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What are strategic levers

What are strategic levers?  How are strategic levers used? Abstract

 Yield management, controlling customer demand through the use of variable pricing and capacity management to enhance profitability; has been examined extensively in the services literature. Most of this work has been tactical and mathematical rather than managerial. In this article, the authors suggest that a broader view of yield management is valuable to both traditional and nontraditional users of the approach. Central to this broader view is the recognition of how different combinations of pricing and duration can be used as strategic levers to position service firms in their markets and the identification of tactics by which management can deploy these strategic levers. The authors also propose that further development of yield management requires that when the service is delivered be treated as a design variable that should be as carefully managed as the service process itself.

The Strategic Levers of Yield Management

           Although commonly associated with marketing as a revenue management tool, yield management has significant impacts on other service business functions. It affects operations in capacity planning, human resource management in worker selection and training, and business strategy through the way the service firm positions itself in the market. Despite this widespread impact and the considerable attention it has received, formal yield management is still viewed primarily as a pricing/inventory management tool. What is lacking is a broader theory of yield management that would permit other service industries to gain the benefits of yield managementtype thinking and provide insights into new areas in which experienced companies might further apply the concept. Our objective in this article is to develop the groundwork for such a theory. Our focus will be on the strategic levers available for yield management, how they have been applied in traditional yield management settings, and how they, along with some tactical tools, can be applied to other service settings.

A Modified Definition of Yield Management

           A common definition of yield management is the application of information systems and pricing strategies to “sell the right capacity to the right customers at the right prices” (Smith, Leimkuhler, and Darrow 1992). Implicit in this definition is the notion of time-perishable capacity and, by extension, the notion of segmentation of capacity according to when it is booked, when and how long it is to be used, and according to the customer who uses it. In other words, “an hour is not an hour is not an hour” when it comes to customer preferences or capacity management. In light of this subtle point, we offer a slightly modified definition of the term.

That is, yield management may be defined as managing the four Cs of perishable service: calendar (how far in advance reservations are made), clock (the time of day service is offered), capacity (the inventory of service resources), and cost (the price of the service) to manage a fifth

C, customer demand, in such a way as to maximize profitability.

Strategic Levers

           A successful yield management strategy is predicated on effective control of customer demand. Businesses have two interrelated strategic levers with which to accomplish this: pricing and duration of customer use. Prices can be fixed (one price for the same service for all customers for all times) or variable (different prices for different times or for different customer segments), and duration can be predictable or unpredictable.

           Variable pricing to control demand is conceptually a straightforward process. It can take the form of discount prices at off-peak hours for all customers, such as low weekday rates for movies, or it can be in the form of price discounts for certain classes of customers, such as senior discounts at restaurants.

           Duration control presents a more complicated decision problem but at the same time represents an area that would improve the effectiveness of yield management. By implementing duration controls, companies maximize overall revenue across all time periods rather than just during high-demand periods. If managers want to increase control over duration, they can refine their definition of duration, reduce the uncertainty of arrival, reduce the uncertainty of the duration, or reduce the amount of time between customers. We will discuss each of these tactics

later.

           Different industries use different combinations of variable pricing and duration control (Figure 1). Industries traditionally associated with yield management (hotel, airline, rental car, and cruise line) tend to use variable pricing and a specified or predictable duration (Quadrant 2).

Movie theaters, performing arts centers, arenas, and convention centers use a fixed price for a predictable duration (Quadrant 1), whereas restaurants, golf courses, and Internet service providers use a fixed price with unpredictable customer duration (Quadrant 3). Many health care industries charge variable prices (Medicare or private pay) but do not know the duration of patient use (Quadrant 4). There is no fixed demarcation point between quadrants, so an industry may lie partially in one quadrant and partially in another. The intent of this classification method is to help industries not currently using yield management develop a strategic framework for developing yield management. More specifically, what we are trying to show is which quadrant industries are in and what they can do to move to Quadrant 2. For example, restaurant management does not have control of duration; they need to pursue some duration management approach. Or, if hotel management does not adequately control length of stay, they may want to modify their forecasting system from room nights to arrivals to enhance their reservation system. As indicated above, successful yield management applications are generally found in Quadrant 2 industries.

           The reason is that a predictable duration enables clear delineation of the service portfolio, and variable pricing enables generating maximum revenue from each service offering within the portfolio. We hasten to point out that even those industries that are listed in this quadrant have structural features that inhibit them from achieving their full profit potential. A brief review of the development of yield management in the airline and hotel industries will help illustrate these points.

Airline Industry

           Deregulation of the American airline industry was the major impetus for the development of yield management. Before deregulation in 1978, major carriers offered one- price service between cities. Essentially, most airlines were operating in Quadrant 1: Their flight durations were extremely predictable, and their price was fixed (Figure 2).

           Immediately after deregulation, many new airlines emerged, and one airline, People’s

Express, developed an aggressive low-cost strategy. The People’s Express story is well known: Their airfares were considerably lower than those of the major carriers, and customers were attracted to the limited service that People’s Express flights offered. The major carriers such as American Airlines, United Airlines, and Delta Airlines, aided by new computerized reservation systems, employed variable pricing on a flight-by-flight basis to match or undercut fares offered by People’s Express. Cost-conscious passengers then switched to the major carriers, and

People’s Express was eventually forced out of business. Donald Burr, the former

CEO of People’s Express, attributes his airline’s failure to the lack of good information technology and the subsequent inability to practice yield management (Anonymous 1992; Cross 1997).

           Seeing the benefits of differential pricing, most major North American carriers instituted yield management and moved into Quadrant 2. Yield management allowed airlines to determine the minimum fare (of a set mix of fares) that should be available for a specific flight. Differential pricing, in combination with the predictability of flight duration, gave them the enviable position of variable pricing with predictable duration.

           Another trend that emerged after deregulation was the hub-and-spoke system. Previously, airlines operated on an origin-destination basis, and although connecting flights existed, the concept of a hub city did not. Most major airlines now operate with a hub-and-spoke system, and their forecasting and yield management systems are based around the associated flight legs (Skwarek 1996). Leg-based solutions have inherent problems and may lead to suboptimal solutions. Although the revenue on each flight leg may be optimized, revenue over the entire airline network may not. In an attempt to circumvent this problem, some airlines (notably American Airlines) developed virtual nesting systems (Smith, Leimkuhler, and Darrow 1992), in which different origin-destination pairs were classified by revenue generated. Unfortunately, current origin-destination forecasting and yield management systems have a high forecast error that results in an unreliable solution.

           The lack of origin-destination forecasting may seem like a minor point, but it prevents airlines from truly managing the predictability of their duration. In a sense, the hub-and-spoke system has caused the airline industry to move into the bottom half of Quadrant 2 or the top half of Quadrant 4. The hub-and-spoke system, in combination with airline pricing systems, has created problems such as passengers attempting to obtain a lower fare by completing only one leg of their multileg flight (a “hidden city”). The empty seat on the remaining flight leg represents lost revenue to the airlines so safeguards have been instituted to avoid this problem. Only one major carrier, Southwest Airlines, has resisted the temptation of the hub-and-spoke system. This represents a competitive advantage for their yield management system because they are better able to manage the predictability of their flight durations (Anonymous 1994b).

Hotel Industry

           Unlike the airline industry, traditional hotels are usually located in Quadrant 3. Although group and tour operators have multiple negotiated rates (Hoyle, Dorf, and Jones 1991; Vallen and Vallen 1991), most traditional hotels charge essentially one room rate (or perhaps a lowseason and high-season rate) for transient guests. Length of stay is not explicitly considered, and forecasts are designed to predict nightly occupancy (Figure 3). Typically, the goal of the traditional hotel is to maximize occupancy for a given night, and managers seldom look at longterm revenue generation.

           After the airlines started using yield management, many hotel managers were impressed with the increased revenue claimed by the airlines and applied the concept of variable pricing to the hotel industry. When hotels started using variable pricing, they did not apply the concept of qualified rates, in which customers had to meet certain requirements to obtain a lower room rate. They instead relied on top-down pricing, in which reservation agents quoted the highest rate first and, if faced with resistance, offered the next of several lower rates until the customers acquiesced or they reached a minimum level previously established by management. Many major hotel chains still use this pricing method. Although short-term revenue gains may result from top-down pricing, customers view the practice unfavorably (Kimes 1994). Most hotels using this approach forecast room nights and use the forecasted nightly occupancy rate to develop pricing recommendations (Kimes 1989). Length-of-stay issues are not considered, and occupancy and rates are managed for one night at a time.

           Some hotel chains, notably Marriott and Forte Hotels, saw the benefits associated with predictable durations (Anonymous 1994a). To reap the benefits associated with duration controls, they switched from forecasting room nights to forecasting arrivals by length of stay and/or room rate. Forte charged only one rate and concentrated solely on length of stay. Guests requesting a 2-night stay might be accepted, whereas those requesting a 1 -night stay might be rejected depending on the projected demand. Marriott forecasted by arrival day, length of stay, and room rate and was able to determine the best set of reservation requests to accept. Still other hotel chains tried to implement length- of-stay controls without changing their forecasting system from room nights to arrivals. Without arrival information, they had no way of knowing if their restrictions made sense or if they were unnecessarily turning away potential customers.       The focus on length of stay not only changed the forecasting systems in place at leading hotels but also changed the mathematical methods used to develop yield management recommendations. Many hotel chains (e.g., Holiday Inn, Hilton, Sheraton, and Hyatt) have instituted linear- programming-based systems in which length of stay and room rate are explicitly considered (Hensdill 1998; Vinod 1995).

Using the Strategic Levers

           Industries in Quadrants 1, 3, and 4 can move into Quadrant 2 to achieve some of the revenue gains associated with yield management by manipulating duration and price. Although there are still problems facing the hotel and airline industries, their experience provides a rich context from which to understand the tactical tools needed to improve revenue generation. Specific tools associated with each strategic yield management lever can allow managers to move their company into a better revenue-generating position.

Duration Methods

           If managers want to increase control over duration, they can refine their definition of duration, reduce the uncertainty of arrival, reduce the uncertainty of the duration, or reduce the amount of time between customers (Figure 4).

Repining the Definition of Duration

           Duration is how long customers use a service and is measured either in terms of time (i.e., the number of nights or number of hours) or by event (i.e., a meal or a round of golf). When duration is defined as an event rather than time, forecasting the length of duration generally

becomes more difficult. Thus, if duration for an industry could be defined in time rather than events, better forecasting, and hence control of duration, would likely result.

           Even industries that use time-based duration definitions can refine this definition and thereby enhance their operations. Most hotels sell rooms by the day, or more specifically, they sell rooms from 3 p.m. (check-in) to noon (check-out). Sheraton Hotels and The Peninsula Hotel in Beverly Hills allow customers to check in at any time of the day and check out at any time without penalty (Anonymous 1997; Barker 1998). By refining their definition of duration, they have improved customer satisfaction, made better use of capacity, and increased revenue.

Uncertainty of Arrival

           Because many capacity-constrained firms have perishable inventory, they must protect themselves from no-shows or late arrivals. Firms can use both internal (not involving customers) and external (involving customers) approaches to decrease uncertainty of arrival.

