This lecture focuses on Political & Economical Environment + Exchange Rate Regimes

1. B416: The Evolution of Global
Economies
Lecture 8 : Political & Economical
Environment + Exchange Rate
Regimes

2. Learning Outcomes
By the end of this lecture, you should understand the
following:
• To discuss the philosophy and practices of the political
environment
• To profile trends in contemporary political systems
• To explain the idea of political risk and approaches to
managing it
• To discusses the institutions of exchange rate regimes.
• To understand the differences between these regimes we
explain the policy trilemma.
• An overview of the different exchange rate regimes since
the second half of the 19th century.
• An overview of the money organizations that coordinate
international monetary policy. 2

3. 3
Introduction
Political and Legal Factors Influencing International Business Operations
• Every country has its own political and legal environment
• Companies must determine where, when, and how to adjust their business practices
without undermining the basis for success

4. 4
Spectrum Analysis
The Political Spectrum

5. 5
The Standard of Freedom
Map of Political Freedom, 2010

6. 6
Democracy: Recession and Retreat
Freedom in the World: Number of Electoral Democracies

7. 7
Democracy: Recession and Retreat
Freedom in the World: Gains and Declines

8. Page 8
Economic Transition
• Economic transition, for example for Central
and Eastern European countries is a multi-
dimensional trajectory
• The slides below focus on only two
dimensions:
– Degree of state ownership (none – total)
– Degree of market intervention (none – total)

9. Page 9
Stateownership
Market interventionnone
none
total
total
USA: public
spending is
30% of
GDP;
North Korea,
Cuba: also
there private
production &
incentives.capitalism
communism
USA
N.Korea
Cuba
Extremes fit
no country:
Economic Transition

10. Page 10
Stateownership
Market interventionnone
none
total
total
A country in
transition is
changing the
mix of state
ownership/
market
intervention
in the
medium run.
Many
different
paths are
possible.
capitalism
communism
USA
N. Korea
Cuba
Welfare state
capitalism
Market
socialism?
Economic Transition

11. Page 11
Stateownership
Market interventionnone
none
total
total
Privatisation
is one-
dimensional,
while
transition
has more
dimensions.
capitalism
communism
USA
N. Korea
Cuba
Welfare state
capitalism
Market
socialism?
privatisation
Economic Transition

12. Page 12
Economic Transition
• Transition involves a series of steps at the institutional,
micro-economic and macroeconomic level
• Adjustments require reallocation of capital, services
and labor between sectors of the economy
• Initial phase of decline in production is to be expected
• Two strategies of reform
– big bang approach: achieves necessary steps of transition
in a short period of time, leads to large initial declines of
production (Poland is the prime example)
– gradual approach: tries to systematically sequence the
steps to be taken and to minimize transition pain and
output loss (successor states of the former Soviet Union).

13. Page 13
GDP per capita, PPP (constant 2005 international $)
index, 1990 = 100
0
50
100
150
200
1990 1995 2000 2005 2010
Poland
Russi
a
Slovaki
a
Romani
a
Ukraine
Economic Transition; big bang vs gradualism

14. Page 14
Policy trilemma summarized
fixed
exchange rate
fixed
exchange rate
fixed
exchange rate
capital
mobility
capital
mobility
capital
mobility
policy
independence
policy
independence
policy
independence
fixed
exchange rate
fixed
exchange rate
fixed
exchange rate
capital
mobility
capital
mobility
capital
mobility
policy
independence
policy
independence
policy
independence

15. Page 15
International monetary regimes
• Policy makers must thus compromise when choosing a
monetary regime. Their choices have changed over time.
• The main international monetary regimes are:
now1870 1914 1945 1971
Gold Standard
fixed exchange rate
regime, currencies
pegged to gold,
global capital market
(London)
World Wars and
Recession
gold standard
broken, beggar-
thy-neighbour,
capital controls
Bretton Woods
fixed exchange
rates (pegged
to dollar - to
gold), initial
capital controls
Floating Rates
managed
floating and
some pegging,
capital market
liberalization

16. Page 16
Gold Standard (±1870 – 1914)
• Over time many countries valued their currencies in
terms of gold; this established a fixed exchange rate
between the currencies.
• As gold could be freely imported and exported, countries
did not have independence of monetary policy.
• The system worked well but had a number of drawbacks:
Inflation determined by random discoveries of gold
Danger of deflation and unemployment
Countries with large gold supplies can influence the world
economy
Restrictions on monetary policy
• The system collapsed at the start of World War I when
countries had to finance the war effort.

17. Page 17
World wars and recession (1914 - 1945)
• After the World War I countries concentrated on
restoring their national economies. These efforts
were exacerbated by the great depression.
• Countries were no longer willing to give up their
policy autonomy. Hence, they instituted capital
controls and/or gave up the fixed exchange rate.
• The focus on domestic policy goals was ultimately
detrimental to the economy. Competitive beggar-
thy-neighbour devaluations caused the
international trade system to collapse and put
millions of people out of a job.

