SIMULATING GOVERNMENTAL EFFECTS ON ECONOMIC DEVELOPMENT Developments in Business Simulation & Experiential Learning, Volume 27, 2000 SIMULATING GOVERNMENTAL EFFECTS ON ECONOMIC DEVELOPMENT Hugh M. Cannon, Wayne State University Attila Yaprak, Wayne State University Irene Mokra, Wayne State University Christine Miller, Wayne State University ABSTRACT The purpose of this game is to help students un- derstand the impact of various strategies of gov- ernment intervention on the dynamic free- market processes stimulating economic devel- opment. The game simulates three developing economies. Within the economies, each of the students represents an independent economic en- tity, able to contribute labor, consume goods, and acquire wealth. In one economy, students are free to act independently, or to collaborate, to invest or save money, to innovate or produce conventional products. In the other two, their ac- tivities are constrained by "government" regula- tions, simulating contrasting strategies of import substitution and export promotion. In the end, students are evaluated according to the wealth they create. The three simulated economies pro- vide experiential evidence as a basis for discuss- ing the relative merits of different strategies of economic development. INTRODUCTION In a recent paper, Cannon, Yaprak and Mokra (1999) developed a simulation designed to help students appreciate how the theory of free- market economics explains economic develop- ment. This paper adds the effects of the key governmental intervention strategies of import substitution and export promotion. A free-market economic system depends on the self-interest of the population, perfect informa- tion, a large number of buyers and sellers, and an absence of externalities in order to promote optimal economic development. In fact, none of these conditions tend to exist in real world economies. This, in turn, provides a rationale for government intervention. The question is whether the cure is worse than the disease. While government interventions can solve specific, targeted problems, they typically have damaging side-effects as well. Indeed, government interventions can subvert many of the natural market mechanisms that stimulate growth and economic efficiency in a free-market economy. For instance, a government strategy of import substitution uses protective tariffs to pro- tect fledgling domestic companies from large foreign competitors. It encourages customers to buy domestic products as a substitute for im- ports. While the strategy is intended to strengthen domestic competitors, the real effect is often just the opposite. While there are more physical competitors in the industry, using tariffs to create artificially high import prices removes the incentive for domestic companies to make the investments in quality and efficiency that are necessary to be globally competitive. An alternative approach -- export promotion -- provides government support for companies that are trying to become globally competitive. This strategy provides an incentive for domestic companies to become more efficient and glob- ally competitive. However, it also provides an unfair advantage to firms who engage in export marketing over others who choose to focus on the domestic market. This distorts the natural mechanism by which the market system allo- cates resources to the most customer-responsive firms, focusing their attention on government policy rather than market demand. 108 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 Unfortunately, the effects of the various strate- gies are hard to observe. The principles are ab- stract. The actual effects on an economy are both broad and typically contaminated by a host of other potential factors. So, how do we teach them to students? The game creates a concrete application that is focused in both time and scope, thus making the principles easier to ob- serve. This, in turn, provides grist for a much richer discussion of the underlying principles. From a pedagogical perspective, the advisability and type of government intervention provides an important topic for discussion. However, again, the principles are abstract and difficult for stu- dents to understand. This paper addresses the problem by incorporating government interven- tion into Cannon, Yaprak and Mokra's (1999) simulation game, Progress. It begins with a re- view of the underlying theory behind the free- enterprise model, the strategies of import substi- tution and export promotion, a review of the Progress game, and, finally, the changes de- signed to simulate the import substitution and export promotion approaches to development. The Free-Enterprise Model As noted earlier, the basis of the free-enterprise system depends on the validity of three basic as- sumptions: consumer self-interest, perfect in- formation, many buyers and sellers and absence of externalities. Exhibit 1 summarizes the theory of how the developmental process works. In this discussion, we will speak of “people” rather than customers or companies. This re- flects the notion that economic theory ultimately applies to individual decision-makers, repre- sented in the Progress game by the individual student participants. They market the product of their labor, just as companies do. They