Unconditional claim, remember? Educational about debt-based securities

My editorial on You Tube

 

Here comes another piece of educational content, regarding the fundamentals of finance, namely a short presentation of debt-based securities. As I will be discussing that topic,  here below, I will compare those financial instruments to equity-based securities, which I already discussed in « Finding the right spot in that flow: educational about equity-based securities ».

In short, debt-based securities are financial instruments which transform a big chunk of debt, thus a big obligatory contract, into a set of small, tradable pieces, and give to that debt more liquidity.

In order to understand how debt-based securities work in finance, it is a good thing to put a few clichés on their head and make them hold that stance. First of all, we normally associate debt with a relation of power: the CREDITOR, or the person who lends to somebody else, has a dominant position over the DEBTOR, who borrows. Whilst being sometimes true, it is true just sometimes, and it is just one point of view. Debt can be considered as a way of transferring capital from entity A to entity B. Entity A has more cash than they currently need, whilst B has less. Entity A can transfer the excess of cash to B, only they need a contractual base to do it in a civilized way. In my last educational, regarding equity-based securities, I presented a way of transferring capital in exchange of a conditional claim on B’s assets, and of a corresponding decisional power: that would be investing in B’s equity. Another way is to acquire an unconditional claim on B’s future cash flows, and this is debt. Historically, both ways have been used and developed into specific financial instruments.

Anyway, the essential concept of debt-based securities is to transform one big, obligatory claim of one entity onto another entity into many small pieces, each expressed as a tradable deed (document). How the hell is it possible to transform a debt – thus future money that is not there yet – into securities? Here come two important, general concepts of finance: liquidity, and security. Liquidity, in financial terms, is something that we spontaneously associate with being able to pay whatever we need to pay in the immediate. The boss of a company can say they have financial liquidity when they have enough cash in their balance sheet to pay the bills currently on the desk. If some of those bills cannot be paid (not enough cash), the boss can say ‘Sorry, not enough liquidity’.

You can generalize from there: liquidity is the capacity to enter into new economic transactions, and to fulfil obligations resulting from such transactions. In markets that we, humans, put in place, there is a peculiar phenomenon to notice: we swing between various levels of required liquidity. In some periods, people in that market will be like immerged in routine. They will repeat the same transactions over and over again, in recurrent amounts. It is like an average Kowalski (the Polish equivalent of the English average Smith, or the French average Dupont) paying their electricity bills. Your electricity bill comes in the form of a six-month plan of instalments. Each month you will have to pay the same, fixed amount, which results from the last reading of your electricity counter. That amount is most likely to be similar to the amounts from previous six-month periods, unless you have just decided to grow some marijuana and you need extra electricity for those greenhouse lamps. If you manage to keep your head above the water, in day-to-day financial terms, you have probably incorporated those payments for electricity into your monthly budget, more or less consciously. You don’t need extra liquidity to meet those obligations. This is the state of a market, when it runs on routine transactions.

Still, there are times when a lot of new business is to be done. New technologies are elbowing their way into our industry, or a new trade agreement has been signed with another country, or the government had the excellent idea of forcing every entity in the market to equip themselves with that absolutely-necessary-thingy-which-absolutely-incidentally-is-being-marketed-by-the-minister’s-cousin. When we need to enter into new transactions, or when we just need to be ready for entering them, we need a reserve of liquidity, i.e. we need additional capacity to transact. Our market has entered into a period of heightened need for liquidity.

When I lend to someone a substantial amount of money in a period of low need for liquidity, I can just sit and wait until they pay me back. No hurry. On the other hand, when I lend during a period of increased need for liquidity, my approach is different: I want to recoup my capital as soon as possible. My debtor, i.e. the person which I have lent to, cannot pay me back immediately. If they could, they would not need to borrow from me. Stands to reason. What I can do is to express that lending-borrowing transaction as an exchange of securities against money.

You can find an accurate description of that link between actual business, its required liquidity, and all the lending business in: Adam Smith – “An Inquiry Into The Nature And Causes Of The Wealth of Nations”, Book II: Of The Nature, Accumulation, and Employment of Stock, Chapter IV: Of Stock Lent At Interest: “Almost all loans at interest are made in money, either of paper, or of gold and silver; but what the borrower really wants, and what the lender readily supplies him with, is not the money, but the money’s worth, or the goods which it can purchase. If he wants it as a stock for immediate consumption, it is those goods only which he can place in that stock. If he wants it as a capital for employing industry, it is from those goods only that the industrious can be furnished with the tools, materials, and maintenance necessary for carrying on their work. By means of the loan, the lender, as it were, assigns to the borrower his right to a certain portion of the annual produce of the land and labour of the country, to be employed as the borrower pleases.”

Here, we come to the concept of financial security. Anything in the future is subject to uncertainty and risk. We don’t know how exactly things are going to happen. This generates risk. Future events can meet my expectations, or they can do me harm. If I can sort of divide both my expectations, and the possible harm, into small pieces, and make each such small piece sort of independent from other pieces, I create a state of dispersed expectations, and dispersed harm. This is the fundamental idea of a security. How can I create mutual autonomy between small pieces of my future luck or lack thereof? By allowing people to trade those pieces independently from each other.

It is time to explain how the hell can we give more liquidity to debt by transforming it into securities. First things first, let’s see the typical ways of doing it: a note, and a bond. A note, AKA promissory note, or bill of exchange, in its most basic appearance is a written, unconditional promise to pay a certain amount of money to whoever presents the note on a given date. You can see it in the graphic below.

Now, those of you, who, hopefully, paid attention in the course of microeconomics, might ask: “Whaaait a minute, doc! Where is the interest on that loan? You told us: there ain’t free money…”. Indeed, there ain’t. Notes were invented long ago. The oldest ones we have in European museums date back to the 12th century A.D. Still, given what we know about the ways of doing business in the past, they had been used even further back. As you might know, it was frequently forbidden by the law to lend money at interest. It was called usury, it was considered at least as a misdemeanour, if not a crime, and you could even be hanged for that. In the world of Islamic Finance, lending at interest is forbidden even today.

One of the ways to bypass the ban on interest-based lending is to calculate who much money will that precise interest make on that precise loan. I lend €9000 at 12%, for one year, and it makes €9000 *12% = €1 080. I lend €9000, for one year, and I make my debtor liable for €10 080. Interest? Who’s talking about interest? It is ordinary discount!

Discount is the difference between the nominal value of a financial instrument (AKA face value), and its actual price in exchange, thus the amount of money you can have in exchange of that instrument.

A few years ago, I found that same pattern in an innocently-looking contract, which was underpinning a loan that me and my wife were taking for 50% of a new car. The person who negotiated the deal at the car dealer’s announced joyfully: ‘This is a zero-interest loan. No interest!’. Great news, isn’t it? Still, as I was going through the contract, I found that we have to pay, at the signature, a ‘contractual fee’. The fee was strangely precise, I mean there were grosze (Polish equivalent of cents) after the decimal point. I did my maths: that ‘contractual fee’ was exactly and rigorously equal to the interest we would have to pay on that loan, should it be officially interest-bearing at ordinary, market rates.

The usage of discount instead of interest points at an important correlate of notes, and debt-based securities in general: risk. That scheme with pre-calculated interest included into the face value of the note is any good when I can reliably predict when exactly will the debtor pay back (buy the note back). Moreover, as the discount is supposed to reflect pre-calculated interest, it also reflects that part of the interest rate, which accounts for credit risk.

There are 1000 borrowers, who borrow from a nondescript number of lenders. Each loan bears a principal (i.e. nominal amount) of €3000, which makes a total market of €3 000 000 lent and borrowed. Out of those 1000, a certain number is bound to default on paying back. Let it be 4%. It makes 4% * 1000 * €3000 = €120 000, which, spread over the whole population of borrowers makes €120 000/ 1000 = €120, or €120/€3000 = 4%. Looks like a logical loop, and for a good reason: you cannot escape it. In a large set of people, some will default on their obligations. This is a fact. Their collective default is an aggregate financial risk – credit risk – which has to be absorbed by the market, somehow. The simplest way to absorb it is to make each borrower pay a small part of it. When I take a loan, in a bank, the interest rate I pay always reflects the credit risk in the whole population of borrowers. When I issue a note, the discount I have to give to my lender will always include the financial risk that recurrently happens in the given market.

The discount rate is a price of debt, just as the interest rate. Both can be used, and the prevalence of one or the other depends on the market. Whenever debt gets massively securitized, i.e. transformed into tradable securities, discount becomes somehow handier and smoother to use. Another quote from invaluable Adam Smith sheds some light on this issue (

Adam Smith – “An Inquiry Into The Nature And Causes Of The Wealth of Nations”, Book II: Of The Nature, Accumulation, and Employment of Stock, Chapter IV: Of Stock Lent At Interest): “As the quantity of stock to be lent at interest increases, the interest, or the price which must be paid for the use of that stock, necessarily diminishes, not only from those general causes which make the market price of things commonly diminish as their quantity increases, but from other causes which are peculiar to this particular case. As capitals increase in any country, the profits which can be made by employing them necessarily diminish. It becomes gradually more and more difficult to find within the country a profitable method of employing any new capital. There arises, in consequence, a competition between different capitals, the owner of one endeavouring to get possession of that employment which is occupied by another; but, upon most occasions, he can hope to justle that other out of this employment by no other means but by dealing upon more reasonable terms.”

The presence of financial risk, and the necessity to account for it whilst maintaining proper liquidity in the market, brought two financial inventions: endorsement, and routed notes. Notes used to be (and still are) issued for a relatively short time, usually not longer than 1 year. If the lender needs to have their money back before the due date of the note, they can do something called endorsement: they can present that note as their own to a third party, who will advance them money in exchange. Presenting a note as my own means making myself liable for up to 100% of the original, i.e signing the note, with a date. You can find an example in the graphic below.

Endorsement used to be a normal way of assuring liquidity in the market financed with notes. Endorsers’ signatures made a chain of liability, ordered by dates. The same scheme is used today in cryptocurrencies, as the chain of hash-tagged digital signatures. Another solution was to put in the system someone super-reliable, like a banker. Such a trusted payer, who, on their part, had tons of reserve money to provide liquidity, made the whole game calmer and less risky, and thus the price of credit (the discount rate) was lower. The way of putting a banker in the game was to write them in the note as the entity liable for payment. Such a note was designated as a routed one, or as a draft. Below, I am presenting an example.