18. Page 18
Bretton Woods (1945 - 1971)
• The experience between the world wars taught policy makers
the benefits of an orderly international economic system.
They devised a new system (Bretton Woods) in which the US
dollar was the international reserve currency. Other countries
fixed the exchange rate to the US dollar, which in turn was
fixed to gold.
• At the start of the Bretton Woods system capital flows were
still highly restricted. Later on most countries gave up on their
policy independence.
• In every fixed exchange rate regime there is one degree of
monetary freedom (the n-1 problem). In the Bretton Woods
system the US could determine its own monetary policy.
• The system collapsed in the 1970s because a monetary
expansion in the US caused “too much” inflation.

19. Page 19
Floating rates (1971 - now)
• At this moment many countries let the value of their currency be
determined by market forces.
• There are, however, still large differences between countries:
De facto exchange rate regimes; # of countries, April 2010
0 5 10 15 20 25 30 35 40 45
No separate legal tender
Currency board
Conventional peg
Stabilized arrangement
Crawling peg
Crawl-like arrangement
Pegged rate with band
Other managed arrangement
Floating
Free floating
Ecuador
Hong Kong
Venezuela, Niger, Morocco, Cameroon
China, Bangladesh
Nicaragua
Ethiopia
Belarus
Russia, Singapore, Egypt
Indonesia, India, Pakistan, Philippines
Australia, UK, USA, Eurozone

20. Page 20
International Monetary Fund (IMF)
• The IMF was established in 1946 with a fourfold objective:
The balanced expansion of world trade
Stability of exchange rates
Avoidance of competitive devaluations
Orderly correction of balance of payment problems
• To perform its tasks the IMF employs three main functions:
Surveillance: The IMF gives annual policy advice to its
members
Technical assistance: Give members training and
assistance for fiscal and monetary policies
Financial assistance: Conditional on the implementation
of a policy program, countries with balance of payments
problems may get financial support.

21. Page 21
International Monetary Fund (IMF)
Decisions within the IMF are taken according to a weighted-voting
system, equiproportional to the quota the country pays (in Special
Drawing Rights or major currencies).
IMF voting power (% of total), before and after reforms
0 2 4 6 8 10 12 14 16 18
Venezuela
S Korea
Brazil
Spain
Mexico
Australia
Switzerland
India
Belgium
Netherlands
Russia
Canada
Saudi Arabia
Italy
China
France
UK
Germany
Japan
USA
2-Mar-11
pre-Singapore
(+25%)
(+20%)
(+75%)

22. Page 22
World Bank
• The World Bank, also established after WW II, has as
its main objective to fight poverty.
• The World Bank consists of five institutions:
International Bank for Reconstruction and
Development (IBRD)
International Development Association (IDA)
International Finance Corporation (IFC)
Multilateral Investment Guarentee Agency (MIGA)
International Centre for Settlement of Investment
Disputes (ICSID)
• Decisions of the World Bank are also taken by
weighted votes

23. Page 23
Criticism on IMF and World Bank
• Recently the IMF and World Bank have been criticised
for depending too much on competition and market
forces and being political tools of Western
governments.
• In response the World Bank has switched from macro
to micro policies, e.g. investing in clean water and
education. Keep in mind that fighting poverty is
extremely difficult and mistakes are easily made by all
participants.
• The IMF has greatly increased its transparency in
response to its critics. It is also too easy to blame the
IMF for a country’s financial troubles – remember that
the IMF enters the stage usually after financial
troubles emerge.

24. Page 24
Bank of International Settlements (BIS)
• The BIS is the bank of the Central Banks. Its tasks
have changed regularly over time:
Settle punitive payments of Germany (1930s)
Implementing the Bretton Woods system
(1945 – 71)
Managing cross border capital flow (1970s and
80s)
Regulatory supervision (Basel Capital Accord)
• The BIS also performs regular banking functions,
such as foreign exchange and gold transactions,
and trustee and agency functions.

25. Page 25
Concluding remarks on Exchange Rate Regimes
• According to the Marshall-Lerner condition, a depreciation of the
domestic currency will improve the current account balance
• Policy makers may have three different objectives:
– 1. monetary policy independence,
– 2. a fixed exchange rate and
– 3. international capital mobility.
• The policy trilemma indicates that only two of these objectives can be
reached at the same time.
• Over time policy makers made different choices. The
– Gold Standard - gave up on objective 1
– Recession period - gave up on objectives 2 or 3
– Bretton Woods era - gave up on objectives 1 or 3
– floating rates era - gave up on objective 2
• The most important International Money Organizations are the IMF, the
World Bank, and the BIS

26. And Now…Work Outside the Lecture
Preparation
For
Padagogic
Style
Preparation
Time Budget
Individual
Task
Group Task Output Week 8 Preparation Activity
Read Chapters 1, 6, 11, 13 & 15 from Core Text
Book: The Age of the Economist
Read Chapter 3, 4 & 10 International Business -
14th Edition by Daniels, Radebaugh &
Sullivan, (available via DawsonEra)
Seminar 8 30 Minutes Read above Material + Seminar material
Workshop 8 1 Hour
Online Collaboration Activities relating Final
Assignment
2 HourLecture 8

27. End of presentation
© Pearson College 2013