What are the determinants ofeconomic development in a country? And identify various political and economic changes ning, that have been happening all across the globe for thepast 30, 40 years. And how transition economies are shifting from either mixed economies or command economies towards being more market driven economies.
And finally, we will also talk about what does all this imply for managers of international or multinational firms? So if you look at the determinants of economicdevelopment, one of the most common figure that is used is known as GNI. That is, gross national income per person, which just measures the total annual incomereceived by residents or citizens of a nation.
So let’s look at the various GNI figures for different countries to make a better look at how these countries are developing economically. So if you look at the firstcolumn here, it shows you information regarding GNI per capita in 2009 in terms of US dollars. And look at the figures for UK, US, Switzerland, Germany, Japan.They are much, much higher than countries such as India, China. For India, it’s just 1,180. China is just 3,650.
So if you look at these figures, they simply show you that China, India, Nigeria, they are poorer countries compared to Switzerland, UK, US, Germany. But what thisfigure doesn’t show you is that different countries, they have different cost of living. So we have to really take account of the cost of living in each country, andcompare it with one country. So take one country as the reference point to understand better, regarding the economy of any country.
So if you look at the second column, it’s GNI PPP per capita, which is just the GNI figures in the first column, they have been adjusted for the cost of living standardsin each of the countries. So the denominator, or the point of reference, is United States. And GNI PPP is just GNI Purchasing Power Parity per capita.
And if you look at these figures, China, now instead of 3,650, the column shows 6,890. And it simply tells us that in China, you could buy same amount of goods for3,650 as you would buy for 6,890 in the US. So GNI PPP per capita gives us much more better understanding in terms of comparisons, in terms of economicdevelopment in different countries.
But GNI per capita, or GNI PPP per capita, they are static measures. So we really need to look at the growth rate. And that is what the third column shows you, theGDP growth rate for between 1999 to 2009. And what is striking here is that even though UK, Switzerland, US, Germany, they have very high GNI per capita, they arevery rich countries. But the economy is growing at a rate of around 1.5% and 2% per annum.
Whereas, if you look at India and China, even though if you look at GNI figures, they are poor countries, but the rate with which these economies have been growingfor the past 10 years is as high as 10%, which really gives us much more prudent picture regarding the future of doing business in these countries. So ifmultinationals, they just look at GNI per capita, which reflects the purchasing power of people in the country, they will say that it’s best to invest in these four or fivecountries such as Switzerland, UK, US. So the importance of looking at GDP growth rate versus GNI per capita is that if a firm just looks at GNI per capita, or GNI PPPper capita, they will just see that it’s good to invest in rich countries. Because these people have high purchasing power. Switzerland, UK, US.
But if you look at the GDP growth rate figures, even economies which are poor, such as China, India, they are very, very lucrative markets. Because their economiesare growing at a much, much faster rate than the economies of these developed nations. And it is estimated, or it is predicted, that by 2020, China is going tobecome the second most largest economy in the world after US. So firms, they need to look at or compare countries based on not only GNI, but also GDP per capitarate, GDP growth rate.
Now, let’s look at other definitions of economic development. So Amartya Sen, he is an award prize winner in economics. And he said that if you look at GNI, if youlook at GDP growth rate, these are all reflections of material growth, right? But Amartya Sen said that to gage the development level of a country, one should alsolook at what opportunities and capabilities people in a country enjoy.
Such that this definition of economic development should also expand to see what real freedom these people in this country have– freedom in terms of economicfreedom, as well as political freedom. So he said that democratization of political communities to give citizens a voice is also one of the good reflectors of the futureeconomic development of a country. Because if a country doesn’t have, the people do not have rights, economic rights, political rights, that really affects the type ofeconomic policy a government has. And ultimately, effects the economic development of a country.
So based on Amartya Sen’s thesis, UN has developed Human Development Index, which takes into account these three factors. That is, life expectancy at birth,education attainment in terms of how educated people are– primary education, secondary education, tertiary education. And finally, whether average incomes aresufficient to meet the basic needs. Because these factors are the social determinants of economic development.
