Economic environment refers to the external economic factors that can influence businesses as well as consumer behavior, and in turn impact the performance of a business. Economic environment factors are further categorized as macroeconomic factors and microeconomic factors.
It is important for managers to appreciate the importance of the economic analysis of foreign markets, to identify the major dimensions of international economic analysis, to compare and contrast the economic indicators of countries, to profile the characteristics of the types of economic systems, to discuss the idea of economic freedom, and to profile the idea, drivers, and constraints of economic transition.
All countries differ in terms of: levels of economic development, economic performance, economic potential. A firm’s managers must understand the economic environments of those countries in which it operates, as well as those of countries in which it does not, in order to predict how trends and events the world over will likely affect firm performance.
The key economic forces include the general economic framework of a country, its degree of economic stability, the existence and role of capital markets, the presence of factor endowments, its market size and the existence of economic infrastructure.
The Factor Conditions refer to a nation’s inputs into the production process, such as human, physical, knowledge, and capital resources, and infrastructure.
However, it is difficult to specify a a definitive set of economic indicators that precisely assess the performance and potential of a nation’s economy, but it is also difficult to understand the systematic relationship of one variable to another.
Gross national income (GNI) refers to the market value of all final goods and services produced by a country’s domestically-owned firms in a given year.
Purchasing power parity (PPP) refers to the number of units of a country’s currency required to buy the same amount of goods and services in the domestic market that one unit of income would buy in another country. PPP is estimated by calculating the value of a universal “basket of goods” that can be purchased with one unit of a country’s currency.
The Human Development Index is designed to capture long-term progress rather than short-term changes. It measures longevity, knowledge (adult literacy rates), and standards of living. It combines indicators of real purchasing power, education, and health. The human development index provides a more comprehensive measure that incorporates both economic and social variables.
Other (second-order) indicators of economic development and potential include Inflation, Unemployment rate, Debt (internal as well as external), Income distribution, Poverty rate, Balance of payments.
The Consumer Price Index (CIP) measures the average change in consumer prices over time in a fixed market basket of goods and services; the misery index represents the sum of a country’s inflation and unemployment rates.
The Balance of Payments (BOP), officially known as the Statement of International Transactions, reports the total of all money flowing into a country less all money flowing out of that country to any other country during a given period of time records a country’s international transactions amongst companies, governments, and/or individuals during a given period of time.
Key Components of The Balance of Payments include:
- Current Account: Value of merchandise exports and imports. Value of services exports and imports. Value of income receipts and payments. Net value of unilateral transfers
- Capital Account: Value of capital inflows and outflows. Value of financial inflows and outflows. Net change in official reserve assets
Surpluses and Deficits: A trade surplus indicates that the value of exports exceeds the value of imports. A trade deficit indicates that the value of imports exceeds the value of exports.
Trends in balance of payments data can reveal important strategic implications with respect to a country’s economic environment and potential economic policies.
Types of Economic Systems
An economic system can be defined as the set of structures and processes that guides the allocation of scarce resources and shapes the conduct of business activities in a nation.
Various types of Economic Systems:
- Market Economy: a free-market (capitalistic) economy built upon the private ownership and control of the factors of production
- Command Economy: a centrally-planned economy built upon government ownership and control of the factors of production
- Mixed Economy: an economy in which economic decisions are largely market-driven and ownership is largely private, but significant government intervention is still evident
The Economic Freedom Index approximates the extent to which a government intervenes in the areas of free choice, free enterprise, and market-driven prices for reasons that go beyond basic national needs. It classifies countries as: free, mostly free, mostly unfree, repressed.
The Determining Factors of The Economic Freedom Index include: Trade policy. The fiscal burden of the government. The extent and nature of government intervention. Monetary policy. Capital flows and investment Banking and financial activities. Wage and price levels. Property rights. Other government regulation Informal market activities .
The shift from a command or mixed economy to a freer market economy largely depends on a government’s ability to: dismantle features such as central planning, create features such as consumer sovereignty. The success of the transition process depends upon the government’s ability to liberalize economic activity, to reform business practices, and to establish legal and institutional frameworks.
The various policies that shape the Economic Transition Process include:
- Privatization: the sale and/or legal transfer of government-owned resources to private individuals and/or entities
- Deregulation: the relaxation or removal of restrictions on the free operation of markets and business practices
- Property rights: the protection of real (tangible) and intellectual (intangible) property
- Fiscal and monetary reform: the reliance upon market-oriented instruments to achieve macroeconomic stabilization, the setting of strict budgetary limits, and the use of market-based policies to manage the money supply
- Antitrust legislation: laws designed to maintain and promote market competition, i.e., to prohibit the anticompetitive behavior of monopolies
To sum it up, the benefits of conducting business in a given country are directly influenced by the size of the market, the openness, stability, growth potential of the economy, as well as the wealth of consumers. The power of economic analysis is a function to identify the best possible indicators and then to understand how they work separately as well as together. The type of economic system prevalent in a country is a strong predictor of the nation’s current economic performance as well as its future economic prospects.
Related: The PESTLE analysis tool explained
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