As banks entered the game of securitized debt, it opened the gates of hell, i.e. the way to paper money. Adam Smith was very apprehensive about it (Adam Smith – “Wealth of Nations”, Book II: Of The Nature, Accumulation, and Employment of Stock, Chapter II: Of Money, Considered As A Particular Branch Of The General Stock Of The Society, Or Of The Expense Of Maintaining The National Capital”): “The trader A in Edinburgh, we shall suppose, draws a bill upon B in London, payable two months after date. In reality B in Lon- don owes nothing to A in Edinburgh; but he agrees to accept of A ‘s bill, upon condition, that before the term of payment he shall redraw upon A in Edinburgh for the same sum, together with the interest and a commission, another bill, payable likewise two months after date. B accordingly, before the expiration of the first two months, redraws this bill upon A in Edinburgh; who, again before the expiration of the second two months, draws a second bill upon B in London, payable likewise two months after date; and before the expiration of the third two months, B in London redraws upon A in Edinburgh another bill payable also two months after date. This practice has sometimes gone on, not only for several months, but for several years together, the bill always returning upon A in Edinburgh with the accumulated interest and com- mission of all the former bills. The interest was five per cent. in the year, and the commission was never less than one half per cent. on each draught. This commission being repeated more than six times in the year, whatever money A might raise by this expedient might necessarily have cost him something more than eight per cent. in the year and sometimes a great deal more, when either the price of the commission happened to rise, or when he was obliged to pay compound interest upon the interest and commission of former bills. This practice was called raising money by circulation”

Notes were quick to issue, but a bit clumsy when it came to financing really big ventures, like governments. When you are a king, and you need cash for waging war on another king, issuing a few notes can be tricky. Same in the corporate sector. When we are talking about really big money, making the debt tradable is just one part, and another part is to make it nicely spread over the landscape. This is how bonds came into being, as financial instruments. The idea of bonds was to make the market of debt a bit steadier across space and over time. Notes worked well for short-term borrowing, but long-term projects, which required financing for 5 or 6 years, encountered a problem of price, i.e. discount rate. If I issue a note to back a loan for 5 years, the receiver of the note, i.e. the lender, knows they will have to wait really long to see their money back. Below, in the graphic, you have the idea explained sort of in capital letters.

The first thing is the face value. The note presented earlier proudly displayed €10 000 of face value. The bond is just €100. You divide €10 000 into 100 separate bonds, each tradable independently, at you have something like a moving, living mass of things, flowing, coming and going. Yep, babe. Liquidity, liquidity, and once again liquidity. A lot of small debts flows much more smoothly than one big.

The next thing is the interest. You can see it here designated as “5%, annuity”, with the word ‘coupon’ added. If we have the interest rate written explicitly, it means the whole thing was invented when lending at interest became a normal thing, probably in the late 1700ies. The term ‘annuity’ means that every year, those 5% are being paid to the holder of the bond, like a fixed annual income. This is where the ‘word’ coupon comes from. Back in the day, when bonds were paper documents (they are not anymore), they had detachable strips, as in a cinema ticket, one strip per year. When the issuer of the bond paid annuities to the holders, those strips were being cut off.

The maturity date of the bond is the moment, when the issuer is supposed to buy it back. It is a general convention that bonds are issued for many years. This is when the manner of counting and compound the interest plays a role, and this is when we need to remind one fundamental thing – bonds are made for big borrowers. Anyone can make a note, and many different anyones can make it circulate, by endorsement or else. Only big entities can issue bonds, and because they are big, bonds are usually considered as safe placements, endowed with low risk. Low risk means low price of debt. When I can convince many small lenders that I, the big borrower, am rock solid in my future solvency, I can play on that interest rate. When I guarantee an annuity, it can be lower than the interest paid only at the very end of maturity, i.e. in 2022 as regards this case. When all around us all of them loans are given at 10% or 12%, an annuity backed with the authority of a big institution can be just 5%, and no one bothers.

Over time, bonds have dominated the market of debt. They are more flexible, and thus assure more liquidity. They offer interesting possibilities as for risk management and discount. When big entities issue bonds, it is the possibility for other big entities to invest large amounts of capital at fixed, guaranteed rate of return, i.e. the interest rates. Think about it: you have an investment the size of a big, incorporated business, and yet you have a risk-free return. Unconditional claim, remember? Hence, over time, what professional investors started doing was building a portfolio of investment with equity-based securities for high yield and high risk, plain lending contracts for moderate yield (high interest rate) and moderate risk, and, finally, bonds for low yield and low risk. Creating a highly liquid market of debt, by putting a lot of bonds into circulation, was like creating a safe harbour for investors. Whatever crazy s**t they were after, they could compensate the resulting risk through the inclusion of bonds in their portfolios.

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund  (and you can access the French version as well). You can also get a free e-copy of my book ‘Capitalism and Political Power’ You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

Finding the right spot in that flow: educational about equity-based securities

 

My editorial on You Tube

 

I am returning to educational content, and more specifically to finance. Incidentally, it is quite connected to my current research – crowdfunding in the market of renewable energies – and I feel like returning to the roots of financial theory. In this update, I am taking on a classical topic in finance: equity-based securities.

First things first, a short revision of what is equity. We have things, and we can have them in two ways. We can sort of have them, or have them actually. When I have something, like a house worth $1 mln, and, in the same time, I owe to somebody $1,2 mln, what is really mine, at the end of the day, is a debt of $1 mln – $1,2 mln = – $0,2 mln. As a matter of fact, I have no equity in this house. I just sort of have it. In the opposite case, when the house is worth $1,2 mln and my debt is just $1 mln, I really have $1,2 – $1 mln = $0,2 mln in equity.

There is a pattern in doing business: when we do a lot of it, we most frequently do it in a relatively closed circle of recurrent business partners. Developing durable business relations is even taught in business studies as one of the fundamental skills. When we recurrently do business with the same people, we have claims on each other. Some people owe me something, I owe something to others. The capital account, which we call « balance sheet », expresses the balance between those two types of claims: those of other people on me, against my claims on other people. The art of doing business consists very largely in having more claims on others than others have on us. That “more” is precisely our equity.

When we do business, people expect us to have and maintain positive equity in it. A business person is expected to have that basic skill of keeping a positive balance between claims they have on other people, and the claims that other people have on them.

There are two types of business people, and, correspondingly, two types of strategies regarding equity in business. Type A is mono-business. We do one business, and have one equity. Type B is multi-business. Type B is a bit ADHDish: those are people who would like to participate in oil drilling, manufacturing of solar modules, space travel to Mars, launching a new smartphone, and growing some marijuana, all in the same or nearly the same time. This is a fact of life that the wealthiest people in any social group are to be found in the second category. There is a recurrent pattern of climbing the ladder of social hierarchy: being restless, or at least open in the pursuit of different business opportunities rather than being consistent in pursuing just one. If you think about it, it is something more general: being open to many opportunities in life offers a special path of personal development. Yes, consistency and perseverance matter, but they matter even more when we can be open to novelty, and consistent in the same time.

We tend to do things together. This is how we survived, over millennia, all kinds of s**t: famine, epidemies, them sabretooth tigers and whatnot. Same for business: over time, we have developed institutions for doing business together.

When we do something again and again, we figure out a way of optimizing the doing of that something. In business law, we (i.e. homo sapiens) have therefore invented institutions for both type A, and type B. You look for doing the same business for a long time, and doing it together with other people, type A just like you? You will look for something like a limited liability partnership. If, on the other hand, you are rather the restless B type, you will need something like a joint stock company, and you will need equity-based securities.

The essential idea of an equity-based security is… well, there is more than one idea inside. This is a good example of what finance is: we invent something akin to a social screwdriver, i.e. a tool which unfolds its many utilities as it is being used. Hence, I start with the initial idea rather than with the essential one, and the initial one is to do business with, or between, those B-type people: restless, open-minded, constantly rearranging their horizon of new ventures. Such people need a predictable way to swing between different businesses and/or to build a complex portfolio thereof.

Thus, we have the basic deal presented graphically above: we set a company, we endow it with an equity of €3 000 000, we divide that equity into 10 000 shares of €300 each, and we distribute those shares among some initial group of shareholders. Question: why anyone should bother to be our shareholder, i.e. to pay those €300 for one share? What do they have in exchange? Well, each shareholder who pays €300, receives in exchange one share, nominally worth €300, a bundle of intangible rights, and the opportunity to trade that share in the so-called « stock market », i.e. the market of shares. Let’s discuss these one by one.

Apparently the most unequivocal thing, i.e. the share in itself, nominally worth €300, is, in itself, the least valuable part. It is important to know: the fact of holding shares in an incorporated company does not give to the shareholder any pre-defined, unconditional claim on the company. This is the big difference between a share, and a corporate bond. The fact of holding one €300 share does not entitle to payback of €300 from the company. You have decided to invest in our equity, bro? That’s great, but investment means risk. There is no refund possible. Well, almost no refund. There are contracts called « buyback schemes », which I discuss further.

The intangible rights attached to an equity-based security (share) fall into two categories: voting power on the one hand, and conditional claims on assets on the other hand.

Joint stock companies have official, decision-making bodies: the General Assembly, the Board of Directors, the Executive Management, and they can have additional committees, defined by the statute of the company. As a shareholder, I can directly execute my voting power at the General Assembly of Shareholders. Normally, one share means one vote. There are privileged shares, with more than one vote attached to them. These are usually reserved to the founders of a company. There can also be shares with a reduced voting power, when the company wants to reward someone, with its own shares, but does not want to give them influence on the course of the business.

The General Assembly is the corporate equivalent of Parliament. It is the source of all decisional power in the company. General Assembly appoints the Board of Directors, and, depending on the exact phrasing of the company’s statute, has various competences in appointing the Executive Management. The Board of Directors directs, i.e. it makes the strategic, long-term decisions, whilst the Executive Management is for current things. Now, long story short: the voting power attached to equity-based securities, in a company, is any good only if it is decisive in the appointment of Directors. This is what much of corporate law sums up to. If my shares give me direct leverage upon who will be in the Board of Directors, then I really have voting power.

Sometimes, when holding a small parcel of shares in a company, you can be approached by nice people, who will offer you money (not much, really) in exchange of granting them the power of attorney in the General Assembly, i.e. to vote there in your name. In corporate language it is called power of proxy, and those people, after having collected a lot of such small, individual powers of attorney, can run the so-called proxy votes. Believe me or not, but proxy powers are sort of tradable, too. If you have accumulated enough proxy power in the General Assembly of a company, you, in turn, might be approached by even nicer people, who will propose you (even more) money in exchange of having that conglomerate, proxy voting power of yours on their side when appointing a good friend of theirs to the Board of Directors.

