The Global Economic Environment

Chapter 2
 Learning Objectives
• Types of economic systems
• Economic freedom
• Economic risks
• Stages of economic development
• Market opportunities
• Balance of payments
• Exchange rate
 Major Changes in the World Economy
• The new realities:
– Capital movements have replaced trade as the driving force of the world economy
– Production has become uncoupled from employment
– The world economy, not individual countries, is the dominating factor
– The struggle between capitalism and socialism began in 1917 is over
– E-Commerce diminishes the importance of national barriers and forces companies to re-
evaluate business models
 Economic Systems

Resource Allocation
Market Command

Private Market Centrally

Capitalism Planned
Capitalism
Resource
Ownership
Centrally
State Market
Planned
Socialism
Socialism
Western Economic Systems
 Economic Freedom
• 2018 Ranking by the Heritage Foundation
– http://www.heritage.org/index/ranking

• 12 Measures of Economic Freedom

– Rule of Law
• Property rights
• Judicial effectiveness
• Government integrity
– Government Size
• Tax burden
• Government spending
• Fiscal health
– Regulatory Efficiency
• Business freedom
• Labor freedom
• Monetary freedom
– Open Markets
• Trade freedom
• Investment freedom
• Financial freedom
 Economic Risks
• Exchange controls
• Local-content laws
• https://business.financialpost.com/transportation/autos/foreign-automakers-oppose-
trumps-nafta-plan-as-u-s-mexico-talks-resume

• Import restrictions
• Tax controls
• Price controls
• Labor issues (e.g., union)
 Trade Barriers
• Tariffs
• Quotas
• Voluntary export restraints
• Boycotts & embargoes
• Monetary barriers
• Standards
– e.g., local content requirement
• Antidumping penalties
• ……
 Monetary Barriers
• Blocked currency: Blockage is accomplished by refusing to allow importers
to exchange its national currency for the sellers’ currency.

• Differential exchange rates: It encourages the importation of goods the

government deems desirable and discourages importation of goods the
government does not want by adjusting the exchange rate. The exchange
rate for importation of a desirable product is favorable and vice-versa.

• Government approval: In countries where there is a severe shortage of

foreign exchange, an exchange permit to import foreign goods is required
from the government.
 Bankers Petroleum
• Bankers Petroleum in Albania
– $57M tax dispute with Albania

– 5/31: acquired by China’s Geo-Jade Petroleum Corp.

– 7/20: extend deadline to receive China’s approval to 7/31.

– 9/9: received Chinese State Administration of Foreign Exchange approval.

 Stage of Economic Development
• The World Bank has defined four categories of development using Gross
National Income (GNI) as a base.
• BEMs (big emerging markets)
– China, India, Indonesia, South Korea, Brazil, Mexico, Argentina, South Africa, Poland,
and Turkey

• BRICS
– Brazil, Russia, India, China and South Africa
 Stage of Economic Development
Stage GNI per capita Mean GNI per % of World % of World
(2018) capita (2011) Wealth (2011) Population
(2011)
High-income >$12,056 $36,608 77 16

Upper-middle $3,896-$12,055 $5,913 10 12

income

Lower-middle $996-$3,895 $2,038 10 35

income

Low-income <$995 $649 3 37

• Source: https://blogs.worldbank .org/opendata/new-country-classifications-inc ome-level-2017-2018

– https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups
• https://data.worldbank.org/i ndicator/NY.GNP.PCAP.CD
• http://www.scribd.com/doc/109256385/The-World-Bank-Stages-of-Market-Development-Model #scribd
 Stage of Market Development
• Low-income
– Afghanistan, Ethiopia, Zimbabwe, Tajikistan

• Lower-middle income
– Cambodia, Bangladesh, Ukraine, Egypt, India

• Upper-middle income
– Malaysia, Thailand, Mexico, Venezuela, Jordan, Cuba
– Brazil, Russia, China, South Africa
• High-income
– Argentina, Chile, Croatia, Panama
 BEMs
• Are all physically large
• Have significant populations
• Represent considerable markets for a wide range of products
• Have strong rates of growth or the potential for significant growth
• Have undertaken significant programs of economic reform
• Are of major political importance within their regions
• Are “regional economic drivers”
• Will engender further expansion in neighboring markets as they grow
 BRICS
• BRICS are key emerging markets.
• Economic development
– Lower/upper-middle income category
– Combined GDP: $16.039 trillion; expect to reach $50 trillion by 2020

