Chapter 2:	The Global Economic Environment			Poorna Pal, MS MBA Ph.D. Glendale Community College Phone: (818)240-1000 x 5517 ppal@glendale.edu Office: SG-152 Office Hours: MWTTh: 3.15 - 5.15 PM (SG-152) or by appointment with your questions
		Overview Lecture Outline	Discussion Questions Test Your Knowledge
	Overview World economy is increasingly integrated. The world economy has changed dramatically since World War II. Perhaps the most fundamental change is the emergence of global markets; responding to new opportunities, global competitors have displaced or absorbed local ones. The integration of the world economy has increased significantly. Economic integration was 10 percent at the beginning of the 20th century; today, it is approximately 50 percent. Integration is particularly striking in the two regions of the European Union (EU) and the North American Free Trade Area. For example, the world’s largest automakers have, for the most part, evolved into global companies. During the past two decades, the world economic environment has become increasingly dynamic; change has been dramatic and far-reaching. To achieve success, executives and marketers must take into account the following new realities: Capital movements have replaced trade as the driving force of the world economy. Global capital movements far exceed the dollar volume of global trade.			Chapter Overviews, Outlines and Sample Questions Introduction to Global Marketing The Global Economic Environment Regional Market Characteristics and Preferential Trade Agreements Social and Cultural Environments The Political, Legal, and Regulatory Environments Global Information Systems and Market Research Segmentation, Targeting, and Positioning Importing, Exporting, and Sourcing Global Market Entry Strategies: Licensing, Investment, and Strategic Alliances Brand and Product Decisions In Global Marketing Pricing Decisions Global Marketing Channels and Physical Distribution Global Marketing Communications Decisions I: Advertising and Public Relations Global Marketing Communications Decisions II: Sales Promotion, Personal Selling, Special Forms of Marketing Communication Digital Revolution Strategic Elements of Competitive Advantage Leadership, Organization, and Corporate Social Responsibility
	Productivity has become “uncoupled” from employment. The second change concerns the relationship between productivity and employment. To illustrate this relationship, it is necessary to review some basic macroeconomics.  Gross domestic product (GDP) , a measure of a nation’s economic activity, is calculated by adding consumer spending (C), investment spending, (I), government purchases,(G), and net exports (NX): C+I+G+NX = GDP Economic growth, as measured by GDP, reflects increases in a nation’s productivity. The world economy dominates the scene; individual country economies play a subordinate role. The struggle between capitalism and socialism is largely over. The Cold War is over; communism is not an effective economic system. Finally, the growth of the personal computer and the advent of the Internet have diminished the importance of national boundaries.

Economic Systems

• Traditionally, there are four main types of economic systems: market capitalism, centrally planned socialism, centrally planned capitalism, and market socialism.

  This classification was based on the dominant method of resource allocation (market versus command) and the dominant form of resource ownership (private versus state)

  • Market capitalism is an economic system in which individuals and firms allocate resources, and production resources are privately owned. Consumers decide what goods they desire, and firms decide how much to produce; the state’s role is to promote competition.

    Market capitalism is practiced worldwide, especially in North America and Western Europe, but all market-oriented economies do not function in the same manner. The U.S. is distinguished by its competitive “wild free-for-all” and decentralized initiative whereas Japan is a tightly run, highly regulated economic system that is market oriented.

• Centrally-Planned Socialism is at  the opposite end of the spectrum. It gives the state broad powers to serve the public as it sees fit. State planners make “top-down” decisions about the goods and services produced and in what quantities; consumers spend money on what is available. Government ownership of industries and individual enterprises is characteristic. Demand exceeds supply, and there is little reliance on product differentiation, advertising, or promotion. To eliminate “exploitation” by intermediaries, the government controls distribution.

  Because of market capitalism’s superiority, many socialist countries have adopted it; the ideology developed by Marx and perpetuated by Lenin has been resoundingly refuted. For decades, the economies of China, the former Soviet Union, and India functioned according to the tenets of centrally planned socialism. All three countries are now engaged in economic reforms characterized, in varying proportions, by increased reliance on market allocation and private ownership.
   

• Centrally-Planned Capitalism and Market Socialism: In reality, market capitalism and centrally-planned socialism do not exist in “pure” form. Command and market resource allocation are practiced simultaneously, as are private and state resource ownership. The role of government in modern market economies varies widely.

  Centrally-planned capitalism is an economic system in which command resource allocation is used extensively in an environment of private resource ownership (e.g., Sweden).

  Market socialism permits market allocation policies within an overall environment of state ownership (e.g., China gives freedom to businesses/individuals to operate in a market system).

