Answer :

Macroeconomic Variables in United States

Analysis of Australian Trading Partner

Executive Summary

The following pages intend to provide a recommendation to ABC Company, an Australian company regarding long-term investment prospects in the United States. ABC Company plans to invest approximately AUD1.2mn.

For this purpose, the United States economy has been selected as the place for investment and it is recommended to invest the money because given the macroeconomic performance, business environment and outlook of the economy, it is expected that the investment will earn a good return.

The country’s GDP has grown consistently during 2012 till 2017, both in GDP and per capita terms. Further, the growth rate is between 2.5% to 4%. For the same period, the inflation-adjusted GDP growth rate has ranged from 1.5% to 2.9% in real terms. The growth rate of inflation in the United States dipped to minimum in 2015 but afterwards has risen steeply to 1.3% in 2016 and 2.1% in 2017. It is expected that the inflation will continue to grow at an increasing rates for coming years. The unemployment rate in the United States is declining continuously from 8.1% in 2012 to 4.4% in 2017 which is a positive sign. While the country’s current account balance deficit has increased slightly for the United States during 2012-2017, it has still been range bound around 2.5% of the country’s GDP for the corresponding year. The real interest rate in the country has been low and range bound from 1.3% to 2.21%. 

The Doing Business survey, 2018 as conducted by the World Bank Group also indicates that the United States ranks 6^th as a good place to do business in. Various reforms and regulations, policies, use of technology, access to various resources, judicial system, taxation policies etc. indicate this.

Additionally, OECD report indicates that the country is going through an expansionary phase. The confidence in the economy is back after the financial crisis of 2007-2008. The consumption and investment both are expected to grow giving a boost to the economy.

Introduction

The following pages intend to provide a recommendation to ABC Company, an Australian company regarding long-term investment prospects in the United States. ABC Company plans to invest approximately AUD1.2mn.

For this purpose, the United States economic performance will be analyzed through various key macroeconomic indicators such as GDP, unemployment, inflation, current account balance, real interest rate etc. 

Further, the analysis will be strengthened by analyzing how the country has performed to provide a conducive environment for investment and setting up a new business. This will be done in terms of various parameters such as starting a business, dealing with construction permit, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts, resolving insolvency etc. 

Additionally, various reports on outlook of United States economy will be used to understand the future prospects of the same. Finally, recommendation will be provided in accordance with above analysis.

Analysis and Discussion

Overview of Macroeconomics

The Greek word macro means large. By this extension, macroeconomics involves study of economy as a whole. The economy to be studied as a whole can be global, national, regional or a state-level etc. The important point is that macroeconomics does not involve analysis of individual units, rather aggregates or averages. Hence, the field is sometimes also called theory of income.

While studying economy as a whole, there are few indicators that are commonly referred to in order to assess how the subject economy is performing. Some of these indicators include output, GDP, unemployment levels, prices and inflation levels, debt levels, performance of various sectors, etc. The level at which these indicators are for a particular economy indicate how the economy is performing with respect to other economies as well as its own historical performance. It is important to note here that these indicators are average for the whole economy and not for individual units. Hence, while one particular unit may be faring relatively well, another may be not doing so well. Both will impact the macroeconomic indicators that will depict the average (Ackley, 1978).

Selection of a Trading Partner

As determined, ABC Company wants to invest approximately AUD1.2bn in one of the major trading partners of Australia. The country selected for the purpose for this analysis is the United States.

According to the Australian department of foreign affairs and trade (2018), the top trading partners of Australia, along with their import and export trading numbers as of 2016, include:

Australia’s Top Ten Trading Partners

Source: Department of Foreign Affairs & Trade, Australia (2018)

It can be seen that as of 2016, the United States is the second top trading partner for Australia in terms of trading volume. The further details of the goods trade with the United States is provided in the following pages:

Source: Department of Foreign Affairs & Trade, Australia (2018)

It can be seen that the trade with the United States is varied across industries with varying volumes.

Macroeconomic Indicators

Now that we have selected the United States as the preferred choice for investment, we will consider key macroeconomic indicators to understand how the country has been performing.

