THE CAPITALIST ECONOMY

There are primarily three types of economic systems: capitalism, socialism and a mixture of capitalism and socialism. We should very easily dispose of socialism because it is idealistic and not realistic. It is predicated on pure cognitive processes, not rooted in the realities of man, as we know him to be. Socialism wants the individual to work for the public, to serve common interests. It generally believes that it is possible to serve other persons more than the individual can serve himself. As it sees it, man is a social animal, and ought to devote his existence to serving other persons’ needs at the expense of his own needs. Obviously this is idealistic and negating of the individual, for if he cannot serve himself, how is he going to be able to serve other persons?

The originators of socialism appreciated the exploitation of workers, by the owners of capital, during the period of primitive capitalist states (during capital accumulation period), and decried the capitalist system of production. They were, of course, right in calling attention to the exploitation of labor by factory owners. However, they sought to throw the baby away with the bathwater. They sought to take away the ownership of private property from individual hands and give it to the state. They wanted the public to run factories and become the owners of the means of production. This is in the face of the obvious fact that, what is publicly owned is owned by no one, and is generally poorly managed.

What one owner would take an hour to do, would take ten bureaucrats ten hours to accomplish. Socialism wanted public ownership of the means of production. As it sees it, this is the only way to prevent exploitation of man by man.

In the Communist Manifesto, and later, Das Kapital, Karl Marx waxed strong and wrote idealistic nonsense that has no bearing on the real world we know of. Simply stated, Communism is rubbish for it has no capacity for producing wealth. Wealth is produced by individuals pursuing their private interests, working hard, working ten or more hour per day, rather than the average of two-hour days worked by bureaucrats in their public works. A gaggle of bureaucrats merely make noise, whereas productive individuals commit themselves to doing work that interests them, that they have aptitude in, and do it for profit.

We are not naïve about human nature. We know that human beings do exploit one another, and will continue to do so if they can get away with it. Therefore, some role for government in the economy is inevitable. Hence, the mixed economic system is probably the most workable economic system, given the realities of the world. In a mixed economy, the government plays some role in making sure that capitalists do not exploit the workers; it does so primarily through regulations of what capitalists can and cannot do, passing laws to protect labor and working conditions; and it intervenes to prevent and or remedy inflation and depression. By and large, a mixed economy is a regulated capitalist system, it is less productive than a pure capitalist system, but seems the best we can do given the nature of man.

The most productive economic system is the capitalist economy, so we shall devote the rest of this chapter to its workings. Many books have been written on this economic system, yet the reader should peruse the granddaddy of them all, Adam Smith’s Wealth of Nations. The premise of this economic system is that man is a rational creature, and that his rationality disposes him to pursue what optimizes his survival, his self-interests. He is motivated by self-interest and only secondarily thinks about social interests. But since he lives in society, the satisfaction of his self-interests is generally attained when he also does what satisfies other persons’ self interests. In effect, he exchanges goods and serves with others, and this way each person satisfies his self-interests.

The basic axiom of this economic system is the laws of supply and demand. Individuals need certain goods and services to sustain their lives. They demand those goods and services and are willing to pay certain prices to obtain them. Businesses supply the goods and services demanded by the people. A successful business is one that understands what the people want to buy, produces it or gets it, and sells it to them at a price they are willing to pay. In the market economy, the producer supplies certain goods or services, and people offer to pay him a certain price for his goods or services. Complex mechanisms affect the interaction of supply and demand; the result is a price for the goods that the supplier is willing to sell his goods at, to a buyer who is willing to pay a certain price for these goods or services. This is the equilibrium price.

Given the desire by the buyers to pay the least price for goods, they would always be on the look out for sellers whose prices are cheaper for similar goods. Therefore, other sellers attempt to produce the same goods and/or sell them cheaper to buyers, and in the process make profits. To be in the market, to sell, all producers of goods and services must be attempting to produce their goods and services in the most efficient manner, and to a specific sector, niche, in the market. Competition for survival in the market place, therefore, compels producers to be efficient, to utilize the factors of production (labor, capital, technology, entrepreneurship, land, raw materials, etc), in the most efficient manner possible.

The capitalist economy, therefore, is characterized by competition for consumers, for the sale of goods and services, and in the process discovering the best way to produce and market them, so as to make a profit.

There are different types of competition. Briefly, there is pure or perfect competition, also called laissez-faire; here the forces of the market, that is, supply and demand, strictly determine the production and distribution of goods and services, with no interference of government. In this type of market, the best seller of goods and services survive, and the weak disappear. This is akin to Herbert Spencer’s Social Darwinism, where the fittest survive and the weak die. This is an unsentimental approach to the economy.

In the real world, people do take care of their old parents and children, and never permit pure competition to determine their approaches to them. People have always intervened to help the least competitive person, the underdog so to speak, for he could be them, tomorrow. The best student may obtain scholarships to go to school but if you ignore the needs of the mediocre student, should something happen to the best student you are stuck with no one to produce knowledge. Therefore, to guarantee the presence of knowledge, you must provide education to as many students as possible, even those that may not appear to aspire in it, for educational provides knowledge on some level to all.

In monopolistic competition, a few relatively large businesses monopolize the production and sales of certain goods and/or services, and exert influence on the prices they charge for their goods and/or services. This is a very inefficient economy, for if there is less competition, there is less incentive to improve the means of production or to improve the quality of goods and services. A monopoly tends to make businesses complacent in their quality of products and services, and not keep up with increasing needs. An economy stagnates, becomes outmoded, if monopoly is permitted.

