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LESSON 18
THE ECONOMIC ENVIRONMENT
Poverty does not destroy virtue, nor does wealth bestow it. subsidiary, made the first contact with Soviet officials. They
- Spanish Provers began lengthy negotiations, which lasted until 1988 when a
formal agreement was signed. In the mean-time, McDonald’s
Learning Objective had opened restaurants in Hungary and Yugoslavia, thus
• To learn the criteria for the dividing countries into different providing the company with valuable experience in operating in
economic categories communist countries. By the mid-1980s, the company was
• To learn the difference among the world’s major economic expanding more rapidly outside the United States than inside,
systems and company executives reasoned that if they were to meet the
• To discuss key economic issues that influence international
company’s rapid growth objectives, that trend must continue.
business Although the Moscow City Council was a partner of
• To assess the transition process certain countries are
McDonald’s in the Russian joint venture, the com-pany
undertaking in changing to market economic-and how this repeatedly ran into negative responses, such as “Sorry, you’re not
transition affects international firms and managers in my five-year plan,” when it attempted to obtain such
materials as sand or gravel to build the restaurant. The company
CASE Study had to negoti-ate to ensure it would be allocated, in the then-
McDonald’s Corporation in Emerging Markets Soviet Union central plan, sufficient sugar and flour, which were
Nearly everyone has an opinion about McDonald’s, including in chronically short supply. Even for some products in sufficient
Jerry Seinfeld. In one of his live standup acts, he relayed the supply, such as mustard, government regulations prevented
following observations. Soviet manufacturers from deviating from standard recipes in
order to comply with McDonald’s needs. In other cases, strict
Why McDonald’s Still counting? How insecure is this company?
allocation regulations dictated that Soviet plants sell all output
40 million, 80 jillion, billion, zillion, killion, tillion. . .. Is
to existing Soviet companies, thus leaving them no opportunity
anyone really impressed anymore? “Oh, 89 billion sold . . ..
to produce products for McDonald’s. Yet another problem was
alright, I’ll have one. I’m satisfied.” . . . Who cares?
that some supplies simply were not produced or consumed in
I would love to meet the chairman of the board of McDonald’s the Soviet Union, including iceberg lettuce, pickling cucumbers,
and just say to him, “Look, We all get it. OK, you’ve sold a lot and the Russet Burbank potatoes that are the secret behind
of hamburgers, whatever the number is. Just put on the sign, McDonald’s French fries.
‘McDonald’s-We’re doing very well: We are tired of hearing
To handle these problems, McDonald’s scoured the country for
about every dang one of them.”
supplies, contracting for such items as milk, cheddar cheese, and
What is their ultimate goal, to have cows just surrendering beef. To help ensure ample supplies of the quality products it
voluntarily or something? Showing up at the door: “We’d like needed, it undertook to educate Soviet farmers and cattle
to turn ourselves in. We see the sign. We realize we have very ranchers on how to grow and raise those products. In addi-
little chance out there. We’d like to be a Happy Meal® if that’s at tion, it built a $40 million food-processing center about 45
all possible.” minutes from its first Moscow restaurant.
With 30,000 outlets in 121 countries, McDonald’s Corporation One problem McDonald’s did not encounter was attracting
is “doing very well” by many measures. It has taken an aggres- employees and customers. The company placed one small help-
sive growth stance by entering into risky emerging markets and wanted ad and received about 27,000 Russian applicants for its
riding on the eco-nomic growth spurt of the 1990s. But as the 605 positions. McDonald’s did no advertising prior to its
world slipped into an economic recession in 2001, McDonald’s Moscow opening. However, Russian television covered the
has felt the blow, showing six consecutive quarters of declining upcoming event extensively. When the restaurant’s doors
results. Although prosperous in some emerging markets, like opened for the first time in January 1990, it was almost
Russia and China, it has done poorly in others, like Turkey, impossible to accommodate the crowd, even though it was the
Malaysia, and the Philippines, where it closed 163 unproductive largest McDonald’s in the world. An estimated 30,000 people
stores at a cost of $91 million in 2001. As the world economy were served the first day, eclipsing the previous daily record of
has taken a downward turn, McDonald’s is facing risks and 9,100 set in Budapest. The crowds continued to arrive, even
challenges that raise questions and doubts about the future of though the price of a Big Mac, French fries, and soft drink
its worldwide operations. equaled a Russian worker’s average pay for four hours of work.
McDonald’s entry into Russia in 1990 exemplifies the process In contrast, lunch at a state-run or private sector cafe cost 15 to
and difficulties it has encountered in most developing countries 25 percent as much as a meal at McDonald’s.
where it has begun operations. During the 1976 Olympics in The entry of McDonald’s into China in 1990 resembled its
Montreal, George A Cohon, president of McDonald’s Canadian experience in Russia. However, the Chinese government moved
Corporation (IFC), the Multilateral Guarantee Agency (MIGA), making much progress.
and the International Center for Settlement of Investment The high-income countries are clustered in just a few geographic
Disputes (ICSID). The World Bank is comprised of 183 areas, whereas the developing countries are found in all areas of
countries, and its major objective is to provide development the world the relative imbalance among the low-, middle-, and
assistance to countries, especially the poorest of the poor. It high-income countries in terms of number of countries, total
uses the measure per capita income to identify those countries GNI, and population. The high-income countries generate
that need the most help. In particular, its programs include nearly 80 percent of the world’s GNI, but they represent a
• Investing in people, particularly through basic health and relatively small number of countries and population. This
education. illustrates the quandary that manager’s face. The high-income
• Focusing on social development, inclusion, governance, and countries are a natural place to do business because of the
institution-building as key elements of poverty reduction. quality and quantity of demand, but the developing countries
exhibit tremendous potential because of the sheer size of the
• Strengthening the ability of the government to deliver
population-74.8 percent of the total number of countries and
quality services, both efficiently and transparently.