           Internal approaches. Most capacity-constrained service firms use overbooking to protect themselves against no-shows. Published overbooking models often use Markovian decision processes or simulation approaches (for example, Lieberman and Yechialli 1978; Rothstein 1971, 1985; Schlifer and Vardi 1975), but in practice many companies use service-level approaches (Anonymous 1993; Smith, Leimkuhler, and Darrow 1992) or the critical fractile method (as suggested by Sasser, Olsen, and Wyck- off 1978). The key to a successful overbooking policy is to obtain accurate no-show and cancellation information and to develop overbooking levels that will maintain an acceptable level of customer service.

           Once an overbooking policy is implemented, companies must develop good internal methods for handling displaced customers. The frontline personnel who must assist displaced customers should receive appropriate training and compensation for dealing with potentially angry consumers. Companies can choose to select which customers to displace on either a voluntary or involuntary manner. The airline industry, with its voluntary displacement system, has increased customer goodwill while increasing long-term profit (Anonymous 1993; Rothstein 1985). Other industries base their displacement decision on time of arrival (if customers are late, their reservation is no longer honored), frequency of use (regular customers are never displaced), or perceived importance (important customers are never displaced).

           External approaches. External approaches to reduce arrival uncertainty shift the responsibility of arriving to the customer. The deposit policies used at many capacity- constrained service firms such as cruise lines and resorts are excellent examples of external approaches. In addition, the cancellation penalties imposed by these companies represent an attempt to make customers more responsible for arriving. Restaurants are experimenting with cancellation penalties and ask customers for their credit card numbers when taking reservations (Breuhaus 1998). If patrons do not arrive within 15 minutes of the reservation time, a penalty fee is charged to their credit cards. Interestingly, the car rental industry, which has considerable yield management experience, makes very limited use of external approaches. With the exception of specialty cars and vans, customers are not asked to guarantee their rental and have no responsibility for showing up. With no incentives for customers to arrive, it is not surprising that in busy tourist markets such as Florida, no-shows can account for as much as 70% of the reservations (Stem and Miller 1995). Besides these negative incentives, some companies use service guarantees to encourage people to show up on time. American Golf, for example, offers discounted or free play to golfers whose actual tee-off time is delayed by more than 10 minutes of their reservation time.

Uncertainty of Duration

           Reducing duration uncertainty enables management to better gauge capacity requirements and hence make better decisions as to which reservation requests to accept. As in the case of arrival uncertainty, both internal and external approaches can be used for this purpose.

           Internal approaches. Internal approaches include accurate forecasting of the length of use and the number of early and late arrivals and departures and improving the consistency of service delivery. By knowing how long customers plan to use the service, managers can make better decisions as to which reservation requests to accept. If a restaurant manager knows that parties of two take approximately 45 minutes to dine and parties of four take about 75 minutes, he or she can make better allocation decisions. Likewise, knowing how many customers will change their planned duration of use enhances capacity decisions. For example, in a hotel, accurately forecasting how many customers book for 4 nights but leave after 3, or request additional nights, facilitates room and staff allocations. Similarly, if a rental car company knows that 20% of its week-long rentals are returned after 5 days, the fleet supply requirement can be adjusted accordingly.

           Early research and practice in yield management focused on single flight legs or room nights and did not consider duration. Expected marginal seat revenue (EMSR) based models (Belobaba 1987; Littlewood 1972) are widely used in the airline industry (Williamson 1992) and result in allocation decisions for flight legs at various days before departure. Early hotel yield management systems based minimum rate decisions on forecasted occupancy but did not consider the impact of length of stay (Kimes 1989). Some airlines have tried to compensate for the lack of duration control by using virtual nesting (Smith, Leimkuhler, and Darrow 1992; Vinod 1995; Williamson 1992) but still have not achieved the goal of full origin-destination control (Vinod 1995).

           Linear programming has been used to help make better duration and pricing allocation decisions (Kimes 1989; Weatherford 1995; Williamson 1992). The bid price, defined as the shadow price of the capacity constraint, can be used to determine the marginal value of an additional seat, room, or other inventory unit (Phillips 1994; Vinod 1995; Williamson 1992).

This value can then be used to determine the minimum price available for different durations. Dynamic programming (Bitran and Mondschein 1995) has also been suggested as a possible method for considering hotel length of stay.

           The accuracy of the forecast affects the effectiveness of the yield management system. Lee (1990), in his study of airline forecasting, found that a 10% improvement in forecast accuracy resulted in a 3% to 5% increase in revenue on high-demand flights.            If duration is to be explicitly addressed, forecasts of customer duration must be developed. Airlines typically forecast demand by flight leg (Lee 1990; Vinod 1995), but to truly practice duration control, airlines must forecast demand by all possible origin-destination pairs. As previously mentioned, the hub-and-spoke system has increased the number of forecasts required and the subsequent accuracy of those forecasts. Some airlines have tried to reduce the number of forecasts needed by using virtual nesting (Smith, Leimkuhler, and Darrow 1992; Vinod 1995). Preliminary research on airline-forecasting accuracy (Weatherford 1998) shows that an increase in the number of daily forecasts required increases the forecast error.

When hotels forecast customer duration, they must forecast by day of arrival, length of stay, and possible rate class (Kimes, O’Sullivan, and Scott 1998). Hotels using linear programming and bid-price approaches forecast at this level of detail, and some have developed even more detailed forecasts. The magnitude of this problem becomes apparent when you consider that for each day of arrival, a hotel might consider 10 different lengths of stay and 10 different rate classes. If room type is included, a hotel may have 200 to 300 different forecasts per day.

           Consistency of duration (i.e., most customers using the service for about the same length of time) is typically achieved through internal process changes. For example, TGI Fridays redesigned their restaurant menus and service delivery systems to make dining time more consistent as well as faster. Some restaurants in the theater district of New York City have placed an hourglass on the table of each party. When the sand in the hourglass is gone, patrons have a visual cue to finish dinner and leave so they will not be late to the theater. Or, in a much different context, if a prison warden knows that 25% of prisoners sentenced to 10 years serve only 4, additional prisoners may be incarcerated.

           External approaches. External approaches for handling uncertainty of duration generally reach the customer in the form of deposits or penalties. Some hotels have instituted early and late departure fees (Miller 1995), and airlines have penalized passengers who purchase tickets through hidden cities. Although penalties may work in the short term, they risk incurring customer wrath and hurting the company in the long run. For this reason, internal approaches are generally preferable.

Reduce Time Between Customers

           Reducing the amount of time between customers (changeover time reduction), by definition, means that more customers can be served in the same or a shorter period of time. Although changeover time reduction is not normally considered a tool of yield management, it is a tactic that can be used to increase revenue per available inventory unit. Such tactics play an important role in the yield management strategy. Changeover time reduction has become a common strategy for airlines. Southwest Airlines and Shuttle by United both boast of 20-minute ground turnarounds of their aircraft (compared to the average of 45 minutes at most airlines) and have been able to increase the utilization of their planes (Kimes and Young 1997). Many restaurants have instituted computerized table management systems that track tables in use, the progress of the meal, and when the bill is paid. When customers leave, the table management system notifies bussers, and the table is cleared and reset (Liddle 1996). The result is an increase in table utilization and, hence, revenue per table.

Price

           Industries actively practicing yield management use differential pricing—charging customers using the same service at the same time different prices, depending on customer and demand characteristics. Passengers in the economy section of a flight from New York City to Los Angeles may pay from nothing (for those using frequent-flyer vouchers) to more than $1,500. The fares vary according to the time of reservation, the restrictions imposed, or the group or company affiliation. In contrast to such Quadrant 2 pricing, Quadrant 1 and 3 industries use relatively fixed pricing and charge customers using the same service at the same time the same price.

           Customers tend to develop reference prices for various transactions. If companies change price, they must do so carefully to avoid upsetting their customers (Kahneman, Knetsch, and Thaler 1986). Although it is possible to charge more solely based on high demand, customers may resent being charged different prices for essentially the same service. Two mechanisms— proper price mix and rate fences—provide opportunities to alter price while maintaining goodwill (Figure 5).

Proper Price Mix

           Companies must be sure that they offer a logical mix of prices from which to choose. If customers do not see much distinction between the different prices being quoted, a differentialpricing strategy may not work. Determining the best mix of prices is difficult because management often has little information on price elasticities. This, in turn, often results in pricing decisions based solely on competitive pressures. It should be noted, however, that airlines such as American Airlines have been working hard on the issues of elasticity and of multiple legs and have made some progress.

           Optimal pricing policies, in which customers are asked to name the prices that they would consider to be cheap, expensive, too cheap to be of reasonable quality, and too expensive to be considered, have been developed by Taco Bell and have been tested for use with meeting planners (Lewis and Shoemaker 1997). Optimal pricing policies represent a relatively simple way of determining price sensitivity and acceptable price ranges.

           Although not widely publicized, some restaurant companies are experimenting with menu pricing based on price elasticities. Large chain restaurant companies analyze the price elasticities of various menu items and make appropriate pricing changes (Kelly, Kiefer, and

Burdett 1994).

Rate Fences

           The possession of a good pricing structure does not ensure the success of a variablepricing strategy. Companies must also have a logical rationale or, in industry terms, rate fences that can be used to justify price discrimination. (Or, as one somewhat cynical hotel executive states, “We want something we can say out loud without laughing.”)

           Quadrant 2 industries often use rate fences, such as when the reservation is booked or when the service is consumed, to determine the price a customer will pay. Rate fences refer to qualifications that must be met to receive a discount (Hanks, Cross, and Noland 1992). Rate fences can be physical or nonphysical in nature and represent a rationale for why some customers pay different prices for the same service.

           Physical rate fences include tangible features such as room type or view for hotels, seat type or location for airlines, or table location for restaurants. Other physical rate fences are the presence or absence of certain amenities (free golf cart use with a higher price, free breakfast with a higher price, or free soft drinks at a movie theater).

           Nonphysical rate fences can be developed that can help shift demand to slower periods, reward regular customers, or reward reliable customers. Nonphysical rate fences include cancellation or change penalties and benefits based on when the reservation was booked, desired service duration, group membership or affiliation, and time of use.

           Even today, it is common practice for companies to adopt differential pricing schemes without rate fences. Hotels use top-down pricing in which reservation agents quote the rack rate (generally the highest rate) and only quote lower rates if customers ask for them. Knowledgeable customers may know to ask for the lower rate, but inexperienced customers may not. Customers view this practice highly unfavorably (Kimes 1994).

Moving To a More Profitable Quadrant

           The strategic levers described above can be used to help companies move into more profitable quadrants by making duration more predictable and/or by varying prices. Generally, companies try to manipulate one strategic lever at a time, but it is possible, although difficult, for a company to try to simultaneously adjust price and duration. The following examples of potential moves show the possibilities for various industries.

Differential Pricing: Quadrant 1 to Quadrant 2

           Movie theaters. Although reservation systems and differential pricing have been used in Europe for many years, American movie theaters usually charge the same price for all seats and offer discounted seats only for matinees or for senior citizens. However, things are changing rapidly, and some new movie houses are now offering differential pricing based on seat location, time of show, and access to amenities. For example, the 70-seat Premium Cinema in Lombard, Illinois, has been booked solid since its opening April 3, 1998. Guests willing to pay $15 for access to a separate entrance with valet parking are admitted to a private lounge, where they can purchase champagne at $12 per glass and buy prime-rib sandwiches at the same price. They offer free popcorn (all you can eat) and have a fulltime concierge to get it for the customers. As of yet, they have not gone to the next step of developing an overbooking strategy.