  Market reforms and nascent capitalism in many parts of the world are creating opportunities for large-scale investments by global companies. For example, Coca-Cola returned to India in 1994, two decades after being forced out by the government. A new law allowing 100 percent foreign ownership of enterprises helped pave the way.

Stages of Economic Development

• At any point in time, individual country markets are at different stages of economic development. The World Bank has developed a four-category classification system that uses per capita gross national income (GNI) as a base. Although the income definition for each of the stages is arbitrary, countries within a given category generally have a number of characteristics in common.

• Today, global attention is focused on opportunities in Brazil, Russia, India and China (collectively known as BRIC). For each of the stages of economic development, special attention is given to the BRIC countries. Add South Africa to the list, and we have BRICS!
   
• Low-income countries have a GNI per capita of less than $936. The general characteristics shared by countries at this income level are:
   
  • limited industrialization and a high percentage of the population engaged in agriculture and subsistence farming
  • high birth rates
  • low literacy rates
  • heavy reliance on foreign aid
  • political instability and unrest
  • concentration in Africa south of the Sahara
     

  Approximately 40% of the world’s population is included in this group. Typically, these countries provided limited investment opportunities. However, there are exceptions; for example, in Bangladesh, where per capita GNP is approximately $450, the garment industry has enjoyed burgeoning exports.

  The newly independent countries of the former Soviet Union present an interesting situation: Income is declining, and there is considerable economic hardship. The potential for disruption is, therefore, high.

  India is the sole low-income county in the BRIC group. In the 1990s India faced high inflation and low foreign exchange reserves. Leaders opened India’s economy to trade and investment and dramatically improved market opportunities.

  The United Nations designates fifty countries in the bottom ranks of the low-income category as least-developed countries (LDCs). The term is sometimes used to indicate a contrast with developing (i.e., upper ranks of low-income plus lower-middle and upper-middle-income) countries and developed (high-income) countries.
   

• Lower-Middle-Income Countries are those with a GNI per capita between $936 and $3,705.

  Consumer markets in these countries are expanding rapidly. Countries such as China and Thailand represent an increasing competitive threat as they mobilize their relatively cheap labor forces to serve target markets in the rest of the world.

  The developing countries in the lower-middle-income category have a major competitive advantage in mature, standardized, labor-intensive industries such as making toys and textiles.

  China and Brazil are the BRIC nations in the lower-middle-income category. China represents the largest single destination for foreign investment in the developing world.  Despite ongoing market reforms, Chinese society does not have democratic foundations. Although China has joined the World Trade Organization, trading partners are still concerned about human rights, protection of intellectual property rights, and other issues.
   

• Upper-Middle-Income Countries, also known as industrializing or developing countries are those with GNP per capita ranging from $3,706 to $11,455. Russia and Brazil, with per capita GNI of $5,770 and $4,710, respectively, are the tow BRIC nations that currently fall into the upper-middle-income category.

  The percentage of population engaged in agriculture has dropped sharply as people move to the industrial sector and the degree of urbanization increases.

  Upper-middle-income countries that achieve the highest rates of economic growth are sometimes referred to as newly industrializing economies (NIEs).
   

• Marketing Opportunities in LDCs and Developing Countries

  • Despite many problems in LDCs and developing countries, it is possible to nurture long-term market opportunities. Although Nike sells only a small portion of its output in China, it clearly has the future in mind when it refers to China as a “two-billion-foot market.”
     

  • The basic misconceptions about countries at the “bottom of the pyramid” that must be corrected:

Marketing can be the link that relates resources to opportunity and facilitates need satisfaction on the consumer's terms. But some, on the other hand, believe that marketing is relevant only in affluent, industrialized countries. They argue that, in less-developed countries the major problem is the allocation of scarce resources toward obvious production needs. Efforts should focus on production and how to increase output, not on customer needs and wants. Conversely, others argue that the role of marketing – to identify people’s needs and wants and to focus individual and organizational efforts to respond to these needs and wants – is the same in all countries, irrespective of level of economic development.

Indeed, when global marketers respond to the needs of rural residents in emerging markets such as China and India, they are also more likely to gain all-important government support and approval.

For example, Nestle introduced Pure Life bottled water in Pakistan and the brand has captured 50 percent of the market. Coca-Cola recently began to address dietary and health needs in low-income countries by developing Vitango, a beverage product that can help fight anemia, blindness, and other ailments related to malnutrition.

There is also an opportunity to help developing countries join the Internet economy.

