What can be wanted only at the collective level

MY EDITORIAL ON YOU TUBE

I am recapitulating on my research regarding cities and their role in our civilization. In the same time, I start preparing educational material for the next semester of teaching, at the university. I am testing somehow new a format, where I precisely try to put science and teaching content literally side by side. The video editorial on You Tube plays an important part here, and I sincerely invite all my readers to watch it.  

I am telling the story of cities once again, from the beginning. Beginning of March 2020. In Poland, we are going into the COVID-19 lockdown. I am cycling through the virtually empty streets of Krakow, my hometown. I slowly digest the deep feeling of weirdness: the last time I saw the city that inanimate, it was during some particularly tense moments in the times of communism, decades ago. A strange question keeps floating on the surface of my consciousness: ‘How many human footsteps per day does this place need to be truly alive?’.

Cities are demographic anomalies. This is particularly visible from space, when satellite imagery serves to distinguish urban areas from rural ones. Cities are abnormally dense agglomerations of man-made architectural structures, paired with just abnormally dense clusters of night-time lights. We, humans, we agglomerate in cities. We purposefully reduce the average social distance, and just as purposefully increase the intensity of our social interactions. Why and how do we do that? The ‘why?’ is an abyssal question. If I attempt to answer it with all the intellectual rigor possible, it is almost impossible to answer. Still, there is hope. I have that little theory of mine – well, not just mine, it is called ‘contextual ethics’ – namely that we truly value the real outcomes we get. In other words, we really want the things which we actually get at the end of the day. This could be a slippery slope. Did Londoners want to have the epidemic of plague, in 1664? I can cautiously say it wasn’t on the top list of their wildest dreams. Yet, acquiring herd immunity and figuring out ways of containing an epidemic outbreak: well, that could be a valuable outcome in the long perspective. That outcome has a peculiar trait: it sort of can be wanted only at the collective level, since it is a collective outcome par excellence. If we pursue an outcome like this one, we are being collectively intelligent. It would be somehow adventurous to try and acquire herd immunity singlehandedly. 

Cities manifest one of the ways we are collectively intelligent. In cities, we get individual outcomes, and collective ones, sort of in layers. Let’s take a simple pattern of behaviour: imitation and personal style. We tend to imitate each other, and frequently, as we are doing so, we love pretending we are reaching the peak or originality. Both imitation and pretention to originality make any sense only when there are other people around, and the more people are there around, the more meaningful it is. Imagine you have a ranch in Texas, like 200 hectares, and in order to imitate anyone, or to pretend being original, you need to drive for 2 hours one way, and then 2 hours back, and, at the end of the day, you have interacted with maybe 20 people.

Our human social structures are machines which make other social structures, and not only sustain the current humans inside. A lot of behavioural patterns make any sense at all when the density of population reaches a reasonably required minimum. Social interactions produce and convey information which our brains use to form new patterns. As I think about it, my take on collective intelligence opens up onto the following claim: we have cities in order to make some social order for the future, and order made of social roles and group identities. We have a given sharpness of social distinction between cities and the countryside, e.g. in terms of density in population, in order to create some social roles and group identities for the future.

We, humans, had discovered – although we might not be aware of what we discovered – that certain types of social interactions (not all of them) can be made into recurrent patterns, and those patterns have the capacity to make new patterns. As long as I just date someone, it is temporary interaction. When I propose, it takes some colours: engagement can turn into marriage (well, it should, technically), thus one pattern of interaction can produce another pattern. When I marry a woman, it opens up a whole plethora of new interactions: parenthood, agreement as for financials (prenuptial contracts or the absence thereof), in-law family relations (parents-in-law, siblings-in-law). Have you noticed that some of the greatest financial fortunes, over centuries, had been accumulated inside family lineages? See? We hit the right pattern of social interactions, and from there we can derive either new copies of the same structure or altogether new structures.

Blast! I have just realized I finally nailed down something which I have been turning around in my mind for months: the logical link between human social structures and artificial neural networks. I use artificial neural networks to simulate collective intelligence in human societies, and I have found one theoretical assumption which I need to put in such a model, namely that consecutive states of society must form a Markov chain, i.e. each individual state must be possible to derive entirely from the preceding state, without any exogenous corrective influence.

Still, I felt I was missing something and now: boom! I figured it out. Once again: among different social interactions there are some which have the property to turn into durable and generative patterns, i.e. they reproduce their general structure in many local instances, each a bit idiosyncratic, yet all based on the same structure. In other words, some among our social interactions have the capacity to be intelligent structures, which experiment with themselves by producing many variations of themselves. This is exactly what artificial neural networks are: they are intelligent structures able to experiment with themselves by generating many local, idiosyncratic variations and thereby nailing down the variation which minimizes error in achieving a desired outcome.

When I use an artificial neural network to simulate social change, I implicitly assume that the social change in question is a Markov chain of states, and that the society under simulation has some structural properties which remain consistent over all the Markov chain of states. Now, I need to list the structural properties of artificial neural networks I use in my research, and to study the conditions of their stability. An artificial neural network is a sequence of equations being run in a loop. Structure of the network is given by each equation separately, and by their sequential order. I am going to break down that logical structure once again and pass its components in review. Just a general, introductory remark: I use really simple neural networks, which fall under the general category of multi-layer perceptron. This is probably the simplest that can be in terms of AI, and this is the logic which I connect to collective intelligence in human societies.

The most fundamental structure of an artificial neural network is given by the definition of input variables – the neural stimuli – and their connection to the output variable(s). I used that optional plural, i.e. the ‘(s)’ suffix, because the basic logic of an artificial neural network assumes defining just one output variable, whilst it is possible to construe that output as the coefficient of a vector. In other words, any desired outcome given by one number can be seen as being derived from a collection of numbers. I hope you remember from your math classes in high school that the Pythagorean theorem, I mean the a2 + b2 = c2 one, has a more general meaning, beyond the simple geometry of a right-angled triangle. Any positive number we observe – our height in centimetres (or in feet and inches), the right amount of salt to season shrimps etc. – any of those amounts can be interpreted as the square root of the sum of squares of two other numbers. I mean, any x > 0 is x = (y2 + x2)0,5. Logically, those shady y and z can be seen, in turn, as derived, Pythagorean way, from even shadier and more mysterious entities. In other words, it is plausible to assume that x = (y2 + x2)0,5 = {[(a2 + b2)0,5]2 + [(c2 + d2)0,5]2}0,5 etc.

As a matter of fact, establishing an informed distinction between input variables on the one hand, and the output variable on the other hand is the core and the purpose of my method. I take a handful of variables, informative about a society or a market, and I make as many alternative neural networks as there are variables. Each alternative network has the same logical structure, i.e. the same equations in the same sequence, but is pegged on a different variable as its output. At some point, I have the real human society, i.e. the original, empirical dataset, and as many alternative versions thereof as there are variables in the dataset. In other words, I have a structure and a finite number of experiments with that structure. This is the methodology I used, for example, in my paper on energy efficiency.

There are human social structures which can make other social structures, by narrowing down, progressively, the residual error generated when trying to nail down a desired outcome and experimenting with small variations of the structure in question. Those structures need abundant social interactions in order to work. An artificial neural network which has the capacity to stay structurally stable, i.e. which has the capacity to keep the Euclidean distance between variables inside a predictable interval, can be representative for such a structure. That predictable interval of Euclidean distance corresponds to predictable behavioural coupling, the so-called correlated coupling: social entity A reacts to what social entity B is doing, and this reaction is like music, i.e. it involves moving along a scale of response in a predictable pattern.

I see cities as factories of social roles. The intensity of social interactions in cities works like a social engine. New businesses emerge, new jobs form in the labour market. All these require new skillsets and yet those skillsets are expected to stop being entirely new and to become somehow predictable and reliable, whence the need for correspondingly new social roles in training and education for those new skills. As people endowed with those new skills progressively take over business and jobs, even more novel skillsets emerge and so the wheel of social change spins. The peculiar thing about social interactions in cities are those between young people, i.e. teenagers and young adults up to the age of 25. Those interactions have a special trait, just as do the people involved: their decision-making processes are marked by significantly greater an appetite for risk and immediate gratification, as opposed to more conservative and more perseverant behavioural patterns in older adults.

Cities allow agglomeration of people very similar as regards the phase of their personal lifecycle, and, in the same time, very different in their cultural background. People mix a lot inside generations. Cities produce a lot of social roles marked with a big red label ‘Only for humans below 30!’, and, in the same time, lots of social roles marked ‘Below 40, don’t even think about it!’. Please, note that I define a generation in sociological terms, i.e. as a cycle of about 20 ÷ 25 years, roughly corresponding to the average age of reproduction (I know, first parenthood sounds kind’a more civilized). According to this logic, I am one generation older than my son.

That pattern of interactions is almost the exact opposite of rural villages and small towns, where people interact much more between generations and less inside generations. Social roles form as ‘Whatever age you are between 20 and 80, you do this’. As we compare those two mechanisms of role-formation, in turns out that cities are inherently prone to creating completely new sets of social roles for each new generation of people coming with the demographic tide. Cities facilitate innovation at the behavioural level. By innovation, I mean the invention of something new combined with a mechanism of diffusing that novelty across the social system.

These are some of my thoughts about cities. How can I play them out into my teaching? I start with a staple course of mine: microeconomics. Microeconomics sort of nicely fit with the topic of cities, and I don’t even have to prove it, ‘cause Adam Smith did. In his ‘Inquiry Into The Nature And Causes of The Wealth of Nations’, Book I, Chapter III, entitled ‘That The Division Of Labour Is Limited By The Extent Of The Market’, he goes: ‘[…] There are some sorts of industry, even of the lowest kind, which can be carried on nowhere but in a great town. A porter, for example, can find employment and subsistence in no other place. A village is by much too narrow a sphere for him; even an ordinary market-town is scarce large enough to afford him constant occupation. In the lone houses and very small villages which are scattered about in so desert a country as the highlands of Scotland, every farmer must be butcher, baker, and brewer, for his own family. In such situations we can scarce expect to find even a smith, a carpenter, or a mason, within less than twenty miles of another of the same trade. The scattered families that live at eight or ten miles distance from the nearest of them, must learn to perform them- selves a great number of little pieces of work, for which, in more populous countries, they would call in the assistance of those workmen. Country workmen are almost everywhere obliged to apply themselves to all the different branches of industry that have so much affinity to one another as to be employed about the same sort of materials. A country carpenter deals in every sort of work that is made of wood; a country smith in every sort of work that is made of iron. The former is not only a carpenter, but a joiner, a cabinet-maker, and even a carver in wood, as well as a wheel-wright, a plough-wright, a cart and waggon-maker. The employments of the latter are still more various. It is impossible there should be such a trade as even that of a nailer in the remote and inland parts of the highlands of Scotland. Such a workman at the rate of a thousand nails a-day, and three hundred working days in the year, will make three hundred thousand nails in the year. But in such a situation it would be impossible to dispose of one thousand, that is, of one day’s work in the year […]’.     