In oligopoly economy, there are few suppliers of a specific product or service, so that one’s actions can have a significant impact on prices and its competitors; often a small number of businesses produce similar products, agree amongst themselves on the prices to charge the buyers of their goods, thus disproportionately affect a large population, much like we see with gas prices due to OPEC. This is an inefficient economy.

In a monopsony, a single customer market, where a specific type of product or service is only being used by one customer, the buyers dictate prices paid to producers of goods and services.

There are many variations of these basic types of competition sketched above. For our present purpose, what is salient is that in a capitalist economy, competition is encouraged as the best way to produce and distribute wealth. It is assumed that businesses are motivated by the profit motive, and the bottom line is: “what is in it for me? How do I benefit from what I am doing? If I am not going to benefit from it, why should I do it?” Profit is the incentive for economic activity. Where there is profit to be made, resources are channeled to it, and in the process the consumers are best served.

Capital goes to where profit is to be made. This way the forces of the market allocate capital in the economy and allocate it most efficiently. No one central committee sits around in an unventilated room in the States, Moscow, Peking, Havana, etc and pools their collective ignorance, to tell the people where to spend their money, and to decide where capital is allocated in the economy.

The capitalist economy is the most efficient means of producing and distributing resources in an economy. No one has yet discovered a better alternative to it. But like everything else that is part of human behavior, it is flawed. Man is an imperfect creature and his actions must be imperfect. Capitalism has built-in problems. It tends to have cycles of inflation, depression and recession.

In inflation, there is too much money chasing too few goods and services, therefore, prices rise.

In depression, there is too little demand for goods and services, therefore, prices fall. Recession is a minor form of depression.

In a hyper inflationary economy, it may take a bucket full of currency to buy a packet of cigarettes. This happened in Germany after the First World War.

In depression, too many people do not have money, are out of work and cannot buy goods and services, hence, businesses cannot sell their goods and services, do not make profits and may have to close down, laying off many persons. As a result of the stock market crash of 1929, the United States economy and its collateral, the rest of the world’s economy went into deep recession. At a point during the depression, over twenty five percent of the adult population were unemployed, hence, had no money to buy goods and services; as a result, many businesses could not sell their goods and services, and had to close down. The world went into a funk, as hordes of unemployed men sloshed about looking for work.

John Maynard Keynes published his “The General Theory of Employment, Interest and Money” in 1936, and in it, proposed new economic behaviors that would prevent the known business cycles of capitalist economies. His ideas were translated into new economic practices, the so-called Keynesian Revolution, that in the United States is commonly referred to as the New Deal or government intervention in an otherwise capitalist economy.

Briefly, Keynes proposed that societies lay to death the idea that governments should have no role in the economy. He suggested what governments could do during inflationary and depressionary periods, to help the economy. Lawrence Klein writings on Keynes shows that the government economic planners would have to have "complete control over the government fiscal policy so that they can spend when and where spending is needed to stimulate employment and tax when and where taxation is needed to halt upward price movements."

Many folks have since added to Keynesian economics, but the basic tenets of this economics remain the same. Keynesian economy, like pure capitalism, accepts that private ownership of property is the best economy, but suggests ways to manage the economy to avert excessive disruptions in economic activities.

Taxation policy. Here the government taxes people, raises or lowers taxes according to how the economy is doing. If the economy is in an inflationary period, that is, too much money is chasing too few goods, governments should raise taxes and that way take away some of that money from the people, leaving them with less money to spend.

With less money available to them to purchase goods and services, people would want to buy goods and services cheaper, hence, suppliers are inclined to reduce the price of their goods and services in order to sell and make profits. Prices fall and inflation is reduced, as money regains some value.

On the other hand, if the people are paying higher taxes, and have less money to purchase goods and services, sellers are unable to sell their goods and services; the economy heads towards recession and/or depression, taxes could be lowered so that the people would have money to spend. With more discretionary income to spend, they buy goods and services, thereby stimulating more production of goods and services. The economy picks itself out of depression and becomes buoyant. Taxation policy, therefore, is an ongoing process, with government raising or lowering taxes to regulate the economy.

Government spending (fiscal policy) is used to stimulate the economy. When the economy is in the doldrums the government can consciously spend money to stimulate it. It could pump money into the economy by building roads, bridges, airports, railway lines and other public infrastructure. In doing so, work is created and workers spend their money buying goods and services that stimulate the production of those goods and services. Sometimes, governments do not have the money to spend to stimulate depressed economies. In such instances, they many have to borrow that money from those who have it, through selling bonds. This is called deficit spending. The government borrows and spends money that it does not collect in revenue, so as to improve the economy, hoping to then collect more taxes to pay off what it owes. Many a government owes so much money through deficit spending, that interest payments on their debts consume much of their current revenues. That is, they pay out large chunks of the money they currently collect in taxes as interests on the money they have borrowed to finance public projects. Ronald Reagan, for example, borrowed extensively to finance his military build up. He saddled future generation of Americans with trillions of dollars of debt to be paid off. In the meantime, the government pays several billions of dollars in annual interests on the trillions it owes.

In Monetary Policy, governments, through their central banks, regulate the behavior of the economy through raising or lowering the interest they charge borrowers of funds from the government banks. Commercial banks borrow money from the central banks. They are charged certain interests for the money they borrow. They, in turn, charge their customers, those they lend to, interest on the loans. The interest the central bank charges determine the interest commercial banks charge, and indirectly affect the performance of the economy. If the prime rate charged by the central bank is low, commercial banks borrow more and lend more money to their customers, who are more likely to borrow because of the lowered interest rates. People borrow money to buy houses and cars. Businesses borrow money to invest in capital goods. This way economic activity is stimulated.

Lowering interest rates can be used to stimulate an economy out of recession or depression. Raising interest rates, on the other hand, lowers borrowing and spending, hence, reduces inflation.