Here you have a glimpse of what equity-based securities are in essence: they are tradable, abstract building blocks of an incorporated business structure. Knowing that, let’s have a look at the conditional claims on assets that come with a corporate share. The company makes some net profit at the end of the year, and happens even to have free cash corresponding to that profit, and the General Assembly decides to have 50% of net profit paid to shareholders, as dividend. Still, voting in a company is based on majority, and, as I already said, majority is there when it can back someone to be member of the Board of Directors. In practical terms it means that decisions about dividend are taken by a majority in the Board of Directors, who, in turn, represent a majority in the General Assembly.

The claim on dividend that you can have, as a shareholder, is conditional on: a) the fact of the company having any profit after tax, b) the company having any free cash in the balance sheet, corresponding to that profit after tax, and c) the majority of voting power in the General Assembly backing the idea of paying a dividend to shareholders. Summing up, the dividend is your conditional claim on the liquid assets of the company. Why do I say it is a conditional claim on assets, and not on net profit? Well, profit is a result. It is an abstract value. What is really there, to distribute, is some cash. That cash can come from many sources. It is just its arithmetical value that must correspond to a voted percentage of net profit after tax. Your dividend might be actually paid with cash that comes from the selling of some used equipment, previously owned by the company.

Another typical case of conditional claim on assets is that of liquidation and dissolvence. When business goes really bad, the company might be forced to sell out its fixed assets in order to pay its debts. When really a lot of debt is there to pay, the shareholders of the company might decide to sell out everything, and to dissolve the incorporation. In such case, should any assets be left at the moment of dissolvence, free of other claims, the proceeds from their sales can be distributed among the incumbent shareholders.

Right, but voting, giving or receiving proxy power, claiming the dividend or proceeds from dissolvence, it is all about staying in a company, and we were talking about the utility of equity-based securities for those B-type capitalists, who would rather trade their shares than hold them. These people can use the stock market.

It is a historical fact that whenever and wherever it became a common practice to incorporate business in the form of companies, and to issue equity-based securities corresponding to shares, a market for those securities arose. Military legions in Ancient Rome were incorporated businesses, which would issue (something akin to) equity-based securities, and there were special places, called ‘counters’, where those securities would be traded. This is a peculiar pattern in human civilisation: when we practice some kind of repetitive deals, whose structure can be standardized, we tend to single out some claims out of those contracts, and turn those claims into tradable financial instruments. We call them ‘financial instruments’, because they are traded as goods, whilst not having any intrinsic utility, besides the fact of representing some claims.

Probably the first modern stock exchange in Europe was founded in Angers, France, somehow in the 15th century. At the time, there were (virtually) no incorporated companies. Still, there was another type of equity. Goods used to be transported slowly. A cargo of wheat could take weeks to sail from port A to port B, and then to be transported inland by barges or carts pulled by oxen. If you were the restless type of capitalist, you could eat your fingernails out of restlessness when waiting for your money, invested in that wheat, to come back to you. Thus, merchants invented securities, which represented abstract arithmetical fraction of the market value ascribed to such a stock of wheat. They were called different names, and usually fell under the general category of warrants, i.e. securities that give the right to pick up something from somewhere. Those warrants were massively traded in that stock exchange in Angers, and in other similar places, like Cadiz, in Spain. Thus, I bought a stock of wheat in Poland (excellent quality and good price), and I had it shipped (horribly slowly) to Italy, and as soon as I had that stock, I made a series of warrants on it, like one warrant per 100 pounds of wheat, and I started trading those warrants.

By the way, this is where the name ‘stock market’ comes from. The word ‘stock’ initially meant, and still means, a large quantity of some tradable goods. Places, such as Angers o Cadiz, where warrants on such goods were being traded, were commonly called ‘stock markets’. When you think of it, those warrants on corn, cotton, wool, wine etc. were equity-based securities. As long as the issuer of warrants had any equity in that stock, i.e. as long as their debt was not exceeding the value of that stock, said value was equity and warrants on those goods were securities backed with equity.

That little historical sketch gives an idea of what finance is. This is a set of institutionalized, behavioural patterns and rituals, which allow faster reaction to changing conditions, by creating something like a social hormone: symbols subject to exchange, and markets of those symbols.

Here comes an important behavioural pattern, observable in the capital market. There are companies, which are recommended by analysts and brokers as ‘dividend companies’ or ‘dividend stock’. It is recommended to hold their stock for a long time, as a long-term investment. The fact of recommending them comes from another fact: in these companies, a substantial percentage of shares stays, for years, in the hands of the same people. This is how they can have their dividend. We can observe relatively low liquidity in their stock. Here is a typical loop, peculiar for financial markets. Some people like holding the stock of some companies for a long time. That creates little liquidity in that stock, and, indirectly, little variation in the market price of that stock. Little variation in price means that whatever you can expect to gain on that stock, you will not really make those gains overnight. Thus, you hold. As you hold, and as other people do the same, there is little liquidity on that stock, and little variation in its price, and analysts recommend it as ‘dividend stock’. And so the loop spins.

I generalize. You have some equity-based securities, whose market value comes mostly from the fact that we have a market for them. People do something specific about those securities, and their behavioural pattern creates a pattern in prices and quantities of trade in that stock. Other people watch those prices and quantities, and conclude that the best thing to do regarding those securities is to clone the behavioural pattern, which made those prices and quantities. The financial market works as a market for strategies. Prices and quantities become signals as for what strategy is recommended.

On the other hand, there are shares just made for being traded. Holding them for more than two weeks seems like preventing a race horse from having a run on the track. People buy and sell them quickly, there is a lot of turnover and liquidity, we are having fun with trade, and the price swings madly. Other people are having a look at the market, and they conclude that with those swings in price, they should buy and sell that stock really quickly. Another loop spins. The stock market gives two types of signals, for two distinct strategies. And thus, two types of capitalists are in the game: the calm and consistent A type, and the restless B type. The financial market and the behavioural patterns observable in business people mutually reinforce and sharpen each other.

Sort of in the shade of those ‘big’ strategies, there is another one. We have ambitions, but we have no capital. We convince other people to finance the equity of a company, where we become Directors or Executive Management. With time, we attribute ourselves so-called ‘management packages’, i.e. parcels of the company’s stock, paid to us as additional compensation. We reasonably assume that the value of those management packages is defined by the price we can sell this stock in. The best price is the price we make: this is one of the basic lessons in the course of macroeconomics. Hence, we make a price for our stock. As Board of Directors, we officially decide to buy some stock from shareholders, at a price which accidentally hits the market maximums or even higher. The company buys some stock from its own shareholders. That stock is usually specified. Just some stock is being bought back, in what we call a buyback scheme. Accidentally, that ‘just some stock’ is the stock contained in the management packages we hold as Directors. Pure coincidence. In some legal orders, an incorporated company cannot hold its own stock, and the shares purchased back must be nullified and terminated. Thus, the company makes some shares, issues them, gives them to selected people, who later vote to sell them back to the company, with a juicy surplus, and ultimately those shares disappear. In other countries, the shares acquired back by the company pass into the category of ‘treasury shares’, i.e. they become assets, without voting power or claim on dividend. This is the Dark Side of the stock market. When there is a lot of hormones flowing, you can have a position of power just by finding the right spot in that flow. Brains know it better than anyone else.

Now, some macroeconomics, thus the bird’s eye view. The bird is lazy, and it prefers having a look at the website of the World Bank, and there it picks two metrics: a) Gross Capital Formation as % of GDP and b) Stock traded as % of GDP. The former measures the value of new fixed assets that pop up in the economic system, the latter estimates the value of all corporate stock traded in capital markets. Both are denominated in units of real output, i.e. as % of GDP, and both have a line labelled ‘World’, i.e. the value estimated for the whole planet taken as an economic system. Here comes a table, and a graph. The latter calculates the liquidity of capital formation, measured as the value of stock traded divided by the gross value of fixed capital formed. Some sort of ascending cycle emerges, just as if we, humans, were experimenting with more and more financial liquidity in new fixed assets, and as if, from time to time, we had to back off a bit on that liquidity.

 

Year Gross capital formation (% of GDP), World Stocks traded, total value (% of GDP), World Year Gross capital formation (% of GDP), World Stocks traded, total value (% of GDP), World
1984 25,4% 17,7% 2001 24,0% 104,8%
1985 25,4% 23,7% 2002 23,4% 82,8%
1986 25,1% 32,4% 2003 23,9% 76,0%
1987 25,4% 46,8% 2004 24,7% 83,8%
1988 26,2% 38,1% 2005 25,0% 99,8%
1989 26,6% 44,5% 2006 25,4% 118,5%
1990 26,0% 31,9% 2007 25,8% 161,9%
1991 25,4% 24,1% 2008 25,6% 140,3%
1992 25,2% 22,5% 2009 23,4% 117,3%
1993 25,0% 30,7% 2010 24,2% 112,5%
1994 25,0% 34,0% 2011 24,5% 104,8%
1995 24,8% 34,1% 2012 24,3% 82,4%
1996 24,7% 41,2% 2013 24,2% 87,7%
1997 24,7% 58,9% 2014 24,4% 101,2%
1998 24,5% 73,1% 2015 24,2% 163,4%
1999 24,1% 103,5% 2016 23,8% 124,5%
2000 24,5% 145,7%

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund  (and you can access the French version as well). You can also get a free e-copy of my book ‘Capitalism and Political Power’ You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

Rummaging inside Tesla: my latest exam in Microeconomics

 

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One more educational update on my blog. This time, it is the interpretation of exam in microeconomics, which took place on February 1st, 2019, in two distinct majors of studies, i.e. International Relations, and Management. First, right below, I am presenting the contents of the exam sheet, such as it was distributed to students. Then, further below, I develop an interpretation of possible answers to the questions asked. One preliminary remark is due: the entire exam refers to Tesla Inc. as business case. In my classes of Microeconomics, as well as in those of Management, I usually base the whole semester of teaching on 4 – 6 comprehensive business cases. This time, during the winter semester 2018/2019, one of those cases was Tesla, and the main source material was Tesla’s Annual Report for 2017. The students who attended this precise exam were notified one week earlier that Tesla was the case to revise.