Microeconomics can be seen as a science of how some specific social structures, strongly pegged in the social distinction between cities and the countryside, reproduce themselves in time, as well as produce other social structures. I know, this definition does not really seem to fall close to the classical, Marshallian graph of two curves, i.e. supply and demand, crossing nicely in the point of equilibrium. ‘Does not seem to…’ is distinct from ‘does not’. Let’s think a moment. The local {Supply <> Demand} equilibrium is a state of deals being closed at recurrent, predictable a price. One of the ways to grasp the equilibrium price consists in treating it as the price which clears all the surplus stock of goods in the market. It is the price which people agree upon, at the end of the day. Logically, there is an underlying social structure which allows such a recurrent, equilibrium-making bargaining process. This structure reproduces itself in n copies, over and over again, and each such copy is balanced on different a coupling between equilibrium price and equilibrium product.

Here comes something I frequently remind to those of my students who have enough grit to read any textbook in economics: those nice curves in the Marshallian graph, namely demand and supply, don’t really exist. They represent theoretical states at best, and usually these are more in the purely hypothetical department. We just guess that social reality is being sort bent along them. The thing that really exists, here and now, is the equilibrium price that we strike our deals at, and the corresponding volumes of business we do at this price. What really exists in slightly longer a perspective is the social structure able to produce local equilibriums between supply and demand, which, in turn, requires people in that structure recurrently producing economically valuable, tradable surpluses of physical goods and/or marketable skills.

Question: how can I know there is any point in producing an economically valuable surplus of anything? Answer: where other people make me understand they would gladly acquire said surplus. Mind you, although markets are mostly based on money, there are de facto markets without straightforward monetary payment. The example which comes to my mind is a structure which I regularly observe, every now and then, in people connected to business and politics, especially in Warsaw, the capital of my home country, Poland. Those guys (and gals) sometimes call it ‘the cooperative of information and favour’. You slightly facilitate a deal I want to strike, and I remember that, and later I facilitate the deal you want to strike. We don’t do business together, strictly speaking, we just happen to have mutual leverage on each other’s business with third parties. I observed that pattern frequently, and the thing really works as a market of favours based on social connections and individual knowledge. No one exchanges money (that could be completely accidentally perceived as corruption, and that perfectly accidental false perception could occur in a prosecutor, and no one wants to go to jail), and yet this is a market. There is an equilibrium price for facilitating a $10 million deal in construction. That equilibrium price might be the facilitation of another $10 million deal in construction, or the facilitation of someone being elected to the city council. By the way, that market of favours really stirs it up when some kind of elections is upcoming.

Anyway, the more social interactions I enter into over a unit of time, the more chances I have to spot some kind of economically valuable surplus in what I do and make. The more such social interactions are possible in the social structure of my current residence, the better. Yes, cities allow that. The next step is from those general thoughts to a thread of teaching and learning. I can see a promising avenue in the following scheme:

>>> Step 1: I choose or ask my students to choose any type of normal, recurrent social interaction. It can be interesting to film a bit of city life, just like that, casually, with a phone, and then use it as empirical material.

>>> Step 2: Students decompose that interaction into layers of different consistency, i.e. separate actions and events which change quickly and frequently from those which last and recur.

>>> Step 3: Students connect the truly recurrent actions and events to an existing market of goods or marketable skills. They describe, with as much detail as possible, how recurrent interactions translate into local states of equilibrium.

Good. One carryover done, namely into microeconomics, I try another one, into another one of my basic courses at the university: fundamentals of management. There is something I try to tell my students whenever I start this course, in October: ‘Guys, I can barely outline what management is. You need to go out there, into that jungle, and then you learn. I can tell you what the jungle looks like, sort of in general’. Social interactions and social roles in management spell power, hierarchy, influence, competition and cooperation on the top of all that. Invariably, students ask me: ‘But, sir, wouldn’t it be simpler just to cooperate, without all those games of power and hierarchy inside the organization?’. My answer is that yes, indeed, it would be simpler to the point of being too simple, i.e. simplistic. Let’s think. When we rival inside the organization, we need to interact. There is no competition without interaction. The more we compete, the more we interact, and the more personal resources we need to put in that interaction.

Mind you, competition is not the only way to trigger intense, abundant human interaction. Camaraderie, love, emotional affiliation to a common goal – they all can do the same job, and they tend to be more pleasant than interpersonal competition. There is a caveat, though: all those forms of action-generating emotional bonds between human beings tend to be fringe phenomena. They happen rarely. With how many people, in our existence, can we hope to develop a bond of the type ‘I have your back and you have my back, no matter what’? Just a few, at best. Quite a number of persons walk through their entire life without ever experiencing this type of connection. On the other hand, competition is a mainstream phenomenon. You put 5 random people in any durable social relation – business, teamwork, art etc. – and they are bound to develop competitive behaviour. Competition happens naturally, very frequently, and can trigger tacit coordination when handled properly.

Yes, right, you can legitimately ask what does it mean to handle competition properly. As a kid, or in your teenage years, have you ever played a competitive game, such as tennis, basketball, volleyball, chess, computer games, or even plain infantile fighting? Do you know that situation when other people want to play with you because you sometimes score and win, but kind of not all the time and not at all price? That special state when you get picked for the next game, and you like the feeling? Well, that’s competition handled properly. You mobilise yourself in rivalry with other people, but you keep in mind that the most fundamental rule of any competitive game is to keep the door open for future games.      

Thus, I guess that teaching management in academia, which I very largely do, may consist in showing my students how to compete constructively inside an organisation, i.e. how to be competitive and cooperative in the same time. I can show internal competition and cooperation in the context of a specific business case. I already tend to work a lot, in class, with cases such as Tesla, Netflix, Boeing or Walt Disney. I can use their business description, such as can be found in an annual report, to reconstruct an organisational environment where competition and cooperation can take place. The key learning for management students is to understand what traits of that environment enable constructive competition, likely to engender cooperation, as opposed to situations marked either with destructive competition or with a destructive absence thereof, on the other hand.

Discover Social Sciences is a scientific blog, which I, Krzysztof Wasniewski, individually write and manage. If you enjoy the content I create, you can choose to support my work, with a symbolic $1, or whatever other amount you please, via MY PAYPAL ACCOUNT.  What you will contribute to will be almost exactly what you can read now. I have been blogging since 2017, and I think I have a pretty clearly rounded style.

In the bottom on the sidebar of the main page, you can access the archives of that blog, all the way back to August 2017. You can make yourself an idea how I work, what do I work on and how has my writing evolved. If you like social sciences served in this specific sauce, I will be grateful for your support to my research and writing.

‘Discover Social Sciences’ is a continuous endeavour and is mostly made of my personal energy and work. There are minor expenses, to cover the current costs of maintaining the website, or to collect data, yet I want to be honest: by supporting ‘Discover Social Sciences’, you will be mostly supporting my continuous stream of writing and online publishing. As you read through the stream of my updates on https://discoversocialsciences.com , you can see that I usually write 1 – 3 updates a week, and this is the pace of writing that you can expect from me.

Besides the continuous stream of writing which I provide to my readers, there are some more durable takeaways. One of them is an e-book which I published in 2017, ‘Capitalism And Political Power’. Normally, it is available with the publisher, the Scholar publishing house (https://scholar.com.pl/en/economics/1703-capitalism-and-political-power.html?search_query=Wasniewski&results=2 ). Via https://discoversocialsciences.com , you can download that e-book for free.

Another takeaway you can be interested in is ‘The Business Planning Calculator’, an Excel-based, simple tool for financial calculations needed when building a business plan.

Both the e-book and the calculator are available via links in the top right corner of the main page on https://discoversocialsciences.com .

You might be interested Virtual Summer Camps, as well. These are free, half-day summer camps will be a week-long, with enrichment-based classes in subjects like foreign languages, chess, theatre, coding, Minecraft, how to be a detective, photography and more. These live, interactive classes will be taught by expert instructors vetted through Varsity Tutors’ platform. We already have 200 camps scheduled for the summer.   https://www.varsitytutors.com/virtual-summer-camps

To my students: an update on the schedule of ZOOM classes

Dear Students,

I made a list of ZOOM meetings up until the end of the semester. Below, I am presenting the current schedule of ZOOM classes, starting from the nearest ones, i.e. from May 6th, 2020. It would be a wise move from your part to copy the table and have those meeting IDs and passwords at hand.

DateTimeDedicated courseDedicated groupMeeting IDPassword
06/05/202010:00 – 11:30International managementZ/M-ang/18/SS864-8741-3349736263
06/05/202012:00 – 13:00International managementZ/M-ang/18/SS810-0220-6075450869
07/05/202011:00 – 12:30Foundations of financeZ/M-ang/19/SS825-5416-3530389190
07/05/202013:00 – 14:30International TradeSM/IB/18/SS , SM/IT/18/SS , SM/IR&CD/18/SS848-7174-8214073419
13/05/202010:30 – 11:30International managementZ/M-ang/18/SS890-0156-8782138985
13/05/202012:00 – 13:00International managementZ/M-ang/18/SS822-3899-2134862134
14/05/202010:00 – 11:30Foundations of financeZ/M-ang/19/SS854-8943-3613079806
14/05/202012:00 – 13:00Foundations of financeZ/M-ang/19/SS893-8431-4288416195
14/05/202013:00 – 14:30International TradeSM/IB/18/SS , SM/IT/18/SS , SM/IR&CD/18/SS870-5811-0884234869
20/05/202010:00 – 11:30International managementZ/M-ang/18/SS848-8416-7085788524
20/05/202012:00 – 13:00International managementZ/M-ang/18/SS881-9216-6055162890
21/05/202011:00 – 12:30Foundations of financeZ/M-ang/19/SS843-1135-2446850647
21/05/202013:00 – 14:30Foundations of financeZ/M-ang/19/SS840-0479-6888779164
27/05/202010:00 – 11:30International managementZ/M-ang/18/SS860-2830-9750001855
27/05/202012:00 – 13:00International managementZ/M-ang/18/SS858-4644-4321675763
28/05/202011:00 – 12:30Foundations of financeZ/M-ang/19/SS815-3329-5309284616
28/05/202013:00 – 14:30International TradeSM/IB/18/SS , SM/IT/18/SS , SM/IR&CD/18/SS824-9039-2700857507
03/06/202010:00 – 11:00International ManagementZ/M-ang/18/SS878-8266-1884589537
04/06/202010:00 – 11:00Foundations of financeZ/M-ang/19/SS845-8559-3688777110
04/06/202011:30 – 13:00International TradeSM/IB/18/SS , SM/IT/18/SS , SM/IR&CD/18/SS826-8619-9719343888
10/06/202010:00 – 11:00International ManagementZ/M-ang/18/SS812-7199-5493165167
11/06/202011:00 – 12:30Foundations of financeZ/M-ang/19/SS873-0553-0941537706
11/06/202013:00 – 14:30Foundations of financeZ/M-ang/19/SS875-4928-8172399422

Did they have a longer breath, those people in the 17th century?

