International

Business 9e
By Charles W.L. Hill
McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 3

Political Economy and

Economic Development

What Determines A Countrys

Level
Of Economic Development?

Gross national income (GNI) per person

measures the total annual income
received by residents of a nation
Japan, Sweden, Switzerland, and the U.S.
have high GNI
China and India have low GNI

GNI can be misleading because it does

not consider differences in the cost of
living
need to adjust GNI figures using purchasing
power parity (PPP)
3-3

How Do Countries
Compare On GNI?
Economic Data for Select Countries

3-4

What Determines A Countrys

Level
Of Economic Development?
Official figures can also be misleading
because they do not account for black
economy transactions
In addition, GNI and PPP data are static
and do not consider economic growth
rates
So, while China and India are currently
categorized as being poor they are growing
more rapidly than many developed nations
and are expected to become among the
largest economies in the world
3-5

How Do Countries
Compare On Growth
Rates?
Economic Data for Select Countries

3-6

What Determines A Countrys

Level
Of Economic Development?
Nobel-prize winner Amartya Sen argues
economic development should be seen as a
process of expanding the real freedoms that
people experience
the removal of major impediments to freedom like
poverty, tyranny, and neglect of public facilities
the presence of basic health care and basic
education

Amartya Sen also claims that economic

progress requires the democratization of
political communities to give citizens a voice

3-7

What Determines A Countrys

Level
Of Economic Development?
The United Nations used Sens ideas to
develop the Human Development Index
(HDI) which is based on
life expectancy at birth
educational attainment
whether average incomes are sufficient to
meet the basic needs of life in a country

3-8

How Do Countries
Compare on Economic
Development?
Economic Data for Select Countries

3-9

How Does Political

Economy Influence
Economic
Progress?
Innovation and entrepreneurship are the engines
of long-run economic growth

innovation includes new products, new processes,

new organizations, new management practices, and
new strategies
entrepreneurs commercialize innovative new products
and processes

Innovation and entrepreneurship help increase

economic activity by creating new markets and
products that did not previously exist
innovation in production and business processes
result in more productive labor and capital further
boosting economic growth rates
3-10

How Does Political

Economy Influence
Economic Progress?

Innovation and entrepreneurship require a

market economy

there is little incentive to develop new innovations in

planned economies because the state owns all
means production and therefore, the gains

There is a strong relationship between economic

freedom and economic growth
the six countries with the highest ratings of economic
freedom from 1975 to 1995 were also among the
highest for economic growth
Hong Kong, Switzerland, Singapore, the United States,
Canada, and Germany
3-11

How Does Political

Economy Influence
Economic Progress?

Innovation and entrepreneurship require

strong property rights
without strong property rights, individuals and
businesses risk having their innovations and
potential profits stolen

Economist Hernando de Soto claims that

inadequate property protection in many
developing nations limits economic growth

3-12

How Does Political

Economy Influence
Economic Progress?

Democratic regimes are probably more

conducive to long-term economic growth than
dictatorships, even the benevolent kind
property rights are only secure in well-functioning,
mature democracies

Subsequent economic growth leads to the

establishment of democratic regimes
South Korea
Taiwan

3-13

How Does Geography

Influence Economic
Development?

Countries with favorable geography are more

likely to engage in trade, and so, be more open
to market-based economic systems, and the
economic growth they promote
Jeffrey Sachs studied economic growth rates
between 1965 and 1990 and found that
landlocked countries grew more slowly than coastal
economies
being totally landlocked reduced a countrys growth
rate by 0.7% per year
tropical countries grew more slowly than countries in
temperate zones

3-14

How Does Education

Influence Economic
Development?

