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Communication is essential to life and imperative if business is to prosper and survive in a competitive environment. It can be verbal - the written word 1 or Oral - the spo!en word. Visual - the illustrated number Electronic - using a computer communication should be received and understood so we must as! ourselves not what we want but what the audience wants. In business life it's important not only to be efficient but also to loo! and sound friendl%$ confident$ sincere and helpful.
Communication is essential to life and imperative if business is to prosper and survive in a competitive environment. It can be verbal - the written word 1 or Oral - the spo!en word. Visual - the illustrated number Electronic - using a computer communication should be received and understood so we must as! ourselves not what we want but what the audience wants. In business life it's important not only to be efficient but also to loo! and sound friendl%$ confident$ sincere and helpful.
Communication is essential to life and imperative if business is to prosper and survive in a competitive environment. It can be verbal - the written word 1 or Oral - the spo!en word. Visual - the illustrated number Electronic - using a computer communication should be received and understood so we must as! ourselves not what we want but what the audience wants. In business life it's important not only to be efficient but also to loo! and sound friendl%$ confident$ sincere and helpful.
Communication is essential to life and imperative if business is to prosper and
survive in a competitive environment. It can be: Verbal the written word 1 Oral the spo!en word Visual the illustration "umerical the written and interpreted number Electronic using a computer Communication should be received and understood so we must as! ourselves not what we want but what the audience wants. #he term communication s!ills covers a number of defferent areas$ including: spea!ing clearl%$ fluentl%$ convincigl%. understanding and responding to non verbal communication&bod% language'. (roducing effective written communications$ including briefs and presentations. In business life it) s important not onl% to be efficient and do %our *ob but also to loo! and sound friendl%$ confident$ sincere and helpful. (oor communication is the cause of all brea!downs in business relationships. +hen the% tr% to communicate people go through different stages and the lac! of care at an% of them lead to confusion and wasted time and energ%. 1.#he need or desire to communicate with someone else aiming. ,.#he translation of internal thoughts and feelings into an e-ternal means of transmitting them as a coherent message encoding. ..#he transmission of the message&spo!en$ pictorial$ written$ bod% language$ tone of voice$ timing' transmitting. /.#he reception of the message&how and wh% people listen'receiving 0.#he translation of the message to internal thoughts and feelings on the part of the receiverdecoding. 1.#he need or desire to respond to the message that has been sent&thin!ing$ feeling$ planning internall%$ setting ob*ectives'responding. 2 successful communication is meant to beware that the meaning of the message is the responsibilit% of the sender first. 3aving decided what it is that %ou need to communicate and whom %ou are going to communicate with$ %ou then need to consider the impact the information will have will it alarm people$ will it ma!e them more efficient$ irritable$ more comfortable$ resentful$ dafer$ happier$ bored$ more productive$ better informed$ more motivated$ more lo%al4 #he impact that %our communication will have on the productivit% of %our organi5ation has to be a primar% concern mostl% if %ou are the bearer of bad news or %our message is concerned with a change that will affect the wor!ing life of others. #hin! about the 6uestions people will need answers to$ as! %ourself what %ou would feel if %ou were to hear this for the first time$ decide *ust what %ou want %our audience to do after %ou have communicated with them$ thin! about the actions and changes that %our communication will cause. #hen$ %ou have to ma!e %our message of interest to the receiver. #he more %ou can personalise %our communication to fit with the needs and interests of %our audience$ the better that information will be received and acted upon. +e have to list the information that is to be sent and then prioriti5e the points into categories such as: must !now$ important to !now$ helps understanding$ gives e-amples$ nice to !now$ interesting but not important7 this is important when communication is verbal since it is linear and it moves the whole time7 the listener is re6uired to ta!e part in and remember all that was said. 2fter organi5ing our thoughts we put them into words and images.#he% are based on our internal dictionaries$ assumptions$ e-periences$ education$ mood. Clarif%ing the meaning comes ne-t as sometimes words alone are not enough to get the meaning when we deal with complicated concepts or spatial information. , +e thin! at least three times faster than we spea!. It is eas% to mishear$ ignore or miss a great deal of information. So$ written communication is easier to focus on because we can return again to parts that we need to consider carefull%. +hat impression do %ou tr% to give to the people %ou deal with in business4 pleasant$ sincere$ efficient$ confident$ calm$ honest$ s!ilful$ intelligent$ nice $ polite. 8nfriendl%$ sh%$ aggressive$ sleep%$ unclear$ la5%$ dishonest$ clums%$ stupid$ inefficient$ nast%$ unhelpful$ off hand$ rude. 2s!ing 6uestions is something people have to do a lot in business. 9ecide what the 6uestions are that led to each of these answers : 1.:es$ than!s I had a ver% good flight. ,.I)d li!e to see ;r. <arr% if he)s in the office. ..On m% last visit I spo!e to ;rs. 3elen. /.It was ;r. +eber who recommended this hotel to me. 0.I thin! I)d li!e to see round the factor% after lunch. 1."o$ m% husband is traveling with me. I)m meeting him later =.+e)ll probabl% be sta%ing till >rida% morning. ?."o$ this is his first visit7 he has never been here before. a.9id %ou have a good flight4 b.+ho would %ou li!e to see4 c.+ho did %ou spea! to last time %ou came4 d.+ho recommended this particular hotel to %ou4 e.+hen would %ou li!e to see round the factor%4 f.2re %ou traveling alone4 g.3ow long are %ou planning to sta%4 h.3as he been here before4 Imagine %ou)re having dinner with ;r. @ohnson who is visiting %our countr% for the first time. +rite down ten 6uestions beginning li!e this: 2reA4BIsA4 9oA4B9oesA4B 9idA4 3aveA4B3asA4 +ho..4B+henA4B+hereA4 +hatA4B +h%A4 3ow man%...4B3ow muchA4B3ow longA4 +hat do %ou consider difficult andBor en*o%able about tal!ing to: Someone %ou)ve never met before4 2 superior or someone who could influence %our future career4 Someone who is considerabl% older than %ou4 2 foreigner4 2 member of the public4 +hat e-perience did %ou have with a public person4 . +hat does the meaning of a message depend on4 3ow do %ou respond to change4 Principal Comunication Media +ritten OralB2ural Internal E-ternal ;emoranda "otices <ulletins 2gendas ;inutes Ceports 3ouse*ournals Contracts 3andboo!s Detters Circulars Invitations Estimates Euotations 2dvertisements Orders Invoices Statements E-port documents (romotion literature (ress releases 2rticles Ceports Information <oo!lets >ace to faceencounters Interviews <riefing sessions Seminars +or!shop ;eetings Conferences #elephone #eleconferencing Intercom (ublic address s%stem Cadio The Principal Communication Media VisualB(h%sical #elecommunicationB #echnological / Charts 9iagrams Fraphs (hotographs Slides >ilms #elevision Video Overhead pro*ector ;odels Conve%er belts ;essengerB Courier services #ele- #ele te-t >acsimile transmission Electronic mail Voice mail Videoconferencing View data +ide area networ!s Cellular radioB #elephone Cable television Satellite transmission MY EVERYDAY ACTIVITIES I start wor! at the same time ever% da%. I wa!e up onl% when the alarm cloc! stri!es. I go to wor! b% carB undergroundB I wal! I wor! overtime and have ver% short brea!s. I am never late at wor!. I am alwa%s in time. I do not complain about m% wor!. I li!e m% *ob and m% boss. I hate cigarettes and coffee. I share m% office with a smo!er who isAm% husband. I get a lot of important calls. I attend meetings and I tal! with people. I as! 6uestions and I give answers. I ta!e decisions$ I negotiate. I reach agreements$ I create a climate of cooperation or e-pectation. I wor! with mone%. I !now that it bewitches people. (eople fret for it$ swear for it$ devise most ingenious wa%s to get it and to get rid of it. I wor! in the ban!ing s%stemBaccountanc%BmanagementBtradeB I operate with consumerB mar!etB currentB overheadB topB bottomB ceiling&ma-imal' flat&unic'Bfloor&minimal'Bclosing&la inchiderea bursei de valori'Bfair&convenabil'B force account rate&de regie'B!noc! out&deri5oriu'B upset&initial$ de pornire''B price 0 I operate in a Stoc! E-change with securities: mar!etable&usor reali5abileB6uotedBun6uoted I operate with : bearer bond&obligatiune la purtator'Birredeemable bond &neamorti5abila'.Bregistered bond&nominativa'B*un! bond&riscanta$ cu evaluare de credit sca5ut'. I operate with shares: preferenceB ordinar%BdeferredBforteitedB in trust. I do mar!et research and I chec! the mercurial&fluctuanta'B sluggish&activa'B sagging&in scadere'Bstead%&stabila'mar!et. I direct the sales for future deliver%&van5are la termen' I tal! about costs: flat&uniform'overheads&indirect'sun!&investit'capital&de investitie'. I chair meetings and ta!e the floor. I order a ca!e as I li!e to eat sweets. I go home late in the evening$ ver% tired. I have supper and I eat some fruit. I listen to the news on #V. I go to bed and I have nice dreams. I rela- on wee!ends: I go shopping$ I watch #V$ I go to picnic$ I breathe fresh air$ I chat with m% friends$ I rest in the countr%side$ I get awa% from the nois% and dust% town$ I listen to music$ I coo!$ I read the latest boo!s$ I meet m% friends$ I drive m% car. Are you in control of your life? I am !een on m% *ob$ enthusiastic$ bursting with energ%$ confident with m%self. I love new challenges$ I anal%5e problems methodicall%$ I am an ob*ective thin!er$ I am friendl%$ highl% trained$ well informed$ generous$ eas% going$ polite$ Sometimes I am boastful$ uncertain$ embarrassed$ mood%$ anno%ed$ bored$ lac!ing confidence$ reluctant$ incomprehensible I often feel that I am at the merc% of outside forces be%ond m% control. I often feel that life is passing me b%. +hen people praise m% wor! I believe that usuall% the% reall% mean it. I have at least one habit that I can)t brea!. I thin! it)s a waste of time planning ahead because something alwa%s turns up which ma!es me change m% plans. I often dream about wor! problems. I have at least three important leisure interests or hobbies that have nothing to do with m% wor!. I often refuse m% friend)s invitations because I have too much wor! to do. +hen I read newspapers m% mind !eeps wandering bac! to wor! problems. I en*o% meeting new people. I li!e to be successful in m% *ob I want to !now as much as possible about customers. I never believe onl% in luc!. I don)t li!e outdated and inefficient things. I admire smart people I en*o% discussions and to hear other people)s opinions. I find it eas% to choose rich colour combinations in clothes$ furniture$&%ellow happiness$ fulfillment$ positive thoughts$ creativit%$ orangepositive energ%$ well being$ blueinfinite power$ balance$ wisdom$ redcourage$ determination$ energ%$ .. I ma!e important decisions based on what loo!s best to me$ on m% feeling and intuition. I thin! of m%self as someone who dresses sensibl%$ neatl%$ tidil%. 1 I li!e to share attitudes and values with m% partner. I li!e to meet the highest demands and standards. I consider signs important in life:nr.1.creative power$ unit%$ nr.,balance$nr.. the #rinit%$nr./order$ nr.0the figure of man$ nr. 1 universal harmon%$ nr.=cosmic order$ nr.?the initiated one$nr.G eternit%A What are your ea!ne""e" ? I am ine-perienced$ too enthusiastic. "ot ver% confident in using the computers$ sh%$ not a ver% good communicator. Sometimes I have no direction in life$ I feel li!e getting lost. Do you a#ree or di"a#ree? 1. whatever reason people have for living together$ it is a private matter. ,. couples need support of other families$ of societ%. .. %oung passions die and interests change. /. rooms reflect our personalities and colours too. 0. man is confronted with possibilities or alternatives on the basis of which he can pro*ect his life. 1. we are left with the freedom of choice as long as we consider e-perience never limited and never complete. =. we will alwa%s search for temporar% solutions$ we will alwa%s move awa% from the values and authorit% of the older generations. ?. relationships will alwa%s remain incomplete even if with wonderful moments. G. we create versions of realit% out of our desires and when the% clash with the e-ternal world the% disappoint us. 1H. we become complete when we assume the responsibilit% for our own lives. 11. if we fail to loo! into ourselves we remain fragments$ unsatisfied$ incomplete$ empt%. 1,. never loo! into the past in order to find out how to live in the present but alwa%s ma!e the effort to find a new direction in life. 1.. some of us fill the gap in our life b% the help of traditional values and %earn for the stabilit% and securit% of marriage$ others respond onl% emotionall% being IprisonersJ of impulses$ following a logic of the soul. 1/. if given a solution$ we face realit% and act1 creativel% in terms of our own powers and we answer the most important 6uestions in life. 10. sometimes we live out an illusion all our life and reali5e that the wor!ings of fate are enigmatic. +e get strength when we cooperate with it as we live in an universe of oppositions where the vertical has to return to the hori5ontal. 11. sometimes human suffering is far from remed% and we find the ordering of e-istence meaningless so that we come to doubt our own doubts. 1=. sometimes we are too intellectuali5ed and the intellect threatens and stifles the life of feelings and emotions. 1?. the awareness of our divided nature has constantl% unsettled us. 9espite such a divided nature$ we still manage to preserve our balance. 1G. our attempts range from the ridiculous to the sublime to cross even if onl% in dreams$ the boundaries of e-istence. ,H. even if our illusions are swept awa%$ we prefer life)s restlessness. = The Inter$ie >ashions seem to change 6uite rapidl% in interview techni6ues and the onl% rules that applicants should be aware of ma% be Ie-pect the une-pectedJ and Ibe %ourselfJ. In different countries$ different trades and different grades$ the salar% that goes with a *ob ma% be onl% part of the pac!age: per!s li!e a compan% car or cheap housing loans$ bonuses paid$ compan% pension schemes$ generous holida%s$ fle-ible wor!ing hours ma% contribute to the attractiveness of a *ob. Ever%bod% has to go through interviews to be offered a position. Cecruiting a new member of %our staff is li!el% to be the most e-pensive decision %ou will ma!e as a manager. If %ou do it right %ou can ma!e a fortune for %our compan%. ;ost managers inherit a team of wor!ers who !now what the% are supposed to do$ who !now something about %our compan%$ about the wa% %our team wor!s$ about %our customers$ about the business processes within the department. +hat happens when %ou bring an outsider in to this situation4 Some of the possible outcomes if %ou do it wrong are: %ou and %our staff spend ages helping the new team member to get started. :our team norms are threatened and possibl% changed. :ou discover that the perfect 6ualifications on the new emplo%ee)s C.V are no more than h%pe. :ou discover that the new emplo%ee is not fit for what %ou want. So$ the recruitment process has to ta!e into consideration the following: a' *ob advertisement b' C.V c' #he interview <oth parties the interviewer and the interviewee have to communicate effectivel%: open 6uestions$ right answers$ positive opinions. 