also pur- chase on the same basis. In Exhibit 1, demand consists of people who are willing and able to purchase need-meeting prod- ucts and services (Box A). Their willingness de- pends on their belief that the purchase will be in their self-interest (Box B), given alternatives available (Box C), and their knowledge of the al- ternatives (Box D). Their ability to purchase de- pends on their buying power, which, in turn, de- pends on the degree to which they have been successful in the marketplace (Arrow E). EXHIBIT 1: AN UNDERLYING MODEL OF FREE- MARKET DYNAMICS Self-interest Alternatives Knowledge Purchase of need- meeting products and services Consumer (demand) activities Value-producing (marketing) activities Producer (supply) activities Market offering Economic rewardsM ar ke t r es ea rc h P ro m ot io n B uying pow er achieved through successful m arketing activity I E B A F C D G H J Notice how supply interacts with demand. Sup- ply depends on marketing success (Arrow E), and marketing success depends on the economic rewards resulting from people’s purchase deci- sions (Arrow F). In order to achieve these re- wards, people anticipate the factors that are likely to drive market response (Arrow I). They use them to organize value-producing marketing activities (Box G), ultimately expressed in mar- ket offerings (Arrow H). These are supported by promotional efforts (Arrow J) designed to en- hance the attractiveness of the offerings by stimulating people’s self-interest, enhancing their knowledge of the alternatives, and/or creat- ing imagery that enhances the nature of the of- ferings themselves. The more value people produce, the greater the rewards they will receive. The greater the re- wards they receive, the more buying power they have, and hence, the more potential they have for meeting their own needs in the marketplace. This, of course, is nothing more than the opera- tion of Adam Smith’s classic “invisible hand,” where the combined self-interest of buyers and sellers acts in concert to maximize societal satis- faction. Self-interest leads people to want more 109 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 need-satisfying buying power. The way to get this is to address the needs of others. Having ob- tained the buying power through addressing the needs of others, others will be more attentive to your needs. And so the process cycles, system- atically focusing marketing effort where it will produce the greatest effect. The cycle is what stimulates economic growth. The more need- meeting goods and services people produce, the greater the wealth of society. The greater the wealth, the greater the stimulus for creating new need-meeting marketing innovations. The Progress game simulates this process by al- lowing players use or sell labor and products to create wealth, and ultimately, create satisfaction through the consumption of products. Simulating Government Intervention Simulating the effects of government interven- tion in the Progress game is as simple as estab- lishing governments and giving them power to tax and create legislation. In order to simulate the effect of import substitution and export trade promotion, we recommend creating three "coun- tries" -- one representing an unregulated "free- market" system, one to represent a society using import substitution, and one to represent a soci- ety using export promotion. Creating a "Developing Economy" As a rule, export promotion, and particularly im- port substitution, are used as policies designed to help underdeveloped, or developing, countries progress. In order to simulate this effect, the ex- ercise should start with a single country, Free- donia. One way to do this is to play the initial phase of the game in three-person teams. The phase continues until Freedonia has developed fledgling companies, with some initial capital development and specialization of labor. Then, once Freedonia has had time to develop, the second two "countries," Isolationia and Expor- tonia, can be created by taking two of the people from each Freedonia teams. A Policy of Import Substitution After creating the import substitution "country," Isolationia, the game administrator must estab- lish a player or players to form the government. The government is free to establish any laws or regulations it deems necessary to implement a policy of import substitution. In order to ensure a maximum effort for success, government per- formance in the game will be measured by the relative success of the economy, as measured by growth in the total number of sats generated by the economy by the end of the game. The only guideline the government has beyond the mandate to grow the economy is to imple- ment a policy of import substitution. The in- structions are as follows: "Your task will be to stimulate growth in your newly independent country of Isolationia. To do this, you have chosen to implement a policy of import substitution. That is, you will encourage people in your country to buy from domestic suppliers, thus strengthening the local economy and creating firms that are strong enough to compete effectively in the global market. There are no established procedures for doing this. You are free to tax, to create laws, or to other- wise manage the activities of