Category: Three currencies: cash, influence and power

Lessons for capitalism from the East India Company

William Dalrymple has helped people who don’t have the time to wade through 576 pages (or perhaps already have backlog of doorstep sized items of reading matter on the bedside table already) by writing an extended article on the subject of his new book about the East India Company in the FT.  However, it is a compelling article and means that I may add “The Anarchy: the Relentless Rise of the East India Company” to my list for Santa this Christmas.

This is a company of superlatives, starting out as a joint stock company operating under charter arising from a petition by entrepreneurs and investors to Elizabeth I, growing to become an empire with 60 million subjects, its own army of 200,000 men , accounting for half of the trade of the leading trading nation.  It’s global impact was enormous, from the fears about its reach – as well as its role in the tea trade – that contributed to the revolution in the Thirteen Colonies, to the part it played in the Opium Wars.  Microsoft, Amazon, Google, Apple and before them the oil majors – they were clearly nothing to this behemoth.

Dalrymple brings out in the his article the complex relationship of the Company to British state, from its original charter, through the continuing lobbying into government, the corruption in the relationships between the Company and the establishment (for example, in 1693 shelling out £1,200 a year to prominent MPs, described by Dalrymple as the first corporate lobbying scandal), and the final demise of the Company in the wake of the Indian Rebellion.

Dalrymple’s article has the effect of drawing attention to is the inadequacy of conventional theory, both “Microeconomics 101” and the Theory of the Firm, to describe one of the greatest commercial entities the world has ever known.  Some of things at work are the complex interfaces with the British state and its politicians, and also its deployment of its own naval operations (envisaged in its original charter) and an army to deliver a return to its joint stock holders, as well creating an entity became transformed into the biggest single component of Britain’s empire.

As I write this, I think he has done the job with his teaser article to promote the book.  Perhaps I should ignore the size of the unread pile by my bed and add “The Anarchy” to the letter to the bloke with the reindeer and sleigh.

Increasing inequality is a problem – a challenge to the Panglossian Pinker

There is much to admire in the Stephen Pinker’s recently published Enlightenment Now.  Building on his success demonstrating in The Better Angels of our Nature that mankind is becoming progressively less violent, he sets out to challenge much of the pessimism that surrounds us.  It is a fashionable thesis, Pinker’s volume beat Hans Rosling’s Factfulness: Ten Reasons We’re Wrong About the World – and Why Things Are Better Than You Think to the bookstalls by less than two months.  It would appear that, whatever it may feel like, the world is not going to hell in a handcart.

Much of the thesis is backed up by solid data and robust argument.  This doesn’t mean that there aren’t plenty of lapses, but this the risk when a writer strays too far from their home turf and are ambitious in drawing on a wide range of sources from outside their own discipline.

One area where Pincker’s panglossian (or pollyannaish?) view of the world falls down is his discussion of inequality.  It is hardly original, but no less untrue, to observe that material inequality does not imply necessarily that some people are less happy than others.  But there is extensive evidence at a  linking health outcomes and many other proxies for happiness and wellbeing to prosperity.  He also slips into the trap of seeing a “lump” fallacy (as in “lump of labour fallacy” as first described by David Frederick Schloss in 1891, referring the idea that there is only a finite amount of work to spread among a population) in relation to material wealth.  At one level, he is absolutely correct – there is nothing to stop us all becoming wealthier together, even if unevenly.  But at another level, he is the subject of another fallacy, to the extent that inequality is measured solely in terms of the distribution of material wealth.  Material inequality is also a measure of inequality in the distribution of the potential power that people have over their own lives and over each other.

There is plenty of evidence around at present of the impact of increasing inequality in income on the distribution of wealth, particularly in relation to relatively scarce resources – witness the decline in home ownership in the UK and the increasing proportion of the population renting, on health outcomes – witness the correlation between life expectancy as you head out on the Central Line from  inner-London Tower Hamlets towards leafy suburban Essex, and on the impact on health of people working at lower income levels of inequality in job autonomy as documented, for example, in Jeffrey Pfeffer’s recent Dying for a Paycheck.