GDP

The first factor to be considered is the GDP of the country. Gross Domestic Product or GDP is one of the key factors which is globally accepted as an economic performance indicator. It indicates the national income or output during a given period of time. In other words, it is the total market value of goods and services produced by an economy during a specified period. The method to arrive at final value of goods and services is the sum of value added at each stage so as to avoid duplication of monetary value of goods and services produced. The GDP is affected by various factors, such as, rate of investment and savings in the economy, government expenditure, etc. (Kira, 2013).

The following graph shows how the United States GDP has changed over a period of five years from 2012 to 2017 (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

It is evident that the GDP has grown consistently. The growth rate has been approximately 3%-4% y-o-y basis.

The per capita GDP provides a better picture as it indicates the GDP per person in the economy and it is as follows (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

Again, the y-o-y growth rate for GDP per capita varied from 2.6% to 3.7% during the given period which indicates that the GDP growth is consistent across.

However, the GDP discussed above is in current prices that also increase due to price changes. When inflation occurs in an economy, the prices increase. Since GDP is measured in current prices for the period in consideration, the GDP as such will increase even though the production of goods and services may have been the same or even declined. Hence, the GDP should be adjusted for inflation in order to arrive at real GDP which gives a better picture (Kira, 2013). 

The real GDP growth rate for the United States during the mentioned period can be represented as follows (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

Now, this gives us a real picture of GDP growth rate in the United States Economy for the period 2012 to 2017. The growth rate has ranged from 1.5% to 2.9% in real terms and reached its lowest in 2016 at 1.5%. However, the growth rate has again picked up as seen by the steep increase in 2017 to 2.3%. Hence, it seems that economy is poised for better growth rates in coming years.

Inflation

Inflation is another important macroeconomic indicator for an economy. Inflation refers to consistent increase in price levels of goods and services within an economy. The point to be noted is that it is a general price rise and that too in prices of goods and services. Assets are excluded from the definition. Further, the rise should be sustained for a period of time so as to qualify to be called inflation (Labonte, 2011).

The inflation rate in the United States economy during 2013-2018 can be depicted as follows (U.S. Bureau of Labor Statistics, 2018):

Source: U.S. Bureau of Labor Statistics (2018)

As seen above, the inflation shows an upward trend which can be confirmed with the below graph that depicts growth rate of inflation (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

As seen above, the growth rate of inflation in the United States dipped to minimum in 2015 but afterwards has risen steeply to 1.3% in 2016 and 2.1% in 2017. It is expected that the inflation will continue to grow at an increasing rates for coming years. Interestingly, post the World War II, the United States has faced continuous inflation or rise in prices of goods and services. Before the World War II, the country was facing deflation.

Unemployment

For understanding the labor market of any country, the key macroeconomic variable to be studied is the unemployment level in the economy. The term is self-explanatory however, to measure the unemployment rate in consistent manner, the most widely acceptable and used definition is as follows: a person is unemployed if the person is not working but is willing to work. Typically, it is difficult to measure unemployment in any country due to factors such as appropriate working age, population counted as out of labor force etc. Large unemployment rates are bad for the economy as apart from the obvious economic losses, it also results in social and health issues that occur with the unemployed population. It may also lead to a dip in the GDP as the country is losing out on the production of goods and services that could have been produced, had the people been employed appropriately.

The unemployment rates in the United States can be depicted through the graph below (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

It can be seen in the above graph that the unemployment rate in the United States is declining continuously from 8.1% in 2012 to 4.4% in 2017. This is a positive sign as it indicates that the economy is able to employ the available labor force. Further, this will increase the GDP output of the country leading to further growth of the economy. More employment also indicates higher purchasing power as well as higher amount of savings that are positives for any economy.

