Chp 3 Political Economy

and Economic Development

What Determines A Country’s Level
Of Economic Development?
 Gross national income (GNI) per person measures the total annual income received by residents of a
nation

 Japan, Sweden, Switzerland, and the U.S. have high GNI

 China and India have low GNI

 GNI can be misleading because it does not consider differences in the cost of living

 need to adjust GNI figures using purchasing power parity (PPP)

 Official figures can also be misleading because they do not account for black economy transactions
 In addition, GNI and PPP data are static and do not consider economic growth rates
 So, while China and India are currently categorized as being poor they are growing more rapidly
than many developed nations and are expected to become among the largest economies in the
world

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What Determines A Country’s Level
Of Economic Development?
 Nobel-prize winner Amartya Sen argues economic development should be
seen as a process of expanding the real freedoms that people experience
 the removal of major impediments to freedom like poverty, tyranny, and
neglect of public facilities
 the presence of basic health care and basic education
 Amartya Sen also claims that economic progress requires the
democratization of political communities to give citizens a voice
 The United Nations used Sen’s ideas to develop the Human Development
Index (HDI) which is based on
 life expectancy at birth
 educational attainment
 whether average incomes are sufficient to meet the basic needs of life
in a country

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 How Does Political Economy
Influence Economic Progress?
 Innovation and entrepreneurship are the engines of
long-run economic growth
 innovation includes new products, new processes, new
organizations, new management practices, and new
strategies
 entrepreneurs commercialize innovative new products
and processes
 Innovation and entrepreneurship help increase
economic activity by creating new markets and
products that did not previously exist
 innovation in production and business processes
result in more productive labor and capital further
boosting economic growth rates

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 How Does Political Economy
Influence Economic Progress?
 Innovation and entrepreneurship require a market economy

 there is little incentive to develop new innovations in planned economies because the state owns all means
production and therefore, the gains

 There is a strong relationship between economic freedom and economic growth

 the six countries with the highest ratings of economic freedom from 1975 to 1995 were also among the highest
for economic growth
 Hong Kong, Switzerland, Singapore, the United States, Canada, and Germany
 Innovation and entrepreneurship require strong property rights
 without strong property rights, individuals and businesses risk having their innovations and potential profits stolen
 Economist Hernando de Soto claims that inadequate property protection in many developing nations limits economic
growth
 Democratic regimes are probably more conducive to long-term economic growth than dictatorships, even the benevolent
kind
 property rights are only secure in well-functioning, mature democracies
 Subsequent economic growth leads to the establishment of democratic regimes
 South Korea and Taiwan

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 How Does Geography Influence
Economic Development?
 Countries with favorable geography are more likely to engage in trade, and so,
be more open to market-based economic systems, and the economic growth
they promote
 Jeffrey Sachs studied economic growth rates between 1965 and 1990 and
found that
 landlocked countries grew more slowly than coastal economies
 being totally landlocked reduced a country’s growth rate by 0.7% per year
 tropical countries grew more slowly than countries in
temperate zones

How Does Education Influence Economic Development?

 Countries that invest in education have higher growth rates because the
workforce is more productive
 countries in Southeast Asia have offset their geographical disadvantages
by investing in education
 Indonesia, Malaysia, and Singapore

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 How Is The Political
Economy Changing?
 Since the late 1980s, two trends have emerged

1. Democratic revolution (late 1980s and early 1990s)

 democratically elected governments replaced
totalitarian regimes
 more committed to free market capitalism

2. A move away from centrally planned and mixed economies

 more countries have shifted toward the market- based model
 Trend 1: Democracy has spread over the last two decades
 many totalitarian regimes failed to deliver economic progress to the vast bulk of their
populations
 new information and communication technologies have broken down the ability of the state to
control access to uncensored information
 economic advances of the last 25 years have led to increasingly prosperous middle and working
classes who have pushed for democratic reforms

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 How Is The Political
Economy Changing?
 Author Francis Fukuyama argues that the new world order will be
characterized by democratic regimes and free market capitalism
 But, political scientist Samuel Huntington argues that while many
societies are modernizing they are not becoming more Western
 predicts a world split into different civilizations
 these civilizations will be in conflict with each other

 Trend 2: The spread of market-based systems

 more countries have moved away from centrally planned and
mixed economies toward the market-based model
 Command and mixed economies failed to deliver the sustained economic
growth achieved in market-based countries

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 What Is The Nature Of
Economic Transformation?
 The shift toward a market-based system involves
 deregulation – removing legal restrictions to the free play of markets, the
establishment of private enterprises, and the manner in which private enterprises
operate

 privatization - transfers the ownership of state property into the hands of private

investors

 the creation of a legal system to safeguard property rights

What Does The Changing Economy Mean For Managers?

 Markets that were formerly off-limits to Western business are now open
 firms need to explore opportunities in these markets

 Despite being underdeveloped and poor, some markets have huge potential
 China -1.2 billion people
 India – 1.1 billion people
 Latin America – 400 million potential consumers
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 What Does The Changing
Economy Mean For Managers?
 However, the potential risks are large
 will democracy thrive especially in difficult
economic times?
 will totalitarian regimes return?
 will a multi-polar world of different civilizations
emerge?
 will China’s financial system be stable?

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 What Are The Implications Of Political
Economy Differences For Managers?
 Countries with democratic regimes, market based economic policies, and
strong property rights protection are more likely to have higher sustained rates
of economic growth
 these markets are more attractive to international
businesses
 the benefits, costs, and risks of doing business in a country are a function
of the country’s political, economic, and legal systems
 The benefits of doing business in a country are a function of
 the market’s size
 the purchasing power of its consumers
 their likely future wealth
 By identifying and investing early in potential future economic stars, firms
may be able to gain first mover advantages (advantages that accrue to early
entrants into a market) and establish loyalty and experience in a country
 China

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 What Are The Implications Of Political
Economy Differences For Managers?
 The costs of doing business in a country are a function of its
 political system
 is it necessary to pay bribes to get market access?

 economic level
 are the necessary supporting business and infrastructure in place?
 legal system
 it can be more costly to do business in countries with dramatically different product,
workplace, and pollution standards, or where there is poor legal protection for property rights
 The risks of doing business in a country are a function of
 Political risk - the likelihood that political forces will cause drastic changes in a country's business
environment that adversely affects the profit and other goals of a business enterprise
 Economic risk - the likelihood that economic mismanagement will cause drastic changes in a
country's business environment that adversely affects the profit and other goals of a business
enterprise
 Legal risk - the likelihood that a trading partner will opportunistically break a contract or
expropriate property rights

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 How Can Managers Determine A
Market’s Overall Attractiveness?
 The overall attractiveness of a country as a potential market and/or investment site for an international
business depends on balancing the benefits, costs, and risks associated with doing business in that
country
 Other things being equal, the benefit-cost-risk trade-off is likely to be most favorable in
politically stable developed and developing nations that have free market systems and no
dramatic upsurge in either inflation rates or private sector debt
Country Attractiveness

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