MODULE 4: WORLD ECONOMIES

POLITICAL ECONOMY AND ECONOMIC DEVELOPMENT

DIFFERENCES IN ECONOMIC DEVELOPMENT
Different countries have different levels of economic development. One common measure of
economic development is a country's gross national income (GNI) per head of population.

GNI is regarded as a yardstick for the economic activity of a country; it measures the total annual
income received by residents of a nation.
*GNI per person figures can be misleading because they don't consider differences in the cost of
living. For example, although the 2009 GNI per capita of Switzerland at $65,430 exceeded that of
the United States, which was $46,360, the higher cost of living in Switzerland meant that U.S.
citizens could actually afford more goods and services than Swiss citizens.

To account for differences in the cost of living, one can adjust GNI per capita by purchasing power.
Referred to as a purchasing power parity (PPP) adjustment, it allows for a more direct
comparison of living standards in different countries. The base for the adjustment is the cost of
living in the United States. The PPP for different countries is then adjusted (up or down) depending
upon whether the cost of living is lower or higher than in the United States.

Human Development Index (HDI) measures the quality of human life in different nations. The
HDI is based on three measures: life expectancy at birth (a function of health care), educational
attainment (measured by a combination of the adult literacy rate and enrollment in primary,
secondary, and tertiary education), and whether average incomes, based on PPP estimates,
are sufficient to meet the basic needs of life in a country (adequate food, shelter, and health
care). The HDI is scaled from 0 to 1. Countries scoring less than 0.5 are classified as having low
human development (the quality of life is poor); those scoring from 0.5 to 0.8 are classified as
having medium human development; and those that score above 0.8 are classified as having high
human development.

INNOVATION AND ENTREPRENEURSHIP ARE THE ENGINES OF GROWTH

There is substantial agreement among economists that innovation and entrepreneurial activity
are the engines of long-run economic growth.
Innovation – refers to the conceptualization and development of new products, new processes,
new organizations, new management practices, and new strategies.
Innovation and entrepreneurial activity help to increase economic activity by creating new
products and markets that did not previously exist. Moreover, innovations in production and
business processes lead to an increase in the productivity of labor and capital, which further
boosts economic growth rates.
*Innovation is also seen as the product of entrepreneurial activity.
Entrepreneurs – the ones who commercialize innovative new products and processes and
provide dynamism in an economy.

INNOVATION AND ENTREPRENEURSHIP REQUIRE A MARKET ECONOMY

What economic system is required for the business environment of a country to be conducive to
innovation and entrepreneurial activity?
The answer is to have a market economy. In a market economy, any individual who has an
innovative idea is free to try to make money out of that idea by starting a business (by engaging
in entrepreneurial activity). Similarly, existing businesses are free to improve their operations
through innovation. Thus, market economies contain enormous incentives to develop innovations.
*In a command economy, the state owns all means of production. Consequently, entrepreneurial
individuals have few economic incentives to develop valuable new innovations, because it is the
state, rather than the individual, that captures most of the gains.

INNOVATION AND ENTREPRENEURSHIP REQUIRE STRONG PROPERTY RIGHTS

Strong legal protection of property rights is another requirement for a business environment
to be conducive to innovation, entrepreneurial activity, and hence economic growth.
*Both individuals and businesses must be given the opportunity to profit from innovative ideas.
Without strong property rights protection, businesses and individuals run the risk that the profits
from their innovative efforts will be expropriated.

THE REQUIRED POLITICAL SYSTEM

People in the West tend to associate a representative democracy with a market economic system,
strong property rights protection, and economic progress. Building on this, we tend to argue that
democracy is good for growth.
Several of the fastest-growing Asian economies adopted more democratic governments during
the past three decades, including South Korea and Taiwan.

THE NATURE OF ECONOMIC TRANSFORMATION

The shift toward a market-based economic system often entails a number of steps:
1. Deregulation - involves removing legal restrictions to the free play of markets, the
establishment of private enterprises, and the manner in which private enterprises operate.
2. Privatization - transfers the ownership of state property into the hands of private individuals,
frequently by the sale of state assets through an auction.
3. Legal Systems - a well-functioning market economy requires laws protecting private property
rights and providing mechanisms for contract enforcement.

NATIONAL DIFFERENCES IN POLITICAL ECONOMY

International business is much more complicated than domestic business because countries differ
in many ways. Countries have different political, economic and legal systems. All these
differences can and do have major implications for the practice of international business.

The term Political Economy stresses that the political, economic and legal systems of a country
are interdependent; they interact and influence each other. The political system of a country
shapes its economic and legal systems.