Current Account Balance of Trade

Current account is one of the components of balance of payment of a country. Current Account refers to the sum total of a country’s net balance of trade, net income, direct transfers and asset income. The net balance of trade refers to export of goods and services minus import of goods and services during a period. The net income refers to income received by the residents of a company minus the income paid to the foreigners. The income earned is mainly from overseas investments and residents working overseas. Direct transfers refer to remittances to the home country. Finally, the asset income refers to income from country’s assets such as bank deposits, real estate etc. (Amadeo, 2018).

When there is a current account deficit, it mainly indicates that imports of goods and services by that country exceed its total exports of goods and services. When this gap is very large, the economy is said to be an unbalanced economy that can pose detrimental effects for the currency of the country as it indicates that economy is relatively weak. However, when there is surplus, it indicates that economy is strong and competitive.

The current account balance of the United States for the period 2012-2017 can be depicted as follows (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

It can be seen in the above graph that the current account balance has been negative all through, except in 2013. Further, the deficit is gradually increasing. This indicates that the United States is importing more goods and services as compared to exports of goods and services and this gap is increasing slowly.

However, the absolute numbers may be misleading. We can get a better estimate if this deficit is presented as a percentage of the GDP of the country for the same period. This will indicate the magnitude of the deficit and whether it is too large to be a cause of concern. If the deficit is increasing in absolute dollar terms but is still low as a percentage of GDP, it does not indicate a large concern.

The current account balance deficit as a percentage of the country’s GDP for the corresponding period for the period 2012-2017 can be depicted as follows (Statistics Section, DFAT, 2018):

Source: Statistics Section, DFAT, 2018

From the above graph, a better picture can be deciphered that while the current account balance deficit has increased slightly for the United States during 2012-2017, it has still been range bound around 2.5% of the country’s GDP for the corresponding year. Hence, the deficit does not pose any concern currently.

Real Interest Rate

The interest rate that prevails in the economy indicates the cost of credit in the economy at a given point of time. Hence, higher interest rate indicates higher cost of credit and conversely, lower rate of interest indicates lower cost of credit.

However, the interest rate itself is of two types, namely, nominal rate of interest and real rate of interest. The nominal rate of interest is the actual rate prevailing in the economy or, the rate that needs to be paid by the borrower as coupon rate. When this rate is adjusted for inflation, it is known as the real rate of interest. Since inflation causes a rise in general price rise over a period of time, the interest rate will indicate the same even if actual rate has not gone up in terms of the purchasing power of that interest money. To arrive at this rate, one needs to subtract the inflation rate from the nominal rate of interest.

This inflation-adjusted, real rate of interest that prevailed in the United States economy for the period of 2012 till 2017 can be presented as follows (World Bank, 2018): 

Source: World Bank, 2018

From the graph above, it is clear that the real interest rate in the country has been low and range bound from 1.3% to 2.21%. While the rate is increasing slightly in recent years, it is mostly low. This is in tandem with the nominal interest rates that have also been low in the economy. The low rate promotes more investment, borrowing and expenditure leading to growth of the economy that is desirable. Low cost of credit also implies that business can borrow funds at a lower rate and increase the profit margins.

Impact of Financial Crisis

The 2007-2008 financial crisis was considered to be one of the worst crisis since the Great Depression in 1930’s. Unfortunately, the financial crisis began in the United States. The subprime mortgage bubble burst in the country led to a domino effect that caused widespread turmoil in the financial sector of the country. Gradually, the crisis became so large that it assumed global proportions and the ripples could be felt for more than half a decade after the crisis.

The main reason behind the subprime mortgage bubble burst was the cheap credit that was given to all and sundry. The mortgage was apparently secured by the real estate owned by the borrower. Hence, as the real estate prices kept soaring in the United States, the extendable value of credit became large and large. This was feasible only till values of the properties were rising. Once the prices crashed and the collateral became almost worthless, there were widespread defaults on the loans. The borrowers no longer saw it feasible to service their debts as it was much more expensive than their properties now. This led to turmoil in the banks that had extended these loans as there was a large amount of bad debt. It was further complicated due to complex securitization structures that were being sold in the market which were again supported by the real estate collateral. Lehman Brothers, one of the most reputed investment banks, was the first to go bankrupt and this was just the beginning. It was followed by multiple bankruptcies by the banks. Finally, the United States government had to intervene in form of emergency economic stabilization bailout package (more than $700bn) which was one of the largest doled out in the history (The Economist, 2013).  

