978-0134129945 Chapter 2 Lecture Note Part 1

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CHAPTER 2

THE GLOBAL ECONOMIC ENVIRONMENT

SUMMARY

A. The economic environment is a major determinant of global market potential and

opportunity. In today’s global economy, capital movements are the driving force,

production is uncoupled from employment, and capitalism has vanquished communism.

Based on patterns of resource allocation and ownership, the world’s economies can be

categorized as market capitalism, centrally-planned capitalism, centrally-planned

socialism, and market socialism. The final years of the twentieth century were marked by

transitions toward market capitalism in many countries that had been centrally controlled.

However, great disparity still exists among the nations of the world in terms of economic

freedom.

B. Countries can be categorized in terms of their stage of economic development: low

income, lower middle income, upper middle income, and high income. Gross

domestic product (GDP) and gross national income (GNI) are commonly used

measures of economic development. The 50 poorest countries in the low-income category

are sometimes referred to as least-developed countries (LDCs). Upper middle-income

countries with high growth are often called newly industrializing economies (NIEs).

Several of the world’s economies are notable for their fast growth; the BRICS nations

include Brazil, Russia, India, China, and South Africa. The Group of Eight (G-8), Group

of Twenty (G-20), and Organization for Economic Cooperation and Development

(OECD) represent efforts by high-income nations to promote democratic ideals and free-

market policies throughout the rest of the world. Most of the world’s income is located in

the Triad, which is comprised of Japan, the United States, and Western Europe.

Companies with global aspirations generally have operations in all three areas. Market

potential for a product can be evaluated by determining product saturation levels in light

of income levels.

C. A country’s balance of payments is a record of its economic transactions with the rest of

the world; this record shows whether a country has a trade surplus (value of exports

exceeds value of imports) or a trade deficit (value of imports exceeds value of exports).

Trade figures can be further divided into merchandise trade and services trade accounts;

a country can run a surplus in both accounts, a deficit in both accounts, or a combination

of the two. The U.S. merchandise trade deficit was $819 billion in 2007. However, the

U.S. enjoys an annual service trade surplus. Overall, however, the United States is a

debtor; China enjoys an overall trade surplus and serves as a creditor nation.

D. Foreign exchange provides a means for settling accounts across borders. The dynamics of

international finance can have a significant impact on a nation’s economy as well as the

fortunes of individual companies. Currencies can be subject to devaluation or

revaluation as a result of actions taken by a country’s central banker. Currency trading by

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international speculators can also lead to devaluation. When a country’s economy is

strong or when demand for its goods is high, its currency tends to appreciate in value.

When currency values fluctuate, global firms face various types of economic exposure.

Firms can manage exchange rate exposure by hedging.

LEARNING OBJECTIVES

1 Identify and briefly explain the major changes in the world economy that have occurred during

the past 100 years

2 Compare and contrast the main types of economic systems that are found in different regions

of the world

3 Explain the categories of economic development used by the World Bank and identify the key

emerging country markets at each stage of development

4 Discuss the significance of balance of payments statistics for the world’s major economies

5 Identify the countries that are the world’s leading exporters

6 Briefly explain how exchange rates impact a company’s opportunities in different parts of the

world

OVERVIEW

This chapter will identify the most salient characteristics of the world economic environment,

starting with an overview of the world economy. We then present a survey of economic system

types, a discussion of the stages of market development, and an explanation of balance of

payments. Foreign exchange is discussed in the final section of the chapter. Throughout the

chapter, we will discuss the implications of the worldwide economic downturn on global

marketing strategies.

ANNOTATED LECTURE/OUTLINE

THE WORLD ECONOMY—AN OVERVIEW

The world economy has changed dramatically since World War II. Perhaps the most fundamental

change is the emergence of global markets; responding to new opportunities, global competitors

have displaced or absorbed local ones.

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The integration of the world economy has increased significantly. Economic integration was 10

percent at the beginning of the 20th century; today, it is approximately 50 percent.

During the past two decades, the world economic environment has become increasingly

dynamic; change has been dramatic and far-reaching. To achieve success, executives and

marketers must take into account the following new realities:

(Learning Objective #1)

a) Capital movements have replaced trade as the driving force of the world economy.

b) Productivity has become “uncoupled” from employment.

c) The world economy dominates the scene; individual country economies play a

subordinate role.

d) The struggle between capitalism and socialism that began in 1917 is over.

e) The growth of e-commerce diminishes the importance of national barriers and forces

companies to reevaluate their business models.

