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9-713-025
RE V: OCT OBE R 7, 2012
ALD O MU SA CCHI O
E RI C WERKE R
GEM 15: Country Development Strategies in 15

Statistics
Managers around the world face the difficult challenge of having to decide what countries to do
business in. In particular, managers have to adapt their strategy taking into account (a) the
macroeconomic fundamentals, (b) the development strategy, and (c) the institutional context
regulating entry and the operation of business in the country. Unfortunately, analyzing a whole
country can seem like a daunting task. In this note we introduce a simple framework we created to
simplify analysis of a country’s development strategy for the second-year MBA course Globalization
and Emerging Markets (GEM) at Harvard Business School. This framework is not properly a model
and it does not provide specific direction on what entry strategy works best given the nature of t he
national development strategy. For that we recommend consulting other sources, such as the
Institutional Voids framework of Tarun Khanna and Krishna G. Palepu ("Spotting Institutional Voids
in Emerging Markets," Harvard Business School Note 106-014) or the Four-Markets framework of
Eric Werker (“4M: Four-Markets Analysis for Emerging Economies,” Harvard Business School Note
713-026).
The GEM15 framework is a simple and time-efficient way to organize information about a country
in a way that will allow you to understand the weaknesses and advantages that countries have when
it comes to a) competing externally; b) growing fast; and, c) providing conditions to facilitate entry
and exit into the market as well as property rights protection. It is quick enough that it can be applied
in advance of any country case discussion, helping both student and instructor organize a handful of
key metrics about an emerging market. The GEM15 has the following components, where the bold-
faced entries represent the 15 quantitative economic statistics:
Professors Aldo Musacchio and Eric Werker prepared this note as the basis for class discussion.
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713-025 GEM 15: Country Development Strategies in 15 Statistics
MACRO PICTURE Internal demand External Demand

-GDP (US$ current) -Incremental domestic -exports as % of GDP
-Real GDP growth demand, Δ(C+I+G) (US$
-Inflation current) -Export performance
-External finance of the - Gini coefficient
trade balance (current (inequality) -Export products?
transfers and investment --To where?
inflow (+) or outflow (-) as a -Growth of middle class
% of GDP) -Investments/savings vs.
-Trend and size of consumption
government debt/GDP -Other sources of internal
growth (e.g., construction,
infrastructure investment)
Productivity Institutions and barriers to Competitiveness
-GDP per capita (US$ PPP entry -Real exchange rate trend
or US$) -Transparency International -Unit labor costs trend
-Labor productivity growth corruption ranking -Location: good/bad? Close
-Education level and quality -Real interest rate to big markets? Cheap
-Doing Business ranking manufacturing costs?
-infrastructure, skills -What countries are the main
shortages competitors?
-religion or other cultural
factors
As the analyst prepares the GEM15, she should be sure not to make it a fill-in-the-blanks exercise; the
country cannot be understood from the statistics alone, but rather what is behind them.
I. Macroeconomic environment (the fundamentals): This is basically an analysis to see if the