Political System refers to the system of government in a nation. Political systems can be
assessed according to two dimensions. The first is the degree to which they emphasize
collectivism as opposed to individualism. The second is the degree to which they are democratic
or totalitarian. These dimensions are interrelated; systems that emphasize collectivism tend
toward totalitarian, whereas those that place a high value on individualism tend to be democratic.

1. COLLECTIVISM AND INDIVIDUALISM

Collectivism refers to a political system that stresses the primacy of collective goals over
individual goals.
When collectivism is emphasized, the needs of society as a whole are generally viewed as being
more important than individual freedoms. In such circumstances, an individual's right to do
something may be restricted on the grounds that it runs counter to "the good of society" or to "the
common good."
*Plato, a Greek philosopher and an advocate for collectivism believed that individual rights
should be sacrificed for the good of the majority and that property should be owned in common.
Individualism refers to a philosophy that an individual should have freedom in his or her
economic and political pursuits. It stresses that the interests of the individual should be considered
first over the interests of the state.
*Aristotle, another Greek philosopher, Plato’s disciple, argued that individual diversity and
private ownership are desirable, that private property is more highly productive than communal
property and will thus stimulate progress as communal property receives little care, whereas
property that is owned by an individual will receive the greatest care and therefore be most
productive.
Individualism is built on two central points: Individual freedom and Self-expression.
2. DEMOCRACY AND TOTALITARIANISM
Democracy refers to a political system in which government is by the people, exercised either
directly or through elected representatives.
*This is based on a belief that citizens should be directly involved in decision making. The most
important implication for a democratic state is the practice of Representative Democracy.
In a Representative Democracy - citizens periodically elect individuals to represent them. These
elected representatives then form a government; whose function is to make decisions on behalf
of the electorate.
In a democratic country citizens enjoy: right to freedom of expression, opinion and organization;
free media; right to vote; limited terms for elected representatives, etc.
FYI: Types of Government: Monarchy – ruled by one; Aristocracy – ruled by a few and
Democracy – ruled by the many
Totalitarianism is a form of government in which one person or political party exercises absolute
control over all spheres of human life and prohibits opposing political parties.
*In most totalitarian states, individual's right to freedom of expression and organization, a free
media, and regular elections-are denied to the citizens. Political repression is widespread, free
and fair elections are lacking, media are heavily censored, basic civil liberties are denied, and
those who question the right of the rulers to rule find themselves imprisoned, or worse.

FOUR MAJOR FORMS OF TOTALITARIANISM

a. Communist Totalitarianism - states that deny many basic civil liberties to their
populations. Communism, however, is in decline worldwide, and most of the Communist
Party dictatorships have collapsed since 1989.
 (China, Vietnam, Cuba, North Korea)
b. Theocratic Totalitarianism - found in states where political power is monopolized by
a party, group, or individual that governs according to religious principles.
(Iran and Saudi Arabia – their laws are based on Islamic Principles)
c. Tribal Totalitarianism – this form of government occurs when a political party that
represents the interests of a particular tribe monopolizes power.
(This is practiced in African countries such as Zimbabwe, Tanzania, Uganda and Kenya)
d. Right-wing Totalitarianism – a form of government that permits some individual
economic freedom but restricts individual political freedom. Many right-wing totalitarian
governments are backed by the military, and in some cases the government may be made
up of military officers.
(Since the early 1980s this form of government ceased to exist – Philippines was once a
Right-wing Totalitarian country under the leadership of Marcos)

NOTE: Democracy and individualism go hand in hand, same with collectivism and
totalitarianism, both complement each other. However, gray areas exist; because it is
possible to have a democratic state in which collective values predominate, and it is also
possible to have a totalitarian state that do not support collectivism.
For example, China promotes individualism, but the country is still ruled by a totalitarian
dictatorship.

ECONOMIC SYSTEMS

TYPES OF ECONOMIC SYSTEM

1. Market Economy - all productive activities are privately owned, as opposed to being owned
by the state.
*Private ownership also encourages vigorous competition and economic efficiency. Private
ownership ensures that entrepreneurs have a right to the profits generated by their own efforts.
This gives entrepreneurs an incentive to search for better ways of serving consumer needs. That
may be through introducing new products, by developing more efficient production processes, by
pursuing better marketing and after-sale service, or simply through managing their businesses
more efficiently than their competitors.
2. Command Economy - the government plans the goods and services that a country produces,
the quantity in which they are produced, and the prices at which they are sold. Consistent with
the collectivist ideology, the objective of a command economy is for government to allocate
resources for "the good of society."
*All businesses are state owned, the rationale being that the government can then direct them to
make investments that are in the best interests of the nation as a whole rather than in the interests
of private individuals.
3. Mixed Economy – this is between market economies and command economies. Certain
sectors of the economy are left to private ownership and free market mechanisms while other
sectors have significant state ownership and government planning.
*In mixed economies, governments also tend to take into state ownership troubled firms whose
continued operation is thought to be vital to national interests.

