MANAGEMENT ACCOUNTING ESSAY 1998/99 The development of a strategic plan is essential

to the achievement of organisational goals. Discuss. The development of a strategic plan is an

essential part of strategic management accounting. If carried out to its full credibility the
organisation will achieve its goals. It is important to note that the strategic plan is set for long
term planning, as much as 3-5 years. It has been established that a strategic plan requires the
specification of objectives distinguished between three key elements, forming a hierarchy: the
mission of an organisation, corporate objectives and unit objectives. These objectives are the
first stage of the strategic plan, before the organisation has to ask, and answer, three simple
but vital questions; 1) Where are we now? 2) Where do we want to be? (long term) 3) How
are we going to get there? This is where we bring analysis such as SWOT analysis, the Boston
matrix, the value chain and the Ansoff matrix into the plan. Corporate objectives relate to the
organisation as a whole. They are expressed in financial terms, such as desired profit or sales
levels, return on capital employed (ROCE), rates of growth or market share, and are normally
measurable in some way. Formulated by members of the board, or directors to be handed
down to senior management. United Biscuits corporate objectives in their annual report of
1985 were; 'The most important objective remains the achievement of a minimum return of
20% on average capital employees, with a target return of 25%'.2 Unit objectives relate to the
specific objectives of individual units within the organisation, such as a division or one
company within a holding company. The unit objectives for costain group plc in their annual
report of 1986 were; 'In the UK costain Homes is budgeted to sell 2'500 homes in 1987, - a
figure that will put it among the top ten house builders'.3 Before the corporate and unit
objectives are incorporated one must start with the mission, and the basic concepts which
involve vision statement, mission statement, goals and objectives. The first thing is to
establish the long-term strategic aims of the organisation, otherwise known as corporate
planning. A vision statement would be drawn up first and is simply a vague sentence
expressing the positive effect it will have on society and is often used to say how the 'world
will become a better place due to the existence of the proposal(s). This is often linked with the
mission statement, and some companies may even omit the vision and focus only on the
mission. This emphasis more on the specific role that the organisation plans. It describes in
very general terms the broad purpose and reason for its existence, the nature of the
business(es) it is in, and the customers it seeks to serve and satisfy over the long run. The
mission statement for international company 'Virgin' is very simple, very brief but informative
as to what they wanted to put across, and is simply; 'The directors aim to develop virgin into
the leading British international media and entertainment group'.4 Equally important are the
goals and objectives. Firstly the organisational goals, the aims that the company strives to
incorporate and achieve. These are a more detailed breakdown of what the mission states.
They will be defined for different groups of shareholders. As one would expect, organisational
goals are established for shorter time frames and are of unquantified sources. Goals can be a
little ambiguous, they can be expressed in simple terms, for example, to make a profit, or in a
wider area, to increase productivity. Therefore such goals can be taken for granted and so tell
us little about the emphasis placed on the various activities of the organisation in meeting
those goals. On the other hand one can say how vitally important they are. They provide a
basis for planning and management control, guidelines for decision making and justification for
the actions taken. The goals that the company set out in their report will be different to that
received by the individuals, groups or departments of that same company. The goals will help
to develop commitment of these people and so focuses attention on purposeful behaviour
providing a basis for motivation and rewards. Fig 1: FORMAL GOALS Personal goals of
managers INFORMAL Perceived goals of officially stated GOALS the organisation organisation
goals Personal goals of other members of the organisation the reason and purpose of the
organisation Figure 1 shows the different types of informal goals that lead to the overall formal
goals of the organisation. Inter-linked with the organisational goals are the objectives. These
can be interpreted as being the same as goals, but they do differ. The goals are the basis for
the objectives and are quantified roles of the organisation. They set out more specifically the
goals, the aims to be achieved and the desired end-results. As with the goals, the objectives
too will be broken down into different sections within the company. The corporate objectives
also need to be broken down into compatible and functional objectives, so as all departments
can contribute their part in maintaining the overall specifications. Large companies would have
to subdivide the organisation as a whole to make there corporate mission more appropriate.
This can be achieved by splitting into functional areas or geographical areas, where the
managers are made responsible for all of the functions carried out within their region. The
most logical and relevant divisions for strategic planning purposes are called 'strategic
planning units' - (Sub's). Sub's are normally defined as being divisions of an organisation
where the managers have control over their own resources and discretion over the
deployment of these resources within specified boundaries, - their own mission statement and
set of goals. The role of corporate strategic planning in this case is to define the overall
corporate values and guiding business principles and to set out the limits of the business,
which can be undertaken by the subsidiary units. Here we recall the three simple but vital
questions mentioned earlier; Where are we now? Where do we want to be? How do we get
there? To help us we start to incorporate analysis and other useful techniques. We start with
the SWOT analysis, otherwise termed 'WOTS UP', which focuses on the strengths,
weaknesses, opportunities and threats of the organisation. By taking into account the
constraints and opportunities, one can take a look at previous performance, competitors and
the rest of the industry, in relation to the holders own company, and then of course one can
do SWOT analysis; Fig 2: INTERNAL STRENGTHS WEAKNESSES EXTERNAL OPPURTUNITY
THREATS The strengths and weaknesses refer to the internal aspects of the organisation,
comparing to the competition and the market place, - what the company is relatively good and
bad at doing. The opportunity and threats relate to the external environment factors and the
inter-relationship they have. Strengths are those positive aspects or competencies, which
provide a significant, market advantage, where the organisation can build upon. This is simply
to tell the present market position, size, structure, managerial expertise, physical or financial
resources, staffing and skill, image and reputation and lastly the situation (for channel ports
and motorways). Weaknesses are obviously the negative aspects in the present competencies
or resources of the organisation. Its image or reputation limiting its effectiveness which need
to be corrected to minimise the effects. Certain examples of weaknesses could be operating
within a particular narrow market, limited accommodation or outdated equipment, high
proportion of fixed costs, high level of customer complaints, poor marketing skills or a
shortage of key managerial staff. Opportunities are favourable conditions and usually arise
from the nature of changes in the external environment. Although the organisation needs to
be responsive to the changes, it also has to be sensitive to the problems of business strategy.
