International Business (9th, Wild) - Notes for Chapter (4).doc

14 Ch 4: Economic Development of Nations 13 Ch 4: Economic Development of Nations Chapter 4 Economic Development of Nations Learning Objectives: 4.1 Explain economic development and how it is measured. 4.2 Describe economic transition and its main obstacles. 4.3 Outline the various sources of political risk. 4.4 Explain how companies can manage political risk. 4.5 Describe China’s and Russia’s experiences with economic transition. Chapter Outline: Introduction Economic Development Classifying Countries Developed Countries Newly Industrialized Countries Developing Countries National Production Uncounted Transactions Question of Growth Problem of Averages Pitfalls of Comparison Purchasing Power Parity Human Development Economic Transition Managerial Expertise Shortage of Capital Cultural Differences Sustainability Political Risk Conflict and Violence Terrorism and Kidnapping Property Seizure Policy Changes Local Content Requirements Managing Political Risk Adaptation Information Gathering Political Influence International Relations The United Nations Emerging Markets and Economic Transition China’s Profile Chinese Patience and Guanxi China’s Challenges Russia’s Profile Russia Challenges Bottom Line for Business A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 4. These slides and the lecture outline below form a completely integrated package that simplifies the teaching of this chapter’s material. Lecture Outline I. INTRODUCTION This chapter introduces different economic systems and their effect on international business. It explains each type of economic system, economic development, how nations are classified, and how countries implement market-based economic reforms. II. ECONOMIC DEVELOPMENT Economic development is a measure for gauging the economic well-being of one nation’s people as compared with that of another nation’s people. It reflects economic output (agricultural and industrial); infrastructure (power and transportation facilities); physical health and level of education; and cultural, political, legal, and economic differences. A. Classifying Countries Classifications normally based on indicators such as GNP per capita, portion of the economy devoted to agriculture, amount of exports in the form of industrial goods, and overall economic structure. 1. Developed countries Highly industrialized, highly efficient, and whose people enjoy a high quality of life. People receive the finest health care and benefit from the best educational systems in the world. Examples are Australia, Canada, Japan, New Zealand, the United States, all western European nations. 2. Newly industrialized countries (NICs) Recently increased the portion of national production and exports derived from industrial operations. Mainly in Asia and Latin America: Hong Kong, South Korea, Singapore, Taiwan, Brazil, China, India, Malaysia, Mexico, South Africa, and Thailand. Depending on the pivotal criteria used for classification, a number of other countries could be placed in this category, including Argentina, Brunei, Chile, the Czech Republic, Hungary, Indonesia, the Philippines, Poland, Russia, Slovakia, Turkey, and Vietnam. Combining NICs with those having potential to become a NIC forms a category called emerging markets. 3. Developing countries Poor infrastructure and extremely low personal income. Rely on one or a few sectors of production—agriculture, mineral mining, or oil drilling. They often lack resources and skills. Mainly in Africa, the Middle East, and the poorest nations in Eastern Europe and Asia. Often characterized by technological dualism—use of the latest technologies in some sectors of the economy coupled with the use of outdated technologies in other sectors. B. National Production Can classify countries by gross national product per capita, but there are problems using GNP and GDP as indicators of development. 1. Uncounted transactions Volunteer work, unpaid household work, illegal activities such as gambling and black market (underground) transactions, and unreported cash transactions. Shadow economy can be so large and prosperous that official statistics are meaningless. Barter is an alternative for buyers who lack hard currency to pay for imports (e.g., Pepsi-Cola in USSR). 2. Question of growth GNP and GDP are a snapshot of one year’s economic output, and do not indicate whether an economy is growing. 3. Problem of averages Per capita figures are averages. Urban areas can be more developed than rural areas and have higher per capita income. 4. Pitfalls of comparison To compare gross product per capita, each currency must be translated into a single currency. Official exchange rates do not show what the local currency can buy in its home country. C. Purchasing Power Parity Purchasing power is the value of goods and services that can be purchased with one unit of a country’s currency. Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. Using purchasing power parity to compare the wealth of nations (e.g., Swiss GDP per capita is $47,900 but only $34,700 at PPP compared to U.S. GDP at PPP of $39,700). D. Human Development Human development index (HDI) measures extent to which a people’s needs are satisfied and the degree to which these needs are addressed equally across a nation’s entire population. Three dimensions: a long and healthy life, an education, and a decent standard of living. (See Table 4.1) There is often disparity between wealth and HDI. HDI demonstrates that high national income alone does not guarantee human progress. III. ECONOMIC TRANSITION Changing a nation’s fundamental economic organization and creating new free-market institutions. Typically involves several reforms: Stabilize the economy, reduce budget deficits, and expand credit availability. Allow prices to reflect supply and demand. Legalize private business, sell state-owned firms, and support property rights. Reduce barriers to trade and investment and allow currency convertibility. A. Managerial expertise Central planners had little need for management skills including production, distribution, pricing, and marketing strategies; investigating consumer wants and needs and conducting research; competitively pricing products; or advertising. Yet the gap in education and experience between managers from the former communist nations and others has narrowed. Shortage of capital Transition is expensive, requiring spending to: Develop a telecommunications and infrastructure system Create financial institutions, including stock markets and a banking system. Educate people in the ways of market economics. Cultural differences Transition causes cultural change and replaces dependence on the government with greater emphasis on individuals. Often cuts are in welfare, unemployment benefits, and guaranteed government jobs. Sustainability Economic and social policies of former communist governments in Central and Eastern Europe were disastrous for the natural environment. Environmental destruction is evident in increased levels of sickness and disease, which cause lower productivity in the workplace. IV. POLITICAL RISK Political risk is the likelihood that a government or society will undergo political changes that negatively affect local business activity. It can threaten an exporter’s market, manufacturing facilities, and the ability to repatriate profits. Political risk levels vary from nation to nation (See Map 4.2). Macro risk threatens all companies regardless of industry affects all companies equally in a country, both domestic and international. Micro risk threatens companies within a particular industry or even smaller groups. Five events can cause political risk: A. Conflict and violence Macro risk threatens all companies regardless of industry and affects all companies equally in a country, both domestic and international. Micro risk threatens companies within a particular industry or even smaller groups. Five events can cause political risk: Local conflict discourages investment. Violence hinders manufacturing, obtaining materials and equipment, and recruiting talented personnel. It can arise from: (1) resentment toward the government; (2) territorial disputes; and (3) ethnic, racial, and religious disputes. Terrorism and kidnapping Used to make political statements. Groups dissatisfied with current political or social situations try to force change through fear and destruction. Kidnapping and hostage-taking can fund terrorism Property seizure Confiscation is the forced transfer of assets from a company to the government without compensation. There is no framework for legal appeal, and compensation is far below market value. Expropriation is the forced transfer of assets from a company to the government with compensation. Nationalization involves government takeover of an entire industry and is more common than confiscation and expropriation. It is used to: (1) protect an industry for ideological reasons, (2) save local jobs in an ailing industry, (3) control industry profits so they cannot be transferred to low tax-rate countries, and (4) invest in industries (such as public utilities) that private companies cannot afford. Policy changes Result from newly empowered political parties, pressure from special interests, and civil or social unrest. One policy tool restricts ownership to domestic companies or limits ownership by nondomestic firms to a minority stake. Other policies relate to investments made across borders. Local content requirements Specify an amount of a product to be supplied locally. Can foster local business activity and create jobs. Force companies to use local raw materials, procure parts from local suppliers, or employ local workers. May force a firm to take on poorly trained or excess workers, and local raw materials could increase costs or reduce quality. MANAGING POLITICAL RISK Companies manage political risks that threaten operations and future earnings. A. Adaptation: Incorporate risk into business strategies, often with the help of local officials. Partnerships can be used to leverage expansion plans through informal arrangements or joint ventures, strategic alliances, and cross-holdings of company stock. Localization entails modifying operations, the product mix, or other elements to suit local tastes and culture. Development assistance allows an international business to assist the host country in developing distribution and communications networks and improving the quality of life for locals. Insurance can be used to protect companies against losses and can provide project financing. The Overseas Private Investment Corporation (www.opic.gov) insures U.S. companies that invest abroad against loss and can provide project financing. B. Information gathering: Predict and manage political risk. Sources include employees with information and political risk agencies. Current employees with relevant information: people who worked in the country and have valuable contacts