My editorial on You Tube

In 1675, the publishing house run by Louis Billaine, located at the Second Pillar of the Grand Salle of the Palace, at Grand Cesar, published, with the privilege of the King, a book entitled, originally, ‘Le Parfait Négociant ou Instruction Générale Pour Ce Qui Regarde Le Commerce’. In English, that would be ‘The Perfect Merchant or General Instructions as Regards Commerce’. The author was Jacques Savary. By the way, the title I provided here above is the abridged one. The full title holds in 13 lines. Master Savary wanted to be precise, and indeed he was. On 829 pages, he covers very comprehensively a lot of practical topics.

I like reading books in a hermeneutic way. It means that I try to deconstruct the context, which the book had been written in. As we are talking 17th century and French monarchy, the most important part of the context could very well be the King, and the king was the Sun King: Louis XIV of France. The second important thing in the context is d’Artagnan. Alexandre Dumas chose to put an end to his hero’s life in 1673, in a battle, identically to the death of the real d’Artagnan, or Charles de Batz de Castelmore d’Artagnan. As we are talking Louis the XIV, we are talking Jean-Baptiste Colbert, the famous minister of finance, and his active, capitalistic policies. We are talking about doing business in an environment strongly marked by the interests of the most powerful people being around. We are talking about the creation of Saint-Gobain, the manufacture of mirrors, today a global business. It was the time, when huge ambitions of the absolutist monarchy went hand in hand with a quick development of really big (I mean bloody big, really) capitalism. There were those first attempts, from the part of the Sun King, of issuing money in order to finance his military prowess. The money in question, later on disdainfully called ‘the Bernardines’, was a failure, but the idea took root.

So, two years after d’Artagnan’s last battle, and during the reign of the Sun King, Jacques Savary publishes that book about being a perfect merchant, in really mousquetaire-friendly an environment. How had he come up with the idea? He states it very frankly in the preface of his book: ‘For although I might have had sufficiently good a name, and sufficiently good a birth, to be employed at some higher profession, I admit that, having been destined for Commerce by my parents, it is the employment, which I occupied myself with for a long time, the care I gave it, the particular cognizance that I took of the most significant and the least things as regards it, the ventures I made with all kinds of Manufactures, the losses that I suffered there, those that I avoided, have given me enough enlightenment and enough experience for ignoring nothing that regards the Negoce’.

I am translating Master Savary’s words the best I can, yet the original is the original. Champagne is a good example. You can get your own PDF of Master Savary’s writing from  www.gallica.bnf.fr , or Bibliothèque nationale de France. Anyway, before I go further in the wording of that preface, I go further hermeneutical with Master Savary. A few interesting things to notice in that first paragraph. ‘Commerce’ and ‘Negoce’ start with capital letters, so I gather it must be something important. Commerce was something slightly different than trade strictly spoken. We are in the world of capitalism based on debt, and more specifically on the bills of exchange. It will take more than an additional century (one and a half, as a matter of fact) to invent the institution of limited liability in a business. Someone could say: in there was no limited liability, it was better to rely on one’s own equity in doing business. Well, yes and no. Yes, because your own equity, contrarily to debt, will not give other people claims on you. No, because if you lose money in a venture, it is, on the whole, better to lose other people’s money than your own. Instead of chipping out of your own possessions, you can borrow money and lend money. The trick, and the art, was to find a balance between lending and borrowing, and it was mostly done with relatively liquid bills of exchange, traded by endorsement.

Those bills of exchange travelled much faster, and changed hands much more frequently than the stocks of goods they were more or less attached to. Commerce was the craft of trading both the goods, and the bills of exchange, at different speeds. Now, comes the subtle shade of Negoce in your Commerce. The merchant called ‘Negociant’ was a really big wholesaler, both in goods and in credit. The Negoce consisted in trading big amounts of goods and capital in a coordinated way. A Negociant could do business for years just by trading credit, without seeing a single barrel of rum or a single sack of corn, or, conversely, he could be an artist in recognizing, for example, good coffee, and making huge deals on it, after sniffing just one handful. A Negociant had to be good in law, in finance, in politics, occasionally in knife fighting, he must have been ready to travel frequently, and to shift elegantly between the crude conditions of an exploration trip and the splendours of Parisian parties. The life of a Negociant was capitalism with its teeth bare and a spark in the eye.

Master Savary says he was well born. He seems suggesting he could afford not to go into Negoce, and yet he did go that way. I guess he must have been the smart guy in the family, but probably not the first in line for inheritance. This is the probable reason why his parents destined him to be a merchant. So he had his teeth cut in doing Commerce, and he must have been really good at it, if, as he writes ‘The cognizance that I had acquired of the practice before being applied to Negoce, stepped from the fact that in the disputes arising ordinarily between Negociants, I endorsed a great number of arbitrages: the advantage I had derived from it is that in the study of evidence, books and personal conduct of those who had recourse to me in their disputes, I made myself sufficiently capable in all the matters the most important and the most difficult in Commerce’.       

Yes, Master Savary must have been really quick on the uptake, and smart enough to conceal his speed of thinking a bit, just enough to appear as a steady, reliable arbiter. One thing that remains unclear in this short curriculum, is the order in time. Did he start as an apprentice with a Negociant and gradually became good at arbitrage? Or, maybe, he started as a lawyer and specialized in commercial arbitrage? I do not know. Anyway, he did not stay in the Negoce for ever. ‘The time came when the Commerce was so weakened and bankruptcies so frequent, that there was no security in playing one’s possessions, I judged then that I will do no bad deed by retiring and embracing another profession. An occasion presented itself, which confirmed me in this decision; for a Minister of His Serenissime Highness Monseigneur the Duke of Mantua came in France, who offered me the intendancy of his business in France and Charlville: which I accepted, and entered in the year 1660 to the service of His Serenissime Highness, in which I still am; […]’.

Right, let’s go hermeneutic once again. ‘Serenissime’ means kind of very calm in his ways. Noble born people, in the past, liked dropping this adjective in those long designations, half-name, half-social status that they used to introduce themselves. It probably meant that they wanted to appear cool and relax. ‘Peace, bro. See that Serenissime on my visit card? It means I am really calm, and I will have you executed only at your second mistake. Are we doing business?’. Thus, Master Savary went into the service of that Italian duke from Lombardy (this is where Mantua is). Being a duke was a good position. The difference between a duke and a prince is that the former is just the top dog in the feudal hierarchy, and the latter is of royal blood and waiting in line for sitting on the throne. Apparently, especially in Italy, being a prince was really unhealthy an occupation. You could have had those horrible hunting accidents, when a wild boar attacked you with five crossbows, and could even follow you home. Waiting in line for top offices is rough. Being a duke was safer, as you were the boss and it was kind of official and legally guaranteed. You just had to wait a few centuries, over some twelve generations, and you had that dukedom. Well, yes, you had to put your bets on the right prince, the one who didn’t get attacked frequently by wild boars with crossbows, or just had more crossbows secured on his side, together with the properly qualified labour force.

So, Master Savary started somehow (?) in the Commerce, then went into business arbitrage, which made him convinced he is really good at Negoce. He went into Negoce, did some business, earned some money, lost some money, and then decided it was not really calm an occupation. When a very calm (i.e. Serenissime) duke from Italy offered him a job, he accepted willingly. As he sketches the job in question, he says: ‘[…] in order to fulfil my obligations it was necessary for me to study the Ordinances and the Customs, as there was much business decisions based thereon; so as I committed myself to read them, and in that reading I made remarks on everything pertaining to Commerce, which served me usefully in the composition of this book. When His Majesty, willing to put a limit, by a Regulation, to the abuses that were being committed in the Negoce, had it ordered by circulating letters to Judges and Consuls, Guards and Communities of Merchants in the good towns of his kingdom to send him their memoirs on this subject, I believed it was my duty to work individually, too, in order to make my eagerness visible and the desire to serve the King and the public; this is why I composed two memoirs, one containing the abuses that were being committed in the Commerce, which I presented to Monseigneur Colbert at the end of August, 1670, the other was a bill of Regulation, which I composed in several chapters, where I proposed dispositions that I saw as just and proper to put a limit all the abuses I mentioned in the first memoire; I presented this bill to Monseigneur Colbert in the following September’.

Right, I am back into hermeneutics. Have you noticed, how long are the sentences in Master Savary’s writing? That was the style of the time, I guess. It survived until the first half of the 19th century, when shorter sentences became definitely the fashion. Did those people, back in the days, have longer breath? Were they able to put more sound between two full stops? Or, maybe, they just have longer and more structured ideas, which they did not feel like truncating? Who knows, they are no longer here to tell us. Anyway, it appears that Master Savary was not really the perfect merchant he wrote about. He had some adventure in the Negoce, but, on the whole, he did not seem to like it. He was more of a bystander to business, who used to have views on business. He was an economist, just as I am. When I was young, I had serious plans for a legal career. In 1989, in Poland, the Big Swing came, everything fell apart, there was not much I could inherit, and so I went into business just in order to survive in the new reality. Doing business was interesting, only I just wasn’t prepared for it, and after fourteen years I decided, just as Master Savary did, to accept a job from a really calm duke. In my case it was a university. Comes the time, comes the calm duke.

