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Strategy Driver for Global or International Business

This is the first installment of a five -part series on global corporate leadership . This article focuses on Economics/Debt.

  1. Economics (Debt)
  2. Environmental Factors
  3. Political Factors
  4. Technology
  5. Social Factors

The series taken as a whole should help you define the answers for your company to these nine questions:

  1. Who are the customers of the future?
  2. How will my company distribute its product or service in the future?
  3. Who will be my competitors in 10 years? 25 years?
  4. What will the source of my company’s competitive advantage be in the future?
  5. What skills or capabilities will make my company unique?
  6. What role will strategic alliances/ mergers/acquisitions play in its strategy?
  7. How will my firm alter the nature of competition in its industry?
  8. How will my organization redefine the boundaries between industries?
  9. What can my company do to create a new industry?

The Opportunity

The impact of personal, corporate (private sector) and government (public sector) debt on global corporations can be deadly to the corporation under specific circumstances. This impact is sometimes too subtle to be noticed at first glance. The debt structure of a foreign country or state must be researched in depth before planning strategic initiatives that require investing in that country or state. What makes this interesting is the inter-relationship between personal, corporate, and government debt; and the obligatory interaction of politics. Debt at all three levels must be assessed as input to strategic planning for investment in a foreign country.

The Solution

Historically, economies are cyclical. The frequency of the cycle is not always predictable, nor is the range always known, but they have been shown to operate in cycles. Thus, if an economy is operating in the positive portion of the cycle, it will tend toward the negative at some future point. The length of time in each portion of the cycle tends to change, given the propensity of governments to intervene for their own reasons. When public debt is high, government is sometimes tempted to print money and ignore inflation. This causes an erosion of the real value of the excessive public debt.

Because of the tendency for economies to operate in cycles, debt levels must be assessed as much as possible on each level. In a strong economy, high levels of debt may not cause an economic downturn. In the event of a downturn, however, high levels of debt will at least amplify the situation that could cause the downturn to deepen into a severe recession.

As we know, when inflation is low, interest rates are typically low, encouraging more extensive borrowing even though real interest rates are no lower. Thus firms and individuals think they can safely afford to borrow a much larger multiple of their income. Although borrowers have historically enjoyed inflation, this is a double-edged sword. This same low inflation that encourages borrowing also makes excessive debt more dangerous, because unlike in a high inflation economy, borrowers can no longer rely on inflation to erode their real debt burden if they need or decide to liquidate. The path of debt therefore is unsustainable. It is likely to make any economic “landing” hard rather than soft.

Conclusion

Debt is not necessarily a bad thing. Long-term economic growth can be increased if savings are channeled into productive investments rather than sitting idle. However, if a sudden surge in debt is seen, some very deleterious side effects can result; specifically, higher interest rates, falling asset prices, and economic slowdown. Asset prices fall because debts can only be serviced from cash, and assets can only be converted to cash if they are sold. If many debtors are required to sell assets at the same time, asset prices will fall.

Corporations (and individuals) must, therefore, assess the foreign country or state debt burden at the private, corporate and government levels before investing in a foreign country. They must also assess whether the debt is increasing or decreasing and if possible, the reasons. This information needs to be input into their strategic plans. Failure to do so could result in a very expensive venture that borders on failure, or at least provides no or little return on investment.

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World Economic Outlook

In January of 2009, the International Monetary Fund (IMF) forecasted that advanced economies would not exit the global recession until the middle of 2010.  However, these economies posted, on average, GDP growth of about 2% in 3Q 2009, and growth in emerging economies accelerated to about 8% in 2Q and 3Q – 2% higher than forecasted.  Additionally, global trade and industrial production are on a sharp recovery path.