It takes a village to maintain a dangerous financial system – and a corporate governance system too

Hillary Clinton popularised the African proverb “It takes a village to raise a child” when she adopted it as the title for her 1996 book. A lawyer representing victims of abuse by Catholic priests in Boston extended when interviewed in 2015 by observing that “If it takes a village to raise a child, it takes a village to abuse a child.” Anat Admati, George G.C. Parker Professor of Finance and Economics at the Graduate School of Business at Stanford University, translates this sentiment to the financial sector in her in chapter in Just Financial Markets? Finance in a Just Society, a collection of essays edited by Lisa Herzog, published by Oxford University Press[1].

Admati’s focus is on the banking system. Her thesis is that the failings in the system, illustrated by the 2008 crash, are a result of the failures of a wide range of players, not just those working within financial institutions, but a host of regulators, commentators and other stakeholders. Very powerfully, she comments on the contrast between the finance industry and other industries (eg aviation) where safety is paramount and all consequently all the stakeholders work together to design effective regulation and where the case for compliance is compelling. But, as she points out, even the most obvious case for regulation to drive safety may require disasters and egregious failures before regulation and compliance catch up with the need (eg in nuclear power and the motor industry).

Her chapter provides a compelling account of the “wilful blindness” of principals, stakeholders, regulators and commentators on the financial system and suggests that even after the dangers inherent in the design, operation and lack of necessary regulation of the banking system were revealed in the crisis, the underlying problems remain unaddressed.

Her arguments are applicable far more widely. She has written an important paper about that should be read with an eye to how her observations can be applied to other industries and, indeed, beyond the commercial enterprises into public sector organisations and not for profit bodies.

[1]Chapter 13, It Takes a Village to Maintain a Dangerous Financial System. Abstract: I discuss the motivations and actions (or inaction) of individuals in the financial system, governments, central banks, academia and the media that collectively contribute to the persistence of a dangerous and distorted financial system and inadequate, poorly designed regulations. Reassurances that regulators are doing their best to protect the public are false. The underlying problem is a powerful mix of distorted incentives, ignorance, confusion, and lack of accountability. Willful blindness seems to play a role in flawed claims by the system’s enablers that obscure reality and muddle the policy debate.

Three Faces of Power, Kenneth E Boulding 1989

The great thing about Amazon is how easy and inexpensive it is to track down potentially interesting texts referenced in footnotes. The outlay of 1p plus £2.70 post and packaging secured the arrival of a copy of Kenneth E Boulding’s “Three Faces of Power”. This arrived virtually in mint condition other than a barcode and a stamps indicating that it been discarded from the library of the Ecole Superieur de Commerce de Paris – and certainly with little evidence that it received much attention from the ESCP’s students.

Published in 1989, it addresses – albeit from a different angle – the three currencies that have since the early 1980s been among the core elements of the Escondido Framework. The publisher’s blurb on the back cover claims that Boulding’s “creative analysis lays the groundwork for important future debates about power.” I have been scratching around for this sort of stuff – albeit as hobbyist rather than academic  – since leaving Stanford in the summer of 1980. The fact that it has taken me so long to come across this work and that it, in turn, appears to have sunk almost without trace, reminds me of T S Eliot’s lament:

                                                   “And what there is to conquer

By strength and submission, has already been discovered

Once or twice, or several times, by men whom one cannot hope

To emulate—but there is no competition—

There is only the fight to recover what has been lost

And found and lost again and again”

(from East Coker, No 2 of The Four Quartets, T S Eliot)

Boulding divides power into three major categories: “threat power”, destructive in nature and applied particularly to political life; “economic power”, resting largely on the power to produce and exchange items, and on the constantly changing distribution of property ownership; and “integrative power”, based on such relationships as legitimacy, respect, affection, community and identity. These three categories do not map directly onto the three currencies within the Escondido Framework, but Boulding himself accepts that they are what mathematicians call “fuzzy sets”. However, there is a rough approximation for “threat power” to the approach to transacting using the “force” currency. It is easy to see how Boulding’s “economic power” maps onto the approach transacting using the “cash” currency. Unsurprisingly, his “integrative power most closely relates to the “influence” currency of the Escondido Framework.

