Economic systems and their impact on international business

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Economicsystems and their impact on international business

IBUS330

Economic systems: What they standfor in business

Firmsoperating in the international environment face different economicand political systems that have a significant impact on theiroperations. Thus, it is very important that before venturing into anyforeign market, businesses understand the different types of economicsystems and the type of system in use in target markets. Differenteconomic systems impact business operations differently. In mostcases, the economic system is linked to the political system in thecountry and the national culture. A majority of scholars andpractitioners in international business identify culture as thegreatest impediment to foreign business operations as opposed toeconomic and political systems in the new markets (Jansson, 2008).Ordinarily, the national culture determines the type of economicsystem adopted in that country. National cultures vary widely thoughthe distance between one and any other may vary. There are three maineconomic systems namely centrally planned (also known as commandeconomy), free market and mixed economy (Nicholson, 2014). Based onthese three systems, the paper seeks to present economic systems as acritical factor in international business with a new leaning towardsculture.

Centrally planned

Acentrally planned economic system is one where the nation’s land,factories and other economic resources are owned and controlled bythe government. As the name suggests, all economic decisions in thecountry are centralized and made by the government. By controllingfactors of production, then the government ultimately controls alleconomic activities within its borders. Economists acknowledge thistype of economic system as an extremity that can hardly functioneffectively in modern times. It is largely associated with Communismand Socialism as used in North Korea and Cuba (Nicholson, 2014). SomeCommunist countries such as China are gradually moving away from thissystem due to its inefficiency only controlling core productseconomic resources. For instance, China controls the banking sector,telecommunications and energy. Much of the country’s success can beattributed to adopting capitalist policies.

However,between 1917 and 1991, the Soviet Bloc functioned effectively as acentrally planned economic system. The government was involved insetting prices for all basic products and owned nearly all forms ofeconomic resources. For example, the government owned farmlands whilepeople were employed to work as farmers. For the manufacturingsectors, the government owned the factories and would set five-yearplans with clear production targets to ensure there were no shortagesof core products (Orr, 2011). The high-level involvement of thegovernment in the economy is hinged on the belief that market forcesare inadequate to ensure equality in distribution of economicresources. However, the collapse of the Soviet Bloc and otherCommunist countries ditching the economic system, it means the systemis inferior compared to others.

Thecentrally planned economy has origins in the works of Karl Marx. Marxwas a German sociologist, philosopher, and economist who developedthe Communist ideology in his book The Communist Manifesto in 1848.He argued that human societies progress economically and sociallythrough class struggles. To him, societies were stratified looselyinto three classes including the rulers, land owners/middle class andthe laborers or the lower class. Marx was concerned that the lowclass and middle class had very few realistic opportunities to moveup the class hierarchy. These classes had an antagonisticrelationship each seeking to put the other down to protect its status(Gregory &amp Stuart, 2013).

Weaknesses of centralized planning

Theplanned economic system does not create economic value which isattained through efficiency. This means producing the highest qualitygoods at the lowest possible cost. This is because the system doesnot allow competition because the government has the monopoly inproducing most products and hence does not pursue the idea ofcreating economic value for customers but rather fulfilling settargets. The economy pursues self-reliance which is evident in thecase of North Korea where the country engages minimally ininternational trade. The system is also characterized by wastage andmisplaced priorities (Gregory &amp Stuart, 2013).

Thesystem does not provide incentives in various industries. Incentivessuch as tax breaks and pioneer advantages from patents are notavailable in the system hence there are no incentives for innovationin various industries. However, in others areas such as nuclear andaerospace, the government can spur growth and innovation throughintensive investment in the industry. The fact that the governmentcontrols all factors of production means that it can direct itseffort in a target areas and achieve desired results more quicklythan in other economic systems where government have to depend onprivate and sometimes foreign capital to push a given industryforward (Nicholson, 2014).

Sloweconomic growth is also associated with the planned economy. Livingexamples are North Korea and Cuba show these countries lag behindcourtesy of their economic systems. These are numerous examples ofcountries that were formerly using the centralized planning approachbut have allowed private ownership of poverty which drive rapideconomic growth. For instance China under the leadership of DengXiaoping enacted reforms starting from 1978 that privatized variousindustries and government functions. Individuals were allowed to ownlands and conduct business. Soon after, the economy registeredimpressive economic growth in double digits as private entitiesformed new businesses and foreign investors flocked into the country(Gregory &amp Stuart, 2013).

Anotherissue that plagues the planned economic system is the inability tosatisfy consumer needs. This, for the most part, emanates from thepoor levels of innovation in the industry, absence of foreign playersand low innovation. This implies that industries do not respond welland in time to emerging needs and changing consumer tastes andpreferences. Consequently, consumers are left dissatisfied(Nicholson, 2014). For international businesses, planned economiesare not practical because as private entities they cannot be allowedto own economic resources in those countries. For countries thatpreviously allowed private ownership of recourses, adoption ofcommunism implied huge losses as resources were nationalized (Orr,2011).