This said, let’s rock. Here comes the exam sheet:

 

Exam in Microeconomics February 1st, 2019

 

Below, you will find a table with selected financial data of Tesla Inc. Use that data, and your knowledge as regards the business model of this firm, to answer the two open questions below the table. Your answer to each of the questions will be graded on a scale from 0 to 3 points. No answer at all, or major mistakes, give you 0 points. Short descriptive answer, not supported logically with calculations, gives 1 point. Elaborate explanation, logically supported with calculations, gives 2 or 3 points, depending on the exhaustiveness of your answer. Points translate into your overall grade as follows: 6 points – 5,0 (very good); 5 points – 4,5 (+good); 4 points – 4,0 (good); 3 points – 3,5 (+pass); 2 points – 3,0 (pass); 0 ÷ 1 points – 2,0 (fail). 

 

 

Values in thousands of USD
Revenues 2017 2016 2015
Automotive sales    8 534 752       5 589 007       3 431 587    
Automotive leasing    1 106 548         761 759         309 386    
Energy generation and storage    1 116 266         181 394          14 477    
Services and other    1 001 185         467 972         290 575    
Total revenues   11 758 751       7 000 132       4 046 025    
Cost of revenues      
Automotive sales    6 724 480       4 268 087       2 639 926    
Automotive leasing      708 224         481 994         183 376    
Energy generation and storage      874 538         178 332          12 287    
Services and other    1 229 022         472 462         286 933    
Total cost of revenues    9 536 264       5 400 875       3 122 522    
Overall total gross profit    2 222 487       1 599 257         923 503    
Gross profit by segments      
Automotive sales 1 810 272 1 320 920 791 661
Automotive leasing 398 324 279 765 126 010
Energy generation and storage 241 728 3 062 2 190
Services and other (227 837) (4 490) 3 642
       
Operating expenses      
Research and development    1 378 073         834 408         717 900    
Selling, general and administrative    2 476 500       1 432 189         922 232    
Total operating expenses    3 854 573       2 266 597       1 640 132    
Loss from operations   (1 632 086)       (667 340)       (716 629)   

 

Question 1 (open): Which operating segment of Tesla generates the greatest value added in absolute terms? Which segment has the greatest margin of value added? How does it change over time? Are differences across operating segments greater or smaller than changes over time in each operating segment separately? How can you possibly explain those phenomena? Suggestion: refer to the theory of Marshallian equilibrium vs the theory of monopoly.

 

Question 2 (open): Calculate the marginal cost of revenue from 2015 to 2017 (i.e. ∆ cost of revenue / ∆ revenue), for the whole business of Tesla, and for each operating segment separately. Use those calculations explicitly to provide a balanced judgment on the following claim: “The ‘Energy and storage’ operating segment at Tesla presents the greatest opportunities for future profit”.  

 

Interpretation

 

Question 1 (open): Which operating segment of Tesla generates the greatest value added in absolute terms? Which segment has the greatest margin of value added? How does it change over time? Are differences across operating segments greater or smaller than changes over time in each operating segment separately? How can you possibly explain those phenomena? Suggestion: refer to the theory of Marshallian equilibrium vs the theory of monopoly.

 

The answer to that question starts with the correct understanding of categories in the source table. Value added can be approximated as gross profit. The latter is the difference between revenues and variable cost, thus between the selling price, and the price of key intermediate goods. This was one of the first theoretical explanations the students were supposed do start their answer with. As I keep repeating in my classes, good science starts with communicable, empirical observation, and thus you need to say specifically how the facts at hand correspond to the theoretical distinctions we hold.

 

As I could see from some of the exam papers that some of my students handed me back, this was the first checkpoint for the understanding of the business model of Tesla. The expression ‘operating segment’ refers to the following four categories from the initial table: automotive sales, automotive leasing, energy generation and storage, and services and other. To my sincere surprise, some of my students thought that component categories of operational costs, namely ‘Research and development’, and ‘Selling, general and administrative’ were those operational segments to study. If, in an exam paper, I saw someone calculating laboriously some kind of margin for those two, I had no other solution but marking the answer with a remark ‘Demonstrable lack of understanding regarding the business model of Tesla’, and that was one of those major mistakes, which disqualified the answer to Question 1, and gave 0 points.

 

In a next step, i.e. after matching the concept of value added with the category of gross profit, and explaining why they do so, students had to calculate the margin of value added. Of course, we are talking the margin of gross profit, or: ‘Gross Profit / Revenues’. Here below, I am presenting a table with the margin of gross profit at Tesla Inc.

 

 

Margin of gross profit 2017 2016 2015
Overall 18,9% 22,8% 22,8%
Automotive sales 21,2% 23,6% 23,1%
Automotive leasing 36,0% 36,7% 40,7%
Energy generation and storage 21,7% 1,7% 15,1%
Services and other -22,8% -1,0% 1,3%

 

There was a little analytical challenge in the phrasing of the question. When I ask whether  ‘differences across operating segments greater or smaller than changes over time in each operating segment separately‘, it is essentially a test for analytical flexibility. The best expected approach that a student could have developed was to use coefficients, like gross margin for automotive sales in 2017 divided by that in 2015, and, alternatively, divided by the gross margin on energy generation and storage etc. Thus, what I expected the most in this part of the answer, was demonstrable understanding that changes over time could be compared to cross-sectional differences with the use of a universal, analytical tool, namely that of proportions expressed as coefficients, like ‘A / B’.

As this particular angle of approach involved a lot of calculations (students could use calculators or smartphones in that exam), one was welcome to take some shortcuts based on empirical observation. Students could write, for example, that ‘The greatest gross profit in absolute terms is generated on automotive sales, thus is seems logical to compare the margin of value added in this segment with other segments…’. Something in those lines. This type of answer gave a clear indication of demonstrable understanding as regards the source data.

As for the theoretical interpretation of those numbers, I openly suggested my students to refer to the theory of Marshallian equilibrium vs the theory of monopoly. Here is how it goes. The margin of value added has two interpretations as regards the market structure. Value added can be what the supplier charges his customers, just because they are willing to accept it, and this is the monopolistic view. As the Austrian school of economics used to state, any market is a monopoly before being a competitive structure. It means that any relations a business can develop with its customers is, first of all, a one on one relation. In most businesses there is at least a small window of price, within which the supplier can charge their customers whatever he wants, and still stay in balance with demand. In clearly monopolistic markets that window can be quite wide.

On the other hand, value added is what the exogenous market equilibriums allow a firm to gain as a margin between the market of their final goods, and that of intermediate goods. This is value added understood as price constraint. Below, I present those two ideas graphically, and I expected my students to force their pens into drawing something similar.

 

Question 2 (open): Calculate the marginal cost of revenue from 2015 to 2017 (i.e. ∆ cost of revenue / ∆ revenue), for the whole business of Tesla, and for each operating segment separately. Use those calculations explicitly to provide a balanced judgment on the following claim: “The ‘Energy and storage’ operating segment at Tesla presents the greatest opportunities for future profit”.  

 

As I reviewed those exam papers, I could see that the concept of marginal change is enormously hard to grasp. It is a pity, as: a) the whole teaching of calculus, at high school, is essentially about marginal change b) the concept of marginal change is one of the theoretical pillars of modern science in general, and it comes straight from grandpa Isaac Newton.

Anyway, what we need, in the first place, is the marginal cost of revenue, from 2015 to 2017, calculated as ‘∆ cost of revenue / ∆ revenue’. The ∆ is, in this case, the difference between values reported in 2017, and those from 2015. The marginal cost of revenue is simply the cost of having one more thousand of dollars in revenue. The corresponding values of marginal cost are given in the table below.

 

Operating segment at Tesla Inc. Marginal cost of revenue from 2015 through 2017
Overall                             0,83
Automotive sales                             0,80
Automotive leasing                             0,66
Energy generation and storage                             0,78
Services and other                             1,33

 

Most of the students who took this exam, on the 1st of February, failed to address the claim phrased in the question, and it was mostly because they apparently did not understand what is the meaning of what they have calculated. Many had those numbers right, although some were overly zealous and calculated the marginal cost for two windows in time separately: 2015 – 2016, and then 2016 – 2017. I asked specifically to jump from 2015 straight into 2017. Still, the real struggle was the unit of measurement. I saw many papers, whose authors transformed those numbers – correctly calculated – into percentages. Now, look people. In the source table, you have data in thousands of dollars, right? A delta of $000 is given in $000, right? A coefficient made of two such deltas is still in $000. Those numbers mean that if you want to have one more thousand of them US dollars in revenues, at Tesla Inc., you need to spend $830 in cost of revenue, and correspondingly for particular operating segments.

Thus, when anyone wrote those marginal values as percentages, I was very sorry to give that answer a mention ‘Demonstrable lack of understanding regarding the concept of marginal cost’.

When considering the marginal cost of revenue as an estimation of future profits, the lower it is, the greater profit we can generate. With a given price, the lower the cost, the greater the profit margin. The operating segment labelled ‘Energy generation and storage’ doesn’t look bad at all, in that respect, certainly better than them ‘Services and other’, still it is the segment of ‘Automotive leasing’ that yields the lowest marginal cost of revenues. Thus, the claim “The ‘Energy and storage’ operating segment at Tesla presents the greatest opportunities for future profit” is false, as seen from this perspective.

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund  (and you can access the French version as well). You can also get a free e-copy of my book ‘Capitalism and Political Power’ You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

 

The mathematics of whatever you want: some educational content regarding political systems

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This time, I go educational, and I go educational about political systems, and more specifically about electoral regimes. I generally avoid talking politics with my friends, as I want them to keep being my friends. Really, politics have become so divisive a topic, those last years. I remember, like 20 years ago, talking politics was like talking about the way to organize a business, or to design a machine. Now, it has become more like an ideological choice. Personally, I find it deplorable. There are always people who have more power than other people. Democracy allows us to have some control over those people in power, and if we want to exercise effective control, we need to get your own s**t together, emotionally too. If we become so emotional about politics that we stop thinking rationally, there is something wrong with us.

OK, enough ranting and moaning. Let’s get into facts and method. So, I start as I frequently do: I make a structure, and I drop numbers casually into it, just like that. Later on, I will work through the meaning of those numbers. My structure is a simple political system made of a juxtaposition of threes. There are 3 constituencies, equal in terms of incumbent voters: each constituency has 200 000 of them incumbent voters. Three political parties – Party A, Party B, and Party C – rival for votes in those 3 constituencies. Each political party presents three candidates in the electoral race. Party A presents its candidate A.1. in Constituency 1, candidate A.2. runs in Constituency 2, and Candidate A.3 in Constituency 3. Party B goes sort of the opposite way, and makes its candidates run like: B.1. in Constituency 3, B.2. in Constituency 2, and B.3. in Constituency 1. Party C wants to be original and makes like a triangle: its candidate C.1. runs in Constituency 2, C.2. tries their luck in Constituency 3, and C.3. is in the race in Constituency 1.