Control Duration: Quadrant 3 to Quadrant 1

           Golf courses. Golf courses seem to be in the worst possible position—they charge a fixed price for an event of unknown duration. Much of the problem stems from the definition of duration as an event, typically 18 holes of golf played during daylight hours. Alternative definitions of duration abound. The golf course could sell 9-hole rounds; it could institute shotgun golf, in which different groups start simultaneously at multiple holes; or it could use express golf, in which golfers run between holes and receive two scores, elapsed time and stroke count, at the end of each round. (The latter perhaps becoming a new Olympic event.) None of these modifications reduce variability in and of themselves; however, they do provide ways of redefining duration for more creative applications of yield management.

           Arrival uncertainty could be reduced by instituting deposit policies or by developing good overbooking policies. Duration uncertainty could be reduced by adding marshals to help move golfers along on the course, by provision of free golf carts to speed the time between holes, and by more accurately forecasting play length based on time of day, week, and party size. More golfers could be accommodated if tee-time interval

 

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Social Dominance Orientation: A Personality Variable Predicting Social and Political Attitudes

Social dominance orientation (SDO), one’s degree of preference for inequality among social groups, is introduced. On the basis of social dominance theory, it is shown that (a) men are more social dominance-oriented than women, (b) high-SDO people seek hierarchy-enhancing professional roles and low-SDO people seek hierarchy-attenuating roles, (c) SDO was related to beliefs in a large number of social and political ideologies that support group-based hierarchy (e.g., meritocracy and racism) and to support for policies that have implications for intergroup relations (e.g., war, civil rights, and social programs), including new policies. SDO was distinguished from interpersonal dominance, conservatism, and authoritarianism. SDO was negatively correlated with empathy, tolerance, communality, and altruism. The ramifications of SDO in social context are discussed.

Group conflict and group-based inequality are pervasive in human existence. Currently, every continent is enduring some form of ethnic conflict, from the verbal debate over multiculturalism in the United States and Canada to civil war in Liberia and Bosnia. Other conflicts between groups are ancient: the European persecution of Jews, “Holy Wars” waged by Christians and Muslims around the Mediterranean, imperialism in South America, and anti-Black racism in northern Africa and elsewhere. Regardless of the intensity of the conflict, the participants justify their behavior to others by appealing to historical injustices, previous territorial boundaries, religious prohibitions, genetic and cultural theories of in-group superiority, or other such ideologies. Prompted by the ubiquitous nature of group-based prejudice and oppression, we developed social dominance theory (see Pratto, in press; Sidanius, 1993; Sidanius & Pratto, 1993a). The theory postulates that societies minimize group conflict by creating consensus on ideologies that promote the superiority of one group over others (see also Sidanius, Pratto, Martin, & Stallworth, 1991). Ideologies that promote or maintain group inequality are the tools that legitimize discrimination. To work smoothly, these ideologies must be widely accepted within a society, appearing as self-apparent truths; hence we call them hierarchy-legitimizing myths.’ By contributing to consensual or

normalized group-based inequality, legitimizing myths help to stabilize oppression. That is, they minimize conflict among groups by indicating how individuals and social institutions should allocate things of positive or negative social value, such as jobs, gold, blankets, government appointments, prison terms, and disease. For example, the ideology of anti-Black racism has been instantiated in personal acts of discrimination, but also in institutional discrimination against African-Americans by banks, public transit authorities, schools, churches, marriage laws, and the penal system. Social Darwinism and meritocracy are examples of other ideologies that imply that some people are not as “good” as others and therefore should be allocated less positive social value than others. Thus far, we have given examples of legitimizing myths that enhance or maintain the degree of social inequality. Other ideologies may serve to attenuate the amount of inequality. For example, the “universal rights of man” and the view summarized by “all humans are God’s children” are inclusive, egalitarian ideologies that explicitly do not divide persons into categories or groups. To the extent that such ideologies are widely shared, there should be less group inequality. There are, then, two varieties of legitimizing myths: hierarchy-enhancing legitimizing myths, which promote greater degrees of social inequality, and hierarchy-attenuating legitimizing myths, which promote greater social equality.

Felicia Pratto, Lisa M. Stallworth, and Bertram F. Malle, Department of Psychology, Stanford University; Jim Sidanius, Department of Psychology, University of California at Los Angeles. We are grateful to a number of people for their diligence and creativity in this research: Erron Al-Amin, Jill Andrassy, Sahr Conway-Lanz, Nick Clements, Magda Escobar, Jack Glaser, Louis Ibarra, Kent Harber, John Hetts, Amy Lee, Johanna Jensen, John Moore, Jenn Pearson, Holly Schaefer, Margaret Shih, Stacey Sinclair, Gayatri Taneja, Jack Wang, and Wes Williams. Bob Altemeyer, Monisha Pasupathi, Vernon Schabert, Michael Mitchell, Steve Gangestad, Corinne Kosmitzki, Ted Goertzel, and three anonymous reviewers provided useful comments on a draft of this article. Correspondence concerning this article should be addressed to Felicia Pratto, Department of Psychology, Jordan Hall, Stanford University, Stanford, California 94305-2130.

SOCIAL DOMINANCE ORIENTATION

Given our theoretical postulate that acceptance of legitimizing myths has significant influence on the degree of inequality in societies, it is quite important to understand the factors that lead to the acceptance or rejection of ideologies that promote or attenuate inequality. Social dominance theory postulates that a

1 The term myth is meant to imply that everyone in the society perceives these ideologies as explanations for how the world is—not that they are false (or true). Social dominance theory is meant only to describe the social and psychological processes that act on these ideologies, not to ascertain whether these ideologies are true, fair, moral, or reasonable.

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742 PRATTO, SIDANIUS, STALLWORTH, AND MALLE

significant factor is an individual-difference variable called social dominance orientation (SDO), or the extent to which one desires that one’s in-group dominate and be superior to outgroups. We consider SDO to be a general attitudinal orientation toward intergroup relations, reflecting whether one generally prefers such relations to be equal, versus hierarchical, that is, ordered along a superior-inferior dimension. The theory postulates that people who are more social-dominance oriented will tend to favor hierarchy-enhancing ideologies and policies, whereas those lower on SDO will tend to favor hierarchy-attenuating ideologies and policies. SDO is thus the central individual-difference variable that predicts a person’s acceptance or rejection of numerous ideologies and policies relevant to group relations. Another way that individuals’ levels of SDO may influence their contribution to social equality or inequality is in the kinds of social roles they take on, particularly, roles that either enhance or attenuate inequality. We thus predict that those who are higher on SDO will become members of institutions and choose roles that maintain or increase social inequality, whereas those who are lower on SDO will belong to institutions and choose roles that reduce inequality. The purpose of the present research was to demonstrate that individual variation in SDO exists and to show that this construct behaves according to the theory outlined above. Specifically, our goals were (a) to develop a measure of SDO that is internally and temporally reliable, (b) to show that SDO is related to the attitudinal and social role variables specified by social dominance theory (predictive validity), (c) to show that the measure is not redundant with other attitude predictors and standard personality variables (discriminant validity), and (d) to show that SDO serves as an orientation in shaping new attitudes.

HYPOTHESES

The first set of hypotheses we tested was derived from social dominance theory and concerned those variables to which SDO should strongly relate, termed predictive validity. The second set of hypotheses, termed discriminant validity, states either that SDO should be independent of other variables or that SDO should have predictive value in addition to the effects of these other variables. We also hypothesized that SDO should relate moderately to certain other personality variables, from which SDO is conceptually distinct. The third set of hypotheses we tested concerns SDO’s power to predict new social attitudes.

Predictive Validity

Gender

The world over, men and women hold different roles with regard to the maintenance of hierarchy. Ubiquitously, men serve as military leaders and hold leadership roles in religious, social, political, and cultural spheres (e.g., Brown, 1991, pp. 110, 137). Moreover, men hold more hierarchy-enhancing attitudes, such as support for ethnic prejudice, racism, capitalism, and rightwing political parties, than do women (e.g., Avery, 1988; Eisler & Loye, 1983; Ekehammar & Sidanius, 1982; Shapiro & Mahajan, 1986; Sidanius & Ekehammar, 1980; see review by Si

danius, Cling, & Pratto, 1991). On the basis of these general societal patterns, we have predicted and shown that, on average, men are more social dominance-oriented than women (see Pratto, Sidanius, & Stallworth, 1993; Sidanius, Pratto, & Bobo, in press). We tested this hypothesis with the measure of SDO developed in the present research.

Legitimizing Myths

Ethnic Prejudice

One of the major kinds of ideology concerning relative group status is ethnic prejudice. In the United States, the most longstanding and widely disseminated version of ethnic prejudice is anti-Black racism. Therefore, we predicted that SDO would be strongly related to anti-Black racism in the present U.S. samples. In the United States, a theoretical and empirical debate about how best to measure anti-Black racism has been conducted for some time (e.g., see Bobo, 1983; McConahay, 1986; Sears, 1988;Sniderman&Tetlock, 1986a, 1986b). Social dominance theory merely postulates that SDO should predict whatever ideologies are potent within the culture at the time of measurement. From our theoretical viewpoint, it does not matter whether the basis for racism is fairness (e.g., Kluegel & Smith, 1986), genetic or biblical racial inferiority theories, symbolic racism (e.g., Sears, 1988), or family pathology (e.g., Moynihan, 1965). Any potent ideology that describes groups as unequal and has policy implications is a legitimizing myth and should, therefore, correlate with SDO. During the period the present research was conducted, our subjects’ country was engaged in a war against Iraq, so we also measured anti-Arab racism and expected it to correlate with SDO.

Nationalism

A more general kind of in-group prejudice that can occur in nation-states is nationalism, chauvinism, or patriotism. Kosterman and Feshbach (1989) suggested that procountry feelings (patriotism) can be distinguished from comparative prejudice, that is, that one’s country is better than other countries (nationalism), and as such should dominate other countries (chauvinism). Even so, all three reflect attitudinal bias in favor of the national in-group, and thus we postulated that patriotism, nationalism, and chauvinism would all be significantly related to SDO.

Cultural Elitism

All societies share the idea that one of the defining features of those who belong to their society (are part of the in-group, or are considered by them to be human) is that they are “cultured.” In some societies, including English and American society, an elitist ideology built on the cultured-not cultured distinction postulates that the elite class has “culture” not shared by middle- and working-class people and is therefore more deserving of the “finer things in life.” We term this legitimizing myth cultural elitism, and we expected it to correlate with SDO as well.

Sexism

We believe that antifemale sexism is a ubiquitous legitimizing myth, although, as with ethnic prejudice, the content basis of

SOCIAL DOMINANCE ORIENTATION 743

sexist ideology varies widely with religion, cultural history, and technology. In the present U.S. samples, we used scales that assess sexism as the extent to which people believe men and women are “naturally” different and should have different work roles outside and inside the home (Benson & Vincent, 1980; Rombough & Ventimiglia, 1981) and the extent to which people believe that women rather than men can be blamed for unwanted sexual advances such as rape and sexual harassment (Burt, 1980). We predicted that all of these would be positively correlated with SDO, even controlling for subject sex.