The changes being, new markets, technology advances, improved economic factors or failure
of competitors. The opportunities offer the organisation the potential to develop existing
products, facilities or services. Threats, the last in the SWOT analysis matrix. These are the
opposite to opportunities, referring to unfavourable situations arising from external
environment developments that are likely to endanger the operations and effectiveness of the
organisation. One would include changes in legislation, the introduction of a radically new
product by competitors, changing social conditions and the actions of pressure groups. The
organisation has to be responsive to changes that have already occurred, and therefore plan
for anticipated significant changes in the environment, being well prepared for such demands.
One has to consider four fundamental issues that are addressed with SWOT analysis. Firstly,
financial performance - allowing one to asses the current performance. Secondly,
competitiveness - here it is vital to consider the non-financial factors which allow a company
to resist competitive pressure, applying it successfully to others. Market input is next, and
lastly external environment - these last two aim to highlight external factors, for example,
potential constraints, via analysis of the external environment. This must take into account all
relevant external environment factors. Once the organisation has completed the SWOT
analysis, the question of where they to be in 3-5 years arises. To help with answering this the
'Boston Consulting Group' (BCG) portfolio matrix will be introduced. This matrix identifies
greater strengths and weaknesses by producing, again, four different types of businesses (or
products), Dogs, Question marks (or Wild cats), Stars and Cash cows, and is shown in the
following Boston Square; Fig 3: Market growth and cash input High STAR ? Low FUNDS CASH
COW DOG High Low Market share and cash generation The Boston square is based on a
product life cycle and the coincidence of high market share with high profitability; Fig 4:
Product Life Cycle: question star cash dog mark cow The product life cycle assumes that the
cost a unit drops as the volume of units produced increases as a result of improvements in the
production process and economies of scale. A typical product developed from concept to
market acceptance, through a period of high demand and eventual market decline. Of course
not all products follow the same cycle, some never reach the market, and others have a
different time scale at each stage of the cycle. Converting the four stages of the product into
matrix form produces the above Boston square, giving four different characteristics,
specifically chosen. The stars are those products with the best profit and potential, requiring
hefty investment to become established products, which generate cash with minimum
investment. The question marks, otherwise known as wild cats, are those products requiring a
high investment for little return. Market growth is high whilst market share is low, initially
funded by income from cash cows. The dogs are those obsolescent products which no longer
merit further investment as the market share has been eroded by new developments or
fashions. The whole idea of the Boston square model is to highlight that the strategic
management of a product, or even a whole industry, needs to focus beyond internal factors to
consider market pressures. It also stresses the need to re-invest income to provide long term
sources of revenue. It is essential that four strategies emerge from this matrix. Firstly, to
'build' - increase market share, turning question marks into stars. Secondly, 'hold' - preserve
market share, ensuring cash cows remain cash cows. Thirdly, 'harvest'- increase short-term
cash flow by using cash cows to fund other business products. Lastly to 'divest' - eliminate
those businesses whose use of resources is inefficient. It is also possible to use a different
type of analysis, namely 'Porters' five-part model, of the existing competitive position. The five
parts are established as 1) buyer power, 2) supplier power, 3) entry opportunity, 4) substitute
possibilities, 5) competitor rivalry. These five factors determine how attractive an area of
business will be to a company. Fig 5: Porters five factors affecting current level of competition
can also be successfully related to his later technique - the value chain, which comes under
our third question - How are we going to get there? The value chain looks at the total value
added by the industry and by the particular organisation within that industry. The objective of
the value chain analysis is to highlight the objectives which contribute most significantly to the
total value added and to develop strategies to improve on, or defend the current share of that
value added which is gained by the organisation. Fig 6: The value chain: Suppliers
Organisation Customers Strategy and administration Research and development Design
Production Marketing Distribution Customer service According to this concept every firm is a
collection of activities that are performed to design, produce, market, deliver and support its
product. Another development by porter in 1980, is that 'competitive strategy splits successful
strategies into three broad categories; Fig 7: Porters model of generic strategies: STRATEGIC
ADVANTAGE Low cost position Uniqueness perceived by customers STRATEGIC TARGETS
Industry niche Overall cost Leadership Differentiation Particular segment only Focus To be
successful across its chosen industry the organisation must either be able to supply the
product from the lowest cost case in the industry or be able to command a higher price in the
market by differentiating its product. It may not be positive to sustain either of these
strategies across the whole industry and so it adopts its third strategic category by 'focusing'
on particular segments of the industry where it can command a sustainable competitive
advantage. The last part of the corporate planning is the Ansoff product/market matrix.
