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
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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
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,
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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.
2. Question of growth
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
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
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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
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
2. Often cuts are in welfare, unemployment benefits, and guaranteed
government jobs.
D. Sustainability
1. Economic and social policies of former communist governments in
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
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market, manufacturing facilities, and the ability to repatriate profits. Political risk
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
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
2. Kidnapping and hostage-taking can fund terrorism
C. Property seizure
1. Confiscation is the forced transfer of assets from a company to the
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.
3. Other policies relate to investments made across borders.
E. Local content requirements
2. Force companies to use local raw materials, procure parts from
local suppliers, or employ local workers. May force a firm to take
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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
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
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.
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
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2. Receives funding from member contributions based on gross
3. UN system consists of six main segments: (1) General Assembly;
(2) Security Council; (3) Economic and Social Council; (4)
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
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.
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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?
2. Q: What are the drawbacks of using national production to measure economic
development?
3. Q: The human development index measures what aspects of a nation’s
development.
Quick Study 2
1. Q: What does the economic transition process involve?
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2. Q: Companies fear open violence and conflict abroad because it can threaten to
do what?
3. Q: What is the name given to the forced transfer of assets from a company to the
government 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
2. Q: What is a good source of information to help conduct accurate political risk
forecasting?
3. Q: What might result from unfavorable political relations among countries?
1. Q: During what time period did China undergo its most rigorous experience with
central planning?
2. Q: What challenges might pose a threat to China’s future economic performance?
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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?
4. Q: What might challenge Russia’s future economic prospects?
A: Political instability, especially in the form of intensified nationalist sentiment
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?
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?
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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
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.
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?
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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?
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?