participants in your economy as you see fit in order to imple- ment this strategy. People within your country are also free to engage in trade with other coun- tries, as long as the overall government policy is to encourage people to 'buy domestic.'" As is the case with the original Progress game, there are no "winners" in the competitive sense. Rather, the game should illustrate how business success is not a zero-sum game. However, the purpose of the exercise is to provide a basis for discussing the relative merits of free-market ver- sus import-substitution and export-promotion economies. As with individual players in the game, successful trade among the "countries" is also a non-zero-sum game. The relative success of each of the three strategies can be seen in the growth of sats. Of course, this implies a com- 110 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 parison, and hence, the possibility of competi- tion. Competition is natural. But the focus of the game should be on absolute success, not on "beating the competition" (the other countries). If competition occurs between countries -- as it probably will -- it parallels the kind of mis- guided nationalism we find in the real world. This provides a good opportunity to enrich the debriefing process by discussing the role of na- tionalism in the economic development process. A Policy of Export Promotion Instructions for the export promotion govern- ment are similar to those for import substitution. After establishing the new "country," the game administrator must establish a player or players to form the government. Again, the government is free to establish any laws or regulations it deems necessary to implement its established policy, in this case, export promotion. Again, government performance in the game will be measured by the relative success of the econ- omy. The guidelines for the export trade promotion government are as follows: "Your task will be to stimulate growth in your newly independent country of Exportonia. To do this, you have chosen to implement a policy of export promotion. That is, you will seek to en- courage people in your country to engage in ex- port trade, thus creating an inflow of external funds to help your country develop. There are no established procedures for doing this. You are free to tax, to create laws, or to otherwise man- age the activities of participants in your econ- omy as you see fit in order to implement this strategy. People in your country are free to en- gage in trade with other people inside your country, as long as the overall government pol- icy is to encourage people to engage in export trade." As with the case of Isolationia, Exportonia's success should not come at the expense of the other countries. Economic growth is a non-zero- sum game. The relative success of Exportonia's economy, if it is superior, should reflect the su- periority of export promotion over import substi- tution, not the success of the players who simu- late the two governments. However, regardless of the approach the players actually take, the re- sults should provide useful grist for discussion. DISCUSSION Central to the discussion of this exercise is the fact that the underlying assumptions behind the free-enterprise system fail on all fronts. The fail- ings may be seen as a basis for government in- tervention. This provides a good framework for evaluating the strategies of import substitution and export promotion. Both of the strategies tend to be aimed at the problem -- or symptom -- of underdevelopment, not its underlying causes. The debriefing process provides a good oppor- tunity to evaluate the two strategies against a more rigorous economic framework. If the un- derlying assumptions of the free-enterprise fail, what might be done to correct them? Failures in Self-Interest The assumption of self-interest maintains that, given adequate information and the availability of meaningful alternatives, people will make de- cisions that will maximize their personal satis- faction. This does not preclude working for the satisfaction of others. Indeed, one of the defining characteristics of humans is their ability to gain personal satisfaction from helping others, even at considerable personal cost or discomfort. However, self-interest does preclude making self-destructive decisions, such as unhealthy liv- ing and failure to save or otherwise plan for fu- ture problems. A moment's reflection suggests that we are all ir- rational, according to this definition. We over- eat, fail to exercise, spend now at the expense of long-term investment or retirement planning, neglect social relationships that offer potential for great long-term satisfaction, and so forth. In- 111 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 deed, these are behaviors that invalidate the free- enterprise model. For instance, if people fail to care for their health when young, and fail to save for medical expenses when old, they will suffer, and society will not maximize its satisfaction. Cannon and Yaprak (1997) support this intuitive argument. They suggest that irrationality not only exists, but that a careful study of the way people make decisions would lead us to expect it. The central concept is that people tend to be governed by what March and Simon (1958) refer to as “bounded rationality.” Natural limitations in the way people process information constrain them to consideration of a relatively few alterna- tives and evaluative criteria at a time. They are “rational” in the way they consider these alterna- tives, but “irrational” in that many attractive al- ternatives and criteria simply do not get consid- ered. EXHIBIT 2: AN UNDERLYING MODEL OF FREE- MARKET DYNAMICS Satisfactory? Evaluation Consider evoked set of alternatives Action Plan • Goals • Search algorithm • Evaluative criteria Purchase Decision that addresses active goals Decision system based on “bounded rationality” Situational Cues • Aroused needs • Situational needs • Situational norms yes Personal Factors • Personal needs • Cultural biases • Past experience Modify the action plan to call for a broader range of alternatives no Consumers make decisions that are rational in light of a given action plan, but violate their greater self-interest by not considering a larger set of goals A B C D E F Exhibit 2 describes the process. It suggests that people develop a kind of psychological action plan (Box C) to govern their thinking in a given situation. The selection of the plan depends on both the demands of situation (Box A) and the personal needs of the individual (Box B). The bias toward short-term thinking is not inevitable, but likely, since a key factor in defining a situa- tion is short-term need arousal (Box A). Simi- larly, situational needs and norms tend to ad- dress immediate problems, not necessarily long- term welfare. Box B reflects the role of personal factors, as re- flected through personal needs, cultural biases and past experience. Given the uncertainties of life, people develop behavioral rules of thumb based on what they see around them. For in- stance, a person whose needs are typically not met will tend to have personal experiences that are shaped by a focus on short-term problem- solving, generally at the expense of long-term planning. When most people share the same deprivation, their collective experience tends to shape a culture that focuses on short-term think- ing. We see this in many developing countries, where people seem ready to sacrifice the poten- tial for long-term prosperity in return for a bribe or other personal benefit that is socially destruc- tive. Of course, long-term social destruction is also destructive to the lifestyles of the individu- als living within the society. The action plan (Box C) governs the goals peo- ple seek to pursue in any given situation, along with the search algorithm through which they seek to identify alternatives. It also determines the criteria by which consumers evaluate the al- ternatives. Box D represents the actual problem-solving process. People evaluate the alternatives, using the selected action plan, as long as this seems to work (Box E). If it doesn't work, they seek to modify the plan so that it does (Box F). The key to the process seems to be situational and personal factors. While these can be influ- enced by experience, the process is a slow one. Bad habits persist for a long time, both individu- ally and collectively. The implications are that society might want to offset or mold their effects by utilizing the tools suggested in Boxes A and B. For instance, education provides a good in- tervention. People can learn that effective busi- ness decisions require long-term thinking (“situ- ational needs” in Box A). Similarly, they can learn that long-term thinking is one of the things good executives should do (“situational norms” in Box A). Case histories can be used to show that long-term thinking is generally a good way to get what you want (“personal needs” in Box 112 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 B), generating a kind of vicarious experience to support this connection (“past experience” in Box B). The long-term effect of these efforts can actually shift the way people tend to look at business problems (“cultural biases” in Box B). These kinds of interventions might be framed as a type of export promotion (but not as import substitution). However, they are designed to cor- rect deficiencies in the underlying assumptions of the free-enterprise system. This is different from subsidies, or other direct interventions, de- signed to promote export trade. As noted earlier, these potentially damage an economy by shifting resources to exporters at the expense of compa- nies who might employ them more efficiently in the domestic market. These are key points to ad- dress in the debriefing process of the game. Failures of Perfect Information Perhaps the most obvious failing of any econ- omy is in the lack of information available to decision-makers. This involves everything from information regarding who is providing what kinds of products and services to a knowledge of what customers need and how they will respond to a particular market offering. Information pro- vides another natural place for government in- tervention. In the real world, information ser- vices, infrastructure investment in the Internet, and so forth all constitute sources of improved market information. In the game, the "government" players will probably discover the need for information -- most obviously, information about who has