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The Economic Environment

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McDonald’s Case

• 1976 Montreal Olympics First contact.• 1988 final agreement.• Moscow City Council + McDonald’s

– Not in the five year plan.– Not enough supplies. – Education of Soviet farmers and cattle ranchers. – Attracting employees and customers

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Matt Paull: CFO McDonald’s

• “When planning openings, we consider each market’s current economic conditions, long term demographic and lifestyle trends, competitive environment and stage of development, as well as the potential effect on existing McDonald’s restaurants and returns”.

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Question

• Which economical aspects would you consider when facing the decision of internationalization?

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Key Questions

1. Under what type of economic system does the country operate?

2. What are the size, growth potential and stability of the market?

3. Is the company’s industry in that country’s public or private sector?

4. If it is in the public sector, does the government also allow private competition in that sector?

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Key Questions

5. If the company’s industry is in the private sector, is it moving toward public ownership?

6. Does the government view foreign capital as being in competition with or in partnership with public or local private enterprises?

7. In what ways does the government control the nature and extent of private enterprise?

8. How much of a contribution is the private sector expected to make in the economy of the country?

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COUNTRY ANALYSIS

• Understanding the economic environment can help the company predict how trends and events might affect its future performance.

• Economic performance can be studied through economic growth, inflation, budget and trade deficits.

• Countries can be classified by: Income, Region and Economic System

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KEY ECONOMIC FORCES

• The general economic framework of a country.• Economic stability.• Existence and influence of capital markets.• Factor endowments• Market Size• Availability of economic infrastructure.

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Where should managers commit resources?

• Factor conditions– Inputs to the production process: human, physical,

knowledge, and capital resources and infrastructure.

• Demand conditions– Composition of home demand (quality)– Size and growth of demand (quantity)– Internationalization of demand.

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Location-Specific Advantage

Other

DemandFactor

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MEASURING PRODUCTIVITY• Gross National Income (GNI):

The market value of final goods and services newly produced by domestic factors of production at home or abroad.e.g.: Ford U.S. $ + Ford Mex with U.S. $ = U.S. GNI

• Gross Domestic Product (GDP):Measures the value of production that occurs within a country’s borders without regard to whether the production is done by domestic or foreign factors of production.

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KEY ECONOMIC INDICATORS• Per Capita Income: Income level per person.

• Per Capita GNI: Used by the world bank for lending policies

• Quality of Life: Life expectancy, educational standards (Literacy), etc.

• Purchasing Power: What a sum of money actually can buy.

• Percentage of GDP Generated from Agriculture: Higher in developing countries.

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WORLD BANK CLASSIFICATION• First World:

High income industrial countries.• Second World:

Countries that formerly had centrally planned economies. These countries are undergoing rapid change and are found in both the upper-middle and the lower-middle income categories.

• Third World:Also known as Developing Countries or LDC’s are the lower-middle and low income economies.

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• Economic Growth.• Privatization.• Inflation: Affects interest rates, the cost of living, &

consumer & investor confidence.• Hyperinflation: Is a rate of inflation that is extremely

high for a sustained period of time.• Balance of payments: Summarizes all international

transactions between domestic residents & foreign residents.

• External Debt.

KEY ECONOMIC FACTORS

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Economic Systems: MARKET ECONOMY.

• The market mechanism involves interaction of price, quantity, supply and demand for resources and products.

• Factors that make market economy work:– Consumer sovereignty The right of the consumer to decide

what to buy.– Freedom of the enterprise to operate in the market.

• The interplay of supply and demand should ensure proper allocation of resources.

• A perfect market economy doesn’t exist.

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Characteristics of Market Economies:

• More means of production are privately owned.• Markets are very competitive.• Strong currencies.• Institutional support.• Well-functioning infrastructure.• Investment opportunities for individuals.

Economic Systems: MARKET ECONOMY.

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Models of Market Economies:

1. Social Welfare: Heavy government spending and high taxation to pay for social services.

2. Consumer-directed: Minimal governmental participation and promotion of growth through mobility of production factors.

3. Administratively Guided: Cooperation among government, management and workers to achieve growth and full employment.

Economic Systems: MARKET ECONOMY.

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• The government coordinates the activities of the economic sectors.

• Goals are set for every enterprise in the country.

• The government is assumed to be a better judge of how resources are allocated.

• Few countries use strict central planning today.

Economic Systems: COMMAND ECONOMY

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• Higher degree of government intervention regarded in two ways:

– Government ownership of the means of production.

– Government influence in economic decision making.

• Greater degree of reliance on market forces.

Economic Systems: MIXED ECONOMY.

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INFLATION

• Condition in which prices are going up.• Consumer Price Index (CPI) measures a fixed

basket of goods and compares their prices over time.