country has good fundamentals. Nowadays having good fundamentals is typically not a
source of competitive advantage (in the 1990s some emerging markets differentiated
themselves on the basis of showing good fundamentals as a way to attract investors, today
this is not really a source of advantage among EM), but having weak fundamentals (e.g., high
inflation, large current account deficits, or large government debt) can be a significant
obstacle for the realization of a country’s potential or its ability to attract foreign investment.
We think the macro framework can be efficiently analyzed using the following statistics (the
acronym GRIFT may help to remember what statistics to include):
1. GDP (US$ at market exchange rates) The size of GDP in US$. Is this a big market?
Is it too small to consider it as part of your company’s strategy? We prefer market
exchange rates to purchasing power parity (PPP) since the implicit perspective is
GEM 15: Country Development Strategies in 15 Statistics 713-025
from a foreign investor or manager. While PPP values are more helpful to see the
effective purchasing power of a nation’s consumers, they are not relevant for foreign
managers, who cannot extract profits from a market in PPP.
2. Real GDP growth How dynamic is this market? Is it a fast growing market?
3. Inflation Is inflation stable (say below 5%)? If it is double-digit (usually identified
as high inflation), is inflation going into single digits soon? Is inflation indicative of
poor macroeconomic management or rapid productivity growth (combined, perhaps,
with exchange rate management by the central bank)? Are there signs that there is
overheating (high inflation/high growth/low unemployment)?
4. External finance of the trade balance (current transfers and investment
inflow (+) or outflow (-) as a % of GDP) This statistic is meant to understand
the external component of the savings-investment balance, which says that a
country’s investment must be funded either by domestic saving or foreign
investment. How is this country financing its growth? How big are Foreign Direct
Investment (FDI) inflows? How big are portfolio inflows? Is current transfers a big
deal? Are the trends in these indicators smooth or volatile? Is there a large
accumulation of claims to foreign firms that will one day need to be paid back?
5. Trend and size of government debt/GDP Is government spending sustainable,
and are current expenditures being diverted to pay interest on past debt? Is a fall in
the value of currency or a sudden stop in capital inflows likely?
II. Productivity: By focusing on two key indicators we can get a fair idea of the level of
development of a country (GDP per capita) and a basic idea of the trend in wellbeing
(productivity growth per worker):
6. GDP per capita, and
7. Labor productivity growth
Economists and analysts usually focus on labor productivity growth because it is a good proxy
indicator for what is happening to the efficiency of production. Think of GDP per capita in the
following way:
GDP/POP = GDP / Workers * Workers/ Population
GDP per capita can be decomposed into labor productivity (output per worker) and labor force
participation (how many people in an economy actually work—economies with young people thus
should have faster GDP per capita growth than economies with a large aging population). To control
for changes in the labor force, the labor productivity component is the most illustrative.
Now, some managers and academics prefer to study the growth of total factor productivity and
the accumulation of capital. Yet, those two changes get reflected on increases in labor productivity, so
to keep things simple we will focus on labor productivity and GDP per capita. Usually labor
productivity and GDP per capita increase either when an economy accumulates more capital (i.e.,
machines) per worker or when the efficiency to produce improves (e.g., when new managerial
techniques are introduced, new factory floor design, ways to motivate workers, etc.) [see the
appendix for an explanation of the link of total factor productivity growth and capital per worker
with labor productivity]. Analysts should take caution with both of these statistics, particularly in
natural-resource driven economies, since price fluctuations or demand from the rest of the world can
lead to changes in measured productivity domestically. Ideally we would have a measure of latent or
potential productivity in addition to labor productivity. In many ways, the more simple GDP per
capita is the better measure for countries whose exports face wild price fluctuations.
We would like to be able to include a reliable and available statistic for education, but vast
differences in quality across countries—particularly emerging markets—make comparisons by
number of years of education, or enrollment, relatively inaccurate. PISA scores are available for some
70 countries, but relatively few emerging markets, where managers have to rely on qualitative
metrics for now.
III. Internal Demand: We want to understand if the country has a vibrant internal market. In
order to do that we will focus on the components that make total aggregate demand:
8. Incremental aggregate demand The change in consumption + investment +
government consumption (in US$ at market rates). The key metric for an investor
considering selling to a new market is the growth in the size of that market. This is
the concept behind BRIC and other frameworks for identifying markets of the future.
This statistic comes as close as possible to measuring new domestic demand; exports
are excluded in spite of their contribution to GDP since the demand for exports is
exogenous to the market (and imports are excluded since they are already counted in
C, I, and G).
9. Gini Coefficient of income inequality Income distribution: Is the country
unequal? How big is the Gini coefficient (it goes from 0 to 1, where 1 is perfect
inequality—the richest 1% of people have 100% of the income—and 0 is perfect
equality the poorest 10% have 10% of the income, and so on). We want to understand
what kind of consumers the country has, so we will pay attention to income
distribution. The Gini coefficient will give us an idea of how skewed income
distribution is. For some countries it is easy to find information about the size of the
middle class and the trajectory of their disposable income. Yet, for frontier economies
that kind of information is harder to find, so we suggest looking at the Gini
coefficient and then exploring these other data if available. For instance, for fast
growing emerging markets one may be able to find population pyramids by income
to map how big the middle class is.
IV. External Demand:

10. Exports/GDP How open is this country to trade? This statistic roughly measures
how much of production is going to foreign markets. How fast are exports (in US$)
growing? What is the country exporting? Commodities, manufactured goods, etc.

