Components of an Economy
Welcome everyone to the course of International Business. In the last few classes, wehave been discussing about you know the factors that affect the international businesswhich every manager in a firm should understand and you know try to keep updatedright. So, some of them being for example, we talked about the cultural factor, thepolitical factor, the legal factor and then, we started about the economic factors right.So, we discussed how economic factors affect the you know any firm for that rightbecause economy of a country is one of the most important things it decides the livingcondition of the people ok. So, when we talked about the economic condition, we talkedyou know some of the terms like GDP Gross Domestic Product, GNP, the purchasingpower parity and you know kind of terms which were used in the last class.Then, we talked about how poverty and you know how inflation kind of things they alsoaffect economic you know situation. We are going to do it in detail today. We alsolearned how human development index becomes one of the factors and how it influencesthe entire economy of a nation. So, as a whole, we have understood by now thateconomy has a very very vital role to play because just to start this lecture I would startwith an example.Let us assume in a famine, when there is a famine right people die of hunger. So, therewas there is an argument why do people die of hunger? Is it because there is a shortageof food? Is it because there is a distribution problem? Is it because you know there issome other reason? What is the basic reason why people die? So, economists likeAmartya Sen they finally, eventually they came to in conclusion and stated that it is notthat food is not available, grains is not available. But what happens is peoples purchasingpower comes down right. So, as a low purchasing power, they are unable to buy thegrains and the food products.So, as a result of it, there is a severe you know malnutrition and crisis which occurs in acountry or a place. So, when we have understood economy and we are getting into it. Letus move further today with some of the other things for example, let us start with whatare the components of an economy?(Refer Slide Time: 02:54)So, when we are saying the components of economy, there are certain factors whichmanagers need to understand. For example, inflation: how inflation affects, what isinflation by the way and how it affects the economy right.Unemployment or employment level in the country, level of debt a country goes throughor has, how is what is the income distribution level, how is income being distributed inthe country is it is there a serious heavy a large gap or it is equally distributed, what kindof a distribution system is there? What is the level of poverty? What is labor cost youknow? What is the productivity of a nation and finally, the balance of payment. So, theseare some of the components which we will understand, we will talk in detail today in thislecture.So, let us start with inflation. So, what is inflation by the way? This word every day wewhen we will you know come across through the some economy, some news and we arefinding we are talking about and we you know listen to that, that there is a growth ininflation or inflation has come down. So, what is this inflation all about?(Refer Slide Time: 04:03)So, as it says in a layman’s word inflation is nothing but a rise in prices of some basiccommodities or basic products right which we use in our day to day life right. So, if youtake this what says what it says is sustained rise in prices measured against a standardlevel of purchasing power. It results when aggregate demand grows faster than thesupply. So, when there is a large amount of demand, but supply is less what happens theprice of the commodities increases right as a result of it, inflation grows.So, if there is sufficient amount of supply and you know there is a purchasing power withpeople, then inflation would be in controlled. A you know there is an argument whetherinflation is good or bad. So, this argument has two places. Many a times we say orlargely we understand inflation is to be a very dangerous thing and it is not very youknow good for any country, but inflation a moderate inflation is always a healthy signbecause a moderate inflation helps a country to grow right.So, as a economist, one has to understand or you know a student of economics, one hasto understand how much inflation is a bad inflation or up to what level can we sustain itand beyond that its dangerous right.So, what is that good and the bad side of it? Managers must watch its influence on manyparts of the economic environment such as interest rates, how inflation affects theinterest rates, the exchange rate, the cost of living, the stability of the current politicalsystem and the climate condition.So, inflation has an influence right on all these factors. Now, if the inflation grows thatmeans, the country would like to you know ensure that there is less money in the marketand to do that, they would increase the interest rate for that right.So, with the interest increase in interest rate, they would ensure the liquidity in themarket is lessened. So, that it would reduce the inflation. So, these kind of thingsinflation is connected with a lot number of factors and it drives the economy to a verylarge extent.So, stability of a current political system; how if the inflation is large even governmentstopple, you know there is a change in government systems because people are not happyand there is an unrest and there is a very high chance of a civil unrest which can youknow result in a you know change in the government also right. So, all of these thingstaken together inflation puts a very big plays a very big role.