Mid Semester Practice

Corruption
The abuse of public office for private gain

Disrupts the natural laws of an economy to flow

Corruption in its many forms (bribery, nepotism, fraud, embezzlement)
Corruption in the way deals are made, contracts are awarded, or economic operations are
carried out, leads to monopolies or oligopolies in the economy.
Political parties or governments are bribed leading to the skewing and manipulation of
policies, laws and taxation leading to artificially high prices and low quality of products and
service due to a lacking competitive playing field
Inefficient allocation of resources
Uneven distribution of wealth
Low attractiveness for foreign investment and international trade
Low quality education and health care systems
Loss of tax revenue
Talent misallocation
Regulatory avoidance

How corruption hampers economic growth

First, it weakens the states capacity to raise revenue and perform its core functions. By
harming the culture of compliance, corruption increases tax evasion. For instance, when tax
exemptions are viewed as arbitrary, citizens have less incentives to pay taxes. As a result,
the state collects less revenue and is unable to provide public services, with potential
negative consequences for growth.
Second, by inflating costs in the public procurement process, corruption undermines the
quantity and quality of public spending. Funds can also be siphoned off through off-budget
transactions. This lowers resources available for public investment and other priority
spending, aggravating infrastructure gaps and impacting on growth.
Third, because of lower public revenues, countries tend to rely more on central bank
financing, which creates an inflation bias in the country. At the same time, corruption
further weakens financial oversight and stability of the financial system. This arises from
poor lending and regulatory practices and weak banking supervision.
Finally, corruption can even raise the cost of accessing financial markets as lenders factor in
corruption. The private sector is further hurt because it raises uncertainty for firms and act
as a barrier to entry for new entrants. Resources are allocated to rent-seeking activities
instead of productive activities.
The social and environmental costs can also be significant. Reduced allocations for social
programs and the resources lost through corruption limit the build-up of human capital. At
the same time, weaker, poorly enforced environmental regulations lead to more pollution
and more than desired extraction of natural resources. In the extreme cases, systemic
corruption can lead to political instability and conflict. It has been argued that natural
resource abundance can accentuate the situation.
 Mitigating strategies

While the paper recognizes that there is no common recipe for all countries, it also
emphasizes that a comprehensive approach is crucial. Short-term measures with more
immediate impact, must be complemented with preventive measures and strict
enforcement. The paper offers policymakers practical guidance, drawing on the IMFs
perspective of helping its members design and implement economic reforms, including anti-
corruption strategies. The paper identifies four building blocks:
Transparency is a pre-requisite. Countries need to adopt international standards on fiscal
and financial transparency. Because of the relative share of extractives industries in many
economies, transparency in this particular sector is crucial. Governments need also to
support international standards on transparent corporate ownership. A free press also plays
a key role in exposing corrupt practices.
To enhance the rule of law, a credible threat of prosecution must exist. Enforcement must
also target the private sector. In certain cases, new specialized institutions must be set up
where existing ones are corrupt. An effective anti-money laundering framework must be in
place to minimize the laundering of proceeds of corruption.
Excessive regulation creates rents which are allocated at the discretion of public officials and
must be eliminated. De-regulation and simplification are cornerstones of efficient anti-
corruption strategies. However, it is important to have an adequate institutional framework
in place first when transitioning from state controlled monopolistic markets (emerging
economies in Eastern Europe).
A clear legal framework is required. However, all of the best frameworks come to nothing,
unless they are implemented. And implementation is all about effective institutions. In
particular, a key objective is to develop a cadre of competent public officials who are
independent of both private influence and political interferenceand are proud of this
independence. Finally, leadership plays a critical underlying role. Leaders must set a personal
example and ensure decisive action is taken when needed.

Examples:

Embezzlement: Nigeria, Zaire and Indonesia

Sample:

Evidence indicates that corruption is likely to adversely affect long-term economic growth through
its impact on investment, taxation, public expenditures and human development. Corruption is also
likely to undermine the regulatory environment and the efficiency of state institutions as rent-
seeking distorts incentives and decision-making processes.

