The World Economy

 Changed since WWII

 Globalization – most fundamental change
 Economic integration (an arrangement among nations that typically includes the
reduction or elimination of trade barriers and the coordination of monetary and fiscal
policies) – 20th century: 10%; today – 50%
 Capital movement replaced trade as the driving force of world economy
 The $ value of trade was $22 trillion in 2020
 Currency trading – world’s largest market
 GDP = C + I + G + NX
 E-Commerce diminishes the importance of national barriers and forces companies to
re-evaluate business models

Economic Structure

There are 5 broad sectors of the economy:

 Business Sector
 Household Sector
 Capital Market
 Government
 External Sector

Traditional Economic Systems

Market Capitalism

 The “free” end of the spectrum

 Privately owned production resources
 Individuals and firms allocate resources
 Driven by consumers
 Government’s role is to promote competition among firms and ensure consumer
protection
 E.g., Hong Kong, Singapore, New Zealand, United States, Switzerland, etc.

Centrally Planned Socialism

 The “repressed” end of the spectrum

 State holds broad powers to serve the public interest; decides what goods and services
are produced and in what quantities
 Consumers spend only on what is available
 Government owns entire industries and controls distribution
 Demand typically exceeds supply
 Little reliance on product differentiation, advertising, pricing strategy
 E.g., formerly communist countries of Eastern Europe and the Soviet Union, as well
as the contemporary governments of Cuba, China

Centrally Planned Capitalism (CPC) and Market Socialism (MS)

 In-between systems
 CPC – Basically, capitalist economies with greater state control on spending –
Sweden, Japan
 Basically, socialist economies allowing for market allocation – India

Basis of Difference Capitalist Economy Socialist Economy

Resources ownership Private Public or state
Foundation belief Competition Cooperation
Earning of wealth Everyone works for his own Everyone works for wealth
 wealth which is equally distributed
among everyone
Market scenario Level playing field Protection to PSUs, private
enterprises are permitted in
few businesses only
Government interference Only in situations when law Full intervention
is broken
Employee motivation Highly motivated due to Rarely motivated as
proportional benefits performance is not rewarded
Merit Perception of better Equal distribution of income
economic growth because of results in wealth for all
competition
Demerit Few individuals/groups Hard work is not rewarded,
attain power, rest are lazy employees also avail
exploited same level of benefits

Economic Freedom

Economic Freedom – 2022 Rankings

Rank Country Score

1 Singapore 84.4
2 Switzerland 84.2
3 Ireland 82.0
4 New Zealand 80.6
5 Luxembourg 80.6
6 Taiwan 80.1
7 Estonia 80.0
8 Netherlands 79.5
9 Finland 78.3
10 Denmark 78.0
168 Central African Republic 45.7
169 Bolivia 43.0
170 Iran 42.4
 171 Eritrea 39.7
172 Burundi 39.4
173 Zimbabwe 33.1
174 Sudan 32.0
175 Cuba 29.5
176 Venezuela 24.8
177 North Korea 3.0

Stages of Market Development

The World Bank has defined four categories of development using Gross National Income
(GNI) as a base:

Group GNI per capita in current USD

Low income
Lower-middle income 1,046 – 4,095
Upper-middle income 4,096 -12,695
High income > 12,695

Low-income countries

 GNI per capita of $935 or less

 Limited industrialization
 High percentage of population in farming
 High birth rates
 Low literacy rates
 Heavy reliance on foreign aid
 Political instability and unrest
 E.g., Afghanistan, Central African Republic, Ethiopia, Madagascar, Sudan

Lower middle-income countries

 Rapidly expanding consumer markets

  Cheap labor
 Mature, standardized, labor-intensive industries like textiles and toys
 E.g., Bangladesh, Bhutan, India, Indonesia, Nepal, Pakistan, Sri Lanka, Ukraine

Upper middle-income countries

 Rapidly industrializing, less agricultural employment

 Increasing urbanization
 Rising wages
 High literacy rates and advanced education – lower wage costs than advanced
countries
 Also known as newly industrializing economies (NIEs)
 E.g., Argentina, Brazil, China, Cuba, Malaysia, Mexico, Thailand