Keynesian economics has ushered in an era of government intervention in the capitalist economy. This serves some good. The problem is that some idle, unproductive bureaucrat may be tempted to over do it, and in the process destroys the goose that lays the golden egg. If the government over regulates the economy, say has too high taxes, people may refuse to work hard; people see no reason why they should work eight or more hours per day to make money, so that some bureaucrat can take much of that money from them, to fatten government coffers and support the malingerers on the public dole.

Clearly, this problem does not have a simple solution, certainly not an either or one. There must be some role for the government in modern economies. The question is how much. How much should be the role of government in the economy is the subject addressed by public policy and public choice. As long as, the national policy enables the capitalist economy to grow jobs and produce wealth for the people, it seems tolerable.

As long as, the people’s standard of living is rising, the Gross National Product (GNP) and Gross Domestic Product (GDP) are rising, there is little to complain about the economy. (GNP is the gross value of the goods and services produced in a country during a period of time, usually a year; GDP is the GNP plus the income paid to non-residents, minus income received from non-residents. Gross national income, GNI is the sum of the various economic sectors in a country. Per capital income is the gross income divided by the population, to figure out what each individual would make if wealth were shared equitably. Unfortunately, many make incomes below poverty level wages…living wages is that wage deemed necessary to sustain an individual in an economy. Goods are generally divided into two main classes, capital goods and consumer goods. Capital goods are those devoted to producing more wealth, such as factories, whereas consumer goods are finished products bought and consumed by people.)

As we see it, governments must play some roles in the economy. It is simply nostalgic to yearn for past eras that probably never existed, when governments were supposedly hands off the economy. (In the past, we had mercantilism, trade from commodities, where governments actively tried to preserve certain trading for their citizens and prevented other countries from doing so.) As long as, governments understand that human nature dictates that people work hardest when they are working for their interests, they pretty much leave them alone to pursue their interests, so the economy grows.

Private enterprise, where most of the factors of production (land, labor, capital, technology, entrepreneurship) are left in private hands, is the most productive economic system. Until any one shows an alternative to it, that is equally productive, or better, it should be titrated and improved, but essentially left alone. We should not make the mistake naïve Russians made of adopting an untested economic system, communism, only to give the people poverty, and brutal authoritarian and totalitarian dictatorship. For all his murderous activities, Stalin did not improve the standards of living of the Russian people. So what was the point of that entire killing? Not any that pure reason can discern.

The profit motive, which drives business activities, is still the best way to generate wealth in an economy. Of course, we need to tax those with money, and give some money to non-profit organizations to use in serving the poor, those who cannot participate or benefit from competitive business. This is the way it should be, wisdom lies in knowing how not to over play our hands and allow our sentiments to over rule our reason.

We need bureaucrats to perform critical governmental functions that must be performed for the survival of the polity. But we also know that bureaucrats are inefficient, so we must keep them to the absolute minimum. As it were, they are necessary but should not be permitted to mushroom all over the place. If allowed, they expand their jobs but not their productivity. So we must keep watchful eyes on the detritus of mankind, and reward our most productive persons, entrepreneurs, those who generate wealth and employment in the economy.

SMALL BUSINESSES

Most people who have jobs are employed by small businesses. For our present purpose, we define a small business as any work organization employing less than twenty-five persons. It is, therefore, critical that we understand the nature and operation of small business ventures.

A small business comes into being when an individual has an idea that he thinks would make him money. An entrepreneur has an idea (product or service) that he thinks there is a market for, that is, he thinks that people would buy, that there is demand for). He attempts to produce and market his idea.

Unless one is trained in business, either formally (a MBA) or through work-experience, as a beginning entrepreneur one often does not possess management skills. Management is the ability to gather human beings and other resources, and coordinate them in pursuit of stated organizational goals. Human beings are complex and it is difficult to tell them what to do, and get them to do it. There is, however, a psychology to managing people that needs to be learned (human resource management).

Small businesses are often handicapped by lack of adequate financing. One may have good ideas, but not have the money to finance them. Moreover, given one’s lack of track record, financial institutions like banks hesitate lending one the money to start one’s business. Thus entrepreneurs are often forced to rely on their own savings, and borrowing from family members and friends to start their business.

We live in an era where government involves itself in practically every aspect of our lives. As noted above, if bureaucrats are permitted, they would over regulate the economy, including making it difficult for persons with good ideas to start and operate their own business. The hoops entrepreneurs have to go through to obtain all the licenses they need to operate their businesses is amazing. One would think that since they are the ones who provide most of us jobs, that idle bureaucrats who do not generate jobs for any one else, but themselves, would cheerfully do everything in their powers to make sure that entrepreneurs succeed. (It is estimated that over ninety percent of all business that start fail before the end of two years.) Often those businesses that manage to survive are burdened with high taxes, actual disincentives to their working hard to stay in operation.

Be this as it may, small businesses are the bedrock of capitalist economies, and people must be encouraged to start their own businesses, rather than aim at working for other persons.

If you intend to start your own business, you should think about it; it is desirable that you provide yourself with some business education, formally or informally, by reading books on business (and that is why we are adding this chapter to this book), studying the market, understand the structure of demand, that is, do a survey to find out whether there are people who want to buy what you want to produce or not. If there is a demand for it, then plan your production carefully to make sure that you avoid cost overruns. Chances are that you do not have training in finance and accounting, and may need to secure the skills of those trained in that field, particularly the services of a good bookkeeper. You must budget and keep good records of your revenues and expenditures, so as to avoid running into major financial problems or having to declare bankruptcy.

You must draw up an effective marketing plan, a strategy on how to sell your goods and/or services to the target market you are aiming at to buy your goods and/or services.