Political-Economic Conservatism

Political-economic conservatism is associated with support for capitalism versus socialism (e.g., Eysenck, 1971). Given that capitalism implies that some people and businesses should thrive, while those who are less “competitive” should not, we consider political-economic conservatism to be a hierarchy-enhancing legitimizing myth that should positively correlate with SDO (see also Sidanius & Pratto, 1993b). Other policies supported by conservatives, such as that women should stay home with children and that the USSR must be kept in its place, divide people into groups “deserving” different treatment, so we feel conservatism generally can be viewed as a legitimizing myth. In fact, Wilson’s extensive work on the body of attitudes that make up conservatism shows that a preference for hierarchical social relationships is one of conservatism’s many dimensions (Wilson, 1973, p. 22).

Noblesse Oblige

A hierarchy-attenuating ideology that exists in many cultures is that those with more resources should share them with those who have fewer resources (e.g., the Marxist maxim, “From each according to his [sic] ability, to each according to his need,” and the potlatch custom of the Kwakiutl). The English-American version is called noblesse oblige, which we expected to be negatively correlated with SDO.

Meritocracy

Another hierarchy-enhancing ideology is that wealth and other social values are already distributed appropriately, based on the deservingness of the recipients. The Protestant work ethic and just world theory are examples of meritocratic ideologies, so we administered standard measures of belief in the Protestant work ethic and belief in a just world and predicted that they would be positively correlated with SDO. In the United States, attributions for poverty due to laziness or to some other inherent fault in the poor are predicated on the idea that equal opportunity is available to all (Kluegel & Smith, 1986), so we wrote an equal opportunity scale and predicted that it would correlate positively with SDO.

Social Policy Attitudes

According to social dominance theory, individuals who are social dominance oriented will favor social practices that maintain or exacerbate inequality among groups and will oppose social practices that reduce group inequality. The particular social policies that correlate with SDO may vary from society to soci

ety, but we predicted that SDO would relate to support for, or opposition to, the following policies in U.S. samples.

Social Welfare, Civil Rights, and Environmental Policies

We expected SDO to correlate with opposition to social policies that would reduce inequality between U.S. nationals and foreigners or immigrants, rich and middle class or poor, men and women, ethnic groups, heterosexuals and homosexuals, and humans versus other species. As such, we measured our subjects’ attitudes toward a variety of government social programs, racial and sexual discrimination laws, gay and lesbian rights, domination of foreigners, and environmental policies. In several samples we also assessed attitudes toward “interracial dating” and “interracial marriage,” because miscegenation has been central to the U.S. racial policy debate.

Military Policy

Because the military is a symbol of nationalism and can be one of the chief means of domination of one nation over others, we expected SDO to correlate positively with expressed support for military programs and actions.

Punitive Policies

Despite its stated creed to enact equality before the law, the U.S. criminal justice system shows class and ethnic bias at all levels from arrest to plea bargaining to sentencing (e.g., Bienen, Alan, Denno, Allison, & Mills, 1988; General Accounting Office, 1990; Kleck, 1981; Nickerson, Mayo, & Smith, 1986; Paternoster, 1983; Radelet & Pierce, 1985; Reiman, 1990; Sidanius, 1988). As one example, in a review of 1,804 homicide cases in South Carolina, Paternoster (1983) found that in cases where Blacks killed Whites, rather than other Blacks, prosecutors were 40 times more likely to request the death penalty. For this reason, we expected support for “law and order” or punitive policies, particularly the death penalty, to be positively related to SDO (see also Mitchell, 1993; Sidanius, Liu, Pratto, & Shaw, 1994).

Discriminant Validity

Interpersonal Dominance

SDO, or preference for unequal relationships among categories of people, is conceptually distinguishable from the common personality conception of interpersonal dominance, which concerns the extent to which individuals like to be in charge and are efficacious. For example, people who score high on the California Personality Inventory (CPI) Dominance scale are confident, assertive, dominant, and task oriented, whereas people who score low are unassuming and nonforceful (Gough, 1987, p. 6). People who score high on the Jackson Personality Research Form (JPRF) Dominance scale attempt to control their environments and influence or direct other people; they are forceful, decisive, authoritative, and domineering (Jackson, 1965). We tested this theoretical distinction between social and task or interpersonal dominance by using the CPI and JPRF Dominance subscales in several samples reported here. We predicted that SDO would not correlate with these two measures.

744 PRATTO, SIDANIUS, STALLWORTH, AND MALLE

Authoritarianism

There is clearly some theoretical similarity in the effects of social dominance theory’s SDO construct and authoritarian personality theory’s authoritarian construct (see Adorno, Frenkel-Brunswik, Levinson, & Sanford, 1950). High-SDO people and authoritarian personalities are theorized to be relatively conservative, racist, ethnocentric, and prejudiced, and they should show little empathy for lower status others. Our conception of SDO, however, differs from classical authoritarianism in several respects. First, classical authoritarian theorists viewed authoritarianism as an aberrant and pathological condition and as a form of ego-defense against feelings of inadequacy and vulnerability (see also Frenkel-Brunswik, 1948, 1949). SDO, however, is not conceived of in clinical terms, as an aberrant personality type, or as a form of ego-defense. Rather, SDO is conceived of as a “normal” human propensity on which people vary. Second, authoritarian personality theory emphasized the sources of authoritarianism as springing from psychodynamic processes. Specifically, Adorno et al. (1950) postulated that strict and harsh parental styles would provoke conflicts between the child and parents that would be “unresolved.” As a way of resolving these, the child as an adult would submit to authorities and be intolerant of those who would not. In contrast, we theorize that such a personal history is unnecessary to developing a relatively high SDO tendency. Rather, both temperament and socialization probably influence one’s level of SDO. Third and most important, whereas authoritarianism is primarily conceived as a desire for individual dominance resulting from experiences with authority figures, SDO is regarded as the desire that some categories of people dominate others. Because the two constructs are defined differently, measurements of each should not be highly correlated. Given that authoritarianism should predict many of the same variables we postulate SDO should predict, it is important for us to show that SDO has explanatory value in addition to authoritarianism. We tested the “marginal utility” of the SDO construct by testing whether correlations between SDO and support for legitimizing myths and policies are significant after partialing out authoritarianism.

Conservatism

Political-economic conservatism serves as a legitimizing myth in our theory, and thus we expect it to correlate positively with SDO. Conservatism is also a well-known robust predictor of social and political attitudes (e.g., Eysenck & Wilson, 1978; Wilson, 1973). To show that SDO has utility in addition to political-economic conservatism, we tested whether SDO substantially correlated with social attitudes after partialing out conservatism.

Standard Personality Variables

Because we think our concept of SDO is a yet unstudied personality dimension, we expected it to be independent of other standard personality variables such as self-esteem and the BigFive personality dimensions: Extraversion, Agreeableness, Openness, Neuroticism, and Conscientiousness (see Costa & MacRae, 1985; John, 1990, for reviews).

Empathy, Altruism, Communality, and Tolerance

People who are highly empathic with others would seem to be less prejudiced and discriminatory against out-groups. Thus, it is reasonable to expect a general concern for other people to be negatively correlated with SDO. Similarly, any general prosocial orientation might mitigate prejudiced feelings and behaviors toward out-group members, so altruism should be negatively correlated with SDO. Furthermore, people who are quite inclusive in their definitions of what constitutes an in-group should be less able to discriminate against out-groups, so we expected communality to be negatively correlated with SDO. And finally, because tolerance is the antithesis of prejudice, we might expect that a general measure of tolerance would be negatively correlated with a general desire for in-group superiority. We used Davis’ (1983) multidimensional empathy scale, Super and Nevill’s (1985) altruism subscale, the Personal Attribute Questionnaire (PAQ) Communality scale (Spence, Helmreich, & Stapp, 1974), and the Jackson Personality Inventory (JPI) Tolerance scale (Jackson, 1976) to test these hypotheses. If SDO has merit as a new personality variable, none of these correlations should be very high.

PRESENT RESEARCH

Overview

We examined data from 13 samples to test the predictive and discriminant validity and reliability of our measure of SDO. Our logic in using this large number of samples is to examine statistically significant results that are reliable across samples. We organized the results by topic, but we report the results in each sample so that the reader can see the magnitude of effects in each sample and the stability of the results across samples. At the end of the Results section, we provide a summary of the results in the form of meta-analyses.

Data Collection

Generally, subjects were college students who participated in a study called “Social Attitudes” for partial course credit. All of their responses were anonymous and confidential, and they completed batteries of self-administered questionnaires. Subjects in Samples 2, 3b, 5,6,8, 9, and 13 spent about 1 hr in our laboratory completing the questionnaires. The experimenter described the study as designed to measure students’ social attitudes and personal preferences. Subjects in Samples 1 and 13 completed the SDO scale after participating in unrelated experiments, and subjects in the remaining samples completed the SDO scale and follow-up scales in two consecutive mass-testing sessions normally conducted on subject pool participants. All subjects completed a demographic background sheet and our 14-item SDO scale intermixed with related items, a Nationalism scale based on Kosterman and Feshbach’s (1989) measure, along with other attitude or experience measures, each having their own instructions and response scales. We also administered some standard personality or attitude scales according to the instructions of their authors. In several samples we also administered ideological (legitimizing myths) or policy attitude items on a questionnaire entitled “Policy Issues Questionnaire.”

SOCIAL DOMINANCE ORIENTATION 745

Measures

SDO In previous archival studies, we measured proxies for SDO using items dealing with equality from the National Election Study or the S6 Conservatism scale (see Sidanius, 1976). In developing the present measure of SDO, we tested over 70 items whose content we felt related to SDO or to constructs one can define as separate but that might be considered adjacent to SDO (e.g., nationalism and prestige-striving), following Loevinger’s (1957) suggestion about scale construction. However, on the basis of our desire to develop a simple, unidimensional scale that is balanced, we selected 14 items from this extensive questionnaire as the SDO scale. The selected items concerned the belief that some people are inherently superior or inferior to others and approval of unequal group relationships (see items in Appendix A). The 14-item SDO scale was balanced in that half the items indicated approval of inequality and half indicated approval of equality (see items in Appendix A). We assume that these items tap a latent construct and so we are interested in the relationships between the scale mean and other measures rather than relationships between individual SDO items and other measures. SDO is an attitudinal orientation, so instructions read, “Which of the following objects or statements do you have a positive or negative feeling towards? Beside each object or statement, place a number from’ 1′ to ‘7’ which represents the degree of your positive or negative feeling.” The scale was labeled very positive (7), positive (6), slightly positive (5), neither positive nor negative (4), slightly negative (3), negative (2), and very negative (1). The order of the SDO items and the filler items differed among Form A, completed by Samples 1, 2, 3, and 4; Form B, completed by Samples 5, 6, 7, 8, and 12; and Form C, completed by Samples 9, 10, and 11. The format and instructions for the three forms were identical, and we saw no evidence that results pertinent to reliability or validity issues differed across the questionnaire form. Subsequent to the present research, we have used just the 14 items on a questionnaire and found reliability coefficients of .90 and predictive validity results similar to those reported below.

Political-Economic Conservatism

Some of the standard scales assessing political-economic conservatism actually measure individuals’ support for particular social policies (e.g., the C-scale, Wilson & Patterson, 1968). Because we wished to measure political-economic conservatism separately from policy attitudes, and because we wanted to use a measure that should not vary with time and place, we used a self-identified liberal-conservative measure in all samples. On the demographic background sheet, the political-economic conservatism question read, “Use one of the following numbers to indicate your political views in the accompanying categories.” Below these instructions was a scale labeled very liberal (1), liberal (2), slightly liberal (3), middle of the road (4), slightly conservative (5), conservative (6), and very conservative (7) and a blank next to each type of issue: “foreign policy issues,” “economic issues,” and “social issues.” Political-economic conservatism was the mean of self-ratings on these three items.

