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LESSON 2.3. Economic Systems and Market Methods

As our first three lessons have shown, cultural, political, and legal systems
influence a company’s decisions on where, when, and how to do business.
Completing our profile of the key dimensions of the macro-business environment,
this lesson presents the general perspectives and specific tools managers use to
analyze economic systems. Managers must be also aware of the country’s
economic environment to assess its development, explain its performance, and
estimate its potential.

New Markets, New Perspectives

Managers track changes, evaluating events and trends to spot opportunities and
preempt difficulties. The scale and scope of new markets easily thwart analysis.
Therefore, managers commensurately stress-test their interpretations by
qualifying analysis with new perspectives.

Key viewpoints include:

Countries Differ in Various Ways.
Countries have different levels of economic development, performance, and
potential. For instance, in absolute terms, gross world output more than
quintupled between 1970 and 2012, growing from $12 to $69 trillion. Thus,
globalization seemingly expanded the economy for all.

Economic and Political Changes Alter Market Circumstances

Although the pace varies from country to country, economic environments
continually change. Since the 1980s, companies came to enjoy
opportunities as nations adopted the principles of capitalism and practices
of free markets.

Connections, Change, and Consequences

Globalization connects countries. Choice in one has consequence in others.
Companies monitor changes in countries where improving macro trends or
revised policies open markets or strengthen competitors.

Challenges of the Comeback

The rise of emerging economies distort traditional economic indicators.

Choices of Citizens, Policymakers, and Institutions

Economics is vital to citizens, policymakers, and institutions.

International Economic Analysis (Daniels, Radebaugh, & Sullivan, 2019)

The World Bank identifies 214 discrete economic environments in the world today
— 188 countries and 26 economies with populations of more than 30,000.22 Few
MNEs can fund and run operations in all 214 markets. Resource constraints mean
managers must prioritize their options, operating in countries that offer the greatest

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return with the least risk. Improving the odds of success depends on assessing the
development, performance, and potential of an economy.

The study of economics has identified a host of objective measures that help
systematize evaluation. However, although economics champions many scientific
principles, it still relies on various behavioral assumptions to interpret activity.23As
a result, the assessment of economic environments is often more conditional than
universal because:
• System Complexity. The complexity of even the simplest economic
system defies straightforward classification. Stipulating indicators that
definitively represent a country’s economic performance and potential is
difficult. Certainly, managers consult an ever-expanding set of indicators.
The challenge is identifying those that matter, mapping them onto a market,
and monitoring their performance.
• Market Dynamism. Often, market changes make today’s valid measures
invalid tomorrow. In the wake of the global financial crisis, some indicators
that worked in 2007 were flawed by 2009 and remained dubious in 2013.
On a larger scale, analysis anchored in the market fundamentalism of the
West poorly fits the state-sponsored capitalism at play in the East.
Challenges arise in determining how to adjust trusted market analytics for
new circumstances.
• Market Interdependence. Just as no one is an island, no country is
isolated. The consequence of connections is an integrated system in which
actions in one market influence outcomes in others. Interdependencies
complicate interpretations. Adjusting analysis for actions and reactions
across a broad scope of markets is difficult.
• Data Overload. Managers are flooded with more information, raw
knowledge, and clever insights than ever before. Rather than improving
market analysis, increasing data streams from workplace chats, mail, email,
websites, voicemails, instant messaging, telephone and cellphone calls,
memos, and onward complicates interpretation. If unchecked, analysis
paralysis confounds decision-making.

Figure 2.3.1. Economic Factors Affecting International Business Operations

Source: International Business: Environments and Operations by Daniels, Radebaugh, &
Sullivan (2019)

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Figure 2.3.1. shows how managers approach these issues. It identifies the macro-
economic conditions that shape a country’s development, performance, and
potential. Although economic environments vary from country to country, they
share telltale principles. Managers often focus on universal characteristics,
tors, notably the matters of economic freedom, type of economic system, and
leading economic indicators, to organize analysis.

Figure 2.3.1. confirms the usefulness of applying a systems perspective.24 It helps

managers qualify their interpretation of economic conditions in terms of three
criteria:
1. how much economic freedom they will have to make investments and run
operations as they see fit;
2. the country’s type of economic system and how current macro policies
shape its development and performance; and
3. the drivers of economic change, particularly the micro-conditions that
moderate economic freedom and the country’s shifts in economic systems.

