International Business Environment MSc International Management with HRM

GLOBAL RECESSION

Mr. Sittichoke Tojirakran

2009

International Business Environment 2009

Business Cycle According to the Schumpeterian system (Maria, 1991) business cycle is to explain economic processes in capitalist societies. The process described itself as elaborate description of an economy in a stationary state and merely reproduces. There are several elements that use to indicate the flow of business cycle which are: Prices, interest rates, production and the quantity of money in circulation. These are 4 series that will be the main indices of business condition in Schumpeter view that could not be left out. Moreover, there are other factors that Schumpeter takes into consideration too which are: Employment rate, GNP, both in real and in nominal terms, investment as an approach to entrepreneurial expenditure, consumption expenditure, the investment/consumption ratio and wage bill and rates, both real and nominal

Source: University of Colorado Reading from above graph, Peak and Expansion period could be explained by Schumpeters theory as prosperity period. Basically every factor will rise in term of price level, interest rate, production, employment rate, amount of credits granted and GNP will increase substantially in nominal terms but only slightly in real terms(Maria, 1991). After successful period regarding to Schumpeters theory, there are two period of successive decline growth. The first period is recession which means every element that Schumpeters use to indicate business condition is declining in term of price level, interest rate, employment rate, GNP, investment and consumption, money in circulation and also stock price. Another period is depression which is far worst than recession in term of business condition. The level of all factors that Schumpeters used to indicate business conditions continue to decline further more than recession period (Maria, 1991).
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The reasons for recessions Many factors contribute to an economy's fall into a recession, but the major cause is inflation. Inflation refers to a general rise in the prices of goods and services over a period of time. The higher the rate of inflation it is, the smaller the percentage of goods and services that can be purchased with the same amount of money because the level of the price increased. Inflation can happen for reasons as varied as increased production costs, higher energy costs, national debt and currency fluctuation. After inflationary environment took place, people tend to cut out leisure spending, reduce overall spending and begin to save more. Unemployment rates rise because companies lay off workers to cut costs and business sector halted their investment because there is no demand in the market due to price is increasing and it will cause firm or individual deficit spending due to cost exceed income. It is these combined factors that cause the economy to fall into a recession (Maria, 1991). For example in 1973-1975 there was 16 months recession which cause came from unprecedented rates of inflation. This inflation was attributable to the relatively easy monetary policies and excessive spending levels via fiscal policy in the years preceding 1973. Moreover, there were other causes that contributed to the recession from oil price rose dramatically because of established OPEC and poor crops in many parts of the world drove food prices up rapidly. As a result, consumer slowed their spending due to the price of goods is high more than income. Workers were laid off because businesses held too much inventories due to before the recession there was expected strong demand so many businesses hold large amount of inventories despite the increasing likelihood of a contraction. When the recession hit the economy, businesses were force to liquidate their inventories and had to downsizing employees in order to save cost (Bails, 1982). Furthermore, there is other external reason that affects economic system such as War. From past experience when world enter World War 2 every countries had faces the epic of economic crisis which is GREAT DEPRESSION. Every intention was shifted toward the war and had left all those heavy industry such as farming and construction suffered. Investment and consumption was halted at that moment because every workforce was used for the purpose of War. The consequences of war causes unemployment rate rose up heavily and GDP or price level dropped sharply; for example United States unemployment reached 23.6% and United Kingdom fallen to 30% which indicate that people were jobless at that time and have no money to spend in order to stimulate economy (McElvaine, 1993).
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Moreover, global recession in year 2008-2009 which now is the scandal issue of the world economy and these are the reason why every country have to encounter this financial crisis. Trade Surplus and Hot Money During the past decade, the accumulated trade surplus of Asian growing economy such as China had contributed vast capital inflow to Western countries and particularly the US and the EU. This so called hot money made available financial loans to major institutions. However, this money refers to foreign funds that can be withdrawn anytime if financial market condition is poor. Therefore, when the crisis took place, we could see foreign investors divested from their asset portfolios of western financial institutions (Federation of American Scientists, 2009).

Low interest rate and accumulate bad-debt After Dotcom Boom and NASDAQ Bubbles in 1998 to 2000, The Federal Reserve cut down interest rate which leads consumer to borrow more and result of huge credit creation for banks. This extremely low interest rate encouraged the risen of the so-called toxic mortgages in early 2007 when the housing bubbles burst (Turner, 2008).