Authoritarianism Authoritarianism research has been fraught with measurement difficulties. After surveying the authoritarianism measurement literature, we decided to administer two rather different measures of authoritarianism, both of which are balanced: the Right Wing Authoritarian (RWA) scale by Altemeyer (1981) and Goertzel’s (1987) bipolar personality measure. Goertzel (1987) intended his adjective checklist to measure the personality rather than the ideological aspect of authoritarianism, but did show that it correlates with attitudes toward policies falling along toughness and consistency dimensions. Altemeyer’s (1981) scale is the only other internally reliable measure of authoritarianism that is close to the original conception of authoritarianism, including conventionalism, authoritarian submission, and authoritarian aggression (see Duckitt, 1989, for a review).

Original Legitimizing Myths and Policy Attitudes

The consent form and instructions informed subjects that their opinions and preferences toward a variety of ideas, kinds of people, events, and so forth would be measured. On our “Policy Issues Questionnaire” we included items from various legitimizing myth or policy attitude scales. Items from each scale were interspersed throughout the questionnaire. Next to each item was a 1-7 scale, and the instructions read, “Which of the following objects, events, or statements do you have a positive or negative feeling towards? Please indicate your feelings by circling the appropriate number alongside each item. Use one of the following responses. Remember, your first reaction is best. Work as quickly as you can.” The scale points were labeled very negative (1), negative (2), slightly negative (3), uncertain or neutral (A), slightly positive (5), positive (6), and very positive (7). Items from the original legitimizing myths and policy attitude scales were selected for their content and for their internal reliability across samples. These scales are shown in Appendix B. Several personality measures were used as well; these are described in the Method section.

Method

Subjects

Although our 1,952 subjects were college students, they represent some diversity in terms of sex, ethnicity, and income groups, coming from public and private universities in California. Demographic information about the samples is shown in Table 1.

Samples and Procedures

Sample 1 (spring 1990) consisted of 98 University of California at Berkeley undergraduates who completed the CPI Dominance, Flexibility, and Capacity for Status subscales (Gough, 1987), the JPRF Dominance subscale (Jackson, 1965), the JPI Tolerance subscale (Jackson, 1976), and the Rosenberg (1965) Self-Esteem Scale (RSE). Sample 2 (fall and winter 1990-1991) consisted of 463 San Jose State University (SJSU) undergraduates who completed the CPI and JPRF Dominance subscales; Mirels and Garrett’s (1971) Protestant Work Ethic Scale; the Just World Scale (Rubin & Peplau, 1975); the fourfactor Interpersonal Reactivity Index (IRI), which measures empathy (Davis, 1983); a number of policy attitude measures; and some demographic descriptors.

746 PRATTO, SIDANIUS, STALLWORTH, AND MALLE

Table 1 Description of Samples

Measure

n Age range % men % women

% Euro-American % Asian-American % Hispanic % Black % Arab-American

Under 20K 20-30K 30-40K 40-55K 55-7OK 70-100K 100-150K 15O-2OOK 200K.+

1

98 17-34 50 50

48 23 13 15 1

2

463 15-56 47 53

38 40 8 5 2

12 9 11 17 20 14 8 5 5

3a

81 17-21

3b

57 17-21 51 49

58 16 4 14 6

4 5

Sample

6

Age and gender br

 

"Not answered?"


Get the Answer

Domestic terrorism MOST closely associated

With which of the following is domestic terrorism MOST closely associated?

 Religious extremism

 Antiglobalization groups

 Devolutionist processes

 Separatist movements

 Supranationalism

Question 2

(09.07 MC)

Which of these is a development initiative aimed at promoting the consumption of locally produced goods?

 Privatization

 Green industrialization

 Import substitution

 Economic integration

 Tariff reduction

Question 3

(08.06 MC)

Subsistence farmers are threatened by the increasing use of genetically modified crops because these crops

 deplete the soil faster than selectively bred crops, resulting in desertification and displacement

 can easily be grown organically, resulting in a decrease in demand for nonorganic foods

 reduce the nutritional value of foods, resulting in increased malnutrition

 make land more profitable to use, resulting in eviction by landlords who want to profit from the land

 require less labor to cultivate, resulting in a shift of the agricultural workforce into industrial labor 

Question 4

(10.02 HC)

Ohio’s Four Largest Cities by Population, 2010 

Rank

Name

Population

1

Columbus

787,033

2

Cleveland

396,815

3

Cincinnati

296,943

4

Toledo

?

According to the rank-size rule, about how many people will Toledo, Ohio, have? 310,000

 70,000

 200,000

 130,000

 275,000

Question 5

(10.03, 10.05 MC)

What type of housing is MOST likely to be located near light-industrial areas?

 Low-density suburban developments

 Low-cost residential apartments

 Gentrified condominiums

 Intermediate-rent apartments

 Medium-cost single-family homes

Question 6

(07.01, 07.02 MC)

Palestine is not considered a nation-state because

 it has historical significance and cannot be declared a state

 its population is not numerous enough to form an independent state

 its population is composed of many different nations

 it has only been recognized as a state by one other country

 it does not have political sovereignty

Question 7

(07.03 MC)

What problems might a prorupted state encounter?

  1. Difficulty creating a common national identity
  2. Invasion from neighboring countries
  3. Too little territory to support its population
  4. Increased push for devolution of power

 I and II

 II and III

 I, II, and III

 I, II, and IV

 II, III, and IV

Question 8

(09.08 HC)

Which of the following scenarios does NOT align to the principles of the National Sustainable Development Strategy?

  1. Argentina wants to build sustainable development, so the government takes Brazil’s sustainable development plan and follows it exactly.
  2. Indonesia creates a sustainable development plan that balances economic and social policy.
  3. Malaysia develops a sustainable development plan that involves improving the quality of roads and telephone lines.
  4. North Korea looks to other countries’ sustainable development plans and uses relevant points of each plan to create its own plan.

 I and II

 II and III

 I and IV

 I, II, and III

 II, III, and IV

Question 9

(10.02 MC)

Which place or places would have the highest range according to the central place theory?

  1. A hospital
  2. A grocery store
  3. A clothing store
  4. A car-repair shop

 I only

 II only

 I and III

 II and III

 III and IV

Question 10

(07.01, 07.02 MC)

A new state has formed and chosen a federal form of government. Based on the state’s choice of government, which of the following can MOST likely be determined about the state?

  1. The country has ethnic groups with a history of self-determination.
  2. The country is a microstate.
  3. The country is landlocked.
  4. The country has a population with little ethnic diversity.

 I only

 III only

 I and IV

 II and III

 III and IV

Question 11

(08.01, 08.06 MC)

Which of these MOST directly contributed to the Green Revolution?

 The domestication of plants and animals

 The signing of international agreements

 A widespread diffusion of industrial agriculture

 The invention of crop rotation

 A decline in the global birthrate

Question 12

(07.01, 07.06 HC)

State A is a multiethnic state. State B, a nation-state, is an enclave of State A. State B’s population is ethnically homogeneous and is made up of one of the ethnic groups living in State A. Which of the following are MOST likely to happen?

  1. Members of State A who belong to the majority ethnic group of State B will migrate to State B.
  2. The border between State A and State B will become a relic border to divide the populations.
  3. State A and State B will have conflicts, and a civil war will erupt.
  4. State A and State B will unite to form a single multiethnic state.

 I and II

 I and III

 I and IV

 II and III

 III and IV

Question 13

(09.04, 09.05 MC)

A reliance on cash crops and mineral exports is MOST common in which of the following areas?

 The countries of Southwest Asia

 Former Soviet satellites in Eastern Europe

 The communist countries of East Asia

 Former European colonies in Africa

 The mountainous regions of Central Asia

Question 14

(09.01, 09.04 MC)

If Brazil’s economy continues on its current development path, which types of activities will MOST likely drive Brazil’s economy in the next 50 years?

  1. Customer service
  2. Textile manufacturing
  3. Commercial agriculture
  4. Professional services

 I and II

 II and III

 I, III, and IV

 II, III, and IV

 I, II, III, and IV

Question 15

(09.06 MC)

All of the following are obstacles to economic development EXCEPT

 a tropical climate

 a small territory

 isolation from trade routes

 absence of a coastline

 a mountainous terrain

Question 16

(10.01 LC)

Early cities performed all of the following functions EXCEPT

 storing food

 facilitating trade

 housing religious structures

 providing entertainment

 protecting the population

Question 17

(10.03 HC)

Which of the following could the sector model account for better than the concentric zone model?

 A sudden renewal of the central business district

 More rapid population growth at the edges of a city

 An outward migration of upwardly mobile populations

 The proximity of wealthy and poor neighborhoods near the city center

 The continued presence of light industry near a city’s core

Question 18

(08.06 MC)

Organic farmers have returned to what traditional agricultural practice?

 Using livestock manure as fertilizer

 Relying on manual labor for harvesting

 Leaving land fallow rather than rotating crops

 Growing diverse crops to create ann self-sustaining community

 Cultivating small plots of land

Question 19

(07.10 MC)

District

Percent Republican Vote

Percent Democratic Vote

I

12%

88%

II

55%

45%

III

62%

38%

IV

37%

63%

V

58%

42%

Which voting results would MOST indicate an excess vote gerrymander? I

 II

 III

 IV

 V

Question 20

(10.04 MC)

A small-sized city has a very low population density. The residents of the city have a distrust of having any one person hold too much power and would rather a group govern than a single individual. Based on this scenario, which of the following would MOST likely be the best government for this city?

  1. Commission
  2. Weak mayor-city council
  3. Strong mayor-city council
  4. City manager-city council

 I only

 IV only

 I and II

 I and IV

 II, III, and IV

Question 21

(08.04 MC)

Which conclusion or conclusions about agriculture can be drawn about formerly colonized countries in tropical and subtropical regions?

  1. The country’s agriculture suffers because the arable land is being used up by industrial companies.
  2. Plantation agriculture is practiced to support the economy of developed countries.
  3. Commercial agriculture is primarily practiced to build the country’s economy.
  4. The country’s land and resources have been severely depleted by the colonizing country.

 I only

 II only

 I and IV

 II and III

 I, III, and IV

Question 22

(10.04, 10.06 MC)

Public Domain

What development dynamic is demonstrated by the photograph above?

  1. Urban sprawl
  2. Ghettoization
  3. Gentrification
  4. Deindustrialization

 I only

 IV only

 I and III

 II and IV

 I, II, and III

Question 23

(08.03 MC)

Which of these did NOT result from the spread of modern agriculture?

  1. Division and globalization of labor among agricultural processes emerged.
  2. Farmers in developing countries began to produce less food.
  3. The sophistication of farming processes diffused globally.
  4. Farming and food processing began to occur on single-family farms.

 I and III

 II and IV

 III and IV

 I, II, and III

 II, III, and IV

Question 24

(08.07 MC)

Which strategy of land use is MOST likely to reduce the effects of desertification?