You must manage your time well and acquire the type of labor you need to aid you in the production of what you want to produce, and compensate them adequately…. people are motivated by self interests; if you do not reward them as they think that they deserve, they would leave, you do not want a high labor turnover rate, for if those who understand your business leave, you may have difficulty finding and training replacements.

One should go into business that enables one to do what truly interests one. Even if one is buying an existing business (business opportunity) or acquiring a franchise (a unit of a chain, like McDonald’s), one must follow a line of business that interests one.

Once the individual decides to go into business for himself, it helps if he creates a Business Plan. A business plan provides a detailed plan of the business goals and objects, and how one intends to accomplish these goals, including how the finances are to be obtained, who the market for the product of the business is, and how the revenue of the business is to be managed.

The mechanics of beginning and running a business, such as acquiring a location and facility for the business (could be out of one’s home), equipment, insurance, means of communication…such as computers and phone systems…obtaining and motivating staff to work hard, meeting the legal requirements for that type of business, going after sources of financing, and so on, can be studied in most books on how to start and run small businesses or books on entrepreneurship. Networking and talking to already successful entrepreneurs is one of the best ways to learn, gain contacts and support to bounce ideas and issues off of someone in the know.

FORMS OF BUSINESS OWNERSHIP

Businesses can be organized in several forms. The primary forms of business organization, in most capitalist economies, are sole proprietorship, partnership and corporation.

The sole proprietor is exactly what the name says, a business owned by one individual. The owner is solely responsible for the firm’s operation, and assumes all the risks involved. If he makes profit it is all his (minus taxes, of course) and if he incurs losses, he is solely responsible for them. From a legal entity the sole proprietor and individual are the same entity.

This type of business organization has some advantages, including ease of formation and dissolution, management freedom and right to do as the owner wants without interference from bosses, and, of course, the keeping of all profits by the owner without sharing it with other persons. Like everything else that has pluses, this type of business organization has disadvantages, including: unlimited financial liability, limited financial resources, perhaps limited managerial skills in the owner, and tendency for the firm to terminate with the demise/death of the owner.

Many businesses start as sole proprietors and in time change forms, perhaps become partnerships or eventually corporations. The need for capital to expand businesses often compels sole proprietors to seek partners, and eventually incorporate and possibly even to go public, financing their business activities through selling of stocks.

A partnership exists where two or more persons pull their resources to start a business and agree to share responsibility for running the business; they take equal risks in doing so. The formation of a partnership often requires following some legal procedures that delineate who the partners are, their individual investments in the business, the salary of each partner, the duties to be performed by each partner, the name of their business, how profits are to be shared, the location of the business and the conditions for dissolving the business.

Partnerships have three forms; general partners, limited partners and silent partners. In general partnership, all the partners are involved in the running of the business and share in the total liability; in limited partnerships, partners are only liable to the extent of their investment in the business, and may not take an active role in the day-to-day operations of the business; silent partners are not involved in the management of the business, but often provide financial support.

Partnerships have certain advantages, including ease of establishment, pooling of management skills, ability to pool funds from many persons and more stability than sole proprietors. Its major disadvantages are that partners have unlimited financial liability, may disagree amongst themselves as to how to run the business, inability to raise larger funds, possible dissolution of the business due to disagreement of the partners.

Corporations are legal entities; they are considered artificial persons in the eyes of the law. This is so because the law considers the corporation like it was a person, and taxes it, as it taxes individuals. The corporation is usually owned by shareholders who are liable to their investments in the corporation.

Corporations tend to have certain advantages, including: limited financial liability for shareholders, greater ability to raise money, greater longevity, greater capacity to expand, greater ability to attract top quality managers, and ease of transferring ownership. The disadvantages include lack of personal interest in the management of the business by employees, greater cost of production, government regulations, and lack of secrecy of operations.

Essentially, corporations are the most effective way to run large business concerns. Money is difficult to come by, and one of the best ways to come by it, is to borrow it from many persons. Public corporations acquire funds by selling shares in their business. Shareholders own stocks in corporation type businesses.

There are many types of stocks: preferred stocks, common stocks, and so on. (If you are planning to become an investor, you are advised to take a course on investments, so that you would understand the various types of stocks and their advantages and disadvantages.)

A board of directors usually runs a corporation. The shareholders elect the board of directors. The board of directors is usually elected from those with the most stocks in a corporation.

The board of directors hires a chief executive officer (CEO or president) to run the business on a day-to-day basis, and is responsible for reporting and keeping the board informed.

A group of individuals can form a corporation by filling out the required forms by the government, and paying the fee for starting their business. Once in business, corporations tend to expand through many ways, including mergers, acquisitions of other businesses, and sometimes through hostile takeovers of other businesses.

There are other forms of business organizations, such as cooperatives, usually a non-profit corporation organized on a voluntary basis, for the benefit of members. An example is credit unions, which is usually a financial cooperative to lend money to members, who pool their money to lend to each other, and that way counter the disadvantages of commercial banks.

MANAGEMENT

Now that a business has been started, it has to be managed on an ongoing basis. Management is the process of planning, organizing, leading and controlling the activities of work members, in order to achieve the business’ goals. Management is the utilization of men and material to achieve organizational goals and to make a profit.

Many writers have delineated the specific functions of management, including planning (setting the goals and objectives of the work team, how best to attain those objectives, the resources necessary for achieving them, and where those resources would be obtained), organizing (establishing a formal organizational structure, delineation of tasks to be performed by members of the organization, lines of reporting authority), staffing (the recruitment of people to perform specified tasks necessary for the organization’s goal attainment), leading (guiding the workers so that their activities are conduce to the organization’s goal attainment), controlling (making sure that the performance of the staff is what is expected and making sure that resources are utilized, as expected, taking corrective actions where necessary.