And this index, the value of this index varies from zero and one. So countries which have a value of less than 0.5, between 0 and 0.5, for them, the humandevelopment is pretty poor in those countries. Whereas countries which have the figure from 0.5 to 0.8, it reflects that they have medium level of humandevelopment. Whereas of course, between 0.8 and 1, if a country has a Human Development Index, it really shows the very high level of human development. Andwhich ultimately reflects on or effects economic development.
So let’s look at how political economy and economic development or progress are related. So it is agreed upon by many, many people and many economists thattoday, innovation and entrepreneurship are the driving engines of growth for any economy in the world. And innovation and entrepreneurship, they create newmarkets and new products which were not even existent before. And which helps in economic growth of a country.
And because of innovation in developing new production processes, it increases labor and capital productivity, which further increases the economic growth rate.So innovation and entrepreneurship are really, really important for the economic progress of any country today. And what kind of a political system, economicsystem, and legal system will help develop or encourage innovation and entrepreneurship in a country?
So let us look at that. So in terms of your economic system, innovation and entrepreneurship would best thrive in a market economy. Wherein there is freedom forprivate ownership, where if a person has come up with a new idea, a new innovation, he has that freedom to commercialize it and make profits from that. Ascompared to, let’s say, in mixed economies or command economies, where all the benefits that a person might get or own, profits that a person might want to ownby commercializing that innovation, may be expropriated by the state either legally or illegally.
So a market economy is beneficial, or encourages innovation and entrepreneurship because it gives economic freedom. And we know that there is a strongrelationship between economic freedom and economic growth. Example, so these are the six countries– Hong Kong, Switzerland, Singapore, US, Canada, andGermany– they had the very high figures in terms of economic freedom between 1999 and 2009.
And all these countries, they also had higher economic growth in the group of countries. So there is a very strong relationship between economic freedom andeconomic growth. And economic freedom is granted by a market economy. What kind of a legal system would support innovation and entrepreneurship?
A legal system could be any– common law, civil law, any kind of legal system, or a combination of these legal ecosystems– as long as it provides strong regulationsor rules that protect property rights. And there’s a strong enforcement of those IP laws. Because [INAUDIBLE] there is a strong IP, intellectual property, rightsprotection in that country.
Even if a person has come up with a new idea, he or she may be hesitant to commercialize it. Because if I’m coming up with a new music video, and if I release itand as soon as I release it, it’s pirated and it’s copied, that really hurts that individual’s potential to make money out of that product. And that will discourage theindividual, too, for the innovate. So strong property rights regime is very, very important for driving innovation and entrepreneurship in a country.
So what kind of a political system would support innovation and entrepreneurship? Democracy. And we have various examples in hand of many countries, whichare democratic states, which have been thriving because of innovation and entrepreneurship. But there are also countries which are totalitarian. And yet, they arealso thriving due to innovation and entrepreneurship. Why?
Countries such as Singapore, South Korea, Taiwan, these are also countries which have totalitarian regimes. But they have been able to grow or to encourageinnovation and entrepreneurship. So yes, we can safely say that democracy is not the prerequisite for supporting innovation and entrepreneurship. But if it is ademocracy, it eventually encourages innovation and entrepreneurship.
And second important point to notice is that even if a country is a totalitarian state with no political or economic freedom, subsequent economic growth often leadsto change in political ideas. So look at the examples, South Korean and Taiwan. Just 20, 30 years ago, they were totalitarian states. But as they have grown, theireconomies have grown, there is a move towards being– they are now much more democratic states than they were earlier.
So we now know that political economy and economic progress are related. For entrepreneurship and innovation drives economic progress, and to sustain or toencourage entrepreneurship and innovation, we need market based economy. We need a legal system which protects property rights. And we need a politicalsystem, which could be a democracy.
So now, let’s look at how the political economy of various countries has been changing for the past 30, 40 years. There have been two important changes to note.One is, your democratic revolution. So it started in 1980s. And if you look at the number of countries which were democratic states in 1980s, ’89, we had just 62countries which had democracy.
Whereas in 2009, we have 123 countries which are democratic states. Where is this change happening? Mostly in Eastern Europe, Southeast Asia, even in LatinAmerican countries, some countries in Africa. So it’s happening all over the world. So communist countries of Eastern Europe, Southeast Asia, totalitarian states ofLatin America, they have been moving away from totalitarianism and communism towards being more democratic states.