At the Massachusetts Institute of Technology’s Media Lab, a project called One Laptop per Child has the goal of developing a laptop computer that governments in developing countries can buy for $100.
 

• High-Income Countries are advanced, developed, industrialized, or postindustrial countries, having a per capita GNP of $11,456 or higher. They have reached their present income level through sustained economic growth. The phrase “postindustrial countries” describes the United States, Sweden, Japan, and other advanced, high-income societies. Opportunities in a postindustrial society depend on new products and innovations because ownership levels for basic products are high. Organizations face difficulty in expanding shares in existing markets, but they can create new markets.

• What countries make up the “Group of Seven”?

Among high-income countries, the U.S., Japan, Germany, France, Britain, Canada, and Italy form the Group of Seven (G-7) to steer the global economy to prosperity and stability.

• What country was added to the G-7 to form the G-8?

Starting in the mid-1990s, Russia began attending the G-7 summit meetings. In 1998, Russia became a full participant, giving rise to the new Group of Eight (G-8).

Another institution of high-income countries is the Organization for Economic Cooperation and Development (OECD).  The 30 OECD nations believe in market-allocation economic systems and pluralistic democracy; the organization has been described as an “economic think-tank” and a “rich-man’s club.”

Evidence of the increasing importance of the BRIC group is the fact that China, India, Brazil, and Russia have all formally announced their intention to join the OECD.

The Triad

·         What three economic centers make up the Triad?

In his book Triad Power, Ohmae argued that successful global companies had to be equally strong in the dominant economic centers of Japan, Western Europe, and the United States.

These three regions, called the Triad, represented the dominant centers of the world and the location of nearly 75 percent of world income, as measured by GNP.

The expanded Triad includes the entire Pacific region, Canada and Mexico; and the boundary in Europe is moving eastward.

Marketing Implications of the Stages of Development

The stages of economic development can serve as a guide to marketers in evaluating product saturation levels, the percentage of potential buyers or households who own a product.

In countries with low per capita income, product saturation levels are low (e.g., ownership of telephones in India is only about 20 percent of the population).

In China, saturation levels of private motor vehicles and personal computers are very low – only about one car or light truck for every 43,000 people, and one PC for every 6,000. Compare this to the EU, with a ratio of 34 PCs per 100 people.

BALANCE OF PAYMENTS

• What is the balance of payments?

The balance of payments is a record of all economic transactions between the residents of a country and the world. It is divided into the current and capital accounts. (Table 2-5).

• What is the current account?

The current account is a measure that includes trade in merchandise and services, plus certain categories of financial transfers such as humanitarian aid.

• Define a trade deficit.
• Define a trade surplus.

A country with a negative current account balance has a trade deficit; that is, the outflow of money to pay for imports exceeds the inflows of money for sales of exports

A country with a positive current account balance has a trade surplus.

·         What is the capital account?

The capital account is a record of all long-term direct investment, portfolio investment, and other short- and long-term capital flows.

The minus signs indicate outflows of cash, payment for (for example, Table 2-5, line 2 shows an outflow of $1.97 trillion in 2007, that represents payment for U.S. merchandise imports).

A country accumulates reserves when the net of its current and capital account transactions shows a surplus; it gives up reserves when the net shows a deficit.

The United States regularly posts a deficit in both the current account and the trade balance of goods.

A close examination of Table 2-5 reveals that the United States regularly posts deficts in both the current account and the trade balance in goods. 

Overall, the U.S. post balance of payments deficits while important trading partners, such as China, have surpluses. (Table 2-6).

TRADE IN MERCHANDISE AND SERVICES

Thanks in part to the achievements of GATT and the WTO, world merchandise trade has grown at a faster rate than world production since the end of World War II.

According to figures compiled by the World Trade Organization, the dollar value of world trade in 2007 totaled $13.9  trillion.

In 2003, Germany surpassed the United States as the world’s top merchandise exporter. Exports generate 40 percent of Germany’s gross domestic product, and 9 million jobs are export related.

China’s third place in the export ranking underscores its role as an export powerhouse.(Table 2-7).

Chinese exports to the United States have surged since China joined the World Trade Organization in 2001; in fact, policymakers in Washington are pressuring Beijing to boost the value of the yuan in an effort to stem the tide of imports.

Table 2-8 provides a different perspective on global trade.  The European Union is treated as a single entity with import and exports that exclude intra-regional trade among the 25 countries that were EU members at the end of 2006.  It shows that the EU is the #1 exporter and importer of world merchandise in 2006.