2 *ob appraisal interview is one of the ma*or tas!s of the leader of a team of people. It enables to: plan the future$ loo! at individual performance$ discuss and plan training and development needs$ contribute to compan% career planning$ salar% planning and *ob progression$ evaluate the efficienc% of past targets and goals$ establish priorities$ identif%$ assess$ solve problems$ loo! at resourceful needs. @ob appraisal needs to be s%stematic if it is to be of an% use. 2ll effective managers have da% to da% or wee! to wee! contact with their team$ the% will also be running up dating sessions where the% inform the team of corporate$ mar!et or local changes in wor!ing$ polic% or law and an% changes that affect the wor!ings of their teams. #hese are da% to da% tas!s of management. #he *ob appraisal interview is an opportunit% for the team member and their manager to thin! about the future months in an organi5ed manner. <efore an appraisal the% both have the opportunit% to thin! in depth about what the% have been doing and where this will lead in the future$ where the success and shortfalls are$ and what ob*ectives the% will set each other in the future. 2ppl%ing good communication practices to the appraisal process will ensure that career progression has the best chance of success from the point of view of both parties. Interviews reall% aren)t out to trap people. #he% evaluate people$ the% !now how to assess %our 6ualities. Characteristics to have a successful interview : ? <e neat and well groomed. <e natural$ friendl%$ rela-ed but not slopp% or overl% casual. <e interested in the wor! involved in the *ob. 3ave definite vocational goals. 2rticulate the goals %ou have in mind. 2ttention to: 1.+hat to wearK Inappropriate clothing or being late can cost %ou the *ob. ,.+hat to bring to the interviewK Select those items from %our bac!ground that demonstrate what emplo%ers loo! for. ..3ow to act. Sit straight$ don)t mumble$ loo! at people when %ou tal!$ don)t smo!e. Part" of an Inter$ie I. The Opening &,0)' #he interviewers will set %ou at ease. #he% will open with eas% 6uestions about %our ma*or interests or b% telling %ou about the *ob of the compan%. II. The Body &1H ,H)' :ou should e-pect 6uestions that give %ou the opportunit% to show %our strong points and of course to raise 6uestions. III. The Close &, 0)' #he interviewer will tell %ou what happens ne-t. Po""i%le Inter$ie &ue"tion": 1.#ell me something about %ourself. ,.+h% do %ou want to wor! for us4 state %our 6ualification state things that separate %ou from other applicants ..9id %ou have an% accomplishments4 pic! up one or two which %ou are proud of. /.+hat is %our class ran!4 +hat 8niversit% did %ou graduate4 0.+here do %ou see %ourself in 0 %ears4 1.+hat would %ou see as the ideal *ob for %ou4 =.+hat do %ou !now about our compan%4 ?.+hat are %our interests outside wor!4 G.+hat are %our strengths and wea!nessesB shortcomings 4 1H.+hen did %ou last lose %our temper4 11.+hat is the best idea %ou have had latel%4 1,.+hat is %our worst fault and what is %our best 6ualit%4 1..3ow long do %ou thin! %ou would sta% with us if %ou were appointed4 1/.+hat ma!es %ou thin! %ou)d en*o% wor!ing for us4 10.+h% are people unluc!% or unsuccessful in getting *obs4 11.If %ou were me what other 6uestions would %ou as!4 2ttention: 9on)t focus on salar%. 9raw the attention that %ou)ll wor! hard with lo%alt%. G +h% are people unluc!% or unsuccessful in getting *obs4 Imagine that a friend of %ours is about to attend an interview. +rite at least ten pieces of advice that %ou would give him. :ou have as suggestions: 1. +ear smart$ formal clothes ,. 9on)t smo!e .. Sit up straight /. 2rrive on time >ind out about %our partner)s career. 2s! about: present *ob wor! e-perience education and training ambitions and prospects for the future its rewards and frustrations
9iscuss how the impression %ou ma% give especiall% to a foreign can be affected b%: a' :our e-pression & smiling$ blin!ing$ frowning$ loo!ing down$ loo!ing straight in someone)s e%esA' b' #he noises %ou ma!e & sighs$ %awns$ !noc!ing loudl% or softl% at a door$ clic!ing a ballpoint penA. ' c' <od% contact & sha!ing hands$ touchingA' d' <od% language & crossing %our arms$ sitting up straight ' e' Clothes and appearance & hair$ ma!e up$ suit$ tie ' f' +hat %ou tal! about & politics$ business$ sport$ famil% ' g' :our tone of voice &sounding cool$ friendl%$ familiar$ serious ' >ind out about %our partner)s career. 2s! about: 1. (resent its rewards and frustrations ,. +or! e-perience .. Education and training /. 2mbitions and prospects for the future Emplo%ees are often given a Iprogress interviewJ some months into a new *ob$ so that the% get feedbac! on their performance so far. (articipants on training courses often ta!e part in similar mid course interviews too. ;a!e a list of ten 6uestions that might be as!ed at such an interview in %our firm. 3ere are some e-amples: +hat have been %our most valuable e-periences with us so far4 +hich parts of the course have been least valuable to %ou4 +hat particular difficulties have %ou had4 3ow will do %ou get on with the other members of the staff4 #r% this 6ui5 with a partner. 1.+hich is the best definition of good conversationalist4 a.Someone who alwa%s has plent% to sa%. b.Someone who has plent% of amusing stories to tell. c.Someone who will listen carefull% to what %ou have to sa%. d."one of them & give %our own definition. ' ,. If someone *ust sa%s Iwhat4J after %ou)ve carefull% e-plained something$ do %ou A a.Fo through the e-planation again using different words4 1H b.>eel that %ou have been wasting %our time4 c.>eel that %ou have not been believed4 d."one of these. .. If someone alwa%s loo!s %ou straight in the e%e this means that he is: a.3onest b.Cude c.>riendl% d.#r%ing to frighten %ou /. If someone sha!es %our hand ver% hard and long$ it means: a.3e is ver% pleased to see %ou. b.3e is tr%ing to show %ou that he is sincere. c.3e is waiting for %ou to sa% something d.3e is reliable and friendl%. 0. If a man wearing *eans and no tie comes into %our office$ do %ou thin! he: a.Isn)t correctl% dressed4 b.Can)t be important4 c.Is 6uite normal4 d.Is someone who has come to fi- the electricit% or something4 1. If %ou are meeting an 2rab client it is polite to: a.Fet straight down to business. b.+ait until he raises the topic of business. c.Stic! to small tal! for the first few minutes. d.2s! him to close the door of his office to prevent interruptions. =. If someone smiles while %ou)re e-plaining something$ this means he is: a."ot sincere. b.3app%. c."ot listening. d.Cra5%.
;anaging our #ime 2re %ou a bus% person4 2re %ou crowded b% events4 9o %ou ma!e %our life manageable4 +ell$ time ma% be infinite$ but each of us has a finite allocation: time is something %ou can)t increase or decrease. 2s far as$ no matter how clever %ou are$ how wealth%$ how industrious$ %ou still get ,/ hours ever% da%. +hat %ou need to do is to carefull% manage the time %ou have got putting it to the best use possible. <efore %ou can save time %ou have to spend some. :ou have to understand time management and ma!e a little effort to do things li!e: plan$ organi5e$ review$ rearrange$ sort$ thin!. Can %ou invest time in time management4 +ell$ most of the words commonl% used about time are mone% orientated: bu%ing$ losing$ saving$ spending$ wasting time. #ime becomes important because %ou can use it to ma!e mone% butAno amount of mone% can bu% %ou one e-tra second of time7 time becomes more valuable the less of it we have: it is li!e most commodities. Food time management can: 11 L give %ou more time to do what %ou want L improve %our availabilit% L improve %our decision ma!ing L improve %our health L improve %our productivit%$ efficienc%$ effectiveness L ma!e %ou easier to live with L ma!e %ou easier to wor! with L ma!e %ou feel more rela-ed L minimi5e the ris!s %ou ta!e L reduce stress Food time management is about setting limits for: Mavailabilit% &how willing %ou are to be disturbed$ to ma!e %ourself available' Mduration &how long %ou spend doing things' Mimportance &how %ou prioriti5e things' Minvolvement &how much %ou do %ourself as opposed to delegate to others' Mstandards &how well %ou do things' Murgenc% &how 6uic!l% %ou do things' +h% are interruptions urgent4& when the phone rings or on there is someone at the door' 9o %ou treat all wor! for a particular person as important4 9o %ou chec! how important something is when %ou receive wor!4 9o %ou limit %our involvement in things4 If we aren)t perfectionists what standards do we set4 Is it important to give priorit% to things that are non urgent4 9o %ou agree with the following statement4 : I%ou need to spend %our time on actuall% doing things$ not being bus%.J K So$ %ou can spend time doing the right things$ doing what %ou li!e doing$ doing what %ou)re good at$ achieving things not *ust being bus%. K #hen$ setting goals is something that we must do because the% increase our motivation$ raise our self confidence$ help us achieve more$ improves our performance$ increase our satisfaction$ improve our concentration. +hich would %ou choose4 L creative &decorate %our house$ landscape %our garden$ write a boo!A.' L career & become a manager$ gain a pa% rise$ wor! part timeA' L educational &gain an e-tra 6ualification$ learn a language$ read more..' L famil% &get married$ spend more time with the famil%$ visit %our relatives more oftenA' L financial &save at least 1HHN ever% month$ reduce mortgage pa%ments$ repa% debts and credit cardsA' L mental &accept %our faults$ be more sociable$ control %our temper more$ stop critici5ing..' L ph%sical &cut down on *un! food$ lose weight$ reduce tea and coffee$ stop smo!ingA L social & have friends round once a month$ read more$ start a hobb%$ ta!e a long wee!end twice a %ear and go awa%..' Di"cu""ion point"' 1. Consider %our personal goals and ma!e a list of these. 9o an% of them conflict with %our wor! goals4 If so$ which is the most important to %ou4 1, ,. 2re %ou aware of %our own limits4 +hich are the%4 .. 9o %ou set unnecessar% high standards$ do %ou aim for perfection4 /. +here do %ou belong to: the optimist$ the perfectionist$ the rebel$ the socialite&important persons' $ the worrier4 9o %ou agree with the following: being too optimistic is being unrealistic optimists are good starters of wor! but poor finishers. perfectionists often ta!e so long to do something that its value is reduced7 the% set impossibl% high standards and then set about achieving them. rebels set their own deadlines with no reference to others7 relish&en*o%' crises and problems as the% can overcome these to show how much in control the% reall% are7 the% are good finishers but poor starters of wor!. socialites li!e to be involved with people7 the% li!e to tal!$ to gather information. the worriers never seem to develop confidence in their own abilit%7 the% ma% avoid certain t%pes of wor! as the% worr% of not being able to do it. #he world would be a ver% simple place indeed if it were an eas% matter to anal%5e what sort of person someone was$ and to handle them accordingl%. It would even be simpler if there were definite t%pes of persons. <ut the% aren)t. In time management terms two t%pes of people cause the ma*orit% of problems and the% are at the two e-tremes: perfectionists and procrastinators. <oth tend to achieve less in a longer time. (erfectionism can be a good thing: societ% has long valued accurac%$ attention to detail$ low error rates. <ut it can actuall% interfere with %our progress and wor!$ to the overall detriment of %our wor!. #r%ing to be perfect can stop %ou feeling satisfied and motivated. Cecogni5ing perfectionism: L all or nothing thin!ing or blac! and white thin!ing. #here is alwa%s one right answer if onl% %ou can find it. L being afraid of disapproval L being afraid to ma!e mista!es L being over sensitive to criticism and the opinions of others L constantl% loo!ing for a mista!e or slip up L difficult personal relationships L difficult !eeping things in perspective L e6uating failure with being worthless L e-pecting too much of others L feeling that what %ou achieve is never enough L living life with a set of rules: a life full of IshouldsJ and Imustn)tsJ L never feeling satisfied with an%thing %ou have done L putting off completing wor! to improve it or get it *ust right L valuing %ourself based on what others thin! of %ou +or!ing with perfectionists: L as! them to help %ou set %our goals so the% can see how others motivate themselves and thin! L be approachable$ so the% encouraged to admit mista!es and not cover them up L be careful of rewarding over achievement L chec! that the% are progressing in the right direction7 stop them focusing on 6ualit% at the e-pense of getting the *ob done L discuss %our own mista!es openl% and constructivel% 1. L encourage them to set goals based on past performance not their best hopes L help them set goals and ma!e sure the% are realistic L let them !now what standard is re6uired L never laugh at them for lac! of success or ma!ing mista!es L openl% discuss priorities (rocrastination &postponement' is li!e perfectionism it)s fault% thin!ing and feelings7 %ou are being dishonest to %ourself when %ou sa% lies such as II)ll do it after this cup of coffeeJ and %ou !now that %ou won)t. Cecogni5ing procrastination: L accepting low standards L being easil% distracted L dawdling L getting side trac!ed L ignoring things in the hope the% will go awa% L I*ust one minute) s%ndromeJ L low priorit% tas!s get in the wa% of high priorit% ones L putting things off until later L underestimating the effort or time needed to achieve a tas! L waiting until %ou are in the mood +or!ing with procrastinators: L compliment and encourage them when the% do ma!e progress L don)t let them get distracted L don)t laugh at their putting things off L help them brea! down large tas!s into phases or sub tas!s L monitor their progress and let them !now the% are being monitored L reward them for progress L set deadlines Di"cu""ion point": 1. Can we understand the causes of perfectionism4B procrastination4 ,. 9o %ou impose %our high standards on others4 .. 9o perfectionists lose trac! of the deadlines4 /. Doo! carefull% through the signs of perfectionism. 3ow man% can %ou see in %ourself4 3ow can %ou wor! on this situation4 +hat about procrastination4 0. +hat is the impact of fearing success$ failure$ the un!nown4 Can it become a cause of procrastination4 1. +hat do lac! of information$ of motivation entail4 =. 3ow can %ou wor! on %our wea!nesses4 Dittle perfectionism can wor! wonders. <ut it isn)t normal thin!ing7 it is fault% thin!ing. <eliefs and feelings are inaccurate7 appropriate wor!ing is far more valuable than perfectionism to an% compan%. The (o% I )i!e (eople have alwa%s wor!ed. So the% have had different occupations along centuries. 