- GDP/GNI
- PPP
- Population and Demographics
- Exports/Imports (Trade Gap)
- FDI
- FPI
- ForEx Reserves
- Inflation
- Interest Rate
- Exchange Rate
- Balance of Payment (BOP)
- Human Development Index (HDI)
- Unemployment
- Income Distribution and Poverty
- Debt
1. GDP
GDP is the total value of all goods and services produced within a nation’s borders over one year, no matter whether domestic or foreign owned companies make the product. For country’s attractiveness GDP is a more important factor. In addition to the GDP, the sectoral break up and growth rate also needs to be known for a country. The three major sectors of India are Agriculture, manufacturing and services. Services sector is the major sector. If we take the growth rate, then developed countries have a stable growth rate but not growing rapidly where as the developing countries are growing at a rapid rate although their economic base is smaller. From an organization point of view, the growth rate of the relevant market’s sector needs to be considered. Also the growth rate of the sector from where the resources are obtained is to be considered. So compared to absolute growth rate, sectoral break up is more important.
GDP Per Capita : Managers divide the GDP to the number of people who live in a country. This ratio leads to a per capita estimator that measures the relative performance of a country’s economy. It signifies the average income level of the country. It determines which kinds of products will be bought by the people of that country. It is a good indicator for consumer goods where as for industrial goods sectoral break up is a good indicator.
GNI : Gross National income is the value of all goods and services produced by a country during a one year period. The absolute size of GNI reveals a lot about the market opportunity in a country.
2. Purchasing Power Parity (PPP)
The Purchasing power parity is the number of units of a country’s currency required to buy the same amounts of goods and services in the domestic market that one unit of income would buy in the other country. It is useful to compare the purchasing power of different countries. The most common PPP exchange rate comes from comparing a basket of goods and services in a country with an equivalent basket in the United States.
3. Population and Demographics
India and China are countries with 1 billion plus population where as the average population of a country is 10 million. There are several parameters like age, gender, level of education, literacy, urban/rural distribution.
Age : Population of the working class workforce, and consumer groups based on age.
Gender : Certain professions are restricted to gents only. (Eg: Saudi Arabia)
Education: The reach of advertisements will be determined by the literacy and education level of the country.
Urban/Rural Population: the nature of market is different whether it is urban populated or rural populated.
4. Exports/Imports (Trade Gap)
The companies opt for exports when the cost of labor in home country is low, transportation costs and tariff barriers are also low. A country can export goods when it has comparative advantage as compared to the host country. When a country is in disadvantage regarding some specific goods and services, it opts for imports.
Trade gap: The difference between the exports and imports of a country is known as trade gap. If exports is greater than imports then the country is said to have trade surplus where as if the imports are greater than exports then the country is said to have trade deficit.
5. FDI
companies adopt FDI route in order to get a controlling stake in a host country for a long term purpose. It might not be only for manufacturing. It can also be a part of the overall supply chain. FDI helps the home country to a great extent in terms of controlling other markets.
Inward FDI : FDI, what comes to home country is known as inward FDI. The inward FDI for India is 15 Billion dollars. Inward FDI indicates, how the country is being perceived by other countries and MNEs. The Inward FDI tells about the competitive sectors of the country.
Outward FDI : FDI what goes out of home country is known as outward FDI. Outward FDI indicates that, the country has certain strengths of world class level (technology, skills) in certain sectors for which they are venturing outside. It indicates the economic development of the host country. Countries go for outward FDI, when there is market opportunity or staying closer to the customer as required by the customer. For outward FDI, the country should have economic strength as well as domain knowledge and capabilities.
6. FPI
Foreign portfolio investments are meant for only short term purpose. Here the main motive is to get a good return at a moderate risk with high liquidity. Countries can’t get any controlling stake by investing through FPI.
7. ForEx Reserves
It indicates the economic health and sustainability of the country. ForEx reserves are required for payment of interests, debts for imports. The forEx reserve of a country should be high.
8. Inflation
Inflation is the pervasive and sustained rise in the aggregate level of prices measured by an index of the cost of various goods and services. Inflation results when aggregate demand grows faster than aggregate supply. From MNE’s perspective it determines the pricing and long term strategy. It is a large measure of MNE’s confidence. A moderate rate of inflation brings stability which is attractive to the MNEs. It is a measure of the government’s success in the economy. Inflation also puts great pressure on governments to control it. Often governments try to reduce inflation by raising interest rates and imposing protectionist trade policies and currency controls.
9. Interest Rate
Interest rate is the indicator of cost of raising capital. Ideally interest rates should be low and stable. Countries try to have interest rates which is close to LIBOR (London Inter Bank Offer Rate). For a country, having stability in inflation, interest rate and exchange rate are the factors which attract other companies to invest in the country. The stability in these rates helps in predicting the uncertainty in the business. Both interest rates and inflation move in the same direction. When inflation goes up, the interest rates also go up to adjust the return for the lender.