Although most projections show a continuation of positive growth in 2010, questions about the strength and sustainability of the recovery remain. To provide an economic outlook for the new year, the Carnegie Endowment hosted a distinguished panel of the heads of the economic forecasting unit at their respective organizations.  The discussion provided a number of insights and perspective on the global economic outlook that many may find of interest; to some, a surprise.  For instance, the consensus was that Asia would lead the global recovery, and that high unemployment and high sovereign debt levels would be experienced in the developed economies. The panelists included Hans Timmer of the World Bank; Jörg Decressin of the IMF; Phillip Suttle of the International Institute of Finance (IIF); Desmond Lachman of the American Enterprise Institute (AEI), and Uri Dadush of the Carnegie Endowment.  The panel moderator was Pieter Bottelier of the Carnegie Endowment.

First up, Dadush of the Carnegie Endowment highlighted several factors behind this stronger-than-expected recovery:

§  Most importantly, unprecedented stimulus and financial rescue efforts in advanced economies largely worked.

§  Asia, where fundamentals like financial sectors and public budgets were healthy before the crisis, recovered rapidly, helping pull the rest of the world to recovery.

§  The world succeeded in avoiding large-scale contagion effects, including sovereign debt crises, competitive exchange rate devaluations, and trade wars.

Next, Timmer from the World Bank noted that, despite these improvements, production levels across the world remain 7-10 % below pre-crisis levels, unemployment in many countries is around 10 percent, and fiscal positions have deteriorated significantly: ultimately, there is still a long way to go.

What to Expect for 2010

Suttle of the IIF, and Dadush offered optimistic outlooks for 2010, citing several supporting factors:

§  The growing role of emerging economies, which did not suffer a financial crisis and remain fundamentally strong, will support the global recovery.

§  The corporate sector, particularly non-financial firms in the United States, reacted quickly and aggressively to the crisis, registering better than expected earnings in 2009. As a result, a significant turnaround is expected soon in their labor, inventory, and investment demand, with employment expected to improve by the middle of 2010.

§  Policy will remain supportive. Much of the fiscal stimulus has yet to enter the market, with only one third of the U.S. stimulus package spent so far. Financial rescue is being withdrawn gradually in response to market signals. In addition, as risk appetites increase, low policy interest rates will be much more effective in increasing consumer and investment demand.

The AEI’s Lachman, however, presented a grimmer picture, projecting a very subdued recovery with a return to recession possible in the United States:

§  With unemployment close to 10 percent in advanced economies, low wage and income growth will depress consumption.  The weak private sector will struggle to support the recovery.

§  Banks, still suffering from huge losses, will be forced to cut credit.  Additionally, regional banks in particular will likely be hit by commercial property market weaknesses.

Advanced Versus Emerging Economies

Major differences have emerged between advanced economies and emerging markets. Emerging economies, which are increasingly driven by domestic growth factors rather than exports, are now contributing significantly more to growth and investment than advanced countries.

§  Decressin of the IMF noted that both groups saw growth from 2007 to 2009 contract by approximately 6 percent, falling from 3 percent to -3 percent in advanced countries and from 8 percent to 2 percent in emerging markets. They remained “cyclically” coupled, though the underlying growth rate in emerging markets is much higher.

§  At the same time, there was much heterogeneity among the emerging economies. While Asia—and China in particular—has led the recovery, Eastern Europe (with the exception of Poland) has been less successful, with little sign of recovery.  Latin America paints the most diverse regional picture, with countries like Brazil faring relatively well and others, like Chile, lagging behind.

§  Decressin argued that as long as the differences between the advanced economies, which are weighed down by both structural and cyclical weaknesses, and emerging ones persist, capital will continue to flow to emerging markets.

Panelists agreed that China must evolve to fit this new paradigm. China is already or may soon be the world’s second largest economy and the largest trader and emitter of C02.  Bottelier argued that China must embrace this new role and take a more prominent leadership role in crucial areas such as global trade reform and climate change. Domestically, China should pursue structural reform and a more flexible exchange rate.  Dadush noted that a flexible and appreciated exchange rate is in China’s interest, as it will help rebalance the economy towards consumption and reduce long-run inflationary pressure. However, placing external imbalances at the center of policy dialogue is misguided.

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