(Refer Slide Time: 06:39)A good example is right after Japan’s earthquake in 2011. It disrupted the supply of autoparts. It also occurred after the Hurricane very famous Katrina right. When the stormdestroyed the oil refineries, gas prices soared and as we have said when there was asoaring in the increase in the gas prices and oil prices, automatically inflation grew.(Refer Slide Time: 09:13)Now, let us see this case now hyperinflation is a situation where inflation has you knowcrossed you know its definition is there it is when the prices of the goods and servicesrise more than 50 percent in a month right. So, this is a very serious condition. So, this isnobody no country would want, but why does it happen right and let us take an examplealso. So, let us understand first what causes the hyperinflation.So, as we said when the price of goods and services rise more than 50 percent in amonth, it is a case of hyperinflation right. It starts when a country’s government beginsprinting money to pay for its spending. So, it is not a very wise idea to print money right,but some of the governments have done it.As the government increases the money supply so, more money is available with people.The rise of prices you know the commodities the there is a price rise in of thecommodities right and as there is a price rise of the commodities because people havemore money to spend so, they can pay.So, that is why the prices also rise and as the price rises, regular inflation happens, orinflation raises. Why then, what is the problem? One needs to understand very as astudent of you know social science and management that yes, money supply hasincreased, but money supply has not been distributed equally in everybody’s hand. So,that is why the inflation cause is a major concern ok.So, instead of tightening the supply to stop inflation, the money supply the governmentskeeps printing more. Now with too much currency prices skyrocket. So, this is a verybeautiful diagrammatic representation which is you can understand.So, the most well known example of hyperinflation was during the Weimar Republic inGermany in the 20’s. First the German government printed money to pay for the WorldWar I. From 1913 to the end of the war, the number of Deutschmarks in circulation wentfrom 13 billion to 60 billion ok.Now, the government also printed government bonds. So, which is again another kind ofa you know tool which affects the inflation like the cash right. German sovereign debtwent from 5 billion to 156 billion marks. So, all these resulted in a very hyperinflationsituation for Germany ok.(Refer Slide Time: 11:41)Another example very recent one, not very oldest Venezuela what happened in 2014, theinflation rate in Venezuela reached 69 percent which was the highest in the world rightand who was the ruler at that time Nicolas Madura’s and he was a president. In 2015, thisrate was 181 percent. Now you see this is 69, now it has moved to 181 again it was thehighest in the world and the highest in the country’s history at that time. Now, that didnot stop there.The rate now reached 800 percent in 2016. So, 2014, 2015, 2016 from 69 to 800 percentand then, in 2017 over 4000 percent right and in 2018, it is 1,698,488 percent. So, youcan see what has happened to the economy right, with Venezuela spiraling intohyperinflation right.While the Venezuelan government has essentially stopped producing official inflationestimates after that, inflation economist Steve Hanke estimated the rate at that time to be5220 percent. In April 2019, the IMF estimated that inflation would reach 10,000,000 bythat percentage by the end of 2019 right.So, you can understand; that means, there is a lot of money but the money has no valueat all because the cost of goods is also skyrocketing right. So that means, what peoplewill go with bags of money and maybe buy a loaf of bread that is the situation.Potential causes of the hyperinflation include heavy money printing and deficit spendinganother bad thing. Now not only money printing, but again what you are doing is you arespending money by taking maybe loans right so, you do not have the money to spend,but you are still spending on what? On what basis will you spend? You take loans fromsomebody which you have to pay.Today Pakistan is in a very bad state because he had taken, they have taken a lot of loanfrom China and today as of now, Pakistan is in a terrible situation. They have they do noteven have money for left for more than 3 months.Implications: Hyperinflation quickly devalues the local currency in foreign exchangemarkets as the prices of the goods and services in conjunction with the increase in moneysupply right. The practice causes a vicious cycle now. As prices rise, people hoard moregoods. See all about economy is behavior. Economy is nothing more to me if Iunderstand correctly. Economy is nothing but a way of human behavior you knowunderstanding that human behavior that is in that is in connection with one tool which iscalled currency or money right.How do humans behave with the tool called currency or money whatever you say, howdo they behave with it? This entire behavior of human beings in relation to the currencyto me is economic right. So, people would hoard more, they would try to save, they weretry to keep. In turn, creating a higher demand for goods and further increasing prices. Ifhyper inflation continues, it causes a major economic collapse. So, such examples wehave seen in Venezuela, we have seen in Argentina, we have seen in Zimbabwe so, therehave been lot of examples.