Easy lending and Subprime There was a time when banks hunting for higher yield, thus banks to buy loans or other credit-risky assets in the market. The interest rate for risky borrowers has been driven down to a much lower level by the motivation of hunt for yield which means banks were anticipated in short-term profit, so there looking for quick and easy transaction from the market. When US lower interest rate there were people whom willing to borrow and banks willing to lend out their money in return of profit. This action led to a credit boom for a very wide range of risky borrowers, including sub-prime mortgage borrowers and the leveraged loans supporting they major private equity boom of these years (Milne 2009). Market Illiquidity As I mention that banks were hunting for higher yields, thus banks kept poor quality asset, so when crisis took place the asset value fall harshly, many investors and lenders started to
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concerned and wanted their money back. as a result, banks couldnt meets all their liability which lead to collapse of Bear Stern, Northern Rock, HBOS Etc (Turner, 2008).

Failure of Risk Management Clearly, banks and financial institutions were not anticipated this risk, or if they did, the anticipation and precaution was insufficient. The losses incurred were mainly due to unexpected illiquidity in structured credit markets. Even though the issues of risk management and control was not found in some institutions that have better governance and investment discipline, poor risk management definitely add crunch to the credit crisis (Milne, 2009).

Current recession In Year 2009 global recession is now the biggest issue in every business, household, organization and every individual must confronted this crisis. Ever since 2007, Subprime crisis shook economy of the world due to collapse of Lehman Brothers, AIG and Bear Stearns. As I mention above about the reason for 2008-2009 financial crisis, the main reason that these financial intuitions that were forced to collapse was at that time they were hunting for yield by buying risky loan from risky borrower and when those borrower dont have money to pay back debt due to increasing of interest rate in US, thus Lehman Brother, AIG and Bear Stearns to ended their business. The fallen of powerful investment banks creates lack of confidence in investors, bankers and household, then its continued to spread in many parts of the world. This Global financial turmoil caused economy of the world to encounter credit crunch which mean banks are facing with liquidity problem caused by accumulate short-term mortgage bad debt. Moreover, this downturn economy happen to be an unsolved problem in year 2008-2009 because after Subprime crisis there are significant increasing number of unemployment rate and fluctuate exchange rate. Many regulations, policies, new theories etc. have been adopted to dissolve all of those side effects from financial crisis (World Bank 1, 2).

International Business Environment 2009

Source: World Bank, Bank Stock Market Wealth Decline From third quarter of 2008, the world economy started to decline sharply due to liquidity had drought out because of Accumulate short-term bad or poor quality asset, so when crisis took place asset value falling sharply cause investor concern and loss confidence. Many lenders and investment withdrawn their money out and makes bank faced liquidity problem and become unwilling to lend money to each other cause the monetary system all over the world to collapse. By the end of 2008, the stock markets all over the world lose value of dollar by 40-60 % implying enormous loss of wealth.

Forecast of global economy

International Business Environment 2009

Despite harshly declining in many countries GDP, but there are indicators that point to a slow recovery economy in late first quarter and second quarter of 2009. The economic growth will fall just 0.5% from 3.4% in late 2008. However, even those fast growing economy countries such as China, India, the Middle East and Brazil still absorb this multiple-affect by growing just 3.25% compare to last year of 6.25% growth rate combined together (CNN Money 1, 2009). Even United State the origin country of financial crisis, GDP grew in the third quarter by 3.5% (The Economist 2, 2009). Four quarter that US living in great recession but now US ended recession since beginning of 2008. Unfortunately theres still doubt from economist whether how long this strong growth going to last because (reading from graph1) second quarter of 2008 US GDP grew by 1.8 % but next quarter the economy back to recession again. Apparently, its means that the official ended date of recession is not expected to declare until sometimes in 2010 (CNN Money 2, 2009). The influence of slow recovery comes from wide-range of public intervention that supported demand, lowered uncertainty and reduced risk in financial market. Government and Central bank take part in contributed to inject the economy by launched new fiscal policy and control interest rate, in order to increase consumption, investment and liquidity in financial market once again. Although there is a sign of recovery but number of unemployment and poverty still remain and these two issues needed to be address closely. Furthermore, there is going to be an improvement in growth rate of 1.1 % in 2010 according to IMF prediction (IMF, 2009). Moreover, according to (World Bank 3, 2009) forecasted world economy GDP will increase to 2% in 2010 and 3.2% in 2011. More specifically, China continues its aggressive development with 7.5% in GDP next year and in Euro Area GDP will increase from contracted (4.5%) to 0.5% in plus zone. This is a sign that slow happened although its just forecast but still there is a sign that world is in first stage of recovery.