Not only does corruption affect economic development in terms of economic efficiency and growth,
it also affects equitable distribution of resources across the population, increasing income
inequalities, undermining the effectiveness of social welfare programmes and ultimately resulting in
lower levels of human development. This, in turn, may undermine long-term sustainable
development, economic growth and equality.
Economic Growth and Development
Key Differences Between Economic Growth and Economic Development

The fundamental differences between economic growth and development are explained in the
points given below:

Economic growth is the positive change in the real output of the country in a particular span of time
economy. Economic Development involves a rise in the level of production in an economy along with
the advancement of technology, improvement in living standards and so on.

Economic growth is one of the features of economic development.

Economic growth is an automatic process. Unlike economic development, which is the outcome of
planned and result-oriented activities.

Economic growth enables an increase in the indicators like GDP, per capita income, etc. On the other
hand, economic development enables improvement in the life expectancy rate, infant mortality rate,
literacy rate and poverty rates.

Economic growth can be measured when there is a positive change in the national income, whereas
economic development can be seen when there is an increase in real national income.

Economic growth is a short-term process which takes into account yearly growth of the economy.
But if we talk about economic development it is a long term process.

Economic Growth applies to developed economies to gauge the quality of life, but as it is an
essential condition for the development, it applies to developing countries also. In contrast to,
economic development applies to developing countries to measure progress.

Economic Growth results in quantitative changes, but economic development brings both
quantitative and qualitative changes.

Economic growth can be measured in a particular period. As opposed to economic development is a

continuous process so that it can be seen in the long run.

Example

To understand the two terms economic growth and economic development, we will take an example
of a human being. The term growth of human beings simply means the increase in their height and
weight which is purely physical. But if you talk about human development, it will take into account
both the physical and abstract aspects like maturity level, attitudes, habits, behaviour, feelings,
intelligence and so on.

In the like manner, growth of an economy can be measured through the increase in its size in the
current year in comparison to previous years, but economic development includes not only physical
but also non-physical aspects that can only be experienced like improvement in the lifestyle of the
inhabitants, increase in individual income, improvement in technology and infrastructure, etc.
 Economic Development Economic Growth

Implications Economic development implies an Economic growth refers to an increase over

upward movement of the entire social time in a country`s real output of goods and
system in terms of income, savings and services (GNP) or real output per capita income.
investment along with progressive
changes in socioeconomic structure of
country (institutional and technological
changes).

Factors Development relates to growth of Growth relates to a gradual increase in one of

human capital indexes, a decrease in the components of Gross Domestic Product:
inequality figures, and structural consumption, government spending,
changes that improve the general investment, net exports.
population's quality of life.

Measurement Qualitative.HDI (Human Development Quantitative. Increases in real GDP.

Index), gender- related index (GDI),
Human poverty index (HPI), infant
mortality, literacy rate etc.

Effect Brings qualitative and Brings quantitative changes in the economy

quantitativechanges in the economy

Relevance Economic development is more relevant Economic growth is a more relevant metric for
to measure progress and quality of life progress in developed countries. But it's widely
in developing nations. used in all countries because growth is a
necessary condition for development.

Scope Concerned with structural changes in Growth is concerned with increase in the
the economy economy's output

Motives for firms to internationalise

1. Market Opportunities

A firm may desire to expand internationally because market opportunities exist abroad. These
opportunities include demand for a firm's product in foreign markets, trends changing to favor the
product in foreign markets, or the absence of competition abroad which would give the firm the first
mover advantage.

More specifically, these market opportunities can be broken down and explained with examples
from existing companies:

A firm's desire to grow by expanding from small or saturated domestic markets to international
markets

Example: Sony selling consumer electronics in international markets. Sony was founded in Tokyo in
1946. One of its founders, Akio Morita, decided that Sony should not be restricted to Japan and
viewed the whole world as a potential marketplace. The company now has major international
markets on almost every continent and has expanded to many countries. Sony started out solely as
an electronics company but expanded to include motion pictures, music entertainment and financial
services, among others.