Countries that invest in education have

higher growth rates because the workforce
is more productive
countries in Southeast Asia have offset their
geographical disadvantages by investing in
education
Indonesia, Malaysia, and Singapore

3-15

How Is The Political

Economy Changing?
Since the late 1980s, two trends have
emerged
1. Democratic revolution (late 1980s and early
1990s)
democratically elected governments replaced
totalitarian regimes
more committed to free market capitalism

2. A move away from centrally planned and

mixed economies
more countries have shifted toward the marketbased model
3-16

How Is The Political

Economy Changing?
Trend 1: Democracy has spread over the last
two decades
many totalitarian regimes failed to deliver economic
progress to the vast bulk of their populations
new information and communication technologies
have broken down the ability of the state to control
access to uncensored information
economic advances of the last 25 years have led to
increasingly prosperous middle and working classes
who have pushed for democratic reforms

3-17

How Free Are

Countries Politically?
Political Freedom in 2010

3-18

How Is The Political

Economy Changing?
Author Francis Fukuyama argues that the new
world order will be characterized by democratic
regimes and free market capitalism
But, political scientist Samuel Huntington
argues that while many societies are
modernizing they are not becoming more
Western
predicts a world split into different civilizations
these civilizations will be in conflict with each
other
3-19

How Is The Political

Economy Changing?
Trend 2: The spread of market-based
systems
more countries have moved away from
centrally planned and mixed economies
toward the market-based model

Command and mixed economies failed

to deliver the sustained economic growth
achieved in market-based countries

3-20

How Free Are

Countries Economically?
Economic Freedom in 2010

3-21

What Is The Nature Of

Economic Transformation?
The shift toward a market-based system
involves
deregulation removing legal restrictions to
the free play of markets, the establishment of
private enterprises, and the manner in which
private enterprises operate
privatization - transfers the ownership of state
property into the hands of private investors
the creation of a legal system to safeguard
property rights
3-22

What Does The Changing

Economy Mean For
Managers?

Markets that were formerly off-limits to Western

business are now open
firms need to explore opportunities in these markets

Despite being underdeveloped and poor, some

markets have huge potential
China -1.2 billion people
India 1.1 billion people
Latin America 400 million potential consumers

3-23

What Does The Changing

Economy Mean For
Managers?

However, the potential risks are large

will democracy thrive especially in difficult

economic times?
will totalitarian regimes return?
will a multi-polar world of different civilizations
emerge?
will Chinas financial system be stable?

3-24

What Are The Implications Of

Political Economy Differences For
Managers?
Countries with democratic regimes, market
based economic policies, and strong property
rights protection are more likely to have higher
sustained rates of economic growth
these markets are more attractive to international
businesses
the benefits, costs, and risks of doing business in a
country are a function of the countrys political,
economic, and legal systems

3-25

What Are The Implications Of

Political Economy Differences For
Managers?
The benefits of doing business in a country are a
function of
the markets size
the purchasing power of its consumers
their likely future wealth

By identifying and investing early in potential

future economic stars, firms may be able to gain
first mover advantages (advantages that accrue
to early entrants into a market) and establish
loyalty and experience in a country
China

3-26

What Are The Implications Of

Political Economy Differences For
Managers?
The costs of doing business in a country
are a function of its
political system
is it necessary to pay bribes to get market access?

economic level
are the necessary supporting business and
infrastructure in place?

legal system
it can be more costly to do business in countries
with dramatically different product, workplace, and
pollution standards, or where there is poor legal
protection for property rights
3-27

What Are The Implications Of

Political Economy Differences For
Managers?
The risks of doing business in a country are a
function of
Political risk - the likelihood that political forces will
cause drastic changes in a country's business
environment that adversely affects the profit and
other goals of a business enterprise
Economic risk - the likelihood that economic
mismanagement will cause drastic changes in a
country's business environment that adversely affects
the profit and other goals of a business enterprise
Legal risk - the likelihood that a trading partner will
opportunistically break a contract or expropriate
property rights

3-28

How Can Managers

Determine A Markets
Overall Attractiveness?
The overall attractiveness of a country as a
potential market and/or investment site for an
international business depends on balancing the
benefits, costs, and risks associated with doing
business in that country
Other things being equal, the benefit-cost-risk
trade-off is likely to be most favorable in
politically stable developed and developing
nations that have free market systems and no
dramatic upsurge in either inflation rates or
private sector debt
3-29

How Can Managers

Determine A Markets
Overall Attractiveness?
Country Attractiveness

3-30