Paul Polman, CEO of Unilever, on sustainability, purpose and living by his values

In the late 1980s, the buying and merchandising team I led at high street retail chain WHSmith launched a substantial new range of environmentally responsible stationery. It resonated with the personal values of the team, in short we believed that it was the right thing to do. We also argued that it would be good for the company and provide us with an edge over competitors, since it would be attractive to a significant number of our customers, would help us with staff recruitment since we believed that smart young people wanted to work for an environmentally responsible company, and would help enhance the wider reputation of the company with marketing benefits spilling over into other product categories and win sympathy for us in other ways, even to the extent, for example, of creating a benign audience in local authority planning decisions.

This weekend’s FT contains a profile of Paul Polman, chief executive at Unilever for the past seven years, who has taken an even bolder and more extensive approach to environmental responsibility. His leadership reflects an explicitly understanding of the diversity of market dimensions and that companies need to consider, a sense of that the purpose of the company reflects long term sustainability – of the company and the environment in which it operates.

His responses to his FT interviewers speak for themselves:

“P&G started in 1837, Nestlé in 1857. These companies have been around for so long because they are in tune with society. They are very responsible companies, despite the challenges that they sometimes deal with, all the criticism they get”

When Polman became chief executive of Unilever …. he said that he only wanted investors who shared his view that Unilever needed to shepherd the Earth’s future as carefully as it did its own revenues and profits…..“Unilever has been around for 100-plus years. We want to be around for several hundred more years. So if you buy into this long-term value-creation model, which is equitable, which is shared, which is sustainable, then come and invest with us. If you don’t buy into this, I respect you as a human being but don’t put your money in our company.”

The FT article explains that Sustainable Living Plan adopted by Unilever has not met all its targets, pushing back the date for halving its products’ environmental impact from 2020 to 2030 but it has reduced the waste associated with the disposal of its products by 29 per cent, with the aim of hitting 50 per cent by 2020.  It is not without its critics, but a report from Oxfam report on the company’s practices in Vietnam identified “a number of critical challenges in translating the company’s policy commitments into practice”, the charity’s latest Behind the Brands ranking, which looks at the top 10 food companies’ record on small farmers, women’s rights, the use of land and water and greenhouse emissions, put Unilever in first place, ahead of other leading consumer products companies.

The outcome has been good for the company’s relationships with investors. In the FT’s words: “while he told short-term shareholders to shove off, he delivered good returns to those who stayed. Unilever’s total shareholder return during Polman’s tenure has been 203 per cent, ahead of his old employer Nestlé and well ahead of P&G………. The company has also succeeded in attracting more long-term shareholders………before Polman’s reign, 60 per cent of the company’s top 10 shareholders had been there for five years or more. Today, 70 per cent have held their shares for more than seven years.”

It is also clear from the FT article that Polman has also adopted this approach to environmental sustainability because of its alignment with his personal beliefs, and that his belief that the wider purpose of the company (which he likes to an NGO) is a further illustration of his own belief that he should live his personal values in his corporate career. The Saïd Business School’s Colin Mayer, author of The Firm Commitment, tells the FT “He has demonstrated immense courage and vision in promoting a concept of the purpose and function of business that initially met with considerable resistance, bordering on hostility, from several quarters.”

Are we seeing a shift in the understanding of ownership rights?

The FT’s Merryn Somerset Webb comments today on the sale by the City of Bristol to the Bristol Port Company of the freehold of the port at an apparently knock-down price, with the mayor appearing to justifying going ahead with the deal against the opposition of the city council who favoured a higher offer from a third party on the basis that the company were good tenants of 20 years standing.

Ms Somerset Webb declares that her interest in the story arises from its parallels with David Cameron’s support for housing association tenants being allowed to buy their homes at heavily discounted prices and the Scottish Land Reform Bill which is “jammed with right-to-buy clauses and power transfers to ‘communities’. “ She goes on to observe:

“Interesting, isn’t it? These examples of wealth transfer from right-to-buy all come from different directions and political positions but they all suggest the same thing: a convergence around the idea that owners shouldn’t have exclusive ownership rights.”

