ECONOMIC ENVIRONMENT. Economic Systems CommandMarket.

ECONOMICENVIRONMENT

Economic Systems

Command Market

Command Economy

A system where the state owns businesses.

The government determines what, where, and how much is produced.

And, who receives how much.

Market Economy

A system where the state allows entrepreneurs to own businesses.

Entrepreneurs bear the rewards and risks

:Command Economies do allow some businesses to be owned

by entrepreneurs.

Likewise, Market Economies may own certain businesses

and regulate businesses and/or inputs.

Market Reforms Cause Unemployment

And, hardship; especially for

unskilled individuals.

Can lead to: poverty, homelessness, crime, and

hopelessness.

Ironically, the biggest losers of non-market reforms are the poor.

They have to put up with lousy products and higher prices.

Economic Freedom 2002_______________________________________Repressed Mostly Mostly Free____________Unfree__ Free ___________Myanmar Saudi Germany Hong Kong

Syria Brazil Czech Singapore

Uzbekistan Turkey Japan New Zealand

Iran China S. Korea Ireland

Cuba India Poland United States

Iraq Russia Greece Australia

N. Korea Vietnam Mexico Chile

Heritage.org/index/2002/#contents

Economic Freedom• Trade Policy

• Taxation

• Government Ownership

• Monetary Policy

• Restrictions on Foreign Investment

...

• Restrictions on Banking

• Wage and Price Controls

• Property Rights

• Regulations

• Black Market

Economic Freedom & Growth

-1.5-1

-0.50

0.51

1.52

2.53

Average Annual

Real per Capita GDP

Growth, 1980-1993

Rep

ress

ed

Mos

tly

Unf

ree

Mos

tly

Fre

e

Fre

e

Economic & Political Freedom

1

2

3

4

5

6

7

Political Freedom (1=Low, 7=High)

Free MostlyFree

MostlyUnfree

Repressed

Adam Smith on Government

• Defense & Rule of Law

• Welfare of the Handicapped, Seniors, and Children.

• Public Services

Invest in Human Capital Enhance Skills of People

Invest in Health & Environment Invest in Infrastructure

Increase the Stock of Physical Capital Do not burden productive sector with government regulations and control

Respect Property Rights Open the Economy to Foreign Trade

Open the Economy to Foreign Investment Keep Government Small

Economic IndicatorsSize

GrowthInflation

UnemploymentBalance of Payment

Gross Domestic Product

The total value of goods and services produced in a

country, regardless of who produces it.

Gross National Product/Income

GDP, plus investment income from foreign

countries, minus investment income to

foreign countries.

GDP/Capita or GNP/Capita

• The contribution of each individual toward the total economic activity of a country.

• Though, not entirely accurate, the GDP per capita is used as a proxy of that country’s individuals’ relative income level.

2001 GDP/CapitaHigh Income >$ 9,206

Middle Income

Low Income <$ 745

GNPs of top 12 countries-2001»Pop GNP Rank

GNP/C Rank»million b $ Dollars

• USA 284 9901 1 34870 7 • Japan 127 4574 2 35590 4• Germany 82 1948 3 23700 20 • U.K. 60 1451 4 24230 16 • France 59 1377 5 22690 24 • China 1272 1130 6 890 138• Italy 58 1123 7 19470 30• Canada 31 662 8 21340 26• Spain 40 587 9 14860 39• Mexico 99 550 10 5540 68• Brazil 173 529 11 3060 89• India 1033 474 12 460 161World Development Report

GNPs of 10 biggest countries-2001»Pop GNP Rank

GNP/C Rank»million b $ Dollars

• China 1272 1131 6 890 138• India 1033 474 12 460 161• USA 284 9901 1 34870 7 • Indonesia 214 145 28 680 146• Brazil 173 529 11 3060 89• Russia 145 253 18 1750 107• Pakistan 141 60 44 420 163• Bangladesh 133 50 49 370 170• Nigeria 130 37 53 290 178• Japan 127 4574 2 35990 4World Development Report

GDPs & MNCs in 2001 in b$• Walmart 220• Exxon 192• General Motors 177• General Electric 126• Citigroup 112• IBM 86• Philip Morris 73• Boeing 58

• Sweden 210• Austria 189• Poland 175• Venezuela 125• South Africa113• Malaysia 88• Philippines 71• Czech 56

Fortune.com World Development Report

Economic Growth

GDPt - GDPt-n

Growth = ----------------- *100 GDPt-n

Where GDPt and GDPt-n are the nominal GDPs for the year (or any period) ‘t’ and

‘t-n’, respectively.