• Population
– over 3 billion; 42% of the world population

• Goldman Sachs report: combined economies of BRICS will outstrip the

current leading economies by 2040.
 Technology
• A Global Quiz
– Which economy has the highest level of cell phone penetration rate in the world?
• A. Canada
• B. U.S.
• C. UAE
• D. Hong Kong
• E. Finland

• http://en.wikipedia.org/wiki/List_of_countries_by_number_of_mobile_phones_in_use
 Technology
• A Global Quiz
– Which economy has the highest level of smart phone penetration rate in the world?
• A. UAE
• B. Sweden
• C. Switzerland
• D. South Korea
• E. Taiwan

• https://en.wikipedia.org/wiki/List_of_countries_by_smartphone_penetration
 Technology
• Which economy has the highest level of Internet penetration
(users/population) rate in the world?
– A. Bermuda
– B. Norway
– C. Canada
– D. Iceland
– E. Luxembourg

• https://en.wikipedia.org/wiki/List_of_countries_by_number_of_Internet_users
 Technology
• Which country is most innovative?
– A. Sweden
– B. U.K.
– C. Switzerland
– D. U.S.
– E. Netherlands

• https://www.globalinnovationindex.org/analysis-indicator
 Infrastructure
• Infrastructure supports production and marketing
– Paved roads, railroads, electrical power, seaports, communication networks

• World Ranking
– Logistics Performance Index
• https://lpi.worldbank.org/international/global?order=Infrastructure&sort=asc
– http://uk.businessinsider.com/wef-countries-in-the-world-with-the-best-infrastructure-
2016-10/#t17-iceland-56-icelands-transport-infrastructure-is-one-of-the-best-in-the-world-
3
 Market Potential Index
• Published by Michigan State University-International Business Center
• 2018 Ranking
– https://globaledge.msu.edu/mpi/data/2018

• Measures of Market Potential

– Market size
– Market intensity
– Market growth rate
– Market consumption capacity
– Commercial Infrastructure
– Market receptivity
– Economic freedom
– Country risk
 McDonald’s Theory
• Thomas L. Friedman, author of “The World Is Flat”
– McDonald's Theory
• A network of McDonald’s restaurants
• = a big enough middle class to support these restaurants

– Dell Theory
• When a country is within the global supply chain
• It is less likely to involve in war
 Marketing Opportunities
• Mistaken Assumptions
– The poor have no money à look at the aggregate buying power
• Rural Bangladesh: villagers use village phones
– The poor are too concerned with fulfilling basic needs to “waste” money on nonessential goods
– The goods are sold in developing markets are so inexpensive that there no room for a new market
entrant to make a profit
– People in bottom of the pyramid (BOP) markets cannot use advanced technology
– Global companies that target bop markets will be criticized for exploiting the poor

• Strategies
– Develop products that suit local needs and income level
 Marketing Opportunities
• Examine factors essential to marketing
• Existing distribution channels, infrastructure
• Existing advertising agencies, marketing research firms, consumer financing agencies,
warehousing facilities, etc.

• Examine the market potential and growth à market attractiveness

• First mover advantages & disadvantages
• Which advantages are sustainable?
 Consumers in Emerging Markets
• Income
– Developed markets: a sizable early adopter segments and a big middle class segment
– Emerging markets: the number of affluent consumers are smaller (though growing everyday)
who prefer to shop aboard or in specialty stores; a large size of the bottom

• Buying habits
– Developed markets: a mix of high-end, medium-quality, cheap products
– Emerging markets: buy the cheapest or the best (more aspirational categories, e.g., sport
shoes, cosmetics, HDTVs).