2ll professions re6uire much training$ learning and responsibilit%. 1/ #o get a *ob it)s not enough to be good$ but %ou must convince others that %ou are good. :ou have to manage %our own wor! easil%$ to be fle-ible in an% situations$ to come up with new ideas to inspire confidence$ to have well established priorities$ to be a good team pla%er. ;ore and more people have part time *obs such as: bab%sitter$ waiterB waitress$ shop assistant$ paper bo%$ ta-i driver .2mong the advantages of part time *obs there might be: the sense of financial independence self reliance getting to !now other people stronger lin!s to real life #here are *obs in all the fields of human activit%: Industr% : o +or!er o >oreman o #echnician o Engineer o Economist o ;echanic o Computer operator Services L Carpenter L (otter L 3ouse painter L <lac!smith L Fla5ier L Doc!smith L Chimne% sweeper L Cooper L (lumber L Electrician L 9ustman L +atchma!er L 9ressma!er B tailor L Shoema!er L Cobbler L 3atter L Ceceptionist L ;illiner L >urrier L Seamstress L <arber L 3airdresser L 9%er L 9r% cleaner L +aiterB waitress L Coo! L #%pewriter L 2ccountant L Cler! 10 L 9esigner Daw @udge (rosecutor Daw%erB solicitor "otar% Cler! of the court Education and culture +riter (rinter (ublisher <oo!seller <oo!binder @ournalist (roducer (la%wright Stage manager 2ctorB actress (ainter Dibrarian Singer 9ancer ;usician Composer Conductor Sculptor #eacher (hilosopher Dinguist Critic (riest Cameraman Commerce Shop assistant <utcher <a!er Freengrocer Salesman Frocer ConfectionerB pastr% coo! #ransport and telecommunication 9river Sailor Cailwa% man 2irman (ostman (hone operator #elegraph operator 2ir hostess 11 Construction 2rchitect (laner <ric!la%er 3ouse painter 2griculture and forestr% o >armer o >orester o 2gronomist o +oodcutter o +inegrower o >isherman 3ealth L (h%sician L Surgeon L Oculist L 9entist L Chemist L "urse Other *obs (oliceman >ireman Officer Soldier Custom officer I* An"er the folloin# +ue"tion": 1. +ho are those ma!ing and repairing things4 ,. 2dvantages and disadvantages of the teaching profession4 .. +hat does the medical profession re6uire4 /. +hat do computer operators do4 0. +hom does the profession of arms include4 1. +hat could the ideal *ob be4 =. +hat 6ualities would somebod% need for the following careers: police officer$ politician$ *ournalist4 ?. E-plain what a part time *ob means4 G. +hat are the 6ualities that business people loo! for when the% want to emplo% someone4 1H. +hat will %ou loo! for in %our future career4 II. >ind out the correct definition for: a. 2ccountant b. Civil engineer c. Computer operator d. <ab%sitter 1= e. Stevedore f. Economist 1. 2n engineer involved in construction ,.2n e-pert in economics ..2 person 6ualified to !eep a compan%) accounts /.2 person who wor!s in the doc!s loading and unloading goods 0.2 person who translates information into a form computers can understand 1.2 person paid to loo! after a bab% III. +hat careers are the following 6ualities needed for4 9etermination Curiosit% S!ill (atience Shrewdness #enacit% Inventiveness 2bilit% Courage >aith #olerance (erceptiveness Selfdenial (h%sical appearance ;odest% IV. ;atch the following columns containing interest *obs 1. scientific a. plumber ,. artistic b. nurse .. practical c. accountant /. welfare d. academician 0. computational e. novelist V. +hat are the things %ou should do or shouldn)t do if %ou want to get a *ob4 ,' >ind out as much as %ou can about %our future *ob. .' Sit down immediatel% when %ou enter the room. /' <e careful about the clothes %ou wear. 0' ;a!e sure where the interview is since %ou should alwa%s be on time. 1' Stress poor aspects of %ourself. =' 3ave a light meal before %ou go to the interview. ?' 3ave a drin!7 so %ou will pluc! up courage. G' <ring %our school certificates or letters of introduction. 1H' Smo!e if %ou li!e. 11' Critici5e %our last boss. VI. 9escribe %our ideal boss: L StrongB wea! personalit% L Ver% ambitious L Easil% adapting L Food organi5er L ;odest L >unn% L +ell informed L Efficient +hat do %ou thin! of the following situations4 1. :ou don)t li!e %our boss. 1? ,. :ou thin! %our boss is rubbish. .. #he boss is pic!ing on %ou personall%. /. :our boss is pre*udiced against %ou. 0. :our boss seems to thin! %ou)re permanentl% on call. 1. :our boss is having a tough time and is ta!ing it out on %ou. =. :our boss ta!es credit for %our ideas. ?. :our boss blames %ou for their mista!es. VII. 3ow important are each of the following to %ou in providing %ou with *ob satisfaction4 Challenge ;eeting people through wor! Securit% #he respect of colleagues +or!ing conditions Status in %our organi5ation Dearning something new (ersonal freedom E-ercising power 3elping other people <eing promoted ;a!ing mone% VIII. 2dvertisements for *obs var% considerabl% in st%le. #here are advantages and disadvantages in using the d%namic st%le. Imagine that %ou are interested in appl%ing for a *ob. 2nd %ou have come across the following advertisement. Cead the advert and write two more. Sd! International 3as an immediate career opportunit% in %our cit%: S2DES;2" Candidates should have e-cellent verbal communication7 s!ills in both English and Comanian$ strong personalit% and creativit% and age should be under .H. (lease respond in English with %our CV and Detter of 2pplication to Sd! International Comania C( 1,G O( 11 <ucharest Cead the advert and write two more. IO. +rite a Detter of 2pplication having the following as model: 9ear Sir$ +ith reference to %our advertisement in the 2devPrul of October ,. I)d li!e to appl% for the *ob I) m ,1 %ears old and I have graduated a course in Economics and Daw. Dast summer I ac6uired some professional e-perience wor!ing in the accountanc% department of an office automation e6uipment compan%. I am fluent in English$ Ferman and >rench. I am not married and I can wor! on wee!ends too. I enclose a CV and hoping that I will suit %our re6uirements I loo! foreword to hearing from %ou. Sincerel% 2drian Voicu 1G O. 2 CV is essential if %ou are appl%ing for a new *ob or for promotion7 it usuall% accompanies a letter of application. "ame 2ddress #elephone 9ate of <irth 2ge "ationalit% Status Education: School College 8niversit% Cesults obtained (ost school 6ualifications (ost graduate 6ualifications Danguages E-perienceB achievements Interests (ublished wor!s Ceferences ,o Can you Mana#e Difficult People? 2t wor! and in our leisure time we are often confronted b% difficult people and aw!ward situations and the% seem to come at us from ever% angle. 3ow can we cope4 (eople do not change easil%. ,H +hat is a difficult person4 In general the% are people who demonstrate bad behavior$ who don)t care how their behavior affects others and who even use it to their advantage. <eing difficult is effective because it wor!s but in the short term. Dong term relationships need a greater comple-it% of behavior. 9ifficult people hope that due to their behavior we will either start to give priorit% to their wishes or that %ou will leave them alone. 9ifficult people are not restricted to the wor!place. +or!ing relationships have few emotional ties and are more detached whereas within the home environment lur!s a comple- web of histor% and emotions. +hen %ou deal with difficult people effective listening is ver% important7 %ou must be able to tune in to what heBshe is tr%ing to tell %ou. 2 good listening means: to hear the message genuinel% listen to what is being said7 to interpret the message to ta!e in all aspects of bod% language$ tone of voice and interpret their significance7 to evaluate the message7 to respond to it. It is not alwa%s the people that are difficult but sometimes it is the situation. +or!ing relationships and environments bring together a whole host of situations for which %ou cannot alwa%s prepare. 2t some point in %our career %ou will have to deal with difficult situations. #he% come up at the wor!place. 9ifficult colleagues create added pressure. #hen$ conflict can hardl% be avoided. :ou also have to cope with difficult managers and with difficult staffs. 9ifficult people and aw!ward situations are ever%where7 therefore$ running awa% is not reall% an option unless %ou want to live a hermit for the remainder of %our da%s. So$ a far better strateg% is to learn to deal with such situations7 this does not mean being wea! or let ever%one ta!e advantage of %ou7 it means having some firm strategies for dealing with people and situations. 2dvantages: the abilit% to wor! with all people being !nown as a person who can get things done being seen as fle-ible and someone who can Ideliver) whether that be pro*ects or products. 9isadvantages: being restricted as to whom %ou can wor! with being seen as wea! and ineffectual and being given a wide berth&mostl% in times of promotion' being thought difficult %ourself owing to %our inabilit% to wor! effectivel% with others.
2nswer the following: 1. +here do %ou encounter difficult people most4 ,. 3ow can %ou achieve a responsible and effective wor!ing relationship4 .. 2re difficult people at wor! fi-ed in %our life4 ,1 /. 9o %ou find that life will become easier each time %ou deal with a difficult situation4 0. +ho are the people at the top4 1. Is it still possible to bull% people into doing what the% want4 =. +hat !ind of people are the negativists4 ?. 3ow important is bod% language4 G. 9o teams need to celebrate success4 1H. 3ow can %ou win people)s respect and %our own peace of mind4 11. 3ow important is the environment when %ou deal with difficult people4 1,. 3ow important is timing in tac!ling a situation4 2ction (oints 1. #hin! of three things that %ou could do now to ma!e %ou feel more confident about %our abilit% to tac!le the ne-t difficult person or situation which comes along. ,. ;a!e a list of all the people %ou have difficult wor!ing relationships with$ then write one thing %ou li!e about them beside each name. #r% at some point in future to complement them on that one thing it will build bridges for the future. .. Ceflect on the last time %ou were critici5ed b% a colleague. 3ow would %ou handle that if the same thing happens again tomorrow4 2re there lessons %ou have learnt4 /. #hin! of three people who have displa%ed difficult behavior in the last month. +hat did their difficult behavior have in common4 0. 3ave %ou ever seen an%one or been involved %ourself in a bull%ing situation at wor!4 +hat could %ou have done to help or done differentl%4 The Media It is impossible to imagine a modern societ% functioning without the media which remains a powerful means of spreading news and information. +e want to get informed and the #.V.$ the press$ the radio have turned out to be great transformers of minds or societ%. L2nswer the following 6uestions. I. +hich of the media provides most of %our: a.' International information. b.' "ational information. c.' Docal information d.' Entertainment II. If %ou had to rel% on onl% one of the media$ which would %ou choose 4 +h%4 III. :ou)ve heard about a local radio program in which ordinar% people are interviewed about their lives and opinions. Each wee! there is a different theme e.g.. >ear Im% most frightening e-perienceJ 2chievements Ithe proudest moment of m% lifeJ 9isasters Ithe worst holida% of m% lifeJ Deisure Im% hobb% is so important to meJ 2dd possible themes for the ne-t programs. 9o %ou classif% the news when %ou listen to or watch it4 9o %ou prefer listening or watching the news4 IV. Dist the negative effects of #.V. ,, V. ;ention some of %our favourite #.V programs on #.V :ou ma% refer to: documentaries soap operas bulletins topics broadcast commercials L2nswer the following 6uestions: 1. Is #.V. a great transformer of minds or societ%4 ,. 9o %ou remember much from a #.V. documentar%4 .. Can %ou name some ideal sub*ects4 /. 9o %ou thin! that a night)s viewing is wonderfull% forgettable4 0. Is #.V. harmful to children4 1. +hat effect does 6uantit% of viewing have on people4 =. +hat is the most interesting documentar% %ou have seen4 ?. +hat do soap operas have all in common4 G. 2re the news alwa%s interesting4 1H. +hat topics do %ou prefer4 11. +hat happens when %ou watch a boring film4 1,. Can %ou name some commercials that %ou li!ed most4 1.. 9o %ou watch politics4 1/. 2re %ou better informed after watching #.V.4 10. 9o %ou consider that some sub*ects are out of placeB The Pre"" #he newspaper remains a powerful means of spreading news and information. #he purpose of the press is to publish news and give information on politics$ finance$ economics$ arts$ theatre$ science. 2part from the ideological difference$ there is also one in the wa% the% are designed. +e read newspapers$ maga5ines$ revues$ *ournals. #here are dail% newspapers$ wee!l%$ monthl% newspapers 6ualit% and popular newspapers. #he newspaper: instructs informs reports caters entertains. 2 newspaper article is based on: 1. a discussion ,. a description .. a narrative or a combination of more than one of these. #he bac!bone of an article is: a' headlineB heading opening b' paragraphing c' 6uoting ,. d' ending @ournalists aim at covering five +)s and an 3& who$ what$when$where$ wh%$how' about the event. "ewspaper columns e-press opinions. +riters contributing to them are famous and influential and the% adopt their own st%le. #he% sa% that a column can be appreciated after reading it in order to understand the attitudes of its author. (opular headlines fre6uentl% use slang and punning references to an article)s content while 6ualit% newspapers tend to provide more information in their headlines. <oth t%pes of newspaper use common *argon words to save space. Doo! at the headlines and chose the correct answer: 9a% the *ailbirds came out in s%mpath% 1. prisoners a' were e-tremel% cooperative b' planned an escape from *ail c' supported a stri!e d' were released from *ail Da5%) doc gets a rap ,. #he doctor has been a' Critici5ed b' Sued c' >ined d' 9ismissed Shoplift slur on 9oris$ =, .. 2n accusation of shoplifting has: a' ;ade an elderl% woman furious b' ;ade an elderl% woman confused c' 9amaged her reputation d' 9amaged her health L2nswer the following 6uestions: 2re %ou a great reader of periodical press4 +hat sort of articles can a newspaper carr%4 +hat !ind of newspapers do %ou !now4 L Suppl% the suitable words: 2 person who sends news$ articles$ reports to a newspaper who loo!s through the manuscript of an article$ corrects it$ suggests$ changes and prepares it for printing. sets up t%pe for printing who bu%s a newspaper$ a maga5ine regularl% who is engaged in publishing$ editing or wor!ing for a newspaper. <ut: +hatever the #.V.B video industr% might now sa%$ television will never have the impact on civili5ation that the written word has had. #he boo! this little hinged thing is cheap$ portable$ unbrea!able$ can be stored indefinitel%$ can be written and manufactured b% relativel% unprivileged individuals or groups$ do5ens of different ones can be going at the same time$ in the same room without a sound. Ad$erti"in# ,/ 2dvertising is the greatest art form of the ,Hth centur%. It ma% be described as a science of arresting human intelligence long enough to get mone% from it. It stimulates debate and sometimes controvers%. It has a powerful effect on the human consciousness as it is around us on television$ radio$ cinemas$ newspapers and maga5ines. #he wa% we dress$ tal! and behave sends a message to other people. It is about manipulating public opinion and getting a message across to an audience so that the% will behave in a particular wa%. #he advertising industr% has been in e-istence since the end of the 1=th centur% when newssheets carried printed advertisements for products and information. ;erchants returning from vo%ages overseas needed to generate mar!ets for the products the% imported and so the% had to advertise. <% the end of the 1Gth centur%$ advertising was big business. 