Competitive strategies should be the most precise level of strategic planning since they relate
to actions regarding products and markets which are to be implemented to achieve the most
specific objectives of the organisation. The organisation here could acquire or develop new
products to sell its existing customers, mapped out in the Ansoff matrix. Fig 8: Ansoff matrix:
PRODUCTS Existing New MARKETS Existing Market Penetration strategy Product development
strategy New Market development strategy Diversification The Ansoff matrix indicates the
appropriate types of strategies which should be implemented depending on which box the
organisation decides to select as its preferred method of growth. The fourth alternative that
this matrix suggests is new products for new customers, otherwise described as a
diversification strategy or questionable strategy, because it doesn't build on any obvious
existing competitive advantage of the business. The other three strategies are examined by
their relevant strengths and weaknesses. From all of the analysis shown, and followed with the
full capabilities of management in achieving what was set out, one would be able to achieve
the original organisation goals. It is possible to see that the development of such a strategic
plan, through corporate planning, is a lenghty but well worthwhile for the company. We should
note that strategic planning and strategic management accounting has become a vital part of
a companies future.

Brief Economic History and Government Policy Korea was one of the poorest countries in world
after experiencing two wars. World War II and Korean war (1950 ~ 1953). The country even
experienced a food shortage so that it had to heavily rely on the foreign aid. Yearly per capita
consumption was a mere $88 as late as 1965. However, since 1965, Korea has been
transformed from its underdeveloped agricultural economy to a leading Newly Industrializing
Country. Between 1965 and 1981, its gross national product GNP multiplied twenty times from
$3 billion to $63 billion and per capita GNP increased sixteen times from $88 to $1,554. There
have been many explanations for Korea’s successful story. Among those, the strong role of
government would be probably the most important one. At the same time, this would be also
responsible for current recession. After Koran war, the government in fact had no sense of
direction and also due to the unstable political situation, the country didn’t have specific
economic policy until 1961 when military government came to power and established the
major institution guiding its economic planning called Economic Planing Board (EPB). This
government set economic development as the top national priority and recognized the
financial system in support of economic development plan. To achieve this purpose, it focused
its policies mainly on export expansion moving its emphasis from import substitution. The
result was considered quite successful for economic growth. Between 1965 and 1973, exports
grew at average annual rate of 45%, from $175 million to $3,271 million. The success of the
expansion was due primary to three factors (Kwack, 72). The first was a favorable
international economic environment, which saw total world imports expand from $175 billion
in 1965 to $536 billion by 1973. This boom in imports of the world reflected the fact that the
industrialized had not yet erected import barriers against exports from developing countries
and were, on the contrary, quite active importers of cheaper goods from Newly Industrializing
Countries such as Korea. A second significant factor was the Korean government’s policy of
promoting exports, which was set in motion in 1965. Initially, the government introduced a
number of fiscal and financial incentives, which I will discuss more later. A third factor was
Korea’s abundant and highly productive labor force. This gave Korea a strong comparative
advantage in producing labor intensive products and provided the impetus for the notable
expansion for exports. In order to expand total exports over time periods, however, Korea
turned to new export industries that were expected to have a comparative advantage with
abundant labor, but skilled labor at this time, such as shipbuilding, electronics, and steel
industries. This attempt was viewed as a manufacturing shifting of its emphasis from light
industries to heavy industries which later started to produce intermediary goods as substitutes
for imports (Kwack, 77). However, this government’s promotion of heavy industries for large-
scale economies led to under-investment in light manufacturing industries causing productive
gap between small and large firms. Actually, the large firm that runs heavy industries has
been given priorities, and small and medium firms relatively disregarded in government’s
allocation of loanable funds and other administrative preference. As a result, conglomerates
later known as chaebol (family owned conglomerate) have been formed through this
expansion of heavy industries. Government’s Policy Before 1961 As seen above, the Korean
government has been focused on import substitution for economic growth during 1953 ~ 65
period and followed by export expansion policy after 1965. However, to progress its policy
efficiently, the government had to face to one of serious problem, poverty. After two major
wars, the country even with a food shortage experienced lack of capital. There was no source
for savings and investment to finance economic growth domestically, so it depended heavily
on foreign capital which inflow in a form of mostly aid and loan in the early stage of economic
growth. The proportion of foreign capital to total capital formation in 1965 was approximately
40 percent. In addition to inflow of foreign capital, the government faced allocation of capital
with using its financial system. Before the military government in 1961, the loan decisions of
commercial banks were heavily influenced by political interference (Haggard, 26). Well, in fact
the loan decisions in Korea mostly were affected by political interference rather than bank
themselves until recent time, but during the 1948 ~ 1961 period, the rent generated by low
interest rate was used for its political activities rather than economic growth. Government’s
Export Promotion Policies In the economic development, the government’s creation of
economic rent for certain segments of business takes critical role. It can be either a source of
political and bureaucratic corruption, but if wisely used, it can be a useful or powerful policy
instrument in supporting business operation and government policies. Furthermore, it can
increase capital formation in the country if it effects a redistribution of income from
consumption to investment activities (Haggard, 23). Since the mid 1960s, the military
government used regulated finance as one of tool to create rent and achieve exports
expansion. What it did were nationalizing commercial banks and amending the Bank of Korea
so that it can control financial systems directly. In general, the Bank of Korea, in its role as the
country’s central bank, determines the allocation of loans, interest rate level and the supply of
money but the decision making in these area is controlled by the Minister of Finance. In other
words, it was government’s responsibility generating monetary and fiscal policy, not by the
central bank. Since foreign aid started to decline later 1960s, the government reformed
interest rate. It raised the interest rate on (one-year) time deposits from 15% per year to
30% per year and general loan rate from 16% to 26%. The reform successfully attracted
private saving. In the first three months after reform, saving deposits increased by 50%. More
importantly, this meant more rent, in other words, more capital to be distributed under
government influence. In addition, the financial reform contributed to a massive inflow of
foreign loans due to the existence of gap between domestic and international interest rate and
since the Korea Development Bank guaranteed to pay back to foreign lender, the inflow of the
loans were accelerated. Also this gap of interest rate was used to promote export expansion
which was the most economic priority. For example, while domestic interest rate was so high
comparing with international rates, the exporters, mostly big business in heavy industry, were
able to get loan at little interest rate. They were not only able to get low interest rates, but
variety of supports that the government could do such as tax break and easy approval of the
loans for exporters. For example, profits earned on exports have been exempt from corporate
or individual income tax and the short-term export credit system gave borrowers holding
export letters of credit (L/C) “automatic approval”. As a result, an increase in domestic savings
and huge inflow of foreign borrowings had positive effect on economic growth in Korea due to
an increase in capital accumulation. Controlling exchange rate is another good example to
describe the effect of government’s role on Korean economic development. After switching its
economic policy from import substitution to export expansion in the mid-1960s, the Korean
government officially moved from a fixed parity to a unitary floating exchange rate system.