Although this package seemed to provide relief, the crisis could not be contained and it spread to other countries as well. The global economy suffered ta the hands of this crisis. This recession lasted a long time. However, as discussed above, we can see that the United States economy has shown resilience by getting its indicators right. The GDP is growing, unemployment is declining, inflation seems fine and the deficit as a percentage of GDP seems under control as well. This shows the strength of the economy. Despite the crisis, the United States economy is one of the largest economies in the world.

Business Environment

Apart from the macroeconomic indicators of an economy, it is important to look at the business environment as well. It refers to various policies of the country that help in setting up a business. Conversely, the adverse policies towards setting up of businesses will discourage investors from entering the country even if the macroeconomic situation of the country is strong. In other words, apart from economic strength, a country also needs to ensure that conducting a business or setting up a new business is streamlined and smooth in the country. It needs to remove various obstacles that may dissuade investors from investing in the country.

Ease of Doing Business

One of the best indicators to understand the ease of doing business is the ‘Doing Business’ survey by the World Bank group. In 2018, the group released 15^th survey in the series that spanned across 190 economies and compared them on various parameters such as, setting up a new business, business regulation, protection of rights, construction permits, getting electricity, registration process, access to credit, taxation policies etc. In all, eleven such aspects or indicators have been covered by the survey. Additionally, the survey also provides how economies have fared in 2018 as compared to the previous years. The data collection for this survey has been done basis the respondents, study of rules and regulations, governments of economies covered and the World Bank staff. In all, around 43,000 professionals across economies assisted in data collection process for the survey.

The following paragraphs will discuss the parameters included in the survey (World Bank Group, 2018):

Doing Business Parameters

Source: World Bank Group (2018)

Before the parameters are discussed, a discussion is required regarding how the countries are ranked under the survey. The countries are a given a ‘distance to frontier’ score one ach parameter and then the overall score is used to rank various economies. The frontier indicates a score of 100 or the best possible performance with respect to parameters. The distance to frontier for an economy with respect to a parameter indicates how far the economy is from the best possible performance. A lower score indicates lower rank for the economy as it indicates that there is scope for lot of improvement to reach the best possible performance. Conversely, higher score indicates higher rank as it indicates that economy is doing well on that particular parameter. The following diagram provides an idea on how the ranking and score works. The vertical axis shows the frontier from 0 till 100. The horizontal axis categorizes economies on geographical and performance basis. The bars indicate highest and lowest scores in a category while the orange mark indicates average score for the category

Ease (difficulty) of doing business

Source: World Bank Group (2018)

Now, various parameters and how they are analyzed will be discussed:

1. Starting a business: This parameter focuses on various procedures involved and also the time and money that someone will have to spend when looking to set up a limited liability company business in an economy. If the time or money involved is huge or if the procedures are cumbersome, this may dissuade an investor from investing in that economy. However, if these factors are favorable, then the investors will be attracted to do business. As per the survey, 38 economies made efforts to streamline the process so as to attract investors. These efforts included simplification of procedures, reducing time involved in getting through and costs involved in the process. Currently, the global average number of days taken by an entrepreneur to formally start a business stands at 20 days. This implies that, on an average, an entrepreneur will take around 20 days to formally kick start a business. Further, economies such as Equatorial Guinea, Niger, Democratic Republic of Congo, made huge improvements in their scores by putting good reforms in place, such as, no permission required from the Prime Minister’s office to set up business, woman does not need husband’s permission to start a business, setting one-stop shop to fulfill the formalities. All of this has helped to reduce the time and cost involved in setting up of new business.
2. Construction Permits: This particular parameter focuses on various procedures involved and also the time and money that someone will have to spend in order to set up a warehouse, set up quality control mechanisms and complete the formalities thereby. Given the importance of construction sector in any economy, it is an important parameter. The state of this sector gives an immediate sense of the wellbeing of the economy. A booming construction sector indicates growth prospects while a sluggish construction sector with projects abandoned midway indicate trouble in the economy. However, the sector is characterized by fragmented players who are resistant to adapting technological changes that causes delays and lags in the permission procedures. Many governments are keen to streamline reforms for the sector. Basis the survey, five of the twenty two economies that introduced reforms for permitting construction focused on reducing total time taken to give permission to start construction. Some of the economies that improved the construction permit reforms tremendously are Côte d’Ivoire, Ukraine, Ghana, Lithunia, etc.
3. Getting Electricity: This particular parameter measures how streamlined the procedures are with respect to getting an electricity connection. It also measures how transparent is the price for electricity and how reliable is the supply of electricity. As with other parameters, it also measures overall time and cost involved in getting electricity connected. According to the World Bank Surveys, entrepreneurs quote access to reliable electricity supply as one of the top five challenges in setting up a business. This particular parameter is fraught with different challenges. While some economies may have cumbersome process to get electricity connection due to corruption, the others may have the same challenge due to multiple interactions required that delay the process. Another challenge is supply of reliable electricity connection and lack of electricity all together. Basis the survey, various economies made efforts to streamline the regulations for getting electricity connection, reduce number of interactions, improve reliability of electricity connection in order to reduce outages, etc.
4. Registering property: This particular parameter measures how streamlined the procedures are with respect to getting a property transferred, including cost and time involved. It also measures the quality of land and administration system. Without property rights, it is not possible to invest and thereby, the economic growth will be hindered. Proper registration also helps to obtain credit as the property becomes collateral. Basis survey, as many as twenty nine economies made efforts to streamline the process of registering the property transfer, mainly by increasing work efficiency in departments and improving regulations quality to remove bottlenecks. Mauritius improved the most by making 10% transfer tax redundant.
5. Getting credit: This particular parameter measures various credit information systems available in the economy and also various laws related to collateral for the loan. Basis the survey, around twenty four economies improved reforms with respect to credit information systems. Basis survey, Malawi improved the most by setting a new credit bureau. The bureau basically improves information systems by collecting and disbursing news regarding individuals, firms that have borrowed. The news can be either favorable or adverse.  
6. Protecting minority investors: This parameter evaluates various corporate governance and rights of minority stakeholders and how protected they are in various related-party transactions. The main tool is to introduce laws that compulsorily ask for disclosure of transactions where the company may have conflicting interest. Further, the regulations may aim to safeguard minority interest through discouraging certain type of transactions which may be conflicting. Basis survey, more than twenty economies made efforts to introduce reforms aimed at protecting minority interest. Some of the economies that improved massively include Djibouti, Costa Rica, etc. 
7. Trading across borders: The parameter measures time and cost involved in exporting goods and services in which economy has competitive advantage and importing goods and services in which it does not have a competitive advantage. International trade is of prime importance for growth and development of any economy. Reforms regarding this parameter related to the efficiency of trade and also lowering costs involved. Further, efforts were there to make the regulations transparent and streamlined for ease of trade. Basis survey, twenty two of the thirty three economies that undertook reforms improved electronic systems utilization for purpose of trade which led to reduction in time taken for the formalities.   
8. Paying taxes: This parameter evaluates various tax related payments, amounts and approximate rate of tax that the firm has to contribute to comply with regulations of a country. It also evaluates the cost and time involved in tax related filing procedures. A robust tax system that works efficiently is an important prerequisite for smooth functioning of economy as well as business. This is because taxes are the main source of revenue for the government. However, the tax system should be such that the burden is allocated equitably amongst the populace and also the system of paying taxes should be smooth and convenient. Basis the survey, El Salvador improved maximum on this parameter through introduction of electronic payment of taxes which has been the most popular reform off late. Additionally, some of the economies also made efforts to rationalize the tax rates.  
9. Enforcing contracts: This parameter focus on the quality of judicial system of an economy and how much time and cost is involved in resolving a dispute that may arise. A good quality and unbiased judicial system is cornerstone of a country. A system that provides quick and fair resolution to disputes is desirable feature in an economy. Basis the survey, Namibia improved the most with respect to this parameter by improving use of technology in communications. 
10. Resolving insolvency: This parameter assesses that in case insolvency arises, what are the available legal frameworks for the same and how much time and cost is involved thereby. Additionally, it also measures the expected outcomes and what is the probability of recovery from the insolvency, given the legal framework. The legal framework that provides efficient resolution with easy access to credit at better terms is desirable for an economy. This is because such regulations instill confidence in creditors that in case a bankruptcy occurs, they will be able to recover their debt. Additionally, if the regulations provide for easier credit terms, the business failure rate may actually decline. Almost thirteen economies introduced reforms for providing easier solution for insolvency. 
11. Labor market regulations: This parameter measures the regulations with respect to employment that are available in an economy. Further, it also assesses quality of the jobs, flexibility offered in the jobs etc. Labor is an important resource in any economy and hence, regulations are required to ensure efficient allocation of this resource. Additionally, reforms are also required to ensure fair working conditions for the employees. If used effectively, the reforms can help not only economically but also at social level by ensuring that equal opportunities are available for all. This is definitely desirable by investor setting up a business as it gives transparency and ensures availability of talented labor force.