2dvertisements dominated the newspapers$ posters were commonplace and spawned a whole art form. <ut the new communication technolog% gave the industr% its biggest boost. ;odern advertising e-ploits ever% medium of communication. +e tend to thin! of advertisements in terms of the mainstream media but we also have posters$ billboards$ point of sale displa%s$ direct selling and cold calling b% phone and fa-$ the internet which taps into worldwide audiences. If %ou wor! in advertising $ %ou will for sure be part of an influential band of people who can change public attitudes and behaviour. #he heart of this industr% lies in the advertising agencies. #he large ones are multinationals with in such far flung places as <ei*ing and <uenos 2ires. If %ou wor! in a small agenc%$ %ou ma% be e-pected to do ever%thing$ including account management$ client liaison$ concept development$ creative wor!. In a larger one$ *ob roles will be more structured. :ou will have a specific role and a greater chance of more formal career development. 2dvertising agencies var% in the services the% offer. #he most familiar names are full service agencies but there are also other companies that speciali5e in media services or focus on particular areas of advertising$ such as recruitment or business to business advertising. <usiness need to advertise so that we should learn of the e-istence of different products. 2dvertising is aimed at conve%ing information to potential customers and clients. 2dvertising is used to persuade the public to bu%. 2t the lowest level people need food$ shelter$ warmth and se-. #hen$ people begin to thin! about personal possessions and finall% we move on to egocentricit%. #he ultimate need is for fulfillment. #his would come when we have all that the advertisers sa% we so desperatel% need. >or most of us it seems that that da% will never comeK Sometimes advertisements are misleading. 2dvertisers shouldn)t ma!e untrue statements about their products but the% so often do it. #he% create a demand which would not otherwise e-ist. 2dvertising goes far be%ond #.V. and hoardings$ newspapers and maga5ines$ the% enrich our lives. L 2nswer the following 6uestions: +hat are the arguments for and against modern advertising methods4 2re there an% controls which %ou thin! should be imposed on advertisers4 ,0 Flamour and humour are two of the appeals which ads tr% to ma!e for us. +hat other appeals do the% ma!e4 In what other wa%s$ apart from advertising are we persuaded to bu% one product rather than another4 3ow do national newspapers benefit from advertising4 3ow can window dressing be seen as forms of advertising4 2rguments for advertising It tells consumers about the products that are available$ allowing them to ma!e a wider choice. It encourages competition between firms. <% creating a wider mar!et for products it ma!es large scale production and sales possible. ;edia would be more e-pensive without it. 2rguments against It is e-pensive. It can be wasteful$ sometimes involving the same firm advertising virtuall% identical products against each other. &eg. washing powder ' It can be misleading. It can e-ert control over media. It can put pressure upon people to bu% products that the% don)t reall% need or can)t afford. 2dvertising media "ational newspapers Cegional newspapers Consumer maga5ines <usiness and (rofessional 9irectories (ress production costs (oster and #ransport Cinema #.V$ Cadio M <anners on Internet sites #elevision commercials #he most effective medium for reaching large numbers of people. #he% have to be brief. <ut: #he% cannot be ver% informative and displa% images rather than information. #he% are selective it is hard to reach a particular group of people e-cept for certain programs. Cadio advertising is cheap and can be effective in reaching certain t%pes of people: old people and housewives. -ational pre"" it is e-pensive too but if has a large geographical selectivit% and allows detailed information to be given. ;aga5ines and trade press It is a wa% of reaching a speciali5ed group of customers. #here are maga5ines for almost an% interest and for an% t%pe of product. (osters and hoardings ,1 Effective if good locations can be found. Sales promotions #he% include free gifts$ competitions$ give awa% samples$ special offers. Sponsorship Of the arts$ public wor!s$ sport can be ver% effective in putting a product or compan% name before the public. (ac!aging and displa% In shops7 the% maintain e-isting sales but also encourage first time bu%ers. Q3ere are some advertisements. a. Iwhen %ou can)t sa% good b%eKJ b. Ifrom here to eternit%J c. I%ou !now the name. It)s the face %ou ma% not recogni5eJ Enlarge on them. L;a!e an advertisement for: a. a shampoo b. a drin! c. a boo! d. a restaurant e. a sofa R +rite some adverts that promise: %ou)ll feel happier %ou)ll en*o% life more %ou)ll have a nice holida% %ou)ll be rich %ou)ll be famous R ;a!e an advert as the one below: >riendl%$ humourous bo% ,H$ not ver% good loo!ing but funn%$ see!s nice girl to go swimming$ dancing$ wal!ing. R Complete the following sentences using %our own words: 2dvertising can help a business to AAAAAAA 2 good advertising agenc% will AAAAAAAA 2lthough newspapers and maga5ines AAAAAA One of the wea!nesses of human beings is that AA It is essential that the pac!ing of a product should be AAA R #his is the information about a *ob advertisement:
2sian ;onetar% Institute Computer (rogrammer in the Statistics 9ivision #he successful candidate will have 2 8niversit% degree in economics or statistics +or! e-perience in ban!ing and financial accounts >luent English and ;andarin 2pplicants should send a C.V.$ a recent photo and references from previous emplo%ers to the 2sian ;onetar% Institute (.O. <o- 1=H= ,= L 2nswer the following 1. +hat is 3ello: a maga5ine or a newspaper4 ,. +hich countr% in the world spends the most on advertising: 8.S.2 or @apan4 .. +h% is +illiam Ca-ton famous: he produced the first printed advertisement in England or in 8.S.2. 4 /. 3ow did the earliest advertising ta!e place4 0. +ho invented paper4 1. 3ow do we promote ourselves4 =. +hen did #V advertising come to <ritain4 ?. +hat is advertising industr% entitled to do4 G. +hat is the difference between small and large advertising agencies4 1H. +hat does modern advertising e-ploit4 11. +hat do advertising campaigns bring4 1,. +hat is business to business advertising4 1.. +hat does concept development refer to4 1/. 3ow important is timing in advertising4 10. +hich are the advantages and disadvantages of advertisements on the internet4 ;a!e an advertisement for: 1. :our #own and the Surroundings. ,. 2 ;useum .. 2 Car. /. 2 3%permar!et 0. 2 ;aga5ine Enlarge upon the following: I ;ore than a watch. 2 dream that has come trueKJ I It is not *ust a bro!en vase. It is the silence %ou feel when %our shoppings are being protected with the credit card.J I #he% are the snapshots of a challenge$ the% are alwa%s with usKJ Meetin#" ;anagers spend a lot of time in meetings. In fact the% would argue Itoo much timeJ a meeting S the gathering of a group of people for a controlled discussion with a specific purpose. 1. (eople should call a meeting a' +hen decisions re6uire *udging rather than calculation or e-pertise. b' +hen pooling ideas improves the chances of good decisions. c' If Tacceptance) of the decision is an important consideration for members. d' #o discuss multifaced problems re6uiring different s!ills or specialists. ,. Essential elements of a meeting: a' 2 purpose problem solving idea gathering training b' 2n agenda ,? c' ;embers the chairman presides the meeting. the secretar% the other participants d' 2 result &most resolutions are voted b% a mere show of hands. >or important decisions$ the so called Iconstitutional ma*orit%J is necessar%$ amounting to two thirds of the assembl%. e' 2 report$ the minutes Ever% meeting has an agenda. +hoever controls the agenda controls the meeting. If the agenda is not made public$ the meeting ma% be hi*ac!ed b% private agendas: the result will be confusion$ frustration and failure. 2 written agenda allows ever%one to focus on what the% are to do: before$ during and after the meeting. It acts as a plan of the meeting to aid preparation$ an ob*ective control of the meeting)s progress$ a measure of the meeting)s success. #he responsibilit% for setting the agenda is the Chair)s. #he agenda should follow a natural shape: the most difficult items will be placed in the middle third of the meeting$ when the group)s ph%sical and mental alertness are at their pea!. #he easiest items can be put at the end. #he agenda should also reflect the thin!ing process that we wish to follow as problem solving$ evaluation of information and conflict resolution will need different approaches. 2n agenda contains the following: title of meeting$ date$ time$ venue$ apologies for absence$ minutes of previous meetings$ matters arising from the previous meeting$ other items to be discussed and decided$ reports from subcommittees$ contributions from guest spea!ers$ an% other business$ date$ time and venue of ne-t meeting. ;inutes are considered: a reminder of what happened at the meeting$ a basis for discussion of matters arising at the ne-t meeting$ a guide for non attendees$ a permanent record. #a!ing minutes involves two s!ills: listening and note ta!ing. In a societ% that communicates through visual images$ listening has become a highl% comple- s!ill. ;ost people will be thin!ing and spea!ing at the same time and sometimes the% will all be tal!ing at once. Onl% a small proportion of the words we use carries the information we wish to communicate. ;ost people surround their thoughts with words which e-press feelings$ attitudes to the listeners or their relationship to the group. :ou cannot listen and ta!e notes at the same time7 %our primar% tas! is to understand what is going on: most of %our time in a meeting should be spent listening. :ou should ta!e notes onl% intermittentl%. #he tric! is to be able to note down onl% !e%words but %ou have to be attentive to record information properl%. #he minutes have to be written as soon as possible after the meeting and the% should follow the agenda e-actl%. .penin# a meetin# L Food morning ladies and gentlemen L If we are all here ,G shall we start ma!e a start let)s start I thin! we should start L >irst of all I)d li!e to introduce let me introduce two colleagues from our ;unich office +ould %ou li!e to sa% a few words about %ourselves4 LCight$ than! %ou. L3ave %ou all got a cop% of the agenda4 LIf ever%one has got a cop% of the agenda$ let me first e-plain the purpose of the meeting. L#he purpose B aim B target of the meeting is to A L"ow7 let)s loo! at the agenda in detail. L2s %ou can there are 0 main points B items. LI suggested that we ta!e them in the following order. L2s we have a lot to get through this morning$ can we agree on ground rules4 LI suggest the following AA ;oving to the first point 3anding over to another person <ringing people in & encouraging hesitant spea!ers ' Iwould %ou li!e to add an%thing4J Stopping people tal!ing One at a time pleaseK +e can)t spea! at once. @ohn first$ then ;ar%. +ould %ou mind addressing %our remar!s to the chair4 Could we have some other opinions4 I thin! that)s clear now. +e)ve all got the point. Shall we move on4 If %ou didn)t hear %ou can sa%: L I)m sorr%. +ould %ou mind repeating4 If %ou didn)t understand %ou can sa%: L I)m sorr%. I don)t 6uite follow %ou. Could %ou go over that again4 If %ou feel the spea!er is being vague or imprecise %ou can sa%: L +hat e-actl% do %ou mean b%4 (reventing irrelevance LI)m afraid that)s outside the scope of this meeting. L +e lose sight of the main point. L Ueep to the point. L I thin! we)d better leave that sub*ect for another meeting. Ueeping on e%e on the time L +e)re running short of time. L #here)s not much time left L Could %ou please be brief4 ;oving to the ne-t point L Det)s move on to the ne-t pointK L +ould li!e to introduce the ne-t point4 L +ell$ I thin! that covers ever%thing on that point. Det)s move onK. Controlling decisionma!ing L I)d li!e to propose thatA .H L I)d li!e to propose the following amendment. L Can we ta!e a vote on that proposal4 L 2ll those in favour. Cight4 L 2ll those against. Cight4 L +ell then we agree B with some reservations. L +ell then we agree B unanimousl%. L +ell it seems that we are broadl% in agreement thatA Indicating follow up tas!s. L 9o %ou thin! %ou couldA4 L 3ow about preparing some figures for the ne-t meetings4 Closing L I)d li!e to than! ;r. O V : for coming over from (aris Participatin# in a Meetin# 1.Fetting the chair)s attention. L I)d li!e to comment on that. L ;a% I have the floor for a moment4 ,. 2s!ing for and giving opinions. L I)m convinced that B sure B positive. L I strongl% believe that A L I have absolutel% no doubt. L I definitel% thin! that A. L I reall% do thin! that A L #o m% mind A L 2s I see it A L >rom m% point of view A L 2m I right in thin!ing that A L +ould I be right A L 9on)t %ou thin! that A L 2re %ou absolutel% sure B convinced B that A Sample sentences L In m% opinion we shouldn)t rush into a long term agreement before considering the implications. L I tend to thin! that the loss of !e% personnel has damaged their confidence. L 9o %ou thin! that national advertising is the right wa% to launch our products4 .. 2greeing and disagreeing L I totall% B agree with %ou B accept full%. L I)m in total agreement. L I)m in favour of that. L 8p to a point. L #o a certain e-tend. L :ou ma% B could B be right but A L #hat ma% be so$ but A L I can)t B agree B accept. L I don)t Bagree B accept. L I can)t go along with A .1 Sample sentences: L I have tal!ed to the foremen and the% completel% agree with the idea to set up a 6ualit% circle. L +e are in agreement over the pa%ment terms. L I agree with (eter to a certain e-tend but I still feel that we are e-posing ourselves to unnecessar% ris!s. L I)m afraid we can)t agree to the terms in %our latest offer. (lease reconsider them and get bac! to us. L 2 productivit% bonus for the wor!ers4 I totall% disagree with that t%pe of incentive. /. 2dvising and suggesting L Shall we get started4 L +h% don)t we move to the ne-t point4 L Det)s postpone this till... L I suggest we close the meeting. L +e should meet again ne-t A L +h% don)t %ou present it at the ne-t meeting4 L 3ow about A L I would recommend A L It)s advisable to A L 3e suggested that we anal%5e the threats and opportunities. Sample sentences L I don)t thin! we)ve got enough for all the points in the agreements. L +h% don)t we discuss point / at the ne-t meeting4 L >irst %ou should do an audit of %our present operationsK L #he consultant suggested that we should focus on the threats to our business. 