• Product knowledge
– Developed markets: a lot
– Emerging markets: not much

• Strategies: aim low; adapt; educate; anticipate change

• Source: “Let Emerging Market Customers Be Your Teacher,” HBR, Dec. 2010
 LV in India
• 2003 – LV opened its first store at a luxury hotel in New Delhi

• 2004 – LV opened a second store at a luxury hotel in Mumbai

• LV is a high-end product. India is a low-income economy. Can this dichotomy be

reconciled?
– “The Rise of India’s Consumer Market” – McKinsey Report 2007
– By 2025, 583 million (41% of the population) middle class ($4,400 - $22,000 = $23,500 -
$118,000 based on purchasing power parity), 23 million are the wealthiest (average $50,000
= about $268,000 PPP)
– More than half of the population will be living in urban areas

• What are the barriers for luxury brands in countries like India?
– Promotion, pricing, retail location, competition, use of credit card
 LV in China
• China is the rising star for luxury goods
– 10% of the global market
– 44% of the global demand in 2020

• Luxury goods are purchased as status symbols & gifts

• Chinese consumers prefer to shop aboard
– Avoid taxes
– Better selections
– Status/show-off: bought at France instead of a local store
• Strategies
– Paris stores: hiring sales people affluent in Chinese;
know the tour bus schedule
– Local stores: different location with different target market:
shopping district: targeting young, aspiring buyers with lower-priced items:
office area: masculine décor for businessmen shopping for gifts;
luxury shopping area: flagship store to educate consumers.
 The Battle for China’s Good-Enough Market
• What problem does Caterpillar face in China?
– Entered the market in 1975.
– Sold construction equipments to government ever since.
– Began selling high quality equipments to the private sector as a premium segment of
the market emerged.
– However, it could never broaden its focus to include other segments.
– By the early 2000s, companies from Japan and South Korea, e.g., Komatsu, Hitachi,
Daewoo, were in the middle market with equipments that cost less but were still
reliable.
– A local manufacture who used to focus on the low end market is trying to getting into
the middle market.
• Source: Harvard Business Review, Sep. 2007
 The Battle for China’s Good-Enough Market

• What is the “good-enough” market segment?

– Reliable-enough products at low-enough prices
– Targeting middle-market consumers
• Three market segments in China (e.g., the TV market)
– Premium: high-end products provided by foreign companies selling to customers with significant
purchasing power (e.g., Panasonic, Philips, Sony, 13% market share)
– Good-Enough: products of good quality, produced by local companies, for a rapidly expanding
group of value-seeking consumers with midlevel income (e.g., Hisense, Skyworth, TCL, 62%)
– Low-End: products of low quality, meeting basic needs, produced by local firms for a large group
of consumers with low incomes (e.g., Konka, 25%, 40-90% cheaper than the premium ones)
 The Battle for China’s Good-Enough Market

• Discussion
– What should foreign companies do?
 How to unlock the wealth in rural markets?

• From 2009 to 2012, the spending by 800+ million rural Indian residents
reached $69 billion, 25% more than their urban counterparts.
• In China, the demand in the countryside has already began to outstrip the
demand in the cities.
• Consumption in rural areas is growing at 1.5 times the rate in urban areas.
• Rural residents are trading up.
• How to find and serve these hard to reach customers?
• Source: HBR, June 2014
HBR, June 2014
 How to unlock the wealth in rural market?

• Distribution
– Tata moto: local residents à village advisors, gas station owners à generate sales lead for the
sales team à increased sales by 20%
– Idea Cellular: youth who live near its cell towers
– Vodafone: “red” stores (mini stores)
– Banking: self-employed banking correspondence
• Partners
– Coke: solar powered cooler
• Customers
– Engaging influencers: teachers, health workers, etc.
– After sale service: locals serving the local, e.g., mobile vans
 Finding Great Ideas in Emerging Markets

