Investing in Arketia.

Dow, James ; Johnson, Gordon

CASE DESCRIPTION

The primary subject matter of this case is the integration of statistics, macroeconomics, and business ethics. Secondary issues include descriptive statistics (interpretation of standard deviation), normal distribution, and statistical hypothesis testing. The case has a difficulty level of three, appropriate for junior level. The case is designed to be taught in three class hours, including a formal case presentation by a team and a challenge by another student team. Three hours of outside preparation by students are required.

CASE SYNOPSIS

Students must balance bottom-line financial criteria against ethical issues of social responsibility as they decide if they should invest in one of two developing countries. East Arketia has a poorly educated work force, an inefficient government, and may not enforce property rights, but it has a democratic government with free speech protection. West Arketia is undemocratic, without free speech, but has a pro-business economic policy and a higher education level compared to East Arketia.

Students interpret the standard deviation in terms of the "gap between the rich and the poor" and use the normal area table to estimate the proportion of households below the poverty level in each country. In addition, they use hypothesis testing to estimate average household disposable income, as well as the proportion of prisoners who are political prisoners.

In the economics question, students evaluate the potential for growth in the two countries. The last question asks students to apply ethical principles to their decision, with specific references to the issue of the alternative political systems. "Does your company have an obligation to support the more democratic political regime of East Arketia, even if it turns out that returns to your firm will be lower?"

INTRODUCTION

Westman, Inc., a large manufacturer of consumer durables, is considering expanding into two developing countries. East and West Arketia recently split off from the former Soviet Union and may provide opportunities for both manufacturing and sales. While the two countries have similar backgrounds and current GDPs, they differ substantially in economic policies. Because of limited resources, Westman can only expand into one country. Westman, Inc. would like to invest in a country that will be growing rapidly so that the citizens will be able to afford to buy its products.

The president of Westman has hired your consulting firm. Members of your firm are assessing the prospects for investing in the two countries. They have met with the Minister of Commerce for West Arketia, Ms. Coranish, and the Minister for Development for East Arketia, Mr. Aliel. Your company has also sent a number of representatives to the two countries to gather data to help make a decision.

EAST ARKETIA

East Arketia has had a democratic and populist tradition. This has resulted in the people enjoying substantial civil rights after independence, including free speech and popular elections. However, the government has an inefficient civil service and a mixed record of enforcing property rights. Investment in education and physical capital is low even though public spending and the federal deficit are high.

WEST ARKETIA

West Arketia is run by a generally peaceful one-party government. The government budget has been balanced, with taxes and tariffs at a level typical for a developing country. Government spending has focused on education with the goal of universal primary education. The legal system is well developed and has been effective in supporting property rights (although less effective for political rights). Corruption is low.

Unlike East Arketia, West Arketia is more restrictive in terms of civil rights and democracy. There are no prospects for elections in the near future and a number of opposition leaders have been jailed. All television and radio is run by the government. Newspapers have a close relationship with the government and generally follow a pro-government line.

REQUIRED

Your consulting firm has been asked by the president of Westman, Inc. to report on the expansion possibilities into East and West Arketia. Write a report incorporating answers to the questions below.

1. Statistics provided by developing countries are not always reliable. Data can be hard to gather and is sometimes reported incorrectly. From the analysis of West Arketia, you conclude that citizens there average $1100 per month in household disposable income. The Minister of Development for East Arketia says that disposable income is the same in his country. To see if the data supports this, your company has randomly sampled 100 households from East Arketia and obtained data on household disposable income. The sample has a mean of $923.62, and a standard deviation of $ 84.64. Test the hypothesis, at the 1% significance level, that East Arketia also has a mean monthly household disposable income of $1100.

2. Suppose East Arketia's government now reports that its population mean disposable household income is $925 per month, with a standard deviation of $70. West Arketia's population mean is $1100, with a standard deviation of $350.

a. Which country has more variation in income? Explain using popular phrases, such as "gap between rich and poor."

b. Each country defines the poverty level to be $800. If you assume that income has a normal distribution, find the probability that a household's income is below the poverty level in West Arketia

i. East Arketia

ii. West Arketia

Does it seem reasonable to assume a normal distribution? Is income symmetric or skewed?

3. In explaining why their country is an attractive place to invest, the Minister of Commerce from West Arketia has argued that the political problems have been exaggerated and that fewer people have been imprisoned for political reasons than you have been led to believe. However, Amnesty International reports that one third of the prisoners in West Arketia are political prisoners. A representative from your company visited a prison and randomly sampled 500 prisoners in West Arketia, concluding that 100 of them are political prisoners. Test the hypothesis, at the 10% significance level, that one third of the prisoners in West Arketia are political prisoners. Does this data support the Minister of Commerce or Amnesty International? What other issues might be important when evaluating this data?

4. Based on the economic and statistical issues, evaluate the potential for growth in the two countries.

5. Westman, Inc. also wanted to know whether economic growth could reduce income disparity and problems with poverty. You collected data from 20 countries and found that 6 had rapid economic growth, 8 currently have a major problem with poverty, and 1 had both rapid economic growth and a major poverty problem.

a. Given rapid growth, what is the conditional probability of a major poverty problem?

b. Are the two events independent? Justify your answer.

c. If you are concerned about poverty, would prospects of economic growth affect your concern? How might this relate to the Arketia region?

6. Some managers at Westman were concerned about the arbitrary definitions of "rapid" growth and "major" poverty problem. A new sample was taken from 6 countries that report more precise data. The new data are:

 X 4 6 5 2 1 8

 Y 23 18 24 32 28 7

Where X = percentage economic growth rate and Y = percentage households below the poverty line.

a. Find the regression equation to estimate Y given X.

b. If a country has a 3% growth rate, estimate the percentage below the poverty line.

c. How does this affect your decision regarding the Arketia region?

7. If it is found that find that economic prospects are better in West Arketia, should Westman invest there? Or, does the company have an obligation to support the more democratic political regime of East Arketia, even if it turns out that the returns to the firm will be lower? To what extent are ethical issues relevant to your recommendation?

James Dow, California State University, Northridge

Gordon Johnson, California State University, Northridge