The Economic Environment

1. The Economic Environment  Jashim Uddin Senior Lecturer, East West University, Bangladesh

2. Key economic factors of a country include the following • The general economic framework of a country • Economic stability • The existence and influence of capital markets • Factor endowments • Market size • Availability of economic infrastructure

3. Understanding the economic opportunities of a country • Factor Conditions: • Physical resources • Human resources • Knowledge resources • Capital resources • Infrastructure Demand Conditions: • Composition of home demand (quality of demand) • Size and pattern of growth of home demand (quantity of demand) • Internationalization of demand Factor conditions are crucial for investments in producing goods, but demand conditions are crucial for market-seeking investments

4. Understanding the economic size Size of particular economy undoubtedly reflects its investment potential. Thus, the measures to understand the economic size require extensive focus. Gross National Income (GNI) and Gross Domestic Product (GDP) GDP is the value of all final goods and services produced in the country within a given period. Receipt of payments from abroad for domestically owned factors are added to GDP to compute GNP, which is synonymously used as GNI. In Bangladesh GNI is US$ 66.3 billion and GDP is US$ 60.0 billion in the year 2005. This difference is not substantial but in many countries this difference may be substantial. Per capita GNI is considered to understand the size of demand of a country, as WB is using it for its landing activities. Countries with high population and high per capita GNI are most desirable in terms of market potential. Those with low per capita GNI and low populations are least desirable, and the other countries fit somewhere in between.

5. Per capita income classifications Low income: US$ 755 or less (holds 3.4% of world GNI) Middle income: US$ 756 – US$ 9265 (holds 17.6% of world GNI) High income: US$ 9266 or more (holds 79% of world GNI) Low and middle income countries are called developing countries or emerging economies. High income countries are known as developed or industrialized countries. The high income countries generate nearly 80% of the world’s GNI but they represent 50 countries having 15% of total world population. This is also relevant with Pereto principle. • Measure of Per capita GNI can be done in two ways • Per capita GNI in dollar value and per capita GNI in PPP. PPP estimate is based on law of one price and have significant implication to understand business potential of a country. High difference between GNI per capita at PPP and actual per capita GNI require more analysis to understand the business potential of a country. Higher per capita GNI at PPP can mean: • More goods and services in domestic land that $1 can buy in US

6. Rate of inflation in domestic land can be less than US • Factor payments in domestic land can be less • Local currency is undervalued Economic System The ownership and control of economic activity in a country by public or private or both explain the economic system of that country. Dominance of public sector depicts the government control on economic activity, more it will be free when private sector dominate the same activity. Economic freedom in a country is measured by an index and when the economic freedom is high economic growth is also high. Different type of economic systems are: Market economy Command economy Mixed economy Market socialism and State capitalism

7. Key macroeconomic issues affecting business strategy Economic growth: The understanding of economic growth mostly depends on historical data and prudent predictions should be made based on that data. Growth rate observations should be made on the basis of real GDP. It is important to note that developing countries with high growth rates are often unstable politically or offer other challenges. Inflation: Inflation occurs because aggregate demand is growing faster than aggregate supply. It also occurs when government spending rising faster than tax revenue. Increase in money supply generate inflation. Inflation effects interest rates, exchange rates, the cost of living, and general confidence in a county’s political and economic system. Surpluses and deficits:The balance of payment is record of the economic transactions between the residents of one country and the rest of the world. A credit transaction is one that results in a receipt of a payment from foreigners. A debit transaction is one that leads to a payment to foreigners. The most important balance of BOP is current account balance. Contd…

8. Components of the Current account includes: Merchandise import (debit-) and export (credit+) includes tangible goods Service import (debit-) and export(credit+) includes travel, passenger fares, royalties and fees on cross-border licensing agreements. Income receipts (credit+) and payments (debit-) include dividends and interest on local capital employed in foreign land and payment on foreign assets invested in domestic land. Unilateral transfers as receipts (credit+) or payment (debit-) include private transfer payments in cash and kind, remittance from immigrants outside(as NRBs), government transfers as gifts and grants to and from foreign governments. Components of Capital and Financial account include: Capital and financial inflow(credit+) and outflow(debit-) include local liability to foreigners rise/decrease, local claim on foreigners decrease/increase, foreign held assets in domestic land rise/reduce, country’s assets overseas reduces/increases.

9. Official Settlement transactions include official reserve assets (gold, SDR, reserve at IMF, convertible forex) and liabilities to foreign official agencies (liability of local bank to foreign agencies, treasury bills, bonds or certificates) Some indications from surplus and deficits Surplus in goods and services balance means increase in GDP value and deficit means the opposite. Increase in trade deficit (goods) puts pressure on exchange rate to be depreciated. Unilateral transfer surplus arising from remittance, earning from foreign assets means increase in local capital formation and increase in consumption capacity by residents. But surplus arising from foreign grants is an indication of poor economy. The Current account surplus means a net receipt of financial claims by home residents which can be used to build up financial assets or to reduce liabilities with rest of the world. So, the nation becomes lender to the world. The deficit means the opposite. Surplus in Capital and Financial account for FDI inflow can bring Current account deficit in near future for profit repatriation.

10. External Debt The external debt can be measured as the total amount of debt and debt as percentage of GDP, when both the amounts are larger the economy also become unstable. MNEs investments in unstable economy is more cautious. Internal Debt and Privatization Internal debt results from an excess of government expenditures over revenues. It can result from poor collection of tax, huge defense and welfare expenditure inconsistent to revenue, subsidized state owned enterprises. When privatization enhanced internal debt can be reduced as burden of subsidized units goes off. Privatization pose opportunities for MNEs also bring threats to deal with existing employees.

11. Transition to a market economy Transition from command economy to market economy provide significant opportunities for MNEs. Possibility of export increases and privatization open up investment opportunity. Transition most of the cases experience difficulties as battle between conservatives and reformers intensifies.