There are levels of management, a hierarchy of the distribution of authority in an organization. The hierarchy usually looks like a pyramid, with more people at the bottom, and less at the top. Generally, there is top management (president, CEO, Vice presidents), middle management (division managers, department managers), and supervisory management (lead workers).

Managers generally are expected to possess technical skills (the mechanics of the jobs in their organization) and social skills (how to relate to people and use them to achieve organizational goals).

Managers make decisions as to what goals and objectives are to be pursued, and how to pursue them. Therefore, managers must understand how to make decisions, positing possible solutions, costing the solutions, studying the consequences of each solution in terms of benefits and social good, and choosing the alternative solution to the problem that seems to optimize benefits and reduce costs, implementing it, and eventually evaluating whether it works, and if not, refining it or throwing it out for other solutions.

The major function of management is planning what goals to pursue and ascertaining strategies to attain them. Gathering of information and analysis of this information is crucial in making future plans as to the business’ direction.

Nowadays there are computer software programs that can aid in planning and decision-making. The manager must be familiar with computers, and respective business software; he must understand the role of computers in his particular industry. Education in computers is now a necessary part of management training. E-commerce is in the future of most business. Knowledge of computer applications, such as word-processing, data processing and management, statistical analysis, excel, and Power Point, is useful for managers.

Managers must be effective communicators. They achieve goals and objectives through people. As such, they must know how to relate to people. Communication is an effective way of relating to people. Indeed, managers are best served if they take courses in communication and human relations. They communicate up and down the organization’s hierarchy, send memos to those above them and to those under them, write business letters and reports for presentations to other managers (management meeting) and other business, etc.

Although managers do not have to become accountants, they must understand money and record keeping. They must be able to prepare budgets and read financial statements, giving the performance…revenues and expenditures…of their units, produced by the accounting department, monthly. Management decisions are based on knowledge of the state of the organization’s finances.

Managers engage in business with other business that requires having formal contracts written, regarding their relationships and obligations. Contract management is one of the required skills of professional managers, in today’s business climate.

Managers involved in production must understand inventory management, the record keeping of raw materials coming into the factory, how they are processed into finished goods and sold (department stores have to keep records on the inventory of merchandise they order and sell).

Project management is now a general skill required of most managers (how specific projects are managed, what it takes to accomplish them, when to start and complete them, costs, technical requirements for accomplishing them, the labor required to accomplish them, and the management of these resources).

Management boils down to the courage to take risks. Academic professors of business talk shop on planning, but are not known to actually set business goals and do what it takes to achieve them. Often business goals are set on a hunch, by pure intuition of what the manager thinks will work. Managers are persons who take calculated and studied risks, and are prepared to take the consequences of their actions. Those who take profitable risks make profits, whereas bureaucrats, who study a problem to death and write tons of literature on it, do nothing to take risks, make no profit.

ORGANIZING WORK ORGANIZATIONS

Work organizations tend to be organized hierarchically, with the majority of employees at the bottom and the minority at the top. This is the so-called organizational pyramid, with top management (usually the chief executive officer, and president and his functional vice presidents, who reports to the Board of Directors, usually seven to twenty members who are elected by shareholders), middle managers (division managers), supervisory or first line managers and finally the workers at the bottom of the totem pole.

The typical corporation usually has a formal organization chart that plots each employee’s position, and what it does within the organization. The formal organization delineates power relationships between employees, and suggests that those at the top tend to have more power than those at the bottom. But this could be deceiving as most organizations’ have an informal organization that indicates that, persons who are not expected to have much formal power and authority actually possesses power. The secretary to the CEO, for example, may wield actual power behind the throne of the organization. The janitor may have more say so in the organization than persons who supervise him formally.

One of the key functions of management is organizing people, to use them to accomplish organizational goals. Organizational structures, learned from the military and the Catholic Church, seem to be an efficient way of organizing people. Communists contended that hierarchical work organizations were anti-democratic, that they indicate master-servant relationships and talk nonsense about the equality of comrades at work. However, examination of communist work organizations revealed a more feudal organization with those at the top presuming to know what is good for those at the bottom while not even bother listening to them, as capitalist organizations, at least, try to do. Communist leaders presume to have all the knowledge there is to have, hence, when in office stay forever, usually until they die or until someone kills them in a coup. At least capitalists make a show of listening to the people, and theoretically, information flows both downwards and upwards, from the workers to the top management, and from management to the workers.

Usually work organizations are departmentalized by function. The work that must be done to accomplish organizational goals are divided and grouped into functional areas, and each is called a department; such as production, accounting, finance, marketing and sells, human resources, etc.

A designated person such as the vice president, finance etc, heads each functional department. The vice presidents report to the president, who reports to the Board of Directors.

Departmentalization can also be made geographically: a large corporation with operations in many geographic areas, in the same country, or even in many different countries, may organize itself by regions so that in each region a manager runs its affairs there. Some organizations have product departmentalization, that is, a unit producing a given product is a department. Some organize through project management, whereby folks from different units come together to pursue a special project within the overall organization.

Whichever way an organization is organized, the goal is to delineate the lines of authority, power and influence.

Power is the ability of one individual to tell another what to do, and he does it, even if he did not want to do it. Power generally implies an ability to punish the person it is exercised over, if he did not do as he is told to do. The boss can punish the employee by sacking him from his job, just as political authorities can put the citizen in jail if he disobeys the laws of the land.

Authority is the reposition of certain powers in positions in an organization. One may have formal organizational authority, but lack power and influence in the organization.