and knowledge. Agencies specializing in political-risk services: such as banks, political consultants, news publications, and risk-assessment services. C. Political influence: Deal with local lawmakers and politicians directly or through lobbyists. Lobbying: policy of hiring people to represent a company’s views on political matters. Foreign Corrupt Practices Act forbids U.S. companies from bribing government officials or political candidates in other countries (unless a person’s life is in danger). A bribe constitutes “anything of value” and cannot be given to any “foreign government official” empowered to make a “discretionary decision” that may be to the payer’s benefit. D. International Relations Favorable political relationships foster stable business environments and increase international cooperation. Stable environments require a strong legal system to resolve disputes quickly and fairly. Multilateral agreements are treaties concluded among several nations, each of which agrees to abide by treaty terms even if tensions develop. E. The United Nations Formed after the Second World War to provide leadership in fostering peace and stability around the world. The UN and its many agencies provide food, medical supplies, educational supplies and training, and financial resources to poor member nations. Receives funding from member contributions based on gross national product (GNP). Entire world is involved with the UN in some manner. UN system consists of six main segments: (1) General Assembly; (2) Security Council; (3) Economic and Social Council; (4) Trusteeship Council; (5) International Court of Justice; and (6) the Secretariat. Within the UN Economic and Social Council is the United Nations Conference on Trade and Development (UNCTAD). The organization has a broad mandate in international trade and economic development. VI. EMERGING MARKETS A. China’s profile—China’s theme is “Socialism with Chinese characteristics,” and the nation has undergone great economic reform over the past two decades. 1. Early years 1949: Communes planned all agricultural and industrial production and schedules. Rural families owned their homes and land and produced particular crops. 1979: Government reforms allowed families to grow crops they chose and sell produce at market prices. 1984: Township and village enterprises (TVEs) obtained materials, labor, and capital on open market and used a private distribution system. TVEs laid the groundwork for a market economy. Mid-1980s: Foreign companies were allowed to form joint ventures with Chinese partners. In 1988, China has relaxed government control over private property. China began selling “land-use rights” for residential, commercial, and other uses to raise capital and formalized the practice into law in 1994. In a capitalist economy this would be called private land ownership. 2. Challenges ahead Political and social problems loom. Skirmishes between secular and Muslim Chinese, and democracy restricted. Unemployment, slow economic progress in rural areas, and misery of migrant workers. China’s one country, two systems policy must preserve order, as Taiwan is watching closely. Russia’s Profile Russia’s experience with communism began in 1917. For 75 years, government controlled all aspects of production and distribution, including prices of labor, capital, and products. 1. Rough transition In the 1980s Russia entered a new era of freedom of thought, freedom of expression, and economic restructuring. Except for criminals and the wealthy, people have difficulty maintaining their standard of living and buying necessities. Some Russians survive because they were factory managers under the old system and retained their jobs. Others have turned to the black market or organized crime. Today, Russia is far more stable as it has made progress on corruption although a good deal undoubtedly remains. 2. Challenges ahead Managers must improve skills in every facet of management practice, including financial control, research and development, employee hiring, training, marketing, and pricing. Political instability, especially nationalism. Nuclear weapons sales for cash can be lucrative, despite the clear threat to global security and Russia itself. Russia and Georgia had a military confrontation in the summer of 2008 over two of Georgia’s restive republics that wanted to draw closer to Russia. Then, in 2014, Russia annexed the Ukraine’s peninsula of Crimea, arguing that the ethnically Russian people in Crimea voted to break away from Ukraine and to become part of Russia. Many nations swiftly rebuked Russia’s actions and some, including the United States, imposed political and economic sanctions. Unstable investment climate causes uneasiness in Russia (e.g., arrest of Mikhail Khodorkovsky, then head of oil giant Yukos, for fraud, embezzlement, and tax evasion). BOTTOM LINE FOR BUSINESS Ongoing market reforms in formerly centrally planned and mixed economies have a profound effect on international business. Freer markets are spurring major shifts in manufacturing activity. Lured by low wages and growing markets, international companies are forging ties in newly industrialized countries and exploring opportunities in developing nations. Global capital markets make it easier to set up factories abroad, and some newly industrialized countries produce world-class competitors of their own. Two topics are likely to dominate conversations on development—the race between China and India and the productivity gap between the United States and Europe. Both China and India have immense potential for growth, and it is only a matter of time before each has a middle class larger than the entire U.S. population. Productivity growth is a key driver of living standards in any nation. Although productivity growth in Europe kept pace with that in the United States for decades, it has fallen behind in recent years. Quick Study Questions Quick Study 1 1. Q: An increase in the economic well-being, quality of life, and general welfare of a nation’s people is called what? A: Economic development is a measure for gauging the economic well-being of one nation’s people, as compared to that of another nation’s people. 