Mixed economy

Asthe name suggests, a mixed economic system, is a blend of twosystems: one being the centrally planned economy and the other beingthe market economy. In this type of system, the government ownsseveral economic resources while the rest are owned privately bybusiness entities and individuals. In this arrangement, thegovernment only seeks to control resources that it considersessential and sensitive (Nicholson, 2014). Such governments own andcontrol major international airports, education and learninginstitutions, seaports, railway tracks, and communicationfrequencies. Good examples include Franc and Germany and other Nordiccountries that portray a higher level of government involvement inthe economy (Orr, 2011).

Theservice industry such as education, health and welfare are criticalfor any functioning economy. While the welfare services may not bedirectly involved in creating national wealth, the government has toprovide such services free of charge to improve the quality of lifeand ensure the fair and redistribution of resources. On the otherhand, economically productive resources such as land and servicessuch as air travel are controlled by private entities. Most of theseservices provided free by government seek to correct the inability ofthe market forces in ensuring equality in the distribution ofeconomic resources. The US, India, UK, Germany, France, Canada andother developed and developing countries in the world used thiseconomic system (Orr, 2011). Therefore, for many internationalorganizations based in the west, they are used to a mixed economicsystem and hence might find it relatively easy operate in countrieswith a similar system as opposed to an entirely new economic system.

Althoughthe systems allows for private ownership of economic resources, thegovernment exerts its control to a certain level. This is achievedthrough government agencies created o oversee and regulate certainindustries. For instance, the fair competition act sets parameters inwhich individuals and private entities can operate. The taxationregime also ensures that the government controls the flow andmovement of currency in the economy. The Minimum Federal Reserverequirement is used by the government through the Federal ReserveBank to regulate interest rates and even exchange rates. However, toa great extent, prices for common commodities such as gas andgroceries are regulated by market forces. Innovation is higher in theeconomy and consumers get higher satisfaction through highlyinnovative products from a wide range spurred by competition amongthe players. Furthermore, the need to higher profits promotesefficiency with players seeking to produce the best quality at thelowest cost.

History of mixed economy

Althoughvarious governments have been practicing the mixed economic system,the system gained official recognition in the early 1930s (Nicholson,2014). This is because past governments such as the British Colonialgovernment in the Americas relied on taxation to control the economywhilst individuals and business entities were allowed to own land andother resources freely (Jansson, 2008). In the US, the merchants andplantation owners alongside other businesses were subject to taxationfrom the British crown government. Trade in some commodities washeavily controlled. For instance, in the late 18thcentury, the British government strictly safeguarded its textileinventions and had banned exportation of mills and their parts or anymaterials such as drawing in the designs of the mills. The onlytextile-related exports allowed from Britain were finished textileproducts. This was to continue until young British man Samuel Slaterwas able to replicate the textile mills in the US setting in motionthe industrial revolution in the country (ibid).

Decline of mixed economy

Mixedeconomic system has received its fair share of criticism from severalscholars. Same as planned economies, scholars have pointed to theneed to eliminate government control in mixed economies. The notionof a mixed economy is apparently misinforming because such systemslean more towards government control as opposed to a free market.Social democrats have also been quick to point out that the mixedeconomy has given space to all the ills that are associated with freemarket economy such as inequality in resource distribution,alienation, economic fluctuations and development of unfair practicessuch as monopolization of industries and creation of cartels(Nicholson, 2014). Where social support and welfare programs are usedto facilitate equality in distribution of resources, the programshave been abused or have been inadequate. For instance, in the USsome individuals can qualify for more than one benefits which equalsor can be higher to a salary. This encourages them to remainunemployed and in the process overburden the welfare support programs(Jansson, 2008)

Consequently,some governments have resolved to address the shortcomings of thissystem by designing and planning new systems that address theaforementioned weaknesses of the mixed economy. Netherlands, Austriaand Sweden are leading the path into a search for a better economicsystem. In doing so, Netherlands has entered into an agreement withlabor unions to restrict wages, allow shorter working hours andenforce budget discipline and trimming of social benefits. With sucha move, the economy has benefited tremendously. One key economicindicator that is sued to assess the suitability of governmentpolicies is employment rates. Following these reforms, Netherlandshas cut down unemployment to 6% compared to the EU average of 11%(Nicholson 2014).

Otherapproaches applied in different countries especially developingcountries such as India seek deregulate certain industries and alsoprivatize government functions. For instance in Canada, thegovernment is planning to privatize Canada Post (Palecek, 2014) whilein Brazil the government has already privatized two airports in a bidto inject efficiency (Horch, 2013). On the overall, governments areseeking to eliminate the weaknesses associated with planned economiesand amplify the benefits of market economy but still retaining theirmiddle ground from the two extremes.