UK ECONOMY 2009

According to GDP: Last eight quarters; United States Gross Domestic Product in percentage

International Business Environment 2009

Source: UK National Statistic GDP UK have been living with downturn economy since second quarter of 2008 until now even the world economy started to recover in slow pace but still UK GDP is in minus zone but US managed themselves to plus zone already( see graph in page 7). This graph shown the figure of UK GDP started to decline in second quarter of 2008 decrease by 0.1% and continue to fall until first quarter of 2009 the figure reached 2.5%. Then in second quarter of 2009, GDP rose up by 1.9% compared with decrease of 2.5% in first quarter of 2009 and another rose up by 0.2% in third quarter. Its obviously better than prediction that GDP will contract 5.2% in third quarter of 2009 (ONS 2009). This mean that UK is still now in recession thus pound fell dramatically after this figure announced despite the fact that many observers anticipated that GDP will rise by 0.2% in this quarter. Due to a result of unexpected substantial decline in service sectors such as distribution, catering and hotel and financial service, which financial service is most likely to be the most important service sector that stretch recession of UK economy. Bank of England issue this problem seriously and stimulus economy by extending its policy of quantitative easing (BBC 1, 2009) from initial target of 75 million pounds, now raised up to 200 million pounds with the aim of injecting newly created money into the economy by buying assets (The Economist 1, 3, 2009). Furthermore, HM Treasury announce forecast of UK economic in term of GDP, Unemployment rate and CPI inflation.

International Business Environment 2009

Year GDP CPI inflation

2010 1.7% 2% 2%

2011

2012 2.1% 2%

2013 2.2% 2%

1.7%

From graph above, it can be concluded that GDP of UK will rise substantially from 2010 to 2013. Unemployment rate will rise in year 2010 of an average of 1.8 million but will decrease continually after year 2010. ( HM Treasury, 2009). Since summit took place in London and raised of quantitative easing by Bank of England there was significant change in UK GDP despite the figure shown minus sign but UK economy have improve in a certain way. With many injection from public and private sector that aim to stimulus the economy, therefore hope of recovery seem reachable according to forecast of HM Treasury.