2. Q: What are the drawbacks of using national production to measure economic development? A: National production provides a good estimate of a nation’s overall wealth. It provides marketers with a broad indicator of whether a nation’s people are wealthy enough to purchase their products. It also gives managers an overall indicator of whether a nation has the level of development to support production facilities. But there are problems with national production as an indicator of economic development. First, estimates for the wealth generated in the official economy can be almost meaningless for countries with large, shadow economies or those that extensively employ barter. Second, national production figures alone do not tell whether an economy is growing, static, or shrinking. Third, national averages ignore differences among different regions within a nation. Fourth, simply converting national production figures at official exchange rates does not provide any indication of the quantity of goods that money can actually buy in an economy. Finally, this indicator takes into account only the financial well-being of a people. 3. Q: The human development index measures what aspects of a nation’s development. A: The United Nations human development index (HDI) evaluates the extent to which a government equitably provides its people with a long and healthy life, an education, and a decent standard of living. This indicator goes beyond estimating only financial wealth and directly assesses human aspects of development. Quick Study 2 1. Q: What does the economic transition process involve? A: Several reform measures include: (1) stabilize the economy, reduce budget deficits, and expand credit availability; (2) allow prices to reflect supply and demand; (3) legalize private business, sell state-owned companies, and support property rights; and (4) reduce barriers to trade and investment and allow currency convertibility. 2. Q: What are the key obstacles for countries in transition? A: (1) A lack of managerial expertise caused by the fact that central planners formerly decided nearly every aspect of the nation’s commercial activities hampers progress today. There was little need for managers to learn management skills including how to develop production, distribution, pricing, and marketing strategies. (2) A shortage of capital presents special problems because of the high cost of economic transition. Governments of nations in transition can often afford only a portion of the required investment. These nations lack capital because of the disastrous financial management during the years of central planning. (3) Economic transition can be especially slow when a nation’s people find reform difficult for cultural reasons. In addition, importing modern management practices without tailoring them to the local culture can have serious consequences. (4) Environmental degradation caused by the headlong rush among transition economies to catch up to developed countries is leaving serious environmental damage in its wake. The direct effects of environmental destruction are evident in increased levels of sickness and disease, including asthma, blood deficiencies, and cancer—which obviously negatively impact national productivity. 3. Q: Transition replaces dependence on the government with greater emphasis on what? A: The process involves several key reform measures to promote economic development. These include: (1) stabilizing the economy, reducing budget deficits, and expanding credit availability; (2) allowing prices to reflect supply and demand; (3) legalizing private business, selling state owned property rights; and (4) reducing barriers to trade and investment and allowing currency convertibility. Quick Study 3 1. Q: How does political abroad risk affect companies? A: Terrorism aims to create fear and force change through the sudden and unpredictable destruction of life or property. Kidnapping and the taking of hostages may be used to fund a terrorist group’s activities. Each of these increases risks for international companies because expatriate executives are prime targets because their companies can afford large ransoms. Property seizure also increases the risks for international firms and can cause them to avoid investing in nations implementing such tactics. Policy changes can result from civil or social unrest or might represent the views of newly empowered political parties. They can cause managers to regard a nation’s business environment as one of a “field of moving goal posts.” Local content requirements are regulations that require international manufacturers to use a certain amount of local resources. They foster local business activity and ease regional or national unemployment, but can also force companies to invest elsewhere if they are too confining. 