International Business

Chapter Four
The Economic Environment

Md Jahidul Islam, MBA, R193134

Chapter Objectives

• To appreciate the importance of the economic analysis

of foreign markets
• To identify the major dimensions of international
economic analysis
• To compare and contrast the economic indicators of
countries
• To profile the characteristics of the types of economic
systems
• To discuss the idea of economic freedom
• To profile the idea, drivers, and constraints of economic
transition

Md Jahidul Islam, MBA, R193134

Introduction
• When a company wants to do business in another
country, it must answer standard questions about
wealth, income, stability, poverty and the like.
• Company managers study economic environments to
estimate how trends affect their performance.
• A country’s economic policies are a leading indicator of
government’s goals and its planned use of economic
tools and market reforms.
• Economic development directly impacts citizens,
managers, policymakers, and institution.

Md Jahidul Islam, MBA, R193134

Introduction
All countries differ in terms of:
-levels of economic development
-economic performance
-economic potential

A firm’s managers must understand the economic

environments of those countries in which it
operates, as well as those of countries in which it
does not, in order to predict how trends and events
the world over will likely affect firm performance.

Md Jahidul Islam, MBA, R193134

Key Economic Forces

• The general economic framework of a country

• Its degree of economic stability
• The existence and role of capital markets
• The presence of factor endowments
• Market size
• The existence of economic infrastructure
• Public policy

Md Jahidul Islam, MBA, R193134

Factor Conditions
Factor conditions: a nation’s inputs into the
production process, such as human,
physical, knowledge, and capital resources
and infrastructure

Not only is it difficult to specify a definitive set

of economic indicators that precisely assess the
performance and potential of a nation’s economy,
but it is also difficult to understand the systematic
relationship of one variable to another.

Md Jahidul Islam, MBA, R193134

Fig. 4.1. Physical and Societal
Influences on
International Business

Md Jahidul Islam, MBA, R193134

Elements of the Economic environment

• Gross national income (GNI):

• Gross domestic product
• Per capita conversion
• Purchasing power parity:
• The Human Development Index

Md Jahidul Islam, MBA, R193134

Gross National Income
Gross national income (GNI): measures the
income generated both by total domestic
production as well as the international
production activities of national companies.
GNI is the value of all production in the
domestic economy plus the net flows of factor
income 9 such as rents, profits, and labor
income) from abroad during a one year period.
Gross domestic product: The total value of all
goods and services produced within a nation’s
borders over one year, no matter whether
domestic or foreign owned companies make
the product.
Md Jahidul Islam, MBA, R193134
Per capita conversion

• Managers transform GNI, as well as many

other economic indicators, by the number
of people who live in a country. This
conversion leads to a per capita estimator
that measures a country’s relative
performance.

Md Jahidul Islam, MBA, R193134

Map 4.2: The World’s Wealth
Measured in Per Capita GNI

Md Jahidul Islam, MBA, R193134

Purchasing Power Parity
Purchasing power parity: the number of units
of a country’s currency required to buy the
same amount of goods and services in the
domestic market that one unit of income
would buy in another country.

Purchasing power parity [PPP] is estimated by calculating

the value of a universal “basket of goods” that can be
purchased with one unit of a country’s currency.
Md Jahidul Islam, MBA, R193134
Map 4.3: The World’s Wealth
Measured in Terms of
Purchasing Power Parity

Md Jahidul Islam, MBA, R193134

The Human Development Index
• Is designed to capture long-term progress
rather than short-term changes
• Measures longevity, knowledge (adult
literacy rates), and standards of living
• Combines indicators of real purchasing
power, education, and health
The human development index provides a more
comprehensive measure that incorporates both
economic and social variables.

Md Jahidul Islam, MBA, R193134

Map 4.4: The Human
Development Index

Md Jahidul Islam, MBA, R193134

Features of an economy

• Inflation
• Unemployment rate
• Debt
– Internal
– external
• Income distribution
• Poverty rate
• Balance of payments
The Consumer Price Index (CIP) measures the average change
in consumer prices over time in a fixed market basket of goods
and services; the misery index represents the sum of a
country’s inflation and unemployment rates.
Md Jahidul Islam, MBA, R193134
Inflation

• Inflation: Inflation is a measure of the

increase in the cost of living.
• A general sustained rise in prices
measured against a standard level of
purchasing power is called inflation.

Md Jahidul Islam, MBA, R193134

Unemployment
• Unemployment: is a measure of the number of workers
who want to work but do not have jobs.
• The unemployment rate is the number of employed
workers who are seeking employment for pay divided by
the total civilian labor forces.
• Countries that are unable to create jobs for their citizens
creates a risky business environment. Generally, people
out of work and unable to find jobs depress economic
growth, create social pressures, and provoke political
uncertainty.

Md Jahidul Islam, MBA, R193134

Debt
• Debt, the sum total of a government’s financial
obligations, measures the state’s borrowing from its
population, from foreign organizations, from foreign
governments, and from international institutions. A
country has two types of debt:
• Internal: portion of the government debt that is
denominated in the country’s own currency and held by
domestic residents.
• External: Debt owed to foreign creditors and
denominated in foreign currency.