And second move, which is related, is these countries, they are moving from command economies and mixed economies towards being more market basedsystems. And why do we see these changes? If you look at Europe, it can be divided into Eastern Europe and Western Europe. So for many decades, EasternEuropean countries, they had communism. They had command economies. Everything was planned by the government.
But these are command economies who are not able to deliver economic progress. So these economies, they actually stagnated. Look at Poland, Yugoslavia. Theyall stagnated for many years because of poor economic policies and having state involvement in everything related to business activities in that country.
And when they looked at Western European countries, which were thriving, which had democracy, which had market based economic systems, these countries inEastern Europe, they realized that we need to change. And this change, this was also further prompted by our advancement in various telecommunicationtechnologies, Internet. Because now, people were able to get information from all across the globe.
So they were aware of the changes happening in other parts of the world. So they were aware, we are stagnating. Whereas various other countries which havedemocracy and market based economic systems, they are thriving. So we need to change. And that prompted them to change, make the this leap. And Poland, ifyou take the example, perfect example, it is now a full democracy with market based system. And it is developing. Its economy is growing very fast.
Transition in many countries has been completed, for example, in Poland. But there are many countries in the word which are still in that transition phase. Forexample, China. Still in transition. India, still in transition. So what does the shift, how does this economic transformation happen?
It involves a shift towards a market based economy, and involves three things– deregulation, privatization, and setting up a stronger legal system that safeguardsproperty rights. What is deregulation? Deregulation is changing the rules of doing business. Allowing private ownership. Allowing foreign firms to invest in acountry. Allowing the market forces of demand and supply to make the decisions regarding what type of products will be made in what quantities, and at whatprices they will be able sold.
Privatization is when the ownership is transferred from state to private individuals or private companies. And we have seen this wave of privatization not only justin developing countries, but also in developed countries such as Britain. After the 1980s, it was a social democratic state. State owned a lot of firms, especially intelecommunication industry and in other various important industries.
But British people, they soon realized that they’re not developing or growing as fast as other countries which have pure market based system. So the government,they watered down this social democratic government. And they brought in a new government, which cleared the path of privatizing all those firms that werepreviously helped by the state.
Because these state-owned firms, they were under the protection of the government. So they knew there was no competition for them. So they had becomeincompetent, inefficient in everything. And because of which, they were not growing.
And third, we are also seeing that legal systems in various countries are now tightening up their legal systems, especially regarding property rights such as in China,such as India. There’s still a long way to go. But things are much, much better today as compared to what they were 10 years ago.
So what are the implications for managers in multinational companies in terms of when they look at all these transition economies that they are moving towardsbeing more market driven? One important thing to note here is that 30, 40 years ago, more than half of the world was closed for international businesses. Now,with this transition to more market driven reforms, international businesses, they are suddenly looking at many countries which were earlier undeveloped or poor.
But they have huge potential. And they have opened up their doors for foreign companies. For example, China, 1.2 billion people. India, 1.1 billion people. Even ifyou just look at these two countries, they are developing fast. Even though people are poor, if you look at India, there is a big group of people which are middleclass people, which is the target consumer for many big multinational companies.
So in India, there are about 200 to 300 million people who are in the middle class. And if you look at population of US, it’s between 300 and 400. So even if these areunderdeveloped or poor, there’s huge potential. Latin America, 400 million.
So again, realizing countries which have democratic political systems which have market based economic system, and which have strong legal system whichprotects property rights of firms or individuals, they are the countries which are very, very attractive for international businesses to get. And if any firm wants tocalculate or to determine the overall attractiveness of a country, they should look at three things.
One, what are the benefits of doing business in that country? And what could be the indicators of future potential of benefits of doing business in that country? Sizeof the market is one indicator. India, China– big, big market, huge potential. Huge potential to increase market size.
Purchasing power. Current purchasing power, as well as future purchasing power, which is reflected by the economic GDP growth rate, or how fast the economy isgrowing. These are all reflections of future potential for growth in earning profits in that particular country. And here, we come across one important concept. Thatis, first move advantage.