Economic Freedom (Daniels, Radebaugh, & Sullivan, 2019)

Passages through the Arctic

Sea Ice. The shrinking Arctic
ice cap is, at best, a very
mixed blessing. If ice melt
rates continue, they threaten
to destabilize the
environment. But, as less ice
steadily opens the Northern
Sea Route and Northwest
Passage, it creates significant
trade and logistic options.
Source: Based on NASA satellite
image
taken September 2010

Economic freedom holds that one has the right to work, produce, consume, save,
and invest in the way that one prefers. Economic freedom is the “absolute right of
property ownership, fully realized freedoms of movement for labor, capital, and
goods, and an absolute absence of coercion or constraint of economic liberty
beyond the extent necessary for citizens to protect and maintain liberty itself.

The Economic Freedom Index estimates the extent to which a government

constrains free choice and free enterprise for reasons that go beyond the need to
protect property, liberty, safety, and efficiency. The index rests on Adam Smith’s
notion that “basic institutions that protect the liberty of individuals to pursue their
own economic interests result in greater prosperity for the larger society.” The

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Index of Economic Freedom analyzes 50 indicators that comprise 10 components

organized into four categories (see Table 2.3.1). The Heritage Foundation
annually applies this index to 177 countries, grading the performance of each. The
higher the score on a factor, within the range of 0 to 100 percent, the higher the
degree of economic freedom (or, conversely, the lower the level of government
interference).

Table 2.3.1 Dimensions of the Index of Economic Freedom

Source: International Business: Environments and Operations by Daniels, Radebaugh, & Sullivan
(2019)

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Economic Freedom Today

Map 2.3.1. Global Distribution of Economic Freedom

Source: Terry Miller and Kim Holmes, 2013 Index of Economic Freedom, Washington, DC: The
Heritage Foundation and Dow Jones & Co., Inc. 2013
(www.heritage.org/index/images/book/2013/region-web-map-WORLD-large.jpg, retrieved
January 31, 2013).

The Index of Economic Freedom classifies a country as either: free, mostly free,
moderately free, mostly unfree, and repressed given the degree to which its
government regulates individual’s economic choices. The greater the regulation,
as indicated by a lower score, the less choice an individual commands.

The Value of Economic Freedom

Economic freedom helps explain a country’s development, performance, and
potential. Higher-rated countries generally outperform laggards on a variety of
measures. They have higher rates of growth and productivity, and their average
income is more than double the worldwide average and seven times higher than
in mostly unfree and repressed economies (see Figure 2.3.2). Furthermore,
inflation and employment rate better in economically free countries, as do life
expectancy, literacy, poverty reduction, and environmental sustainability. The
message of economic freedom is unequivocal: liberating resources from
government control improves financial performance, economic stability, and
standards of living.

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Figure 2.3.2. Economic Freedom by Region, with Population

Source: Terry Miller and Kim Holmes, 2013 Index of Economic Freedom, Washington, DC: The
Heritage Foundation and Dow Jones & Co., Inc. 2013,
retrieved January 31, 2013 from www.heritage.org/index/book/chapter-1, Chart 7.

The relationship between economic freedom and population indicates that the vast
majority of the world, approximately 5.5 billion people, lives in countries whose
governments constrain their choices on how they wish to work, produce, consume,
save, and invest.

Figure 2.3.3. Economic Freedom and the Standard of Living

Source: Terry Miller and Kim Holmes, 2013 Index of Economic Freedom, Washington, DC: The
Heritage Foundation and Dow Jones & Co., Inc.
2013, retrieved January 31 from www.heritage.org/index/book/chapter-1, Chart 3, 2013.

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Trends in Economic Freedom

For the past few decades, managers had reasonably presumed that countries
would reform their markets to increase economic freedom. Driving change was the
fact that nations with free markets consistently outperformed unfree countries.

Economic freedom has powerful relationships with a variety of market, social, and
political measures. Here, we see a strong positive correlation between economic
freedom and a broad indicator of the standard of living.

Fear of Freer Markets

The causes and consequences of the crisis challenge the legitimacy of the
quest to maximize economic freedom. Many countries, especially those hit
hardest and still experiencing anemic growth—such as Spain, Italy, Ireland,
Portugal, Cyprus, Greece, France, and Japan—show weakening support
for free markets.

The Market Test

A first-order goal of an economic system is straightforward: apply sound
macroeconomic policies that sustain productive enterprise. Low inflation,
high employment, prudent public finances, and openness to trade and FDI
are telltale signs. Meeting these standards powers performance and boosts
potential.