0. Ce6uesting information and action. L Can B could %ou tell me A L +ill B would A L I)d li!e to A L 9o %ou happen to !now A L I wonder if %ou could tell me A 11. +rite a complete report having the following as a model. Ceport ;eeting held on 10 October ,HHH. Docation: 9anavian Insurance Compan%$ Stoc!holm (resent: 8lf Edberg &#reasurer$ 9enavian' self 2genda: Detter of Credit >acilit%. Client is not %et sure about compan% re6uirements for ,HHH. E-pressed worr%$ however$ over the increase in our commissions and estimates that this will cost 9enavian three times as much as before. Client pointed out that the counter value of SEU ?HH million is deposited with us. Currentl% pa%s H.,/W for outstanding volume of standb% letters of credit but changes will mean pa%ing H.=0W flat on this amount. Ce6uested that we loo! into the possibilit% of setting up a trust found with 9enavian)s securities. Volume of letters of credit li!el% to fall 6uite heavil% because of increased charges. I promised to investigate the possibilities of setting up a trust fund and to contact the client earl% ne-t month with our outline proposals. +hat do %ou thin! about the following: ., 1. I#raining and e-perience go hand in hand if we want to reach a high level of responsibilit% in our career.J ,. I;anagers spend too much of their time in meetings and the% ma% be sometimes too confidentJ. .. I9on)t learn from boo!s but from practice and ma!e things happenJK /. I#eam wor! and the !now how offers %ou stabilit%J. 0. J Ever%bod% has to be aware that competition ma!es us tougher and more resourceful.J Mar!et Originall% it was a ph%sical place where bu%ers and sellers gathered to e-change goods and services. #o an economist$ a mar!et describes all the bu%ers and sellers who transact over some goods or services. 2 mar!et is: the set of all actual and potential bu%ers of a product the set of bu%ers and an industr% in the set of sellers. 1' (otential mar!et the set of consumers who profess some level of interest in a particular product or service. ,' 2vailable mar!et the set of customers who have interest$ income and access to a particular product or service. .' Served mar!et the part of the 6ualified available mar!et the compan% decide to pursue. #he compan% ma% decide to concentrate its mar!eting and distribution efforts on Central and Eastern Europe. /' (enetrated mar!et the set of consumers who have alread% bought the goods. If a compan% is not satisfied with current sales it can consider a number of actions. It can tr% to attract a larger percentage of bu%ers from its served mar!et. It can e-pand to other available mar!ets. It can lower its price to e-pand the si5e of the available mar!et. It can tr% to e-pand the potential mar!et b% increasing its advertising. Mar!etin# It is a creative management function which promotes business and emplo%ment b% assessing needs of the end user of products or services$ initiates research and development and produces products or services which can be profitabl% provided to service mar!et re6uirements. It coordinates the resources of production and distribution of goods and services$ determines and directs the nature and scale of the total effort re6uired to sell profitabl% the ma-imum production to the ultimate user. #his is the process of: identif%ing ma-imi5ing satisf%ing consumer demand for a compan%)s products. ;ar!eting a product involves: anticipating changes in demand promotion of the product .. ensuring that its 6ualit%$ availabilit% and price meet the needs of the mar!et providing after sales service. ;ar!eting can be split into four components: 1.research ,.strateg%. ..planning. /.implementation. ;ar!eting and selling influence and control almost ever% part of a compan%)s activities. ;ar!eting is customer rather than product focused. #hat means understanding how ever%thing about %our product or service impinges on the customer. It is not *ust the product itself that counts$ but the wa% in which it is presented$ delivered$ repaired$ replaced. ;ar!eting touches on man% areas of product management7 the mar!eting department will be involved from the ver% beginning of a product)s life in determining its image$ deciding when$ where and how it should be launched and monitoring its success in the mar!etplace. ;ar!et research is based on the idea that if %ou find the customers) needs and wants and then use the information to provide a pac!age that meets these$ then %ou will be no doubt successful. #here are two main t%pes of research: des! &local librar%' and field research &phone research$ written 6uestionnaires$ street interviewing$ face to face interview$ product tests$ consumer panels$ focus groups'. ;ar!eting offers a range of career opportunities at different levels for people who are interested in ma!ing things sell. In a large organi5ation$ the mar!eting function will wor! in tandem with other functions$ such as bu%ing$ logistics$ distribution$ retailing. If this is the chosen field$ then %ou will be wor!ing at the heart of %our compan% and will gain valuable e-perience. ;ar!eting staff ma% wor! on rebranding a product if it starts to loose popularit% or launching the product into new mar!ets overseas. 2ll !inds of products and services are activel% mar!eted these da%s$ even public services and monopolies. #hin! of eight products & goods and services ' that are produced or provided in %our cit% or region and answer the following 6uestions: L +hat competition does each product face4 L +hat is the image of each product4 L +hat is the image of the compan% that produces it4 >ill in the gaps using the words from the list: profitable$. price$ promotion$ need$ image$ design$ place$ product$ creative process$ satisf%. 1. +hat is mar!eting4 ;ar!eting is the AAA.satisf%ing customer needsAA ,.+hat is )the mar!eting mi-)4 It consist of Tthe four ()s): providing the customer with the right ( A. at the right ( AA. presented in the most attractive wa% & (A..' and available in the easiest wa% & (AA'. .. +hat is a product4 It is something customers bu% toAA a AA.. the% feel the% have. #he AA. and the AA of the product are as important as it)s specification. L 3ow strongl% or wea!l% is each of the products mar!eted4 L +here is each product advertised4 e.g. a. 2 brand of beer or soft drin!. b. 2 grocer% product. c. 2n industrial product. ./ d. 2 service e. 2 place of entertainment f. 2 public service g. 2n educational service h. 2 financial service L +hat sort of 6uestions are most useful in a sales meeting4 L +hat answer is each of these 6uestions li!el% to provideB L +hich of the 6uestions are li!el% to give more useful information4 Five %our own e-amples. XIn mar!eting a product we should: L anal%5e statistics L conduct mar!et research L devise a 6uestionnaire L carr% out a mar!et surve% L consider the strengths and wea!nesses L devise a mar!eting strateg% Ldraft an advertisement Comment on the advertisements LIceland as nature intended LSweden refreshing L;alawi the warm heart of 2frica X ;a!e a list of five or more regions or countries that are in competition with %ours. 9esign a 6uestionnaire to find out about people)s attitudes to %our region and to its competitors. #he people %ou as! should rate each destination for its 6ualities on a scale 1 to 1H: Food value for mone% Food entertainment >riendliness Culture Eas% to get to 3ealth and sport 3ospitalit% <eautiful scener% (eace and 6uiet 8ni6ueness 2s! them to describe each place in one sentence li!e this: I+hen I thin! of Sweden I thin! of cold winds and a flat landscapeJ X#he promotion of a product involves considering it as a Itotal productJ7 its brand name$ presentation$ labeling$ pac!aging$ instructions$ reliabilit%$ after sales service. (romoting a product involves developing a I8ni6ue Selling (ropositionJ & 8S( ': the features and benefits which ma!e it unli!e an% of the competing products. #here are / stages in promoting a product &2I92': a' 2ttract the 2ttention of potential customers. b' 2rouse Interest in the product. c' Create a 9esire for its benefits. d' Encourage customers to ta!e good 2ction. X 9id %ou !now that: 1' #he world)s largest advertising agenc% is <ritish SaatchiV Saatchi. .0 ,' #he world)s greatest consumers of coffee are the Swedes. &? !g per person per %ear'. .' #he world)s largest emplo%er is Indian "ational Cailwa%s with , million emplo%ees. /' GGW of all business is @apan and Swit5erland emplo% an average of 10 people. 0' #he world)s biggest manufactures of motor vehicles is @apan. 1' Over N1 billion a %ear is spent on advertising in the 8S2 and the rest of the world is over N1.0 billion. =' #he world)s largest airport is @eddah &b% area' or Chicago &b% number of passengers' ?' ;ost @apanese companies pa% professional trouble ma!ers not to cause trouble at their shareholders) meetings otherwise the meeting is sure to be disrupted. G' #he airport that handles the second largest number of international passengers in the world is Fatwic!. "umber one is 3eathrow. 1H' #he average person over 10 smo!es$ 1$=0H cigarettes annuall%. 11' #he world)s number one e-porting countr% is Ferman%. 1,' #he world)s biggest restaurant chain ;c9onald)s serves about 10 million hamburgers a da% at its GHHH restaurants. 1.' #he world)s largest food compan% is "estle. 1/' #he world)s greatest and busiest port is Cotterdam. 10' #he world)s greatest beer drin!ers are the Fermans. X how would %ou deal with ;r. Call. as he !eeps raising ob*ections to %our products: he sa% the% are too e-pensive$ that he)s worried about %our after sales service$ that %our new technolog% ma% not be reliable$ that %our design ma% not appeal to his customers. X +hat would %ou do if %ou wor!ed in mar!eting for I9entalloJ. 9entallo is a medium si5e firm mar!eting toothpaste and toothbrushes. :our 9a55le toothpaste and (rotect toothbrushes are mar!et leaders in the domestic mar!et$ but due to heav% competition from multinational companies with big advertising budgets %ou are no longer able to reach %our e-port sales targets. ;ar!et research shows that a large proportion of consumers aboard find %our product image is old fashioned and dull though %our prices are lower than the competition. Tra$ellin# (eople travel abroad on business or for pleasure b% road$ b% air and b% sea. #he% travel at their own e-pense or at the firms) e-pense$ the% arrange accommodation$ the% ma!e travel arrangements$ the% even find out the IromanceJ of travel. #ravel is a solitar% enterprise: to see$ to e-amine$ to assess. #ravelling on %our own can be ver% lonel% so even if we crave for a little ris!$ some danger$ an e-perience we should have companions. L +hat are the advantages B disadvantages B of travelling: alone with a companion in a group with a guide4 L Can travel broaden the mind4 3ow4 L 2dvantages and disadvantages of travelling on business. L Spea! about %our e-periences and feelings about: sta%ing in a hotel .1 driving a car abroad traveling b% train visiting new places leaving out of a suitcase eating in restaurants abroad wee!ends awa% from home waiting for a dela%ed flight L +hich are en*o%able$ e-citing4 L +hich are stressful$ anno%ing$ depressing4 L +hat difference does it ma!e if %ou)re on holida% and not traveling on business. L 9o %ou agree or disagree4 ta!e hand luggage not large suitcases. it)s essential to organi5e ever%thing before %ou travel. %ou should ta!e a wal!man and plent% of reading matter. learn as much as %ou can about the customs of the people. it)s important to arrive a da% earlier to give %ourself time to ad*ust and acclimati5e. be careful about local food and drin!. don)t get involved in a political discussion. treat ever%one %ou meet with respect. Inever forget that %ou)re a foreignerJ 2dd some more pieces of advice. L 3ow man% of these tips for travelers are worth following4 never get to the airport too earl% in case the plane is late. alwa%s ta!e a good long boo! to read on a *ourne%. alwa%s tr% to get some sleep on the plane. never ta!e more than one suitcase on a *ourne%. alwa%s tr% to do some wor! on the plane. never drin! alcohol on a plane. %ou can avoid losing an% important document b% !eeping it in %our hand luggage. %ou can save mone% on a hotel accommodation b% getting rooms at a discount through %our travel agent. %ou can avoid dela%s b% ta!ing carr% on luggage onto a plane. alwa%s have some water with %ou. L :ou ma% depend on a travel agent or %our firm)s travel department to ma!e %our travel arrangements but there ma% be times when %ou want to change an itinerar% for a visitor or %ourself. Some phrases %ou might need to use: I want to fl% to ;iami on the 1H of the ne-t month$ returning on the ,H. I)d li!e to reserve a seat on >light number A I)d li!e to change m% reservation on >light no.. I need to get to the airport B railwa% station B as 6uic!l% as possible. One coach class B round trip B one wa% to 3uston. One first class B club class B tourist class return B single. Is it too late to chec! in for flight nr. EHHG4 +hich platform B trac! B gate does the 1.: /H to Dondon leave from4 Can %ou tell me what time flight nr. A is due to arrive B departB 4 L +ho would %ou spea! to in each case to get the information %ou re6uire4 +hat would %ou sa%4 :ou have heard that flight <Y /.1 is dela%ed. .= :ou want a rail tic!et to ;anchester. :ou want a plane tic!et to (aris. :ou are in hurr% to get to the airport. :ou have arrived at the airport three hours before %our flight. :ou have three minutes before %our train leaves. :ou want to ma!e sure of a hotel room in ;adrid before %our flight departs. L 9o %ou !now: where a visitor could go on a free da% or at the wee!end4 when the museums are open4 how a visitor can get tic!ets for a show4 which restaurant to go4 where a visitor can bu% local specialities to ta!e home4 L Imagine %ou)ll welcome two people from the other side of the world who haven)t left their own countr% before. #he%)re coming to wor! with %ou for a few months. ;a!e a list of customs and habits that will seem strange to them and which will be different from their countr%. +hat will %ou e-plain them about: eating public transport shopping wor! entertainments sports 2ccommodation L +here can %ou find accommodation: in comfortable chaletsBvillasB4 private houses B bungalows B4 motelsB holida% camps4 L +hat !ind of hotel do %ou prefer to sta% in on a business trip4 L +hat facilities do %ou !now4 Chose those %ou are interested in: buffet st%le brea!fast fitness centre Bg%mB *acu55i Vsauna secretarial service video movies B#.V. B restaurant serving local specialities coc!tail lounge free car par!ing photocop%ing self service cafeteria ,/ hour coffee shop room service swimming pool lifeguard golf course beach #ravel and hotels have alwa%s been closel% related. +e place hotels in four groups: Commercial hotels providing services mainl% for transients. ;ost of them traveling on business. .? Cesort hotels located in vacation areas providing recreational facilities of their own. Conventions hotels which service conventions meetings usuall% held %earl% of business or professional groups. Cesident hotels where people can rent accommodations on a seasonal basis or even permanentl%. Each hotel has got: a large lounge furnished with settees and chairs. a lobb% with the reception des!. a service bureau. information des!. foreign e-change des!. waiting room with new stands. post office des!. souvenirs shop. lifts. restaurants bars. modern convenience. L #he hotel staff include: manager assistant manager night auditor cashier des! cler! reception cler! bellbo% porter door!eeper chambermaid houseman coo! waiter Bwaitress store!eeper wine steward bartender L +hat sort of rooms can %ou boo! in a hotel. single double suites rooms with bath Bshower room loo!ing out to A L +hat modern convenience can %ou have in a hotel4 central heating laundr% service air conditioning disco L "ame some of the do)s and don)ts of the hotels. Start with: when going out %ou should not forget to leave the !e%s at the des!. %ou must pa% the bill before leaving the hotel. rooms must be vacant b% 1, am on the da% of departure. .G %ou are re6uested not to disturb other people)s rest. complaints should be made to Ceception or to the manager. L 9escribe a hotel that %ou li!ed most. Tra$ellin# %y Train Cailwa%s toda% still carr% the bul! of passenger and goods traffic. It is one of the cheapest wa%s of transporting freight over long distances. #he railwa% station is provided with: 2 waiting room 2n in6uire office (arcels office &heav% luggage is registered and labeled' Deft luggage office <oo! stalls (ost office #elephone booth <oo!ing office Catering facilities & restaurant$ snac! bar$ coffee room$ tea room..' #ime table Shop #he passengers hurr% along the platforms getting on or off the train7 the porters carr% the luggage to the train or push it on their truc!s to the luggage van. #he luggage van is placed behind the engine$ then the mail van and the passenger carriages with smo!ing and non smo!ing compartments$ a dining car. #he passengers) compartments have numbered seats. 