10. Exchange Rate
Exchange rates between two currencies specifies how much one currency is worth as compared to other. The foreign exchange market is one of the largest markets of the world. The daily transactions in foreign exchange market is about $3.2 trillion dollars. When inflation is high, export competitiveness go down and exchange rates also go down.
11. Balance of Payment (BOP)
It records a country’s international transactions that take place between companies, governments or individuals. In doing so the BOP reports the total of all the money that comes into a country from abroad less all the money going out of the country to any other country during the same period. BOP is also officially known as the statement of International transactions. BOP has two main accounts namely current account and capital account.
Current Account: It tracks all trade activity in merchandise. The components of Current account are
a. Value of exports and imports of physical goods.
b. Receipts and payments for services and intangible goods
c. Private transfers such as money sent home by expatriate workers
d. Official transfers.
Capital Account : It tracks both loans given to foreigners and loans received by citizens. The components of capital account are
a. Long term capital flows.
b. Short term capital flows.
Current accounts indicate trade balance, dividends, interests for investments, unilateral transfers where as Capital accounts indicate FII, Investments, loans, repayments, real estate.
BOP is an important measure for long term stability of a country. The BOP should be moderate.
12. Human Development Index (HDI)
HDI measures the average achievements in a country on three dimensions.
Longevity : as measured by life expectancy at birth
Knowledge : as measured by the adult literacy rate and the combined primary, secondary and tertiary gross enrolment ratio.
Standard of living : as measured by GNI per capita expressed in PPP for US dollars.
United Nations refined the HDI by adding two more dimensions i.e.
Gender : a gender related development index that adjusts for gender inequalities.
Poverty : a measure of poverty to adjust for human deprivations and the denial of choices and opportunities.
HDI aims to capture long-term progress in human development rather than short term changes. HDI is scaled in between 0 and 1. Countries scoring less than 0.5 are having low HDI. From 0.5 to 0.8 are having moderate and from 0.8 to 1 have high HDI.HDI measures both economic and social parameters to estimate its current and future economic activity. It indicates a country’s long term potential.
13. Unemployment
If the country has high level of unemployment, then it triggers political risk. The proportion of unemployed workers in a country shows how well a nation’s human resources are used and serves as a measure of economic activity.Managers access the situation of a country by checking the misery Index. Misery Index is the sum of country’s inflation and unemployment rates. The higher the misery, the lower are the chances that foreign companies will invest in the country.
14. Income distribution and Poverty
The top 20% of the world population account for the 86% of the income where as the bottom 20% account for only 1%. In India 80 percent of the population earn less than $2 a day and 40 percent of the population earn $1 a day. Therefore managers look for the economic potential of a country by adjusting their analyses to reflect the actual distribution of income. The skewness of the income distribution is very high in India as well as Asian countries. If income distribution is unequal, then it will lead to poverty. So only a part of the population will be relevant. Poverty impacts the economic environment and analyses to a huge extent. International companies facing such situations must deal with their implications to virtually every feature of the economic environment. In countries with high poverty levels customary market systems may not exist, national infrastructure may not work, criminal behaviours may be pervasive. So companies have to deal with all such situations.
15. Debt
It is the sum total of government’s financial obligations. It measure the state’s borrowing from its population, foreign organization, foreign governments and international institutions. The larger the total debt, the more unstable the country’s economy becomes.A country’s debt has two parts : Internal and External debt.
Internal Debt : Internal debt results when the government spends more than it collects in revenues. Internal deficit occurs due to imperfect taxing system, state owned enterprises run deficits.
External Debt: External debt results when a government borrows money from foreign lenders. Foreign investors monitor debt levels to gauge debt pressures on the government to revise its economic policies.
Types of Economic Systems
An economic system is the set of structures and processes that guides the allocation of resources and shapes the conduct of business activities. On one end there is capitalism and on the other hand there is communism. Capitalism is a free market system built on private ownership and control. Communism is a centrally planned system built on state ownership of all economic factors of production and control of economic activity. So basically there are three types of economic systems.
- Market Economy
- Command Economy
- Mixed Economy
Market Economy
It is basically a capitalist economy. In market economy individuals, rather than government, make the majority of economic decisions. The theoretical principles that define free-market economies are based on the principle of laissez-faire (non-intervention by government in economic matters). This principle is credited to Adam Smith and his proposition that a market economy has two general features
- Producers efficiently make products that consumers want in a profit making motive.
- Consumers determine the relationships among price, quantity, supply and demand so that capital and labor are allocated productively.
So the consumer sovereignty, where by consumers influence the allocation of resources through their demand of products is the essence of market economy. A market is very less dependent upon government rules and restrictions. However for some public goods like traffic systems or national defence, government intervenes to enforce contracts, property rights to ensure fair and free competition and to regulate certain economic activities and provide general security.