So 1970s, ’80s, South Korea was still a developing country. And firms which invested in South Korea 30 years ago, now they are reaping the benefits of thatinvestment today. Because today, South Korea is a developed country, huge potential. So firm managers should also be aware that even if the country is poor orunderdeveloped, they should look at the future potential. Because things will change in future.
Overall attractiveness will also be determined by looking at risks. What are the risks of doing business in that country? There could be political risks. There could beeconomic risks. As well as, they could be legal risks. In terms of, when you look at political risks, if you’re looking at countries where you have a lot of terrorism, youhave high level of social unrest, because of which there is a lot of unions and commotion within the society, those countries are very risky politically.
Because a political system might change any time. Let’s suppose a military government is established. That government can simply change the economic policies.And that can have an adverse effect on foreign companies operating in that country. That happened with companies who were operating in Iran. In 1970s, ’80s,after the revolution in Iran, government that came, the totalitarian government which gained power, it confiscated all the properties of all the foreign companies.
And there was nothing that these foreign companies could do about it. So if you look at political risks are one important determinant whether to go into a countryor not. Economic risks. Indicators could be if a country has high inflation rate, or high debt, which is a reflection of economic mismanagement by the government.And you don’t want to go in a country which has these problems of high inflation and high debt.
Legal risks. We discussed earlier legal rules and regulations can be present. But if the enforcement is weak, you might end up your property being stolen orexpropriated by another firm or another individual, or even the government of a country. So if I believe that by going into a country, and by forming a joint venturewith a local firm, I am sharing that proprietary information.
And I think that if my joint venture partner expropriates that knowledge, and if the legal system is not strong to help me, then it’s not advisable to go in suchcountries. So we have talked about benefits. We have talked about risks. There’s third important category.
What are the costs? And these costs are also, again, related to political costs, your economic costs, as well as legal costs. Political cost. Corruption. If a country you’relooking at has high corruption, wherein you will have to pay bribes, and government puts excessive taxes on foreign earnings, then it automatically increases yourcost of doing business in that country. And decreases the attractiveness of a country for investment.
Economic costs. Perfect example would be, McDonald’s went in to Russia. When it opened its first store in Moscow, they soon realized that the quality of the foodingredients, food such as dairy products as well as chicken or meat, they were not at par with the product quality or the input quality they were using in other partsof the world. So because of this lack of infrastructure, McDonald’s had to indicate back.
They had to open up their own dairy farms. They had to develop their own, bring their own chicken farms. So all this increases the cost of doing business in thatcountry. And finally, we have legal costs. So we talked about, we know that countries have different product liability laws, product standards. So countries whichhave high product standards, the cost of doing business goes up.
Because you have to adhere to strong or higher standards. You have to provide better quality products. And so if you look at the government’s overallattractiveness of a country for investment from the point of view of any multinational company, that’s a combination of benefits of doing business in that country.What are the risks of getting involved in that country? And what are the specific costs that will accrue to the firm?
And most multinationals, they make the decision to go to any foreign country, but after balancing out these three components. So let’s look at China. We know thatdoing business in China is risky. Because it’s a totalitarian state. Government can change economic policies any time. The economic risks are also high.
Legal risks are also very high. Because property rights are not really protected. Look at costs. There are infrastructure problems sometimes. So there are politicalcosts, because of high corruption. There are legal costs. There are economic costs, as well.
So when there are very high costs and risks of doing business in China, why are most multinational firms, they want to go to China? Almost everybody wants to go to China. Simply because they believe that benefits, they outweigh the risks and costs. And what are the benefits?
Size of the economy. So many potential customers. And the economy is growing at an annual base of 10%. That is hard to ignore. So even when we know that it’s atotalitarian state, people do not have political freedom, and the legal system is weak in terms of predicting property rights, and there is risks, it is beneficial to investin China today, so as to reap higher benefits in future when these legal system, political system, and economic systems, they have evolved.
And so just for recap, we discussed what determines the economic development of a country. We also identified various changes, political and economic changesthat are happening in various countries all across the globe. And we also discussed how the changes– the transition economies, where these political and economicchanges are happening. How do they effect the practice of international business? And what are the implications for managers?

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