Trigger 4: Economic reforms and the role of the government

On our fourth session (time flies!) we got to experience a different approach with our new tutor Kevin. So far I really like it and I am looking forward to our next session. We are starting to work very well as a group, usually everybody has a say and we are able to develop each other's ideas.
This week's trigger has been (at least for me) the trickiest one. It was very hard for us to come up with the right questions and without the help of our tutor we would end up discussing for hours.

However, this week's topic is very important to us. Many of us read (or definitely should read) business news but it can be quite difficult to understand all the economical terms. Also, the world is changing a lot nowadays and it is wise to try to understand it.

Based on a text about Indian economical situation and its prime minister Modi, we chose the main question for this week:

The role of the government in economic reform

And also the following questions:  

• What are the types of economies (case study)
• What are the methods to make a country attractive for FDI?
• What are government policies for economic growth?

a) Economic systems

I usually like to start studying a topic by watching a video because it shortly summarizes the main point in an illustrative way. A short introduction to Types of economies can be find here: https://www.youtube.com/watch?v=5xgwYRX19VU.

To find out more about each type, I looked again to the textbook International Business Environments and operations, which I consider as a highly reliable source of information.

There are basically two main types of economies, which go to extreme precision:

Market economy: 

In an ideal market economy there is no government and no restrictions. Government is seen as a problem not as a solution.

Decisions are made by individual there is no limitation for private ownership. Consumers have a freedom of choice and thus all sources are allocated effectively. 

The key features of this type are: privatization, deregulation of the market, property rights and antitrust legislation.  

Of course, such economy wouldn't be capable of existing and it would lead to an anarchy. Strong market economy can be found for example in Hong Kong, Switzerland or- typically given as an example- the United states.

However, a pure market economy does not exist.

Command economy:

The exact opposite of market economy. Everything is planned by the government: ownership of resources, prices, employment. It also regulates the amount of production. Private ownership is forbidden and entrepreneurs might even be imprisoned.

There is no real competition on the market and there is a very limited amount of products. 

The economy often focuses on industry and agriculture. 

Very typical is central planning, usually in specific cycles: 5 or 10 years. These plans are expected to be followed no matter what is going on in the world.

All of this usually results in great inefficiency and inequality.  

The purest example of command economy is North Korea and to a certain extend Myanmar. In the past, China, the Soviet Union, countries belonging to the eastern bloc and Afghanistan also practiced this type. The consequences are usually still visible even till today in these countries. 

Mixed economy:

Similarly as in the case of company structure, most of the countries apply practices from both types, even though leaning to the market economy. 

Easily described: in a mixed economy the ownership is mostly private, while the decisions are made by the government. The market usually works on itself by the interaction of supply and demand. 

Traditional economy:

The video mentioned above also mentions an old type called traditional economy. This type used to be practiced in all countries, nowadays we can only find it in some primitive communities, in the video they gave as an example an inuit community in the north America.

b) Factors that make a country attractive for FDI

Today's business world is all about investments. Many countries (especially developing ones) are depended on foreign investment. The importance of FDI is highlighted in an article, which I found on The Balance website: https://www.thebalance.com/foreign-direct-investment-fdi-pros-cons-and-importance-3306283. It even developed countries need FDI's but from different reasons. International organizations like the European Union make it much easier for investments to be transfered from one country to another. That of course has a boosting effect on economies.

Now, more than ever investors are very careful with where they put their money. Many developing countries are becoming important players on the international markets and only time shows, how will their development continue. 

Basically all countries are trying their best to attract foreign investors. Some of the ways I found in another textbook: International Business: The challenges of globalization.

It divides the incentive into:

Financial: for example a host country can offer lower taxation for foreign investors or low interest loans- these should however be done so that the hosting country doesn't generate any loss. 

The downside is that it can be perceived as unfair by local entrepreneurs and they might move their production to other- for them more responsive country.

Infrastructure improvements: not all countries can afford to offer financial incentives, they can make themselves attractive by offering excellent infrastructure- Seaports for container shipping, or airports for freight transportation. Even though it might not seem as important, the supply chain is one of the main things companies struggle with.

Unfortunately in many cases, not very positive aspects appear attractive for the investors. Cheap workforce or low environmental legislation. It is then up to the company and its SCR to decide whether it is worth it to base their production on such aspects.

Also, restrictions from the host country side are often necessary. They have to protect local business from competition and keep necessary jobs. 

c) Government policies for economic growth.

As I mentioned above, most economies belong to the mixed type, so the government has a significant role. Working, trustworthy and reliable government can encourage stable economic growth. The government should act in compliance with the phase of the economical cycle. I am adding a picture to illustrate the cycle. So for example when the economy is in trough, the interest rate should be lowered to encourage people to take loans and spend money. That way more money will be pumped into the economy.  

 Unfortunately, most governments act according to the elections times. When the election is closing, they will encourage and boost economy to put the voters in an optimistic mood.

And finally, what are the policies that a government can use to influence the economy? There are two different policies that include more specific practices. I have decided to again include a small chart to put in a simple way:

I chose a simple article from the Investopedia (http://www.investopedia.com/ask/answers/100314/whats-difference-between-monetary-policy-and-fiscal-policy.asp) to find out about the tools a government uses. So here is a short summary

Monetary policy is usually in hands of a central bank or a similar institution and its task is to control the supply of money by increasing/decreasing the interest rate, selling and buying securities or providing loans to commercial banks (banks for regular people). Also, it determines the exchange rates, which is crucial for boosting international trade.

By all of these, the authority should achieve a stable amount of money in the economy. The start of the economical crisis in 2008/2009 was mainly caused by a failure in the control of money supply.

Fiscal policy: is directly in the hands of a government, usually within the ministry of finance. The main goal is to gain revenues for government spending (such as social transfers). The most important part are direct and indirect taxes and the amount of government's expenditure.

Sources

Daniels, J. & Radebaugh, L. & Sullivan, D. International Business Environments and Operations. Pearson, Global Edition. 15th edition.

Investopedia. What's the difference between monetary policy and fiscal policy? URL: http://www.investopedia.com/ask/answers/100314/whats-difference-between-monetary-policy-and-fiscal-policy.asp. Accessed: 25. September 2017.

Manahil Estate. Best Housing schemes for Investment in 2017. URL: http://manahilestate.com/best-housing-schemes-islamabad-investment-2017/. Accessed: 25. September 2017.

Tamoclass. AP Macro: AD AS Fiscal Policy. URL: https://tamoclass.wordpress.com/category/fiscal-policy/. Accessed: 25. September 2017.

The Balance. Foreign Direct Investment: Pros, Cons and Importance. URL: https://www.thebalance.com/foreign-direct-investment-fdi-pros-cons-and-importance-3306283. Accessed: 25. September 2017.

Unowacademics. UniversityNow: Types of Economic Systems. URL: https://www.youtube.com/watch?v=5xgwYRX19VU. Accessed: 25. September 2017.

Wild, J & Wild, K. International Business The Challenges of Globalization. Pearson, Global Edition. 6th edition.