High-income countries

 Also known as advanced, developed, industrialized or post-industrial countries

 Sustained economic growth through disciplined innovation
 Service sector is more than 50% of GNI
 Ascendancy of knowledge over capital, intellectual over machine technology,
scientists and professionals over engineers and semi-skilled workers
 Future oriented
 E.g., Australia, Canada, Denmark, France, Germany, Japan, United Kingdom, United
States

G-8 Countries (now G-7)

 United States
 United Kingdom
 France
 Germany
 Italy
 Canada
  Japan
 Russia (former member, permanently withdrew in 2017)

OECD

 Organization for Economic Cooperation and Development

 38 nations
 Promotes economic growth and social well-being
 Focuses on world trade, global issues, labor market deregulation
 Member – Australia, Canada, Denmark, Finland, France, Italy, Japan, Costa Rica
(became member in 2021), United States, United Kingdom, etc.

Balance of Payments (BOP)

 Record of transactions done by resident country with the rest of the world
 Sources of fund for nation: exports or receipts of loans and investments are recorded
as positive or surplus items.
 Uses of funds: imports or to investments in foreign countries are recorded as negative
or deficit items.

Structure of BOP
Components of BOP

Current account: The current account monitors the inflow and outflow of goods and services
between countries. This account covers all the receipts and payments made with respect to
raw materials and manufactured goods. It also includes receipts from engineering, tourism,
transportation, business services, stocks, and royalties from patents and copyrights, and
unilateral transfers. Unilateral transfers refer to money sent as gifts or donations to residents
of foreign countries. This can also be personal transfers like – money sent by relatives to their
family located in another country. When all the goods and services are combined, they make
up a country’s Balance of Trade (BOT).

Capital account: All capital transactions between the countries are monitored through the
capital account. Capital transactions include purchasing and selling assets (non-financial) like
land and properties. The capital account also includes the flow of taxes, purchase and sale of
fixed assets etc., by migrants moving out/into a different country.

Financial account: The flow of funds from and to foreign countries through various
investments in real estate, business ventures, foreign direct investments etc., is monitored
through the financial account. This account measures the changes in the foreign ownership of
domestic assets and domestic ownership of foreign assets. Analyzing these changes can be
understood if the country is selling or acquiring more assets (like gold, stocks, equity, etc.).

Uses of BOP

 The BOP provides an extremely useful data for the economic analysis of the country’s
weakness and strength as a partner in international trade.
 BOP also reveals the changes in the composition and magnitude of foreign trade.
 BOP also provides indications, future repercussions based on countries past trade
performances.

Disequilibrium of BOP

When total receipts (R) from foreigners are not equal to total payments (P) to foreigners, then
it is known as disequilibrium of BOP. A country is in surplus when R>P while a country is in
deficit when P>R.
Exchange Rate Regimes

 Fixed exchange rate

 Flexible exchange rate
 Managed floating

Fixed exchange rate regime

A fixed exchange rate is a regime applied by a government or central bank that ties the
country's official currency exchange rate to another country's currency, a basket of currencies
or the price of gold. The purpose of a fixed exchange rate system is to keep a currency's value
within a narrow band. Fixed exchange rates provide greater certainty for exporters and
importers and help the government maintain low inflation. For example, the Hong Kong
dollar is pegged to the U.S. dollar – 1 US$ = 7.80 HK$

In the above diagram, 7.80 is the fixed exchange rate for HK$ to the US$. D is the initial
demand curve and S is the initial supply curve. These curves meet at A where demand is
equal to supply. However, when the demand for HK$ increases and shifts the demand curve
to the right from D to D1, there occurs a shortage for HK$ represented by AB. The Hong
Kong Monetary Authority (HKMA) intervenes and increases the supply of HK$ in the
market which shifts the supply curve to the right from S to S1. The new equilibrium point is at
B where demand is equal to supply and this is how the exchange rate is kept fixed.

Managed floating

A managed floating exchange rate (also known as dirty float’) is an exchange rate regime in
which the exchange rate is neither entirely free (or floating) nor fixed. Rather, the value of the
currency is kept in a range against another currency (or against a basket of currencies) by
central bank intervention.