Just to recapitulate that distribution of candidates as a choice presented to voters, those in Constituency 1 choose between candidates A.1., B.3., and C.3., voters in Constituency 2 split their votes among A.2., B.2., and C.1.; finally, voters in Constituency 3 have a choice between A.3., B.1., and C.2. It all looks a bit complicated, I know, and, in a moment, you will read a table with the electoral scores, as number of votes obtained. I am just signalling the assumption I made when I was making those scores up: as we have 3 candidates in each constituency, voters do not give, under any circumstance, more than 50% of their votes (or more than 100 000 in absolute numbers) to one candidate. Implicitly, I assume that candidates already represent, somehow, their local populations. It can be achieved through some kind of de facto primary elections, e.g. when you need a certain number of officially collected voters’ signatures in order to register a candidate as running in a given constituency. Anyway, you have those imaginary electoral scores in Table 1, below. Save for the assumption about ‘≤ 50%’, those numbers are random.

 

  Table 1 – Example of electoral score in the case studied (numbers are fictional)

Number of votes obtained
Party Candidate Constituency 1 Constituency 2 Constituency 3
Party A Candidate A.1 23 000
total score [votes]

              174 101    

Candidate A.2 99 274
Candidate A.3 51 827
Party B Candidate B.1 6 389
total score [votes]

              111 118    

Candidate B.2 40 762
Candidate B.3 63 967
Party C Candidate C.1 13 580
total score [votes]

              134 691    

Candidate C.2 33 287
Candidate C.3 87 824
Total 174 791 153 616 91 503

 

On the whole, those random numbers had given quite a nice electoral attendance. In a total population of 600 000 voters, 419 910 had gone to the ballot, which makes 70%. In that general landscape, the three constituencies present different shades. People in the 1 and the 2 are nicely dutiful, they turned up to that ballot at the respective rates of 87,4%, and 76,8%. On the other hand, people in Constituency 3 seem to be somehow disenchanted: their electoral attendance was 45,8%. Bad citizens. Or maybe just bloody pissed.

Now, I apply various electoral regimes to that same distribution of votes. Scenario 1 is a simple one. It is a strictly proportional electoral regime, where votes from all three constituencies are pooled together, to allocate 5 seats among parties. The number of seats going to each party are calculated as: “Total score of the party/ Total number of votes cast”. Inside each party, seats go specific candidates according to their individual scores. The result is a bit messy. Party A gets 2 seats, for its candidates A.2. and A.3., party B passes its B.3. man, and Party C gets C.3. into the Parliament. The first, tiny, little problem is that we had 5 seats to assign, and just 4 got assigned. Why? Simple: the parties acquired fractions of seats. In the strictly proportional count, Party A got 2,073075183 seats, Party B had 1,323116858, and Party’s C score was 1,603807959. I agree that we could conceivably give 0,32 of one seat to a party. People can share, after all. Still, I can barely conceive assigning like 0,000000058 of one seat. Could be tricky for sharing. That is a typical problem with strictly proportional regimes: they look nice and fair at the first sight, but in real life they have the practical utility of an inflatable dartboard.

Scenario 2 is once again a strictly proportional regime, with 6 seats to distribute, only this time,  in each constituency, 2 seats are to be distributed among the candidates with the best scores. The result is a bit of an opposite of Scenario 1: it looks suspiciously neat. Each party gets an equal number of seats, i.e. 2. Candidates A.2., A.3., B2., B.3., C.2., and C.3. are unfolding their political wings. I mean, I have nothing against wings, but it was supposed to be proportional, wasn’t it? Each party got a different electoral score, and each gets the same number of seats. Looks a bit too neat, doesn’t it? Once again, that’s the thing with proportional: growing your proportions does not always translate into actual outcomes.

Good. I go for the 3rd scenario: a strictly plural regime, 3 seats to allocate, in each constituency just one candidate, the one with the best score, gets the seat. This is what the British people call ‘one past the post’, in their political jargon. Down this avenue, Party A pushes it’s A.2. and A.3. people through the gate, and Party C does so with C.3. That looks sort of fair, still there is something… In Constituency 1, 87 000 of votes, with a small change, got the voters one representative in the legislative body. In constituencies 2 and 3, the same representation – 1 person in the probably right place – has been acquired with, respectively, 99 274, and 33 287 votes. Those guys from constituencies 1 and 2 could feel a bit disappointed. If they were voting in constituency 3, they would need much less mobilisation to get their man past the post.

Scenario 4 unfolds as a mixed, plural-proportional regime, with 5 seats to allocate; 3 seats go to the single best candidate in each constituency, as in Scenario 3, and 2 seats go to the party with the greatest overall score across all the 3 constituencies. Inside that party, the 2 seats in question go to candidates with the highest electoral scores. The results leave me a bit perplex: they are identical to those in Scenario 3. The same people got elected, namely A.2., A.3., and C.3., only this time we are left with 2 vacancies. Only 3 seats have been allocated, out of the 5 available. How could it have happened? Well, we had a bit of a loop, here. The party with the highest overall score is Party A, and they should get the 2 seats in the proportional part of the regime. Yet, their two best horses, A.2. and A.3. are already past the post, and the only remaining is A.1. with the worst score inside their party. Can a parliamentary seat, reserved for the best runner in the winning party, be attributed to actually the worst one? Problematic. Makes bad publicity.

Scenarios 5 and 6 are both variations on the d’Hondt system. This is a special approach to mixing plural with proportional, and more specifically, to avoiding those fractional seats as in Scenario 1. Generally, the total number of votes cast for each party is divided by consecutive denominators in the range from 1 up to the number of seats to allocate. We get a grid, out of which we pick up as many greatest values as there are seats to allocate. In Scenario 5, I apply the d’Hondt logic to votes from all the 3 constituencies pooled together, and I allocate 6 seats. Scenario 6 goes with the d’Hondt logic down to the level of each constituency separately, 2 seats to allocate in each constituency. The total number of votes casted for each party is divided by consecutive denominators in the range from 1 up to the number of seats to allocate (2 in this case). The two greatest values in such a grid get the seats. Inside each party, the attribution of seats to candidates is proportional to their individual scores.

Scenario 5 seems to work almost perfectly. Party A gets 3 seats, thus they get all their three candidates past the post, Party C acquires 2 seats for C.2. and C.3., whilst Party B has one seat for candidate B.3. In a sense, this particular mix of plural and proportional seems even more fairly proportional that Scenario 1. The detailed results, which explain the attribution of seats, are given in Table 2, below.

 

Table 2 – Example of application of the d’Hondt system, Scenario 5

Number of votes obtained divided by consecutive denominators
Denominator of seats Party A Party B Party C
1        174 101            111 118            134 691    
2          87 051              55 559          67 346     
3          58 034              37 039          44 897
4          43 525          27 780          33 673
5          34 820          22 224          26 938
6          29 017          18 520          22 449

 

On the other hand, Scenario 6 seems to be losing the proportional component. Table 3, below, shows how exactly it is dysfunctional. As there are 2 seats to assign in each constituency, electoral scores of each party are being divided by, respectively, 1 and 2. In Constituency 1, the two best denominated scores befall to parties C and B, thus to their candidates C.3. and B.3. In Constituency 2, both of the two best denominated scores are attributed to Party A. The trouble is that Party A has just one candidate in this constituency, the A.2. guy, and he (she?) gets the seat. The second seat in this constituency must logically befall to the next best party with any people in the game, and it happens to be Party B and its candidate B.2. Constituency 3, in this particular scenario, gives two best denominated scores to parties A and C, thus to candidates A.3. and C.2. All in all, each party gets 2 seats out of the 6. Uneven scores, even distribution of rewards.

 

Table 3 – Application of the d’Hondt logic at the level of separate constituencies: Scenario 6.

Party A Party B Party C
Denominator of seats Constituency 1
1        23 000        63 967            87 824    
2        11 500        31 984        43 912
Constituency 2
1        99 274            40 762  (?)        13 580
2        49 637            20 381          6 790
Constituency 3
1        51 827              6 389        33 287    
2        25 914          3 195        16 644

 

Any mechanism can be observed under two angles: how it works, and how it doesn’t. It applies to electoral regimes, too. An electoral regime doesn’t work in two respects. First of all, it does not work if it does not lead to electing anyone. Second of all, it does not work if it fails to represent the votes cast in the people actually elected. There is a term, in the science of electoral systems: the wasted votes. They are votes, which do not elect anyone. They have been cast on candidates who lost the elections. Maybe some of you know that unpleasant feeling, when you learn that the person you voted for has not been elected. This is something like frustration, and yet, in my own experience, there is a shade of relief, as well. The person I voted for lost their electoral race, hence they will not do anything stupid, once in charge. If they were in charge, and did something stupid, I could be kind of held accountable. ‘Look, you voted for those idiots. You are indirectly responsible for the bad things they did’, someone could say. If they don’t get elected, I cannot be possibly held accountable for anything they do, ‘cause they are not in a position to do anything.

Wasted votes happen in all elections. Still, an efficient electoral regime should minimize their amount. Let’s compare those six alternative electoral regimes regarding their leakiness, i.e. their tendency to waste people’s voting power. You can see the corresponding analysis in Table 4 below. The method is simple. Numbers in the table correspond to votes from Table 1, cast on candidates who did not get elected in the given constituency, under the given electoral regime. You can see that the range of waste is quite broad, from 4,8% of votes cast, all the way up to 43% with a small change. It is exactly how real electoral regimes work, and this is, in the long run, the soft spot of any representative democracy. In whatever possible way you turn those numbers, you bump on a dilemma: either the race is fair for the candidates, or the ballot is fair for voters. A fair race means that essentially the best wins. There is no point in making an electoral regime, where inefficient contenders have big chances to get elected. On the other hand, those who lose the race represent people who voted for them. If we want all the voters to be accurately represented in the government, no candidate should be eliminated from the electoral contest, only then it would not be a contest.