Master Savary was an economist, only he did not know he was. The word ‘economist’ comes from the French ‘économiste’, and this was the label put on the followers of Francois Quesnay, the author of ‘The Economic Table’ (French: ‘Tableau économique’), published in 1758, a few years before Adam Smith published his ‘Enquiry Into The Nature and Causes of The Wealth of Nations’. The work by Francois Quesnay was probably among the first piece of macroeconomics officially published, together with ‘The Theory of Taxation’ (French: ‘La Théorie de l’Impôt’) by Marquis de Mirabeau. Initially, the term ‘économiste’ was a bit pejorative and meant some loonies obsessed with numbers. Economics, at the time, the time being the verge of the 18th and the 19th centuries, were ‘political economy’. It was only at the end of the 19th century that any scholar could call himself seriously an economist.

I am summoning Master Savary from the after world of social sciences, and we start chatting about what he wrote regarding manufactures (Book II, Chapter XLV and XLVI). First, a light stroke of brush to paint the general landscape. Back in the days, in the second half of the 17th century, manufactures meant mostly textile and garments. There was some industrial activity in other goods (glass, tapestry), but the bulk of industry was about cloth, in many forms. People at the time were really inventive as it came to new types of cloth: they experimented with mixing cotton, wool and silk, in various proportions, and they experimented with dyeing (I mean, they experimented with dying, as well, but we do it all the time), and they had fashions. Anyway, textile and garment was THE industry.

As Master Savary starts his exposition about manufactures, he opens up with a warning: manufactures can lead you to ruin. Interesting opening for an instruction. The question is why? Or rather, how? I mean, how could a manufacturing business lead to ruin? Well, back in the day, in 17th century, in Europe, manufacturing activities used to be quite separated institutionally from the circulation of big money. Really big business was being done mostly in trade, and large-scale manufacturing was seen as kind of odd. In trade, merchants of the time devised various legal tools to speed up the circulation of capital. Bills of exchange, maritime insurance, tax farming – it all allowed, with just the right people to know, a really smooth flow of money, even in the presence of many-year-long maritime commercial trips. In manufacturing, many of those clever tricks didn’t work, or at least didn’t work yet. They had to wait, those people, some 200 years before manufacturing would become really smooth a way of circulating capital. Anyway, putting money in manufacturing meant that you could not recover it as quickly as you could in trade. Basically, when you invested in manufactures, you were much more dependent on the actual marketability of your actual products than you were in trade. Thus, many merchants, Master Savary obviously included, perceived manufacturing as terribly risky.

What did he recommend in the presence of such dire risk? First of all, he advised to distinguish between three strategies. One, imitate a foreign manufacture. Second, invent something new and set a new manufacture. Third, invest in ‘an already established Manufacture, whose merchandise has an ordinary course in the Kingdom as well as in foreign Countries, by the general consent of all the people who had recognized its goodness, in the use of fabric which have been manufactured there’. I tried to translate literally the phrasing of the last strategy, in order to highlight the key points of the corresponding business plan. An established manufacture meant, first of all, the one with ‘an ordinary course in the Kingdom as well as in foreign Countries’. Ordinary course meant a predictable final selling price. As a matter of fact, this is my problem with that translation. Master Savary originally used the French expression: ‘cours ordinaire’, which, in English, becomes ambiguous. First, it can mean ‘ordinary course’, i.e. something like an established channel of distribution. Still, it can also mean ‘ordinary rate of exchange’. Why ‘rate of exchange’? We are some 150 years before the development of modern, standardized monetary systems. We are even some 100 years before the appearance of paper money. There were coins, and there was a s***load of other things you could exchange your goods against. At Master Savary’s time, many things were currencies. In business, you traded your goods against various types of coins, you accepted bills of exchange instead of coins, you traded against gold and silver in ingots, as well, and finally, you did barter. Some young, rich, and spoilt marquis had lost some of its estates by playing cards, he signed some papers, and here you are, with the guy who wants to buy your entire stock of woollen garments and who wants to pay you precisely with those papers signed by the young marquis. If you were doing really big business, none of your goods has one price: instead, they all had complex exchange rates against other valuables. Trading goods with what Master Savary originally called ‘cours ordinaire’ meant that the goods in question were kind of predictable as for their exchange rate against anything else in that economic jungle of the late 17th century.

What worked on the selling side, had to work on the supply side as well. You had to buy your raw materials, your transport, your labour etc. at complex exchange rates, and not at those nice, tame, clearly cut prices in one definite currency. Making the right match between exchange rates achieved when purchasing things, and those practiced at the end of the value chain was an art, and frequently a pain in your ass. In other words, business in 17th century was very much like what we would have now if our banking and monetary systems collapsed. Yes, baby, them bankers are mean and abjectly rich, but they keep that wheel spinning smoothly, and you don’t have to deal with Somalian pirates in order to buy from them some drugs, which you are going to exchange against natural oil in Yemen, which, in turn, you will use to back some bills of exchange, which will allow you to buy cotton for your factory.

Now, let’s return to what Master Savary had to say about those three strategies for manufacturing. As he discusses the first one – imitating a foreign factory – he recommends five wise things to do. One, check if you can achieve exactly the same quality of fabric as those bloody foreigners do. If you cannot, there is no point in starting imitation. Two, make sure you can acquire your raw materials, in the necessary bracket of quality, in the place where you locate your manufacture. Three, make sure the place where you locate your operations will allow you to practice prices competitive as compared to those foreign goods you are imitating. Four, create for yourself conditions for experimenting with your product and your business. Launch some kind of test missiles in many directions, present your fabrics to many potential customers. In other words, take your time, bite your ambition, suck ass and make your way into the market step by step. Five, arrange for acquiring the same tools, and even the same people that work in those foreign manufactures. Today, we would say: acquire the technology, both the formal, and the informal one.

As he passes to discussing the second strategy, namely inventing something new, Master Savary recommends even more prudence, and, in the same time, he pulls open a bit the veil of discretion regarding his own life, and confesses that he, in person, had invented three new fabrics during his business career: a thick woollen ribbon made of camel wool, a thick drugget for making simple, coarse, work clothes, and finally a ribbon made of woven gold and silver. Interesting. Here is a guy, who started his professional life as a merchant, then he went into commercial arbitrage for some time, then he went into the service of a rich aristocrat ( see ‘Comes the time, comes the calm duke’ ), then he entered into a panel of experts commissioned by Louis XIV, the Sun King, to prepare new business law, and in the meantime he invented decorative ribbons for rich people, as well as coarse fabrics for poor people. Quite abundant a walk of life. As I am reading the account of his textile inventions, he seems to be the most attached to, and the most vocal about that last one, the gold and silver ribbon. He insists that nobody before him had ever succeeded in weaving gold and silver into something wearable. He describes in detail all the technological nuances, like for example preventing the chipping off of the very thinly pulled, thread size, golden wire. He concludes: ‘I have given my own example, in order to make those young people, who want to invent new Manufactures, understand they should take their precautions, not to engage imprudently and not to let themselves being carried away by the profits they will make on their first fabrics, and to have a great number of them fabricated, before being certain they will be pleasant to the public, as well as for their beauty as for quality; for it is really dangerous, and they will risk their fortune at it’.  

Master Savary discusses at length a recent law: the Ordinance of 1673 or Edict of the King Serving as Regulation For The Business of Negociants And Merchants In Retail as well As In Wholesale. This is my own, English translation of the original title in French, namely “ORDONNANCE DE 1673 Édit du roi servant de règlement pour le commerce des négociants et marchands tant en gros qu’en détail”. You can have the full original text of that law at this link: https://drive.google.com/file/d/0B1QaBZlwGxxAanpBSVlPNW9LeFE/view?usp=sharing

I am discussing this ordinance in connection with Jacques Savary’s writings because he was reputed to be its co-author. In his book, he boasts about having been asked by the King (Louis the XIV Bourbon) to participate in a panel of experts in charge of preparing a reform of business law.

I like understanding how things work. By education, I am both a lawyer and an economist, so I like understanding how does the business work, as well as the law. I have discovered that looking at things in the opposite order, i.e. opposite to the officially presented one, helps my understanding and my ability to find hidden levers and catches in the officially presented logic. When applied to a legal act, this approach of mine sumps up, quite simply, to reading the document in the opposite order: I start with the last section and I advance, progressively, towards the beginning. I found out that things left for being discussed at the end of a legal act are usually the most pivotal patterns of social action in the whole legal structure under discussion. It looks almost as if most legislators were leaving the best bits for the dessert.

In this precise case, the dessert consists in Section XII, or ‘Of The Jurisdiction of Consuls’. In this section, the prerogatives of Judges and Consuls are discussed. The interesting thing here is that the title of the section refers to Consults, but each particular provision uses exactly this expression: ‘Judges and Consuls’. It looks as if there were two distinct categories of officers, and as if the ordinance in question attempted to bring their actions and jurisdictions over a common denominator. Interestingly, in some provisions of section XII, those Judges and Consuls are opposed to a category called ‘ordinary judges’. A quick glance at the contents of the section informs me that those guys, Judges and Consuls, were already in office at the moment of enacting the ordinance. The law I am discussing attempts to put order in their activity, without creating the institution as such.

Now, I am reviewing the list of prerogatives those Judges and Consuls were supposed to have. As I started with the last section of the legal act, I am starting from the last disposition of the last section. This is article 18, which refers to subpoena and summonses issued by Judges and Consuls. That means those guys were entitled to force people to come to court. This is not modern business arbitrage: we are talking about regular judicial power. That ordinance of 23rd of March, 1673, puts order in much more than commercial activities: it makes part of a larger attempt to put order in adjudication. I can only guess, by that categorization into ‘Judges’, ‘Consuls’, and ‘ordinary judges’ that at the time, many parallel structures of adjudication were coexisting, maybe even competing against each other as for their prerogatives. Judges and Consuls seem to have been victorious in at least some of this general competition for judicial power. Article 15, in the same section XII, says ‘We declare null all ordinances, commissions, mandates for summoning, and summonses issued by consequence in front of our judges and those of lords, which would revoke those issued in front of Judges and Consuls. We forbid, under the sanction of nullity, to overrule or suspend procedures and prosecutions undertaken in the execution of their verdicts, as well as to bar the way to proceeding in front of them. We want that, on the grounds of the present ordinance, they are executed, and that parties who will have presented their requests to overrule, revoke, suspend or defend the execution of their judgments, the prosecutors who will have signed such requests, the bailiffs or sergeants who will have notify about such requests, be sentenced each to fifty livres of penalty, half to the benefit of the party, half to the benefit of the poor, and those penalties will not be subject to markdown nor rebate; regarding the payment of which the party, the prosecutors and the sergeants are constrained in solidarity’.