NOTE: Political Ideology and Economic Systems are connected. In countries where individual
goals are given primacy over collective goals, we are more likely to find market-based economic
systems. In contrast, in countries where collective goals are given importance, the state may have
taken control over many enterprises; markets in such countries are likely to be restricted rather
than free.

LEGAL SYSTEM
Legal System refers to the rules, or laws, that regulate behavior along with the processes by
which the laws are enforced and through which redress for grievances is obtained.
*The legal system of a country is of immense importance to international business. A country's
laws regulate business practice, define the manner in which business transactions are to be
executed, and set down the rights and obligations of those involved in business transactions. The
legal environments of countries differ in significant ways.

Like the economic system of a country, the legal system is influenced by its prevailing political
system. For example, collectivist-inclined totalitarian states tend to enact laws that severely
restrict private enterprise, whereas the laws enacted by governments in democratic states where
individualism is the dominant political philosophy tend to be pro-private enterprise and pro-
consumer.
DIFFERENT LEGAL SYSTEMS
1. Common Law System - is based on tradition, precedent, and custom. Tradition refers to a
country's legal history, precedent to cases that have come before the courts in the past, and
custom to the ways in which laws are applied in specific situations.
2. Civil Law System – is based on a detailed set of laws organized into codes. When law courts
interpret civil law, they do so with regard to these codes.
3. Theocratic Law System - is one in which the law is based on religious teachings.

PROPERTY RIGHTS AND CORRUPTION

Property refers to a resource over which an individual or business owns and holds a legal title.
Property rights refer to the legal rights over the use to which a resource is put and over the use
made of any income that may be derived from that resource.

Property Rights Violations

1. Private Action - refers to theft, piracy, blackmail, and the like by private individuals or groups.
2. Public Action or Corruption - occurs when public officials, such as politicians and government
officials, extort income, resources, or the property itself from property holders.
NOTE: High levels of corruption significantly reduce the foreign direct investment, level of
international trade, and economic growth rate in a country.

THE PROTECTION OF INTELLECTUAL PROPERTY

Intellectual Property refers to property that is the product of intellectual activity, such as
computer software, books, or chemical formula for a new drug.
*Patents, copyrights, and trademarks establish ownership rights over intellectual property.
1. Patent grants the inventor of a new product or process exclusive rights for a defined period to
the manufacture, use, or sale of that invention. (20 years)
2. Copyrights are the exclusive legal rights of authors, composers, play wrights, artists, and
publishers to publish and disperse their work as they see fit. (50 years)
3. Trademarks are designs and names, often officially registered, by which merchants or
manufacturers designate and differentiate their products.

The philosophy behind intellectual property laws is to reward the originator of a new invention,
book, musical record, clothes design, restaurant chain, and the like, for his or her idea and effort.
Such laws stimulate innovation and creative work.

China and Thailand have recently been among the worst offenders in Asia of piracy of intellectual
property. Pirated computer software is widely available in China. Similarly, the streets of Bangkok,
Thailand's capital, are lined with stands selling pirated copies of Rolex watches, Levi Strauss
jeans, videotapes, and computer software.

Piracy in music recordings is also rampant. About one-third of all recorded music products sold
worldwide are pirated (illegal) copies, suggesting that piracy costs the industry more than $4.5
billion annually.

WORLD ECONOMIES

CLASSIFYING WORLD ECONOMIES

When evaluating a country, a manager is assessing the country’s income and the purchasing
power of its people; the legal, regulatory, and commercial infrastructure, including communication,
transportation, and energy; and the overall sophistication of the business environment.

Why does a country’s stage of development matter? Well, if you’re selling high-end luxury
items, for example, you’ll want to focus on the per capita income of the local citizens. Can they
afford a P10,000.00 designer handbag, a luxury car, or cutting-edge, high-tech gadgets? If so,
how many people can afford these expensive items (i.e., how large is the domestic market)?

Let’s look more closely at some of these globally standard statistics and classifications that are
commonly used to define the stage of a country’s development.