Although the exchange rate system has been “floating”, its actual (real) rate was managed by
government’s market control and Korean currency “won” was undervalued mostly against the
U.S. dollar so that the price of exports remain cheap. Followings are the plans that the Korean
government set over time period as a guide for economic growth. They are quite helpful to
understand how major government’s policies on financial sector have been varied with given
the world economic situations like oil crisis and its own economic recession. The First Five Year
plan (1962 – 1966) The first plan was prepared in a hurry by the military government that
took power in 1961. The major contents of fiscal and financial policies as stated in the plan
document were largely about the tax, budget, and monetary system, financial market and
foreign exchange system. During this period, its main purpose was, however, to expand
exports as much as possible by providing export firm with cheap loans, tax benefits, export
compensation schemes, and various administrative support. Economic growth in this period
was result by an increase in export and output and as well as price level (since output and
price level are positively correlated), so there was inflationary pressure at the end of the first
plan- actually the inflation rate exceeded 23 percent in 1964. The Second Five-Year Plan
(1967 –1971) During this period, the major reforms include a financial reform assuring
positive interest rate in 1965, and exchange rate reform normalizing highly overvalued
exchange rate, and trade reform allowing wide imports of parts and machinery used for the
production of export goods. These reforms were reflected in the second plan and carried
further throughout the second plan period. In addition, there was an increase in domestic
savings and a decrease in foreign borrowing. The Third Five-Year Plan ( 1972 –1976) The third
five-year plan put its major emphasis on the promotion of heavy and chemical industries. The
government made great effort to raise domestic savings to finance the heavy and chemical
industries, but the amount of domestic savings fell far short of investment requirement. As a
result, foreign borrowing expanded enormously, and management of foreign borrowing and
debt became a major policy issue. In addition, due to different emphasis on light and heavy
industries, the growth gap increased substantially. Inflation caused by the first oil shock in
1973 also takes a part of unstable situation of economy. Inflation rate exceeded 40 percent in
1974. The Fourth Five-Year Plan (1977 – 1981) Because of high inflation cause by the first oil
crisis, stability was given relatively high policy priority. The government adopted monetary
rule of fixing money supply growth at a prescribed constant rate of 20 percent per annual to
stabilize price level and overall economy. He major change in trade policy during the fourth
plan period included the expansion of imports related to exports, maintenance of effective
exchange rate, expansion of export subsidies, tax benefits and foreign loans to export firms.
In addition, the government improved the number of industrial estates for export firms by
creating industrial export estates and free export zones. The fifth Five – Year Plan (1982-
1986) In the early 1980s, the Korean economy was characterized by very slow growth rapidly
expanding foreign debt, and high inflation. Consequently, export promotion was given the
highest policy priority again, so the major change in trade policy included intensive promotion
of export goods and market diversification, reform of the export support system, lowing tariff
rates to expand importation of good used in manufacturing. The Sixth Five year Plan (1987 –
1991) As of 1986 the Korean economy realized high economic growth, stable price, and a
trade surplus and thus faced a new phase of growth with enhancing the efficiency and
strengthen the international competitiveness of the Korean economy in general by reforming
the free enterprise market system. Thus the major contents of policy reforms included the
dramatic reduction of various government regulations constraining growth of enterprises plus
extensive promotion of liberalization of finance, imports and foreign exchange. The Seventh
Five – Year Plan (1992 – 1996) This plan was formulated after Korea became a member of the
United Nations and emphasized the role of private sector in preparation and implementation of
the plan. The Eighth Five – Year Plan (1993-1997) The preparation of this plan started with
the beginning of the Seventh Republic and the plan emphasized that management of the
economy will no longer be government led or government controlled, as in the past, but will
be based on the participation and innovative spirit of the Korean people. It also stresses the
importance of reform of finance, government administration, budgets, ethics, etc. Even though
the government on each period recognized the problems it was facing and made five-year
plans, they were not always successful. Throughout the plans above, we will be able to find a
common policy used without difficulty. That is the government’s massive supports toward
export firms. It must work during the early stage of development when the country had little
capital accumulation. However, the government’s unbalanced incentives on big businesses
which are mostly in heavy and chemical industries, later known as chaebol, actually led them
to depend too long on protection and debt financing. This policy wasn’t a serious problem
when the economy boomed, but when it slowed, most debt ridden firms fell back on the
government for relief causing the issue whether the policy and the industry are efficient or
not. (Haggrd, 24). For example, the combined sale of the five largest big companies, chaebol,
take 37percent of Korea’s gross out, and their exports were 44 percent of total exports in
1997. If there is a little slow down of the one of the largest business, then it is obvious the
economy is not in quite safe situation. Since chaebol’s share of Korean economy is already
huge, if they are allowed to fail or banks are to write off their debt, then the whole banking
system would be pushed into collapse. This is real problem, nor chaebol or their associated
companies, be easily shut down (Economist). As a example, the price of a 16 MB dynamic
random access memory (DRAM) chip fell from more than US $40 in January 1996 to less than
US $10 by the end of 1997. The dollar export price index for Korea’s electronic components
fell by 50 percent over the same time period. Another example is current collapse of Daewoo,
a second largest chaebol, which had huge debt to equity ratio (over 400 percent), went to a
bankruptcy this year. This company was well known with a very close relationship with the
governments in the past. It was ironic to see that Daewoo was expanding its size when the
country was in recession and other chaebols tried to reduce their size and increase efficiency.