2t intervals a guard or a special inspector chec!s the travelers) tic!ets. #he train arrivals and departures are posted up in time$ the passengers being invited to the trains b% loudspea!er. L +hat !ind of trains can passengers get on4 E-press trains >ast trains Slow trains #hrough trains Commuting trains L +hat luggage do %ou usuall% have about %ou4 Dight luggage 3eav% luggage 2 suit case 2 truc! 3and luggage L 8nder what circumstances do %ou boo!4 2 single$ one wa% tic!et 2 return$ round trip tic!et 2 platform tic!et 2 season tic!et L I wonder whether %ou have watched the rush in a railwa% station. (eople loo!ing up members in the #elephone 9irector%. (eople consulting the time table. (eople boo!ing in advance. (eople getting on and off the trains. /H (orters seeing to the passengers) luggage. #he incoming and outgoing trains. #rains pulling out the station and pic!ing up speed. L >ind the definition for each of the words: a. railwa% b. railroad c. railhead d. bul! e. station f. bul!% 1. 8.S. s%stem using trains to carr% ,. end of a railwa% line .. <.E. s%stem using trains to carr% passengers V goods /. large and aw!ward 0. large 6uantit% of goods 1. place where trains stop L 9escribe %our last *ourne% b% train using the following vocabular%: >irst class sleeper #hrough train <oo!ing office Duggage rac! Smo!ing carriage Ceturn tic!et Entrance gate platform #ic!et collector <reath tal!ing landscape 8ni6ue landscapes #o travel light #o run on time #o change times #o dela% #o en*o% #o put out B off the lights #o have a change Tra$ellin# %y Air It is most comfortable and speediest of all means of transport. 2irlines are constantl% improving their services. #he% are concerned about improving chec! in facilities hiring well trained dec!in personnel providing e-cellent in flight services such as: cabin services$ seat comfort$ in flight entertainment$ good catering. It is advisable to boo! tic!ets in advance. :ou can boo! : 2 first class &(' seat 2 <usiness class &C' 2n Econom% class &:' <efore boarding the plane the passengers must have their tic!ets and passports chec!ed$ their luggage inspected$ weighed and tag attached to it. #he passengers can avail themselves of the various services offered b% the airport: /1 the e-change office the dut% free shop the boo! stall the restaurants #he% will be waiting for the announcer calling the flight. #he stewardess will ta!e the passengers to the concrete runwa% where the plane is read% to ta!e off. L +hat sort of classes and tic!ets can %ou boo! on an% flight4 >irst class &(' <usiness &C' Econom% &:' Single one wa% Ceturn round trip 9irect point to point Open dated return 9ated tic!et L +hich are the airport formalities4 >l%ing tic!et chec!ing Duggage weighing Customs control formalities (assport control Securit% chec! L +h% are these necessar% when the plane ta!es off4 >asten %our seat belt Stop smo!ing Disten to the instructions given b% the air hostess L +hat are these for4 #he information des! #he currenc% e-change office #he public address s%stem #elephone booth L Can %ou e-plain4 2ircraft 2ircrash #o board a plane #o boo! a tic!et Chec! in facilities Catering #o hit an air poc!et Diable to dut% "on stop flight (oint to point flight Cunwa% L >ind the definition for the words and e-pressions: 1' 2 direct flight ,' Catering .' Doad factor /' Open dated tic!et 0' Chec! in facilities 1' <rea! even point =' Ceturn tic!et ?' Dong haul /, G' :ield a' a point where sales cover cost but do not ma!e a profit b' one wa% flight c' round trip tic!et d' amount of weighed factor e' long distance f' to boo! a tic!et leaving the date of the return open. g' suppl%ing food read% to eat h' profit i' places where passengers give in their tic!ets for a flight L :ou want to fl% from <ucharest to "ew :or!. <oo! a flight. +rite down a short dialogue. +h% do people prefer to travel b% air4 +hat might a travel b% plane depend on4 +hat aspects are the airlines all over the world concerned about4 The Cu"tom" Sy"tem Customs clearance consists in the following operations of the means of conve%ance to customs units and production of the accompan%ing documents. customs inspection of the means of conve%ance and of the merchandise carried. the chec!ing of customs declarations. #he customs #ariffs are applied when clearing the goods through the customs then customs duties are being charged in conformit% with the guide to the law of Import Customs #ariffs. #he guide enters the goods under several columns: tariff heading and subheading description of the goods rate of dut% Customs bodies should chec! whether the merchandise is in accordance with the customs declaration and transport documents. Customs duties are charged on the customs value of the goods. If the goods fall under customs restrictions the% are liable to duties$ if the% don)t e-ceed the free ta- 6uota the% are un dutiable. "atural persons ma% bring in the countr% personal effects which are dut% free. #he Customs Cegulations prohibits the introduction into the countr% of: arms$ narcotics$ to-ic substances$ radio transmitters and receivers$ documents and printed matter under law restriction. It is prohibited to ta!e out of the countr% securities$ goods that belong to the national cultural patrimon%. 2n% traveler who has items coming under customs restrictions should declare them either orall% or in writing on a special form. L +hat should the officer do in case of contraventions4 fine %ou confiscate %our ob*ects. charge a penalt% for dutiable goods$ for deliberate concealment of prohibited goods. L 3ow can %our passport be4 in order /. needs the entr% B transit visa needs no visa has e-pired L Chose the correct definitions: a. customs b. to go through the customs c. customs clearance d. customs formalities e. customs officers f. customs tariffs g. customs union 1. agreement between several countries that goods can travel between them pa%ing dut%. ,. the government department that organi5e the collection of ta-es or imports. .. to pass through the area of an airport &port where customs officials e-amine goods'. /. documents given b% customs to show that customs dut% has been paid and the goods can be moved. 0. declaration of goods and e-amination of them b% the customs. 1. people wor!ing for the customs. =. list of duties to be paid on imported goods. L ;a!e up a dialogue using the following vocabular%: I came from A I)ll spend a few da%s as a tourist :our passport is in regular order I have no cash Diable on dut% (ersonal effects "o charge on On condition (rohibited goods +e are through with the customs Clearance Cestrictions #o register Visa Money 2ll values in the economic s%stem are measured in terms of mone%. Our goods and services are sold for mone% and mone% is in turn e-changed for other goods and services. Coins are ade6uate for small transactions$ while paper notes are used for general business. +e also have a wider sense of the word Imone%J covering an%thing which is used as a means of e-change. Originall%$ a valuable metal &gold$ silver$ cooper' served as a constant store of value7 even toda%$ the 2merican dollar is Ibac!edJ b% the store of gold which the 8S government maintains. // 2s gold has been universall% regarded as a valuable metal$ national currencies were man% %ears *udged in terms of Igold standardJ #oda% national currencies are considered to be as strong as the national economies which support them. Valuable metal has been replaced b% paper notes. #he% are issued b% governments and authori5ed ban!s and are !now as Ilegal tenderJ. Che6ues and mone% orders perform the function of substitute mone% and are !nown as Iinstruments of creditJ Credit is offered when creditors believe that the% have a good chance of obtaining legal tender. If a man)s assets are !nown to be considerable then his credit will be good. If his assets are in doubt then it ma% be difficult for him to obtain large sums of credit. #he value of mone% is basicall% its value as a medium of e-change or its Ipurchasing powerJ which is dependent on suppl% and demand. #he demand for mone% is rec!onable as the 6uantit% needed to effect business transactions. 2n increase in business re6uires an increase in the amount of mone% coming into general circulation. <ut the demand for mone% is related not onl% to the 6uantit% of business but to the rapidit% with which the business is done. #he suppl% of mone% is the actual amount in notes and coins available for business purposes. If too much mone% is available$ its value decreases and this condition is !nown as Iinflation.J #he unit of English coinage is the pound sterling which is worth 1HH new pennies. #he s%mbol Z is alwa%s placed before the figures. #he abbreviation of IpJ is written after the corresponding figures. #he <an! of England issues ban!notes for Z1$ Z0$ Z1H$ Z0H and Z1HH. there are three bron5e coins [ &half penn%'$ the one and two new penn%$ two copper nic!el coins: the five and ten new penn%. #hen there is the 0Hp. coin. X #he unit currenc% in 8.S.2: dollar a paper bill or a silver coin. ban!notes of N 1$ ,$ 0$ 1H$ ,H$ 0H$ 1HH$ 0HH$ 1HHH coins 1\ 0\ &nic!el'$ 1H\ &dime'$ ,0\ &6uarter'$ 0H\ &half dollar' are made of silver. X 3ow can %ou as! for a price4 L 3ow much is it4 L 3ow much does it come to4 L 3ow much do I owe %ou4 L 3ow much do %ou charge4 L It)s ver% e-pensiveA L It)s rather cheapA L I)m short of mone%$ can I bu% cheaper4 X Sa% whether these statements are true &#' or false &>' L #he 8.S. dollar is a constant store of value. L Instruments of credit are accepted because the% can be converted easil% into substitute mone%. L #he purchasing power of mone% depends upon suppl% and demands. L #he demand for mone% is related to the rapidit% with which business is done. L :ou can earn interest on a current account. L <an!s lend mone% to depositors who need capital. L #he main profits of a ban! come from lending mone% at a fi-ed rate of interest. /0 L ;one% is described as Ili6uidJ because it is compared to flowing water. Ever%one borrows mone%. 2nd when %ou do this %ou improve %our lifest%le. It ma% be a ris! but it also promises great rewards. +here do %ou borrow mone% from4 <an!s are considered to be profit ma!ing machines. #he% come in all shapes and si5es and the% help %ou. Dending mone% becomes one of the main functions of a ban!. It is the interest earned from ban!s that brings in most of the revenue to pa% the e-penses$ including staff salaries of the ban! and give a sufficient surplus to pa% shareholders a dividend and retain funds in reserves accounts for the e-pansion of the ban!. <efore an% loan is granted$ the following 6uestions must be answered b% the customer: how much is re6uired4 the purpose of the loan length of time the advance is re6uested the source of repa%ment +e have the following sources of funds for the Comanian ban!s: ban! deposits&Short term$ long term' borrowed funds own funds&own capital$ supplementar% capital' #he funds that are put out on loans belong to customers. It is their mone% that is put at ris!$ so if a ban! is ma!ing bad or unprofitable loans$ this will be reflected in the deposits. #%pes of credit or loans: 1.Countr% loans.&in order to achieve national$ political$ social and economic goals' ,.Corporate lending.& such as loans for: wor!ing capital and fi-ed assets overdrafts term loans s%ndicated loans revolving credit . #%pes of credits: +e can have: 1. Cevocable credits& ma% be cancelled or amended at an% time without prior notice being given to the beneficiar%' ,. Irrevocable credits&can be cancelled with the agreement of all parties' .. Sight credits&allow for pa%ment to be made as soon as documents are presented' /. 9eferred credits&it allows for pa%ment at a future date without calling for a <ill of E-change'. 0. #ransferable credit& it can be transferred b% the original beneficiar% to one or more second beneficiaries'. 1. Ced clause credits&incorporate a special concession to the beneficiar% allowing the advising ban! to advance a percentage of the total credit amount before presentation of the shipping documents'. =. Cevolving credit&the amount can be renewed or reinstated without specific amendments to the credit being needed'. ?. Stand b% credits&acts as a guarantee b% the issuing ban! to the overseas beneficiar% against defaults b% its applicant customer'. #he main principles of granting credits are: /1 the ban!ing prudence the creditworthiness of the borrowers the credits granted should be profitable both for the ban! and for the borrowers the credits have a destination precise and mandator% which cannot be changed b% the borrowers. credits are granted under guarantees that are written in the credit contract. #he ban! shall reserve the right to verif% its customers.
>orms of (a%ment: 1. Cash& small amounts can be sent in note form ver% easil%$ impractical and e-pensive if in large amounts'. ,. Che6ue&remittance is 6uic! and simple$ e-change ris!s unless issued on appropriate currenc% account$ dela% in receipt of proceeds b% beneficiar% where ban! insists on collection' .. <an!er)s 9raft& issue process is straight forward7 available in ma*or currencies$ e-pensive to purchase$ involves length% formalities including giving an indemnit% to the ban!' /. International ;one% Order&cheap$ issue process is 6uic!$ but appropriate for smaller amounts up to F<( 1HHH or 8S9 ,$0HH..' 0. International (a%ment Order&no limit of amount$ documents can be attached$ pa%ment is inter ban!$ therefore secure$ not appropriate for urgent transfers' 1. #elegraphic #ransfer&6uic!$ no limit on amount$ an e-pensive method' =. Firo Che6ue&ine-pensive$ but can be lost or stolen$ remittance is 6uic! and simple' ?. Firo #ransfer&simple and 6uic!$ number of countries limited' G. (ostal Order&e-change ris! for the recipient$ can be lost or stolen$ number of countries limited'.