 Preventing monocrop cultivation from spreading further in semiarid grasslands

 Reducing the population growth rate in regions in or near deserts and grasslands

 Enabling farmers in semiarid regions to make more widespread use of irrigation

 Preventing deforestation in timberlands that border on desert and grassland regions

 Reducing the number of animals that graze on grasslands in semiarid regions

Question 25

(09.01 MC)

Which pattern resulted from the spread of industrialization during the 19th century?

 Unequal development between Europe and Asia

 Concentrations of wealth in countries with more territory

 Expansion of free-trade zones in the Northern Hemisphere

 Decolonization in Asia, Africa, and Latin America

 Increased conflict between capitalist and non-capitalist countries

Question 26

(10.03 MC)

What prediction do the sector and the concentric zone models make about a city’s central business district (CBD)?

 The CBD will have a relatively high proportion of residents to workers.

 The CBD will retain a core of high-income workers throughout the life of the city.

 The CBD will be the place of employment of the people who live in the closest residential areas.

 The CBD will largely employ light-manufacturing and other low-skill workers.

 The CBD will have a shifting mixture of banking, retail, and entertainment workers.

Question 27

(07.05 MC)

© 2011 The Exploration Company 

The map above shows the consequences of

 bureaucratization

 imperialism

 political fragmentation

 liberal internationalism

 decolonization

Question 28

(08.04 MC)

Subsistence agriculture is common in all of the following regions EXCEPT

 Western Europe

 Central Africa

 South Asia

 South America

 Central America

Question 29

(09.01, 09.05 MC)

A country that outsources most of its factory work is likely to be experiencing which other trend at the same time?

 Agricultural agglomeration

 Cultural homogenization

 Deindustrialization

 Fragmentation

 Infrastructure development

Question 30

(10.05, 10.06 MC)

Which type of infrastructure project is MOST likely to result in increased suburbanization?

 The updating of sewer, electricity, and water lines

 The extension of transit lines

 The enlargement of airport and port facilities

 The construction of new highways

 The replacement of old school buildings

Question 31

(08.01 MC)

What effect did the Neolithic Agricultural Revolution have on human populations?

 It reduced the ability of governments to restrict movement.

 It resulted in violent conflict between urban and rural dwellers.

 It produced a significant drop in infant-mortality rates.

 It prompted significant northward migrations.

 It led to the establishment of early civilizations.

Question 32

(10.02 MC)

Central place theory is which type of model?

 Localization

 Concentric zone

 Multiple-nuclei

 Gravity

 Rank-size

Question 33

(08.03 MC)

Which of the following shifts have resulted from the industrialization of agriculture?

  1. A reduction in per capita income
  2. A slowing of the population growth rate
  3. A movement of the rural workforce to urban areas
  4. An increase in average longevity for men

 II only

 III only

 I and IV

 II and III

 III and IV

Question 34

(07.02, 07.06 MC)

Public Domain 

Based on the map, which of the following conclusions can be drawn?

  1. Countries that were formerly colonies are more likely to have a democratic government.
  2. The majority of the world’s developed countries have democratic governments.
  3. Democratic governments are most often found in countries where Christianity is the dominant religion.
  4. There is no clear connection between level of development and a country’s government system.

 I and II

 II and III

 III and IV

 I, III, and IV

 II, III, and IV

Question 35

(09.07 MC)

Rapid industrialization in the developing world is MOST closely associated with which problem?

 Ethnic conflict

 Explosive population growth

 Political disintegration

 Environmental damage

 Inflation-driven unemployment

Question 36

(09.09 MC)

In developing regions, women participate MOST heavily in which area of the economy?

 Manufacturing

 Information technology

 Food production

 Service jobs

 Construction

Question 37

(08.04 MC)

Dispersed settlements are settlements characterized by isolated farms and not clustered villages. This type of settlement pattern is the basic pattern in the American Midwest because farmers in this region

 cultivate large plots of land that are profitable because the cost of land is relatively low when located far from markets

 plant a wide variety of crops to ensure economic viability in the face of fluctuating market prices for individual crops

 use the same kind of agricultural practices as the farmers who originally settled the region in the 19th century

 increasingly rely on single-crop cultivation to maximize yields as global crop prices have risen

 need large amounts of land to serve as range for the livestock that supply fields with the majority of its natural fertilizer

Question 38

(08.04 MC)

Which corn-growing region is MOST heavily involved in export production?

 North America

 Africa

 Brazil and Argentina

 Western Europe

 South and Southeast Asia

Question 39

(08.05 MC)

In which of the following regions would von Thünen’s model MOST accurately predict the patterns of agricultural use?

  1. A region in which the soil quality level decreases as the land moves farther from the marketplace
  2. A region in which methods of transporting crops to the marketplace varies
  3. A region in which the soil quality and methods of transportation have little variation
  4. A region in which soil quality varies but transportation costs are static

 I only

 II only

 III only

 I and II

 I and IV

Question 40

(10.02 MC)

In which region would the FEWEST megacities be found?

  1. Northern Australia
  2. Central Africa
  3. Eastern North America
  4. Western Europe

 I only

 II only

 IV only

 I and II

 I and III

Question 41

(10.05 MC)

In which of the following regions of the United States will the cities MOST likely have high concentrations of African American residents?

 Northwest

 Midwest

 Central

 Southwest

 Southeast

Question 42

(07.02 MC)

Which of the following scenarios illustrate the concept of territoriality?

  1. Country A permits citizens of Country B to cross its borders to find temporary work.
  2. Country C’s army invades Country D, causing Country D to declare war on Country C.
  3. Country E and Country F, two bordering countries, support the creation of a regional alliance.
  4. Country G and Country H enter into a treaty to help one another protect their lands.

 I and II

 II and III

 I, II, and III

 I, II, and IV

 I, II, III, and IV 

Question 43

(10.03 HC)

English immigrants set up a hypothetical city in the United States. After the urban area has been settled and developed, German immigrants move into the region. According to the concentric zone model, which of the following BEST explains what might happen as a result of the Germans entering the area?

  1. The German immigrants would buy homes and live in zones 3 or 4.
  2. The English settlers would remain in the city’s core and adapt German culture.
  3. The German immigrants would move into the core of the city.
  4. The English settlers would move out of the city’s core into the outer rings.

 I and IV

 III and IV

 I, II, and III

 II, III, and IV

 I, II, III, and IV

Question 44

(10.05 MC)

The residential demographics of a city are MOST likely to change in which of the following places?

 Ethnic neighborhoods

 The innermost residential neighborhoods

 Edge cities

 Older suburban developments

 The central business district

Question 45

(07.09 MC)

Which of the following MOST significantly reduces limitations on the movement of people across borders?

 The dissolution of a supranational group in a region

 The rise of imperialism in a region

 The devolution of power to local political leaders

 The annexation of another state

 The formation of a federation

Question 46

(09.01, 09.05 MC)

How does offshoring affect the spatial organization of the world economy?

  1. It pulls populations into urban areas from rural areas.
  2. It increases exports from countries that industrialized most recently.
  3. It leads to greater levels of resource extraction in former colonies.
  4. It shifts manufacturing from developed regions to developing regions.

 I and II

 I and IV

 II and III

 II and IV

 III and IV

Question 47

(10.01 MC)

Suburbanization and urban sprawl have become more common in the developed world as a result of which of the following?

 Lack of effective pollution control

 Conflicts resulting from social heterogeneity

 Stresses on infrastructure from population growth

 Housing shortages and substandard housing quality

 The shift from an industrial economy to an information economy

Question 48

(08.01 MC)

The Second Agricultural Revolution was made possible by all of the following EXCEPT

 the invention of crop rotation

 improvements in drainage and irrigation systems

 advancements in farm machinery

 the migration from urban cities to rural regions

 the application of scientific methods to breeding

Question 49

(08.07 MC)

Which of these changes in agricultural practices has put the greatest strain on the environment?

 The use of irrigation to support the spread of agriculture to arid regions

 The processing of grains into sugars and starches to make crops more versatile

 The grazing of livestock on smaller plots of land to protect fragile grasslands

 The increasing use of grain crops to feed livestock instead of humans

 The development of genetically modified crop strains to increase yields

Question 50

(09.01 MC)

Which of the following energy resources are MOST likely to increase in importance during the next 50 years?

  1. Natural gas
  2. Solar power
  3. Hydroelectric power
  4. Coal

 I and II

 I and III

 II and III

 II and IV

 III and IV

Question 51

(10.03 MC)

© 2011 FLVS 

Which model of urban land use is shown in the diagram above?

 Sector

 Edge city

 Multiple-nuclei

 Concentric zone

 Urban realms

Question 52

(07.03, 07.06, 07.09 MC)

In which of the following regions would devolutionist forces MOST likely be at work?

  1. An elongated state in which the capital city is located in a northern region
  2. A prorupted state with a centrally located capital city
  3. A fragmented state with an ethnically homogeneous population
  4. A compact state with central and local governments that share equal power

 I only

 III only

 I and II

 II and IV

 III and IV

Question 53

(07.02, 07.06, 07.09 MC)

Which of the following states are LEAST likely to experience threats to their sovereignty in the next 10 years?

  1. Bhutan
  2. France
  3. Japan
  4. Turkey

 I and II

 I and III

 III and IV

 I, III, and IV

 II, III, and IV

Question 54

(09.05, 09.06 MC)The process of globalization results in an international division of labor that creates a greater level of

 government regulation

 economic interdependence

 sustainable development

 material equality

 political fragmentation

Question 55

(07.04 MC)

Countries X and Y border each other. Country X establishes its boundaries to include the mouth of a major river flowing through the region. Country Y establishes its boundaries to include a portion of the river that Country X has already claimed. Country Y builds a wall to surround its section of the river. To avoid this dispute, countries X and Y should have come to a clear agreement during which step or steps of the boundary’s location?

  1. Definition
  2. Delimitation
  3. Demarcation
  4. Administration

 II only

 IV only

 I and II

 II and III

 II, III, and IV 

Question 56

(10.01, 10.05 MC)

The growth of suburbs is MOST limited by which factor?

 Cultural stagnation

 Inadequate transportation

 Scarcity of land

 Pollution controls

 Proximity of energy sources

Question 57

(10.04, 10.05 MC)

Which of the following BEST describe scenarios that urban planning could be used to resolve?

  1. A city is becoming increasingly deindustrialized as the population moves into the service sector.
  2. A city has a growing population but lacks a mass-transit system to serve the needs of that population.
  3. A city is experiencing high levels of pollution because of the cars that travel around a shopping center.
  4. The major industries in the area are too spread out and would benefit from being concentrated in one area.

