COUNTRIES: GETTING A VIEW
The extensive research on foreign direct investment and on investor reaction to announcements of cross-border acquisitions underscores how important it is for the practitioner to have a view about a country in which an acquisition is contemplated. Such a view would inform the analysis of deals with insights about:
Expected economic growth in the country and region. Exhibit 5.10 depicts the development curve of a country over time, commonly used by economists to convey the evolutionary process by which a country achieves developed status. The country progresses from entrepôt (distribution center), through stages of rising value-added manufacturing, to highly integrated operations. In seeking to gauge the attractiveness of a country market, the M&A analyst can use a framework such as the path of development to assess the current status and future outlook for a country.
Foundations of special competitive advantage stemming from unique resources or capabilities. Porter (1990) highlighted the role of clusters of competition within countries that creates capabilities.
Outlook for inflation, interest rates, and exchange rates.
Relative valuation of assets.EXHIBIT 5.10 The Curve of Country Development
Risks. Expectations about any of these elements are never certain. Country analysis should identify the sources of uncertainty and the size of their influence. A quick assessment of the risk in a country might be derived from its sovereign debt risk rating.
Most government issues are rated for default risk by major rating agencies. These form important assumptions that will underpin the cross-border deal evaluation outlined in Chapter 13. Four perspectives inform one’s view: macroeconomic, microeconomic, institutional, and cultural.
Macroeconomic View
In the long run, national economic results are materially influenced by government policies in six areas:
1 Fiscal policy. This addresses the volume and priorities of government spending, as well as the means of financing that spending through taxes or the issuance of debt. Fiscal policy affects monetary, exchange rate, and employment policies. The key points of focus for an analyst are government surpluses or deficits, spending priorities, tax rates, and government indebtedness.
2 Monetary policy. Management of the national money supply through central bank and government activities is a major influence on inflation rates, interest rates, and currency exchange rates. Monetary policy affects fiscal policy, exchange rate policy, employment, and trade. Key points of focus for the analyst are interest rate levels and trends, inflation rates, the velocity of money, and government interventions that seek to influence these (e.g., open market transactions, bank reserve requirements, and discount window transactions).
3 Exchange rate policy. Governments may choose among a variety of alternatives from letting the national currency float against other currencies to fixing the rate of exchange (in terms of a commodity such as gold or other currencies). Exchange rates are closely linked to flows of capital and the national balance of payments. Exchange rate policy affects monetary, fiscal, trade, and employment policies. Key points of focus for the analyst are the trend and level of exchange rates, trade balances and capital flows (which indicate the relative supply and demand for the local currency), interventions in currency markets by the government or by supranational organizations such as the International Monetary Fund (IMF).
4 Intervention policy. Economies that are tightly centrally controlled by governments may be slow to adapt to innovations and changes in market conditions. On the other hand, intervention may dampen swings in economic activity. Governments intervene in business markets through industry regulations, state ownership of enterprises, the judicial system, and oversight of financial institutions. Key points of analysis are the severity of government regulations, the existence of centralized regulatory boards, policies on privatization or nationalization, the use of government subsidies to support private enterprise, the history of expropriation, and generally the development priorities indicated through government action in these areas.
5 Trade policy. Government policy can range from strong protectionism (through tariffs and other barriers) to free trade. Barriers may shelter the development of “national champions,” but they restrict the inbound flow of goods and services to consumers in the country. In contrast, the theory of comparative advantage suggests that national welfare is maximized when goods trade freely across borders. Trade policy affects fiscal, monetary, and exchange rate policies. Key points of analysis are the size and distribution of tariffs across imported goods and services and the trend of flows of imports and exports.
6 Employment and welfare policy. Many countries seek to manage unemployment and stimulate the creation of jobs as the flip side of providing a social safety net of welfare and health care payments. Employment and welfare policy affect fiscal policy. The focus of analysis should be the trend and size of the unemployment rate, trend and size of social welfare payments in the economy, existence of labor unions, and laws and policies that affect union activity.
Microeconomic View
This second perspective on a country considers activity at the level of industries and firms. Of general interest to the analyst will be the demographic profile of the country’s industrial base, the breadth of different industries, their maturity, and their prosperity. Central to microeconomic analysis is an understanding about average and marginal costs and revenues as indicators of the competitive advantage of individual firms, of entry barriers, and of the competitive makeup of industries. This view of a country is rooted in theory and research of industrial organization economics.
Porter (1990) argues that country performance is essentially a matter of microeconomic performance. Conventional thinking about national competitiveness, he says, is rooted in macroeconomics: trade balances, interest rates, exchange rates, labor costs, and economies of scale. Instead, he argues that national performance can be traced to processes of innovation and productivity improvement at the level of industries: “The only meaningful concept of competitiveness at the national level is productivity…. A nation’s standard of living depends on the capacity of its companies to achieve high levels of productivity—and to increase productivity over time. Sustained productivity growth requires that an economy continually upgrade itself.” (Page 76) Based on an analysis of competitive success in 10 trading nations, Porter concludes that the ability to innovate and to improve productivity resides in four interrelated factors. Exhibit 5.11 depicts these factors in the “diamond” of national competitive advantage:
Factor conditions. These regard the inputs of production, such as labor, land, natural resources, physical facilities, and infrastructure. Human resources and intellectual capital are especially important in advanced national economies. Here the analyst should assess how specialized are a nation’s factors, and how tailored they are to the needs of the acquisition target. Porter argues that “nations succeed in industries where they are particularly good at factor creation. Competitive advantage results from the presence of world-class institutions that first create specialized factors and then continually work to upgrade them.” (Page 79)
Demand conditions. The home-market demand for the goods or services of an industry will heavily influence the international