 

Table 4

Number of votes, which do not elect any candidate
Constituency 1 Constituency 2 Constituency 3 Total elections
Scenario 1 23 000 40 762 33 287 97 049
Scenario 2 0 13 580 6 389 19 969
Scenario 3 23 000 54 342 33 287 110 629
Scenario 4 63 967 54 342 39 676 157 985
Scenario 5 (d’Hondt method, pooled) 0 54 342 6 389 60 731
Scenario 6 (d’Hondt method, separately by constituency) 23 000 54 342 39 676 117 018
Percentage of votes cast, which do not elect any candidate
Constituency 1 Constituency 2 Constituency 3 Total elections
Scenario 1 13,2% 26,5% 36,4% 23,1%
Scenario 2 0,0% 8,8% 7,0% 4,8%
Scenario 3 13,2% 35,4% 36,4% 26,3%
Scenario 4 36,6% 35,4% 43,4% 37,6%
Scenario 5 (d’Hondt method, pooled) 0,0% 35,4% 7,0% 14,5%
Scenario 6 (d’Hondt method, separately by constituency) 13,2% 35,4% 43,4% 27,9%
Average 12,7% 29,5% 28,9% 22,4%

 

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. As we talk business plans, I remind you that you can download, from the library of my blog, the business plan I prepared for my semi-scientific project Befund  (and you can access the French version as well). You can also get a free e-copy of my book ‘Capitalism and Political Power’ You can support my research by donating directly, any amount you consider appropriate, to my PayPal account. You can also consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?

Educational: microeconomics and management, the market and the business model

My editorial

This time, in the educational stream of my blog, I am addressing the students of 1st year undergraduate. This update is about microeconomic and management. Regarding your overall educational curriculum, these two courses are very much complementary. I am introducing you now into the theory of markets, and, in the same time, into the managerial concept of business model. We are going to consider a business of vital importance for our everyday life, although very much unnoticed: energy, and, more specifically, electricity. We are going to have a look at the energy business from two points of view: that of the consumer, and that of the supplier. If you have a look at your energy bill, you can basically see two lines: a fixed amount you pay to your supplier of energy, just for being connected to the grid, and a variable amount, which is, roughly speaking, the mathematical product: [Price of 1 kWh * Quantity of kWh consumed]. Of course, ‘kWh’ stands for kilowatt-hour. On the whole, your expenditure on electricity is computed as:

E = Fixed price for connection to grid + [Price of 1 kWh * Quantity of kWh consumed]

                             P1                                                                 P2                                 Q   

From the point of view of the supplier of energy, their market is made of N consumers of energy. We can represent this market as a set made of N elements, for example as N = {k1, k2, …, kn}, where each i-th consumer ki pays the same fixed price P1 for the connection to the grid, the same price P2 for each kWh consumed, and consumes an individually specific amount Q(ki) of energy measured in kWh. In that set of N = {k1, k2, …, kn} consumers, the total volume Q of the market is computed as:

Q = Q(k1) + Q(k2) + …+ Q(kn) [kWh]

…whilst the total value of the market is more complex a construct, and you compute it as:

Value of the market = N*P1 + Q*P2

  Most consumers have a more or less fixed budget to spend on electricity. If you take 1000 people and you check their housing expenses every month, you will see that their expenditures on electric power are pretty constant, unless some of them are building spaceships in their basements. So we introduce in our model of the market a budget on electricity, or Be, specific to each individual customer ki. Hence, that budget can be noted as Be(ki). Actually, that budget is the same as what we have introduced earlier as expenditure E, so:

Be(ki) = E = P1 + P2*Q(ki)

This mathematical construct allows reverse engineering of individual power consumption. Each consumer uses the amount Q(ki) of kilowatt-hours, which satisfies the condition:

Q(ki) = [Be(ki) – P1] / P2

In other words, each of us has a budget to spend on electricity bills, from this budget we subtract the fixed amount of money P1, to pay for being connected to the power grid, and we use the remaining sum so as to buy as many kilowatt-hours as possible, given the price P2. This condition is a first approach to what is called the demand function, on the part of the consumers. Although this function is still pretty sketchy, we can notice one pattern. The total amount of electricity Q(ki) that I consume depends on three parameters: my budget Be(ki), and the two prices P1 and P2. In economics, we call this an elasticity. We say that the quantity Q(ki) is elastic on: Be(ki), P1, P2. How elastic is it? We can calculate it, if we now the magnitudes of change in particular factors. If I know that my consumption of electricity has changed from like 40 000 kWh a year to 42 000 kWh, and I know that in the meantime the price P2 of one kilowatt-hour has moved from 0,1 euro to 0,12 euro, I can calculate something called deltas:

delta [Q(ki)] = ∆ Q(ki) = 42 000 40 000 = 2 000 kWh

delta (P2) = ∆P2 = €0,12 €0,1 = €0,02

The local (i.e. specific to this precise situation) elasticity of my consumption Q(ki) to the price P2 can be estimated, in a first approximation, as

e = ∆ Q(ki) / ∆P2 = 100 000 kWh per €1

The first thing to notice about this elasticity is that it is exactly contrary to what you see in my lectures, and what you can read in textbooks, about the demand function. The basic law of demand says something like: the greater the price, the lower the consumers’ willingness to buy. Here, we have something contrary to that law: greater consumption of energy is associated with a higher price, through a positive elasticity. I am behaving contrarily to the law of demand. In science, we call such a situation a paradox. Yet, notice that it is a local paradox: I cannot keep on increasing my personal consumption of electricity ad infinitum, even in the presence of a constant price. At some point, I have to start saving energy and increase my consumption just as much, as the prices possibly fall. So, generally, as opposed to locally, I am likely to behave in conformity with the law of demand. Still, keep in mind that in real life, paradoxes abound. It is not obvious at all to peg down a market equilibrium exactly as shown in textbooks. Most real-life markets are imperfect markets.

Now, if you look at this demand function, you can find it a bit distant from how you consume electricity. I mean, personally I don’t purposefully maximize the quantity of kilowatt-hours consumed. I just buy stuff powered by electricity, like a computer or a refrigerator, I plug it in, I turn it on, and I use it. Sometimes, I vaguely practice energy saving, like turning off the light in rooms where I am not currently staying. Anyway, my consumption of electricity Q(ki) is determined by the technology T I have at my disposal, which, in turn, consists of a set M = {g1, g2, …, gm} of goods powered by electricity: fridge, computer, TV set etc. We say that each j-th good gj, in the set M, is a complementary good to electricity. I can more or less accurately assume that an average refrigerator consumes x1(fridge) kWh, whilst an average set of house lighting burns x2(lighting) kWh. We can slice subsets out of the set N of consumers: N1 people with fridges, N2 people with air conditioners etc. With Q(gj) standing for the consumption of electricity in a given item powered with it, I can write:

 Q(ki) = N1*Q(g1) + N2*Q(g2) + …+ Nm*Q(gm) = [Be(ki) – P1] / P2

It means that, besides being elastic on my budget and the prices of electricity, my individual demand for a given amount of kilowatt-hours is elastic on the range of electricity-powered items I possess, and this, in turn, means that it is elastic on the budget I spend on those pieces of equipment, as well as on the prices of those goods (with a given budget to spend on houseware, I am more likely to buy a cheaper fridge rather than a more expensive one).

Now, business planning and management. Imagine that you are an entrepreneur, and you want to build a solar farm, and sell electricity to the people living around it. Your market works as shown above. You know that whatever you want to do, your organisation will have to satisfy the needs of those N customers, with their individual budgets and their individual elasticities in expenditures. The size of your organization, and its structure, will be significantly determined by the necessity to maintain profitable relations with N customers. Two questions emerge: what such organizational structure (i.e. the one serving to build and maintain those customer relations) would look like, and how could it be connected to other functional structures in the business, like building the solar farm, maintaining it in good technical state, purchasing components for construction and maintenance, hiring and firing people etc. You certainly know one thing: you have a given value of the market = N*P1 + Q*P2 and you have to adapt your costs (e.g. the sum total of salaries paid to your people) to this value of the market. Thus, you know that:

Average salary in my business = [(N*P1 + Q*P2) – The profit I want – Other costs] / the number of employees

In other words, the size of my business, e.g. in terms of the number of people employed, as well as my profit and the wages I can pay, will be determined by the value of my market. Now, let’s go along a path at the frontier of economics and management. I want to know how much capital I should invest in my business. I posit a condition: that capital should return to me, in the form of profits from business, in 7 years. Thus, I know that:

My initial investment = 7* My annual profit = 7*(N*P1 + Q*P2 – Current costs) = N*Be(ki) current costs = N*E current costs = N*[P1 + P2*Q(ki)] current costs

This is how the size of my business, both in terms of capital invested, and in terms of the number of people employed, is determined by, or is elastic on, the prices I can practice with my customers, the sheer number of those customers, as well as on their individual budgets.

Educational: International Economic Transactions, Analysis of the GATT 1994

My editorial

In this update, I am mostly addressing my Graduate Master’s students in their curriculum entitled ‘International Economic Transactions’. Still, I will be delighted to provide meaningful insight to any of my readers. We take on analysing the GATT 1994. It is on purpose that I am not starting with GATT 1947. That mother-treaty of the World Trade Organization was signed in very special circumstances, when the Western world was shaking off after World War II. The political and economic climate was somehow unique. The GATT 1994 is much closer to the present reality, and the road covered between its signature and that of the Trade Facilitation Agreement (2013 – 2017) is easier to trace than if we were starting in 1947. And so we start with GATT 1994. I am starting with decrypting the acronym: GATT means ‘General Agreement on Tariffs and Trade’. Nothing to write home about, basically, and still one thing is interesting. If there is a general agreement, it logically implies the existence of specific agreements. This is very much the reality of international trade: wherever you look, you see complicated, multi-level, intricate structures made of bilateral agreements, multilateral ones, letters of understanding, memoranda and whatnot (e.g. protocols).

If now, you care to read GATT 1994, there is not much reading to do, indeed: it is just two pages. It is a strange logical structure. On those two pages, you have just two sections. Section 1 says what specific documents does the GATT 1994 cover, and section 2 provides ‘Explanatory Notes’. The questions pops up: why the hell should anyone put any effort in negotiating that looks like two pages of minutes from a management meeting? As you read through section 1, you notice that the member countries of the World Trade Organization (WTO) have hatched quite a lot of various documents concerning trade, between 1947 (some of them even before the entry into force of the GATT 1947) and 1994. The most cryptic category is to be found under section 1(a)(iv), namely ‘Other decisions of the Contracting Parties’. Thus, many governments had had signed the GATT 1947, and then they had been doing things that stretched the original agreement in so dire a way that a new agreement had to be signed, recognizing the legal validity of those things that governments had been doing.

