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
Copyright © 2019 Pearson Education, Inc.
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
a. 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.
b. Examples are Australia, Canada, Japan, New Zealand, the United States,
all western European nations.
2. Newly industrialized countries (NICs)
a. Recently increased the portion of national production and exports derived
from industrial operations.
b. 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.
c. Combining NICs with those having potential to become a NIC forms a
category called emerging markets.
3. Developing countries
a. Poor infrastructure and extremely low personal income.
b. Rely on one or a few sectors of production—agriculture, mineral mining,
or oil drilling. They often lack resources and skills.
c. Mainly in Africa, the Middle East, and the poorest nations in Eastern
Europe and Asia.
d. 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
a. Volunteer work, unpaid household work, illegal activities such as
gambling and black market (underground) transactions, and unreported
cash transactions.
b. Shadow economy can be so large and prosperous that official statistics
are meaningless.
c. Barter is an alternative for buyers who lack hard currency to pay for
imports (e.g., Pepsi-Cola in USSR).
2. Question of growth
a. 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
b. Per capita figures are averages. Urban areas can be more developed than
rural areas and have higher per capita income.
4. Pitfalls of comparison
a. To compare gross product per capita, each currency must be translated
into a single currency.
b. Official exchange rates do not show what the local currency can buy in
its home country.
C. Purchasing Power Parity
1. 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.
2. 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
a. 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)
b. There is often disparity between wealth and HDI.
c. 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
1. 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.
2. Yet the gap in education and experience between managers from the former
communist nations and others has narrowed.
B. Shortage of capital
1. Transition is expensive, requiring spending to:
a. Develop a telecommunications and infrastructure system
b. Create financial institutions, including stock markets and a banking
system.
c. Educate people in the ways of market economics.
C. Cultural differences
1. Transition causes cultural change and replaces dependence on the government
with greater emphasis on individuals.
2. Often cuts are in welfare, unemployment benefits, and guaranteed government
jobs.
D. Sustainability
1. Economic and social policies of former communist governments in
Central and Eastern Europe were disastrous for the natural environment.
2. 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:
1. Local conflict discourages investment. Violence hinders manufacturing,
obtaining materials and equipment, and recruiting talented personnel.
2. It can arise from: (1) resentment toward the government; (2) territorial disputes;
and (3) ethnic, racial, and religious disputes.
B. Terrorism and kidnapping
1. Used to make political statements. Groups dissatisfied with current political or
social situations try to force change through fear and destruction.
2. Kidnapping and hostage-taking can fund terrorism
C. Property seizure
1. 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.
2. Expropriation is the forced transfer of assets from a company to the government
with compensation.
3. 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.
D. Policy changes
1. Result from newly empowered political parties, pressure from special interests,
and civil or social unrest.
2. One policy tool restricts ownership to domestic companies or limits ownership
by nondomestic firms to a minority stake.
3. Other policies relate to investments made across borders.
E. Local content requirements
1. Specify an amount of a product to be supplied locally. Can foster local business
activity and create jobs.
2. 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.
V. 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.
1. Partnerships can be used to leverage expansion plans through informal
arrangements or joint ventures, strategic alliances, and cross-holdings of
company stock.
2. Localization entails modifying operations, the product mix, or other elements to
suit local tastes and culture.
3. 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.
4. 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.
1. Current employees with relevant information: people who worked in the country
and have valuable contacts and knowledge.
2. 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.
1. Lobbying: policy of hiring people to represent a company’s views on political
matters.
2. 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
1. 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.
2. Receives funding from member contributions based on gross national product
(GNP). Entire world is involved with the UN in some manner.
3. 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.
4. 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
a. 1949: Communes planned all agricultural and industrial
production and schedules. Rural families owned their homes and land
and produced particular crops.
b. 1979: Government reforms allowed families to grow crops they
chose and sell produce at market prices.
c. 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.
d. 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
a. Political and social problems loom. Skirmishes between secular
and Muslim Chinese, and democracy restricted.
b. Unemployment, slow economic progress in rural areas, and
misery of migrant workers.
c. China’s one country, two systems policy must preserve order, as
Taiwan is watching closely.
B. 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
a.In the 1980s Russia entered a new era of freedom of
thought, freedom of expression, and economic
restructuring.
b. Except for criminals and the wealthy, people have
difficulty maintaining their standard of living and buying
necessities.
c.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
a.Managers must improve skills in every facet of
management practice, including financial control, research
and development, employee hiring, training, marketing,
and pricing.
b. Political instability, especially nationalism.
c.Nuclear weapons sales for cash can be lucrative, despite
the clear threat to global security and Russia itself.
d. 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.
e.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).
VII. 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.