Eg: Hong Kong, Great Britain, Canada, United States are major market economies.
Command Economy
Also known as centrally planned economy. It is the exact opposite of market economy. Here the government owns and controls all resources. Here the government decides the type, quantity, price, production and distribution of goods. In a centrally planned economy, the government owns the means of production i.e. land, farms, factories, banks, stores and are managed by the employees of the state. Here the price of the goods and services usually remains constant however the quality deteriorates over a time period because
- Whatever product is made is usually in short supply.
- Consumers typically have few to no other choices.
- There is not much incentive for companies to innovate and little profits to invest.
Command economies are traditionally found in communist countries. In communist countries, the state economic planners give highest priority to industrial investments and military spending where as consumer goods and food products are given little or no priority. However centrally planned economies sometimes allowed free market forces to play in the informal gray markets where scarce consumer goods are exchanged at market determined rates. Command economies can perform well in terms of growth rates for short periods of time by mobilizing unemployed or underemployed resources to generate growth. However the products produced are not competitive with global standards, often achieved marginal rates of efficiency while making acceptable products. Currently very fewer countries are practicing command economies like North Korea and Cuba. Many Countries are transiting from command economies to market economies, thereby creating business opportunities.
Mixed Economy
Most of the economies are neither purely market nor command economies. Most of them fall in the midway of the capitalism-communism spectrum. In a mixed economy the public sector, private sector and private sector co-exist simultaneously. A mixed economy is a system where economic decisions are largely market driven and ownership is largely private, but the government intervenes in many private economic decisions. Here the government owns key factors of production, yet consumers and private producers still influence price and quantity.
The proponents of mixed economies concede that an economic system should aspire to achieve the efficiencies endemic to free markets. But an economic system must also protect the society from the excesses of individualism and greed and ideally apply policies needed to achieve low employment, low poverty, steady economic growth and an equitable distribution of wealth.
Operationally government intervention in the economy takes various forms.
- Central, regional, local governments may actually own some means of production.
- The government can influence private production or consumption decisions.
- The government can redistribute income and wealth in pursuit of some equity objective.
The extent and nature of government intervention varies from country to country and changes over time based on a country’s political, social, cultural and institutional traditions and trends.
Transition to a market economy
Since the market economies outperformed command and mixed economies, therefore it is apparent that government ownership and control of the factors of production constrained growth and prosperity due to operational inefficiency and strategic ineffectiveness. Also due to globalization, there is free flow of products, people and ideas among nations. Together these developments aggravate a fundamental limitation of mixed and command economies. Market economies create powerful individual incentives that stimulate innovation, whereas mixed and command economies seemed to create weak or no incentives.
The process of transition to a market economy varies from country to country. It largely depends on how well the country’s government can dismantle its central planning system and consumer sovereignty in its economic environment. The success of transition appears to be intricately linked to how well the government deals with privatizing the means of production, deregulating the economy, protecting property rights, reforming fiscal and monetary policies and applying antitrust regulation.
Privatization
It is the process of transfer of ownership and control of factors of production from government to private owners. It will lead to a certain level of unemployment. Privatization improves general market efficiency and shapes the relationship between supply and demand. Privatization reduces govt debt by eliminating the need to subsidize typically inefficient, money loosing state owned enterprises. Privatization leads to up gradation of technologies, improvisation of business practices and creation of innovations.
Deregulation
Deregulation involves relaxing or removing restrictions on the free operation of markets and business practices. The country, by deregulating, makes it more attractive for MNEs. The result will be employee generation, exports, infrastructure development, knowledge growth, sectoral growth. The govt gains taxes in the form of (income taxes, company taxes, and indirect taxes). It increases the productivity due to less regulation compliance. Therefore the resulting freedom and savings encourage managers to make the investments into the innovations that then lead to economic growth. The disadvantage in deregulation is, the control remains elsewhere instead of the host country.
Property Rights
Protection of property rights means that entrepreneurs who come up with an innovation can legally claim the present and future rewards of their idea, effort and risk. The protection also supports a competitive economic environment by assuring investors and entrepreneurs that they will prosper from their hard work.
Fiscal and Monetary Reform
Adopting free market principles requires a government to rely on market-oriented instruments for macroeconomic stabilization, set strict budget limits, and use market based policies to manage the supply. Using the market to enforce fiscal and monetary discipline leads to stable economic environments that attract the investors, companies and capital needed to start and finance growth.
Antitrust Laws
By enforcing antitrust laws, governments can prevent monopolies from exploiting consumers and restraining market growth. The government’s intent on liberalizing its economic system must legislate antitrust laws that encourage the development of industries with as many competing businesses as the market will sustain. In such industries, prices are kept low by the forces of competition.
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