 I and III

 II and III

 I, II, and IV

 II, III, and IV

 I, II, III, and IV

 

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New international money game-7th edition summary

New international money game-7th edition summary. A System Is How the Pieces Fit: The years since the early 1970s have been the most tumultuous in monetary history. The world price level in 2008 was more than five times higher than in 1970; never before have price levels increased so rapidly in so many countries. The US dollar price of gold at the end of 2008 was more than 25 times higher than the US$35 parity in 1970 – and this price had been 25 percent higher in the summer of 2008 than at the end of the year. A barrel of oil nearly reached $150 in June 2008, more than 50 times higher than at the end of 1970; the oil price had quintupled between 2003 and 2008 and then declined to below $50 toward the end of the year. The US financial system had shattered. The two large government-sponsored lenders, Fannie Mae and Freddie Mac, that together carried the credit risk associated with more than 50 percent of US home mortgages, were placed in a US ‘conservatorship’ because they were effectively bankrupt; the individuals and firms that owned both the common stock and the preferred stock in these firms lost all their money. AIG, the largest insurance company in the world, required a massive loan from the US Government. The US investment banking industry collapsed; two of the five largest firms disappeared, one by bankruptcy and the other by a forced merger, while two of the other large investment banking firms sold themselves to large commercial banks. Many of the 20 largest US commercial banks were forced to take capital from the US Treasury. The British banking system also was in turmoil. Northern Rock, the largest mortgage lender in the country, was taken over by the government. The British Treasury became a two-thirds owner of the Royal Bank of Scotland and a large owner of Lloyds. Similarly, banks in Ireland, Iceland, and even Switzerland received large capital investments from their governments. This global financial crisis led to a recession in most of the large industrial countries. Japan imported a recession because of a decline in the foreign demand for its autos and electronics and other manufactures. Similarly, Taiwan, South Korea, and Singapore experienced sharp declines in their exports. The growth rate in China declined sharply, and 20 million migrant workers became unemployed. The global financial crisis that began in the summer of 2007 is the fourth since the early 1980s. The first involved the inability of Mexico, Brazil, Argentina, and ten or so other developing countries to make the payments on their US dollar-denominated debt in a timely way. Their currencies depreciated sharply and many of the borrowers and banks in these countries became bankrupt; some large US banks that had made extensive loans to these borrowers would have failed if the regulatory authorities had not connived in the fiction that these loans were performing. The second financial crisis was in Japan in the 1990s, when most of the commercial banks and investment banks and insurance companies failed. At about the same time, many of the banks in Finland, Norway, and Sweden failed. The third crisis began in the second half of 1997 when the Thai baht depreciated sharply, which triggered the depreciation of the Malaysian ringgit, the Indonesian rupiah, the Philippine peso, the South Korean won and eventually the Russian ruble in the summer of the 1998, the Brazilian real in January 1999, and the Argentinean peso 2 years later. Once again many of the domestic banks in these countries failed when the currencies depreciated. Each of these financial crises followed the implosion of a credit bubble, which had involved the rapid growth in the indebtedness of a particular group of borrowers, often at annual rates of 20-30 percent for 3 or 4 or more years. During the 1970s the major international banks increased their loans to the governments and government-owned firms in Mexico and other developing countries at the annual rate of 30 percent; the external indebtedness of these countries increased from $120 billion at the end of 1972 to $800 billion 10 years later. During the 1980s and especially during the second half of that decade the real estate loans of the banks headquartered in Tokyo and Osaka increased at the rate of 30 percent a year. Industrial firms invested in real estate because the rates of return from ownership of property were so much higher than the rates of return on investment in manufacturing. The prelude to the Asian financial crisis of the second half of the 1990s was a large inflow of money from mutual funds and pension funds, which led to increases in stock prices and real estate prices. The global financial crisis that began in 2007 followed the sharp increase in real estate prices in the previous 4 or 5 years. These financial crises have occurred in waves, which generally have involved four or five or more countries usually at about the same time, although the debacles in some of the non-Asian countries in the late 1990s followed the collapse of the Thai baht by more than a year. Similarly, the credit bubbles that preceded these crises also occurred in waves that involved four or five or more countries at the same time. That so many countries were involved in these bubbles and crisis at about the same time suggests that they have had a common origin. The changes in the values of national currencies in the foreign exchange market since the early 1970s have been much larger than ever before, even after adjusting for differences in national inflation rates. The US dollar price of the euro varied within a range of 80 percent between 1999 and 2008 even though the annual inflation rates in the United States and Europe usually differed by less than 1 percentage point. At the end of June 2008, the US dollar price of the euro approached $1.58, higher than at any previous time – but by September the US dollar price declined to less than $1.30. The US dollar price of the British pound was above $2.00 in June 2008; by the end of the year the price had declined below $1.50.

Despite the turmoil in the currency markets and the security markets, national income and wealth surged at least until the second half of 2008. Tens of million of people have moved from poverty to the middle class in China, Brazil, South Korea, Mexico, and other emerging market countries as their economies have become more fully integrated with global markets. In 1980 the United States was the world’s largest international creditor country; its net foreign assets were larger than the combined net foreign assets of all other creditor countries. By 2000, the United States had evolved into the world’s largest debtor country, and its net foreign liabilities were larger than the combined net foreign liabilities of all other debtor countries. This dramatic change is the US international investment position has no precedent in the experience of any other country. Moreover, this change did not occur because US goods and services were too expensive; the paradox is the combination of a US trade deficit that has reached 6 percent of US GDP and yet a value for the US dollar that is so low that Europeans and Latin Americans have traveled to New York and other US cities for their Christmas shopping. Tourists find Disneyland in California and Disneyworld in Florida significantly less expensive than their counterparts in Europe and Asia. US net international indebtedness has been increasing twice as rapidly as US GDP. Mexico and Thailand and numerous other countries also experienced rapid increases in their indebtedness relative to their GDPs in the 1990s; when the inflow of foreign money declined abruptly, their currencies depreciated sharply and most experienced financial crises. The sharp increase in US stock prices in the late 1990s was a bubble; the market value of US stocks doubled in the 3 years after December 1996 when the Chairman of the Federal Reserve commented on ‘irrational exuberance.’ Stock prices in Europe increased almost as rapidly as in the United States. The implosion of this bubble in stock prices was followed by a recession but not by a financial crisis. The likelihood that the surges in national price levels, the large changes in currency values, the waves of asset bubbles, and the massive failures in banking systems are independent and unrelated events is low. A model is needed to link the large variations in the values of national currencies and the episodic surges in the prices of real estate and of stocks in different countries. Scientists in every field search for models that describe how the basic components of their universe fit together. The pervasive view in astronomy until the fourteenth century was that Venus and Mars rotated around the Earth. Galileo and Copernicus used the data obtained from new and more powerful telescopes to propose a revolutionary model that had the Earth, Venus, Mars, and the other planets rotate in a more or less flat plane around the Sun. Their model integrated the Sun, the planets and their moons, comets and asteroids and also placed the solar system within the constellation of stars. Einstein integrated the speed of light, matter, and energy. Biologists seek to relate the understanding of the most minute and basic components of life, including genes and chromosomes. Climatologists view patterns of wind, rainfall, temperature, and ocean currents in a comprehensive model.

Those who seek to become the Copernicus of the international financial arrangements must integrate the relationships among the monetary systems of the United States, Britain, Japan, Germany, and France and their neighbors that use the euro, Switzerland and more than 150 other countries each with its own money. The models must highlight the relationships among the changes in the values of the US dollar, the British pound, the Japanese yen, the euro, the Swiss franc, and other currencies with the changes in the rates of growth of money in each country and with the changes in the prices of domestic goods and of real assets and of securities denominated in each currency. The relationships among the planets in the models developed by Copernicus and Galileo have not changed in the last five centuries; Mars will never replace Venus as the planet closest to the Earth. In contrast, those who deal with international monetary issues recognize that the financial arrangements are in flux; the British pound was the dominant international currency during the nineteenth century before it was displaced by the US dollar at the outset of the First World War. While the US dollar has remained the dominant currency, the supremacy of the US dollar has been challenged by the shift in the US international financial position to the largest international debtor. Gold was at the center of international monetary arrangements in 1900, but at the periphery of these arrangements in 2000. Similarly, the relationships among both the levels and rates of growth of the GDPs of individual countries change; Japan was at the top of the GDP growth rate hit parade in the 1950s and the 1960s while China was in number one position on this hit parade in the 1980s and the 1990s. Countries often experience relatively high rates of growth during the first two or three decades after they begin to industrialize; subsequently their growth rates slow. Britain was the first country to industrialize during the middle decades of the nineteenth century; Germany and the United States then followed in the last several decades of that century

Fitting the pieces: central bank monetary policies

From time to time, the descriptive title for international financial arrangements has changed. The ‘gold standard’ was the applicable name during much of the nineteenth century and until the First World War; its dominant feature was that the central bank in each of the participating countries had a fixed price for gold in terms of its own currency. In the 1920s there was a modest change in the name to the ‘gold exchange standard’; its distinguishing feature was that some central banks acquired securities denominated in the British pound and in the US dollar as part of their international reserve assets. From the end of the Second World War to the early 1970s ‘the Bretton Woods system’ was the descriptor (derived from the village in New Hampshire where the treaty that established the International Monetary Fund (IMF) was signed); one of its key attributes – that currency values would be fixed or at least not allowed to vary significantly – was derived from the gold standard. Its innovative feature was that changes in currency values would be discrete and in accord with the provisions of the IMF Treaty. This system of adjustable parities became obsolete in the early 1970s; the thrust of the successor arrangement of floating exchange rates was that currency values would change in response to market forces, much like the prices in the markets for stocks, bonds, and commodities. One initial name for the new arrangements was the ‘Post-Bretton Woods system.’ Many central banks have intervened extensively to limit changes – and especially increases – in the price of their currencies and the term ‘Bretton Woods II’ has been applied to these arrangements. Virtually every country except the relatively small ones has its own national money, produced by its national central bank. Iceland, with a population of 300,000, has an independent central bank and its own currency. Panama and Luxembourg have much larger populations than Iceland but do not have a national currency; Panama has used the US dollar as its money for more than 100 years and Luxembourg used the Belgian franc as its money before the adoption of the euro. Central banks – the Bank of England, the Bank of France, the Federal Reserve, the Bank of Japan, and the Swiss National Bank – were established to enhance financial stability by providing an ‘elastic supply of currency.’ Each central bank initially had a fixed price for its currency in terms of gold, which was part of a ‘marketing plan’ to induce individuals to acquire its currency notes. During the last several decades of the nineteenth century the British, French, German, and American monetary systems were linked by flows of gold from one country to others. The theory was that the money supply and the price level in a country would increase in response to the inflow of gold; conversely, the money supply and the price level would decline in response to an outflow of gold. When a national currency was pegged to gold, it was also pegged to every other currency that was also pegged to gold. Each central bank was supposed to insulate its national economy from the financial problems of individual banks by reducing the likelihood that depositors might rush to get their money from one or several banks at the same time, because of their concern that if the bank closed, they would lose part or all of their money. Since the banks would not have enough money to meet the demands of many depositors at the same time, these rushes for money sometimes caused the result they anticipated. During the First World War governments borrowed from their banks to get much of the money needed to finance military expenditures. After the war governments imposed additional objectives on their central banks; one was to achieve a low inflation rate and another, at least in some countries, was to achieve a high level of employment. Since the early 1970s central banks have not been committed to maintain a fixed price for their currencies; instead, many have given greater priority to domestic objectives in managing the growth of their money supplies. One consequence – at least for a while – was greater divergence in national inflation rates. The unique development at the end of the twentieth century was that 11 of the then 15 member countries of the European Union (EU) adopted the euro – essentially a supranational currency – as the successor to the German mark, the French franc, the Italian lira, and the currencies of eight other countries. The European Central Bank (ECB) is owned by the national central banks and develops a common monetary policy for its members. Britain and several other members of the EU have retained their national currencies, although Greece subsequently adopted the euro. Most of the countries that are scheduled to join the EU appear likely to adopt the euro, eventually if not immediately.