She continues by expanding her argument to rising real wages in countries around the world arising both from market pressures to changes in government policy. She notes that she wrote a column here a year and half ago where she:

“talked about just how much of a “boss’s world” ours has become over the last 20 years — the share of corporate output going to profits (and hence to shareholders) had soared and that to workers collapsed……. At the time I noted that these swings in the relationships between profit and labour — or tenant and landowner — take decades to play out, but I felt we were seeing the same signs of a shift as we saw back in the 1960s when the government was ‘irrevocably committed to doing something for the low paid’.”

The primary purpose of her article is actually to suggest that these shifts are good for the global economy because they are likely to transfer income to wealth to people who are more likely to spend it. However, one of the other points she has the effect of making is that the rights that go with ownership of the shares of a company and the rights that are accorded to workers in their employment contracts (which for some people a few centuries ago would have been capable of being bought and sold) and the income flows that go with them, are subject both to general exogenous effects and to the outcome of political action.

Ms Somerset Webb is writing this in her column for private investors and appears to be warning her readers about to recognise that their property rights are not immutable and sacred but are ultimately subject to the will of government, responding to public pressure:

“With tenants getting increasingly angry about our dysfunctional property market and governments and councils across the UK clearly all for right-to-buy, is it really safe to assume that landlords will keep the rights they currently think they have over their rental properties?”

HBR Case Study: Do Business and Politics Mix?

The case study feature in the November 2014 issue of Harvard Business Review is titled “Do Business and Politics Mix?” At the most basic level, this is a daft question.  The fact that it has been worded like this illustrates some of the shortcomings in the way that business in general, and the nature of firm in particular, is discussed.  It is not a matter of whether they mix, business operates within a political environment. Indeed , many businesses engage with least two “markets interfaces”  that are essentially political in nature. The question should not be “do they mix”, but how does a firm position itself on each of the political market interfaces.

The case study describes a fictional US business called Natural Foods that has made donations to a “super PAC” (a peculiarly American artifice for getting round restrictions on the financing of candidates for political office) funding pro-business candidates, only to discover that one of the candidates backed by the super PAC takes an anti-gay stance.  The characters in the case study debate whether or not they should be trying to engage with the political establishment, by funding candidates in order to secure influence with the legislative and executive branches of government, and how they should present themselves to their public and to their immediate stakeholders, who are socially liberal.

The value of this case study is not the specific conundrum faced by the management of the fictional business or the advice provided the pundits assembled by HBR to comment on it. Rather, it is elegant illustration of the significance of political aspects of market interfaces illustrated in the case: the interface with the branches of government as regulators and enablers, and the political dimensions of the market interfaces with employees and customers, for whom the political positions with which the company is identified are considerations in their dealings with the company.

Three Sanctions: Cash, Influence and Force

“War is not merely an act of policy but a true political instrument, a continuation of political intercourse carried on with other means. What remains peculiar to war is simply the peculiar nature of its means.” Carl von Clausewitz, On War, 1832

“All diplomacy is a continuation of war by other means”.   Zhou Enlai, Saturday Evening Post (27 March 1954)

The firm does not just interact with the outside world through cash denominated markets, but also has to deal with and through politics, and many also interact with other parties by employing force itself either as a matter of its own choice or in response to other party’s resort to direct action. Although there may be hybrids and crossovers, the sanctions available to the firm fall into one of these three categories: commercial exchange, political influence and power, and physical force.

The quotations from Clausewitz and Zhou Enlai illustrate the recognition by soldiers and politicians that they may have something in common in their purposes, but employ different means.   Ultimately both are seeking power or control over assets or people, on behalf of the institution (nation, party, faction, class, tribe) they serve. The widespread use of military metaphors by business leaders, and particularly management consultants and business academics, illustrates a degree of recognition of crossover between the commercial world and the political and military as the business seeks to secure control over assets, services and revenues. No wonder that Lawrence Freedman, in his comprehensive history of strategy[1] – from the Book of Genesis to the gospel according to Michael Porter – divides his subject into “Strategies of Force” (military), “Strategy from Below” (politics), and “Strategy from Above” (business).

