Question: New Economy

1. How much of each company's revenue and profit is generated outside its country of origin? Chavez told private banks and Ternium-Sidor, the country's largest steelmaker, to adapt their businesses to what he called the 'national interest'. Meanwhile, earlier this year, cement-makers were told they could be nationalised if they were found to be worsening a housing shortfall by favouring exports over domestic sales.
 2. What does the code of ethics statement for each company say? Oilfields and utilities have been nationalist in an attempt to preserve 'national interest', pushing the country towards a fully fledged socialist state. Chavez, who labels capitalism an evil, has ordered firms to fall into line with his self-styled socialist revolution or face nationalisation for what he describes as 'the benefit of the people'. This looks set to continue and spread, with aspirations to nationalise banks, a steelmaker and cement companies
3. What changes have they had to cope with in their people policies and product/service mix in the past decade? Venezuela's largest telecommunications firm, CANTV, was nationalised, Chavez talked for months about a takeover if it did not adjust its pension payments. In December, CANTV said in response to a court ruling it would make retroactive payments to more than 4,000 employees
4. How effective are the firms? (Describe what basis you use to determine effectiveness.) Chavez told private banks and Ternium-Sidor, the country's largest steelmaker, to adapt their businesses to what he called the 'national interest'. Meanwhile, earlier this year, cement-makers were told they could be nationalised if they were found to be worsening a housing shortfall by favouring exports over domestic sales.
5. Would you want to work for either of these firms? Why? Because it is the country's last privately run oilfields that he has taken over, were previously owned by some of the world's largest companies. This will undoubtedly play a great influence in all private sector decisions, both inside the country and outside. With Chavez vowing to leave the International Monetary Fund, he risks closing the door on an economic community which may come to haunt the country later on. Up until now, the majority of the firms upset have had leading shareholdings owned by US-owned companies.

Question: Traditional Economy

1. How much of each company's revenue and profit is generated outside its country of origin? Production processes that use a lot of capital relative to labour are capital intensive; those that use comparatively little capital are labor intensive. Capital takes different forms. A firm’s assets are known as its capital, which may include fixed capital (machinery, buildings, and so on) and working capital (stocks of raw materials and part-finished products, as well as money that are used up quickly in the production process).

2. What does the code of ethics statement for each company say? But everyone agrees that, at the very least, for capitalism to work the state must be strong enough to guarantee property rights. According to Karl Marx, capitalism contains the seeds of its own destruction, but so far this has proved a more accurate description of Marx’s progeny, communism.
3. What changes have they had to cope with in their people policies and product/service mix in the past decade? Markets in SECURITIES such as BONDS and SHARES. Governments and companies use them to raise longer-term CAPITAL from investors, although few of the millions of capital-market transactions every day involve the issuer of the security.
4. How effective are the firms? (Describe what basis you use to determine effectiveness.) One reason to expect catch-up is that workers in poor countries have little access to CAPITAL, so their PRODUCTIVITY is often low. Increasing the amount of capital at their disposal by only a small amount can produce huge gains in productivity. Countries with lots of capital, and as a result higher levels of productivity, would enjoy a much smaller gain from a similar increase in capital.
5. Would you want to work for either of these firms? Why Because this is one possible explanation for the much faster GROWTH of Japan and Germany, compared with the United States and the UK, after the second world war and the faster growth of several Asian “tigers”, compared with developed countries, during the 1980s and most of the 1990s.

New Economy

Going it alone

From oil, to television, to steel, Hugo Chavez has a bold vision of nationalization. But does it look like he is biting off more than he can chew?

The last year has been a busy one in Venezuela. Oilfields and utilities have been nationalist in an attempt to preserve 'national interest', pushing the country towards a fully fledged socialist state. Chavez, who labels capitalism an evil, has ordered firms to fall into line with his self-styled socialist revolution or face nationalisation for what he describes as 'the benefit of the people'. This looks set to continue and spread, with aspirations to nationalise banks, a steelmaker and cement companies. However, with the effects of these moves stretching far beyond national boundaries, the implications look set to prove significant.

The steel industry has been that most recently facing the threat of nationalisation. Argentine-owned Ternium-Sidor has been threatened with an ultimatum, suggesting Venezuela's largest steelmaker supply the local market before exports are made, or face nationalisation. Chavez complained that the company, which is majority-owned by Latin America's largest steel-making group, Ternium, mainly exports its steel, leaving Venezuelans to import the product from as far away as China. Such a move will be ratified using the powers given to Chavez by Congress to rule by decree this year.