Fitting the pieces: the market in national currencies

 International transactions for the purchase of goods, services, and securities differ from domestic transactions in one unique way – either the buyers or the sellers must transact in a foreign money. When Americans buy new Mercedes and new Volkswagens, they pay US dollars to the dealers, who in turn pay the US subsidiaries of Mercedes and of Volkswagen. These subsidiaries then take most of these dollars to the currency market to buy the euro so they can pay their head offices in Germany. One of the two basic approaches toward organizing the currency market is that each central bank buys and sells its currency to limit the changes in its price, usually within a narrow or modest range; this practice follows from the gold standard arrangements. The other basic approach is that the price of each national currency increases and decreases in response to changes in demand and supply, much like the prices of pork bellies and of government bonds and of copper and of stocks. The intermediate approach is that central banks buy and sell their currencies to limit changes in their prices – and to achieve some other national objectives. For most of the 200 years from the advent of the United States as a newly independent country until the early 1970s, the US dollar price of the British pound was pegged because the British pound had a parity for gold of 87 shillings 6 pence per ounce while US dollar had a parity of $20.67 per ounce. The ratio of the two gold parities was $4.86 = 1 British pound after an adjustment for the small difference in the gold content of British coins and of US coins. The US dollar price of the British pound was not pegged between 1797 and 1821, during and immediately after the Napoleonic Wars. Nor was the US dollar price of the British pound pegged during and after the US Civil War – from 1861 until 1879. The move away from pegged values for currencies reflects the fact that wars have been associated with higher inflation rates and larger differences in national inflation rates. A system of pegged currency values requires that central banks buy and sell their own currencies to limit the changes in their prices. The securities that central banks acquire after they have sold their currencies in the foreign exchange market are grouped as international reserve assets. Some central banks began to acquire securities denominated in the British pound and securities denominated in the US dollar at the end of the nineteenth century because they wanted the interest income on these securities. Nevertheless, central bank holdings of gold were the largest component of international reserve assets until the 1960s. Then securities denominated in the US dollar became the largest component. In the 1960s and the 1970s central banks acquired securities denominated in the German mark and in the Japanese yen as international reserve assets, although securities denominated in the US dollar still account for two-thirds of international reserve assets; securities denominated in the euro are the second largest component.

During the nineteenth century, the stability of international financial arrangements resulted from the self-interest of individual countries. In contrast, during the twentieth century national governments signed treaties, agreements, accords, and communiqués that contained commitments about how they would manage their currencies. One pattern about changes in currency values since the early 1970s is evident from the comparison of changes in the Japanese yen price of the US dollar with the changes in the Swiss franc price of the US dollar. At the end of 1970, the Japanese yen had a parity of 360 while the Swiss franc had a parity of 4.30; the ‘cross rate’ was 84 Japanese yen for each Swiss franc. At the end of 2008 the Japanese yen price of the US dollar was 111 while the Swiss franc price of the US dollar was 1.11; the Japanese yen price of the Swiss franc was 100. The declines in the price of the US dollar in terms of both the Swiss franc and the Japanese yen have been much larger than the changes in the Japanese yen price of the Swiss franc. The inference is that many of the shocks that have led to changes in the value of the US dollar have centered on the United States. Inflation rates in the twentieth century were much higher than in the nineteenth century. The American and British price levels at the end of the nineteenth century were not significantly different from those at the end of the eighteenth century, although there had been extended episodes of sharp increases and then decreases of price levels within the century. In contrast, the US price level at the end of the twentieth century was nearly 20 times higher than at the beginning, and the British price level was more than 25 times higher. Increases in national price levels in the twentieth century occurred in three major episodes; the first was during and immediately after the First World War and the second was during and after the Second World War. The third surge in national price levels occurred in the 1970s and differed from the earlier episodes both because the price increases were larger and because they occurred during peacetime. During the nineteenth century governments accepted changes in their domestic price levels as a way to maintain parities for their currencies in terms of gold. In contrast, during most of the twentieth century governments – especially the governments of large countries – were reluctant to accept a significant external constraint on the choice of their domestic economic policies. Financial crises were more severe in the last several decades of the twentieth century than in the earlier period, although the period between the First World War and the Second was also marked by major crises.

The waxing and waning of financial hegemony

Copernicus believed that the orbits of the planets were determined by gravitational pulls and would not change; similarly, he was not concerned that the relative size of the various planets might change. In contrast, one of the dominant features of international financial arrangements is that the economic standing of individual countries and of their currencies changes. Britain was the dominant economic power during the nineteenth century and London was the primary international banking and financial center; Britain also was the largest international creditor country. The British pound was the dominant currency; import prices and export prices were quoted in terms of the pound and world trade was financed by credits denominated in the pound. US railroad firms went to London to borrow money to finance their expansion. The United States supplanted Britain as the dominant economic power during the First World War; US GDP was three times larger than the British GDP. For the next 30 or 40 years – until the 1960s – the United States became an even more ascendant economic power, in part because of the dislocations to production and trade in both Europe and Asia associated with the Second World War. US industrial capacity surged, while wartime damage reduced productive capacity in Britain, Germany, France, and Japan. At the end of the 1940s it seemed as if the United States would remain the dominant economic power ‘until the end of time.’ US industrial supremacy seemed unchallenged and unchallengeable. The US dollar was the dominant currency, in part because of US industrial leadership and in part because the US commitment to a low inflation rate seemed stronger than that of any other large country. During the 1950s and the 1960s the United States developed a persistent payments deficit; US holdings of gold declined by more than half and foreign holdings of US dollar securities surged. Despite the decline in US gold holdings, the US international financial position seemed impregnable, in part because the United States was the world’s largest net international creditor country. In 1971, an event that seemed unthinkable 10 years earlier occurred: the US Treasury stopped selling gold at $35, and the price of gold began to increase; by the end of the decade the price had nearly reached $1000. The US dollar depreciated extensively relative to the German mark and the Swiss franc and the Japanese yen through most of the 1970s. In 1980 the United States began to develop a persistent annual trade deficit and the US net international creditor position began to decline and by the late 1980s the United States had evolved into an international debtor; the United States became the world’s largest international debtor in 2000. The transformation of the US net international investment position from the world’s largest creditor to the world’s largest debtor occurred because foreign investors and central banks wanted to increase their holdings of US dollar securities. The invisible hand was at work, and the United States developed the trade deficit that was the mirror of the trade surpluses of Japan, China, and many other developing countries.

The plan of the book

The chapters in this book are arranged in two major groups. The first group – Chapters 2 through 13 – focus on macro international topics, including changes in the monetary roles of gold, the costs and benefits of floating exchange rates and of pegged exchange rates, the waves of credit and asset bubbles since the 1970s, and the evolution of the United States from the world’s largest creditor country to the world’s largest debtor. The second group – Chapters 14 through 24 – has a micro focus and centers on specific topics, including the nature and impacts and causes of globalization, the impacts of differences in national tax rates on the competitive position of firms producing in different countries, and the changes in the structure of the international banking industry. The impacts of the Organization of Petroleum Exporting Countries (OPEC), the cartel of the oil-producing countries, on the supply of petroleum in the long run are analyzed. The first chapter in Part I (Chapter 3) summarizes the changes in the monetary role of gold in the last 300 years. The changes in international financial arrangements are summarized in Chapter 4. The changes in organization of the foreign exchange market are described in Chapter 5, and the attention is given to why the range of movement in the price of national currencies in the foreign exchange market has been so large relative to the difference in national inflation rates. The unique international roles of the US dollar are reviewed in Chapter 6. The thrust of Chapter 7 is the growth of the offshore banking market, identified by the mismatch between the currency in which a transaction is denominated and the currency of the country where the transaction occurs. The causes of the several inflations of the twentieth century are examined in Chapter 8. The relationships among the various asset price bubbles since the 1980s are reviewed in Chapter 9. The causes of the financial crises are analyzed in Chapter 10. The explanations for the change in the US international investment position from the world’s largest creditor to the world’s largest debtor are evaluated in Chapter 11. The thrust of Chapter 12 is the factors that determine the rate of growth of national money supplies. One of the major concerns since the breakdown of the Bretton Woods system of adjustable parities has been monetary reform; a major question is how to maintain an open trading system in an increasingly fractious world. The first chapter in Part II (Chapter 14) analyzes the globalization of markets over the centuries and then provides an overview of subsequent chapters. The thrust of Chapter 15 is on the impacts of national taxation and regulatory regimes on the international competitiveness of firms that produce in different countries. The question addressed in Chapter 16 centers on the impact of the financial crisis on the competitiveness of US banks relative to banks headquartered in various foreign countries. The impact of the production-limiting arrangements by OPEC on the Malthusian specter that the world petroleum supplies will be exhausted is analyzed in Chapter 17. Whether national markets for bonds and stocks are segmented or integrated is evaluated in Chapter 18. The focus of Chapter 19 is the revolution in finance and the surge in the number of new financial instruments – futures and options and swaps and credit default swaps. Whether there is a pattern in the ownership of multinational firms is discussed in Chapter 20. The economic success of Japan in the 1960s, 1970s, and 1980s is summarized in Chapter 21. The transformation of China from a command economy to a market economy is reviewed in Chapter 22. Russia’s evolution from a Marxist command economy to a market economy is reviewed in Chapter 23. The final chapter considers the likelihood these international monetary and financial problems will become less severe.

2 The Name of the Game Is Money – But the Disputes Are about Where the Jobs Are

International finance is a game with two sets of players: one set includes the politicians and bureaucrats and the central bankers in different countries and the other set includes the chief financial officers and treasurers of giant, large, medium-large, medium, medium-small, and small firms and banks and hedge funds, and other financial institutions. The government officials want to win elections and secure a niche in the histories of their countries for enhancing economic well-being and financial stability. The cliché is ‘good jobs at good wages.’ A few aspire to get their portraits on the national currency. And to do so, they want to manage their economies to provide more and better-paying jobs and greater financial security for their voters. These officials want to avoid sharp increases in inflation rates and sharp declines in the prices of their currencies. The chief financial officers and corporate treasurers want to profit from – or at least avoid losses from – changes in currency values, changes that are inevitable in a world with more than 150 national monies. The traders in the large international banks and in the hedge funds want a lot of variability in the prices of individual currencies; the larger the variability, the greater the scope for trading profits.

Changes in the price of the US dollar

 Consider the changes in the Japanese yen price of the US dollar in the last 50 years. Throughout the 1950s and the 1960s the Japanese currency had a ‘fixed price’ of 360 yen per US dollar, which had been set in the late 1940s when Japan was still occupied by US military forces. The productive power of the Japanese economy then was far below that of the early 1940s as a result of destruction of factories and business relationships during the war and the loss of what had been several colonies. In the early 1970s, the Bank of Japan stopped pegging the yen – largely at the insistence of the US Government – and the currency appreciated to 175 yen per dollar by the end of the decade. In contrast, in the early 1980s the yen declined sharply; in the second half of the 1980s the yen again appreciated, and by 1997 had reached 80 yen per dollar – briefly. For much of the period between 1995 and 2008 the yen traded in the range of 110-150 yen per dollar, although at the end of 2008 the yen had again appreciated to 90 yen per dollar. As the yen appreciated the managers of most Japanese firms and many Japanese politicians were concerned that exports from Japan would be less profitable and decline, while imports would increase because they would be less expensive and they would pose more of a competitive threat to Japanese firms. The Bank of Japan often bought US dollars to limit the appreciation of the yen in the effort to support the competitive position of Japanese firms in global

 

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