That article 15 is a real treat, for institutional analysis. Following my upside down way of thinking, once again, I can see that at the moment of issuing this ordinance, the legal system in France must have been like tons of fun. If anyone was fined, they could argue for marking down the penalty or at least for having a rebate on it. They could claim they are liable to pay just a part of the fine (I did not do it as such; I was just watching them doing!). If a fine was adjudicated, the adjudicating body had to precise, whose benefit will this money contribute to. You could talk and cheat your way through the legal system by playing various categories of officers – bailiffs, sergeants, prosecutors, lord’s judges, royal judges, Judges and Consuls – against each other. At least some of them had the capacity to overrule, revoke, or suspend the decisions of others. This is why we, the King of France, had to put some order in that mess.

Francois Braudel, in his wonderful book entitled ‘Civilisation and Capitalism’, stated that the end of the 17th century – so the grand theatre where this ordinance happens – was precisely the moment when the judicial branch of government, in the more or less modern sense of the term, started to emerge. A whole class of professional lawyers was already established, at the time. An interesting mechanism of inverted entropy put itself in motion. The large class of professional lawyers emerged in dynamic loop with the creation of various tribunals, arbiters, sheriffs and whatnot. At the time, the concept of ‘jurisdiction’ apparently meant something like ‘as much adjudicating power you can grab and get away with it’. The more fun in the system, the greater need for professionals to handle it. The more professionals in the game, the greater market for their services they need etc. Overlapping jurisdictions were far from being as embarrassing as they are seen today: overlapping my judicial power with someone else’s was all the juice and all the fun of doing justice.

That was a general trait of the social order, which today we call ‘feudal’: lots of fun as various hierarchies overlapped and competed against each other. Right, those lots of fun could mean, quite frequently, paid assassins disguised in regular soldiers and pretending to fend off the King’s mousquetaires disguised in paid assassins. This is why that strange chaos, emerging out of a frantic push towards creating rivalling orders, had to be simplified. Absolute monarchy came as such a simplification. This is interesting to study how that absolute monarchy, so vilified in the propaganda by early revolutionaries, laid the actual foundations of what we know as modern constitutional state. Constitutional states work because constitutional orders work, and constitutional orders are based, in turn, on a very rigorously observed, institutional hierarchy, monopolistic in its prerogatives. If we put democratic institutions, like parliamentary vote, in the context of overlapping hierarchies and jurisdictions practiced in the feudal world, it would simply not work. Parliamentary votes have power because, and just as long as there is a monopolistic hierarchy of enforcement, created under absolute monarchies.

Anyway, the Sun King (yes, it was Louis the XIV) seems to have had great trust in the institution of Judges and Consuls. He seems to have been willing to give them a lot of powers regarding business law, and thus to forward his plan of putting some order in the chaos of the judicial system. Articles 13 and 14, in the same section XII, give an interesting picture of that royal will. Article 13 says that Judges and Consuls, on the request from the office of the King or from its palace, have the power to adjudicate on any request or procedure contesting the jurisdiction of other officers, ordinary judges included, even if said request regards an earlier privilege from the King. It seems that those Judges and Consuls are being promoted to the position of super-arbiters in the legal system.

Still, Article 14 is even more interesting, and it is so intriguing in its phrasing that I am copying here its original wording in French, for you to judge if I grasped well the meaning: ‘Seront tenus néanmoins, si la connaissance ne leur appartient pas de déférer au déclinatoire, à l’appel d’incompétence, à la prise à partie et au renvoi’. I tried to interpret this article with the help of modern legal doctrine in French, and I can tell you, it is bloody hard. It looks like a 17th century version of Catch 22. As far as I can understand it, the meaning of article 14 is the following: if a Judge or Consul does not have the jurisdiction to overrule a procedure against their jurisdiction, they will be subject to judgment on their competence to adjudicate. More questions than answers, really. Who decides whether the given Judge or Consul has the power to overrule a procedure against their authority? How this power is being evaluated? What we have here is an interesting piece of nothingness, right where we could expect granite-hard rules of competence. Obviously, the Sun King wanted to put some order in the judicial system, but he left some security valves in the new structure, just to allow the releasing of extra pressure, inevitably created by that new order.

Other interesting limitations to the powers of Judges and Consuls come in articles 3 and 6 of the same section XII. Article 3, in connection with article 2, states the jurisdiction of Judges and Consuls over the bills of exchange. Before I go further, a bit of commentary. Bills of exchange, at the time, made a monetary system equivalent to what today we know as account money, together with a big part of the stock market, as well as the market of futures contracts. At the end of the 17th century, bills of exchange were a universal instrument for transferring capital and settling the accounts. Circulation in bills of exchange was commonly made through recognition and endorsement, which, in practice, amounted to signing your name on the bill that passed through your hands (your business), and, subsequently, admitting (or not) that said signature is legitimate and valid. The practical problem with endorsement was that with many signatures on the same bill, together with accompanying remarks in the lines of ‘recognise up to the amount of…’, it was bloody complicated to reconstruct the chain of claims. For example, if you wanted to kind of sneak through the system, it came quite handy to endorse by signature, whilst writing the date of your signature kind of a few inches away, so as it looks signed before someone else. This detail alone provoked disputes about the timeline of endorsement.

Now, in that general context, article 2 of section XII, in the royal ordinance of March 23rd, 1673, states that Judges and Consuls have jurisdiction over bills of exchange between merchants and negociants, or those, in which merchants or negociants are the obliged party, as well as the letters of exchange and transfers of money between places. Article 3, in this general context, comes with an interesting limitation: ‘We forbid them, nevertheless, to adjudicate on bills of exchange between private individuals, other than merchants or negociants, or where a merchant or negociant is not obliged whatsoever. We want the parties to refer to ordinary judges, just as regarding simple promises’.

We, the King of France, want those Judges and Consuls to be busy just with the type of matters they are entitled to meddle with, and we don’t want their schedules to be filled with other types of cases. This is clear and sensible. Still, one tiny little Catch 22 pokes its head out of that wording. There visibly was a whole class of bills of exchange, where merchants or negociants were just the obliged party, the passive one, without having any corresponding claims on other classes of people. Bills of exchange with obliged merchants and negociants involved entered into the jurisdiction of Judges and Consuls, and, in the absence of such involvement, Judges and Consuls were basically off the case. Still, I saw examples of those bills of exchange, and I can tell you one thing: in all that jungle of endorsements, remarks and clauses to endorsements and whatnot written on those bills, there was a whole investigation to carry out just in order to establish the persons involved as obligators. Question: who assessed, whether a merchant or negociant is involved in the chain of endorsement regarding a specific bill? How was it being assessed?

Now, I am reading, and translating on the go in English, what he wrote about the securitisation of contracts by the means of the so-called bills of exchange, or promissory notes.  He starts discussing the issue when I would start, i.e. at the origins. ‘It is one thousand years since we learnt what bills of exchange and promissory notes are, an invention which came from the Jews, who, chased away from France, during the reigns of Dagobert the 1st, Philippe Augustus, and Philippe the Long, in the years 640, 1181, and 1316, took refuge in Lombardy, and in order to retrieve money and other possessions that they left in France in their friends’ hands, necessity taught them to use letters and bills written in few words and containing little substance, as it is the case with letters and bills of exchange today addressed to their friends; and to that purpose they used the intermediary of travellers, pilgrims, and foreign merchants. This means allowed them to retrieve all their assets, but, as these people have mind infinitely what regards gain and profit, they paid attention to make themselves intelligent in the knowledge of the pure and the tarnish in currencies, so as not to mistake themselves at the evaluation and reduction of different alloys in coins, which was strongly variable at the time’.

The turn of phrase you could have just read is my personal translation. I made my best so as to keep the original spirit of the text, and, in the same time, make it intelligible. The linguistic niceties properly introduced, I can give that loaf of information to my internal bulldog, for economic analysis, just to see it happy. The passage mentions two distinct economic functions, somehow coinciding with the use of the bills of exchange: controlling distant assets, and setting the market price of capital goods.

Let’s move forward with Master Savary. A few paragraphs later, he writes: ‘The etymology of the word “letter of exchange” is easy to understand, for it means no other thing than changing the money that a Merchant has in one town, and giving it to another [Merchant], who has use for it, and who has no such sum in the town of his residence, where the letter has been drawn from. This exchange is equally advantageous to them both, for the one who will have money in a town without this commodity would have to have his money transported by messengers and carters, and the one who would have need it in the same town, for doing business, would have to have it carted from the place of his residence. Again, the word “change” comes from the fact that the interest, or profit, offered when drawing or offering letters of exchange is never the same: sometimes it is high, sometimes it is low, sometimes you lose on it, sometimes you gain, and sometimes it is just at par; it means that there is nothing to lose or to gain between the Changers: and so it is perpetual change, which is being encountered in the Commerce [done with] the letters of exchange’.

Language is intriguing. When we deconstruct the etymology of a word, we can find the function that it corresponds, too. Here, Master Savary explains us the etymology of ‘letter of exchange’, and, by the same occasion, unveils the social function behind. When some capital good, coined money in the case of Master Savary’s explanation, is pretty clumsy and costly to transport, homo sapiens invents ways to use just the information about said capital good. Information travels faster, cheaper, and less riskily than coined metal, so let’s use information as payment. Information has its price, too, and, in this case, the price of letters of exchange – thus their exchange value – was made as the local (i.e. in the given transaction) evaluation of how much exchangeable value I can acquire when accepting, as payment, a letter of exchange allowing to draw on that other gentleman’s metal money stored somewhere far (too far for transporting the money physically).

Thus, as soon as an acceptably stable legal system with acceptably reliable property rights emerged, that little idea emerged as well: what has the most bulk value are big things, hard to move around, like real estate, big stocks of metals, big stocks of food etc. They have value, those big things, but they have little velocity, so let’s give them a kick into more velocity by drawing more or less standardized legal deeds, embodying claims on parts of those big things.