The classical model of the firm assumes that all its business involves commercial exchange, with goods, services and investment rights exchanged for cash or entitlements to cash. But even at the time the classical model was evolving, it failed to describe the world as it existed. The men behind the chartered companies that exploited the new worlds for the British, Dutch and French in the eighteenth century understood that their business would employ all three sanctions, to the extent that the East India Company had its own standing army, whilst back at home its mandate to trade depended on a charter that in turn depended on political bargaining. The slave plantations of the West Indies that provided the investment for the Industrial Revolution depended on the labour of slaves who were bought for cash in West Africa and then worked under the overseers’ lash until the trade in slaves was banned and eventually the institution of slavery itself as a consequence of the plantation owners losing the moral and political argument. There are plenty of examples in the twentieth and twenty first centuries where businesses employ, or have to respond to, political and physical force sanctions, even if only at the level of coping with the union picket line or employing security services to protect their assets, and lobbying politicians to secure favourable, or less unfavourable, legislation.

The three sanctions are distinct from one another in a number of ways, although the boundaries between them in their deployment depend in part on the other sanctions: weapons and allies may be bought with cash or political influence; the rules that govern commerce generally depend on political sanction that may in turn be backed up by force. They can be seen as a hierarchy, with the cash based, commercial sanction claiming superiority over the other two as the basis for the market solutions that allow individuals to make the vast number of choices about the goods and services they consume, how they deploy their own labour to generate income and create wealth, and invest in capital goods – whether roofs over their heads or equipment to make human labour more productive. But for the cash denominated marketplace to generate equitable and efficient outcomes and address externalities that diminish the aggregated wealth of a society, the state has to be summoned into existence, which requires deployment of the political sanction. Hobbes was right: without the state, life in the state of nature is nasty, brutish and short. Adam Smith may have betrayed a charming naivety when he asserted that “When the trade or practice becomes thoroughly established and well known, the competition reduces them to the level of other trades” and failed to recognise many of the conditions that frustrate the development of perfect competition, but he also acknowledged the very same self-interest that fuelled his economic model also contained the seeds of the cartel in his memorable observation that “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices”.

The legitimacy of the commercial exchange derives from the possession of currency whose value is recognised by the counterparty, of goods on which they place a value, or of the ability to provide services on which the counterparty places value. Through the medium of money, commercial marketplaces provide for highly granular exercise of choice by individuals and, despite all the limitations of market failure and moral questions about unequal distribution of income and wealth, have underpinned most of what is generally recognised as the progress of the human condition and liberation from decisions imposed on them by others.

The legitimacy of the political sanction is derived from potentially a variety of sources. It may be underpinned by the threat of force (of a ruler with backing from his tribe or his loyal palace guard, of a military class, or of popular uprising), or a widely accepted value system which generally finds is voice in a written constitution interpreted by courts but may have its roots in religion, cultural values, political theory, or reference to totemic elements in a nation’s heritage. In practical terms, the exercise of political sanction will be in reference either to values (for example, an appeal to principles embodied in a constitution), to potential levers within a constitutional framework (for example, the potential influence on how voters may cast their votes in a future election) or to direct influence, whether by strength of logical argument or emotional appeal, to those with political power. The limitation of political sanctions is that the political process is less granular and frequently binary: you may be able to exercise some influence over what goes into the manifestos of political parties, but when elections come around the voter is confronted by a choice between the platforms of the parties and unable to cherry pick the policies they like. But for all the shortcomings of political processes compared to commercial markets, they are all we have available to address the problems created by market failure and address the issues of equity surrounding the unequal endowments we receive at birth and the unequal outcomes for individuals from untrammelled exercise of the market[2].

So what about the legitimacy of physical force? It is the sanction of the Hobbesian state of nature. If we accept the analysis of Thomas Pinker[3], mankind has moved inexorably away from using violence. However, there are still people who have recourse to physical force when they cannot see any resolution of disputes through political means or they have concluded that the benefits of remaining within the laws created by the state and exercising whatever limited economic power they may have within the market moderated commercial system are outweighed by using physical force. This applies equally to London low life snatching a handbag on Oxford Street or a Mexican cartel member or Mafiosi assassinating the local police chief getting too close a drug deal. But it also applies to the Occupy Movement and to campaigners against fracking: when something is sufficiently important to you and you cannot achieve your goals through commercial means or the normal instruments of politics, it is entirely rational to resort to physical force, accepting that it is very crude, inefficient, and not without cost to all concerned. In the same way that we require political instruments to address failures in commercial markets, an individual, a movement, a social class, or an ethnic minority may conclude that the failure of the political process can only be addressed by resort to physical action. There is also a reciprocal implication: if you are using physical force to respond to physical force, you should recognise that you are engaged in a political process and addressing political problems, as Emile Simpson articulates in his account of operations in Afghanistan[4]