The first change is the increased volume of capital movements. The dollar value of trade in

goods and services was $23.4 trillion in 2013. However, the Bank for International Settlements

has calculated that foreign exchange transactions worth approximately $4 trillion are booked

every day. This works out to more than $1 quadrillion annually, a figure that far surpasses the

dollar value of world trade in goods and services. An inescapable conclusion resides in these

data: Global capital movements far exceed the dollar volume of global trade. In other words,

currency trading represents the world’s largest market.

The second change concerns the relationship between productivity and employment. To

illustrate this relationship, it is necessary to review some basic macroeconomics. Gross domestic

product (GDP), a measure of a nation’s economic activity, is calculated by adding consumer

spending (C), investment spending (I), government purchases (G), and net exports (NX):

C _ I _ G _ NX _ GDP

Economic growth, as measured by GDP, reflects increases in a nation’s productivity. Until the

recent economic crisis, employment in manufacturing had remained steady or declined while

productivity continued to grow.

Now, employment rates have declined in countries where a bubble economy of misallocated

resources in housing and real estate has collapsed. In the United States, manufacturing’s share of

GDP declined from 19.2 percent in 1989 to13 percent in 2009.

In 2011, manufacturing employment accounted for about 9 percent of the U.S. workforce; in

1971, the figure was 26 percent. During that 40-year period, productivity has increased

dramatically. Similar trends can be found in many other major industrial economies as well.

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Manufacturing is not in decline—it is employment in manufacturing that is in decline.

Creating new jobs is one of the most important tasks facing policymakers today.

The third major change is the emergence of the world economy as the dominant economic unit.

Company executives and national leaders who recognize this have the greatest chance of success.

This change has brought two questions to the fore: How does the global economy work, and

who is in charge? Unfortunately, the answers to these questions are not clear-cut.

The fourth change is the end of the Cold War. The demise of communism as an economic and

political system can be explained in a straightforward manner: Communism is not an effective

economic system. The overwhelmingly superior performance of the world’s market economies

has given leaders in socialist countries little choice but to renounce their ideology.

A key policy change in such countries has been the abandonment of futile attempts to manage

national economies with a single central plan. This policy change frequently goes hand in hand

with governmental efforts to foster increased public participation in matters of state by

introducing democratic reforms.

Finally, the personal computer revolution and the advent of the Internet era have in some ways

diminished the importance of national boundaries.

ECONOMIC SYSTEMS

(Learning Objective #2)

Traditionally, there are four main types of economic systems: market capitalism, centrally

planned socialism, centrally planned capitalism, and market socialism. This classification was

based on the dominant method of resource allocation (market versus command) and the

dominant form of resource ownership (private versus state) (see Figure 2-1).

Alternatively, more robust descriptive criteria include the following:

Type of economy

Type of government

Trade and capital flows

The commanding heights

Services provided by the state and funded through taxes

Institutions

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Markets

Market Capitalism

Market capitalism is an economic system in which individuals and firms allocate resources, and

production resources are privately owned. Consumers decide what goods they desire, and firms

decide how much to produce; the state’s role is to promote competition (see Table 2 -1).

It would be a gross oversimplification to assume that all market-orientated economies function in

an identical manner.

Centrally-Planned Socialism

At the opposite end of the spectrum is Centrally-planned socialism. Centrally-planned

socialism gives the state broad powers to serve the public as it sees fit.

State planners make “top-down” decisions about the goods and services produced and in what

quantities; consumers spend money on what is available.

Government ownership of industries and individual enterprises is characteristic. Demand

exceeds supply, and there is little reliance on product differentiation, advertising, or promotion.

To eliminate “exploitation” by intermediaries, the government controls distribution.

Because of market capitalism’s superiority, many socialist countries have adopted it; the

ideology developed by Marx and perpetuated by Lenin has been resoundingly refuted.

For decades, the economies of China, the former Soviet Union, and India functioned according

to the tenets of centrally planned socialism. All three countries are now engaged in economic

reforms characterized, in varying proportions, by increased reliance on market allocation and

private ownership.

Centrally-Planned Capitalism and Market Socialism

In reality, market capitalism and centrally-planned socialism do not exist in “pure” form.

Command and market resource allocation are practiced simultaneously, as are private and state

resource ownership. The role of government in modern market economies varies widely.

Centrally-planned capitalism is an economic system in which command resource allocation is

used extensively in an environment of private resource ownership (e.g., Sweden).

