I've mentioned that this course is like a course in practical economics, and in order to understand why that so, I want to devote just a few minutes to showing you how economic indicators, macroeconomic and international economic indicators can affect the bottom line of business. In other words, I do care about inflation, about the balance of payments, about the value of the currency, because if I am a company investing in that country where the indicators are evolving in a certain way, my profits will be affected. So, let's just let the bottom line be the beginning, the top of this chart, which is where profits, of course, equal revenues minus costs. When we think about companies and they're contemplating investing in another country, they're usually looking for opportunities, and their fleeing risks. So, let's just think about those two elements a little bit. What are the basic opportunities that a company is looking for, an investor is looking for in a country? Well obviously, they would like to go somewhere where there is growth because growth will raise your revenues. Relative to your cost, more profits. They'd like to go to a place where incomes are high or rising. They'd like to go to a place that's stable and that's safe, where the investment is not likely to suffer attacks or expropriation or there will be regulatory change. They like things to be stable, to be safe. So, these might be some of the opportunities that they're looking for. Of course, growth could include size. How big is the country or what other countries does it have access to in its sales? Those are the opportunities. Now, what risks are associated with investments? Well, actually, it's just sort of the opposite of the, so, a risk would be that you stop growing, that you stagnate or you shrink. What that would do is affect your revenues negatively and so, then your profits would be less. If incomes are stagnating or shrinking, that would mean also that your market's not growing so much. If population is stagnating or shrinking, again it's going to affect your growth. So, anything that causes your market to get smaller is a risk. Also, instability is a risk. If I don't know who's going to win elections or if I don't know what the person who wins elections is going to do and I expect major change, that could be risky for my investment because growth could be smaller or there could be some new source of costs because of new regulations or insurance or something that I have to obtain to guard myself against that instability, and of course, in the extreme case where there's violence, the investment could lose value because there's destruction. Sometimes governments will take over a company or an industry, and so you can see that the opportunities and the risks are just sort of the negative of each other. So, let's think about some different economic indicators and see how they affect the opportunities or the risks that we perceive for a company investing in a country. Let's just start out at the top where we think of GDP growth. Obviously, when a country is growing, this is an opportunity. If there's a recession, it becomes a risk. If the recession is long, it's riskier. If you recover quickly, it's less risky. Also, there's GDP per capita, that's GDP per person, and this indicates how much each person has to spend. This also affects the growth and the size of the economy, and there's an indicator we're going to be looking at which is the Gini coefficient and this shows how equally income is distributed. If income is distributed quite equally, all other things equal, we have a big middle class. That means a big size of market to serve. So, I look for a low Gini coefficient. I want this to be high. I want this one to be low. If the Gini coefficient is high, then there's a good chance of instability because people become dissatisfied when there are large income differences, and also growth may go down over time because when income is distributed less equally, you don't have such a big middle class, it spends most of what it earns. The upper class tends to keep more of what they earn. What about inflation? Well, inflation, if it's too high, is a risk because it affects your costs, cause your costs to go up, okay? If inflation is low, we like that. But if you have deflation, then that's a risk because deflation is usually an indication of a shrinking economy, an economy where people will wait to buy products because they think the price will go down in the future. So, you see, you want pretty low inflation but not too low, okay? This brings us back to this as well. What about growth? Do I want it to be as high as possible? Well, actually no, because if growth gets too high, then it stimulates inflation and this causes new problems for it. It also stimulates bubbles which can lead to financial crisis. So, not too high. We don't want growth to be too high, we don't want it to be too low, okay? What other indicators are interesting to us? Well, unemployment can be interesting and we're not going to spend much time on that in this course. So, I'll move right quickly through it, but the idea is, if unemployment is very low, you've probably got a lot of people willing to buy your product. However, salaries may be quite high because the labor market is tight. If on the other hand unemployment is high, then you may have instability, okay? Maybe your costs will be lower because you can hire workers at low prices, but you may have instability. There are some other indicators that are of special interest to investors and these are all the ones that we call fiscal indicators. So here, we talk about the fiscal deficit, which is taxes minus government spending, and the fiscal debt, which is accumulated borrowing by the government. Now, how can these be related to risk? Well, imagine that a deficit is high or debt is high, there's a possibility that the government will have to raise taxes in order to face that deficit or to pay off that debt, which would affect me as a business because I will have higher costs or maybe the country's going to go into a problem at default or investors abandon the country and they can't obtain the financing they need, then we may have a problem of instability. The deficit, if it gets too large, it can also affect the value of our currency, which could affect revenues and costs. It could also affect interest rates, which will affect our costs. So, fiscal deficits become particularly interesting and we're going to spend some time in the course looking at what makes a debt risky. Then there are some other indicators that I'm going to be talking about as we go. So, I'm not going to develop them too much now. One is the current account, and we'll spend some time just describing this and talking about the risks associated with countries that have surpluses and countries that have deficits. We're going to talk about demography, and demography is related, again, to growth. So, we'll be talking about how this affects investors' perceptions of opportunities and risk. We're also going to talk about currencies and how values move. When the currency goes down, you may be able to export more but you're importing will become more costly. Then, there's another set of risks that we're going to spend quite a bit of time on at the end of the course, which is what we call institutional risks. Is this country a place that politically, socially, institutionally, legally is stable, is safe, is a place where I'm likely to be able to bring my profits home not to have to spend money on bribing people or paying administrative personnel to try to get things done because a country's bureaucratic, or is it a country where the institutions are weak or inadequate and we may have instability and even violence? So, institutions are very important. Then finally, just to wrap it up, policy is important. Is the government following the right policy for the country? For example, let's imagine that a country has a deficit. If the government tries to take care of this deficit, that would be an appropriate policy and would make us more stable in the future. But if the government ignores the fact that it has a deficit and makes it larger and makes the debt larger without thinking of the consequences, this could entail risks for a country in the future. So, what you can see is just from a macroeconomic perspective. Just from these macroeconomic indicators, we can get an idea of the opportunities and the risks that a country presents and an investor can actually start to make decisions before looking at sectoral data. They can start to make decisions on which country they would like to be present in and which one they would like to avoid.
