ECONOMIC

ENVIRONMENT
Introduction

■ Any MNC seeking to invest in any country should analyse and understand the local economic
environment
■ understanding the economic environment of foreign countries can help international managers
predict how trends and events in those environments might affect performance of businesses
there.

■ In this chapter propose to discuss all those forces which constitute the economic environment of a
country
Elements of economic Environment

■ Economic Systems
■ Financial Systems
■ Economic Policies
■ Structural Adjustments
INCOME-WISE CLASSIFICATION OF
COUNTRIES
■ Classifications are done by OECD and UN
■ World Bank classifies 211 economies with a population of at least 30,000 are ranked by their
levels of gross national income (GNI) per capita.
■ These economies are then classified as
– low-income (LIC),
– lower-middle income (LMC),
– upper-middle income (UMC),
– high-income OECD, and other high-income countries.
Classification based on income

■ Developing Countries
■ Most developing countries share a set of common and well-defined goals.
■ These include a reduction in poverty, inequality, and unemployment; the provision of minimum
levels of education, health, housing, and food to every citizen; the broadening of economic and
social opportunities; and the forging of a cohesive nation-state.

■ Developing countries include many nations in Africa, the Middle East, and the poor formerly
communist nations in Europe and Asia.
■ Some of these countries (for example India and China) have the potential to emerge as
superpowers in the near future
Developed Countries

■ Those countries that are highly industrialised, highly efficient, and whose people enjoy a high
quality of life are the developed countries
■ People in these countries usually receive excellent healthcare and benefit from the best
educational systems in the world.
■ Most developed nations also support programmes for helping poorer nations improve their
economies and standards of living
COUNTRIES CLASSIFIED BY ECONOMIC
SYSTEM

■ Countries are classified as market economies, command economies, and mixed economies.

■ The system of economy a nation follows depends on its political ideology. In countries where

individual goals are uppermost over collective goals, market economies do find their place.

■ In contrast, in countries where collective goals are given prominence, state interventions and

restricted markets do exist

Classification based on economic systems
Market Economy

 In a market economy, also called capitalism, all productive functions are privately owned
 Production of goods and services is not planned by individuals. Rather production is determined by
the interaction of supply and demand forces.
 Whether to produce more or less depends on the price factor. If demand for a product exceeds its
supply, price tends to rise prompting producers to produce more

 The system of capitalism stresses the philosophy of individualism believing in private ownership
of all agents of production, in private sharing of distribution processes that determine the functional
rewards of each participant, and in the individual expression of consumer choice through a free
marketplace
Conditions for classifying as market
economy
 Trust (in banks, insurance companies, suppliers, etc.)
 Law and order (enforcement of contracts)
 Security of persons and of property
 Balancing competition with cooperation (for a safe workplace and a
cleaner environment)
 Division of responsibility and diffusion of power (an independent
judiciary)without restrictions or favoritism
Conditions for classifying as market
economy
 Community altruism (a social “safety net” for the impaired, chronically unemployed, the elderly,
 etc.)
 Social mobility, legitimation of ambition, and toleration of competitiveness
 Materialistic values as a stimulus to greater production
 Deferring gratification to generate private saving
 Rationally unconstrained by tradition
 Honesty in government
 Efficient forms of competition, as opposed to monopolistic control
 Freedom of information (along with protection of privacy)
 Flow of information
■ Command Economy
■ Also called socialism, in a command economy planning is a must. Decisions relating to all
economic activities—what to produce, how to price—are determined by a central government
plan. In fact, in a pure command economy the tools of production are organised, managed, and
owned by the government, with the benefits accruing to the public.
■ Mixed Economy
■ This falls midway between a market economy and a command economy. Largely followed in
France, India, Italy, and Sweden, mixed economies admit existence of private sector along with
government ownership.
CLASSIFICATION OF COUNTRIES
BY REGION
■ East Asia and Pacific
■ Europe (East and Central Europe) and Central Asia
■ Latin America and the Caribbean
■ Middle East and North Africa
■ South Asia
■ Sub-Saharan Africa
ECONOMIC SCENARIO

■ Macro economic scenario determines the attractiveness or otherwise of a country as

an investment destination.
■ Such a scenario is characterised by the size of economy income levels and distribution, consumption,
population, inflation, external financial status, banking and financial markets and tax system.
■ India’s status on the above parameters in growing positive and hence India is receiving attention from
MNCs around the world
Country Analysis

■ Size of the economy

■ Income Distribution
■ Income Levels
■ Personal Consumption-A country in which people spend major portion of their income on food
and shelter offers little scope for luxury products. The same country is an attractive market for
inexpensive goods that meet the basic necessities of life
■ Population
■ Inflation
Country Analysis

■ External Financial Status

■ Banking and Financial Markets
■ Tax System
FINANCIAL SYSTEM

■ The financial system comprises two segments; money market and capital market
■ Money market is the market in which short-term funds are borrowed and lent
■ mainly through Money market is of great help to an economy as it helps enhance liquidity,
stabilizes interest rates and helps financial and commercial institutions and commercial banks
earn attractive interest on monetary assets.