what to sell at what price, but also information regard- ing future possibilities and trends, the strategic positions of various companies, and so forth. Of course, the information has value for the players, and hence, their self-interest should drive them to pay for it. However, as we have seen, short- term thinking, lack of experience, and cultural biases can all militate against the spontaneous investment in information. This is true in the game, as well. As Exhibit 5 suggests, players will likely engage in a kind of "satisfying" be- havior, engaging in transactions that are conven- ient and that are consistent with their cultural norms, rather than maximizing their utility. For instance, experience in the Progress game sug- gests that players will often seek to be "manag- ers" rather than selling their labor, even when the economics of the situation make selling labor more attractive. They will likely stick with es- tablished sales and supply relationships, as long as they are satisfactory, rather than seeking to optimize the system. One of the things a government might do is take actions that will increase the amount of informa- tion available to the students playing the game. In the debriefing session, discussing the role of information and how it was or was not used will be very important in helping students understand the lessons of economic growth. More important will be a discussion of the various means by which information can be delivered to the mar- ket place. Theory would suggest that the best way would be to market it, so that companies come to recognize its value and begin to demand it. Failures in the Number of Buyers and Sellers Both the Progress game and this governmental modification begin with each player acting as both a buyer and seller. There are, however, sig- nificant economies of scale available that drive players to combine their efforts. Economies of scale that motivate coordinated activity can also lead to unhealthy constraints of trade. Indeed, one of the economic arguments people provide in support of import substitution is the need to foster new domestic business development by protecting it from the domination of global firms who enjoy greater economies of scale. In the process of debriefing, issues of monopoly can play a prominent role in understanding what has really happened. For instance, notwithstand- ing the theoretical rationale for import substitu- tion, the effect is generally to decrease the com- petition, giving domestic firms monopolistic, or at least oligopolistic, powers. As the game con- 113 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 tinues, and the companies grow and mature, the larger companies will inevitably end up cooper- ating with each other in ways that utilize their distinctive competencies. This will provide an opportunity to discuss how modern forms of joint-venture management and unbundling of services can provide economies of scale without creating monopolistic structures. The Problem of Externalities Externalities consist of situations where the de- cisions of one economic unit affect the welfare of another who has not participated in the deci- sion. When these situations occur, they provide a justification for government involvement to counteract the effects of the externality. For in- stance, if someone invests in the development of Internet technology, and the economy grows as a result, everyone benefits, whether or not they use the Internet. This, then, suggests that they should bear part of the expense. This is the rationale provided for getting gov- ernment involved in the business of economic development. If everyone in the society benefits, they should pay (through their tax money and the activities of their governmental representa- tives). If we argue that any failure in the funda- mental economic assumptions behind the free- enterprise system hurts everyone in a society, this provides a rationale for government becom- ing involved in addressing these failures. This argument should play a prominent role in de- briefing the game. SUMMARY AND CONCLUSIONS In the initial presentation of the Progress game, Cannon, Yaprak and Mokra (1999) suggested that one of its major benefits is that it can be eas- ily modified to simulate other economic effects, one of which was government effects. This pa- per addresses that possibility. It provides direct and immediate experience with the impact gov- ernment activities can have on a simulated econ- omy. While it does not simulate every possible effect, it provides the grist for some very pro- ductive discussions of what might happen in a real economy as a result of various types of gov- ernment intervention. Students who have just completed the game will typically have an easy time imagining various different scenarios that would otherwise seem abstract and irrelevant. Again, the promise of the game is to provide a laboratory for simulating a host of economic ef- fects, only one of which is government interven- tion. Hopefully, the future will bring additional modifications that can be used to sensitize stu- dents to specific issues, including everything from various types of government strategy (such as the two addressed here) to social issues, such as cultural biases and issues of diversity. Even