If you read carefully Master Savary’s explanation, you will see that letters of exchange, which, centuries after their invention, turned into paper money, were initially options on the value of coined metal. I had money stored somewhere far from the place where I was currently doing business. I offered to other business people to pay them with letters of exchange, giving them claim on some amount of my far-stored money. Those business people weighed the practical value that having a claim on that money had, from their point of view, and proposed a price for those letters. It went (probably, more or less) like: ‘Good, so you want that cart of silk, and you want me to pay with a letter of exchange that gives me unconditional claim on your silver money, and let’s say – for the sake of convenience in those folks who will read it like in four hundred years from now – that silver money is 200 ducats. That money is stored 100 miles from here. I am pondering two things now. Firstly, I am going through the idea of going and physically claiming that money of yours. Secondly, I am thinking about, instead of doing the trip, to hand that letter of exchange over to another business person, who might be willing to go and claim the money, or to make the letter circulate further. I am anticipating both the for and against of claiming physically your money, and the odds that your letter of exchange will have any exchangeable value in itself. All in all, I propose you to buy this letter of exchange from you for the equivalent, in that silk you want to buy from me, of 200 ducats minus one fifth, thus 160 ducats’.

Complicated? Yes, certainly, and this is not all. There was another factor in the game of pricing the letters of exchange: the properties of the metal money they allowed claiming. Here, a little remark is due about the origins of coined money, and, by the same means, another deceased gentleman joins the conversation. Welcome Adam Smith. What Master Smith explained, in a book published 90 years after that by Master Savary, is that coined money emerged out of the necessity to evaluate the true value of metals used in exchanges. Copper, silver, and, less frequently, gold, were the main metal exchangeable, back in the days (many days). Somehow, people came to the idea that the purer is the metal offered in exchange, the more it is worth. The presence of other substances than silver, in your average pound of silver, decreased the exchange value of that pound of silver. I know, I know, from the today’s point of view it is not one hundred percent logical, yet it was what it was. People used small, portable scales to weigh the metal in exchange (this is where the scales held by Themis, the goddess of justice, might be coming from), but it was a bit slow to use. Besides, once the metal graded by weighing, the question of how precise was the weighing naturally came to the fore, possibly together with skilled labour force, equipped with tools proper for violence.

What the sovereigns (kings, princes, and whoever efficiently claimed to rule the land) came up with was the idea of minting. The local sovereign proposed the following deal to business people: ‘See, here I have that little facility, which I have just named “mint”. The people I employ at the mint will weigh your metal and grade it, and, in order to streamline the subsequent exchanges, will make it into small pieces of standard weight each, with my royal/ducal/whatever-I-am-currently stamp on them. My minting stamp will guarantee the exchangeable value of your metal. Isn’t it a tremendous improvement? Oh, there is that tiny little detail: as minting will take off your shoulders the burden of (some) transaction costs, you pay me a fraction of the exchangeable value in the metal being minted. Deal?’.

In the Europe of the past, which, fault of a better word, we call ‘feudal’, there were many sovereigns, living in really complicated, hierarchical combinations. Most of them used to run their mints, whence the presence of many minting stamps in the market. Ducats were metal stamped with ducal minting stamps, for example. A duke was the highest in rank in the feudal hierarchy, regarding the control over precise territories. Kings and their royal families were technically above that hierarchy, but, as regards the claim on territories, kings made themselves into dukes, frequently. You can find a trace of that legal trick in the today’s royal families, whose members, whilst being kings, queens, princes or princesses, are dukes or duchesses of something as well.

As I intellectually compile my notes on Master Savary’s writings, I notice an interesting pattern: the connexion between quantitative growth in markets, and the opportunity for investment. I compare ‘Le parfait négociant’ by Jacques Savary, published in 1675, with ‘An Inquiry Into The Nature And Causes of The Wealth Of Nations’ by Adam Smith, published in 1763. Adam Smith firmly stated that quickly growing markets offer the best opportunities for making profits. As a matter of fact, if you take into account the operational profits from current business, and the financial return on capital engaged in the corresponding assets, Adam Smith would say that only markets endowed with quick quantitative growth offer any chance of profits whatsoever. Master Savary, on the other hand, would much rather do business in stationary, predictable markets. Question: what has changed, between the end of the 17th century, and the end of the 18th, so as to provoke such a change in approach?

Three factors come to my mind: demographic growth, standardization of monetary systems, and diversification of technologies. The 1670ies, in Europe, was a period of us, Europeans, sort of hesitating between demographic recession, and just a demographic slowdown. That hesitant frame of our collective approach to there being possibly more of us around turned into a firm ‘yes, more’ attitude precisely in the 1760ies, thus when Master Smith was observing society around him, and writing about it. You can find a fascinating description of that long process in

« La théorie de l’impôt » (1760) by Victor Riqueti, marquis de Mirabeau (yes, the same Mirabeau, I mean the revolutionary). Cold as finance – which it talks about – but a lot of facts to find inside.

Anyway, when Jacques Savary was writing, in 1675, that ‘it is an important thing to undertake manufactures, for it is nothing less that the entrepreneurs’ ruin, should (this undertaking) be not conducted with prudence and judgment’. This was a sketch against the background of a population on decline, and it married interestingly with technological diversity. In Master Savary’s times, the textile – garments and fabrics – was THE cutting edge of technology. When Adam Smith was writing his treaty, European population was on the rise again, and innovation was taking place across the board, really, financial instruments included.

Here comes the third factor: cash. Jacques Savary was operating in a world where money was diverse, a bit obscure and largely dependent on local sovereigns’ caprice. Adam Smith was observing a different context, where monetary systems were progressively tending towards standardization, although it required one more century to become effective.  

That little digression serves me just to show my students in management the fundamentals of growing a business: you need a growing market, you need generally innovative an economic environment (when you are the only one to innovate, it sucks), and you need to have cash secured.

Discover Social Sciences is a scientific blog, which I, Krzysztof Wasniewski, individually write and manage. If you enjoy the content I create, you can choose to support my work, with a symbolic $1, or whatever other amount you please, via MY PAYPAL ACCOUNT.  What you will contribute to will be almost exactly what you can read now. I have been blogging since 2017, and I think I have a pretty clearly rounded style.

In the bottom on the sidebar of the main page, you can access the archives of that blog, all the way back to August 2017. You can make yourself an idea how I work, what do I work on and how has my writing evolved. If you like social sciences served in this specific sauce, I will be grateful for your support to my research and writing.

‘Discover Social Sciences’ is a continuous endeavour and is mostly made of my personal energy and work. There are minor expenses, to cover the current costs of maintaining the website, or to collect data, yet I want to be honest: by supporting ‘Discover Social Sciences’, you will be mostly supporting my continuous stream of writing and online publishing. As you read through the stream of my updates on https://discoversocialsciences.com , you can see that I usually write 1 – 3 updates a week, and this is the pace of writing that you can expect from me.

Besides the continuous stream of writing which I provide to my readers, there are some more durable takeaways. One of them is an e-book which I published in 2017, ‘Capitalism And Political Power’. Normally, it is available with the publisher, the Scholar publishing house (https://scholar.com.pl/en/economics/1703-capitalism-and-political-power.html?search_query=Wasniewski&results=2 ). Via https://discoversocialsciences.com , you can download that e-book for free.

Another takeaway you can be interested in is ‘The Business Planning Calculator’, an Excel-based, simple tool for financial calculations needed when building a business plan.

Both the e-book and the calculator are available via links in the top right corner of the main page on https://discoversocialsciences.com .

Chitchatting about kings, wars and medical ventilators: project tutorial in Finance

My editorial on You Tube

I continue with educational stuff, so as to help my students with their graduation projects. This time, I take on finance, and on the projects that my students are to prepare in the curriculum of ‘Foundations of Finance’. The general substance of those projects consists in designing a financial instrument. I know that many students struggle already at the stage of reading that sentence with understanding: they don’t really grasp the concept of designing a financial instrument. Thus, I want to sort of briefly retake it from the beginning.

The first step in this cursory revision is to explain what I mean by ‘financial instrument’. Within the framework of that basic course of finance, I want my students to develop intellectual distinction between 5 essential types of financial instruments: equity-based securities, debt-based securities, bank-based currencies, virtual currencies (inclusive of cryptocurrencies), and insurance contracts. I am going to (re)explain the meaning of those terms. I focus on those basic types because they are what we, humans, simply do, and have been doing for centuries. Those types of financial instruments have been present in our culture for a long time, and, according to my own scientific views, they manifest collective intelligence in human societies: they are standardized parcels of information, able to provoke certain types of behaviour in some categories of recipients. In other words, those financial instruments work similarly to a hormone. Someone drops them in the middle of the (social) ocean. Someone else, completely unknown and unrelated picks them up, and their content changes the acquirer’s behaviour. 

When we talk about securities, both equity-based and debt-based, the general idea is that of securing claims, and then making those secured claims tradable. Look up the general definition of security, e.g. on Investopedia. If you want, in your project, to design a security, the starting point is to define the assets it gives claim on. Equity-based securities give direct, unconditional claims on the assets held by a business (or by any other type of social entity incorporated in a business-like way, with an explicit balance sheet), as well as conditional, indirect claims on the dividend paid out of future net income generated with those assets. Debt-based securities give direct, unconditional claim on the future cash flows, generated by the assets of the given business. The basic idea of tradable securities is that all those types of claims come with a risk, and the providers of capital can reduce their overall risk by slicing the capital they give into small tradable portions, each accompanied by a small portion of adjacent risk. Partitioning big risks and big claims into small parcels is the first mechanism of reducing risk. The possibility to trade those small parcels freely, i.e. to buy them, hold them for however long pleases, and then sell them, is the second risk-reducing device.

The entire concept of securities aims, precisely, at reducing financial risks connected to investing big amounts of capital into business structures, and thus at making that investment more attractive and easier. Historically, it literally has been working like that. Over centuries, whenever people with money were somehow reluctant to connect with people having bold ideas, securities usually solved the problem. You were a rich merchant, like in the 17th century-France, and your king asked you to lend him money for the next war he wanted to fight. You would answer: ‘Of course, my Lord, I would gladly provide you with the necessary financial means, yet I have a tiny little doubt. What if you lose that war, my Lord? Who’s going to pay me back?’. Such an answer could lead into two separate avenues: decapitation or securitization of debt. The former was somehow less interesting financially, but the latter was a real solution: you lend to the King, in exchange he hands you his royal bonds (debt-based securities), and you can further sell those bonds to whoever is interested in betting on the results of war.      