,o ca you define a %an! ri"!? It is that ris! that the ban! is being confronted with in its current operations. <an!s are sub*ect to all the ris!s that their customers face. #he most significant is the the credit one that arises from lending to individuals$ companies$ ban!s$ governments. #he main t%pes of ris!s involved in the ban!ing activit% are: 1. #he >inancial Cis!s ,. 9eliver% Cis!s .. Environmental Cis!s >inancial ris!s: Credit ris! Interest rate ris! Di6uidit% ris! >oreign e-change ris! Capital ris! 9eliver% ris!s: operational ris! technological ris! new product ris! /= strategic ris! Environmental ris!s: defalcation economic competitive regulator% Some <ritish authors divide the main ris!s into : 1. product mar!et ris!s ,. capital mar!et ris!s (roduct ;ar!et Cis! credit ris! strateg% ris! ban! ris! operating ris! merchandise ris! human ris! legal ris! product ris! Capital ;ar!et Cis! interest rate ris! li6uidit% ris! currenc% ris! discount ris! basic ris! +e ma% also have: L #he fraud ris! L #he countr% ris! L #he mar!et ris! Electronic /an!in# Ser$ice" Electronic ban!ing essentiall% automated pa%ment b% computer will increase in importance and volume. #he main forms of electronic ban!ing services are: Telephone /an!in# Such a service represents a competitive area and it ma% be either voice activated &i.e. the computer is e-pected to react to customer]s voice and compl% with his or her instructions accordingl%'$ or electronicall% activated & the client spea!s over the microphone of their telephone and dials certain numbers meaning a certain transaction'. #he telephone ban!ing can offer transfers of funds$ pa%ments of regular bills$ applications for loans and overdrafts etc. /an!er" Automated Clearin# Sy"tem #his s%stem is especiall% used for funds transfers between the participating members and essentiall% operates standing orders$ direct debits$ pa%ment of wages$ salaries$ rentals$ trade debts$ etc. <an!ers 2utomated Clearing is supplied with a magnetic tape containing the details of the accounts to be debited or credited. It sorts them into ban! orders and$ then$ it provides each pa%ing ban! with the relevant details$ a printout being also Electronic and Internet 0/a"ed Payment" /? Internet ban!ing is a ban!ing product$ which follows the older solutions li!e e ban!ing. Eban!ing represents a solution which is technologicall% obsolete$ supposing at the client level of that service a phone line and a computer dedicated for such an operation$ able to fulfill technical needs 6uested b% the ban! and to run &e-ecute' a software program necessar% for lie optimal communication with the client]s ban!. In that wa%$ the person who will handle the eban!ing application have to wor! onl% from that computer which it is not ver% good for someone with a d%namical *ob and with man% ph%sical places of wor! even in different localities or countries. 9espite e ban!ing$ the Iban!ing &Internetban!ing' supposes the usage of a computer from wide world on which is installed a browser and an Internet connection. #he performances of such a solution are far awa% better also for the ban! and for the end user &the client'. #he costs are calculated to a number of 1HH ban!s from the 8nited States of 2merica which are using all the channels$ but the costs are represented at a world wide level because the% are common to all the ban!s that promote the electronic pa5ments. +orld tendencies 1. W from the great ban!s are offering Internet ban!ing services and 0G W are offering electronic ban!ing services. "ot all Internet ban!ing institutions are charging the services$ but most of those$ which do$ are starting to use a monthl% subscription for the base services . 11 W from the firsts 10Hth ban!s of the 8nited States of 2merica are offering online ban!ing services$ 10 W don]t have included in their strategies for the future the offer of online ban!ing service and 1G W alread% announced their intention to provide such services b% the end of ,HH1. In ;a% ,HHH$ >orrester Cesearch estimated that b% the end of the %ear ,HH. there will e-ist over ,H million of home users in the 8nited States of 2merica which will use the Iban!ing services$ that means around .H W of the profits obtained from retail. 2t the end of ,HHH$ the specialists from 9ata monitor estimated that at the end of the %ear ,HH0$ around ,HW of the world population would be connected at the Internet. Cegarding Europe$ since ;arch 1G$ ,HH1 the <ritish group Vodafone has announced that the first transaction pilot pro*ect that will use the digital signature using the mobile phone will start in 2pril ,HH1 together with the Cadio Communications 2genc%. #hat announcement was made at a short period of time after the <ritish Fovernment announced that it intended to allow all ph%sical persons to pa% their ta-es throw an electronic environment$ using digital signatures. On @ul% 1G$ ,HH1$ the cutoff time until which all the member state of the European 8nion had to implement the 9irective regarding digital signature e-pired. #he ending of that period will lead inevitabl% to a new beginning in the development of electronic transactions field and in the ebusiness area. 2s a conse6uence of that$ the ban!s renounced at their territoriall% development and instead the% are concentrating on the new products which are based on new technologies and the Internet development. So$ the ban!s are reorienting their investment politics to new technologies. #hat supposes the reconsideration of the concept of territorial networ! of a ban!$ which is about to become an informational networ!. 2t the end$ the new technologies allow the ban!s to be closer to their clients and in the same time to provide them more comfort and a depersonali5ation of the /G services due to the elimination of the classical ph%sical direct relation between the account officer and the ban!]s customer. S+I># #hese initials stand for the Societ% for +orldwide Interban! >inancial #elecommunication$ which is an international organi5ation whose members consist of several hundred of the largest international ban!s. #he societ%$ which was created under <elgian Daw and located in <russels$ was formed to accelerate the transfer of funds and other messages between the member ban!s. . #he s%stem wor!s b% means of a telecommunication lin! between the computer s%stems of the ban!s$ which allows the rapid transmission of messages. #he s%stem is used to e-ecute telegraphic transfers previousl% sent b% cable or telegraph and ma% also be used for international pa%ment ordersBairmail transfers at the discretion of the ban!$ ma!ing for a much faster e-ecution of a customer]s instructions. +hen instructions are transmitted in this wa% the ban! is said to be sending a S+I># message and for telegraphic transfers the phrase used is urgent S+I># message. De-ical Inde- 2dvertising 2dvert anun^ _n 5iar 2dvertisement anun^$ reclamP$ publicitate 2dvertisement canvasser prospector de publicitate 2dvertisement column rubricP anun^uri 2dvertisement department serviciu de publicitate 2dvertisement manager director de publicitate 2dvertisement office birou de primire a anun^urilor 2dvertising agent agent de publicitate 2dvertising appeal atrac^ie publicitarP 2dvertising contest concurs de reclame 2dvertising director% anuar de publicitate 2dvertising e-penditure cheltuieli de publicitate 2dvertising rates tarif de publicitate 2dvertising schedule calendar al anun^urilor 9rawbac! nea*uns >older pliant$ dosar 3oarding. plancardP ;isleading _n`elPtor (oster afi` #arget customer client ^intP #o advertise a face reclamP #o boost a populari5a prin reclamP +ant ads anun^ la rubrica cereri de serviciu ;ass media <lurb pre5entare$ reclamP. <roadsheets 5iar popular Cover copertP. Coverage relatare. >eature rubricP fi-P. 0H 3eadline titlu. 3eadlines re5umatul `tirilor principale. Item articol. @ac!et supra copertP. Da%out aran*area materialului pentru o carte. "ews caster crainic. "ews haw! reporter. "ews release comunicat autori5at. "ews sheet ga5etP de format redus. "ews stand chio`c de 5iare. "ewsbill afi` de 5iar. "ewsbutcher van5Ptor ambulant. "ewsreel *urnal de actualitP^i. Oblituar% anun^ mortuar. (ea! viewing time orP de ma-imP audien^P (ress clipping tPieturP din 5iar. (ress release comunicat de presP. (rinting wor!s tipografie. Cadio schedule programul emisiunulor. Cumour 5von. Script scenariu Se6uel continuare Sets decor S!im a atinge u`or. Snap shot instantaneu Soap opera telenovelP Stunt artist cascador #abloids presP de scandal. #he picture flic!ers imaginea palpaie #he picture is blurred imaginea este estompatP. #he picture is distorted imaginea este deformatP. #he picture washing out imaginea se `terge. #ime signal ora e-actP. #o bribe a mitui #o broadcast a transmite #o browse through a rPsfoi #o cover news a relata$ a comenta. #o hint a face alu5ie. #o issue a edita.. #o reedit a reface #o release a lansa ;ar!et <ase rate curs de referin^P <lue chips stoc! ac^iuni sigure <ond obliga^iune$garan^ie <ond mar!et pia^a hPrtiilor de valoare <rand image imagine de marcP <rand leader cap de serie <ris! pia^a activa Canvasser prospector de pia^P 01 9eferred shares ac^iuni e`alonate 9emand cerere 9emand rate curs la vedere >utures pia^a livrPrilor la termen 3ardening of the futures redresarea pie^ei 3ome demand cerere internP 3ome mar!et pia^a internP ;argin mar*P ;argin in cash acont _n numerar ;argin of profit mar*P de beneficii ;ar!et overt pia^P publicP ;ar!et share cota pie^ei ;ar!et swing tendin^a pie^ei ;ar!et value valoarea comercialP (rices levelled off pre^urile au atins un nivel constant (rices pic!ed up pre^urile sau redresat (rices roc!eted pre^urile au crescut vertiginos Cate of e-change curs de referin^P Cate of interest .rata dobPn5ii Cate of return rata de recuperare Cevenue venit al statului Sales plummetted vPntPrile sau prPbu`itA Sales topped vPn5Prile au depP`itA Securities garan^ii$titluri Securit% valoare$titlu Settlement da% 5i de referin^P Soft mar!et pia^P _n scPdere Stead% demand cerere permanentP Stead% mar!et pia^P stabilP Stoc! account cont de capital Stoc! adventure speculare de ac^iuni Stoc! holder ac^ionar Stoc! on hand stocuri nevandute Suppl% ofertP #erms of suppl% condi^iile livrPrii #o dabble in the stoc!s a *uca la bursP #o ta!e stoc!s a cumpPra ac^iuni 8ncertain mar!et pia^P nesigurP 8nderwriter garant Venture capital capital de risc :ield venit al unei investi^ii #ravelling 2ccommodation gP5duire. 2menit% farmec$plPcere. 2ppeal atrac^ie. 2ppropriate adecvat. 2vailable accesibil. <oo!ing re5ervare. Cler! func^ionar. 0, Chargeable call convorbire ta-atP Commercial hotels hoteluri pentru oameni de afaceri Continental brea!fast mic de*un u`or Convenience confort. Courses feluri de mancare 9iscount price pre^ redus 9iscount bonifica^ie 3alf fare tic!et bilet cu pre^ redus 3eight _nPl^ime @oint destination combinarea a douP destina^ii. @unction _ncruci`are de drumuri Dobb% culoar$ hol mic. Dounge hol. ;aid cameristP. (romotional fares pre^uri promo^ionale Cegistration card registru de hotel Cesort hotels hoteluri _n sta^iuni. Coundabout ocol. Season tic!et abonament Settee canapea. Shallow water apP pu^in adancP Silversmith argintar Soft drin!s bPuturi slabe Spar!ling landscapes peisa*e strPlucitoare. Spic% condimentat Straight ahead drept _nainte #ender ofertP. #ic!et nipper compostor #ic!et window ghi`eu de bilete #ip bac`i` #o accommodate a gP5dui. #o add a adPuga #o cater a se _ngri*i de nevoile cuiva #o chill a rPcii #o chop a tPia #o dip a _nmuia #o disturb a deran*a. #o go sight seeing a vi5ita ora`ul. #o melt a topi #o offer facilities a oferii condi^ii. #o outline a contura #o peel a desco*i #o pour a turna #o provide with a furni5a #o put up at a hotel a se opri la hotel #o season a condimenta #o sha!e a agita #o sprin!le a stropi #o whis! a bate ouPle 8ndercoo!ed crud Vacant liber. +ell sitted comod. 0. +idth lPrgime #o put through a face legPtura ;one% 2ccount cont 2ccount boo! registru de conturi 2ssets active <an! return venitul bPncii <ill of e-change Bdraft cambie <oard of trade returns statisticP comercialP <ounds obliga^iuni <ullion lingou Cash account cont _n casP Cash assets capital _n numerar Cash deposits vPrsPminte _n numerar Cash flow flu-ul numerarului Cash in hand numerar disponibil Che6ue to bearer cec la purtPtor Che6ue to order cec la ordin Currenc% depreciation devalori5are monetarP Current account cont curent 9ebenture bounds obliga^iune cu dobandP fi-P 9eferred pa%ments pla^i _ntar5iate 9eposit account cont de depo5it Earnings venituri E-penses cheltuieli >igure cifrP >inancial bac!ing spri*in financiar >inancial futures contracte pe termen Famble *oc de noroc Fross return beneficiu brut 3ard currenc% valutP forte Interest dobandP Degal tender currenc% monedP legalP Det down declin ;one% chest casP de fier$ seif ;one% in cash bani lichi5i ;one% mar!et pia^P monetarP ;one% on deposit bani depu`i ;one% pressure lipsP de bani Overdraft sold debitor (a% in ship borderou de vPrsPmant (a%ee beneficiar Ceturn venit$ beneficiu$ rambursare Cevenue venit mare$ ca`tig Cevenue assets capital circulant Cevenue office administra^ie financiarP Saving bonds titluri de economii Savings economii #a- return declara^ie de impo5it #enor scaden^a unei obliga^iuni 0/ #o earn a ca`tiga #o get into dept a avea datorii #o grant a loan a acorda un _mprumut #o open an account a deschide un cont #o owe a datora #o save mone% a economisi bani #o settle an account a lichida un cont /1SI-ESS and /1SI-ESSES 00 <usiness is a long term$ highl% repetitious activit%$ fre6uentl% re6uiring people to do the same thing toda%$ tomorrow$ the ne-t da%. ;an% of toda%)s well !nown businesses were started b% one or two people and the ownership of those businesses was ver% simple. It was during the 1Gth centur% that businesses wanted to e-pand and increase the number of owners. #o do this the% needed to sell shares. #o encourage people to bu% shares$ governments around the world passed laws which gave people limited liabilit%. 9uring the ,Hth centur% man% people bought shares in sucessful businesses for the following reasons: to have a share in the profit made b% the business. the hope that a profitable business would attract more and more people to bu% shares and this will ma!e the price rise so that shares could be sold at a profit. #he simplest form of business ownership is the sole trader. 3ere$ one person owns the business$ ta!es all the decisions and ris!s his own mone%. (eople en*o% to be self emplo%ed and the% are happ% to have complete control of their own business. <ut there is no one to share the responsibilities involved in decision ma!ing and raising finance is a problem. Sole traders finance their business through a ban! loan and the ban! will charge a high rate of interest. 2 ban! will ensure that it can get the mone% bac!$ if the loan is not repaid$ b% re6uiring securit% on the loan. Sole traders are liable for an% debts the% have$ even if the% are not the trader)s fault. 2 trader ma% do a *ob for a larger business7 it ma% be worth ,H HHHN but it will not be paid until the *ob is complete. #he sole trader must spend G HHH N on e6uipment$ but when the *ob is complete the larger business closes down and the ,H HHHN are not paid7 still$ the sole trader has to cover the G HHH alread% spent as he has unlimited liabilit%. Sometimes$ a pair of a small group of people will get together to run a business. #his is called a partnership. (artnerships face unlimited liabilit% as sole traders do. (artners ma% put some mone% into the partnership in return for a share of the profits but ta!e no part in the running of the partnership$ do not wor! for it and have bno sa%J in an% decisions.8nder these circumstances$ it is onl% the mone% that has been invested that is liable to be used in order to ap% off an% debts. #his is a silent partner and he has onl% limited liabilit%. #he technical name for both private and public limited companies is *oint stoc! compan%. It means that the stoc! in a compan% is owned *ointl% b% several people. Some business activit% is carried on b% the government and this forms the public sector. (rofit ma-imisation ma% not be the onl% aim of a busines7 in public companies there is a separation of ownership and control$ so that directors and managers ma% run a compan% in their own interests. <usiness is the production$bu%ing$ and selling of goods and services. 2 business$ compan% or firm is an organi5ation that sells goods or services. 2 business ma% be referred to formall% as a concern. #hen$ it ma% be referred to approvingl% as an enterprise in order to emphasi5e its adventurous$ ris! ta!ing 6ualities and business in general ma% be referred to in the same wa%$ in combinations such as free enterprise and private enterprise. 