And such a move is hardly a surprise. Due to exchange controls, some companies put a priority on selling products abroad to ensure they are paid in a foreign currency rather than the local bolivar, which trades on the black market at almost half its official rate. Inevitably, at the detriment to national interest, it drew Chavez to instruct, prior to a recent meeting: "Before exporting a single ton abroad, first you have to guarantee me that all the (Venezuelan) companies are supplied". Chavez told private banks and Ternium-Sidor, the country's largest steelmaker, to adapt their businesses to what he called the 'national interest'. Meanwhile, earlier this year, cement-makers were told they could be nationalised if they were found to be worsening a housing shortfall by favouring exports over domestic sales.

Popular among the majority of the poor for lavishing high oil revenues on them, Chavez does not engender enthusiasm among all. Indeed, many polls show that the people generally do not share his vision for turning the South American country into a socialist state. Recent protests took to the streets following the alleged censorship of national television content after the taking over of Venezuela's largest media firm News agent Reuters. They recently published the comments of an annoymous government insider who insisted that Cavez's nationalisation threats were more than mere bluster. Despite being in opposition to the nationalisation program, his remarks backed up the general consensus that Chavez has the drive to follow through on his rhetoric.

The rhetoric can seem very convincing. Improvements in the country's previously impoverished social services have given opportunity to many, while enforcing the importance of the 'national interest' has appealed to those in other countries, including neighbouring Colombia, who have seen assets decimated with profits seeping out to multinationals, who re-invest little back into the country. Oil means much more to the country than just cash. The oil industry had integrated the whole country's infrastructure and development, and boosted its thin population as immigrants arrived in search of work. Government policy-makers insist that they are fully backed by a population adamant it is they who should fully benefit from Venezuela's considerable riches.

Yet some of the moves taken to safeguard such resources have looked, on the outside, extremely dubious. Before Venezuela's largest telecommunications firm, CANTV, was nationalised, Chavez talked for months about a takeover if it did not adjust its pension payments. In December, CANTV said in response to a court ruling it would make retroactive payments to more than 4,000 employees, but Chavez ordered its takeover a month later anyway.

He is also making some powerful enemies. The country's last privately run oilfields that he has taken over, were previously owned by some of the world's largest companies. This will undoubtedly play a great influence in all private sector decisions, both inside the country and outside. With Chavez vowing to leave the International Monetary Fund, he risks closing the door on an economic community which may come to haunt the country later on. Up until now, the majority of the firms upset have had leading shareholdings owned by US-owned companies. Although this is politically easier, Ternium-Sidor is owned by a company from Chavez's leftist ally Argentina. Chavez, had said he was reluctant to nationalise the company because its main investors were Latin American. Still, the parent company's share price fell to an almost two-month low immediately after the move became imminent.

Meanwhile, the banking sector is equally controversial. There is considerable Spanish involvement in Venezuelan banks, with Banco Provincial being a unit of Banco Bilbao Vizcaya Argentaria and Banco de Venezuela a subsidiary of Banco Santander Central Hispano. By threatening such a globally established structure, Chavez risks further alienation from the economic system as well as jeopardising political relations with Spain, with the most important socialist government in Europe. Yet Venezuela is not the only Latin American nation which has accelerated its bid to reclaim resources. Just over a year ago, Bolivian President Evo Morales, a leftist ally of Chavez, ordered troops to seize gas fields in his country.

Venezuela's new policies have given the nation a new self-image, according to those who styled Chavez' new-look nation including Venezuelan Deputy Energy Minister Bernard Mommer. This meant, among other things, that it no longer offered the option of international arbitration in deals as its legal system offered sufficient security.

With a new-found confidence, Venezuela is flying the flag for all those countries unwilling to accept the policies of a few super-powerful governing nations. By re-investing the country's oil profits in its people, and standing up the multinational, Chavez has reinvented socialism in his own image. The extent to which this is possible within the economic structures so intrinsically adhered to by most of the rest of the world remains to be seen. A collision course with the US, as well as major institutions such as the World Trade Organisation, appear likely and there are those who fear that Hugo Chavez will follow the route of many self-styled 'dictators', placing his own legacy above the good of the nation. Yet the romantic notion of freeing his people from under the wheels of capitalism is certainly causing the world to sit up and take notice.

Traditional Economy

History

Cannibalize

Eating people is wrong. Eating your own business may not be. FIRMS used to be reluctant to launch new products and SERVICES that competed with what they were already doing, as the new thing would eat into (cannibalize) their existing business. In today's innovative, technology-intensive economy, however, a willingness to cannibalize is more often seen as a good thing. This is because INNOVATION often takes the form of what economists call creative destruction (see SCHUMPETER), in which a superior new product destroys the market for existing products.

In this environment, the best course of action for successful firms that want to avoid losing their market to a rival with an innovation may be to carry out the creative destruction themselves.