Actually, this is not the first time Daewoo asked for the government’s help. Every time the
company went into a trouble, the government didn’t let the company to fail and put more
capital available into the company. However, this time it doesn’t seem happening that way.
Actually, the government is trying to solve the problem under the market operation, so this
inefficient and insolvent chaebol can be sold. Chaebols may not be the only one to be blamed,
even though they were blamed as a major cause of Asian financial crisis happened in Korea
brining the country to the brink of insolvency, as well as weak banking system, in fact, they
could be victims of misleading government policy. The long term close relationship between
government and big business creating rent and using them with unbalanced support between
industries had worked well in the early stage of development, but as stated early, rent can
bring corruption of bureaucracy or industries also, since it is caused by inefficiency. Allocation
of financial resources is not an easy job, but this would be best time for Korea to consider
again about the efficiency of closed relationship between the government and businesses while
the country is restructuring its economy system.

Bibliography

Blinder, Alan S.. The Economics of Finance. Washington D.C.: the Brooking institution, 1974.
Haggard, Stephan, et al. The politics of Finance in Developing Countries. London: Cornell Univ.
P, 1993. Lau, Lawrence J.. Models of Development. San Francisco: ICS Press, 1986.

Economics 001A: Macroeconomics Macroeconomic Case Studies Stephen Rossi Economics

001A: M 6:30-9:15 Slowing the US Economy The article titled 'Fed Unlikely to Alter Course' by
John M. Berry of the Washington Post takes an interesting look at actions that Alan Greenspan
his colleges of the Federal Reserve have been taking over the last 9 months to slow the
economic growth of United States. The astonishing growth rate of 7.3% is fueled by an
economy that is in the midst of a high tech revolution. The article also explores the contrasting
view of other economists that say that the Fed has increased interest rates too much in its
attempts to slow the economy. The means by which Alan Greenspan and the Federal Reserve
have chose to slow the economy is through a monetary policy, or more specifically, an
increase in the national interest rate. The article states that the Fed officials have come to a
broad agreement that they will keep raising the rates until growth slows to a more sustainable
pace to make sure inflation stays under control. Because of the booming economy and the
investment in the stock market the exchange of money has increased for goods and services,
which in turn increases the price level or the quantity of money demanded. By increasing the
interest rates the Fed commits itself to adjusting the supply of money in the United States to
meet that rate at a point of equilibrium. If the interest rate is increased, less goods and
services are demanded, and therefore will slow down the economy and reduce the rate of
inflation. The article points out that as stock prices have risen over the last couple of years, so
have American household wealth and consumer spending. This is precisely the cycle that Fed
officials want to interrupt to slow growth before it fuels more inflation. At the time this article
was written the stock market prices had fallen sharply especially in the technology sector. But
the Fed continued on the path to raise interest rates further noting that the index that they
closely follow and contains a broader rage of public traded US stocks, the Wilshire 5000, is up
for the year. Even though they began raising rates gradually 9 months ago, it takes almost a
year for the economy to feel the full effects. In this case the results of the interest rates
increased could be felt as last as the second half of 2000. Yet the economy has not slowed
down, and the demand for goods and services continues to increase as wealth does. One of
the ideas that has been presented to Greenspan by the fed officials was to take bigger steps in
raising the interest rates. They feel that this will decrease the money demand in a quicker
fashion. In turn these actions will lead to lower consumer spending, and thus decrease the
inflation rate. However, because of the erratic patterns in today's high tech economy
Greenspan is expected to stick to his pattern of more gradual increases to the interest rate.
Eventually when monthly loan payments increase enough, consumers will back on purchases
and investments. The article points out an example where the rate for a new 30 year fixed-
rate home mortgage is up to 8.5% from 7.75% nine months ago in June. In the situation of a
$150,000 home loan, this new interest rate will add almost $100 to each monthly payment.