• Product ideas that originated from emerging markets

– ConocoPhilips: 5-gallon (vs. U.S. 55-gallon) lubricants from Central America
– Intel: Classmate notebook PC – portable, durable, inexpensive, socially oriented PCs
(with camera) from Brazil
– GE Healthcare Systems: portable ultrasound technology – small, cheap – from China
• Source: Harvard Business Review, Sep/Oct 2011
 Balance of Payment
• Record of all economic transactions between the residents of a country and
the rest of the world.
– http://data.imf.org/?sk=7A51304B-6426-40C0-83DD-CA473CA1FD52

• 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
Top Exporters and Importers in
World Merchandise Trade, 2012
 Foreign Exchange
Purchasing Power Parity (PPP) – The Big Mac Index
• http://www.economist.com/content/big-mac-index

§ Based on purchasing power parity theory, i.e., a dollar should purchase the
same amount in all the countries à the price of a big Mac in any country
should be the same.
§ Is any currency over/under valued compared to others?
§ The role of central bank?
§ Limitations of Big Mac Index
 Factors Affecting the Exchange Rate
• Trade balance
• Interest rate
• Inflation
• Investor expectations
• Productivity

• Devaluation: the reduction of a nation’s currency against other currencies

• Revaluation: a nation allows its currency to strengthen
Exchange Rate Risks
 Managing Exchange Rate Exposure
• Economic Exposure
– The impact of currency fluctuations on a company’s financial performance
– Hedging involves balancing the risk of loss in one currency with a corresponding gain in
another currency
• Internal Hedging: price adjustment clauses, intra-corporate borrowing/lending
• External hedging:
– Forward Contracts: buy/sell currency at a predetermined exchange rate on a specific date in the future
– Foreign currency option: the option of buy/sell currency at a predetermined exchange rate on a
specific date in the future

– Other non-hedging methods:

• Determine the type of currency in the contract, reinvesting in local currency
 Forward Contracts
• A Canadian company needs to pay $1,000 on Feb. 1, 2017
– Today: CAD 1.32 = USD 1
– Forward contract on 2/1/17 to buy $1,000

• A Canadian company will receive $1,000 in payment on Feb. 1, 2017

– Forward contract on 2/1/2017 to sell $1,000
Supplemental Slides
 Low-Income Countries
• GNI per capita of $1,045 or less
• Characteristics
– Limited industrialization
– High percentage of population in farming
– High birth rates
– Low literacy rates
– Heavy reliance on foreign aid
– Political instability and unrest
– Concentrated in Sub-Saharan Africa
 Lower-Middle-Income Countries
• GNI per capita: $1,046 to $4,125
• Characteristics
– Rapidly expanding consumer markets
– Cheap motivated labor
– Mature, standardized, labor-intensive industries like footwear,
textiles and toys
• 50 bottom-ranked countries are LDCs—least
developed countries
• India is the only BRIC nation
 Upper-Middle-Income Countries
GNP per capita: $4,126 to
$12,745
Characteristics:
•Rapidly industrializing, less
agricultural employment
•Increasing urbanization
•Rising wages
•High literacy rates and
Venezuelans have to cope with a advanced education
shortage of goods as oil prices •Lower wage costs than
have dropped. advanced countries
• Also called industrializing or developing economies
• BRICS: Brazil, China, South Africa
• Other countries: Malaysia, Chile, Venezuela, Mexico
 Newly Industrializing Economies
(NIEs)
• Lower-middle and upper income economies with the
highest sustained rates of economic growth
– Greater industrial output that developing economies
– Exports of manufactured and refined products
– Next -11 (N-11) a new country grouping identified by Goldman
Sachs
• NIEs include Egypt, Indonesia, the Philippines, (lower-middle
income) Mexico, and Turkey (upper-middle income)
 High-Income Countries
• GNI per capita: $12,476 or more
• Also known as advanced, developed, industrialized, or
postindustrial countries
• Characteristics:
– Sustained economic growth through
disciplined innovation
– Service sector is more than 50% of
GNI
– Households have high ownership
levels of basic products
 High-Income Countries
• Characteristics, continued:
– Importance of information processing
and exchange
– Ascendancy of knowledge over capital,
intellectual over machine technology,
scientists and professionals over
engineers and semiskilled workers
– Future oriented
– Importance of interpersonal
relationships