Results of Doing Business survey for United States

As per the latest survey, the United States has a distance to frontier score of 82.54 which is the 6^th highest score among all the economies covered in the survey. The country is also ahead of United Kingdom (82.22), Canada (79.29), and Germany (79.00). The country’s score is also above the regional average of 77.46 for the OECD high income countries.

The country’s distance to frontier score with respect to each of the parameters discussed above are presented in graph below:

Source: World Bank Group (2018)

As seen above, the United States’ distance to frontier score is very high for majority of parameters.

Further, the country’s rankings with respect to each of the parameters discussed above are presented in graph below. The ranking is among the economies that were covered in the survey:

Source: World Bank Group (2018)

As seen above, the United States scores well on almost all parameters. This indicates that the country presents a fertile ground for setting up a business as various parameters are conducive to a business’ growth.

Conclusion and Recommendations

In the above discussion, it was found that the key macroeconomic indicators such as GDP, inflation, unemployment, real interest rates and current account balance of trade were found reasonably positive for the economy of United States: 

The GDP has grown consistently during 2012 till 2017. The growth rate has been approximately 3%-4% y-o-y basis while the y-o-y growth rate for GDP per capita varied from 2.6% to 3.7%. For the same period, the inflation-adjusted GDP growth rate has ranged from 1.5% to 2.9% in real terms and reached its lowest in 2016 at 1.5%. However, the growth rate has again picked up as seen by the steep increase in 2017 to 2.3%. The growth rate of inflation in the United States dipped to minimum in 2015 but afterwards has risen steeply to 1.3% in 2016 and 2.1% in 2017. It is expected that the inflation will continue to grow at an increasing rates for coming years. The unemployment rate in the United States is declining continuously from 8.1% in 2012 to 4.4% in 2017. This is a positive sign as it indicates that the economy is able to employ the available labor force. Further, this will increase the GDP output of the country leading to further growth of the economy. While the country’s current account balance deficit has increased slightly for the United States during 2012-2017, it has still been range bound around 2.5% of the country’s GDP for the corresponding year. Hence, the deficit does not pose any concern currently. From the graph above, it is clear that the real interest rate in the country has been low and range bound from 1.3% to 2.21%. 

The Doing Business survey, 2018 as conducted by the World Bank Group also indicates that the United States ranks 6^th as a good place to do business in. The various reforms and regulations, policies, use of technology, access to various resources, judicial system, taxation policies etc. indicate this.

Additionally, OECD report indicates that the country is going through an expansionary phase. The confidence in the economy is back after the financial crisis of 2007-2008. The consumption and investment both are expected to grow giving a boost to the economy.

Source: OECD, 2018

Give this situation, it is recommended that ABC Company invests the money in United States as it is expected to earn a good return.