By far the most significant system of managed floating exchange rate in recent years is the
Chinese currency regime. The Chinese Yuan is allowed to trade within a narrow band of 2%
above or below the day’s midpoint rate. If it deviates too far, according to some market
watchers, the Chinese central bank (the People’s Bank of China) steps in to buy or sell the
yuan, putting a lid on its daily volatility.
Let’s assume that the CNY (Chinese Yuan) is trading at 6.67 US$ at the point A where
demand (D) is equal to supply (S). The Chinese central bank sets the upper and lower limit as
2% above and below the mid-range. Now, the demand for CNY increases shifting the
demand curve to the right from D to D1. The equilibrium would be at the point B. However,
that point is crossing the upper limit set by the Chinese central bank. This is when they would
step in and increase the supply of CNY shifting the supply curve to the right from S to S1.
The new equilibrium comes down at 6.80 and the CNY trades at this value against the dollar.
This is how, in a managed floating system, the exchange rate is kept between a narrow band.

BRIC Countries

BRIC is an acronym for the developing nations of Brazil, Russia, India, and China. They are
countries that some believe will be the dominant suppliers of manufactured goods, services,
and raw materials by 2050.

Chapter 1: Nature and Dynamics of Business Environment

Problems with global capitalism

 Volatility in markets
 Race to cut costs
 Increased inequality
 Degradation of democracy

Role of developing countries

BRIC nations can play an important role to correct the global capitalism by:

 Adopting sound macroeconomic policies

 Engaging in better disclosure of information
 Pursue sound banking practices such as bank supervision by Central Bank
 Engage in good corporate governance
 Institute capital controls, if necessary
Economic and Business Environment of Cuba (your project group)
(Answer to Question 1)

 Mixed command economy dominated by state-run enterprises

 Dominated by state hiring of employees
 As of 2000, public-sector employment was 76% and private-sector employment
(mainly composed of self-employment) was 23%.
 Investment is restricted and requires approval by the government.
 Housing and transportation costs are low.
 Cubans receive government-subsidized education, healthcare, and food subsidies.
 Economic freedom rank – 175 (by the Heritage Foundation)
 Cuba's energy sector lacks the resources to produce optimal amounts of power.
 Agriculture - Cuba produces sugarcane, tobacco, citrus, coffee, rice, potatoes, beans
and livestock. As of 2015, Cuba imported about 70–80% of its food.
 Cuba has also done pioneering work on the development of drugs for cancer
treatment.
 Cuba has a small retail sector and the financial sector remains heavily regulated and
access to credit for entrepreneurial activity is seriously impeded by the shallowness of
the financial market.
 The Netherlands receives the largest share of Cuban exports (24%),
 Cuba's primary import partner is Venezuela.

Chapter 15: Global Recession and New Business Environment

The financial crisis of 2008-09 (sub-prime mortgage crisis)

 Occurred as a result of giving mortgages to sub-prime borrowers (borrowers with

lesser ability to repay)
 In reality, sub-prime mortgages intended to be temporary loans for borrowers who
were expected to sell their property early or increase their income soon after purchase
 Real estate prices in the US began to decline in 2006-07 resulting in soaring of
mortgage delinquencies and securities backed with sub-prime mortgages (held mostly
by financial firms) lost their value
  Lehman Shock (15th September 2008) – Collapse and bankruptcy of Lehman
Brothers, a huge global financial services firm with global headquarters in New York
City
 Shipping rates were declining at alarming rates
 Result was a large decline in the capital of many banks and tightening credit around
the world
 Considerable slowdown in most developed countries (especially the U.S.)
 Collapse of investment banks
 Rescue packages of more than a trillion US dollars
 Interest rates cut around the world
 US investors pulled out of BRIC nations’ stock markets, making the stock indexes in
these countries shrink

Business environment in emerging countries (BRIC)

 Economies close to reaching the mature stage

 Increase in number of people in the upper income brackets and, thus, broadening of
domestic demand

WTO: Agreements and Current Issues

 Formed in 1995 with GATT (General Agreement on Tariffs and Trade)