How sophisticated are those goods? What are the main destinations of exports?
V. Institutions and Barriers to Entry
11. Corruption rating This is a rank of countries by the perception of corruption
according to the studies of Transparency International. Corruption is one of the
major obstacles to doing business, especially in emerging markets. We see corruption
as a barrier to entry, especially for multinational firms that have to comply with the
OECD, American, or British anti-bribery legislation.
12. Real interest rate This is simply the nominal interest rate that borrowers face
minus the inflation rate. Usually a sign of tight credit markets, high real interest rates
create credit constraints for local, and foreign, players. High interest rates may be a
sign of credit constraints or of instability, or of a high likelihood of a new loan
becoming non-performing since some markets with excess bank liquidity are still
characterized by high interest rates. Thus, they can be an advantage or disadvantage
for foreign entrants.
13. Doing Business ranking A shortcut to studying everything from barriers to entry
in the form of bureaucratic procedures, or complications to enforce contracts, to pay
taxes, or to hire or fire workers, the Doing Business Ranking gives a short hand
measure to compare countries in their general ease of doing business. Those
interested in specific issues such as the difficulty of firing/hiring, or taxes should do
additional research, but we think it is important to have a good idea of at least the
general rank of the country.
VI. Competition:
14. Real exchange rate trend Real exchange rates may be appreciating or depreciating,
depending on domestic inflation as well as the evolution of the nominal exchange
rate. An appreciating real exchange rate indicates a likelihood of increasing external
demand for either the exports or investments of a country (and a depreciating rate
the converse). However, an appreciating exchange rate is also an indication that the
future of cost-competing exports may be threatened (and vice versa).
15. Unit labor costs trend While the real exchange rate captures the movement in
relative prices in the product market, looking at the trends in unit labor costs (ULCs)
does the same in the labor market. ULCs rise with wage increases but decrease with
productivity gains, so can be seen as the price of producing a certain amount of
output. They can be expressed in dollars or local currency, depending on the
perspective of the manager.
 Other indicators people managers may be interested in are: Who are the country’s
competitors? Is the location of the country good? Is it close to a big market? Is it
cheap to manufacture products there? (the real exchange rate can get at the last
question when it incorporates labor costs).
Having analyzed these components it should be easy to understand the country’s Development
Strategy (managers can think of the development strategy of a country as its “value proposition” or
the way in which a country differentiates from other countries).
Development Strategy: “What is this country’s business model? What differentiates this country
from others? In short, what is this country’s value proposition?” (Sometimes there will be a clear
answer, sometimes the answer is more complex, and sometimes it is not even clear whether the country
has a source of advantage that will allow it to stay ahead of the curve for a sustained period of time).
From the GEM15 analysis we think it should be clear where countries get their advantages. For
instance, oil exporting countries have the advantage of having the natural resource wealth. In the same
way, fast-growing developing countries usually have high productivity growth because they have
favorable institutions, low barriers to entry, a big internal market or they are competitive abroad,
and they are good at adopting foreign technological and managerial advances (they have fast
productivity and TFP growth). Alternatively, other countries simply rely on their location to obtain
advantages and have strategies that are consistent with such differentiating factors. Still other nations
may be designed not for productivity growth or export success, but rather to protect the rents of a
privileged set of interests—this is a sort of business model as well, but one that will not bring about
radical improvements in the standard of living of the citizens.
The success of a development strategy in this framework will depend on whether the country has
the conditions, either macroeconomic or contextual, which allow it to increase its production year
after year. Some countries do not necessarily need to be successful exporters to grow (e.g., the United
States, which has a very low share of exports to GDP), as long as they have a vibrant and competitive
internal market. The boom in emerging markets in the early twenty-first century is tightly linked to
the rise of a large middle class of consumers with incomes ranging from $3,000 to $10,000 or $15,000
per year that allows them the discretionary income to buy consumer products, durables, and more
sophisticated “necessities” like food and shelter that can, in turn, provide the demand for new and
better supply. Obviously at the end of the day, firms need to push for sustained productivity
increases either by accumulating capital or by innovating, adopting or developing new technologies,
and improving managerial techniques. Governments can play a part by creating the conditions in
which firms can do this successfully, and in some countries they can create firms themselves.
Appendix: Why do we care so much about GDP per capita growth, labor
productivity growth and TFP growth?
GDP per capita is our basic measure of living standards in a country. It obviously obscures whether
income inequality is steep or not. We can think of GDP per capita as having two components
GDP/POP = GDP / Workers * Workers/ Population
One component is output per worker, also known as labor productivity, and the other one is labor
force participation (how many people in an economy actually work). Thus, finding ways to improve
labor productivity can help to improve the living standard of a country (e.g., if there is more output
for the same number of workers).
What is behind improvements in labor productivity?
Labor productivity can increase for mainly two reasons. First, labor productivity is ti ed to total
factor productivity increases. If a manager can increase total output using the same inputs, then output
per worker should automatically be higher. Second, if the capital-labor ratio increases, i.e., if there is
more capital per worker (think of having more machines or servers per worker and how that should
increase overall labor productivity as the same worker should be able to produce more output). Total
factor productivity (TFP) is a measure of the efficiency with which a country or company uses the
resources it has. TFP can thus increase if managers/governments find ways to improve the way in
which existing resources are used. Imagine a Starbucks that has one cashier, two baristas and one
espresso machine. The owner of the coffee shop could increase productivity by increasing the capital
labor ratio (e.g., buying another espresso machine) or improving the way it uses the resources it has
(increasing TFP), for instance, by dividing tasks in a way that streamlines production.
If you want to think about it as a cooking recipe, think about the following (where  represents
the rate of change over time)
%Output (GDP) ≈ %Capital*(share of capital) +%Labor * (share of labor)+% TFP
A country or a company can increase output by increasing total capital (times the share of capital)
or increasing the number of workers (times the share of labor), or by improving the efficiency with
which it uses capital and labor.
Now, economists prefer to look at labor productivity in the following way. First, let’s say α is the
share of capital and 1-α is the share of labor, then we can regroup
%Output (GDP) ≈ α%Capital +(1-α)%Labor +% TFP
%Output (GDP) ≈ α%Capital +1%Labor –α%Labor +% TFP
Then we subtract %Labor from both sides
%Output (GDP) - %Labor ≈ α(%Capital -%Labor) + %Labor +% TFP -%Labor
And get to
%Output (GDP) - %Labor ≈ α(%Capital -%Labor) +% TFP
The equation above looks at the changes in labor productivity (the change in output/labor or
output/worker) as either a consequence of a change in TFP or a change in the capital labor ratio. In
simple terms, we would have an equation like this:
% (Output (GDP)/Labor) ≈ α% (Capital /Labor) +% TFP
Putting the pieces back together we have that:
 Labor productivity (output/worker) increases if there is more capital per worker or if there is
an improvement in TFP (a productivity enhancement that is not related to having more
capital per worker).
 Labor productivity is an important measure because it is directly tied to the living standard
of a country. If you can produce more per worker, then the average living standard of the
country, i.e., its GDP per capita should go up, all else equal.
 One way to increase GDP per capita is to increase labor force participation (workers to
population). That would happen if there are more workers (or working hours) for the same
population. That is why some analysts produce reports showing population pyramids.
Those pyramids not only tell us when there is going to be a spurt in the adult population
who can consume (i.e., the population that has more disposable income to consume), but also
when we may have jumps in GDP per capita (or living standards) simply because the
economy will be able to produce more thanks to an increase in the number of workers!
 Therefore, if we care about the living standard of a country in the long run, we want to study
how countries sustain increases of GDP per capita and labor productivity in the long run.
Appendix 2: Real Exchange Rates and Unit Labor Costs