Over time the full effect of the interest rates will be felt. One economist, James Glassman of
Chase Securities takes a different look at the new interest rate. He points out that the rates
that the Fed has set are fairly high in comparison to the rate of inflation as it is currently in the
United States. The formula that Glassman follows examines the inflation rate when food and
energy items are excluded because they are so volatile. With these items removed the rate of
inflation in the US is less than 2%. As with other measurements, this rate can be subtracted
from the interest rates to find a 'real' interest rate which consumers a paying. So in terms of
30-year home mortgage rate set at 8.5%, only 6.5% of it is what the consumers are actually
paying and the rest is accounted for by inflation. Glassman goes further to point out that with
inflation so low, wages aren't going up all that fast. To be said more specifically, the interest
rates are increasing faster than consumers' wage increases. This will eventually be felt in the
tightening of the American economy. However with stock market fueling the incredible
momentum of the economy, the affects of the interest rate hikes have not yet been felt, and
the question has risen to whether or not the Fed's tactics are actually going to work. However
evidence is pointing back to when in 1995 the 'real' interest rate was close to 6.75% and the
economy began to apply its breaks. Between that time in now a lot of money has been placed
into the economy, and now to slow growth and inflation, the fed is using these high rates to
take some of it away. Secrets of the CPI The article Unveiling the Secrets of the CPI by
Kathleen Madicgan Focuses on exploring what exactly the Consumer Price Index is by using
some recent examples from the United States economy. It delves into how the rate of inflation
relates to the CPI and what tools the government uses to predict inflation. Moreover, it
explores what happens when the government incorrectly predicts the rate of inflation. The
U.S. government watches the CPI as a way to determine how fast the rate of inflation is
growing. The CPI is a good measurement simply because it is an index of all the goods and
services used by consumers in households, and is calculated on a monthly basis. The goods
and services that are actually looked at come from a survey of the past couple of years.
Usually economists look at the core rate of the CPI, which excluded food and energy prices,
since they fluctuate so rapidly. The article points out some examples where the corn produced
in the United States could be directly affected by the weather. Also the recent oil price
increases is directly related to OPEC and their choice to cut back on the production of oil.
However the CPI is not a perfect measurement as Alan Greenspan, chairman of the Federal
Reserve, has acknowledged. It usually overestimates the rate of inflation because the goods
looked at are from previous years and do not include the addition of new products into the
market. One example of this was the increase in cellular phones over in the 1990's. The
Bureau of Labor Statistics was not including them in the price index simply because they didn't
seem to fit into one particular category. So how does the CPI relate to some of the current
events in the U.S. economy? Kathleen Madigan writes about last April when the CPI was
overestimated by analysts. When the CPI jumps sharply it suggests that rate of inflation is
increasing. In April of 1999 the CPI jumped a sharp 0.7 percent suggesting that inflation was
on the rise. At the same time market analysts anticipated that the Federal Reserve was going
to increase the interest rates at the beginning of May. Because of this combination, the Dow
Jones industrial average tumbled almost 200 points. If some one who borrows money in terms
of something such as a home mortgage loan suddenly encounters unexpectedly high increase
in inflation, the adjusted rate (the interest rate minus the inflation rate) becomes increasingly
lower. Or in simpler turns, the money that is paid back to the lenders is less and less over
time. Therefore more money will be injected into the economy and the wealth transfers form
the people lending the money to the people borrowing the money. At this point the Federal
Reserve will have to step in and raise the interest rates once again to compensate for the
inflation. It is not bad for inflation to increase at a steady rate, but when there is an unusual
spike in the rate, it hurts the economy because when regulating interest rates, it will take a
long time to feel the full effects. Another way of looking at how the rate of inflation is affecting
the economy is in terms of the earnings of many corporations. When analysts predict the
estimates for future earnings, the rate of inflation is figured into their calculations. However in
the case of April of last year, the inflation rate as seen by the CPI increased unexpectedly.
Therefore the earnings of many companies were overestimated, and investors may have
overpaid for the price of a particular share of stock. Conversely the bond market yields were
shown as increasing to a 12 month high. This is accounted by the yield rate being correlated
to the rate of inflation in the economy. As the rate of inflation increases, so will the bond yield
rate to compensate for inflation. In this case it makes the bond market much more attractive
to investors considering the long-term yields may be higher than other forms of investment. It
is also a benefit for the Federal Reserve in the sense that as investors choose to buy bonds, it
will remove some of the money supply from the economy. Overall the Consumer Price Index is
an important tool provided by the Bureau of Labor Statistics that the government looks at
closely to determine the growth of the economy and value of money because of inflation.
When there is an unexpected increase in this rate, the results trickle down to many outlets of
the economy such as the stock and bond markets, which can be clearly seen by the sudden
stock market fluctuation. In the last year the Federal Reserve began to regulate the economy
by increasing interest rates because of the fear of rising inflation. Time will tell the
effectiveness of these measures.

After North America, Europe, and Japan, the area of China, Taiwan, and Hong Kong is a fourth
growth pole in the world economy (Jue 108) which in 1994 was expected to double in size by
2002. Today, the growth rate is still on track to fulfill that prediction. Recent Chinese economic
policies have shot the country into the world economy at full speed. As testimony of this,
China’s gross domestic product has risen to seventh in the world, and its economy is growing
at over nine percent per year (econ-gen 1). Starting in 1979, the Chinese have implemented
numerous economic and political tactics to open the Chinese marketplace to the rest of the
world. Chinese reform measures even anticipated the rush of foreign investment by opening
newly expanded industries to out-of-country investors. As trade expands globally and
countries within geographical proximity and of similar cultural descent and philosophies ally
themselves in order to better compete on a world level, we are seeing the development of
increasing number of geographical trade alliances, whatever the underlying reasons behind
each. The alliances that have been in place for a while are proving to be very successful in
competing in the international markets, stimulating the economies of nearly all of their
member states. Effects of this change in economic strategy by a world power can be felt by
practically every nation of the globe involved in international trade. The change in the amount
of imports and exports to and from China will increase the demand on countless markets.