Managers watch key events to gauge the contest between economic

freedom and state control. These include how the
government
• regulates the economy
• protects property rights
• sets fiscal and monetary policies
• enforces antitrust regulation

Types of Economic Systems

Market Economy
An economic system whereby individuals, rather than the government, make most
decisions is a market economy. It is anchored in the doctrine of capitalism and the
principle that private ownership confers inalienable property rights that legitimize
the profits earned by one’s initiative, investment, and risk. Optimal resource
allocation follows from consumers exercising their freedom of choice and
producers responding accordingly.

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Figure 2.3.4. Types of Economic Systems

Source: International Business: Environments and Operations by Daniels, Radebaugh, &
Sullivan (2019)

The three predominant types of economic systems endorse different philosophies,

advocate different principles, and apply different approaches.

Table 2.3.1. Means and Methods of a Market Economy

Source: International Business: Environments and Operations by Daniels, Radebaugh, &
Sullivan (2019)

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Command Economy
In theory, communism champions state ownership of resources and control of all
economic activity. Nominally a political ideology, communism calls for an
egalitarian, classless, and ultimately stateless society based on the government’s
command of the economy. Implementing this socioeconomic structure imposes a
command economy in which the government owns and controls resources, taking
on the authority to decide what products to make, in what quantity, at what price,
and in what way.

Mixed Economy
Most economies, broadly labeled mixed economies, fall between the market and
command types. A mixed economy is a system in which economic decisions are
principally market driven and ownership is largely private, but the government
intervenes, from a little to a lot, in allocating resources.

Assessing Economic Development, Performance, and Potential (Daniels,

Radebaugh, & Sullivan, 2019)
Given an understanding of the general types of economic systems, managers turn
to evaluate their critical components. They tap a rich portfolio of macro and micro
measures to assess a country’s economic development, performance, and
potential. Some measures may be informal or idiosyncratic, such as number of
wireless subscriptions, amount of electrical power generated, internet searches for
telltale terms, or military officers running companies. Typically, convention
dominates practice. Matters of income and wealth often anchor analysis.
Managers elaborate their analyses with indicators of sustainability and stability.

Broad classes of countries include

• Developing countries
• Emerging economies
• Developed countries

Table 2.3.2. The Alphabet of Emerging Economies

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Measures of Economic Performance

The expanding barrage of data spurs managers to streamline market evaluation.
Many anchor analysis in comprehensive single-item measures that provide a quick
indicator of whether an economy (1) is expanding or contracting, (2) needs a boost
or should be constrained, and (3) is threatened by recession or inflation.

Gross National Income (GNI)

GNI is the broadest measure of a country’s economy. It measures the value
of all production in the domestic economy together with the income that the
country receives from other countries (mainly interest and dividends), less
similar payments it has made to other countries.

Figure 2.3.5. Top 10 Largest Economies in the World

Source:https://www.ig.com/us/news-and-trade-ideas/top-10-largest-economies-in-the-world-
190819

Gross National Product (GNP)

GNP is the value of all final goods and services produced within a nation in
a given year, plus the income earned by its citizens abroad, minus the
income earned by foreigners from domestic production.

Gross Domestic Product (GDP)

GDP The total market value of all output produced within a nation’s borders,
no matter whether generated by a domestic or foreign-owned company, is

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reported as a nation’s GDP.65 It the most commonly used estimator of the

true performance of an economy given that it measures income, not wealth.
That is, GDP estimates the flow of economic activity within a country, not
simply its stock of productive assets.

Adjusting Analytics
GNI and its offshoots estimate an economy’s absolute performance. Despite their
strengths, they can mislead managers when comparing countries.
• Rate of Economic Growth. Gross aggregates give a static snapshot. They
do not measure the rate of change in an indicator.
• Population Size. Managers adjust GNI, like many other economic
indicators, by the number of people who live in a country.
• Purchasing Power. Parity GNI per capita does not account for the cost of
living from one country to another.

Performance and Potential: Alternative Interpretations

Measures of gross national income emphasize monetary aggregates. As a result,
GNI, GNP, and GDP, even after adjusting for growth rates, population size, and
cost of living, only partially profile a country’s performance and potential. Further
complicating matters is the so-called “black” or “shadow” economy, namely legal
and illegal business activities that fall beyond official measurement.