This is a good moment to exemplify the relation between an international agreement pertaining to trade, and its economic context. The GATT 1947 had been signed with a general purpose of avoiding so-called ‘trade wars’, i.e. a spiral of aggressive pro-export policies in individual countries, when a government deliberately depreciates its own currency in order to make its exported goods more price-competitive in foreign markets. Thus, the GATT 1947 had been originally combined with an international financial architecture, where the currencies of major economies had been tied nominally to the price of gold, and de facto to the price of the US dollar. On the other hand, the general principle of free trade, in GATT 1947, was strongly supported by economic sciences, either on the grounds of the so-called Ricardian paradigm – countries benefit from free trade by the development of their most competitive categories of businesses – as well as based on the the Heckscher – Ohlin model , which, in turn, stated that free trade compensates the negative effects of the otherwise imperfect geographical distribution of production factors. Still, since 1947, things kept happening, and they did so in a way which very much contradicted the fundamental principles of free trade. The biggest economies in the world, led by the biggest of the biggest, the United States of America, kept enforcing protectionist policies regarding trade. The clause of domestic components has been really the fashion since 1947. It says that you can import any goods inside a given country, but if you do not include in those goods a given percentage of components made domestically in this country, you pay additional tariffs, or, for example, your goods are excluded from public procurement (i.e. the government cannot buy them). In the 1970ies, most economies started departing from the gold standard, and even the United States detached their dollar from the price of the gold. As the system of tied monetary exchange rates faded progressively, the idea of free trade supporting said system became obsolete as well. New economic research showed that whilst the Ricardian paradigm, and the Heckscher – Ohlin one generally hold, other forces are at work, which can actually increase economic inequalities . The idea of aggressive depreciation in domestic currencies returned, with the energetic showing around from the part of Asian economies (Japan, China etc.), and with the governments of developed countries rediscovering an old truth that manipulating their own currencies could help in alleviating the burden of public debt. Regional zones of free trade, like the European communities or the ASEAN in the Asia and Pacific region, made the provisions of GATT 1947 look a bit pale. All in all, by the beginning of the 1990ies, it became obvious that the GATT 1947 has to be changed somehow, only in the meantime, i.e. since 1947, a whole bureaucratic structure had emerged under the label of World Trade Organization, and this structure was not keen to give up their position. It is funny how an otherwise quite substantial bureaucratic structure can call for ‘minimizing bureaucracy in trade’.

Now, here is the first big lesson in understanding international economic transactions. When countries transact ‘economically’, it means they do so in a way that affects whole economic orders. In fact, countries do not transact at this level: governments do. In international economic exchanges, there is a business level, and a government level. The latter expresses itself in policies, and some of these policies find an expression in international agreements and treaties. Second lesson: those international agreements and treaties are usually at least one step behind the business level of economic exchange. When governments claim they ‘signed a forward looking agreement’, it is to be understood as ‘we sincerely hope that no bloody business people will think about something new and unexpected, which would force us to renegotiate this document’. Trade has been going on for millennia, and it will keep going on. When governments claim they ‘stimulate’ trade with their policies, it means that at best they don’t get in the way.

The third lesson in more complex: if you want to understand how a given regulation works, trade agreements included, try and build various antithetic alternatives for it, i.e. regulations built with provisions logically opposing those actually studied ones. Section 1 of the GATT 1994 starts with a general provision that “The General Agreement on Tariffs and Trade 1994 (“GATT 1994”) shall consist of: […]’, and the […] takes the remaining of the A4 first page of the document, listing all those things that governments had done since 1947. Imagine an agreement starting with “This agreement SHALL NOT consist of […]’, with the […] being rigorously the same as in the original. The first option means that the agreement being signed explicitly incorporates all those past, particular polices. It is usually practiced when the agreement being signed has to deal with, and de facto recognize, deep disagreement between the contracting parties. This is the type of agreement we sign just in order to give some flesh to further negotiations that we know inevitable. The second, antithetic a version means a sharp divide: we do not recognize the validity of those policies. It is being used when a real agreement has been reached, and the new regulations can safely supplant the old ones.

Thus, when a new agreement is being signed in the place of an old one, two big strategies can be followed: the new one can build on the predecessor, or it can completely supplant it. The GATT 1994 is an example of the former, but, for example, consecutive treaties of the European Union bend more towards the latter.

Educational: Opening remarks for the winter semester 2017/2018

My editorial

As the academic year starts, I start using my scientific blog for educational purposes, too. During the winter semester 2017/2018, I will be holding classes in English in the following subjects (curriculums): International Economic Transactions, Economic Policy, Principles of Organization and Management, Microeconomics, and Undergraduate Thesis Seminar. In order to assure as smooth a delivering of educational content as possible, I will be using my two, mutually mirroring scientific blogs, to find respectively at  https://discoversocialsciences.com or at https://researchsocialsci.blogspot.com . By ‘mirroring’ I mean that every update on one blog has a twin on the other, and the reason for mirroring is my willingness to be present in two environments: Blogger, and Word Press. My students can feel free to browse any content I am placing there, and the updates specifically addressed to your curriculum will be labelled as: ‘Educational’ followed by the name of the subject, followed by any additional information. If you need to contact me individually, here are my email addresses: kwasniewski@afm.edu.pl  or  krzysztof.wasniewski@gmail.com .

Curriculum ‘International Economic Transactions’

This specific update addresses specifically the curriculum labelled ‘International Economic Transactions’, at the graduate (Master’s) level of studies. In these classes, we will be studying various types of international economic relations, and to that extent, it will be very much a development on what you have already learnt in the classes of macroeconomic, international trade or economic policy, during your Undergraduate studies. Still, there is one particularity to this particular curriculum, namely the focus on the process of institutionalisation in international economic transactions. In these classes, we will be focusing mainly on those aspects of international economic relations, which are institutionalized in international agreements and treaties. In your earlier years of study, you have certainly acquired some knowledge about international organizations like World Trade Organization, European Union, ASEAN and others. You probably remember, as well, the institution of bilateral agreements and treaties between countries. In this class, we are going to focus on the ‘how?’ of those institutions: how do they come into being? what are the premises for the underlying negotiations? what type of phenomena hides behind particular dispositions in those agreements and treaties?

You will be graduating this subject with your individual research project. Your task, and the basis for your final grade in this curriculum, consists in preparing a written analysis of an international economic agreement or treaty. Of course, such an assignment gives rise to questions from your part: what’s the point? what should it look like? which particular agreement or treaty? how to do it? First things first, the point of doing it. The didactic goal of this particular curriculum is to develop your skills in the analysis of documents pertaining to international economic relations, for one, and your presentational skills, for two. I expect the work you will present to demonstrate that you can: a) search and analyse the relevant sources, documentary and others b) wrap your observations up into an intelligible document of your own.

Now, the way your work should look. What I basically expect from you is an essay, of at least 2500 words, with proper referencing of the sources you have used. I will be grading this essay on the grounds of three criteria: scope of research (weight 0,5 in the final grade), depth of analysis (weight 0,5), logic and grammar (acceptable or not). The scope of research means simply the number of sources you convincingly reference in your work. By convincingly referencing I mean, first of all, referencing at all, i.e. providing a proper bibliographic reference to any sources (google up ‘scientific referencing’ or ‘bibliographic referencing’ to know more). Convincing referencing means, in turn, that in the body text of your essay you explicitly refer to those sources, i.e. I can see a logical link between the contents of the source in question and your own writing. The basic source you will have to reference to will be the international agreement or treaty that you will be writing about. Convincingly referencing to the contents of this particular document gives you 1,5 points, or the Polish ‘pass’ grade, namely 3.0, weighed 0,5. If you expand your referencing up to 5 sources in total (books, articles, official policy statements etc.), you get 2,0 points (or 4,0 * 0,5), and referencing more than 5 sources gives you 2,5 (5,0 * 0,5). The depth of analysis means the understanding you demonstrate in your writing. I distinguish four basic levels regarding this criterion of grading. At the lowest level, your writing does not demonstrate any understanding at all. This is the case of those ‘I-will-copy-and-paste-from-Wikipedia’ essays. It is worth a fail, and disqualifies your whole work, even if your reference list looks impressive. I give the ‘fail’ grade to plagiarisms, as well. The basic level of demonstrable understanding, worth 1,5 points (3,0 * 0,5) is an essay, where you describe correctly the economic context of the agreement (treaty) you are working with, but you do not articulate it into an argumentation with a hypothesis. You can get 2,0 points (4,0 * 0,5) if you present an articulate argumentation, but without clear conclusion. Finally, if the flow of logic in your essay convincingly leads to an explicitly formulated conclusion, you get 2,5 (5,0 * 0,5).

Now, a remark as for logic and grammar. As many of my students come from Ukraine, Russia, or other countries in the East, the temptation is strong to Google translate or Yandex translate texts in your native tongue. Still, keep in mind two things. Firstly, automatic translators translate words, not syntax. The syntax used in Russian or Ukrainian, for example, is very different from the English one, especially in the formal register. If you Yandex translate a document, the raw result in English is very likely to be utter gibberish and will disqualify your work for the reason of unacceptable grammar. Besides, I can read Cyrillic, and if I trace back the source document of your translation, we are in the fairy tale of plagiarism, and this is a tale where really bad monsters dwell. One of them is called ‘Disciplinary Procedure with The Dean’.

And so we pass to the ‘how?’. You can choose any international agreement or treaty to work with, as long as it pertains to economic relations between countries. You can be smart, at this point, and take on studying more than one agreement or treaty. Each of those agreements will count as a separate source and will pump up your scope of research. Feel the blues? If you don’t feel like being smart, I can assign you a particular agreement to work with. Just ask. As for the way of working with those sources, you will be using, of course, the content delivered in my classes. As for now, I am giving you the following hints. Firstly, do your research. Go to Google Scholar , Microsoft Academic Research  or to the Social Sciences Research Network and find publications connected to the agreement (treaty) you are working with. Secondly, keep it close to real life. Imagine real situations in business, covered by the scope of the agreement at hand. Imagine how can the enforcement of this agreement change those situations.

Now, I am listing, here below, the fundamental pieces of theory – in other words, the contents of the lecture – you will be smart to google up (or bing up, whatever) and which will make the backbone of our in-class activity:

Fundamental concepts: international agreement, international treaty, signature of an agreement, ratification of a treaty, bilateral and multilateral agreements (treaties), scope (hypothesis) of a legal norm, disposition of a legal norm, sanction of a legal norm, balance of payments (and related concepts), political system, constitutional order, barriers to trade, trade facilitation.

Analytical methods: basic analytical tools of economics, micro and macro.