COMPARE & CONTRAST BRITISH AIRWAY AND LlOYD BANK IN CURRENT RECESSION BRITISH AIRWAY British Airways established since 1910 providing air service from London to difference counties and towns all around the world. Now British Airways is the largest international scheduled airline with 141 destinations worldwide and 245 aircrafts in service (British Airways, 2009). Before financial crisis took place in second quarter of 2008 in UK economy, British Airways had strong profit portfolio even through fuel price rose cruelly in 2007 but still the airline generated income of 833 million pounds from year 2007 to March 2008(BBC 2, 3, 2008). However when the crisis started in second quarter of 2008 suddenly had an effect on British Airways revenue contracted 90% from April to June 2009 as a result of downward economic environment and sky-high fuel cost (The New York Times, 2008) and also there is decreasing in number of air passenger in UK, with figure 13% drop in the number of people using UK airport (Guardian3, 2009). This combination of problems cause BA to merge with Iberia
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Airways which is Spanish airline, in order to help BA during this downturn economic situation gaining more shares price by 7.5%. Moreover, it will help British Airways and Iberia to reduce costs of (350m) and BA expanding to new markets more in Latin countries (BBC 4, 2008). After 16 months long talked, now BA and Iberia agree to merge which will worth 4.3 million with a result of increased revenue to 13.4 billion pounds make this co-operation to be the third largest airline in EU and the sixth largest in the world (Guardian 1, 2009). But still the latest pre-tax profit in past 6 months ending on 30 September showed loss of 292 million pounds concerned by BA boss Willie Walsh prompted to cutting back cost by slashing 3,000 jobs positions in BA over the next 6 months. This increased anger of Unite Trade Union and will attempting to halt the reduction with a strike ballot which will hit BA from 21 December onwards (Guardian 2, 2009). According to (The Wall Street Journal, 2009) The CEO of BA told reporters he saw no green shoots of recovery in the industry and said BA must focus on reducing its cost base, so this could means that cost management is now the priority of British Airways. LlOYD BANKING GROUP Over a year ago, Britains banking sector encountered a near-death experience that government had to intervene and rescue those UK banks such as HBOS, Lloyd, RBS and Northern Rock. Now Lloyd is one of those major banks that managed by government because of liquidity problem cause by toxic assets (The Economist 4, 5, 2009). Its once had been said that Lloyd bank is strong and well capitalised institution which could save HBOS during the first stage of recession that HBOS is in greater of risk to collapse due to holding of poor asset quality. This was an opportunity for Lloyd TSB to merge with HBOS in order to gain more yield, reduce cost and gain more market share without considered the credit quality of the assets and in the end its turned out these two banks were part-nationalised by the government(The Economist 5, 2009). The merger of these 2 well-known banks was said to be pointless government to support in term of acquisition by injected 17billion into Lloyds Bank Group (LBG) which makes government own 43% of LBG shares. Also in the case of RBS and Northern Rock that faces this crisis and now were in the hand of UK government (The Economist 4, 2009). The recent support to bail-out this setback crisis for banking sector was made by HM Treasury pumped in more money into system. The Chancellor of the Exchequer Alistair
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Darling wants to create competitive market in banking market, apparently the merger result in a substantial lessening of competition in current account and mortgage lending, Thus forced LBG to shed at least 600 branches and its online business (The Economist 4, 2009). Such a result of shedding branches, now Lloyds already cut jobs more than 10,000 so far this year but mostly will be its operation unit such as IT and collection payment service(BBC 5, 2009). This is the price that LBG have to pay but in the same time there will be another policy from Treasury which is Asset Protection Scheme (APS) that will underwrote toxic assets for Lloyds (260b) and UBS (325b). Unfortunately, Lloyds escape from the scheme due to healthier markets and injection of 5.7 billion by current owner which is government. As up now the main obligation for LBG is to divest the businesses within 4 years (The Economist 4, 2009). These are 2 giant organizations that operated in different sectors but providing the same objective which is services. Recession had been an essential impact for these 2 organizations which lead to an enormous change in term of merger and acquisition. Lloyds merger was futile and BA merger was just only settled but somehow they used this strategy in order to reduce cost and gain more market shares. For Lloyds Bank, seem to be a fault decision to merge with HBOS because banking sector was heavily hit by the crisis cause credit in the system drought out. In the other hand BA merger with Iberia just started and the target is to boost profit by reducing cost. However, even merger took place but still Lloyds fell to survived and hand its problem to government shedding large amount of employees, same with BA even merger already patch up but still recession haunted BA to slashed 3,000 job position. BA is fighting to improve its balance sheet figure back to green again but in contrast Lloyds is fighting to survive in banking sector by helping of taxpayer or in other words is the people money. These 2 organizations are large organization with many shareholders, employees, and capital is essential and delicate to UK economic so when it collapses, government must hold the business. Lloyds shows UK a possibility of collapse by merging with HBOS in the other hand BA just merger with Iberia may be BA have to think twice of this merger or be cautious with this merger carefully. REFERENCES Bails, D.G., and Peppers, L.C. (1982) Business Fluctuations 2nd ed., United States of America: Prentice-Hall Inc.

