Assessing the Potential of Different Economies
Two Different Decisions
A firm expanding abroad can sell in a country, produce there, or both. Each decision asks a different question:
- Selling into a market: are there enough customers who can afford the product?
- Locating production: can the firm make the product there cheaply and reliably?
Factors Influencing Expansion Into a Market
| Factor | What the firm looks for | Why it matters |
|---|---|---|
| Disposable income | High incomes, or incomes growing fast | More people can afford the product, now or soon |
| Ease of doing business | Simple rules, quick approvals, little corruption | Lower set-up costs and a faster start to selling |
| Infrastructure | Good roads, ports, power and internet access | Goods reach customers cheaply and on time, and online sales are possible |
| Political stability | A steady government and laws that don't change suddenly | Less risk of losing sales or assets to unrest |
| Exchange rate | A stable rate, and a pound that isn't strong against the local currency | Keeps UK goods affordable and protects revenue in pounds |
Levels and Growth of Disposable Income
Disposable income: household income after income tax and National Insurance, plus any state benefits. It is what people have to spend.
The level shows how many people can buy the product today. The growth shows how the market will change. Average incomes in India are far below the UK's, but they are rising quickly (unit 3.1.1), so it can be a better long-term prospect than a wealthy but saturated market.
Incomes rise → more households join the middle class → demand for cars, branded food and holidays grows faster than incomes, as these goods are income elastic (unit 2.2.4) → higher sales for firms that got in early.
Ease of Doing Business
Ease of doing business: how simple, quick and cheap it is to set up and run a firm in a country, from registering the company and getting permits to paying tax and enforcing contracts.
Red tape and corruption → months of delay and extra fees before trading starts → higher costs and later revenue → a lower return on the expansion.
The World Bank used to rank countries on this in its Doing Business report. It stopped the report in 2021 after finding problems with its data, so treat older rankings with care.
Political Stability
War, unrest or a sudden change of government can close shops, stop imports or lead to a firm's assets being taken. After Russia invaded Ukraine in 2022, McDonald's sold all its Russian restaurants to a local buyer and expected a loss of over $1 billion.
Exchange Rates
Exchange rate: the price of one currency in terms of another (unit 2.4.4).
When the pound strengthens against the market's currency:
- Sales: UK goods cost more in the local currency → customers buy fewer → lower sales.
- Revenue in pounds: revenue earned in the local currency converts into fewer pounds → lower revenue and profit in pounds.
A weaker pound does the reverse. A rate that swings a lot makes planning hard, because the firm cannot tell what its foreign sales will be worth.
Factors Influencing the Location of Production Sites
Three factors appear on both lists: infrastructure, ease of doing business and political stability. For a production site they matter more, because the firm has put money into buildings and machinery it cannot easily move.
| Factor | What the firm looks for | Why it matters |
|---|---|---|
| Costs of production | Low wages, rents, energy and material costs | Lower unit costs, if productivity is high enough |
| Skills and availability of labour | Enough workers with the right skills | A shortage pushes wages up; complex products need trained engineers |
| Infrastructure | Ports, roads and a reliable power supply | Materials arrive and goods leave on time; power cuts stop the line |
| Location in a trade bloc | A site inside the bloc the firm sells to | No external tariff on goods sold in the bloc (unit 3.1.3) |
| Government incentives | Grants, tax breaks or cheap land | Cut the cost of building and running the site |
| Ease of doing business | Quick planning approval and simple rules | The site opens sooner and costs less to run |
| Political stability | Low risk of conflict or the site being seized | Protects an investment that cannot be moved |
| Natural resources | Raw materials or cheap energy close by | Lower transport and energy costs; a mine has to go where the ore is |
| Likely return on investment | The highest expected profit for the money spent | Brings all the other factors together |
Likely Return on Investment
Return on investment (ROI): the profit an investment earns as a percentage of its cost (unit 1.1.2).
\[ \text{ROI } (\%) = \frac{\text{Annual profit}}{\text{Cost of investment}} \times 100 \]
A £20 million factory expected to earn £3 million a year has an ROI of 15%. A rival site costing £30 million and earning £3.6 million a year returns 12%, so the first is better value, unless it is riskier.
Weighing Up the Factors
No country scores well on everything, so firms trade one factor off against another. Which matters most depends on:
- What the firm makes: clothing and simple assembly need lots of labour, so low wages count most. Medicines and microchips need skilled staff and reliable power.
- Risk against return: a less stable country has to offer a higher expected ROI to be worth the risk.
Match the factor to the decision. Low wages are a reason to produce in a country, not to sell there, as they usually mean low disposable incomes. Check whether the question is about entering a market or locating a factory, then weigh the two or three factors in the extract that matter most for that firm.
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