Market socialism permits market allocation policies within an overall environment of state

ownership.

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Market reforms and nascent capitalism in many parts of the world are creating opportunities for

large-scale investments by global companies.

The Heritage Foundation, a conservative think tank, classifies economies according to the degree

of economic freedom enjoyed. The variables considered in compiling the rankings include:

trade policy

taxation policy

government consumption of economic output

monetary policy

capital flows

foreign investment

banking policy

wage and price controls

property rights

regulations

the black market

The rankings form a continuum from “free” to “repressed.” Hong Kong and Singapore are

ranked first and second in terms of economic freedom; Zimbabwe, Cuba, and North Korea are

ranked lowest (see Table 2-3).

A high correlation exists between the degree of economic freedom and the extent to which a

nation’s mixed economy is heavily market orientated.

STAGES OF MARKET DEVELOPMENT

(Learning Objective #3)

At any point in time, individual country markets are at different stages of economic

development.

The World Bank has developed a four-category classification system that uses per capita gross

national income (GNI) as a base. Although the income definition for each of the stages is

arbitrary, countries within a given category generally have a number of characteristics in

common. (Table 2-4).

Today, global attention is focused on opportunities in Brazil, Russia, India, China and South

Africa (collectively known as BRICS). For each of the stages of economic development, special

attention is given to the BRICS countries.

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Low-Income Countries

Low-income countries have a GNI per capita of less than $1,045 or less. The general

characteristics shared by countries at this income level are:

limited industrialization and a high percentage of the population engaged in agriculture

and subsistence farming

high birth rates

low literacy rates

heavy reliance on foreign aid

political instability and unrest

concentration in Africa south of the Sahara

Approximately 13 percent of the world’s population is included in this group. Typically, these

countries provided limited investment opportunities.

However, there are exceptions; for example, in Bangladesh, where per capita GNP is

approximately $1,010. The garment industry has enjoyed burgeoning exports.

The newly independent countries of the former Soviet Union present an interesting situation:

Incomes are low, and there is considerable economic hardship. The potential for disruption is,

therefore, high.

Lower-Middle-Income Countries

The United Nations designates fifty countries in the bottom ranks of the low-income category as

least-developed countries (LDCs).

The term is sometimes used to indicate a contrast with developing (i.e., upper ranks of low-

income plus lower-middle and upper-middle-income) countries and developed (high-income)

countries.

Lower-middle-income countries are those with a GNI per capita between $1,046 and $4,125.

With a 2013 GNI per capita of $1,570, India has transitioned out of the low-income category and

now is classified as a lower-middle-income country.

Consumer markets in these countries are expanding rapidly. Countries such as China, Indonesia

and Thailand represent an increasing competitive threat as they mobilize their relatively cheap

labor forces to serve target markets in the rest of the world.

The developing countries in the lower-middle-income category have a major competitive

advantage in mature, standardized, labor-intensive light industry sectors such as footwear,

textiles and toys.

Emerging Markets Briefing Book – Myanmar is Open for Business

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In 2011, Myanmar, formerly known as Burma, changed course. Encouraged by Myanmar’s

transition from dictatorship toward economic openness and democracy, may Western

governments lifted sanctions such as bans on the country’s imports.

Upper-Middle-Income Countries

Upper-middle-income countries, also known as industrializing or developing countries are

those with GNP per capita ranging from $4,126 to $12,475.

Brazil is the largest country in Latin America in terms of the size of its economy, population, and

geographic territory.

Brazil also boasts the richest reserves of natural resources in the hemisphere; China, Brazil’s top

trading partner, has an insatiable appetite for iron ore and other commodities.

Government policies aimed at stabilizing Brazil’s macroeconomy have yielded impressive

results: Brazil’s GNI has grown at an average annual rate of 4 percent over the past 8 years.

During the same time period, nearly 50 million Brazilians have joined the middle class as

incomes and living standards have risen.

Lower-middle- and upper-middle-income countries that achieve the highest sustained rates of

economic growth are sometimes referred to collectively as newly industrializing economies.

Overall, NIEs are characterized by greater industrial output than developing economies; heavy

manufactures and refined products make up an increasing proportion of exports. Goldman Sachs,

the firm that developed the BRIC framework a decade ago, has identified a new country

grouping called Next-11 (N11).

Five of the N11 countries are considered NIEs. These include three lower-middle-income

countries: Egypt, Indonesia, and the Philippines. Mexico and Turkey are N11 NIEs from the

ranks of the upper-middle income category.

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