2. Q: Companies fear open violence and conflict abroad because it can threaten to do what? A: Conflict and violence can arise from people’s resentment toward their government or over territorial disputes between countries. Violent disturbances impair a company’s ability to manufacture and distribute products, obtain materials and equipment, and recruit talented personnel. 3. Q: What is the name given to the forced transfer of assets from a company to the government with compensation? A: Expropriation is the forced transfer of company assets with compensation. Quick Study 4 1. Q: How can a company incorporate political risk into its business strategies? A: (1) Adaptation involves incorporating risk into business strategies—often with the help of local officials. Companies can incorporate risk by establishing partnerships, localizing operations, offering development assistance, and obtaining insurance. (2) Information gathering involves monitoring and even trying to predict political events that could threaten local operations and future earnings. (3) Political influence involves proposing changes that positively affect their local activities, often through lobbying. 2. Q: What is a good source of information to help conduct accurate political risk forecasting? A: There are two sources that companies use to conduct accurate political risk forecasting. Current employees who have worked in a country long enough to gain insight into local culture and politics are often a good source of information. Second, agencies specialized in providing political risk services include banks, political consultants, news publications, and risk assessment services. 3. Q: What might result from unfavorable political relations among countries? A: Unfavorable political relations among countries will foster an unstable business environment, decreasing business opportunities, increasing risk, and hindering economic development. Quick Study 5 1. Q: During what time period did China undergo its most rigorous experience with central planning? A: China began its experiment with central planning in 1949, after the communists defeated nationalists in a long and bloody civil war. 2. Q: What challenges might pose a threat to China’s future economic performance? A: Political and social problems pose threats to China’s future economic performance. The nation’s leadership has poor relations with ethnic minorities and skirmishes between secular and Muslim Chinese in western provinces still occur. For the most part, political leaders restrict advanced democratic reforms. Protests sporadically arise from time to time whenever ordinary Chinese citizens grow impatient with political progress. Another potential problem is unemployment, largely the result of the collapse of state-owned industry, intensified competition, and entry of international companies into China. 3. Q: Over what aspects of Russia’s centrally planned economy did planners exercise control? A: Russia’s experience with Communism began in 1917. For the next 15 years, factories, distribution, and all other facets of operations, as well as the prices of labor, capital, and products were controlled by Russia’s government. 4. Q: What might challenge Russia’s future economic prospects? A: Political instability, especially in the form of intensified nationalist sentiment is a potential threat to progress; for example, The Russia–Georgia military confrontation and the Russian annexation of the Crimean peninsula in the Ukraine in 2014. Finally, Russia’s unstable investment climate is another concern among international business, which stems from the governments attacks on business owners who disagree with official policy and on firms that it wants to control. Ethical Challenge You are managing director of your U.S. firm’s subsidiary in southern France. The social welfare states of Western Europe were founded in the Second World War with specific ethical considerations in mind: reduce social and economic inequality, improve living standards for the poor, and provide nearly free health care for all. Many countries in Western Europe have trimmed social welfare provisions, privatized businesses, and increased their reliance on market forces. 4-5 Do you think that the cultures of Western Europe have changed over the years and that such ethical concerns are a remnant of the past? A: Students responses will vary. Here are some more things that Western European cultures have in common and that American culture does not have in common: (a) Christianity has less fervor; there are fewer fundamentalists and fewer political decisions influenced by religion. (b) Stronger belief in human rights, e. g. against torture, against death penalty, higher tax rates, etc. (c) the government supports a lot of theaters, opera houses, museums, art galleries etc. (d) at least in the UK, France and Germany, social interactions with strangers are generally less openly friendly, wait staff will affect less interest and so on. (e) at least in the UK, France and Germany, social interactions with friends and relatives are deeper. 