Influence is the ability to influence persons with or without formal authority to do so. Persons, who have the power of speech, may not have a formal authoritative position in society, yet exercise the ability to get people to do certain things.

In formal organizations, there are different types of authority, such as, line and staff. Line authority is the authority in a position within the organization chart. Staff authority is the authority exercised by those not holding formal positions in the organization’s chart.

Theoretically all the power in the organization is in the hands of the chief executive officer. He then delegates some of his power to his subordinates, who in turn may delegate some power to lower subordinates. For delegation to be meaningful, the person doing the delegating must really permit the person he gave power and authority to, the freedom to act within his given power. However, he must be expected to be accountable for his behavior; if he does not do what is expected of him, and if he does not improve as needed to work within the organizational structure, may be let go. Delegation of power must be real for folks to truly feel empowered by the work organization.

It is generally believed that each supervisor is only able to supervise so many persons, if he is to do an effective job. Some believe that six to twelve persons are the best span of control. There is no hard and fast rule about this matter, for it may depend on individual managers. Some managers are only able to keep an eye on a few subordinates, whereas others can keep an eye on a large number of subordinates. Each organization must know its people, in designing its chain of command.

There is a debate going on whether large organizations should centralize authority or decentralize it. Either end of this argument has its merits. In the nature of things, a bit of both is probably inevitable. Management must be centralized to have effective control, but it must also be decentralized to give subordinates a sense of empowerment to do their jobs. If folks feel told what to do, by people external to them, they tend not to work very hard. Yet workers must be told what to do by their bosses, while being given the impression that they are in charge of their work lives.

Large organizations often form a committee to perform a certain task and then disperse. A committee is a group of persons, usually selected from different parts of the organization, to perform a particular task or a particular project, while still performing their usual line work. Committees are useful ways of pooling expertise from many parts of the organization to solve problems.

There is an academic debate going on as to whether organizations should be flat or hierarchical, vertical or horizontal. This is an idle debate by idle academics. In the real world, persons performing different tasks tend to have different skills. Moreover, persons in an organization tend to possess different levels of information. The vice president of finance is probably more knowledgeable, or should be so, about finance than the janitor. It would, therefore, be silly to expect the janitor to have the same input as the financial manager in making decisions on where to invest the organization’s money or where to borrow money from. The point is that, whereas, democracy seems an ideal social organization, we are not going to have participative democracy in the work place; perhaps we can have an enlightened commitment to the workers’ interests by bosses, and that is the best we can hope for.

HUMAN RELATIONS

The key function of management is to get people to perform tasks, performance of which leads to the accomplishment of organizational goals. Organizational goals are attained through human beings. Therefore, to achieve these goals, human beings must be understood and motivated to do their jobs. Management theories are, in effect, ideas as to how to get people to produce at their best.

Frederick Taylor performed Time and Motion studies, and figured out how best to perform each task needed to be done in a work process, and how quickly it could be done; he then hired those who are best able to perform such tasks within the most efficient time parameters to perform them. If it takes a teller at a bank, approximately five minutes to complete each customers transaction: of depositing or withdrawing money from his checking and/or saving accounts, then test potential tellers and select those who have the capability to perform this task within the expected time parameters. This is what time and motion studies amount to. Clearly, it has some merits, and as such, is still used in hiring and training employees.

Human beings are flesh and blood creatures, not robots. Even if you hire them based on their efficiency, you still have to treat them in a certain manner, for them to perform at their best. George Elton Mayo and the Hawthorne experiment, found that the ambience of the work environment plays a role in workers’ productivity. Such a seeming minor issue, as the lighting in the room and color of the paint on the walls, affects how happy and productive workers are. Thus, the human relations school of management stressed paying attention to human psychological needs, if productivity is to be raised.

Abraham Maslow talked about the hierarchy of needs: physiological, security, social, esteem and self-actualization. Frederick Herzberg posited a hypothesis that says, jobs that offer challenge and opportunity for advancement, tend to motivate people to work harder than jobs that offer their opposite. He suggested combining good wages, security of employment with challenge, if the worker is to be motivated to work hard.

Douglas McGregor postulated that there are two basic types of managers, what he called Theory X and Theory Y. Theory X managers make assumptions that workers are lazy and need to be closely supervised if they are to work hard; whereas, Theory Y managers assume that with trust people can do what they are hired to do on the job.

Clearly this bifurcation of attitudes towards management is unrealistic, for in the real world people need to be trusted, as well as monitored, if they are to do what they are hired to do, and do it well. It is not an either or case, for men are complex creatures and no one approach to them serves them well. Theory X managers may alienate workers but then if workers are not monitored the business may not be there for the employees to be monitored.

More behavioral psychologists divided management into what they called task-oriented managers and people oriented managers. Supposedly the former is interested in the task of the organization and seldom interested in the emotional well-being of the managers. Thus he asks: what can I do to produce good computers, and does not worry about the feelings of his workers. On the other hand, people oriented managers are too preoccupied with the personal needs of the workers, to pay close attention to the technical aspect of management.

Again, this bifurcation of management into two grids is self-defeating, for in the real world, managers must be concerned with both technical and social aspects of management. The jobs needed to done to produce goods and services have technical and engineering aspects to them, and since they are done through people, the psychological needs of people must be paid attention to, also. It is not an either or question. However, it is clear that some managers tend to lean in one direction or the other, whereas excellent managers combine both traits. Morton’s managerial grid is obviously useful in talking about leadership styles.