Also, with all the foreign investment China is receiving, the socialistic republic will only grow
more and more interdependent upon the world economy. However, the impressive growth rate
of China’s economy is not without its shortcomings. Problems such as inflation and inefficient
state-owned enterprises plague the rise of the Chinese economy. When China opened its
economic borders 19 years ago, environmentalists spoke of the efficiency of their farming
systems and how they used hardly any organic fuels in the production of food for their people
relative to some of the other countries of the world-most notably the United States. What they
neglected to mention, however, that one farmer at the end of one rake struggling to feed his
family kept fuel consumption very low indeed. It was not, by any stretch, efficient. Matching
conditions still exist today. Rumors of the wonderful prosperity of the south and eastern
provinces have reached the more isolated-and less prosperous-interior provinces. Those
current farmers who would travel in order to be more prosperous themselves are often
stopped at the borders of industrial growth and made to turn back. Everyone in China
seemingly wants a share, but the industrial provinces can physically support no more drain on
their existing housing and infrastructures, and they are finding themselves unable to enhance
their current positions despite their economic prosperity. When examining an issue, it is
imperative to honestly look at all sides, and not all of China’s sides are forthcoming. The
country has indeed become more open toward foreign investment, and in fact openly courts it.
China have been known to have placed several restrictions on the multinational companies
that have opened operations within their borders, but they are generally not so restrictive as
to be prohibitive. For example, after IBM accepted China’s conditions regarding the true
ownership of IBM’s facilities and environmental rulings, it seemed that all of the rest of the
world wanted to join in. Deng Xiaoping called China’s entrance to and courting of the
industrialized world crossing the river by feeling for the stones (The Economist 26). In feeling
for the stones, China’s already realized economic transformations have vastly improved the
lives of hundreds of millions of people (The Economist 26)- Chinese people. Economic
measures instituted by Deng Xiaoping have been grouped together, under the general term of
gradualism, but many observers now say that in order for China to continue its double-sized
growth over the long term and to rectify the problem of the state industries that are losing
billions of dollars, economic shock therapy needs to be administered, and quickly. But the
current plan of China’s President Jiang Zemin and his advisors includes no such shock therapy.
It does include, however, divesting the government of all but one thousand of the more than
three hundred thousand state-owned businesses that have cost the Chinese government $85
billion in looses over the past ten years. The following chart shows the distinctions of several
of China’s economic indicators, and their changes since 1987. Table 1. Selected Economic
Indicators (Billions of dollars) Factor 1987 1997 Change Gross Domestic Product 300 610 610
Merchandise Exports 30 180 150 Foreign Investment 2 48 46 Hard Currency Reserves 25 128
103 Losses of State-Owned Industries 3 88 85 (Business Week, Sept. 1997) From the
preceding chart, the growth in China’s GDP over the past ten years in nearly indefinable. Other
indicators are highly favorable, with the economy’s only apparent problem being that of the
losses of the state-owned industries. The losses incurred over the past ten years could have
served extremely well in furthering the quality of life of the Chinese people, rather than simply
supporting the workers in those industries. Those workers represent no small percentage of
the Chinese population- there are 100 million workers in those state supported industries that
have lost so much money (Clifford et al.). The plan of action proposed by Jiang Zemin in
rebuilding the Chinese economy includes: · Restructuring state enterprises. Already
responsible for a third of the country’s industrial output, these could be converted to public
corporations. When these companies become shareholder-owned companies, it opens the door
to foreign competition. Government holdings can be at the level of minority shareholder. ·
Strengthening financial markets. Set up the equivalent of our SEC and allow annual capital-
generating stock listings in Shanghai and Shenzhen. (China already has a start on regulating
securities exchanges (Reuter’s).) · Selling state assets. Currently, there are 305.000 state-
owned businesses. The government would retain 1,000; the remaining would be sold. Those
that cannot be sold will be allowed to go bankrupt. · Building social services. Literally millions
of Chinese citizens stand to lose their jobs through the sale and conversion of state-owned
businesses. This action is intended to both replace some of those state-owned enterprises and
provide assistance to those affected in the form of training, housing, and pensions design. ·
Cutting trade tariffs. Though China is not a member of ASEAN, the country does aspire to join
the World Trade Organizations (WTO) by the year 2000. Tariffs must be reduced to 15 percent
by that time in order for China to be eligible for WTO membership (Business Week). Even
while concentrating on internal adjustments, the government apparently intends to work
toward that end. Jiang’s objective is to build a complete market system which will give China a
chance to grow at an average of 6.5 percent annually for about 25 years and come forth as a
$5 trillion modern industrial superpower (Clifford et al.). If the President is able to succeed
with his plan of action, the impact will be tremendous for the global economy of the 21st
century. Hong Kong, the center of the Chinese capitalism, could have the opportunity to be
side-by-side with London, Tokyo, and New York as financial centers. As long as Chinese
individuals move in on global bonds and stock markets to help finance everything, like
superhighways to steel mills, China could take part in even more parts of the world’s capital.
The main goal for China’s modern foreign policies is the development of the Chinese
infrastructure. The significance of improved communication and transportation cannot be over-
stressed. Economically, enhanced means of communication and transportation allows more
expedient supply of demand scheduling. Two of the latest Chinese reform measures to aid in
the development of the country are the Provisional Regulations on Direction Guide to Foreign
Investment and the Catalogue Guiding Foreign investment in China. Both these policies place
specific industries including telecommunications, machinery, and electronics on top priority.
Funding for these projects come from foreign investments and appropriations from the
Chinese government in the form of grant financing, and legislative or administrative support.
Yet another example of the Chinese emphasis on industrial based growth is far reaching goal
of having just under 100 million telecommunication lines by the year 2000. China’s Central
Ministry of Posts and Communication said that in order to complete this major task China will
enlist the aid of major overseas suppliers and create manufacturing plants within the nation.