 Help producers of goods and services, and exporters and importers in conducting their
businesses internationally
 Deals with rules of trade between nations
 Primary decision-making body – Ministerial Conference held at least once in 2 years
 General Council of the WTO – oversees regulatory operations and acts as the body for
dispute settlement mechanism
 WTO agreements – negotiated and signed by member nations and ratified in their
parliaments. These agreements lay out the ground rules for international business and
grant important trade rights.
Arguments for WTO

 Official settlement of disputes

 Consumer-friendly rules
 Free trade cuts cost of goods
 More choice of products

Arguments against WTO

 WTO dictates important terms

 Difficult for small traders to compete with MNCs
 Indigenous products have no demand when branded imported goods are easily
available

Answers to Past Questions

2. “The internal and external environment of business affects the overall performance
of the companies.” Explain.

Ans. A business concept that looks perfect on paper may prove imperfect in the real world.
Sometimes failure is due to the internal environment – the company's finances, personnel or
equipment. Sometimes it's the environment surrounding the company. Knowing how internal
and external environmental factors affect a company can help its business thrive.

External Environment:

 The economy
 Competition from other businesses
 Politics and government policy
 Customers and suppliers

Internal Environment:

 Employees and managers

 Financial and other resources
 Company culture
3. What is economic recession? Discuss the impact of global recession on the world
economy specially with reference to the Covid-19 pandemic.

Ans. A recession is a period of declining economic performance across an entire economy

that lasts for several months. The NBER (National Bureau of Economic Research) defines a
recession as a significant decline in economic activity spread across the economy, lasting
more than a few months, normally visible in real GDP, real income, employment, industrial
production, and wholesale-retail sales.

Result of global recession due to sub-prime mortgage crisis in 2008-09:

 Interest rates cut around the world

 Japan, which depended largely on US as its export partner, suffered deeply
 Financial firms across the world hit badly resulting in failure
 Stock markets crashed in several countries, especially the U.S. and the emerging
nations (BRIC)
 US investors pulled out of many developing countries
 Soaring unemployment

The impact of the COVID-19 recession:

 Advanced economies fell to recession

 Stock market crash – major indices fell 20-30% in February and March of 2020
 Rapid rate of unemployment in many countries as countries imposed total lockdown
 Record drop in oil prices
 Collapse of tourism, hospitality and energy sectors worldwide
 High inflation rates

6. Discuss the effectiveness of policy measures with reference to global financial crisis of
2008 and Greek debt crisis.

Ans. Financial crisis of 2008:

Until September 2008, the main policy response to the crisis came from central banks that
lowered interest rates to stimulate economic activity, which began to slow in late 2007.
However, the policy response ramped up following the collapse of Lehman Brothers and the
downturn in global growth.

 Lower interest rates: Central banks lowered interest rates rapidly to very low levels
(often near zero); lent large amounts of money to banks and other institutions with
good assets that could not borrow in financial markets; and purchased a substantial
number of financial securities to support dysfunctional markets and to stimulate
economic activity once policy interest rates were near zero (known as ‘quantitative
easing’).
 Rescue packages amounting to $1 trillion were released
 Starting in the summer of 2007, the monetary authorities generally acted quickly to
adopt measures responding to the demand by financial institutions for increased
access to central bank liquidity. Central banks relaxed the terms of access to discount
windows and employed a variety of similar mechanisms. Those actions were
reasonably well coordinated.
 Increased government spending: Governments increased their spending to stimulate
demand and support employment throughout the economy; guaranteed deposits and
bank bonds to shore up confidence in financial firms; and purchased ownership stakes
in some banks and other financial firms to prevent bankruptcies that could have
exacerbated the panic in financial markets.

These policy responses prevented a global depression.

Greek debt crisis:

Greece faced a sovereign debt crisis in the aftermath of the financial crisis of 2007–2008. The
Greek crisis started in late 2009, triggered by the turmoil of the world-wide Great Recession,
structural weaknesses in the Greek economy, and lack of monetary policy flexibility as a
member of the Eurozone.