85 percent of the total population. It might be safer to focus on
• Protecting the environment. the high-income countries because of their relative political and
• Supporting and encouraging private business development. economic stability, but the future is in the developing countries,
• Promoting reforms to create a stable macroeconomic and managers must establish a strategy for penetrating them in
environment, one that is conducive to investment and long- the short and long-term.
term planning? Another measure of wealth, per capita GNI, is computed by
The activities of the World Bank are important to MNEs, taking the GNI of a country and converting it into dollars at
because they build infrastruc-ture and promote economic market rates and then dividing the total by the population.
growth and stability, thus improving the quality and quantity of However, the World Bank points out that nominal exchange
demand. In particular, the World Bank is most interested in rates (the actual market rates not adjusted for inflation) do not
eliminating poverty and its demand-reducing influences. The always reflect international differences in prices. So the World
World Bank classifies economies into one of the following Bank has come up with GNI per capita in international dollars
categories according to per capita GNI. converted at purchasing power parity (PPP) rates. PPP is the
number of units of a country’s currency required to buy the
Low income $755 or less in 1999
same amounts of goods and services in the domestic market
Middle income $756-$9,265 that $1 would buy in the United States provides some striking
Lower middle income $756-$2,995 comparisons between GNI per capita and PPP GNI per capita
Upper middle income $2,996-$9,265 for a small sample of countries. Note how much higher PPP
income is for China and the Czech Republic than regular per
High income $9,266 or more
capita GNI and how much lower Japan’s PPP income is. In
The World Bank refers to the low- and middle-income coun- China’s case, measuring its per capita income in PPP terms
tries as developing countries, even though it recognizes that not would raise it from a lower-middle-income country to an
all “developing” countries are alike-nor are they all “developing.” upper-middle-income country, which is more consistent with
Developing countries are also known as emerging countries, a people’s perceptions of economic improvements in China.
term also used to distinguish the capital markets (debt and
The United Nations publishes an annual report, the Human
equity markets) in those countries from the cap-ital markets in
Development Report that ranks countries according to the
the more advanced countries. In addition, the World Bank’s
Human Development Index. The index measures a coun-try’s
terminology does not imply that the high-income countries
achievements by looking at life expectancy, education, and
have reached some preferred or final stage of development.
income per person. The index does not include political
High-income countries are also sometimes called developed
freedom or inequality measures. The index for 2002, as shown
countries or industrial countries. Initially, this was because those
in that the United States ranks second in per capita GDP but
countries had a relatively high percentage of their GNP and
only sixth in the Human Development Index; it is outranked
employment from industry rather than from agriculture. Now,
by neighboring country Canada.
however, these countries have a larger percentage of their GNP
and employment tied up in services rather than industry. But Countries Classified by Region
the term industrial country is still popular. The developing Much of the World Bank data for developing countries is
countries; adude different types of countries-some with large provided by geographic region, and this factor will be especially
populations, such as China (1.2 billion people) and India (997 important as we discuss economic growth in a later section of
million people), and others with small populations, such as the lesson.
Guyana (697,181 people). These countries also include counties East Asia and Pacific
in economic transition to a market economy, such as China,
Latin America and the Caribbean
Poland, Russia, and Vietnam. Some developing countries, espe-
cially those in Asia and Latin America, are generally moving The Middle East and North Africa
South Asia
Notes -
earlier in the market context, the price of gasoline always stays
the same in a command econ-omy, because the government
determines its price. When supply becomes tight, people line up
and buy gasoline until the supply is exhausted, so supply is
allocated by the queue rather than by price. Before prices were
freed in Russia, people used to say that if they ever saw a line,
they just stood in it. When they got to the front of the line,
they bought whatever was being sold. Even if they didn’t need
the item, they figured that someone in their extended family
did, so they just bought it. When the supply ran out, there
wouldn’t be any more left, no matter what price you were
willing to pay.
Mixed Economy In actuality, no economies are purely market
or completely command. Most market economies have some
degree of government ownership and control, whereas most
command economies are moving toward a market economy
and away from command concepts. If you think of economic
systems as a spectrum with market on one end and com-mand
on the other, Hong Kong and the United States would
represent two of the countries at the market end of the
spectrum, and Vietnam and North Korea would represent two
countries at the command end of the spectrum. In Hong Kong
and the United States, the government plays a very small role in
economic activity, desiring instead to provide a stable environ-
ment in which economic activity can take place. In communist
countries such as Vietnam arid North Korea, the government
still owns and controls most aspects of economic activity. China
is an example of a communist country that is trying to move
from command to market.
Another example of a mixed economy is market socialism, in
which the state owns sig-nificant resources, but in which
allocation of the resources comes from the market-price
mechanism. France, as mentioned earlier, is a good case in
point. Although the government owns significant economic
resources, it allows supply and demand-rather than government
fiat-to set prices. Sweden is a country that owns few economic
resources, but it levies heavy taxes to fund an aggressive social
program. Although the market determines prices, a lot of
economic activity is controlled by government fiscal policies.
As mentioned in the eight questions raised at the beginning of
the lesson, managers need to be aware of both the type of
economic system in which they are doing business and what the
role of their companies is and is likely to become. Many
Western managers com-plain about the government bureaucracy
in China and the degree of influence of the Chinese govern-
ment in economic decision-making. However, China is going
through a transition, so it is important for managers to
understand the direction and speed of change and how their
own industries will be affected by these changes. The same is
true of any country, especially those going brough transition, so
managers need to understand the context of the owner-ship
and control of resources of the countries where they wish to
operate. In addition, the degree of interference by the govern-
ment may vary by state within a country, especially those that are
quite decentralized.