[1] Lawrence Freedman Strategy: a history (Oxford: Oxford University Press 2013)

[2] Thomas Pickety, Capital in the 21st Century

[3] Thomas Pinker, The Better Angels of Our Nature

[4] Emile Simpson, War From the Ground Up.

“It’s 80% Dark Matter”

I attended the launch of “Collaboration Strategy: How to Get What You Want from Employees, Suppliers and Business Partners”, the new book by Felix Barber and Michael Goold of the Ashridge Strategy Management Centre. The book contains plenty of good material on structuring terms with the parties who you work with and aligning incentives. Reflecting the past service of both authors with the Boston Consulting Group, it has plenty to say about focusing on those activities in which you enjoy competitive advantage and outsourcing the others.

Publisher’s glass in hand, I was listening to Felix deliver a short lecture providing a synopsis of the themes of the book when someone¹ muttered in my ear:  “they’re talking entirely about markets and financial incentives, but in reality it’s 80% Dark Matter”.  This is a powerful metaphor and an important insight: we need to recognise that there is lot of dark matter out there in the economy and without it nothing works.  Market forces and financial incentives alone do not explain how organisations, partnerships and collaborations operate and why we need them.  Barber and Goold do acknowledge, buried deep in their text, that there may be more going on by commenting that they “don’t wish to downplay the importance of other approaches to motivating employees and other partners”.  But, possibly reflecting lifetimes as consultants and academics, they convey in the book the impression that they don’t recognise the amount of Dark Matter that the system needs.

 

¹ David Pitt Watson, sometime managing director of BCG rivals Braxton Associates, Labour Party Finance Director, boss of the activist investment fund Hermes Focus and now social entrepreneur and responsible investment guru.

 

Strategy: a dialogue between desire and possibility

When someone as eminent as military historian Sir Michael Howard reviews a new book by a young former soldier by describing it as “a work of such importance that it should be compulsory reading at every level in the military” and (recognising himself that he is “really go[ing] overboard” ) that the book “deserves to be seen as a coda to Clausewitz’s On War” you know that you have to read it and that your expectations have been set very high.

Emile Simpson’s War from the Ground Up: 21st Century Combat as Politics deserves a much wider audience than just the military.  It sparks ideas about analogies in other parts of life; the experience of a young officer in Helmand Province has meaning elsewhere.

One of his most powerful ideas is the recognition that we need to understand how our actions will be interpreted, and when then they can be interpreted in multiple ways they risk becoming ineffective:

To use an analogy, the market is an interpretive structure whose function is to impose a specific type of meaning, a price, on a product. When the market cannot allocate a price (which is one of its basic functions), its mechanism breaks down and it loses utility. This happened in the financial crisis of 2008, when many derivatives were so complex that the market could not price them.  The market seized up its basic mechanism stopped working. When an action in war can be interpreted in a multitude of different ways depending on the prejudice of the audience, it is very hard to make armed force have political utility in a Clausewitsian conception of war: for a military outcome to set conditions for a political solution it needs to be recognised as such.  (p.74)

But his comments on strategy are more powerful still:

Essentially strategy is the dialectical relationship, or the dialogue, between desire and possibility. At the core of strategy is inevitably the problem of whether desire or possibility comes first. Does one start with the abstract idea of what is desired, or should one commence by consideration of what is realistically possible? This is a chicken and egg situation.

The two should ideally be in perpetual dialogue, not just before but also during a conflict. Desire must be grounded in possibility; possibility clearly requires an idea in the first place which informs any analysis of possibility…..

Understood as dialogue between desire and possibility, strategy is as much the process that handles this dialogue as the output of the dialogue itself. (p.116)