Higher profitability of the international market

Example: Ever heard of Cheng Loong Corp? You probably havent, but if you have an iPhone, iPod or
Apple Mac, youve bought their products! Cheng Loong Corp are based in Taiwan, and they
manufacture Apple product packaging. Although they have been producing similar packaging since
1959, they now find that the international market is the most profitable.

2. Risk diversification

Another reason to go global is the willingness to diversify the risk of the company. Thus, firms are
likely to avoid "putting all of their eggs in one basket". By doing that, companies become more
immune to changing trends in consumption for each of the markets, and they are also less affected
by external factors affecting consumer behaviour and purchasing of their products, such as climate.]

As a reaction to the actions of a competitor

Example: H&M will open its first stores in India this year after Zara expanded to India in 2010 where
it now has 13 stores. In 2 out of the 3 years since Zara has opened in India, it has gained profits. This
was a signal for H&M that it could also be successful in India's market. Its aim is to take Zara's spot as
the world's number one apparel retailer.

The Motivations for Internationalization of a Firm

There are various reasons as to why firms would want to expand their company internationally. In
this post, we will go over the reasons discussed in class, and we will also analyze other possible
motivations for firms to expand their company abroad.

1. Market Opportunities

A firm may desire to expand internationally because market opportunities exist abroad. These
opportunities include demand for a firm's product in foreign markets, trends changing to favor the
product in foreign markets, or the absence of competition abroad which would give the firm the first
mover advantage.

More specifically, these market opportunities can be broken down and explained with examples
from existing companies:

A firm's desire to grow by expanding from small or saturated domestic markets to international
markets

Example: Sony selling consumer electronics in international markets. Sony was founded in Tokyo in
1946. One of its founders, Akio Morita, decided that Sony should not be restricted to Japan and
viewed the whole world as a potential marketplace. The company now has major international
markets on almost every continent and has expanded to many countries. Sony started out solely as
an electronics company but expanded to include motion pictures, music entertainment and financial
services, among others.

Unsolicited orders received from abroad

Example: Abercrombie & Fitch found that many customers were ordering online and by catalog from
abroad. In 2007, the company took this as a signal to expand its stores, both Abercrombie & Fitch
and its sister store Hollister overseas. The company first started in the US and then continued to
expand across Europe and Asia. By 2013, the retailer opened stores in the Middle East and Australia.

Higher profitability of the international market

Example: Ever heard of Cheng Loong Corp? You probably havent, but if you have an iPhone, iPod or
Apple Mac, youve bought their products! Cheng Loong Corp are based in Taiwan, and they
manufacture Apple product packaging. Although they have been producing similar packaging since
1959, they now find that the international market is the most profitable.

Obtain prestige in the domestic market

Example: Beiersdorf expanded its brand Nivea internationally to create appeal in the domestic
market. Its ads had testimonials from customers of different ethnicities to give the sense of an
international brand. Many consumers desire international products because they believe it makes
them feel more sophisticated and cosmopolitan, so Beiersdorf used this to its advantage.

2. Risk diversification

Another reason to go global is the willingness to diversify the risk of the company. Thus, firms are
likely to avoid "putting all of their eggs in one basket". By doing that, companies become more
immune to changing trends in consumption for each of the markets, and they are also less affected
by external factors affecting consumer behavior and purchasing of their products, such as climate.

Compensate a strong seasonality in the local market

Example: IDE Technologies is a company that provides the service of "snowmaking" to ski resorts
around the world. They operate in countries in both hemispheres (e.g. Switzerland and South Africa)
in order to maintain a consistent revenue. When it is Summer in one part of the world and they are
not able to operate, they focus on the part of the world where it is Winter and their business can
thrive.

As a reaction to the actions of a competitor

Example: H&M will open its first stores in India this year after Zara expanded to India in 2010 where
it now has 13 stores. In 2 out of the 3 years since Zara has opened in India, it has gained profits. This
was a signal for H&M that it could also be successful in India's market. Its aim is to take Zara's spot as
the world's number one apparel retailer.