Capacity

The amount a company or an economy can produce using its current equipment, workers, CAPITAL and other resources at full tilt. Judging how close an economy is to operating at full capacity is an important ingredient of MONETARY POLICY, for if there is not enough spare capacity to absorb an increase in DEMAND, PRICES are likely to rise instead. Measuring an economy’s OUTPUT GAP – how far current OUTPUT is above or below what it would be at full capacity – is difficult, if not impossible, which is why even the best-intentioned CENTRAL BANK can struggle to keep down INFLATION. When there is too much spare capacity, however, the result can be DEFLATION, as FIRMS and employees cut their prices and wage demands to compete for whatever demand there may be.

Capital

MONEY or assets put to economic use, the life-blood of CAPITALISM. Economists describe capital as one of the four essential ingredients of economic activity, the FACTORS OF PRODUCTION, along with LAND, LABOUR and ENTERPRISE. Production processes that use a lot of capital relative to labour are CAPITAL INTENSIVE; those that use comparatively little capital are LABOUR INTENSIVE. Capital takes different forms. A firm’s ASSETS are known as its capital, which may include fixed capital (machinery, buildings, and so on) and working capital (stocks of raw materials and part-finished products, as well as money, that are used up quickly in the production process). Financial capital includes money, BONDS and SHARES. HUMAN CAPITAL is the economic wealth or potential contained in a person, some of it endowed at birth, the rest the product of training and education, if only in the university of life. The invisible glue of relationships and institutions that holds an economy together is its social capital.

Capital adequacy ratio

The ratio of a BANK’s CAPITAL to its total ASSETS, required by regulators to be above a minimum (“adequate”) level so that there is little RISK of the bank going bust. How high this minimum level is may vary according to how risky a bank’s activities are.

Capital asset pricing model

A method of valuing ASSETS and calculating the COST OF CAPITAL (for an alternative, see ARBITRAGE PRICING THEORY). The capital asset pricing model (CAPM) has come to dominate modern finance.

The rationale of the CAPM can be simplified as follows. Investors can eliminate some sorts of RISK, known as RESIDUAL RISK or alpha, by holding a diversified portfolio of assets (see MODERN PORTFOLIO THEORY). These alpha risks are specific to an individual asset, for example, the risk that a company’s managers will turn out to be no good. Some risks, such as that of a global RECESSION, cannot be eliminated through diversification. So even a basket of all of the SHARES in a stockmarket will still be risky. People must be rewarded for investing in such a risky basket by earning returns on AVERAGE above those that they can get on safer assets, such as TREASURY BILLS. Assuming investors diversify away alpha risks, how an investor values any particular asset should depend crucially on how much the asset’s PRICE is affected by the risk of the market as a whole. The market’s risk contribution is captured by a measure of relative volatility, BETA, which ­indicates how much an asset’s price is expected to change when the overall market changes.

Safe investments have a beta close to zero: economists call these assets risk free. Riskier investments, such as a share, should earn a premium over the risk-free rate. How much is calculated by the average premium for all assets of that type, multiplied by the particular asset’s beta.

But does the CAPM work? It all comes down to beta, which some economists have found of dubious use. They think the CAPM may be an elegant theory that is no good in practice. Yet it is probably the best and certainly the most widely used method for calculating the cost of capital.

Capital controls

government-imposed restrictions on the ability of CAPITAL to move in or out of a country. Examples include limits on foreign INVESTMENT in a country’s FINANCIAL MARKETS, on direct investment by foreigners in businesses or property, and on domestic residents’ investments abroad. Until the 20th century capital controls were uncommon, but many countries then imposed them. Following the end of the second world war only Switzerland, Canada and the United States adopted open capital regimes. Other rich countries maintained strict controls and many made them tougher during the 1960s and 1970s. This changed in the 1980s and early 1990s, when most developed countries scrapped their capital controls.

The pattern was more mixed in developing countries. Latin American countries imposed lots of them during the debt crisis of the 1980s then scrapped most of them from the late 1980s onwards. Asian countries began to loosen their widespread capital controls in the 1980s and did so more rapidly during the 1990s.

In developed countries, there were two main reasons why capital controls were lifted: free markets became more fashionable and financiers became adept at finding ways around the controls. Developing countries later discovered that foreign capital could play a part in financing domestic investment, from roads in Thailand to telecoms systems in Mexico, and, furthermore, that financial capital often brought with it valuable HUMAN CAPITAL. They also found that capital controls did not work and had unwanted side-effects. Latin America’s controls in the 1980s failed to keep much money at home and also deterred foreign investment.

