ECONOMIC ENVIRONMENT
INTRODUCTION
An economic system refers to the manner in which a culture produces and distributes its
goods and services. It refers to the conditions under which a cultural group makes use of
the capabilities of its individuals and the environment to derive some benefits.
THE ECONOMIC SYSTEMS
In order to make an informed judgment about global construction markets, it is
necessary to perform an analysis of the prevailing economic systems. The economic systems
are broadly classified into three categories: (1) Capitalist, (2) Socialist, and (3)
Mixed. A better classification, however, may be made using the criteria of property
ownership type and mode of resource allocation and governmental control. Using these two
criteria, a taxonomy of economic systems may be created as shown in Figure 1.
Figure 1. The Economic Systems
Control
- Market Economy
- This mode of control implies that the resources are allocated by the consumers; the
individuals own resources and products The mechanism involves an interaction of price,
quantity, supply, and demand for resources and products:
- Labor is supplied by an individual to another individual, group, company, or government
in exchange of an adequate wage.
- Products are consumed if the price is within a certain acceptable range.
- Wages are set on the basis of the quantity and quality of labor available to perform a
job.
- Resources are allocated as a result of constant interplay between the parties involved.
- Consumer sovereignty is the key factor in market economy; the consumer has the right to
decide what to purchase and can influence production by exercising the power of choice
regarding purchases. As long as all the parties involved are free to make decisions, the
interrelationship of supply and demand should ensure proper allocation of resources.
- Large corporations, labor unions, and policies formulated by the government may limit
consumer and business freedom to a considerable extent in any market economy.
- Command Economy
- This mode of control implies that resources are allocated and controlled by the decision
of the government. The activities of different economic sectors are coordinated by the
governmental agencies.
- Goals for all enterprises in the society are set by the government.
- Quantity of products, their price, and producers of those products are determined
centrally.
- Mixed Economy
- This mode of control is characterized by different mixture of market and command
economies.
- In fact most of the economies around the world today may be defined as as mixed to a
certain extent, because pure market economy hardly exists.
Ownership
- Private: All resources are owned by individuals.
- Public: All resources are owned by the government.
- Mixed: A mixture of public and private ownership's.
KEY ECONOMIC ISSUES
INFLUENCING INTERNATIONAL CONSTRUCTION
The global construction companies must be able to identify the issues they
may confront while working abroad. The impact of these factors may vary considerably from
country to country. Therefore, strategies for handling those issues may be different for
different regions.
The factors that are most likely to influence international construction
include:
Economic growth:
- One of the broadest measures of economic growth and productivity is the GNP or gross
national product of a country. It is defined as the total market value of goods and
services produced per year by the domestic factors of production of a country; the
production by domestic factors could take place either at home or abroad.
- Another indicator that is often used is GDP or gross domestic product that measures the
value of production that occurs within the country's borders. It reflects economic
activity within the country more accurately than done by GNP.
- An analysis of economic growth may provide information about the rate of real growth of
a region so that a company or an individual can take decisions related to financial
investment.
- Rate of inflation:
- Inflation is a gradual reduction of the purchasing power of money, usually related
directly to the increases in the money supply by the federal government.
- It is an important aspect of economic environment because of its influence on interest
rates, exchange rates, cost of living, and general confidence in a country's economic and
political system.
- Inflation higher than growth rate contracts economy and usually causes political
destabilization that may result in increased political risk
- High inflation rate makes the currency unstable leading to difficulties in planning for
development.
- It is part of a vicious circle leading to a balance of payments deficit, which in turn
leads to a devaluation of the local currency and further inflation, and the cycle
continues.
Figure 2. The Inflation Cycle
- Balance of payment
- Balance of payments is a systematic record of all international transactions between
domestic and foreign residents. Two main categories in BOP are the current account
(summarizing transactions involving currently produced goods and services) and capital
account (summarizing transactions involving existing assets, capital flow from one country
to another).
- Balance of payments surplus and deficits can influence trade policies, value of
currencies, and consequently the business environment.
- Trade strategy
- Trade strategies may either be outward or inward oriented. They may range from no trade
control (i.e. very low protection of domestic market) to absolute trade control (i.e.
strong protection for domestic market).
- Country debt
- Results from borrowing from foreign private or government institutions to finance
development programs. A large share of the export earning of a country with a high
debt-service ratio (ratio of interest payments plus principal amortization to exports)
goes to service its debts. Thus very little of the earning is available for economic
development.
- High debt situation causes imports to be often curtailed, and foreign currency hard to
come by.
- In order to control debt, government may institute measures that result in slowing down
of economic growth. This in turn would have a negative impact on construction companies
trying to sell goods and services.
- Exchange rate (Baker,1990)
- Exchange is the price of one currency in terms of another currency.
- Exchange rates could either be fixed or flexible.
- At a fixed exchange rate, the government intervenes in the foreign exchange market that
the demand of supply of foreign exchange are equal at a chosen exchange rate.
- At a flexible exchange rate, there is no governmental intervention. The demand and
supply of foreign exchange are equalized by exchange rate movements.
- The effects of the above systems on a country's fiscal policy are shown in Figures 3 and
4.
Figure 3. Effect of Fixed Exchange Rates on Monetary Policy
Figure 4. Effect of Flexible Exchange Rate on Monetary Policy
References:
Baker, S. A. (1990). An introduction to international economics.
New York: HBJ.