4-6 Do you think that free-market reforms will simply re-create the conditions that gave rise to the welfare state in the first place? A: Students responses will vary. _Welfare_ States in Europe share several broad characteristics. These generally include a commitment to _full_employment_, _social_protections_ for all citizens, _social_inclusion_, and democracy. Examples common among European countries include _universal_health_care_, free higher education, strong labor protections and regulations, and generous welfare programs in areas such as unemployment insurance, retirement pensions, and public housing. On the other hand, a free market system is one in which the prices of goods and services are determined by the open market and consumers, in which the laws of supply and demand are free from any government intervention. 4-7 What can governments do for workers who become displaced, or perhaps obsolete, in a more open and competitive economy? A: As a manager, you must convey to your workers that there are risks involved with capitalism, yet the potential rewards are great. Ethical issues never become dated. The dilemma of the role of the state in providing for its people was argued two thousand years ago by the great philosophers of the time. The issues remain the same, only the context is different. The reason many Western European nations are cutting back on corporate welfare is because they believe market forces are more efficient at allocating resources in most situations. They are also imposing austerity programs to reduce rising government debt levels since the global recession began in 2008–2009. The extent to which these nations cut back on social-welfare benefits for individuals is difficult to estimate. However, it is highly unlikely that we will anytime soon see the kinds of conditions that existed in Europe immediately following the Second World War. Teaming Up Debate Project. Two groups of four students each will debate the ethics of political lobbying activities in a foreign country where a company does business. After the first student from each side has spoken, the second student will question the opponent’s arguments, looking for holes and inconsistencies. The third student will attempt to answer these arguments. The fourth student will present a summary of each side’s arguments. Finally, the class will vote on which team has offered the more compelling argument. A: Students should be sure to support their arguments with ideas and topics discussed in this chapter. They should also be prepared to defend their positions, after the debate, if they are called on to give a synopsis of their position in class. It may also be useful to give students some time to do outside research to prepare for the debate. Practicing International Management Case Cuba Comes Off Its Sugar High 4-16 Q: Why do you think the Cuban government requires non-Cuban businesses to hire and pay workers only through the government? A: The Cuban government is clearly skimming off the top the difference between what it is being paid for workers and what is actually paid to workers. This allows the government to keep the people under its thumb because they continue to feel powerless with little or no voice in matters. The practice also allows the government to control where these profits go such as into the military, infrastructure, or perhaps into the private offshore bank accounts of politicians and powerful business leaders. 4-17 Q: Suppose Cuba’s government collapses and the nation embarks on a path of economic transition. How might Cuba’s experience differ from that of Russia and China? A: There are obviously a large number of possible scenarios. Students should be encouraged to be creative, yet realistic. They should recognize several important differences between these nations. First, Cuba became communist in 1959 (versus 1917 for Russia) and this might mean that the roots of communism are shallower. Second, the tie with the United States is very strong with there being a large Cuban-American population waiting for economic reform to begin in Cuba so they can invest and help their people’s development. Although there are many Russian- and Chinese-Americans, their proportion is not as great as the proportion of Cuban-Americans relative to the population of Cuba. Third, because of the difference in size between Cuba and the United States, U.S. companies will likely dominate the Cuban landscape very quickly—the scale of which could not occur in Russia or China. 4-18 Q: A U.S. law permits U.S. companies to sue firms from other nations that traffic in U.S. property nationalized by Cuba. The law also empowers the U.S. government to deny entry visas to the executives of such firms as well as their families. Why does the United States maintain such a hard line against doing business with Cuba? A: Implementation and enforcement of this law, called the Helms-Burton Law, have been repeatedly suspended by the United States in fear of reprisals from Canada and European nations. Reasons for the continued embargo are rooted in politics and foreign relations. The main political argument is rooted in continued U.S. policy against allowing a communist nation to operate freely just 90 miles from the United States (the “not in this hemisphere” argument). As far as whether it is in the best interest of the United States, there are again political and economic arguments involved. Obviously, there is no easy answer to such a question. Although U.S. companies cannot invest now, they will likely have little trouble catching up to others as soon as political and economic reforms occur. In discussing whether it is in the United States’ best interest, students might want to consider the perspective of many Cuban-Americans who themselves engage in debate over whether the embargo should continue because of the impact on ordinary citizens. -