02 Capitalism and Currency

Chapter 2The Global Economic

Environment

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IntroductionThis chapter includes

An overview of the world economyA survey of economic system typesThe stages of market developmentThe balance of payments

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The World Economy—An OverviewIn the early twentieth century economic integration was at 10%; today it is 50%EU and NAFTA are very integratedGlobal competitors have displaced or absorbed local ones

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The World Economy—An OverviewThe new realities

Capital movements have replaced trade as the driving force of the world economyProduction has become uncoupled from employmentThe world economy, not individual countries, is the dominating factor

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The World Economy—An OverviewThe new realities, continued

75-year struggle between capitalism and socialism has almost endedE-commerce diminishes the importance of national barriers and forces companies to reevaluate business models

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Economic Systems

Resource Allocation Market Command

Private

ResourceOwnershi

pState

Market capitalism

Market socialism

Centrally planned

capitalism

Centrally planned socialism

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Market CapitalismIndividuals and firms allocate resourcesProduction resources are privately ownedDriven by consumersGovernment’s role is to promote competition among firms and ensure consumer protection

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Centrally Planned SocialismOpposite of market capitalismState holds broad powers to serve the public interest; decides what goods and services are produced and in what quantitiesConsumers can spend on what is availableGovernment owns entire industries and controls distributionDemand typically exceeds supplyLittle reliance on product differentiation, advertising, pricing strategy

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Centrally Planned CapitalismEconomic system in which command resource allocation is used extensively in an environment of private resource ownershipExamples

SwedenJapan

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Economic FreedomRankings of economic freedom among countries

free, mostly free, mostly unfree, repressedVariables considered include such things as:

Trade policyTaxation policyCapital flows and foreign investmentBanking policyWage and price controlsProperty rightsBlack market

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Economic FreedomFree

1. Hong Kong2. Singapore3. Ireland4. Luxembourg5. Iceland/U.K.7. Estonia8. Denmark9. Australia/New

Zealand/United States

Repressed150. Cuba151. Belarus152. Libya/Venezuela153. Zimbabwe154. Burma155. Iran156. North Korea

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Stages of Market DevelopmentThe World Bank has defined four categories of development using Gross National Income (GNI) as a baseBEMs, identified 10 years ago, were countries in Central Europe, Latin America, and Asia that were to have rapid economic growthToday, the focus is on BRIC, Brazil, Russia, India, and China

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Low-Income CountriesGNP per capita of $825 or lessCharacteristics

Limited industrializationHigh percentage of population involved in farmingHigh birth ratesLow literacy ratesHeavy reliance on foreign aidPolitical instability and unrestConcentrated in Sub-Saharan AfricaIndia is the only BRIC country

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Lower-Middle-Income CountriesGNI per capita: $826 to $3,255Characteristics

Rapidly expanding consumer marketsCheap laborMature, standardized, labor-intensive industries like textiles and toys

BRIC nations are China and Brazil

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Upper-Middle-Income CountriesGNP per capita: $3,256 to $10,065Characteristics

Rapidly industrializing, less agricultural employmentIncreasing urbanizationRising wagesHigh literacy rates and advanced educationLower wage costs than advanced countries

Also called newly industrializing economies (NIEs)Examples: Malaysia, Chile, Venezuela, Hungary, Ecuador

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Marketing Opportunities in LDCs

Characterized by a shortage of goods and servicesLong-term opportunities must be nurtured in these countries

Look beyond per capita GNPConsider the LDCs collectively rather than individuallyConsider first mover advantageSet realistic deadlines

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Mistaken Assumptions About LDCs1. The poor have no money.2. The poor will not “waste” money on

non-essential goods.3. Entering developing markets is

fruitless because goods there are too cheap to make a profit.

4. People in BOP (bottom of the pyramid) countries cannot use technology.

5. Global companies doing business in BOP countries will be seen as exploiting the poor.

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High-Income CountriesGNI per capita: $10,066 or moreAlso know as advanced, developed, industrialized, or postindustrial countriesCharacteristics

Sustained economic growth through disciplined innovationService sector is more than 50% of GNI

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High-Income CountriesCharacteristics, continued

Importance of information processing and exchangeAscendancy of knowledge over capital, intellectual over machine technology, scientists and professionals over engineers and semiskilled workersFuture orientedImportance of interpersonal relationships

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G-8, the Group of EightGoal of global economic stability and prosperity

United StatesJapanGermanyFranceBritainCanadaItalyRussia (1998) 2007 G-8 leaders in Germany

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OECD, the Organization for Economic Cooperation and Development

30 nationsPost–World War II European originCanada, United States (1961), Japan (1964)Promotes economic growth and social well-beingFocuses on world trade, global issues, labor market deregulation

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The TriadUnited States, Western Europe, and JapanRepresents 75% of world incomeExpanded triad includes all of North America and the Pacific Rim and most of Eastern EuropeGlobal companies should be equally strong in each part

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Product Saturation LevelsThe percentage of potential buyers or households who own a productIndia: 1% of people have telephonesAutos: 1 per 20,000 Chinese; 21 per 100 Poles; 49 per 100 EU citizensComputers: 1 PC per 6,000 Chinese; 11 PCs per Poles; 34 PCs per EU citizen

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Balance of PaymentsRecord of all economic transactions between the residents of a country and the rest of the world

Current account—record of all recurring trade in merchandise and services, and humanitarian aid• Trade deficit—negative current account• Trade surplus—positive current account

Capital account—record of all long-term direct investment, portfolio investment, and capital flows

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Balance of Payments

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Top Exporters in 2004See Tables 2-7 and 2-8

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Top Importers in 2004See Tables 2-7 and 2-8

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Overview of International FinanceForeign exchange makes it possible to do business across the boundary of a national currency Currency of various countries are traded for both immediate (spot) and future (forward) deliveryCurrency risk adds turbulence to global commerce

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Foreign Exchange Market DynamicsSupply and demand interaction

Country sells more goods/services than it buysThere is a greater demand for the currencyThe currency will appreciate in value

Exchange risks and gains in foreign transactions

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Purchasing Power Parity (PPP)The Big Mac Index

Is a certain currency over-/under-valued compared to another?Assumption is that the Big Mac in any country should equal the price of the Big Mac in the United States after being converted to a dollar price

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Managing Economic ExposureEconomic exposure refers to the impact of currency fluctuations on the present value of the company’s future cash flowsTwo categories of economic exposure

Transaction exposure is from sales/purchasesReal operating exposure arises when currency fluctuations, together with price changes, alter a company’s future revenues and costs

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Managing Economic ExposureNumerous techniques and strategies have been developed to reduce exchange rate risk

Hedging involves balancing the risk of loss in one currency with a corresponding gain in another currencyForward contracts set the price of the exchange rate at some point in the future to eliminate some risk

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Looking Ahead to Chapter 3The global trade environment