■ Capital markets, also called stock exchanges, constitute a vital element of an economy.
■ Corporate sector raises its long-term funds through capital markets. Well developed stock
exchanges obviously add to attractiveness of a country for FDI inflow
ECONOMIC POLICIES

■ Industrial Policy
■ Monetary Policy
■ Fiscal Policy
■ Trade Policies
POLITICAL ENVIRONMENT
Political Environment

■ Political environment refers to the influence of the system of government and judiciary
in a nation on international business.
■ The system of government in a nation wields considerable impact on its business

■ The type and structure of government prevailing in a country decides, promotes, fosters,
encourages, shelters, directs, and controls the business of that country.

■ political system that is stable, honest, efficient, and dynamic and which ensures political
participation to the people, and assures personal security to the citizens, is a primary
factor for economic development
Political environment

■ Italy probably better exemplifies the impact of political environment on a nation’s economy. Italy
■ holds a record in political instability. In the last 63 years since World War II, the country has had
63 governments.

■ Story of Pakistan, Srilanka

Type of government

■ Democracy
■ Totalitarianism
Totalitarianism

 In totalitarianism, also called authoritarianism, individual freedom is completely subordinated to

the power of the authority of state and concentrated in the hands of one person or in a small group,
which is not constitutionally accountable to the people.
 Societies ruled by a pressure clique—political, economic or military or by a dictator, plus most
oligarchies and monarchies—belong to this category.
 The doctrines of fascism and erstwhile communism are examples of totalitarianism
Types of Totalitarianism

■ Theocratic- country’s religious leaders are also its political leaders

■ Secular- political system in which political leaders are guided by military and bureaucratic power

■ Tribal- political party that represents the interests of a particular tribe monopolises power.

■ Right-Wing To-talitarianism- private ownership of property is endorsed by government, market

■ forces are also allowed free play, but political freedoms are rarely granted
Implications of Doing Business with
Totalitarian Regimes
■ MNCs need not worry about any opposition to their activities from rival political parties.
■ On the negative side, they may be required to pay bribes and kickbacks to government officials

■ Ethical Issues- Investments by MNCs in such countries will encourage dictators to justify their
actions and probably reinforce repressive measures.
■ The ethical issues involved in having business deals with authoritarian countries are:
– (i) should a firm do business in a repressive totalitarianism state, and
– (ii) should a firm pay bribes to dictators to gain market access?
Democracy

■ Generally, democracy is accompanied by capitalism which confers freedom to business to decide

and act
■ Freedom to invest, produce and earn is essential for business growth.
■ Democracy ensures security to citizens by allowing them to participate in decision making
■ Non-government organizations (NGOs), social activist groups and other voluntary organisations
form part of democracy
■ As Niels Bohr has opined, “The best weapon of dictatorship is secrecy, but the best weapon of a
democracy should be the weapon of openness”.
POLITICAL RISK

■ Political risk is any governmental action or politically motivated event that could adversely affect
the long-term profitability or value of a firm.
■ Political risk affects different firms in different ways.
■ It can threaten the market of an exporter, the production facilities of a manufacturer, or the ability
of a firm to repatriate its profits from a host country to its home country.
■ Political risk arise when the host government makes a decision which is adverse to the interests of
the subsidiary.
■ It also arises when laws and government policies instituted by the firm’s home country, adversely
affect the firms that do business in a foreign country
Types of Risks

■ Macro political risk-A macro political risk affects all international businesses in the same way.
Expropriation, the seizure of privately owned assets, as for example, a farm or a factory, by
government with little or no compensation to the owners, is a macro political risk.
■ Taking of ownership of an entire industry that had been generated privately, as a part of a plan
to restructure an entire economy, is called nationalisation, again a macro political risk.
■ Communist governments in eastern Europe and China expropriated private firms following World
War II. Fidel Castro did the same in Cuba during 1958–59.
■ Political boycotts also result in macro political risk-
■ Ex. Israel related companies
Micro Political Risk

■ A micro political risk affects a specific foreign business

■ Micro political risks include industry regulations, taxes, kidnapping and terrorist threats.

■ bombing of the Chinese embassy in Belgrade by NATO forces in 1997. In retaliation,

demonstrators in China thrashed KFC stores but did not touch Pizza Hut stores though both were

owned by a US based company. Chinese protestors did not attack Pizza Hut thinking that it was

Italian-owned.
Macro and Micro Risks
Managing political risks