly hal o global GDP growth over the next 25 years will occur in

developing countries. As a group, these countries will grow their share o global GDP rom 22% to 37%. Thisis a development that ew international rms can aord to ignore.

Goldman Sachs BRICs Analysis

Goldman Sachs, the well respected investment bank, issued a widely infuential study in October 2003

that changed the way many managers view the uture o the global economy. The paper, Dreaming theBRICs: The Path to 2050, projected economic growth or the six largest economies today (the G6, which

includes the United States, Japan, Germany, the U.K., France, and Italy) with projected growth or our large

developing countries it labeled the BRICs (Brazil, Russia, India, and China).

The study built an economic model that considered current economic policies, capital accumulation,

demographics, and technical innovation. The conclusions are interesting and have caused a undamental

reassessment o emerging market strategies in many leading companies. Conclusions include:

Over the next 50 years, the BRICs will become a much larger orce in the world economy. O todays

G6, only the United States and Japan will remain among the six largest economies in 2050.

As early as 2009, incremental GDP growth in the BRICs will exceed growth in the G6.

Total GDP or the BRICs will surpass the current G6 by 2039.

The list o the worlds largest economies will look much dierent in 2050. Many o the largest

economies will no longer be among the richest. This will make strategic planning and choices much

more complex or international rms.

Table 6 summarizes the aggregate GDP projections or each group o countries over the next 50 years.

By 2050, the our BRICs will account or more than 60% o these 10 countries output.

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Table 5

Projected GDP Growth by Income Level and Region

GDP Growth Projected GDP Share GDP Share % Incremental1974-98 Growth 2000 in 2025 Growth

High Income Countries 2.6% 2.6% 78.0% 62.6% 52.3%

Low - and Middle Income 3.6 5.5 22.0 37.4 47.7

East Asia 6.9 7.5 6.3 17.9 25.6

South Asia 5.3 5.9 2.0 3.7 4.9

Latin Am and Caribbean 2.9 4.4 7.0 9.0 10.4

Cent. Europe/ Cent. Asia 1.4 5.2 3.7 5.8 7.2

Middle East / N. Africa 1.9 3.7 1.9 2.0 2.1

Sub-Saharan Africa 2.3 4.2 1.1 1.3 1.5


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The projections are that the United States will continue to have the highest per capita GDP, but that

China will become the largest economy, with India a close third and every other country ar behind.

The study also projected development paths or individual countries. All our BRICs are projected to

close the per capita GDP gap with todays leaders, with Russia orecast to catch and surpass Germany by the

end o the period. Table 7 summarizes the current and projected GDP measures or a selection o countries.

Conclusion

The global economy has undergone substantial changes in the past 20 years. It is likely to change even

more over the next 50 years. The engines o growth in the new global economy are increasingly located

in developing countries. How managers seize these opportunities and manage the challenges these trends

create will determine the success or ailure o their companies, and o their careers.

Table 6

Projected GDP (billions of 2004 USD)

2005 2010 2020 2030 2040 2050

Current G6 22,548 24,919 29,928 35,927 44,072 54,433

BRICs 3,330 5,441 12,248 24,415 47,013 84,201

Table 7

Current and Projected GDP Measures (billions of 2004 USD)

United States Germany Brazil Russia India China

2000

GDP 9,825 1,875 762 391 469 1,078

per capita GDP 34,797 22,814 4,338 2,675 468 854

2050

GDP 35,165 3,603 6,074 5,870 27,803 44,453

per capita GDP 83,710 48,954 26,592 49,646 17,366 31,357


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Exhibits

Exhibit

1

GDP-WeightedMapoftheWorld


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10

Exhibit

2

Population-WeightedMapoftheWorld


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Exhibit 3

Total Delivered Cost as a Percentage of US Cost

80%

65%55%

48%40% 40%

35%

0%

25%

50%

75%

100%

Auto Parts Textiles SW - DetailedDesign SW-TestingCoding SW -Maintenance Call Center PaymentSevices

"Manufacturing" "Services"

Potential for Trade

% US Employment


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The William Davidson Institute is a non-prot, independent,

research and educational institute which is dedicated to developing and

disseminating expertise on business issues in emerging economies. It was

established at the University o Michigan in 1992, and today integrates

research, executive education, and practical project-based assistance in

order to:

generate knowledge o, and management skills or, emerging

economies

oer unique educational opportunities to individuals and both

indigenous and multinational companies which operate in

emerging economies

provide a orum or managers and public policy-makers to discuss

business issues in emerging economies

For more inormation: www.wdi.umich.edu

GlobaLens is the William Davidson Institutes online resource or

international business educators. It eatures:

Cases: a searchable catalogue o international business cases,

exercises, and other teaching materials

Courses: a searchable library o syllabi or developing international

business courses

Community: an interactive space or discussing international

business cases, courses, and teaching issues

For more inormation: www.globalens.com

the global business environment

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