(Refer Slide Time: 15:24)So, this is an example of you know we have taken from the IMF data. So, inflation rate ifyou can see, these are some of the indicators given to you. So, 25 percent or more rightinflation rate average consumer prices of some countries has been given.So, where it is if you see the red color so, these are like the reddish ones which has got25 percent or more which have a 10 to 25 percent inflation rate is in slightly in the youknow in the darkest region and then, it goes on, So, 0 to 3 percent is green and darkgreen is less than 0 percent.So, let me show you some of the countries if you if I want to show you. So, for example,let us take this one, the red one right. So, in case I would not forget so, I have alsobrought it in writing so, for you. So, Argentina right. So, let us take some more red ones,let us say this one. So, this is Iran right. So, this one is I think Sudan right. So, this isSudan. Then, you have here Libya. So, these are some of the economies which have avery high.Where is India? India is somewhere here right; India is somewhere here. So, India comesand then a 3 to 10 percent condition right and if you see the good ones, the green onesfor example, Australia right, this is Australia. Then, you have this one is if I am notwrong China right; China, this is Russia the Russian federation basically and then, youcome this side let us say this is the US right Canada and US right. So, this is Canada so,this is the USA. So, so there are different kinds of conditions which I have mentioned.So, you can see all of them and this gives you an idea about the inflation rate and howthey are varying in the different parts of the world right.(Refer Slide Time: 17:27)Unemployment also another indicator which affects the economic largely. Now what isthis? Share of unemployed workers seeking employment for pay relative to the totalcivilian labor force right. So, I will explain it. ILO, the International Labor Organizationunemployment rates refer to any person. According to ILO, it refers to any person that isnot working, but is willing and able to work.So, what does the ILO say? The ILO says that unemployment rates refers to any personthat is not working, but he is willing to work, he is interested to work, they are interestedto work, but they are not getting a work.So, in that condition, it would only be categorized in the unemployed sector or categoryright and actively seeking work, they are looking for work. So, but if somebody is notlooking for work, then he is not part of the labor force it is as simple as that. What itdoes? It reduces economic growth. Due to unemployment, economic growth is you knowcomes down. There is a social pressure right. Some somebody has money, somebody hasdo not have money. So, there is a chance of crime and all these things are getting larger.Provoking the political uncertainty and show how well a country productively uses itshuman resources.So, unemployment is very important because the more unemployment and we will seelater on that the more unemployment is there; that means, people do not have the powerto you know purchase thing, they do not have money right and as they do not havemoney, then what will it happen? Then they will not be able to buy things and as theywill not have you know money to buy things, automatically there will be a you know fallin the demand of the goods and as there is a demand of goods falls down, automaticallythere is a you know loss of job and again, when there is a loss of job so, there is a loss ofmoney earning capacity. So, this is again a cycle, a vicious cycle right.Unemployment rate is calculated as for example, persons unemployed divided by thetotal labor force right. Now what is this? Persons unemployed divided by labor forcesperson employed plus persons unemployed into 100. This is how it is calculated.(Refer Slide Time: 19:41)These are again some of the examples which I have shown you. So, for example, you cansee some countries like Libya right. Libya is somewhere here right. If I am not wrong,Libya exactly this one is Libya right. So, this one is Libya right. then we have SouthAfrica which is that you know end the tip I think yes, so, this is South Africa; SouthAfrica. So, these are some of the countries which have got a high unemployment rateright. India has not got a much problem, but then that is a dicey to understand becausehow it is calculated sometimes unemployment calculation is a little confusing thing ok.