The fastest-growing sector of world trade is trade in services. Services include travel and entertainment; education; business services such as engineering, accounting, and legal services; and payments of royalties and license fees.

U.S. services exports in 2007 totaled $500 billion. This represents more than one-third of total U.S. exports. The U.S. services surplus (service exports minus imports) stood at $119 billion.

OVERVIEW OF INTERNATIONAL FINANCE

 Foreign exchange makes it possible for a company in one country to conduct business in other countries with different currencies.

• What two basic markets make up the foreign exchange market?

The foreign exchange market consists of a buyer’s market and a seller’s market where currencies are traded for both spot and future delivery on a continuous basis.

• What is the difference between the ‘spot’ market and the ‘forward’ market?

The spot market is for immediate delivery; the market for future delivery is called the forward market.

• Who are the participants in this market?

1.      A country’s central bank can buy and sell currencies in the foreign exchange market and government securities in an effort to influence exchange rates.

2.      Some of the trading in the foreign exchange market takes the form of transactions needed to settle accounts for the global trade in goods and services. (For example, because Porsche is a German company, the dollars spent on Porsche automobiles by American car buyers must be converted to euros.)

3.      Currency speculators also participate in the foreign exchange market.

• What is ‘devaluation’?
• What is ‘revaluation’?

Devaluation can result from government action that mandates a reduction in the value of the local currency against other currencies.

The opposite is revaluation. In 2005, the Chinese government responded to pressure from its trading partners by adopting a policy of revaluation to strengthen the yuan against the dollar and other currencies. A stronger yuan would make China’s exports to the United States more expensive while making U.S. exports to China less expensive.

Purchasing Power Parity

Given that currencies fluctuate in value, a reasonable question to ask is whether a given currency is over- or undervalued compared with another.

• What is the “Big Mac Index”?

One way to answer the question is to compare world prices for a single well-known product: McDonald's Big Mac hamburger. The so-called “Big Mac Index” is a ‘quick and dirty’ way of determining which of the world's currencies are too weak or strong.

The underlying assumption is that the price of a Big Mac in any world currency should, after being converted to dollars, equal the price of a Big Mac in the United States.

A country’s currency would be overvalued if the Big Mac price (converted to $) is higher than the U.S. price. Conversely, a country’s currency would be undervalued if the converted Big Mac price is lower than the U.S. price.

Economists use the concept of purchasing power parity (PPP) when adjusting national income data to improve comparability.

Economic Exposure

·         What is ‘economic exposure’?

Economic exposure reflects the impact of currency fluctuations on a company’s financial performance.  Economic exposure can occur when a company’s business transactions result in sales or purchases denominated in foreign currencies.

Managing Exchange Rate Exposure

Forecasting exchange rate movements is a major challenge. Over the years, the search for ways of managing cash flows to eliminate or reduce exchange rate risks has resulted in the development of numerous techniques and financial strategies. 

Hedging exchange rate exposure involves establishing an offsetting currency position such that the loss or gain of one currency position is offset by a corresponding gain or loss in some other currency.

External hedging methods for managing both transaction and translation exposure require companies to participate in the foreign currency market. Specific hedging tools include forward contracts and currency options.

Internal hedging methods include price adjustment clauses and intra-corporate borrowing or lending in foreign currencies.

The forward market is a mechanism for buying and selling currencies at a preset price for future delivery.

In some situations companies are not certain about the future foreign currency cash inflow or outflow. In such an instance, forward contracts are not the appropriate hedging tool.

A foreign currency option is best for such situations.

·         What is a ‘put option?’

·         What is a ‘call option?’

A put option gives the buyer the right, not the obligation, to sell a specified number of foreign currency units at a fixed price, up to the option's expiration date.

Conversely, a call option is the right, but not the obligation, to buy the foreign currency.

Discussion Questions

1. Explain the difference between market capitalism, centrally planned capitalism, centrally planned socialism, and market socialism. Give an example of a country that illustrates each type of system.

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2. Use the seven criteria found on pp. 42-43 to develop a profile of one of the BRIC nations, or any other country that interests you.  What implications does this profile have for marketing opportunities in the country?

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3. Why are Brazil, Russia, India, and China (BRIC) highlighted in this chapter? Identify the current stage of economic development for each BRIC nation.

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4. A manufacturer of satellite dishes is assessing the world market potential for his products. He asks you if he should consider developing countries as potential markets. How would you advise him?

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5. A friend is distressed to learn that America's merchandise trade deficit hit a record $780 billion in 2005. You want to cheer your friend up by demonstrating that the trade picture is not as bleak as it sounds. What do you say?

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