Sustainability
Concern for the ecological welfare of the world spurs calls for green
Measures of growth that expands analysis beyond narrow measures of
monetary aggregates.

Green economics holds that each country is a component of, and

dependent on, the natural world.

Measuring the monetary quantity of market activity through GNI, GNP, and
GDP— without accounting for the associated social and ecological costs
that result from the activity that generated economic growth—misrepresents
performance and misinterprets potential. Instead, sustainable development
proponents encourage interpreting economic activity in terms of its capacity
to “meet the needs of the present without compromising the ability of future
generations to meet their own needs. As such, it endorses a broader
accounting of the gains and costs of growth to better gauge an economy.
Presently, there is no consensus on how to greenify GNI, GNP, or GDP.
Current candidates include:
• Net National Product (NNP): Measures the depletion of natural
resources and degradation of the environment that result from
generating GNI. As a company must depreciate its tangible and
intangible assets when making a product, goes this reasoning, so too
should countries. NNP does so by depreciating the country’s assets
commensurate with their use to generate growth.

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• Genuine Progress Indicator (GPI): Starts with the same accounting

framework used to calculate GDP but then adjusts for values assigned
to environmental quality, population health, livelihood security, equity,
free time, and educational attainment. For example, unlike GDP, GPI
values voluntary and unpaid household work as paid labor and subtracts
the costs of crime, pollution, and family breakdown.
• Human Development Index (HDI) Matters of human development do
not show up immediately in income or growth figures. Ultimately, the
reasoning goes, they will, given that improving the human condition
improves economic performance.

Stability
Policymakers have long puzzled over a paradox that questions the validity
of monetary aggregates as performance measures.77 Namely, people in
rich countries do not appear to be any happier than people in poor countries.
No matter how high income rose, little evidence indicated that it improved
people’s reported happiness.

Rethinking the goal of economic activity in terms of happiness, the

argument goes, better represents performance and potential.
Happynomics calls for moving “from the concept of financial prosperity to
the idea of emotional prosperity.

The intricacies of happiness capture increasing attention; insight should

clarify measures. In the meantime, managers consider the following indices:
• Your Better Life Index (YBLI). This index measures well-being and
perceptions of living conditions. Developed by the Organization for
Economic Cooperation and Development (OECD), the YBLI advocates
evaluating economic performance in terms of matters that people
worldwide believe are important, such as housing, jobs, social
relationships, health, security, work-family balance, and education, but
that fall beyond the narrow scope of monetary measures. Explained the
OECD, YBLI pushes the “boundaries of knowledge and understanding
in a pioneering and innovative manner . . . It has extraordinary potential
to help us deliver better policies for better lives.” The top ten countries,
in terms of the YBLI and beginning with the leader, are Denmark,
Canada, Norway, Australia, the Netherlands, Sweden, Switzerland,
Finland, Israel, and Austria.
• Gross National Happiness (GNH). Progressive society presumes
that material and spiritual development occur side by side; one
reinforces the other or both suffer. GNH measures a country’s ability to
promote equitable and sustainable socioeconomic development,
preserving and promoting cultural values, conserving the natural
environment, and establishing good governance.

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• Happy Planet Index (HPI). Utilitarian views hold that people aspire to
live long, healthy, happy lives. Therefore, a country’s economic
performance and potential is represented by how well it helps its
citizens do so while not infringing on the opportunity of future
generations, and people in other countries, to do the same. HPI
advocates measuring the environmental costs of growth while
emphasizing that maximizing happiness and health, not monetary
wealth, is the objective.

Economic Analysis (Daniels, Radebaugh, & Sullivan, 2019)

Narrow (e.g., GNI, GDP, and GNP) and broad (e.g., HDI, HPI, NPP) estimators
profile absolute and relative economic conditions. They meaningfully indicate a
country’s performance and potential. Managers study other features to refine
analyses and elaborate interpretation. Popular indicators include inflation,
unemployment, debt, income distribution, poverty, and the balance of payments.