(Refer Slide Time: 20:31)So, there is something called a misery index. Now what is this? What does it say? Thesum of a country’s inflation and unemployment rate taken together is called the miseryindex right. Higher the sum that means, the inflation plus the unemployment. Higher thesum, the greater the economic misery and more likely consumer and companies willcurtail spending and investment.If you remember during any recession, what happens is largely companies tend to stoptheir investments into marketing, promotion of goods and all right. But some companieshave understood this is not a very wise way of you know addressing the problem ofrecession. If you do that, then again it is a spiral, it is a visual cycle which again reducesyour chances of you know people buying your product.So, some intelligent and good companies have always understood that even during thetime of recession, there should be some money spent on you know marketing andbranding of products right.So, that when the good time comes, you are the most ready company. You are thecompany with the best condition. So, that you can people can automatically rememberyou and can try your products out. This index gauge the health of the economy sinceboth high unemployment and high inflation are major factors to the average wage earnerright.With the help of the misery index, the economic health of the country can be seen whichwill be helpful while conducting an analysis of the economy. So, if you can understandthe misery index, it helps you to understand the economic health of the nation.Some other factors affecting unemployment are labor regulations and working agepopulation which are for example, labor regulation is one which like in India, our laborlaws are very archaic, very old right. So, hardly they had changed from the British timesright. So, now many what happens is because of this very stringent norms where youcannot remove people, it is very difficult to remove even one person. What happens isthe private companies now are in a problem.So, now, there have been some changes in the recent past, but earlier days, there used tobe lot of problems. So, they if they wanted some workers also, they would not hire itwhy because they were afraid, they have to keep those workers for lifelong.So, now that is an too much of a burden for these companies. So, they wanted maybe fora time period 2 years, 3 years, 1 year whatever 6 months so, they could have hired. Nowthat would have been still an earning mechanism for the workers, but because of the fear,that these regulations will be you know will be legal regulations are very damaging, thecompanies do not hire.So, now, not hiring creates a very difficult situation and what they do is they try tooptimize with the existing labor, but the existing labor because it knows it is protected bythe government to a very large degree as it happens I am; I am I feel I can openly saythis. In the government sector in India, the people are protected.So, as they feel protected so, then they what they do is they do not try to improve theirproductivity. They are happy doing whatever they like. So, that hampers the growth of acompany right. So, at one end, you cannot hire good people, at the other end the peoplewho are working they are not interested, and they are not very you know productive innature right.Second is the working age population with. Now, this is a natural condition which cannotbe controlled a very largely it cannot be controlled because, now the working agepopulation for example, in Japan is a very aged country that means, the average age ofthe people is high on the higher side. So, more people are growing old whereas, on theother side India is in a young country. So, when it is a young country, more people arecoming to the job market every year.So, if we cannot afford, if we cannot provide them jobs, then automatically theunemployment rate can grow tremendously right. But on the other hand, Japan the mightbe the unemployment rates the demand in the employment might not be very highbecause many people are getting old now right. So, this is a condition which affects it.(Refer Slide Time: 24:54)Let us see this example will understand unemployment. So, is a person working is onequestion right yes, there are two possibilities yes or no. If it is a yes, then let us say this isa number we have taken for a calculation, then these people are the employed people. So,in this case this is an example, we have taken 144,958 people are employed. Let us saynot employed, is the person working? No.So, is the person now there are two questions again. Is the person looking and availablelooking for work is he looking for work? If it is a yes, then he comes under theunemployed right which is let us say 10,080. If he is not looking for a work, then hecomes in the not in the labor force which is in this case are let us say 79038 right. So,which can happen right for example, people working in their own farms, agriculturalfields, they do not look for jobs many a times. Somebody has his own business;somebody does a handicraft. So, the government tries to, every government tries toincrease the business you know climate of a country so that, people are self-employed,they do not mind, you know they are not looking for a job.Though the unemployment rate in August is that is why you know our Prime Ministerhad given a statement which was a lot of hue and cry. When he said people could makesome fry you know some items and sell it in the market, even that is a job, but then hemeant here that is any job, it is creating job right.So, if you are even having a stall where you know you are making food items and sellingit to the public, still it is a job because you are creating more economical conditions, youare more you are hiring people, you are giving them wages. So, that is not to be looked ata negative side only, it has some positive connotations. But yes, you might define jobs indifferent manners that is a different story.So, the unemployment rate in August 2008 was 6.5 percent. Now, how does it come yousee. 