Typical scopes of international economic agreements and treaties: free trade, selective removal of barriers to trade, facilitation of investment, free flow of capital and people.

Typical institutional forms of international economic cooperation: agreements, treaties, joint ventures and joint operations, international organizations, international agencies.

Case studies (this is an indicative list, still you can use those links, download those documents, and you can use them for your projects): WTO Establishing Marakesh Agreement , GATT 1947, GATT 1994, WTO Trade Facilitation Agreement, United Nations Arms Trade Treaty, Egypt – EFTA Free Trade Agreement, China – Nigeria Bilateral Investment Treaty, and the Charter of The Shanghai Cooperation Organization.     

This is it as for the opening update. See you in class. Now, I pass to sketch the landscape for other curriculums.

Curriculums: ‘Microeconomics’ and ‘Principles of Organization and Management’

The curriculums ‘Microeconomics’ and ‘Principles of Organization and Management’ are both addressed to students in the first year of undergraduate studies. I teach those two subjects to the same group of students, and I am trying to make as much meaningful connection between the two as possible. So, my basic didactic goal in these two curriculums is to give you fundamental analytical skills for preparing a decent business plan, period. My understanding of what a business plan is corresponds to quite broad a range of situations. It can be a business plan strictly spoken: you want to start a business, you go to a bank for a loan, and they ask you to present a business plan. Besides this basic version of events, others are possible. You start some kind of social action, you will need to make it sustainable in financial terms, and so you will need some kind of plan as for how to make capital come to your project and stay there. You work in a corporation, and you can get a promotion if you present a convincing plan, together with a budget, for a project built around an idea of yours. These are all situations, which I refer to when I say ‘business plan’. Any student wants to pass their exams, rather than fail at them, and it is a natural thing that you try to predict the expectations of your professor, me in the occurrence. So, here they are, my expectations: demonstrate your skills in building a business plan.

The curriculum of ‘Microeconomics’ regards the way markets and businesses work, whilst in the path of ‘The Principles of Organization and Management’ we will study the way organizations work and what you can possibly do about it. I am giving, here below, the formal contents of both courses, i.e. the list of theoretical concepts we will be working with this semester. So, the formal contents of ‘Microeconomics’ are the following:

Fundamental concepts of microeconomics: economic good, private goods, public goods, utility, substitute goods, complementary goods, opportunity cost (alternative cost), economic profit, market, capital, assets, equity, debt, fixed assets, circulating assets, value added.

Analytical methods: marginal value, elasticity, isoquant (indifference curve), balance sheet, income statement, statement of cash flow, rate of return on investment, net present value, fundamentals of calculus and of algebra.

Theory of markets: demand, supply, function/curve/law of demand, function/curve/law of supply, perfect competition, Marshallian equilibrium, equilibrium price, equilibrium product, imperfect competition, monopoly, oligopoly, monopolistic competition.

Theory of production: production factors, production function, costs of production, fixed costs, variable costs, total cost, average cost, marginal cost.

Institutional forms of doing business: individual (private) business, partnerships, companies, corporations, cooperatives, non-profit organisations.

Financial markets: money, credit and the supply of money, borrowing capacity, credit risk, interest rate, discount rate, market of securities and types of securities, fundamentals of financial investment, financial risk.

Now, I pass to the contents of the ‘Principles of Organization and Management’:

Fundamental concepts: organization, social structure, hierarchy, behaviour, social communication, goals.

Analytical methods: mathematical probability, sequence and timeline, mathematical sets, goal setting, scenarios.

Theory of organizations: social structures and organizations, types of organizations, process and structure inside an organization.

Theory of communication: media of communication in management, the basic pattern of communication (message > coding > medium > decoding > feedback).

Hierarchy building: types of hierarchies, orders and their formulation, types of orders (directive, semi-directive, non-directive), enforcement of orders.

Network building: negotiating and contracting, stable and unstable networks, the use of network-type structures.

Uncertainty and risk: types of risk, evaluation of risk, operational risk, financial risk, systemic risk.

Basic functions of management: organizing, marketing, human resource management, finance and investment, production.

Good, now that you know the contents of the course, the next question is ‘where should we take all that stuff from?’, or the question about your resources. Firstly, you can try and participate in those strange gatherings we will have at the university. They are called ‘classes’, ‘lectures’ (PL: wykład) or ‘workshops’ (PL: ćwiczenia) in your schedule and sometimes they are useful. Secondly, arm yourself with textbooks. Anything that has ‘Microeconomics’ or even just ‘Economics’ on its cover will be OK for the course of microeconomics, the same holding for management (i.e. any textbook with ‘Management’ on the cover will do). Thirdly, I will do my best to deliver educational content on this blog. Finally, you can smartly use online resources. Wikipedia is just fine: feel free to use it. Search by those keywords I have just given as the formal contents of those two curriculums.

Now, assessment and evaluation. Both curriculums – ‘Microeconomics’ and ‘Principles of Organization and Management’ – end up with an exam. Both exams will consist of two parts: test questions and essay. The scope of each exam will correspond to the same formal contents of each course, which I have just specified. I practice so-called ‘pre-exams’: they are risk-free attempts at the final exam. They have the same contents and the same requirements as the final exam, but you cannot fail, i.e. if you fail at them, the fail grade is not official: you just take the final, formal exam. If, at the pre-exam, you have the very good grade (5,0), you are just done with me for this semester and you have this grade as your final exam grade. If, on the other hand, at the pre-exam you get pass (3,0), or good (4,0), or something in between, like 3,5 or 4,5, you can keep this grade kind of in reserve and try your luck at the regular final exam. I schedule the pre-exams so as to have them at the penultimate (i.e. the one before the last) lecture in each curriculum. That will be January 10th 2018 as regards ‘Principles of Organization and Management’, and January 17th 2018 as for ‘Microeconomics’. In the last lecture of each curriculum, I will discuss the results and contents of the pre-exam.

In the course of ‘Microeconomics’, besides the lectures, you also have workshops (PL: ćwiczenia) with me. They are supposed to be training in the usage of microeconomic theory. Your assessment regarding workshops is based on your activity, which, this semester, I am evaluating on the grounds of your performance in presenting solutions to complex economic problems. What kind of problems, will you ask? Here it comes, an example, I mean. Look outside, through a window, or just look around you in the street. What kind of economic phenomena can change that urban landscape you see? How those changes are likely to occur? You study this problem, you present a complex answer to it in workshops, taking care of using meaningfully that microeconomic theory, and you can have very good for workshops. I will give you such problems to solve in class, on an ad hoc basis, the kind ‘I ask and you respond on the spot’. I will give you such complex mindfucks on this blog, as well, and, finally, you can invent those problems by yourselves. I will report in my notes each case of presenting in class a solution to a complex economic problem, and the student who does it will have points for their final credit in workshops. If you want to have very good (5,0) in workshop credit, solve and present one really complex problem, like the one I have just phrased, or achieve at least 3 successful solutions of ad hoc problems given in class. Each student has to achieve at least a partial solution to a complex problem, or one solution to a simple problem given in class, in order to be credited with a pass (3,0) for workshops. Cases in between will be credited at 3.5, 4.0, or 4.5, accordingly to the demonstrated performance.

Curriculum ‘Undergraduate Thesis Seminar’

Now, I am addressing the students of third year in Undergraduate studies, who chose me as their scientific supervisor and tutor for the writing of their Undergraduate thesis. This curriculum is the most open and the least formal of all, and yet I find it useful to provide some basic principles we will be following. We have two semesters for working together. The end game of this work is your Undergraduate thesis, properly written, positively reviewed, and backed by a successfully passed Undergraduate final exam. This curriculum is supposed to lead you towards this complex goal. These two semesters are slightly distinct, and it is reflected in the assessment procedure. The winter semester ends up, for you, with a dummy credit (i.e. credit or refusal of credit, PL: ZAL <> NZAL). It means you have to do some minimum work in order to consider you eligible for taking the same curriculum in the summer semester 2018. The base for that dummy credit in winter will be the completion of at least 4 reviews of scientific sources suitable for your topic of research. They can be articles or books, but they have to be 4 distinct bibliographic resources thoroughly reviewed. By review, I mean, first of all, a summary of the contents, and secondly, a personal position, from your part, on the points you judge the most important. The purpose of the whole exercise is to develop your skills in working with literature, which is fundamental in the writing of your thesis. In the summer semester 2018, you will be writing your thesis properly spoken, and you will get a scalable credit (PL: ZAO), from 2,0 to 5,0. If you want to get 5,0 (very good) in that second semester, you have to finish writing your thesis, and to convince me, in class, that you can defend it in your Undergraduate final exam, and all that before the end of the summer exam session, i.e. before June 25th, 2018. I think it could be a smart idea to use this blog as a kind of knowledge-bank for your whole group. Just follow along and we will figure something out together.

Curriculum ‘Economic Policy’

Finally, I am addressing the students of 3rd year in Undergraduate studies, regarding the curriculum of ‘Economic Policy’. This is one of your final courses, and it is an integrative one, i.e. we will be combining theory from many fields (mostly economics, but not only). From this point of view, it will be a pre-seminar for you. The formal contents of the course are the following:

Fundamental concepts: you are expected to have a good grasp of economics (mostly macro, but you can do with some micro as well), political sciences and sociology.

Analytical methods: revise your economics and your maths; balance sheets, functions, probabilities and equations will just pop up from under every stone on this path.

Political systems: political players, constitutional orders and partisan orders

Monetary policy: money and monetary systems; the institutional frame for the supply of money; central banks and commercial banks; stability of the monetary system; interest rates; expansionary, restrictive, and neutral monetary policy; exchange rate and the Mundell – Fleming model.

Fiscal policy: the impact of public expenditures and taxes on the economy; the public sector, its internal structure, and its financing; the budget of the government; the distinction between the primary and the structural fiscal balance; automatic stabilizers; public debt and its financing; expansionary, restrictive, and neutral fiscal policy.

Institutional policy: the way governments can use law to influence business and markets; restrictive and liberal legal regimes;

You graduate this course with an essay, of at least 2500 words, which will demonstrate your grasp of the theory I have just specified here-above. As this is an integrative course, you will have to use many resources. There are few textbooks about economic policy in general, and so you are the most likely to compile a small library of your own. Online resources are just fine. I will use this blog to update you, from my part. This course is very much like the work of a journalist: I expect you to get s*** done rather than just learn theory. Do your homework and do your research, write your essay, send it to me via email, improve it according to my remarks, and get rid of me before the exam session comes in winter: this is the drift to follow.

This is all, folks. See you all in class.