Thus, start with a simple business concept, e.g. something of current interest, such as a factory of medical ventilators. You have a capital base, i.e. some assets, and you finance them with equity and liabilities. Classical. You can skip the business planning part by going to the investors relations site of any company you know, taking their last financial report and simply simulating a situation when those guys want to increase their capital base, i.e. add to their assets. I mentioned medical ventilators, so you could go and check Medtronic’s investors relations site (http://investorrelations.medtronic.com/ ), and pick their latest quarterly financials. They have assets worth $92 822 mln, financed with $51 953 mln in equity and $40 869 in debt. Imagine they see big business looming on the horizon, and they want to accumulate $10 000 mln more in assets. They can do it either through additional borrowing, or through the issuance of new shares in the stock market.

You can go through the reports of Medtronic as well as through their corporate governance rules, and start by taking your own stance at the basic question: if Medtronic intends to accrue their assets by $10 000 mln, would you advise them to collect that capital by equity, or by debt, or maybe to split it somehow between the two. Try to justify your answer in a meaningful way.

If you go for equity-based securities (shares in equity), keep asking questions such as: what should be the nominal value (AKA face value) of those shares? How does it compare with the nominal value of shares already outstanding with this company? What dividend can shareholders expect, based on past experience? How are those new shares expected to behave in the stock market, once again based on the past experience?

If your choice is to bring capital through the issuance of debt-based securities, go for answering the following: what should be the interest rate on those corporate bonds? What should be their maturity time (i.e. for how long should they stay in the market of debt before Medtronic buys them back)? Should they be convertible into something else, like in the shares in equity, or in some next generation of bonds? Once again, try to answer those questions as if I were just a moderately educated hominid, i.e. as if I needed to have things explained simply, step by step.

See? Chitchatting, talking about kings, wars and medical ventilators, we have already covered the basics of preparing a project on equity-based securities, as well as on the debt-based ones.

If you want to go somehow further down those two avenues, you can check two of my blog updates from the last academic year: Finding the right spot in that flow: educational about equity-based securities , and  Unconditional claim, remember? Educational about debt-based securities.

Now, we talk about money, i.e. about a hypothetical situation when my students design a new currency in the framework of their project. Money is strange, to the extent that technically it should not have any intrinsic value of itself, as a pure means of exchange, and yet any currency can be deemed mature and established once its users start hoarding it a little bit, thus when they start associating with it some sort of intrinsic value. Presently, with the development of cryptocurrencies, we distinguish them from bank-based or central-unit-based currencies. In what follows immediately, I am focusing on the latter category, before passing to the former.

So, what is a bank-based currency, AKA central-unit-based currency? A financial institution, e.g. a bank, issues a certain number of monetary units (AKA monetary titles), which are basically used just as a means of exchange. The bank guarantees the nominal value of that currency, which, in itself, does not embody any claim on anything. This is an important difference between money and securities: securities secure claims, money doesn’t. Money just assures liquidity, understood as the capacity to enter into exchange transactions.   

When designing a new currency, step #1 consists in identifying a market with liquidity problems, e.g. we have 5 developing countries, which do business with each other: they trade goods and services, business entities from each of those countries invest in the remaining four etc. Those 5 countries have closed or semi-closed monetary systems, i.e. their national currencies either are not exchangeable at all against any other currency, or there are severe limitations on such exchange (e.g. you need a special authorization from some government agency). Why do those countries have closed monetary systems? Because their governments are afraid that if they make it open, thus when they allow free exchange against foreign currencies, the actual exchange rate will be so volatile, and so prone to speculative attacks (yes, there are bloody big sharks in those international financial waters) that the domestic financial system will be direly destabilized. Why any national currency should be so drastically volatile? It happens when this currency is not really exchanged a lot against other currencies, i.e. when exchange is sort of occasional and happens in really big bundles. There is not enough accumulated transactional experience. Long story short, we have national currencies which are closed because of the possible volatility and are so prone to volatility because they are closed systems. Yes, I know it sounds stupid. Yet, once you see that mechanism at work, you immediately understand. In the communist Poland, we had a closed monetary system, with our national currency, the zloty, technically being not exchangeable at all against anything else. As a result, whenever such exchange actually took place, e.g. against the US dollar, you needed to be a wizard, or a prime minister, to predict more or less accurately the applicable exchange rate.

Those 5 countries have two options. For one, they can use a third-country, strong currency as a local means of exchange, i.e. their governments, and their national business entities can agree that whenever they do business transnationally, they use a reference currency to settle their mutual obligations. The second option consists in creating an international currency, specifically designed for settling business accounts between those countries. This is how the ECU, the grandpa of the euro, was born, back in the day. The ECU was a business currency – you couldn’t have it in your wallet, you just could settle your international accounts with it – and then, as banks got used to it, the ECU progressively morphed into the euro. What you need for such a currency is a financial institution, or a contractually established network thereof, who guarantee the nominal value of that business currency.

If our 5 countries go for the second option, the financial institution(s) who step in as guarantors if the newly established currency need to bring to the table something more than just mutual trust. They need to assign, in their balance sheets, specific financial assets which back the aggregate nominal value of the new currency put in circulation. Those assets can consist of, for example, a reserve basket of other currencies. Once again, it sounds crazy, i.e. money being guaranteed with money, but this is how it works.

Therefore, step #2 in designing a new, bank-based currency, requires giving some aggregate numbers. What is the aggregate value of transactions served by the new currency? Let’s go, just as an example, for $100 billion a year. How long will each unit of the new currency spend on an individual bank account? In a perfectly liquid market, each unit of currency is used as soon as it has been received, thus it just has one night to sleep on a bank account, and back to work, bro’. In such a situation, that average time on one account is 1 day. Therefore, in order to cover $100 billion in transactions, we need [$100 / 365 days in the year] = $0,2739726 billion = $274 million in currency. If people tend to build speculative positions in that currency, i.e. they tend to save some of it for later, the average time spent on an individual account by the average unit of that new money could stretch up to 2 weeks = 14 days. In such case, the amount of currency we need to finance $100 billion in transactions is calculated as [$100 / (365/14)] = [$100 * 14 / 365] = $3,8356 billion.

There is a catch. I talk about introducing a new currency, but I keep denominating in US dollars, whence the next question and the next step, step #3, in a project devoted to this topic. The real economic value of our money depends on what we do with that money, and not really on what we call it. One of the things we do with an international currency is to exchange it against national currencies. In this case, we are talking about 5 essentially closed national currencies. For the sake of convenience, let’s call them: Ducat A, Ducat B, Ducat C, Ducat D, and Ducat E. Once again for sheer convenience we label the new currency ‘Wanderer’. So far, our 5 countries have been using the US dollar for international settlements, whence my calculations denominated therein. The issue of exchange rate of the Wanderer against the US dollar, as well as against our 5 national Ducats, is a behavioural one. Yes, behavioural: it is about human behaviour.

We have businesspeople doing international business in USD, and we want to convince them to switch to the Wanderer. What arguments can we use? There are two: exchange rate per se, and exchange rate risk. Whoever is a national of our 5 countries, needs to exchange their national Ducat against the US dollar and the other way around. As neither of the Ducats is freely convertible, exchange with the dollar takes place, most probably, in the form of big, bulk transactions, like once a month, mediated by the central banks of our 5 countries. Those bulk transactions yield an average exchange rate, and an average variance around that average.

We want to put in place an alternative scheme, where the national Ducats (A, B, C, D, E) are exchanged in real time against the Wanderer, and then the Wanderer gets exchanged against the US dollar. The purpose is to make the exchange {Ducat Wanderer USD} more attractive, average-rate-wise or variance-in-rate-wise, than the incumbent {Ducat Individual, National Central Bank USD} one. Some of you might think it is not realistically possible, yet it really is. If 5 central banks of developing countries gang up together to buy and sell US dollars, they can probably achieve a better price, and less volatile a price, as compared to what each of them separately could have. There is even an additional trick, and this is like really a trick: central banks of our 5 countries could hold some of their financial reserves in US dollars, more specifically the part devoted to backing the Wanderer. That’s the trick that our central bank in Poland, the National Central Bank of Poland, uses all the time. We are in the European Union, but we do not belong to the European Monetary Union, and yet we do a lot of business with partners in the eurozone. The National Bank of Poland holds important financial reserves in euros, and thus gives itself a better grip on the exchange rate between the Polish zloty and the euro.

Summing up the case of graduation projects focused on designing a new bank-based currency, here are, rephrased once again, the basic logical steps. Start with identifying a market with liquidity problems, such as closed monetary systems or very volatile national currencies. This is usually an international market made of developing countries. Imagine a situation, when the central banks of the countries in question place some of their financial reserves in a strong currency, e.g. the US dollar, or the Euro, and then the same central banks introduce a currency for international settlements in that closed group of countries. Keep in mind that the whole group of countries will need an amount of currency calculated as: [Aggregate value of international transactions done in a year * [Average number of days that one user holds one unit of currency / 365].  

The whole scheme consists, at the end of the day, in obtaining a better and less volatile exchange rate of individual national currencies against the BIG ONES (e.g. the US dollar) through aggregating their exchange transactions in the financial market.       

That would be all in this tutorial. I have covered three types of financial instruments that my students can possibly design for their graduation: equity-based securities, debt-based securities, and bank-based currencies. In the coming weeks I will try to write something smart on designing cryptocurrencies and insurance contracts. Till then, you can additionally read entry March, 26th, 2019 – More and more money just in case. Educational about money and monetary systems – and entry March 31st, 2019 – The painful occurrence of sometimes. Educational about insurance and financial risk.

Cut some slack. Project tutorial for International Management at the Frycz University.

My editorial on You Tube

I am focusing, for a few days starting from today, on delivering educational content. In the framework of 4 courses I teach, this semester, at the Andrzej Frycz Modrzewski Krakow University, three – Foundations of Finance, International Management, and International Trade – require preparing graduation projects. I am presenting guidelines for those projects, and I start with the way I advise for preparing a project in International Management, Summer-Spring 2020.