AT&T, Motorola, Northern Telecom, Alcatel, Ericsson, NEC, and Siemens are just a handful of
the multinational companies which hold a considerable share of the Chinese telecom market,
once again proving that China is becoming a party to interdependence. The Chinese
pharmaceutical market, much like Chinese industrial markets, is experiencing rapid growth
due to reforms in China’s economic strategy. The nation’s government has decided to lower
import tariffs and remove the necessity of an import license to bring pharmaceuticals into the
country. Also, patented foreign drugs, such as Tylenol, are now being protected from
counterfeiting by administrative action. The result of these provisions are overseas contractual
investments totaling $1.5 billion in the past five years, and income from the medical industry’s
exports reaching 2.6 times the amount five years ago, according to Zheng Xiaoyu, director of
the State Pharmaceutical Administration (moftec.gov). The pharmaceutical market’s growth is
another example of the economic progress China has made. Even after accounting for all the
economic benefits recognized by the world, the Chinese still come out as the country with the
most gains. However, there are more motives behind China’s market reforms than just purely
economic. On the political front, China is fast becoming an integral part of international
organizations. The government is making a conscious effort to reenter GATT (General
Agreement on Tariffs and Trade), realizing the importance of creating a favorable trading
status among foreign nations. Slowing this progress, the 124 nations strong trade bloc has
requested that numerous conditions must be met by China before the nation can become a
member of GATT once again. Several of these provisions are the elimination of import
prohibitions, restrictive licensing requirements and other controls or restrictions; lifting of all
restrictions on access to foreign exchange and full convertibility of the Chinese currency
(fmprc.gov). Other important key themes behind China’s Open Door policies are economic and
technological cooperation with the West (fmprc.gov) and that China’s government no longer
supports Third World revolution. Instead, China realizes that cooperation with developing
countries would be far more practical. Although Chinese foreign policies is aimed at opening
the nation’s economy to the world, it neglects the agricultural market almost entirely, with the
exception of technical contracts. These contracts are designed to improve the transfer of
technologies to improve crop yields. Technical Contracts are made between farmers and
village economic cooperatives and a wide variety of offices and technical personnel from
different administrative levels (fmprc.gov). The funding for the technology used by the
agricultural industry can be traced to extension stations of political parties, finance bureaus, or
local insurance company. Since the groups funding technical contracts are nothing more than
investors, a portion of the profits from increased production due to the technological
advancements are returned to these groups. However, the technology providers also bear the
risk of investors, if output and economic returns can’t reach prescribed figures, the extension
administrations have to make up the losses(fmprc.gov). Like all good things, China’s
formidable economic growth had its downsides. There are a few detriments like inflation, an
under-aided agricultural market, government inefficiency, and geographically uneven
development. High inflation, caused by a demand for more exchange medium on the Chinese
market is causing Chinese currency to depreciate relative to other national currencies.
Currency conversions and management remains a sticking point for many businesses wishing
to invest in China. There has been some movement in Asia toward a more uniform level of
currency exchange, but not so much that it has affected the difficulties in trading with China.
And, a lack of emphasis on the agricultural market is causing that sector of the Chinese
economy to fall behind, and soon the supply of agricultural products will fall below the demand
for these goods, resulting in a shortage. Another problem is also the inefficiency of large,
state-owned production facilities can be explained by excess bureaucratic red tape and
corruption. Finally, there has been an uneven distribution of development between the land-
licked, western section of China and the industrialized east-coast, consequently causing
ineffective land use. A lot of China’s economic problems seem to be internal, and connected
with supporting the massive population while divesting the government of money-losing
businesses. Indicative of the overall industrial health of China is the amount of tax the country
collected through their industrial and commercial tax in August, 1997. The total collected was
$6.5 billion-a 12.9 percent increase over the same period in 1996. Included in the overall tax
is a business tax, which grew by 49.5 percent in August, 1997 alone. There are hundreds of
American businesses wanting to take advantage of the growth of China’s business sector.
Several US- based, multinational companies already have entered the Chinese market, and
now the smaller entrepreneurs would like to be included, too. One of the keys to this
movement is that China now claims an emerging middle class, most of which wants American
goods (Cross 25). US-China trade has increased by fully 90 percent since 1990, reaching $64
billion in 1996. Before Hong Kong reverted to Chinese ownership and rule, US businesses used
Hong Kong agents to negotiate with the Chinese government. Now, however, Hong Kong is
the international administrative arm of the Chinese government (Barnathan 30). Such
negotiations are less certain and requires either the services of an international trade
consultant, or at the very least, more than a passing glance at US government-generated tips
on doing business in China (Cross 25). Jiang announced that the unorthodox brand of market-
driven socialism that has propelled China this far needs a radical overhaul. In one of the most
sweeping sets of policy changes since the late Deng Xiaoping unleashed the forces of
modernization in 1978, Jiang announced that the state sector is in for a wrenching downsizing
(Clifford et al.). Of course, his plan to restructure carries with it the risk of opposition among
the worker’s, particularly those that will be left to fend for themselves. Historically, each
governmental liberalization of the past has resulted in a wave of capitalistic activity. Market
driven socialism and totally free markets are two very different entities, and the Chinese
government is faced with decisions of how much control they will levy on a freer market
system. Indeed, Jiang’s plan is so sweeping that it could unleash perhaps the largest wave of
corporate restructuring, mergers, and acquisitions the world has ever seen (Clifford et al.).
Certainly, China is poised to become the world’s next economic super power. Their success in
attaining that status will depend largely on how they collectively deal with their existing and
future economic issues, however. China recognizes the necessity of radical changes in some of
their current practices, most notably the ownership and operation of state enterprises.