Inflation
Inflation is the sustained rise in prices measured against a standard level of
purchasing power. We estimate it by comparing two sets of products at two points
in time and then computing the increase in cost that is not due to quality
improvement.
Indicators:
• Inflation and the Cost of Living
• Measuring Inflation
• If Not Inflation, Then Deflation

Unemployment
Unemployment measures the number of workers who want to work but do not have
paid jobs. The unemployment rate is the share of out-of-work citizens seeking
employment for pay relative to the total civilian labor force. Countries that cannot
create jobs suffer sluggish growth, social pressures, and political instability. The
proportion of employed workers in a country shows how well it productively uses
its human resources.
Indicator:
• Measuring Unemployment

Debt
Debt, the total of a government’s financial obligations, measures what the state
borrows from its citizens, foreign organizations, foreign governments, and
international institutions. The larger the total debt, the more uncertain an
economy’s performance and potential are. Interest expenses divert resources from
more productive uses. More insidiously, future worries about the ability of coming
generations to repay the debt saps consumer confidence and constrains
government flexibility.

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Income Distribution
Income distribution often defines a market’s performance and potential. GNI, even
when adjusted for population size or purchasing power, can misestimate the
relative wealth of a nation’s citizens. That is, GNI per capita reports how much
income the average person earns.
Indicators:
• Benefits and Costs
• Gini Coefficient

Poverty
Poverty prevails throughout the world. Managers fine-tune their study of income
and wealth by considering its conditions and consequences. Poverty is a
multidimensional condition whereby a person or community lacks the essentials
for a minimum standard of well-being and life. These essentials can be life-
sustaining resources such as food, clean water, and shelter; they may be social
resources such as access to information, education, and healthcare; they may be
the opportunity to sustain extended families or connect with people to build
communities.
Indicators:
• Prevalence of Poverty
• The Potential of the Poor
• Success Standards

The Balance of Payments

A country’s balance of payments (BOP) officially known as the Statement of
International Transactions, reports its trade and financial transactions (as
conducted by individuals, businesses, and government agencies) with the rest of
the world.137 The BOP tracks two different kinds of transactions: the current
account, which tracks cross-border payments for goods and services (i.e., exports
and imports) and the capital account, which tracks loans for cross-border
payments for assets.

Elaborating Economic Analysis with Global Indices

The study of individual dimensions of a nation’s economic environment, much in
the spirit of partial equilibrium analysis, is a productive approach. The complexity
of modern market systems, however, both absolute and relative, means that the
properties of a given system cannot be fully explained by evaluating a snapshot of
disaggregated components. Studying the connections that link the parts of the
systems improves analysis of its performance and potential. Managers often
consider meta-models to improve their understanding of the absolute and relative
potential of an economic environment.

Popular indices include:

• Global Competitiveness Index
• Global Innovation Index
• Where-To-Be-Born Index
• World Competitiveness Index

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Activity 2.3.

 Read Chapter 4. Economic Systems and Market Methods on pages 179-227

of International Business: Environments and Operations by Daniels,
Radebaugh, & Sullivan.

 Watch online video on “Where Does the U.S. Rank in World Economic
Freedom?” by 2020 Index of Economic Freedom

 Explore the 2020 Index of Economic Freedom website

Study Questions

1. What is the importance of profiling the economic development,

performance, and potential?

2. How do economic freedom help a business and society?

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References

2020 Index of Economic Freedom. Retrieved 11 August 2020 from

https://www.heritage.org/index/about

Cavusgil, S.T., Knight, G. & John Riesenberger, J. (2018). International Business

The New Realities (4th Ed.)

Daniels, J. D., Radebaugh, L. H., & Sullivan, D. P. (2019). International business:

Environments and operations. PEARSON.

Luthans, F. and Doh, J. P. (2015). International management: Culture, society and

behavior. McGraw-Hill

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ONLINE READING MATERIALS

 Read Chapter 2. Culture on pages 87-128 of International Business:

Environments and Operations by Daniels, Radebaugh, & Sullivan.

 Read Chapter 3. Governmental and Legal Systems on pages 129-177 of

International Business: Environments and Operations by Daniels,
Radebaugh, & Sullivan.

 Read Chapter 4. Economic Systems and Market Methods on pages 179-227

of International Business: Environments and Operations by Daniels,
Radebaugh, & Sullivan.

• Freedom House. Retrieved 8 August 2020 from

https://freedomhouse.org/explore-the-map?type=fotn&year=2019

ONLINE VIDEO LINKS AND MATERIALS

 “International Trade and Business for Beginners (2020)” by Murat Ozturker.

Retrieved 7 August 2020 from
https://www.ssyoutube.com/watch?v=o3BNXCKGBpg

• “Where Does the U.S. Rank in World Economic Freedom?” Retrieved on 11

August 2020 from
https://www.ssyoutube.com/watch?time_continue=56&v=RmMUIwoXFSs&fea
ture=emb_logo

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