The International Business Environment

Chapter 2: The Global Economy

LEARNING OUTCOMES

This lecture on the global economy will enable you to:

• identify the global pattern of income• analyse the pattern of international trade• explain why countries trade with each

other • explain the pattern and reasons for FDI

Measuring the Global Economy

Gross Domestic Productmarket value of total output of goods and services produced within a nation, usually over a year.

Problems of comparisonWhich Currency? – local or $US

Purchasing Power Parity

Gross National Income(IMF, World Economic Outlook Database, 2008)

  % WORLD POP

% OF WORLD GDP GDP PER CAPITA

Current $US

PPP Current $US

PPP $US

           

G7 11 58.4 44.5    

USA 4.6 27 21.9 44,118 44,118

CHINA 20.2 5.5 10 2,012 4,650

INDIA 17 1.8 4.4 791 2,405

GDP and the standard of living

• Population – per capita income• Shadow economy• Environmental degradation• Resource depletion• Distribution of income• Composition of spending

Human Development Index(UNDP)

Measure combining:

– life expectancy

– Education (adult literacy + average years schooling)

– Standard of living (PPP per capita income)

Income Inequality Source: UNDP, Human Development Report 2006

HDI rank

Country Poorest 10% (1)

Poorest 20%

Richest 10% (3)

Richest 20%

Ratio of (3) to (1)

8 USA 1.9 5.4 29.9 45.8 15.9

18 UK 2.1 6.1 28.5 44.0 13.8

81 CHINA 1.8 4.7 33.1 50.0 18.4

115 BOLIVIA 0.3 1.5 47.2 63.0 168.1

126 INDIA 3.9 8.9 28.5 43.3 7.3

Economic Growth

Key to raising living standards

Measured by annual % change in GDP

Source: IMF

2000-2006 (annual average %)

World 3.65

G7 2.23

Developing Economies

6.14

China 9.63

India 6.79

Brazil 3.16

Russia 6.87

Implications for Business

Attraction of high growth emerging economies

• Demand for infrastructure investment– Capital equipment– Construction materials– Power transmission equipment– Transport

• Demand for consumer goods from growing middle class

– Cars– Electronic goods– Household appliances– Entertainment– International travel

Implications for Business

World Merchandise Trade 2005WTO

Exports Imports

  Share (%)   Share (%)

Germany 9.3 USA 16.1

USA 8.7 Germany 7.2

China 7.3 China 6.1

Japan 5.7 Japan 4.8

France 4.4 UK 4.7

Netherlands 3.9 France 4.6

UK 3.7 Italy 3.5

Italy 3.5 Netherlands 3.3

WHY DO COUNTRIES TRADE

Mercantilism

Absolute advantage

Comparative advantage

Hecksher Ohlin

Leontief paradox

Vernon

Linder

Mercantilism

• The country has to export more and import less so that to keep and increase “the precious metals”, i.e. money which pays for the imports

• M. protects mainly the interests of the state and of the traders

• The poverty of the working class and farmers was seen as desirable and the increase of their spending power – as weakening the economy

Absolute advantage• Adam Smith (1776). An Inquiry into the

Nature and Causes of the Wealth of Nations • Against the restrictions on trade, as well as all

sorts of intervention of the government in business. Except for the national security.

• free export and import of commodities, i.e. import of cheap grain, export of manufactured products

Comparative advantage• Absolute advantage is a rare case. Also the countries

can be interested in the trade with each other even if one has an absolute advantage in the production of many goods

• David Ricardo (1817) England and Portugal, cloth and wine, Portugal is more efficient in the production of both. Ricardo states that they still can trade with benefit to both if say each of them specializes in one commodity based on the opportunity cost of producing both products in both countries

Comparative advantage

• If Portugal is 2 time more productive in producing cloth and 3 times more productive in wine, then Portugal has comparative advantage in producing wine.

Hecksher-Ohlin Theory• Theory of factor endowments• Comparative advantage of one country over

another in the production of something comes from the fact that the first country has advantage in a factor which plays substantial role in that production process. The original theory: labour and capital, two commodities and two countries (2x2x2)

• Examples: better soil, more sun, specific row materials, qualification of labor, etc.

Hecksher-Ohlin Theory• Limitations:

–This theory assumes perfect competition in factor and production markets.

–Important factors as transportation are not considered.

–Capital and labor are mobile in the country of analysis but not internationally

Leontief paradox• In 1954, Leontief found that the US exported

labour-intensive commodities and imported capital-intensive commodities, in contradiction with Heckscher-Ohlin theory

• The country with the world's highest capital-per-worker has a lower capital/labour ratio in exports than in imports.

Raymond Vernon

• Vernon’s model : all countries (might) benefit from any innovation, no matter if it was invented there or not.

• Critics say that it fails to address “the complexity of socio-economic implications of technology and production transfer over time”.

Linder hypothesis• Linder hypothesis states that demand plays a more

important role than comparative advantage as a determinant of trade--with the hypothesis that countries which share similar demands will be more likely to trade. For instance, both the U.S. and Germany are developed countries with a significant demand for cars, so both have large automotive industries. Rather than one country dominating the industry with a comparative advantage, both countries trade different brands of cars between them.

COMPETITIVE ADVANTAGE OF NATIONS

• Factor conditions• Demand conditions• Related and supporting industries• Firm strategy, structure and rivalry• Chance• Government

PORTER’S DIAMOND

TRADE INTERVENTION

• Import restrictions •tariffs•non-tariff barriers

– quotas– licences– rules or origin– product requirements– procedures

• Export promotion•subsidies

•Exchange rate manipulation

WHY INTERVENE?

• National defence• Infant industries• Declining industry protection• To spread risk• Political reasons• Strategic trade policy- first in the market• Protection from dumping• Retaliation• To protect against undesirable products• To resist cultural imperialism

CONTROL OF TRADE

GATT/WTO• non-discrimination• reciprocity• transparency• predictability and stability• freeing of trade• special assistance and trade concessions for

developing countries

GATT/WTO ROUNDSPeriod Round Countries Subjects

1947 Geneva 23 Tariffs

1949 Annecy 13 Tariffs

1950-51 Torquay 38 Tariffs

1955-56 Geneva 26 Tariffs

1960-61 Dillon 26 Tariffs

1964-67 Kennedy 62 Tariffs, anti-dumping measures

1973-79 Tokyo 102 Tariffs, non-tariff measures and framework agreements

1986-94 Uruquay 123 Tariffs, agriculture, textiles and clothing brought

into GATTAgreement on services (GATS)Intellectual property (TRIPS)Trade related Investment (TRIMS)Creation of WTO and dispute settlement

2001 - Doha 141 Not yet resolved

FOREIGN DIRECT INVESTMENT

REASONS FOR FDI

• A quest for natural resources– Minerals and energy– Increased competition from developing economies

• Lower production costs– Offshoring

• Market access