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BBC News 1 (2009), Record Recession for UK economy. (Accessed November 15, 2009) <http://news.bbc.co.uk/1/hi/8321970.stm> BBC News 2 (2008), Strong Profit at British Airways, (Accessed November 15, 2009) <http://news.bbc.co.uk/1/hi/business/7221537.stm> BBC New 3 (2008), British Airways Soar 45%, (Accessed November 15, 2009) <http://news.bbc.co.uk/1/hi/business/7404085.stm> BBC New 4 (2008), BA and Iberia hold merger talks. (Accessed November 18, 2009) <http://news.bbc.co.uk/1/hi/7530819.stm> BBC New 5 (2009), Lloyds announced 5,000 jobs but. (Accessed November 18, 2009) <http://news.bbc.co.uk/1/hi/8352231.stm>

British Airways (2009), About British Airways (Accessed 31 January, 2010) <http://www.britishairways.com/travel/about-british-airways/public/en_gb >

CNN Money 1 (2009), Global Economy: 2009 Just like World War 2. (Accessed November 18, 2009) <http://money.cnn.com/2009/01/28/news/economy/imf_world_economic_outlook/index.htm > CNN Money 2 (2009), Economy finally back in gear. (Accessed November 18, 2009) <http://money.cnn.com/2009/10/29/news/economy/gdp/index.htm>

Federation of American Scientists (2009), Chinas Hot Money Problem. (Accessed Novembe, 16 2009) <http://www.fas.org/sgp/crs/row/RS22921.pdf>

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Guardian 1 (2009), Q&A: Iberia British Airways merger. (Accessed November 18, 2009) < http://www.guardian.co.uk/business/2009/nov/13/implications-iberia-ba-merger> Guardian 2 (2009), British Airways makes record loss of 292m. (Accessed November 18, 2009) <http://www.guardian.co.uk/business/2009/nov/06/british-airways-record-loss> Guardian3 (2009), UK air passenger numbers slump as recession bites. (Accessed January 31, 2009) <http://www.guardian.co.uk/business/2009/jun/16/uk-air-passenger-numbers-decreaserecession>

HM Treasury (2009), Forecast for the UK economy. (Accessed November 22, 2009) <http://www.hm-treasury.gov.uk/d/200911forcomp.pdf>

IMF (2009), World Economy Outlook (WEO): sustaining the recovery. (Accessed October 31, 2009) <http://www.imf.org/external/pubs/ft/weo/2009/02/pdf/c1.pdf>

Maria, B. (1991) SCHUMPETERIAN PUZZLES. 1st ed. United States: The University of Michigan Press Milne A. (2009) The Fall of the House of Credit. McElvaine, Robert S. (1993). The great depression: 1929-1941. New York: Three rivers press

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New York Times (2008), British Airways Offers Bleak Earnings Report. (Accessed November 18, 2009) <http://www.nytimes.com/2008/08/02/business/worldbusiness/02air.html>

ONS (2009), Economy: GDP Growth. (Accessed November 18, 2009) <http://www.statistics.gov.uk/cci/nugget.asp?id=192>

Turner, G. (2008). The Credit Crunch: Housing Bubbles, Globalization and the worldwide economic crisis. London: Pluto Press

The Economist 1 (2009). The Bank of Englands next step: Engineering that elusive recovery. 44, pp. 4 The Economist 2 (2009). Business. 44, pp. 10 The Economist 3 (2009). Business. 45, pp. 9 The Economist 4 (2009). New Banking Measures. 45, pp. 35 The Economist 5 (2009). Banks Funding. 41, pp.84

University of Colorado (2009). Business cycle graph. (Accessed January 31, 2009) http://www.colorado.edu/Economics/courses/econ2020/section7/section7-main.html

The Wall Street Journal (2009), BA Posts Loss Plans 3,000 More Job Cuts. (Accessed November 18, 2009) http://online.wsj.com/article/SB10001424052748704013004574518812703312746.html

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World Bank 1, Prospect for Global economy 2009: outlook summary. (Accessed October 22, 2009) http://web.worldbank.org/external/default/main? theSitePK=659149&pagePK=2470434&contentMDK=20370063&menuPK=659159&piPK= 2470429

World Bank 2, Prospect for Global economy 2009: crisis impact. (Accessed October 22, 2009) http://web.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTDECPROSPECTS/EXTGB LPROSPECTSAPRIL/0,,contentMDK:20370624~menuPK:659178~pagePK:2470434~piPK: 4977459~theSitePK:659149,00.html

World Bank 3, The Global Outlook in Summary 2007-2011. (Accessed November 14, 2009) http://web.worldbank.org/external/default/main? theSitePK=659149&pagePK=2470434&contentMDK=20370107&menuPK=659160&piPK= 2470429

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