Real GDP Growth/year for 90-00of Selected Countries

• China 10.3

• Ireland 7.3

• India 6.0

• USA 3.5

• Japan 1.3

• Russia -4.8

• Ukraine -9.3

World Development Report

Beware

GDP/GNP growth rates are usually based on figures in local currency.

These do not account for inflation.

An apparent high growth in the GDP/GNP may be deceptive if the rate of inflation in that country is

high.

For Example: Consider Argentina

Year GDP Growth

(m Pesos) %

1985 10

1986 22 120

1987 108 391

1988 3103 2773

1989 67974 2091

1990 178704 163

Real GDPThe real GDP for year t:

rGDPt = GDPt / (1+i)

Where, i is the inflation rate between period t and t-n, and GDPt is the “nominal” GDP for the year t.

Inflation

CPIt - CPIt-n

Inflation = ---------------CPIt-n

where CPI = Consumer Price Index for period t and t-n

The inflation adjusted GDP means that it is the value of GDP for year t, measured in the currency value

of some previous year (t-n).

Real GDP Growth Rate

rGDPt - GDPt-n

Growth = ----------------------- *100 GDPt-n

Where GDPt-n is the nominal GDP for the year t-n.

Consider Argentina again.

Year GDP Nominal Inflation Real

(m Pesos) Growth Fraction Growth

1985 10 100 6.00 -71%

1986 22 120 0.86 18%

1987 108 391 1.23 120%

1988 3103 2773 3.48 541%

1989 67974 2091 30.87 -31%

1990 178704 163 23.14 -89%

COUNTRY’S ABILITY TO SUPPORT FOREIGN

TRADE/INVESTMENTS

Current Earnings

Savings

Credit Potential

BALANCE OF PAYMENTS STATEMENT

A summary of a nation’s financial transactions with

the rest of the world.

THREE CATEGORIES

1) Current Account

2) Capital Account

3) Reserves Account

CURRENT ACCOUNT

1- Merchandise Trade

2- Service trade

3- Investment Earnings

4- Private and Official Transfers

CAPITAL ACCOUNT

1) foreign direct investment

2) portfolio investment

3) loans by private foreign banks, government, and multilateral agencies.

RESERVES

1) Cash

2) Gold, etc.

Balance of Payment U.S.: 1999: $b

• Current Account

Debit

– Merchandise -1030

– Services -197

– Income -299

– Transfers -47

Total -1573

Credit Balance

683 -347

277 80

274 -25

0 -47

1234 -339

US Census Bureau, Statistical Abstracts of the US:2000

Balance of Payment of the U.S.: 1999

• Capital Account Debit

– FDI -152

– Portfolio - 98

– Other -131

Total -381

Current Balance

Overall Balance

Credit Balance

283 131

326 228

97 - 34

706 325

-339

- 14

Balance of Payment of the U.S.: 1999

Debit• Overall Balance -1954• Reserve Account

– Foreign Assets 0– Change in Res.

0

Discrepancy -39

Total 1993

Credit Balance

1940 -14

45 45

8 8

-39

1993 0

Merchandise Trade Balance

• ban or restrict the import of foreign goods

• encourage setting up of import- substitution industries

• encourage setting up of export based industries

Service Trade Balance

• prohibit or restrict the import of foreign services

• encourage setting up of import substitution industries

• promote setting up of export based industries (tourism)

Investment Earnings Balance

• severe restrictions on the use of foreign exchange

• place restrictions repatriation of incomes

• encourage reinvestment/generation of foreign exchange

Transfers Balance

• restrictions on financial aid.

Capital Account Balance

• Restrictions on outgoing foreign investments.

• Incentives to attract foreign direct investment.

ReservesFalling reserve base triggers:

devaluation of currency

This, however, lead to:

High inflation

Capital flight

ECONOMIC INTEGRATION

1- Free Trade Agreement

2- Customs Union

3- Common Market

4- Monetary Integration

5- Full Economic Integration

Free Trade Area

• A formal agreement between two or more countries to reduce (preferably eliminate) import barriers among member countries.

• Example: NAFTA

»EFTA

»MERCOSUR

Customs Union

• Members of a customs union not only have reduced or eliminated tariffs among themselves, but also have a common external tariffs on goods imported from non-member countries.

• Example: ASEAN

Common Market

• A common market eliminates all tariffs and barriers to trade among member countries, adopts a set of common external tariffs on non-members, and removes all restrictions on the flow of capital and labor among member countries.

Monetary Union

• Monetary union establishes a common currency and a common central bank to coordinate the monetary policies of the member countries.

• Example: EU

Political Union

• Political union entails a common political system among member countries.

• Example: U.S.A.