An easy example to understand real exchange rates looking at it from the point of view of China
ERREAL ($/¥)= ERNOMINAL ($/¥) * PCHI / PUSA
First, let’s assume the exchange rate (ER) stays fixed. We want to see how having high inflation in
the US (change in PUSA ) will affect China’s competitive position vis a vis the United States. Start from
an arbitrarily chosen year and look at the changes from there ( usually we want to start in a year in
which there is no big disequilibrium in the balance of payments or the balance of trade)
ERREAL ($/¥)≈%ERNOMINAL ($/¥)+%PCHI — %PUSA
If %PCHI>%PUSA, say by 5%. Then, under a fixed exchange rate the real exchange rate would
appreciate 5% (%ERREAL ($/¥)=5%).
So if we arbitrarily choose a year to start our exercise and say that the real exchange rate in the
year 2000 is ERREAL=100, then if the exchange rate is fixed and in 2001  PCHI—PUSA =5%, then the
real exchange rate in 2001 would be ERREAL =105. Just because we know inflation was higher in
China. Thus, we would say that China is losing competitiveness vs. the United States.
Now, let’s say we are in a floating exchange rate regime. There if inflation in China is bigger than
in the United States, %PCHI >%PUSA, by say 5%, but the nominal exchange rate depreciates by 15%
(i.e., %ER$/¥= -15% ). Then the real exchange rate overall would depreciate 10% and would make
China more competitive, even if inflation was higher there than in the United States.
Real exchange rates in and off themselves have no meaning, that is why when we examine real
exchange rates we look only at trends using indices. That is we only care about whether a country
is becoming less competitive or more competitive. In our specific example, an exchange rate index
going up means, from the point of view of China, that its exchange rate is appreciating and that the
country may be becoming less competitive. Americans usually prefer to see real exchange rates defined
as foreign currency units per US dollar and thus relate indices going down with real exchange
rate appreciations in China. This is because of the vantage point from which the index was constructed.
Thus, it is important to pay attention to the definition of real exchange rates used by each analyst.
Usually central banks and other agencies that report real exchange rates report exchange rates that
compare a country, say China, against all of its trading partners. So instead of looking at China’s
inflation say vs. inflation in the United States, they create a weighted average of inflation of all the
trading partners (weighted by the importance of exports to each country). The same with the
exchange rate, instead of looking at the Yuan-dollar exchange rate, they create an index that takes
into account the movements of the Yuan against those of the currencies of the main trading partners.
This is also sometimes referred to as the Real Effective Exchange Rate.
Now, competitiveness here is defined very narrowly as just price differentials adjusted for the
exchange rate. This ignores productivity differentials and cost of labor in both countries. That is why
we recommend to also look at the so-called ULC-based real exchange rates, or the real exchange rates
that take into account the differences in Unit Labor Costs.
Unit Labor Costs