10080 which is the unemployed rate unemployed divided by 10080 plus 144958.Now, if you this if you take this total this is 6.5 percent. If you would have added thisone, then this scene would look very bad right.(Refer Slide Time: 27:01)This another you know thing that comes into the discussion is debt. What is therelationship with debt and economy? Debt is basically the total of a government’sfinancial obligations right so, financial obligations. So, there could be two kinds of youknow when you talk about debts: internal debt and external debt. Debt is to beunderstand we have taking some money from borrowed some money or something so,that is a debt right.Most countries around the world rely on sovereign debt to finance their government. So,they ask money from foreign players and foreign other countries and all to run their owneconomy. So, that is something we talk about we say is the debt right. When this debt isused in moderation, it is good. Suppose you want to you know for example, in financealso we have heard the debt you know way of going for generating revenue or the equitybased system which is better. So, there are lot of arguments for it.If you can use your debt properly, then it is always good. Having no debt does not meanthat a company is always doing good because if you have taken debt, taken loan and youare using it for productive purposes for example, like more schools, more hospitals andall then it is good for the economy. But if you are not using it in that way and you arewasting your money for let us say other purposes which are not creating more jobs ormore productivity, then that is a dangerous condition right.So, to, but too much debt can lead to a number of problems because you will not be ableto even pay the interest then what happens is the you know it goes on the principal plusinterest goes on piling up and then you are in a position where you might not be able topay at all right. So, the debt-to-GDP ratio is designed, is one of the indicators is designedto help investors determine if a country has too much debt or not.So, for example, when a foreign investor would come to India, he would like to see thedebt it could GDP ratio for India. Some of those signals for growing debt public debt isfor example, then the government increases the tax right, he cuts the public expendituresso, basic expenditures which are important they are cut down, growth is reduced,inflation goes on rising and austerity measures again like you know cutting publicexpenditures is one of them is growing, is rising.So, in these conditions we would say maybe the country is going in a debt condition andthere is a lot of debt which to manage it, they are now using this kind of techniques, butthey are may not be the wise techniques right.(Refer Slide Time: 29:50)So, anyway we can understand now that how inflation and debt taken together right hasthis is yes, this is one thing which I wanted to show you. Some of the top you know thecompany countries how much government debt exists. For example of 2018, this value istaken.So, they are ranked some countries with the top 5 leaders. United States has a debt of thismuch right in billions which is 31.8 percent of the global debt, Japan 18.8, China it goeson right together just these 5 countries together hold 66 percent of the worlds debt innominal terms good for a total of 41.6 trillion right.But if you can see interestingly, all these are economies which are growing. So, fromhere also if you do not understand anything, still you can say that all the time debt is notas bad as it looks ok. On the other side, if you look at the top 5 for debt-to-GDP, thenumber one country that comes from in debt-to-GDP is Japan right which has 18.8percent of the global debt here and when you talk about the debt-to-GDP it is 239 240percent right. Greece is 181.6 percent. Greece is in a bad condition right.So, if you can see here, Japan’s 2018 debt-to-GDP ratio is over 200 percent, but itseconomy received very little analyst attention because they are still doing good. WhileGreece is only 160 percent and it has been on the verge of collapse why? Why did ithappen? Reason 90 percent of the debt in Japan is held domestically. So, it is not fromoutside. High economic growth, they are using their money well. Viable plan to address.They have a good plan to address the GDP to debt ratio right. So, this is somethingwhich we have covered.So, today we have understood how inflation and debt and all these things how they areaffecting unemployment they are affecting the economy of a country right. In the cominglecture, we will carry on from here and understand some of the more components whichare connected with economic factors and how they affect the international business right.So, thank you for the day. Have a nice day.