3. Economies of scale

Another reason why firms may want to globalize their company is to achieve economies of scale.
Economies of scale are advantageous because it allows a firm to economize the transport and
distribution network. Additionally, they can allow firms to produce their products cheaper in some
countries because of factors such as component costs, flexibility, supplier availability, wages and
different legislations.

To increase competitiveness against global companies of the industry

Example: Apple, began manufacturing iPhones in China to take advantage of the lower cost to
produce and its flexibility. Apple's production volumes and unpredictable engineering changes
require it to manufacture in a location that offers flexibility, which the US cannot offer. Factories in
China can employ thousands of engineers that are able to respond to changes overnight if necessary.
For example, Apple redesigned the iPhone screen last minute and within hours, the new screens
arrived in the Chinese plant to be assembled with the phones. This would not have been possible in
the domestic market. This easiness of adapting to changes gives Apple a competitive edge against
companies that produce their products in the US.

PROACTIVE Reasons

1. Profit Seeking:

Price pressure is STRONG! Entering a market with lower prices than competitors grants your
business a competitive edge. Also, manufacturing products in low-cost countries enables to increase
profits.

2. Sales Expansion:

Customers are global and theres a strong potential in expanding your business abroad rather than
to concentrate on the domestic market.

It is also a response to the seasonality of a domestic market.

It depends on the life cycle of the product: if a product enters its last cycle in one country, it is
essential for the firm to look for new markets to re-engage the whole process abroad.

Expansion abroad is also a strategic decision in order to find new markets or prospects. It depends
on the segments and niche of the company; a firm which is specialized (targets a niche, prestigious
products etc.) has strong incentives to exploit several markets because of a small consumer
segment.

3. Uniqueness and Exclusivity

Expanding abroad can give you exclusive information about the activities of foreign customers or
prospects and markets.

Moving abroad can also guarantee exclusivity over a market that has not been exploited yet (Blue
Ocean). This is the first-mover advantage (gaining all benefits of being first in a market) which can
also be related with uniqueness (products distinctive attributes which is not likely to meet
competition in foreign markets).

Expanding abroad may be driven by the desire to obtain a prestigious corporate image.

4. Resource Seeking

Access to scare resources that can only be found in foreign markets (trained/skilled workforce,
natural resources, low-cost labor, ideas & new concepts etc.)

REACTIVE Reasons

1. Market Opportunities - The company is responding to demand it discovers abroad

Some foreign markets form as part of emerging economies and therefore represent a strong
potential. Some market opportunities may appear (i.e. new tastes, new consumption
habits/occasions, new segments) and must be exploited.

International markets may also have higher profitability than the domestic ones. Foreign markets
can also be exploited because there is a similarity in tastes, habits or consumption occasions.
2. Overproduction, Declining Domestic Sales, or Excess Capacity

If a domestic market is saturated or too little, offer may excess demand. Expansion abroad is a
means of tackling this issue.

3. Competitive strike

It could also be a strategic decision to attack foreign competitors (competitive strike). Companies
can enter directly the home market of a competitor to increase competition and reduce
competitors market shares offense as defense.

Following is also a common reaction to a competitors moves; companies enter a foreign market
because a competitor has done so. The objective is to avoid the competitor in order to gain
competitive advantage it would have if it were operating alone in this market.

4. Governmental Reasons

Governments can also give incentives to domestic companies to internationalize. The government
can, for example, assist exports by offering financial helps.

Another reason is because trade barriers have decreased or disappeared in a foreign country and
gives opportunities to go abroad.

5. Economic & Political Changes

Costs of production at home increase, forcing the company to find a cheaper place to produce.

Tariff or non-tariff barriers: if an exporting company finds that the government in the recipient
country starts to build tariff or non-tariff barriers to block the export, then it might be a reason for
the exporter to set up a manufacturing operation overseas in order to avoid the tariffs.

"Buy-Local" policies: exporting companies may find that "buy-local" policies may restrict their
exports - which may cause the exporter to set up a local alliance or relationship.

Environmental regulations or changes in work/safety regulations may cause the company to go

overseas to a less restrictive location.