Md Jahidul Islam, MBA, R193134

Income distribution

• Income distribution is a description of the

fractions of a population that are at
various level of income.

Md Jahidul Islam, MBA, R193134

Poverty
• Poverty refers to a condition in which a person or
community is deprived of, or lacks the essentials for, a
minimum standard of well being and life. These
essentials can be life sustaining material resource such
as food, safe drinking water, and shelter, they may be
social resources such as access to information,
education, health care, and social status.
• The world bank defines extreme poverty: as living on
less than $1 per day.
• Moderate poverty: as less than $2 per day.

Md Jahidul Islam, MBA, R193134

Productivity

• Productivity measures the efficiency with

which goods and services are produced.

Md Jahidul Islam, MBA, R193134

The Balance of Payments
• reports the total of all money flowing into a
country less all money flowing out of that
country to any other country during a given
period of time
• records a country’s international transactions
amongst companies, governments, and/or
individuals during a given period of time
The Balance of Payments [BOP] is officially known
as the Statement of International Transactions.

Md Jahidul Islam, MBA, R193134

The Balance of Payments:
Key Components
• Current Account
– Value of merchandise exports and imports
– Value of services exports and imports
– Value of income receipts and payments
– Net value of unilateral transfers
• Capital Account
– Value of capital inflows and outflows
– Value of financial inflows and outflows
– Net change in official reserve assets
Md Jahidul Islam, MBA, R193134
Surpluses and Deficits

• A trade surplus indicates that the value of

exports exceeds the value of imports.
• A trade deficit indicates that the value of
imports exceeds the value of exports.

Trends in balance of payments data can

reveal important strategic implications with
respect to a country’s economic environ-
ment and potential economic policies.
Md Jahidul Islam, MBA, R193134
Economic System Defined
An economic system is a mechanism that deals with the
production, distribution, and consumption of goods and
services
Economic system: the set of structures and processes
that guides the allocation of scarce resources and
shapes the conduct of business activities in a nation

Spectrum of Economic Systems

Centrally-planned Free-market
N. Korea China Brazil Japan USA
Cuba Russia India Germany Canada
Vietnam S. Korea France UK

Md Jahidul Islam, MBA, R193134

Types of Economic Systems
• Market Economy: a free-market (capitalistic)
economy built upon the private ownership and
control of the factors of production
• Command Economy: a centrally-planned
economy built upon government ownership
and control of the factors of production
• Mixed Economy: an economy in which
economic decisions are largely market-driven
and ownership is largely private, but significant
government intervention is still evident

Md Jahidul Islam, MBA, R193134

Fig. 4.3: Relationships between the
Control of Economic Activity and the
Ownership of Production Factors

Md Jahidul Islam, MBA, R193134

The Economic Freedom Index
• approximates the extent to which a government
intervene in the areas of free choice, free
enterprise, and market-driven prices for reasons
that go beyond basic national needs
• classifies countries as:
-free
-mostly free
-mostly unfree
-repressed

Md Jahidul Islam, MBA, R193134

The Economic Freedom Index:
Determining Factors
• Trade policy
• The fiscal burden of the government
• The extent and nature of government intervention
• Monetary policy
• Capital flows and investment
• Banking and financial activities
• Wage and price levels
• Property rights
• Other government regulation
• Informal market activities
Md Jahidul Islam, MBA, R193134
 Map 4.5: Countries Ranked
According to Economic Freedom

Md Jahidul Islam, MBA, R193134

Map 4.6: GDP Per Capita
Growth Rate

Md Jahidul Islam, MBA, R193134

Economic Transition
The shift from a command or mixed economy to
a freer market economy largely depends on a
government’s ability to:
-dismantle features such as central planning
-create features such as consumer sovereignty.

The success of the transition process depends

upon the government’s ability to liberalize
economic activity, to reform business practices,
and to establish legal and institutional frameworks.

Md Jahidul Islam, MBA, R193134

Policies That Shape the
Economic Transition Process
• Privatization: the sale and/or legal transfer of
government-owned resources to private
individuals and/or entities
• Deregulation: the relaxation or removal of
restrictions on the free operation of markets
and business practices
• Property rights: the protection of real (tangible)
and intellectual (intangible) property
[continued]

Md Jahidul Islam, MBA, R193134

• Fiscal and monetary reform: the reliance upon
market-oriented instruments to achieve
macroeconomic stabilization, the setting of
strict budgetary limits, and the use of market-
based policies to manage the money supply
• Antitrust legislation: laws designed to
maintain and promote market competition,
i.e., to prohibit the anticompetitive behavior
of monopolies

Md Jahidul Islam, MBA, R193134

Fig. 4.4: Reforms and
Economic Progress

Md Jahidul Islam, MBA, R193134

Implications/Conclusions

• The benefits of doing business in a given

country are directly influenced by the size
of the market, the wealth of consumers,
and the openness, the stability, and the
growth potential of the economy.
[continued]

Md Jahidul Islam, MBA, R193134

• The power of economic analysis is a
function of identifying the best possible
indicators and then understanding how
they work both in isolation and
interactively.
• The type of economic system is a strong
predictor of a nation’s present economic
performance and its future economic
prospects.
Md Jahidul Islam, MBA, R193134