Fred Fiedler’s contingency Theory suggests that not one-leadership hat fits all; that leadership and working conditions determine what leadership style is called for. In effect, different situations require different leadership styles, and good leaders adjust their style to suit the condition they find themselves in. In the political arena, for example, during emergency times, such as wartime, it is probably that strong-willed leaders are called for. Churchill was probable the best leader for Britain during World War II. It takes a mad dog to check another mad dog. Hitler was a mad dog and required a man unafraid of blood and dying to checkmate him. The softhearted, democratic Neville Chamberlain, was probably more suited for peacetime parliamentary talk-fests, than wartime leadership that required brutality and non-squeamishness in the face of blood, death and dying. Notice that the Great War leader, Churchill, did not make good leader material after the war, and was thrown out of office, as if the people knew that he was not suited for democratic leadership. For one thing, he was an outdated jingoist, who did not read the winds of change blowing through the world, asking for an end to colonialism. In a similar vein, the war loving George Bush did not seem to be an effective economic manager.

In the 1970s, it became clear that the Japanese were onto something that was not happening in the West; after all, the Japanese were outselling the West in such consumer goods as cars and electronics. To understand how they did it, scholars studied the Japanese management style. William Ouchi came up with what he called Theory Z management style. Essentially, he advocated doing what the Japanese were supposed to be doing: transform the work place into a family-like organization, with the leaders acting as surrogate parents, protecting the workers. The fact that there was no real democracy here was overlooked. The benign dictatorship of the Samurai system of social organization, residual in the Japanese social organization, obviously would not work in the West. For now let it be said that fascination with all things Japanese is now passé particularly since the free fall of the Japanese economy in the 1990s.

Whatever mode of management is adopted, the aim is to motivate workers to do their best at doing what they are hired to do. Management tries to improve workers’ morale, to make them identify with their work, and do their best while at it. Obviously not one approach is required to skin a cat. Whatever is necessary to make workers to like their jobs must be done, including such concepts as job enrichment, empowerment, flextime, socio-technical systems, redesigning jobs, management by objectives (MBOs), participatory management, Total Quality Management, and so on. Every decade sees its own management fad; these must be evaluated and some paid attention to, provided the bottom line is there and profit made.

FUNCTIONAL AREAS OF MANAGEMENT

Managers must understand the key functional areas of management: production, accounting and finance, marketing, and human resources.

Production entails the process of converting resources…raw material, capital and human labor… into goods and services.

In those businesses producing goods, production usually means the manufacturing aspect of their business. This area of management is often the domain of engineers and others trained in the world of machines and men.

Managers make decisions about the level of machinery and labor they need to produce their particular goods. They may need to cover some of the following aspects: decide on standardization…the production of uniform products… determine the question of automation or labor intensiveness, purchase of raw material for conversion into finished products, how much inventory of these materials is to be bought, and held in stock etc.

The organization of the production’s department is generally a technical matter, that is, it is determined by the state of the technology in the industry. This involves an idea of the products to be produced, what type of machinery is needed to produce it, and where to obtain them or how to design them, the production process itself (assembly line), plant layout, capacity planning, maintenance of equipment in good shape, planning where to locate plants, where to obtain raw materials, location of markets, work design, work measurement, forecasting of demand for the products produced, inventory management and costs of carrying large inventory versus just in time inventory, scheduling of work to appropriate work centers, purchasing and relationships with suppliers, quality controls, the role of robots in manufacturing, the role of computers in manufacturing, distribution planning, and so on.

Marketing management entails the activities that get the products and/or services of a business organization to the end user. The marketing function involves performing marketing research to ascertain whether there is demand for the goods and/or services to be produced by the business organization. And if there is market for it, what is the nature of that market? What is the target market…. their demographic, lifestyle characteristics, purchasing characteristics, motivation for purchasing the goods and/or services and their available money to do so…markets are further segmented, that is, divided into sub-markets, based on the specific needs of each segment. Marketers develop the marketing mix: the combination of products, prices, promotions, and place in order to satisfy a particular segment of the market.

Markets are divided into capital and consumer goods markets. Capital or industrial goods markets entail the demand of industry, usually businesses, whereas, consumer goods markets entail, those who buy goods that they consume, as individuals. Clearly the two markets have different needs.

Marketing managers usually work very closely with production managers in creating products to be manufactured. This is done for obvious reasons: marketers give realistic feedback as to what type of goods buyers want. Both plan products and the lifecycles of products (product life cycles include: product introduction, market growth, market maturity, and sales decline).

Production mangers and marketing managers work closely to brand, package and label their products. (Brand is the effort to identify the business products by name, packaging is the manner the product is packaged; labeling provides information on the products and its manufacturer). These two managers also work closely in pricing the product.

Pricing entails consideration of many factors, such as the cost of manufacturing the product, break even analysis, demand for the product, markup prices, skimming the market, and so on. Essentially the manufacturer strives to sell his products so that he covers his cost of production and makes profits, but do so in such a manner that buyers are willing to pay the price he is demanding.

Once goods are produced, they have to be promoted, made known to the buying public. This is usually done through promotion mix: mass advertising, personal selling, sales promotions and publicity. Each of these activities has costs attached to it and the marketer chooses what option optimizes benefits for his business.

Once goods are manufactured, they have to be gotten into the hands of their consumers. Distribution channels have to be established. These include: retailers, wholesalers, agents, etc. The idea is to get the product to the consumer in the most cost effective manner. Clearly, the nature of the product affects how it is distributed; some products can be sold directly by the manufacturer, whereas others need agents to do so, and still others need retailers to do so. Whichever mix of distribution channels are deemed optimal, arrangements must be made for the flow of goods from the producer to the consumer.

The most common form of distribution is through the chain retail stores. We go into food stores and buy manufactured and fresh food from all over the world. The manufacturers of these products have arrangements, agreements, with these stores to sell their goods and how these goods are brought into their stores. In typical department stores, like Wal-Mart, products from all over the world are sold. Arrangements are made to bring those products demanded by consumers into the store, on an on-going basis, and to stop carrying those that are no longer demanded by consumers.