When my students prepare a project in management, I keep repeating the truth: neither I, the teacher, nor you, my students, are professional managers. We are looking at the world of management from outside. This is a harsh truth to swallow: I teach something I have almost no practical experience with. What kind of skills can I, the teacher, bring to the table, in such case? I have skills in patterning and modelling social structures. That could be the reason why I do social sciences, and this is the bacon I can feed my students in any kind of management course. Thus, when you do management with me, in class, we are all throwing our limited knowledge at real situations and try to understand our own cognitive limitations. From that angle, the course of management aims at learning how much you don’t know, and what you need to learn about the situations we are talking about.   

In the course of International Management, the general frame for your graduation projects is to figure out an organisational solution to problems, which manifest themselves as officially acknowledged risk factors, explicitly discussed in annual reports of the companies, whose cases we discuss in class. That general approach unfolds in a few distinct steps. You read the annual report of, for example, General Electric, which you have already worked with in the first online class this semester. You take any risk factor named in that report. That risk factor means that something specific can happen, which will harm GE’s business. What exactly is that specific, adverse event? Try to imagine very realistically what kind of real situation can it be. When you do that, you will probably figure out 4 types of situations.

Firstly, someone recurrently makes small mistakes, over and over again. Those small mistakes pile up, and they sort of capitalize on each other. If today I neglect checking something important, tomorrow that negligence is likely to bring some adverse effects, and when I repeat it, i.e. when I skip that important check once again, adverse effects combine. When I neglect to check, whether the salary system for salespeople in my business is working well, those people get more and more pissed every month. Their frustration accumulates, and they react more and more nervously to even small imperfections in the wage system.

Secondly, someone can make one, big, catastrophic mistake, e.g. signing a big, really bad contract, which, in turn, will expose our business to a whole series of adverse outcomes, or, for example, a person will take revenge on the top management by transmitting the details of some in-house technology to a competitor. Please, note that mistakes can fluidly transform, or coexist with opportunistic behaviour. What is seen as a mistake from outside can be the manifestation of wrongful intentions on the part of the person who makes that mistake.

A big, catastrophic event can take place as ‘force majeure’, e.g. a hurricane, or a pandemic such as the present COVID-19 one, and this is the third type of risk factor. Finally, the external structure of our market can change in an unfavourable direction, and this usually takes place on an adverse change in prices, e.g. the present slump in the prices of crude oil, which is a good thing for some businesses, and a very bad one for others. That fourth type of risk is usually called ‘financial risk’.

Thus, whatever bad happens to a business, the roots of that adverse event usually fall into one of those four categories: repeated, small human mistakes, occasional big mistake, external disaster, or unfavourable external change in the prices of something. Now, think how you can make an organisation resilient to those risks. What kind of people would you need, in order to shield the business against those risks? What kind of jobs should those people do? How can you pay them? What kind of internal control you need? What kind of organisational structure will work better, in terms of resilience? Do you need, for a given business, a solid, relatively slow functional structure with a lot of internal controls, exhaustive documentation etc., or, maybe, what you need is an agile, very horizontal structure, with task-teams focused on projects rather than functional divisions with distinct competences? Which organisational pattern which shield you better against small, bitchy mistakes or frauds? Which is going to play out better when it comes to preventing a disaster-like bad decision?

In that case of General Electric, I asked my students to study the risk of making bad investments or unfavourable dispositions (reminder: disposition, in this context, means selling and entire business or an important portion of strategic assets from a business), thus the risk named as ‘Portfolio strategy execution’. We focused on the healthcare segment of GE’s business (i.e. technologies for healthcare and biotech), and I gave my students (it was in the beginning of March) a task which looks prophetic now. I asked them to imagine that GE wants to sell (i.e. divest from) the entire healthcare segment of their business. Right now, hardly anyone in their right mind would get rid of technological assets in healthcare. Still, in the beginning of march, the s**t we currently have was just outlining itself.

Anyway, we focus on the healthcare segment in the general portfolio of General Electric. In the discussion of ‘Portfolio strategy execution’, in the GE’s annual report for 2019, you can read the following passage: “Our success depends on achieving our strategic and financial objectives, including through dispositions. We are pursuing a variety of dispositions, including the planned sale of our BioPharma business within our Healthcare segment and exiting our remaining equity ownership position in Baker Hughes. The proceeds that we expect to receive from such actions are an important source of cash flow for the Company as part of our strategic and financial planning”. Let’s break it down into adverse events, and then I can take a risk (!) at trying to lead my students from risk factors to organisational solutions that can shield against those risks.

The first sentence of that passage says: “Our success depends on achieving our strategic and financial objectives, including through dispositions”. It roughly means that the top management of GE sees the entire portfolio of businesses, all segments combined, as a hand of cards in a poker game. You probably know that in poker you can ask the croupier to exchange one or more of the cards from your hand against cards from the deck. When you go for such an exchange, you expect that the cards you get from the croupier will make a better match to the remaining ones, which you still keep in hand. You are a top manager with GE, and you decide to sell (i.e. to dispose of) an entire business, in order to generate a cash inflow, which, in turn, will serve you to buy (i.e. invest in) another entire business.

Your basic challenge in such a situation is limited, imperfect information. You know, how the business you intend to sell is playing out with all the rest in your hand, and you have some expectations as for how another business – which you intend to buy – could work with the same rest in your hand. From the cognitive point of view, you are trading actual, hard-facts-based knowledge of a presently owned business, against much foggier expectations as for future possible gains from another business. You are exchanging some known s**t against some unknown s**t, with the unknown being somehow tempting you with potentially higher rewards.

Let’s translate this situation into the four basic types of risk: repeated, small human mistakes, occasional big mistake, external disaster, or unfavourable external change in the prices of something. Someone, further down the corporate hierarchy, could have been making small recurrent mistakes, or could have been perpetrating small recurrent frauds, which could have brought the healthcare business you intend to dispose of to a situation of suboptimal performance. You think the business you want to sell is worth X $ million in terms of expected net income, but in fact it could bring much more, like 2*X $ million, if you eliminate the risk factor of recurrent, small human mistakes. How can an organization shield itself against this type of risk? The most obvious answer is that if you currently control, in a rational way, operational performance in the given business, you can have a pretty good idea of what that business is capable of. If you don’t have such a controlling system, you could be selling a business with a lot of potential, and you would be selling because you cannot see that potential.

Conclusion #1: if you have in place a rational system of KPIs (Key Performance Indicators), in each business you have in your portfolio, you can make much more informed decisions as for selling (disposing of) each such business. Topic #1, which my students can develop in their projects, and which arises from that partial conclusion, could go as follows: ‘Study the entire portfolio of businesses in General Electric. Look for any piece of information you can find about it. How can you know that each of those businesses is currently working at 100%? What system of performance measurement you would like to see in place, so as to be well informed? At the end of the day, what information would you need to be sure that the decision of selling a business is really well-founded?

Let’s move further. The next sentence, in the same passage says: ‘We are pursuing a variety of dispositions, including the planned sale of our BioPharma business within our Healthcare segment and exiting our remaining equity ownership position in Baker Hughes’. A variety of dispositions means that GE is selling, or, potentially, can be selling at any given moment, many businesses at once. You can lose your balance in the midst of variety. You can do something relatively well, at the expense of doing something else much less efficiently that what you expect from yourself. Let’s try to find ways of preventing it.

When you perform many similar actions in parallel, you would like to carry out each of those actions with a maximum of efficiency. You study, you practice some sport, and you engage in business, and you would like to deliver your A game in each of these fields. There are some basic techniques you can use to assess whether you can find efficient balance at all, and whether your actions are balanced at a given moment. One of those techniques consist in assessing your resources. If, pursuing that existential example, you study, you do sport and you do business, a basic personal resource is time and human energy (i.e. the chemical energy you need in order to generate neurotransmitters, which, in turn, your nervous system needs to have all the major angles covered). Question: do you have enough time to cover studies, sport and business? It is a harsh question. The answer might be no, I haven’t. The even harsher implication of that answer is the necessity to cut something out. I focus on exams, and I give up my performance in an important sports event, or I focus on business and take a sabbatical at the university. Another answer could be yes, I have enough time, but I need to cut some slack. I need to give up on some pleasures (e.g. watching Netflix, or partying), and that will give me 2 extra hours a day for packing all my priorities in it.      

We can translate it back into the context of General Electric. When ‘We are pursuing a variety of dispositions’, we can ask: ‘Do we have enough organisational resources to pursue that entire variety of dispositions efficiently? Do we have enough people, enough computational power in our digital systems, enough good relations (or good enough relations!) with external entities so as to handle all that variety as it is?’. The answer can be yes, we have, or no, we haven’t. In the former case, the immediately following question is: ‘Do we have those resources organized optimally? Does every person involved know what they are supposed to do? Etc.’. In the latter situation, when we conclude that we cannot possibly cover all the angles with the resources we have, we follow up by asking ourselves: ‘What do we do? Do we hire additional human resources, or/and engage additional technology into the process of managing as wide a variety of dispositions as we are currently handling, or, maybe, it is a better idea to reduce variety? Maybe we can postpone some of those dispositions and focus more efficiently on the remaining deals? Does it all have to be carried out right now? Maybe we can make a timeline over the 2 years to come?’. By the way, in unstable market conditions, such as every business is facing now, with the COVID-19 pandemic and its consequences, it might pay off to slow down our decision-making, to observe and learn more before taking strategic decisions.

Conclusion #2: in a given context of external market conditions, the organization we actually have in place has a given capacity to process information and to make strategic change on the grounds of that information. If we want to pursue more operations in parallel than our organizational resources actually allow to, we risk losing our bearings in the midst of variety. There are two alternative ways out of that predicament. On the one hand, we can cut on the variety of our operations and/or our strategic decisions so as to focus on the amount we can really handle. On the other hand, we can expand our organizational resources so as to pursue efficiently the entire variety of actions that presents itself to us.

Thus, a possible topic #2 emerges for my students in International Management. Once again, go over the business of General Electric. Try to understand very practically, what do they mean by ‘pursuing a variety of dispositions’. Variety means what exactly? Now, what organizational resources (people, information, business relations etc.) does GE need so as to carry out efficiently one single disposition? Expand by assuming that you run an investment fund, with participations in many high-tech businesses. Every few months, you need to decide whether each of those businesses is worth holding in your portfolio, or maybe it would be better to sell it. What organizational resources do you need to manage such decisions efficiently? How many people would you need to hire, in such an investment fund? What kind of duties would those people have to carry out, and what skillset you would expect in them?