more important, we hope the future will bring reports of actual classroom testing. The nature of a simulation is never fully understood until it has been tested in a variety of different educational and laboratory settings. Progress was designed to elicit different patterns of activ- ity with different types of students. If this was true of the basic game, it is even more true of the government modification. REFERENCES Cannon, H. M. & Yaprak, A. (1998). Marketing and Economic Development: Implications for Emerging Economies. Paper presented to the Consortium for International Marketing Re- search Conference on Globalization, The In- ternational Firm and Emerging Economies, Izmir, Turkey, May. Cannon, H. M., Yaprak, A. & Mokra, I. (1999). "Progress: An Experiential Exercise in Devel- opmental Marketing." Developments in Busi- ness Simulation and Experiential Learning, Volume 26 (1999), 265-273. March, J. G. & Simon, H. (1958). Organiza- tions. New York: John Wiley & Sons). 114 Table of Contents Volume 27, 2000 Internet International: A Simulation Exercise for Understanding Technological Innovation and customer Service In a Rapidly Growing Internet Server Company Simulations and Learning: Dialog and Directions Endnote Activity: A Tool for Integration of Course Content and Communication Skill Practice Incorporating Video as a Teaching Strategy in Interpersonal Communication Vision Quest: An Alternative Approach to Industry Analysis for MBA Courses in Strategic Strategic Management: An Evaluation of the Use of Three Learning Methods Trainer, Mentor, Educator: What Role for the College Business Instructor in the Next Century? Using the Internet and Shareware to Facilitate Computer Simulation in Distance Learning Classes Visual Modeling of Business Simulations Teaching about Information with Management Games A Self-Evaluation Based on the Discussion and Decision in Experts' Business Gaming The Restaurant Game Using Journals to Enhance Computer Simulation Based Learning Exercises to Facilitate Better Student Writing in the Undergraduate Strategy Class Identifying, Resolving, and Managing Common Ethical Dilemmas in the Workplace: An Experiential Approach Integrating the Digital Revolution into the Classroom The Wheel of Learning: An Integrative Business Curriculum Experiment The Changing Nature of Simulation Research: A Brief ABSEL History Perspectives on Simulation & Gaming's Review Process Experiential Learning Across Disciplines: Mixing International Business and Accounting Simulating Governmental Effects on Economic Development Internationalizing the Introduction to Business Course Using an International Text and Domestic Simulation with a Twist Using Stock Value as the Performance Measure in a Business Simulation Game Introducing Cross-Elasticities in Demand Algorithms Validating a Model of Currency Valuation An Exercise for Exploring the Relationship between Jungian Psychological Types and Organizational Politics Exercise: Preparing Financial Reports Using the Group Categorizing Technique Effect of Trust and Cultural Beliefs on Negotiation Processes: Data from an Experiential Role Play Experiential Learning Gets Stamp of Approval From the Boyer Commission Talent Search 2000 - An Experiential Activity to Help Strengthen Skills in Employee Recruitment and Selection Clemson University's Collaborative Learning Environment Initial Data on a Test Bank Assessing Total Enterprise Simulation Learning Changing the Assessment Paradigm: Using Student Portfolios To Assess Learning from Simulations How We Learn and Why We Don't: The Cognitive Profile Model: A Workshop in Teaching to Reach Your Students Knowing Thyself: A Portfolio Approach to Student Self-Assessment Collaborative Learning and Web-Based Instruction in a Cognitive Apprenticeship Model Teamwork Attributes in a Classroom Simulation Virtual Teams: Meeting the Next Challenge for Experiential Education New Age Learning: Nuance or Nonsense Developing Charisma: An Experiential Exercise in Leadership Problems and Solutions in Going Web-based with an Agribusiness Simulation Creating a Comprehensive Web-Enhanced Classroom Your Class is in Session, Now What? The Challenges of Teaching On-line An Application of Process Control Charts for Attributes as a Form of Classroom Assessment for Experiential Learning Work Goals and Life Aspirations: Do You Have What it Takes to be an Entrepreneur An Exercise to Develop Initiative: Possible Dream? The Ball Point Pen Assembly Company Management Game Review System Development Total Enterprise Simulations and Optimizing the Decision Set: Assessing Student Learning Across Decision Periods Facilitating Learning in the New Millennium with the Complete Online Decision Entry, System (CODES) The Marketing Management Experience The Right Venue for Your Simulation One More Time: Overall Dominance in Total Enterprise Simulation Performance A Profile of ABSEL Conference Attendees Learning Readiness: An Underappreciated Yet Vital Dimension in Experiential Learning Active Learning in a Professional Undergraduate Curriculum The Problem Is - They Think Differently! Cultures Integration in Mergers and Acquisitions: Putting Managers Together in a Business Simulation The Global Business Game: A Strategic Management and International Business Simulation