 Electronic payments to reduce tax evasion: In 2016 and 2017, the government was
encouraging the use of credit card or debit cards to pay for goods and services in order
to reduce cash only payments. By January 2017, taxpayers were only granted tax-
allowances or deductions when payments were made electronically, with a "paper
trail" of the transactions. This was expected to reduce the opportunity by vendors to
avoid the payment of VAT (sales) tax and income tax. By 28 July 2017, numerous
businesses were required by law to install a point-of-sale device to enable them to
 accept payment by credit or debit card. The greater use of cards was one of the factors
that had already achieved significant increases in VAT collection in 2016.

7. Is regional economic integration compatible with globalization? Explain

Ans. Regional integration helps countries overcome divisions that impede the flow of goods,
services, capital, people and ideas. These divisions are a constraint to economic growth,
especially in developing countries.

Divisions between countries created by geography, poor infrastructure and inefficient policies
are an impediment to economic growth. Regional integration allows countries to overcome
these costly divisions integrating goods, services and factors’ markets, thus facilitating the
flow of trade, capital, energy, people and ideas.

Regional integration allows countries to:

 Improve market efficiency;

 Share the costs of public goods or large infrastructure projects;
 Decide policy cooperatively and have an anchor to reform;
 Have a building block for global integration;
 Reap other non-economic benefits, such as peace and security.

Greater regional integration—if done right—can be complementary to the process of global

integration—in both seizing the opportunities presented by globalization, and in guarding
against and overcoming the attendant vulnerabilities and challenges. Indeed, for small open
economies regional integration may be critical in helping overcome some of the natural
disadvantages and limitations that small nation states face with respect to the unavoidable
forces of globalization.

In the economic sphere, regionalism has proven to be extremely effective in helping to secure
markets and providing economic strength through the creation of Regional Trade Agreements
(RTAs). In globalizing institutions such as the International Monetary Fund and the World
Trade Organization, agreements binding governments to liberalization of markets restrict
their ability to pursue macroeconomic policies. However, under RTAs, economic policies
remain more stable and consistent since they cannot be violated by a participant country with
provoking some kind of sanctions from other members. An excellent example of this is the
North American Free Trade Agreement’s (NAFTA) stabilization and increase of Mexico’s
political and economic policies.

In the face of weakly tamed globalizing world, it has been argued that states have responded
through regionalizing in order to preserve economic, political, and cultural stability. It should
be concluded that regionalist blocs have resulted mostly out of the current system’s inability
to address ad hoc situations occurring in various fields throughout the world; not to mention,
they have also resulted from the unpredictable future the globalizing world offers with its
varying economics, political motivations, and cultural migrations. Although it could be
argued that regionalism is simply placing the international system on a larger scale, the
amount of stability and regulation that comes with regionalism is incomparable. Therefore, it
has been properly argued that regionalism is in fact a building bloc of achieving global peace
and cohesiveness through its more specified and regulative approach.

10. “What is Globalization? Describe the impact of globalization in the different sectors
of the Indian economy.

Ans. Globalization is the word used to describe the growing interdependence of the world’s
economies, cultures, and populations, brought about by cross-border trade in goods and
services, technology, and flows of investment, people, and information. Countries have built
economic partnerships to facilitate these movements over many centuries. But the term
gained popularity after the Cold War in the early 1990s, as these cooperative arrangements
shaped modern everyday life.

Impact of globalization on agricultural sector: Globalization has helped in raising living

standards, alleviating poverty, and assuring food security. Greater food exports has also
increased the standard of living of farmers in India.

Impact of globalization on industrial sector: The benefits of the effects of globalization are
that many foreign companies set up industries in India, especially in the pharmaceutical,
BPO, petroleum, manufacturing, and chemical sectors and this helped to provide employment
to many people in the country. This helped reduce the level of unemployment and poverty in
the country. Foreign companies also brought in highly advanced technology with them and
this helped to make the Indian industry more technologically advanced.
Impact of globalization on financial sector: The recent economic liberalization measures have
opened the door to foreign competitors to enter into our domestic market. Innovation has
become a must for survival. Financial intermediaries have come out of their traditional
approach and they are ready to assume more credit risks. As a consequence, many
innovations have taken place in the global financial sectors which have its own impact on the
domestic sector also.