Today, selling of goods and services is increasingly done through the Internet, E-commerce. This is a new form of the old practice, of ordering and selling goods through the catalogue and mail. Suppliers, through marketing, advertise their goods on their web pages; buyers order through the internet from these websites, pay with their credit cards, and have the goods shipped to their homes.

Financial and accounting management involves determining the level of funds necessary for operating the business, and ascertaining where those funds are to be obtained.

Manufacturing businesses invest a lot of money on buying equipment (fixed capital-buildings, machines, equipment, furniture, etc). Working capital (the cash used in the daily operation of the business) must be obtained.

Cash flow is the movement of money into and out of your business; it’s the cycle of cash inflows and cash outflows that determines the business’ solvency. Net or free cash flow is the difference between cash inflows and cash outflows. Accounts receivables provide cash inflows and form revenues, while accounts payables use cash outflows and form operating expenses. The difference between them becomes profit.

Businesses sometimes have to borrow money in order to operate. There is short term financing and long term financing.

Short term financing is borrowing that must be paid off in a few months to a year, such as from banks credit lines for the business. (Bank loans are usually secured with collaterals such as the business’ accounts receivables, inventories.) Long-term financing is borrowing that takes several years to pay off in full, such as a mortgage on a building.

Factoring…here businesses borrow money from lenders by selling their accounts receivable to a factor company at a discount; the factor company then collects the money from the businesses’ customers.

Businesses also obtain funds from finance companies and from venture capitalists that take risks in funding business ventures with the hope of making profits in the future.

But by far, the way public corporations obtain most of their financing for long term projects, is through selling stocks to those interested in becoming shareholders in their company. As noted elsewhere corporations are often authorized to sell stocks through the stock market. Loans are also obtained from governments.

All monies coming into a business must be kept track of and how they are spent accounted for. Financial accounting keeps tracks of business revenues and expenditures, and profit or lack of it. This is generally done through bookkeeping (a clerical function that record’s a company’s daily financial transactions, accounts received and accounts paid out).

Management accounting provides managers financial information, usually on a monthly basis, with which they make managerial decisions. This information includes how each unit of the organization is doing, how much money comes in to it, how much flows out of it, and whether it is in the red or in the black. A unit that is in the red, for example, may lead the manager to lay off some workers in order to cut costs.

The accounting process is a critical part necessary for the business’s survival. The balance sheet (which shows the income and expenditure of the business at a particular point in time, usually monthly) is critical in making management decisions, for example, to continue a line of product or to stop producing it, if it is not bringing in sufficient income to cover costs of producing it. Income statements show the net profit or loss from the firm’s operations over a period of time usually a month or year. Budgets state how a business plans to spend its money during a period, usually a year, and how they intend to obtain their income.

Much of budgets are based on forecasting of future revenue streams, hence, have to be adjusted with the reality of actual cash flow during the year. A business forecasts how much in sales it hopes to make, but reality determines its actual sales, which may be more or less, hence, profit or loss.

There are different types of budgets but the two main ones are capital budgets and operating budgets.

Capital budgets cover the cost of capital goods and equipment, and their depreciation and replacement time and cost, and where revenue for such replacement would be obtained.

Operating budgets cover current operating costs: labor costs, manufacturing costs, selling costs, administrative costs and expected sells revenues.

Financial budgeting shows how the business intends to raise funds for planned business expansion, from internal savings or from borrowings?

Corporate borrowings are usually in the nature of stocks and bonds. Stockholders lend money to businesses, on a gamble that companies would make profits in the future and share these profits with the stockholders, investors, by paying dividends.

Quarterly, although it may be less frequently, many large corporations declare their profits or losses, and on that basis elect to pay out dividends or not.

When companies are performing optimally, their stocks go up in value, hence, can be resold at profit by their holders; conversely when they are doing poorly, their stocks go down in value, and may indeed become valueless. Clearly, the buying and selling of stocks is a gamble that requires the buyer and/or his stockbroker to do background research on companies before their stock offerings are bought.

Whereas, bonds are usually the means governments raise money to finance projects they do not have money to finance, larger corporations are these days permitted to also raise money in this manner. Bonds are different from stocks in that the buyer gives the seller a certain amount of money, and the seller promises to pay him a certain annual interest on his money, and to return the entire amount during a specified period of time, when the bond matures.

The securities market (on stocks and bonds, for example, the New York Stock Exchange) provides a daily barometer on how stocks are doing. Some of the major stocks indexes such as the Dow Jones and NASDAQ provide daily feedback on how the stocks registered with them are doing.

Human resources management deals with securing the right personnel a business needs to have in order to produce its product or services effectively and efficiently, compensating them appropriately, training and motivating them to do their jobs well. Human resources is a staffing department, for it is not directly involved in the production of what the business exists to produce. For many years this department performed mostly clerical functions, handling the paperwork for hiring and paying employees. Over time it has evolved into much more, with needs to keep track of the various labor laws that govern management-labor relationship making it more of a managerial function. For our present purposes, personnel managers hire workers for large business outfits. Small businesses do not have the luxury of personnel departments, the overall owner of the business hires whomever he judges able to help him produce the goods he is there to produce, compensates them when they do good jobs and sacks them when they are inefficient.

Human resource planning entails making plans on what personnel the business requires in the future, where to obtain them, how much they will cost and whether the business can afford such costs.

Personnel departments perform job analysis, job specification and job description. They study what functions need be performed by each position in the organization, specify and describe them in specific position descriptions. New employees are given their job descriptions and are evaluated on this basis.

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