Statistics Used in Classifications

1. Gross Domestic Product (GDP)
Gross domestic product (GDP) is the value of all the goods and services produced by a country
in a single year. An official accounting of the country’s output of goods and services.
2. Purchasing Power Parity (PPP)
To compare production and income across countries, we need to look at more than just GDP.
Economists seek to adjust this number to reflect the different costs of living in specific countries.
Purchasing power parity (PPP) is, in essence, an economic theory that adjusts the exchange rate
between countries to ensure that a good is purchased for the same price in the same currency.
For example, a basic cup of coffee should cost the same in London as in New York.
3. Human Development Index (HDI)
GDP and purchasing power provide indications of a country’s level of economic development by
using an income-focused statistic. However, in recent years, economists and business analysts
have focused on indicators that measure whether people’s needs are satisfied and whether the
needs are equally met across the local population. One such indication is the Human
Development Index (HDI), which measures people’s satisfaction in three key areas—long and
healthy life in terms of life expectancy; access to quality education equally; and a decent, livable
standard of living in the form of income. The HDI is a summary composite index that measures a
country’s average achievements in three basic aspects of human development: health,
knowledge, and a decent standard of living.
Health is measured by life expectancy at birth; knowledge is measured by a combination of the
adult literacy rate and the combined primary, secondary, and tertiary gross enrollment ratio; and
standard of living by (income as measured by) GDP per capita.
*In 1995, the UNDP introduced two new measures of human development that highlight the
status of women in each society.
4. Gender-related Development Index (GDI)
GDI measures achievement in the same basic capabilities as the HDI does, but takes note of
inequality in achievement between women and men. The methodology used imposes a penalty
for inequality, such that the GDI falls when the achievement levels of both women and men in a
country go down or when the disparity between their achievements increases. The greater the
gender disparity in basic capabilities, the lower a country’s GDI compared with its HDI. The GDI
is simply the HDI discounted, or adjusted downwards, for gender inequality.
5. Gender Empowerment Measure (GEM)
GEM is a measure of agency. It evaluates progress in advancing women’s standing in political
and economic forums. It examines the extent to which women and men are able to actively
participate in economic and political life and take part in decision making. While the GDI focuses
on expansion of capabilities, the GEM is concerned with the use of those capabilities to take
advantage of the opportunities of life.
*In 1997, UNDP added a further measure:
6. Human Poverty Index (HPI)
If human development is about enlarging choices, poverty means that opportunities and choices
most basic to human development are denied. Thus a person is not free to lead a long, healthy,
and creative life and is denied access to a decent standard of living, freedom, dignity, self-respect
and the respect of others. From a human development perspective, poverty means more than the
lack of what is necessary for material well-being. The HPI is a composite index that uses indicators
of the most basic dimensions of deprivation: a short life (longevity), a lack of basic education
(knowledge), and a lack of access to public and private resources (decent standard of living).
There are two different HPIs—one for developing countries (HPI-1) and another for a group of
select high-income OECD (Organization for Economic and Development) countries (HPI-2),
which better reflects the socioeconomic differences between the two groups. HPI-2 also includes
a fourth indicator that measures social exclusion as represented by the rate of long-term
unemployment.

THE DEVELOPED WORLD

In essence, developed economies, also known as advanced economies, are characterized as
postindustrial countries—typically with a high per capita income, competitive industries,
transparent legal and regulatory environments, and well-developed commercial infrastructure.
Developed countries also tend to have high human development index (HDI) rankings—long life
expectancies, high-quality health care, equal access to education, and high incomes. In addition,
these countries often have democratically elected governments.
Note: In general, the developed world encompasses Canada, the United States, Western Europe,
Japan, South Korea, Australia, and New Zealand.
*While these economies have moved from a manufacturing focus to a service orientation, they
still have a solid manufacturing base. However, just because an economy is developed doesn’t
mean that it’s among the largest economies. And, conversely, some of the world’s largest
economies—while growing rapidly—don’t have competitive industries or transparent legal and
regulatory environments. The infrastructure in these countries, while improving, isn’t yet
consistent or substantial enough to handle the full base of business and consumer demand.
Countries like Brazil,
 The United States is the fourth-largest country in the world—after Russia, China, and
Canada. However, the United States is the world’s largest single-country economy and
accounts for nearly 25 percent of the global gross domestic product (GDP). The strength
of the US economy is due in large part to its diversity. Today, the United States has a
service-based economy. In 2009, industry accounted for 21.9 percent of the GDP;
services (including finance, insurance, and real estate) for 76.9 percent; and agriculture
for 1.2 percent.
 Germany, a member of the EU (European Union), has the fifth-largest economy in the
world. The country is a leading exporter of machinery, vehicles, chemicals, and household
 equipment and benefits from a highly skilled labor force. It is the largest and strongest
economy in Europe. Services drive the economy, representing 72.3 percent (in 2009) of
the total GDP. Industry accounts for 26.8 percent of the economy, and agriculture
represents 0.9 percent.
 Japan’s post–World War II success has been the result of a well-crafted economic policy
closely administered by the government in alliance with large businesses. It also benefits
from its highly skilled workforce. Japan has very few mineral and energy resources and
relies heavily on imports to bring in almost all of its oil, iron ore, lead, wool, and cotton. It
is the world’s largest importer of numerous raw materials including coal, copper, zinc, and
lumber. As with other developed nations, services lead the economy, representing 76.5
percent of the national GDP, while industry accounts for 21.9 percent of the country’s
output.
Note: Russia, India, and China—also known as BRIC—are hot emerging markets but are not yet
considered developed by most widely accepted definitions.