Before we explain how analysts construct indices of real exchange rates using unit labor cost (ULC),
let us explain in simple terms what ULC is. It usually measures the cost per labor hour to produce one
unit of output. We define formally as follows:
ULCUS$ = Wage per hour of labor in US$ / output per labor hour.
Note that output per labor hour is simple labor productivity. Thus, if ULC go up, the cost of
producing a unit of output goes up and could lead to a loss of competitiveness if the increase is larger
than that in other countries. Usually we care about ULC in manufacturing to measure competitiveness.
It is common to find ULC expressed as an index (year t =100). Again, tracking those indices over time
tell us about the dynamics in the labor market and in productivity in a country.
Real Exchange Rates Using Unit Labor Cost

Now, to properly use ULC to compare the competitiveness of a country versus another or a group of
countries, analysts usually track an index of real exchange rate of the following form:
ERREAL (ULC, $/¥) ≈ % ULC US$-CHI — %ULC US$-USA ,
where ULC is an index of unit labor cost in US$ for each country. If  ULCCHI>ULCUSA, say by 5%,
then we know that the China is losing competitiveness vs. the United States because its labor costs are
increasing. Of course, if Chinese manufacturing wages are twenty times lower than those of the United
States, China can lose competitiveness for years before losing factories to the United States. Yet, if we
see the trend in Chinese unit labor costs going up, we can infer that competitors with low wages such
as Vietnam or Bangladesh may actually become more attractive places to manufacture low value
added goods, such as simple textiles or shoes.
In sum, real exchange rates are used to measure competitiveness, but they are not absolute
measures of competitiveness—they are aggregate indicators that tell us trends in competitiveness. A
manager in the United States worried about a competitor in China would most likely rely in her own
measure of real exchange rate, that is the cost of her product in US$ vs. the cost of the Chinese
competitor’s product in US$. A manager from Germany thinking about locating a manufacturing plant
in another country may use the ULC-based real exchange rate because it may provide more
information about costs and productivity than a real exchange rate that uses price indices (e.g., the
consumer price index—CPI—or a producer’s price index—PPI).
10

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9-713-025

RE V: OCT OBE R 7, 2012

GEM 15: Country Development Strategies in 15

MACRO PICTURE Internal demand External Demand

I. Macroeconomic environment (the fundamentals): This is basically an analysis to see if the

GDP/POP = GDP / Workers * Workers/ Population

IV. External Demand:

growing? What is the country exporting? Commodities, manufactured goods, etc.

GDP/POP = GDP / Workers * Workers/ Population

What is behind improvements in labor productivity?

%Output (GDP) ≈ %Capital*(share of capital) +%Labor * (share of labor)+% TFP

%Output (GDP) ≈ α%Capital +(1-α)%Labor +% TFP

%Output (GDP) ≈ α%Capital +1%Labor –α%Labor +% TFP

Then we subtract %Labor from both sides

%Output (GDP) - %Labor ≈ α(%Capital -%Labor) + %Labor +% TFP -%Labor

%Output (GDP) - %Labor ≈ α(%Capital -%Labor) +% TFP

% (Output (GDP)/Labor) ≈ α% (Capital /Labor) +% TFP

Putting the pieces back together we have that:

Appendix 2: Real Exchange Rates and Unit Labor Costs

ERREAL ($/¥)= ERNOMINAL ($/¥) * PCHI / PUSA

ERREAL ($/¥)≈%ERNOMINAL ($/¥)+%PCHI — %PUSA

Unit Labor Costs

Real Exchange Rates Using Unit Labor Cost

ERREAL (ULC, $/¥) ≈ % ULC US$-CHI — %ULC US$-USA ,

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%Output (GDP) ≈ %Capital(share of capital) +%Labor (share of labor)+% TFP