The Asian economic crisis and CAPITAL FLIGHT of the late 1990s revived interest in capital controls, as some Asian governments wondered whether lifting the controls had left them vulnerable to the whims of international speculators, whose money could flow out of a country as fast as it once flowed in. There was also discussion of a “Tobin tax” on short-term capital movements, proposed by James TOBIN, a winner of the NOBEL PRIZE FOR ECONOMICS. Even so, they mostly considered only limited controls on short-term capital movements, particularly movements out of a country, and did not reverse the broader 20-year-old process of global financial and economic LIBERALISATION.

Capital flight

When CAPITAL flows rapidly out of a country, usually because something happens which causes investors suddenly to lose confidence in its economy. (Strictly speaking, the problem is not so much the MONEY leaving, but rather that investors in general suddenly lower their valuation of all the assets of the country.) This is particularly worrying when the flight capital belongs to the country’s own citizens. This is often associated with a sharp fall in the EXCHANGE RATE of the abandoned country’s currency.

Capital gains

The PROFIT from the sale of a capital ASSET, such as a SHARE or a property. Capital gains are subject to TAXATION in most countries. Some economists argue that capital gains should be taxed lightly (if at all) compared with other sources of INCOME. They argue that the less tax is levied on capital gains, the greater is the incentive to put capital to productive use. Put another way, capital gains tax is effectively a tax on CAPITALISM. However, if capital gains are given too friendly a treatment by the tax authorities, accountants will no doubt invent all sorts of creative ways to disguise other income as capital gains.

Capital intensive

A production process that involves comparatively large amounts of CAPITAL; the opposite of LABOUR INTENSIVE.

Capital markets

Markets in SECURITIES such as BONDS and SHARES. Governments and companies use them to raise longer-term CAPITAL from investors, although few of the millions of capital-market transactions every day involve the issuer of the security. Most trades are in the SECONDARY MARKETS, between investors who have bought the securities and other investors who want to buy them. Contrast with MONEY MARKETS, where short-term capital is raised.

Capital structure

The composition of a company’s mixture of DEBT and EQUITY financing. A firm’s debt-equity ratio is often referred to as its GEARING. Taking on more debt is known as gearing up, or increasing lever age. In the 1960s, Franco Modigliani and Merton Miller (1923–2000) published a series of articles arguing that it did not matter whether a company financed its activities by issuing debt, or equity, or a mixture of the two. (For this they were awarded the NOBEL PRIZE FOR ECONOMICS.) But, they said, this rule does not apply if one source of financing is treated more favourably by the taxman than another. In the United States, debt has long had tax advantages over equity, so their theory implies that American FIRMS should finance themselves with debt. Companies also finance themselves by using the PROFIT they retain after paying dividends.

Capitalism

The winner, at least for now, of the battle of economic “isms”. Capitalism is a free-market system built on private ownership, in particular, the idea that owners of CAPITAL have PROPERTY RIGHTS that entitle them to earn a PROFIT as a reward for putting their capital at RISK in some form of economic activity. Opinion (and practice) differs considerably among capitalist countries about what role the state should play in the economy. But everyone agrees that, at the very least, for capitalism to work the state must be strong enough to guarantee property rights. According to Karl MARX, capitalism contains the seeds of its own destruction, but so far this has proved a more accurate description of Marx’s progeny, COMMUNISM.

Cartel

An agreement among two or more FIRMS in the same industry to co-operate in fixing PRICES and/or carving up the market and restricting the amount of OUTPUT they produce. It is particularly common when there is an OLIGOPOLY. The aim of such collusion is to increase PROFIT by reducing COMPETITION. Identifying and breaking up cartels is an important part of the competition policy overseen by ANTITRUST watchdogs in most countries, although proving the existence of a cartel is rarely easy, as firms are usually not so careless as to put agreements to collude on paper. The desire to form cartels is strong. As Adam SMITH put it, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.”

Catch-up effect

In any period, the economies of countries that start off poor generally grow faster than the economies of countries that start off rich. As a result, the NATIONAL INCOME of poor countries usually catches up with the national income of rich countries. New technology may even allow DEVELOPING COUNTRIES to leap-frog over industrialised countries with older technology. This, at least, is the traditional economic theory. In recent years, there has been considerable debate about the extent and speed of convergence in reality.

One reason to expect catch-up is that workers in poor countries have little access to CAPITAL, so their PRODUCTIVITY is often low. Increasing the amount of capital at their disposal by only a small amount can produce huge gains in productivity. Countries with lots of capital, and as a result higher levels of productivity, would enjoy a much smaller gain from a similar increase in capital. This is one possible explanation for the much faster GROWTH of Japan and Germany, compared with the United States and the UK, after the second world war and the faster growth of several Asian “tigers”, compared with developed countries, during the 1980s and most of the 1990s.