THE DEVELOPING WORLD

The developing world refers to countries that rank lower on the various classifications. The
residents of these economies tend to have lower discretionary income to spend on nonessential
goods (i.e., goods beyond food, housing, clothing, and other necessities).
Developing economies typically have poor, inadequate, or unequal access to infrastructure. The
low personal incomes result in a high degree of poverty, as measured by the human poverty index
(HPI). These countries, unlike the developed economies, don’t have mature and competitive
industries. Rather, the economies usually rely heavily on one or more key industries—often
related to commodities, like oil, minerals mining, or agriculture. Many of the developing countries
today are in Africa, parts of Asia, the Middle East, parts of Latin America, and parts of Eastern
Europe.
In the World Trade Organization (WTO), there are no WTO definitions of “developed” and
“developing” countries. Members announce for themselves whether they are “developed” or
“developing” countries.
Note: It’s important to understand that the term developing countries is different from Third-World
countries, which was a traditional classification for countries along political and economic lines.
FIRST WORLD VS SECOND WORLD VS THIRD WORLD
The use of the terms First, the Second, and the Third World is a rough, and it’s safe to say,
outdated model of the geopolitical world from the time of the cold war.
There is no official definition of the first, second, and the third world. Below is OWNO’s [One
World—Nations Online] explanation of the terms:
After World War II the world split into two large geopolitical blocs and spheres of influence with
contrary views on government and the politically correct society:
1. The bloc of democratic-industrial countries within the American influence sphere, the “First
World.”
2. The Eastern bloc of the communist-socialist states, the “Second World.”
3. The remaining three-quarters of the world’s population, states not aligned with either bloc were
regarded as the “Third World.”
4. The term “Fourth World,” coined in the early 1970s by Shuswap Chief George Manuel, refers
to widely unknown nations (cultural entities) of indigenous peoples, “First Nations” living within or
across national state boundaries…
Note: The term “First World” refers to so-called developed, capitalist, industrial countries, roughly,
a bloc of countries aligned with the United States after World War II, with more or less common
political and economic interests: North America, Western Europe, Japan and Australia.

DEVELOPING COUNTRY TO AN EMERGING MARKET

A developing country, in order to evolve into an emerging market, must:
1. seek to implement transparency in its government as well as in its political and economic
institutions to help inspire business confidence in its country
2. develop the local commercial infrastructure and reduce trade barriers to attract foreign
businesses
3. educate the population equally and create a healthy domestic workforce that’s both skilled and
relatively cheap

EMERGING MARKETS
The term “emerging markets” dates back to 1981, recalls the man who invented it, Antoine van
Agtmael. He was trying to start a “Third-World Equity Fund” to invest in developing-country
shares, but his efforts to attract money were constantly rebuffed. “Racking my brain, at last I came
up with a term that sounded more positive and invigorating: emerging markets. ‘Third world’
suggested stagnation; ‘emerging markets’ suggested progress, uplift and dynamism.” For many
businesspeople, the definition of an emerging market has been simply a country that was once a
developing country but has achieved rapid economic growth, modernization, and industrialization.
However, this approach can be limiting.
An emerging market country can be defined as a society transitioning from a dictatorship to a
free market-oriented economy, with increasing economic freedom, gradual integration within the
global marketplace, an expanding middle class, improving standards of living and social stability
and tolerance, as well as an increase in cooperation with multilateral institutions (Kvint).