Market economy

Inthis economic system, a large fraction of factors of production andeconomic resources are owned by private entities. The law of demandand supply is dominant and sets prices and supply with the governmentonly facilitating the interplay of the forces. This type of market isevident in the US and partly in Canada where the economy allowsindividuals and other private entities to exploit the market forcesfor their own benefit without much consideration for the country orother people. The market economy is characterized by three mainfeatures: free choice, free enterprise and price flexibility. Withthese features, the market economy has the highest potential infacilitating rapid economic growth. It is therefore highlyrecommended by economists and works best for private businesses butthere are certain issues that the government has to enforce. Toensure that the features of market economy are protected, theseeconomies assign the government peripheral roles recognizable throughpopular government agencies in the US.

Forinstance, the Drug Enforcement Agency (DEA) controls trade in certainsubstances while the Food and Drug Administration regulates medicaldrugs and foods to protect consumers. Such government involvement,though indirectly, falls within the four roles of government underthis system namely: enforcing antitrust laws, protecting propertyrights, creating a stable political environment and creating asuitable fiscal and monetary environment. The other role isprotecting the freedoms of choice, enterprise and price flexibility.

Thismarket economy has been blamed on a number of issues. Janssen (2008)notes the promotion of individual freedoms and rights more than therights of society has led to ills such as pollution, discriminationand exploitation. As private entities seek to create more and moreprofits, they tend to ignore critical factors and social goods suchas being ethical in their operations. For this reason, players inmarket economies continue to engage in unethical practices. Forinstance, arms manufacturers in the US sell weapons and artillery towarring factions around the world that contributes to destabilizingglobal peace.

Economic systems and culture

Asaforementioned in the beginning of this essay, culture plays acritical role in shaping economic systems. Geert Hofstede (n.d.)developed a model that predicts a country’s national culture. Inthis model, countries that record high individualism levels embracebetter free market policies. Free market policies are enshrined incapitalism, which recognizes that the individual’s rights supersedethe group’s rights. However, this does not mean that individualrights are less important. Ideally, the rights are a moral conceptthat provides a logical transition from principles steering anindividual’s conduct to the principles that steer his relationshipwith others. In simple words, it is impossible to protect the rightsof the group if the rights of an individual are not secured first.Consequently, in the highly individualized society, the sole functionof the government is to protect the rights of the individuals. Theserights of the individual provide guidance on how to relate withothers and thus by protecting the rights of the individual, thegovernment protects the rights of the group. Additionally, ideologiesof individual freedom prevail over equality ideologies inindividualized countries while it is opposite in collectivistsocieties (Throsby, 2001).

Sucha scenario has far reaching implication for businesses. The economicsystem in place in any given country not only affects the businesspart but also predicts the culture of the people and how the firmwill need to handle its marketing, HR, branding and distributionprocesses among others. Researchers have viewed the national cultureas a function of the sum behavior of individual members of thatcountry (Gregory &amp Stuart, 2013). Consequently, the economy isperceived as having an identity of its own that transcends theconstituent elements. Accordingly, the economy is described to be‘weak’ or ‘strong’, aspects used in describing human behavior(Throsby, 2001). In so doing, the economy is portrayed in a culturalcontext as a system of social organization which is a change from theperception of the economy as a system of thought. For instance,countries that score high on collectivism tend to prefer dominantrole for the state in the economic system while the individualistsocieties are characterized by a minor role of the government in theeconomic system. Firms should thus be able to perceive the roleeconomic systems as cultural element has in the operations of thefirm and relating with the host nation’s government and people.

Inconclusion, it is clear that government’s role in an economicsystem can vary according to the national culture. Economic systemsnot only influence the financial aspects of business but also thecultural aspect. Therefore, in order to succeed, firms operating inthe international market must learn the different economic systemsand understand how each type influences its place and role as aprivate entity in an economic system. The three different systemsdiscussed show the benefits and challenges that they can pose toprivate businesses. As discussed, the market economy is the bestsuited for businesses. Nonetheless, firms are subject to restrictionsplaced by government sin market economies to protect the existence ofthe economy itself.

References

Gregory,P. &amp Stuart, R. (2013). Theglobal economy and its economic systems.New York:

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Hofstede,G. (n.d.). Hofstede: Cultures and organizations – software of themind. Retrieved from,

http://www.novsu.ru/file/1092483

Horch,D. (Nov 22, 2013). BrazilRaises $9.1 Billion in Privatizing 2 Airports.New York

Times.Retrieved fromhttp://dealbook.nytimes.com/2013/11/22/brazil-raises-9-1-billion-in-privatizing-2-airports/?_r=0

Jansson,H. (2008). Internationalbusiness strategy in emerging country markets: the

institutionalnetwork approach.New York: Edward Elgar.

Nicholson,J. (2014). Thepower of knowledge across cultures, IBUS 330: International Business

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Orr,T. (2011). UnderstandingEconomic Systems.New York: The Rosen Publishing Group.

Palecek,M. (2014). The smoking gun… Harper`s plan to privatize Canada Post.Retrieved from

http://rabble.ca/news/2014/07/smoking-gun-harpers-plan-to-privatize-canada-post

Throsby,D. (2001). Economicsand cultureNew York: Cambridge University Press.

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