• High Inflation High Interest Rates– Banks need to attract money.– Governments have to slow down economic

growth.

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BALANCE OF PAYMENTS

• Is a summary statement of all transactions that take place between a country and the rest of the world during a given period of time (usually a year).

• Transactions are recorded as debits and credits.

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DEBIT TRANSACTIONS

• A debit transaction is a flow for which the home country must pay and requires the supply of the home currency.– Imports of goods and services– Transfers to foreign residents (remittances)– Acquisition of long-term assets or reduction of a

long-term liability (i.e., stocks, bonds, real capital)– Acquisition of a short-term asset or reduction of a

short-term liability (i.e., bank deposits, cash or short-term bonds such as treasury bills).

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CREDIT TRANSACTIONS

• A credit transaction is a flow for which the home country is paid and increases the demand for the home currency by foreign residents.– Exports of goods and services– Transfers from foreign residents– Sale of a long-term asset or increase of a long-term

liability.– Sale of a short-term asset or increase of a short-term

liability.

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ACCOUNTS IN THE BALANCE OF PAYMENTS

• Current account: trade in good and services and income from assets abroad.– Merchandise trade balance: the net balance of

exports minus imports of merchandise.– Services: travel, passenger fares, royalties and

fees.– Income receipts: payments on assets.

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ACCOUNTS IN THE BALANCE OF PAYMENTS

• Capital account: transactions in real or financial assets between countries, such as the sale of real state to a foreign investor.

• Deficit: imports exceed exports.• Surplus: exports exceed imports.

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THE FOREIGN EXCHANGE MARKET

• Exchange rate: relative price, that can be expressed in either direction.– If the euro rises against the US dollar, the US dollar falls

against the euro.• Indirect Quotation: How much foreign currency

exchanges for one unit of the domestic currency.– 1 home currency unit = x foreign currency units.

• Direct Quotation: A country's home currency as the price currency.– 1 foreign currency unit = x home currency units.

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02/09/2011

• Direct Quotation– 1 USD to COP = 1 779

• Indirect Quotation– 1 COP to USD = 0.000562

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EXTERNAL DEBT

• The amount of money borrowed from foreign public or private sector banks.

• Major debtor nations: United States, United Kingdom, Germany, France and Spain.

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Rank Country External

debt(millions US$)

Date of information

External debt

per capita (US$)

Date of population

External debt (% of

GDP)

1 United States

$13,773,000 6/30/2009 $42,343 31-March-

08 95%

2 United Kingdom

$9,191,104

12/22/2009 $150,673 November

2009 365.44%

3 Germany $5,208,000 6/30/2009 $63,350 30-Jun-07 185.2%

4 France $5,021,000 6/30/2009 $ 30-Jun-07 237.62%

5 Spain $2,478,000 9/30/2008 $49,619 30 June

2007 est. 150.65%

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Rank Country External debt(millions US$)

Date of information

1 United States$

13,980,000,000,000

30 June 2010

2 EU$

13,720,000,000,000

30 June 2010

3 United Kingdom $

8,981,000,000,000 30 June 2010

4 Germany $ 4,713,000,000,000 30 June 2010

5 France $ 4,698,000,000,000 30 June 2010

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INTERNAL DEBT

• Excess of government expenditures over tax receipts.

• Privatization

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THE INTERNATIONAL MONETARY SYSTEM

• A network effecting international payments through institutions, rules, and regulations.

• Characteristics:1. countries must be allowed sufficient time to

adjust without severe recessions or high inflation but, at the same time, should not be allowed to avoid adjustment at the expense of other countries.

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THE INTERNATIONAL MONETARY SYSTEM

2. The choice of the unit of account, that is the agreed measure of the value of currencies. (AU)

3. International cooperation with respect to adjustment methods, concerted intervention, and reserve assets.

4. Promotion of free international trade so that productive resources are optimally allocated.

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THE GOLD STANDARD

• The values of currencies were fixed relative to the value of gold, which was used as a unit of account and the main reserve asset. Each country participating in the gold standard fixed the value of its currency relative to gold and maintained gold reserves.

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THE GOLD STANDARD

• Suspended in 1914, before WW I.• Reintroduced in the 1920s• Collapsed in the Great Depression and WW II.

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THE BRETTON WOODS SYSTEM

• Bretton Woods, New Hampshire, 1944• Fixed, but adjustable, exchange rates based on

the free convertibility of the US dollar to gold and the establishment of the IMF.

• The dollar overvalued United States deficit.• Dollars held by foreigners grew 60s and 70s, it

exceeded the amount of gold held by the United States.

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THE PRESENT “NONSYSTEM”

• industrialized countries switched to managed exchange rates but the system is so diverse that it is sometimes referred to as a “nonsystem.”

• Fixed (but adjustable) exchange rates.