2 business re6uires tremendous effort to get it going and once going$ it re6uires minimum effort to !eep it going. #he role of business is to sta% in business$ providing wages$ goods and services into the communit% and meeting the profit needs of the business and the !e% sta!eholders in the business. #he source of funding and capital is considered to be the main difference between the sta!eholders and the 01 shareholders. In the sta!eholder model$ funding is being supplied through ban! loans. #his means that the% will as! for managerial consideration and response from those running the compan%. In the shareholder model$ stoc!holders advance capital to managers who act as their agents in preauthori5ed wa%s. Shareholdes bu% shares to ma-imise the return on their investment7 the responsibilit% of the manager in a firm is to engage in activities designed to increase the profits$ that is to engage in open and free competition. #o create shareholder wealth$ the management needs to outperform the e-pectations shareholders had when the% made their investment decisions. In the shareholder model of corporate governance$ the focus is on institutional agents monitoring corporate agents in order to enhance the investment prospects of investors. In the sta!eholder model$ the premise is that a compan% is more li!el% to perform well and the shareholders are more li!el% to benefit$ if opportunities are created for the various groups holding an interest in the compan% to enter into binding relationship. #he emphasis in the sta!eholder model is the wa% enterprises are governed while in shareholder model the emphasis is on the wa% enterprises are managed. #he shareholder based entit% is more responsive to changes in mar!et conditions. <oth approaches ta!e account of the issues of board chec!s and balances$ abuse of authorit% and power$ the role of boards$ director rewards and participation in setting standards for accounting$ safet%$ emplo%ee relations and ris! management. In toda%Js business world we have to ta!e into consideration the two models. #he shareholder model encourages a top down$ command and control leadership approach whereas in the sta!eholder model a team based$ shared decision ma!ing$ servant leadership approach is more li!el%. Sta!eholder based governance refers to how the organi5ation ma!es cost effective decisions in terms of wealth creation but with consideration of sta!eholders) rights. Corporations have multiple responsibilities and need to balance competing conditions$ such as long and short term notion of gain$ profit and sustainabilit%$ cash and accounting concepts of value$ democrac% and authorit%$ power and accountabilit%. #his model is more common in continental Europe and @apan. #he micro approach to corporate governance refers to shareholders. #his is concerned with ma-imi5ing wealth creation for shareholders. Control is lin!ed here to profitabilit%$ an 2nglo 2merican model. #hen business ma% be referred to as commerce$ commercial distinguishing the business sphere from other areas such as government or arts or from non mone% ma!ing activities. Darge companies are being referred to as corporations. Corporate is used to describe things relating to a corporation or to corporations. Darge companies operationg in man% countries are multinationals. <ig business can refer to large business organi5ations or to an% business activit% that ma!es a lot of mone%. Small companies are referred to as small businesses or small firms. +hen a private compan% is bought b% the state and brought into the public sector in a sell off$ it is privati5ed. #he first to be sold in a privati5ation programme are often the companies responsible for the public suppl% of electricit%$ water and gas: the utilities. If a compan% 2 owns shares or e6uit% in compan% <$ then 2 holds a sta!e$ holding or shareholding in <. If 2 owns less than half the shares in <$ then it has a minorit% sta!e in <. If 2 owns more than half the shares in <$ it has a ma*orit% sta!e or controlling sta!e in <. If %ou have shares in a compan% %ou are a shareholder. 2 holding or holding compan% is the one that holds sta!es in one or more subsidiaries. If it owns all the shares in a subsidiar%$ then the subsidiar% is a wholl% 0= owned one. 2 holding compan%Js relationship to its subsidiaries is that of parent compan% and the subsidiariesJ relationship to each other is that of sister companies. 2 holding and its subsidiaries form a group. 2 conglomerate is a group containing a lot of different companies in different businesses. Compan% 2 ma% be attempting to gain control of compan% < in a ta!eover bid$ ma%be b% increasing its holding or sta!e in compan% < if it alread% owns shares in <. Compan% < ma!es or launches a bid against compan% 2$ the ta!eover target. If compan% < does not want to be ta!en ober$ the bid is hostile. #here are other wa%s of sa%ing that one compan% is ta!ing over another one and it means that the compan% is ac6uiring another or ma!ing an ac6uisition. In a leveraged bu%out or D<O$ a compan% is ac6uired b% a group of investors$ often financed b% heav% borrowing. #he debt is then paid out of the target compan%Js operating revenues or b% selling its assets. #he borrowing involved inD<Os is often high ris! debt called *un! bonds. D<Os financed b% *un! were fre6uent in the 1G?Hs and after an absence following the e-cesses of that period$ the% are now coming up again. #wo or more companies ma% decide to wor! together b% setting up a *oint venture or alliance in which each holds a sta!e. +hen two companies combine voluntaril%$ the% merge in a merger. #he social role of an% business is lin!ed to what we call as serving the future: sufficient profits to satisf% the business and the sta!eholders meet toda%)s profits needs. <ut as the e-pectations increase societ% has to invest in ideas and technolog% that e-pands the economic base and the wealth of the societ%. 2n essential re6uirement is that each and ever% business strives to achieve profits over and above immediate business needs and the sta!eholders) needs. +ithout this bsurplus profitJ there can be no venture capital. +ithout venture capital$ economic growth will struggle to match population growth and the growth in social e-pectations. 2n% business re6uires true professionalism the courage to care about people$ clients$ career. #rue professionalism means the pursuit of e-cellence. If %ou value something$ then %ou must monitor %our performance in that area$ acept nothing less than e-cellence and activel% wor! to learn what to do differentl% ever% time %ou fall short of e-cellence. >irms must provide help and counsel to those who are encountering difficulties in living uo to their standards$ in order to help them get bac! on trac!. Once professionals have confirmed their core values$ the% need to design s%stems which provide conse6uences for noncompliance. <% leaving each individual professional to decide for himself what level to achieve in !e% value areas$ firms sa% that the compan% as a societ% has no standards that must be adhered to. E-cellence in such areas become a matter of personal professional choice. (rofessionals must live b% the slogan b %ou are allowed to fail$ %ou are not allowed to give up tr%ing.J #he oposite of the word professional is not unprofessional$ but rather technician. #hese ma% be highl% s!illed$ but the% aren)t professionals until the% demonstrate characteristics such as:ta!ing pride in their wor!$ showing a personal commitment to 6ualit%$ reaching out for responsibilit%$getting involved$ loo!ing for wa%s to ma!e things easier for those the% serve$ listening to the needs of those the% serve$ being team pla%ers$ honest$ trustworth%$ lo%al$ open to constructive criti6ues. (rofessionalism is an attitude not a set of competences. 2 true professional is a technician who cares. 2nd if finding people with technical s!ill is usuall% eas%$ finding people who are filled with energ%$ drive$ enthusiasm personal commitment to e-cellence is hard. <ecause real professionalism has little to do with which business %ou are in$ what role within that business %ou perform$ how man% degrees %ou have. 0? It implies a pride in wor!$ a commitment to 6ualit%$ a dedication to the interests of the client$ a sincere desire to help. #raditional definitions of professionalism are filled with references to status$ educational attainments$ noble calling. "ow$ we refer to attitude and character. So$ firms should hire people for attitude and train for s!ill. <eing a professional as!s for treating people as professionals that is invest in them. #hen professional success re6uires more than talent$ it as!s for initiative$ involvement$ enthusiasm$ commitment.<eing good at business development involves nothing more than a sincere interest in clients and their problems and a willingness to go out and spend the time being helpful to them. Success in business life means not onl% good professionalism but effective functioning of the firms$ positive outloo!s. The Secret" of Achie$in# More ith )e"" Some things are li!el% to be considered more important than others. :ou can achieve more with less effort$ time and resources. +e thin! that there is an inbuilt imbalance between causes and results$ inputs and outputs$ effort and rewards. <ut each individual can be more effective and happier$ each profit see!ing corporation can become ver% much more profitable$ each non profit organi5ation can also deliver more useful outputs$ ever% government can ensure that its citi5ens benefit much more from its e-istence. >or ever%one and ever% institution it is possible to obtain much more that is of value and avoid what has negative value$ with less input of effort$ e-pense or investment. 2t the heart of this progress there is a process of substitution. Cesources that have wea! effects in an% particular use are not being used sparingl%. #hose which have powerful effects are being used as much as possible. Ever% resource is ideall% used where it has the greatest value. +herever possible$ wea! resources are developed so that the% can mimic the behaviour of the stronger resources. <usiness and mar!ets have used this process for man% %ears. 2nd so we call for a well !nown principle namel% Ithe 23453PrincipleJ which tells us that a minorit% of causes$ inputs$ efforts lead to a ma*orit% of the results$ outputs or rewards and that our dail% lives can be improved b% using this principle. 2 new wa% to use this principle is the ?HB,H thin!ing$ that is about an% issue that is important to %ou and as!s %ou to ma!e a *udgement on whether the principle is wor!ing. #his is the dail% life $ non 6uantitative putting into practice of the principle. It is used to change behaviour and to focus on the most important ,H per cent. It wor!s when it multiplies effectiveness. 2ction resulting should lead us to get much more from much less. +hen using this principle we do not assume that its results are good or bad or that the powerful forces we observe are necessaril% good. +e decide whether the% are good and either determine to give the minorit% of powerful forces a further shove in the right direction or to wor! out how to frustrate their operation. <% putting it into practice$ this principle implies that we should do the following: celebrate e-ceptional productivit%$ rather than raise average efforts. loo! for the short cut$ rather than run the full course e-ercise control over our lives with the least possible effort be selective strive for e-cellence in few things$ rather than good performance in man% 0G delegate or outsource as much as possible in our dail% lives and be encouraged rather than penali5ed b% ta- s%stems to do this choose our careers and emplo%ers with e-traordinar% care onl% do the thing we are best at doing and en*o% most loo! beneath the normal te-ture of life to uncover ironies and oddities in ever% important sphere wor! out where ,H per cent of effort can lead to ?H per cent of returns calm down$ wor! less and target a limited number of ver% valuable goals where the ?HB,H principle will wor! for us$ rather than pursuing ever% available opportunit% ma!e the most of those few Jluc!% strea!sJ in our life where we are at our creative pea! and the stars line up to guarantee success. #he ?HB,H (rinciple applied to business has one !e% theme to generate the most mone% with the least e-penditure of assets and effort. #he classical economists of the OIOth and OOth centur% developed a theor% of economic e6uilibrium and of the firm that has dominated thin!ing ever since. #he theor% states that under perfect competition firms do not ma!e e-cess returns$ and profitabilit% is either 5ero or the normal cost of capital$ the latter usuall% being defined b% a modest interest charge. #hen the theor% of the firm goes li!e this: in an% mar!et$ some suppliers will be better than others at satisf%ing customer needs. #he% will obtain the highest price achievements and the highest mar!et shares. ;ore than this$ the ob*ective of ?HB,H thin!ing is to generate action which will ma!e sharp improvements in %our life and that of the others. #hin!ing escapes from the linear logic trap b% appealing to e-perience$ introspection and imagination. If we are unhapp% we do not worr% about the pro-imate cause. +e thin! about the times we have been happ%$ we do not loo! for causes of failure$ we imagine and then create the circumstances that will ma!e us both happ% and productive. What do you thin! a%out the folloin# in"i#ht" for our per"onal life' ?H per cent of achievement and happiness ta!es place in ,H per cent of our time. Our life can be affected b% a few events and a few decisions. #he decisions are often ta!en b% default rather than conscious choice7 we let life happen to us rather than shape it7 we can improve it b% admitting the turning points and b% ma!ing the decisions that will ma!e us happ% and productive. #here are alwa%s a few !e% inputs to what happens and the% are often not the obvious ones7 if the !e% causes can be identified and isolated we can ver% often e-ert more influence on them that we thin! possible. Ever%one can achieve something significant. #he !e% is not the effort but to find the right thing to achieve. :ou are no doubt more productive at some things than at others but one have to dilute the effectiveness of this b% doing too man% others where our s!ill is nowhere near as great. #here are alwa%s winners and losers and alwa%s more of the latter. :ou can be a winner b% choosing the right competition$ the right team and the right methods to win. 1H ;ost of our failures are in races for which others enter us. ;ost of our success comes from races we ourselves want to enter. +e fail to win most races because we enter too man% of the wrong ones: their ones$ not our ones. >ew people ta!e ob*ectives reall% seriousl%. #he% put average effort into too man% things$ rather than superior thought and effort into a few important things. (eople who achieve the most are selective as well as determined. ;ost people spend most of their time on activities that are of low value to themselves and others. #he ?HB,H thin!er escapes this trap and can achieve much more of the few higher value ob*ectives without noticeable more effort. 2n important decision is the choice of allies. 2lmost nothing can be achieved without allies7 but most people do not choose them carefull%. Some of us have too man% and do not use them properl%. ?HB,H thin!ers choose a few allies carefull% and build the alliances carefull% to achieve their specific ob*ectives. ;one% used rightl% can be a source of opportunit% to shift towards a better lifest%le. >ew people spend enough time and thought cultivating their own happiness. #he% see! indirect goals&mone%$ promotion'$ that ma% be difficult to attain and will prove to be e-tremel% inefficient sources of happiness. 3appiness not spent toda% does not lead to happiness tomorrow. It will atroph% if not e-ercised. #he ?HB,H thin!ers !now what generates their happiness and pursue it consciousl%$ cheerfull% and intelligentl%$ using happiness toda% to build and multipl% happiness tomorrow. #he logic of professional success leads to ever greater professional demands. #o succeed %ou must aim for the top. #o get there$ %ou must turn %ourself into a business. #o obtain ma-imum leverage$ %ou must emplo% a large number of people. #o ma-imi5e the value of %our business$ %ou must use other people)s mone% and e-ploit capital leverage to become even larger and more profitable. If %ou decide which shares to bu% it is good to speciali5e in an area in which %ou consider %ourself an e-pert. (ossibilities are almost endless7 %ou could speciali5e in shares of the industr% in which %ou wor! or of %our hobb%$ %our local area or an%thing else %ou are interested in. if %ou li!e shopping %ou might decide to speciali5e in the shares of retailers. #hen$ if %ou notice a new chain springing up$ where new store seem to be full of !een shoppers$ %ou might want to invest in those shares. #he !e% to ma!ing a career out of an enthusiasm is !nowledge. :ou must !now more about an area than an%bod% else does7 then wor! out a wa% to mar!et it$ to create a set of lo%al customers. It is not enough to !now a lot about a little. :ou have to !now more than an%bod% else$ at least about something. :ou should not stop improving %our e-pertise until %ou are sure %ou !now more$ and are better in %our niche than an%bod% else. #hen$ reinforce %our lead b% constant practice and do not e-pect to become a leader unless %ou reall% are more !nowledgeable than an%one else. ;an% %ears ago$ 2ristotle said that the goal of all human activit% should be happiness. It seems that we haven)t listened too much to him. (erhaps he should have told us how to be happ%. So$ he could have started b% anal%5ing the causes of happiness and unhappiness. 3appiness is profoundl% e-istential. (ast happiness ma% be remembered or future happiness planned$ but the pleasure it gives can onl% be e-perienced in the InowJ. One of the ?HB,H h%pothesis would be that ?H per cent of 11 happiness occurs in ,H per cent of our time. It is interesting that those who are happ% with most of their lives are more li!el% to be happier overall7 those whose happiness is concentrated in short bursts are li!el% to be less happ% with life overall. 2re there some wa%s to be happier4 Identif% the times when %ou are happiest and e-pand them as much as possible. Identif% the times when %ou are at least happ% and reduce them as much as possible. Or : spend more time on the t%pe of activities that are ver% effective at ma!ing %ou happ% and less time on other activities. start b% cutting off the spots of unhappiness$ the things that tend to ma!e %ou activel% unhapp%. #he best wa% to start being happier is to stop being unhapp%. :ou have more control over this b% avoiding situations where e-perience suggests %ou are li!el% to become unhapp%. for such activities that are ineffective at ma!ing %ou happ% it is good to thin! s%stematicall% of wa%s that %ou could en*o% more. b% cultivating habits of optimism we can have a happier life as optimism is an ingredient for both success and happiness. we must sometimes change the wa% we thin! about events7 we can train ourselves to brea! the self reinforcing pattern of depression b% simple steps such as see!ing out compan%$ changing our ph%sical setting or forcing ourselves to e-ercise. we can change the wa% we thin! about ourselves7 we can ma!e ourselves happ% or unhapp% b% the wa% we decide to feel. +e must ma!e the choice that we want to be happ%. +e owe it to ourselves and to other people too. 2 positive self image is ver% important$ a sense of self worth can and should be cultivated7 %ou !now that %ou can do it: give up guilt$ forget about %our wea!nesses$ focus and build on %our strengths$ remember all the good things %ou have done$ all the small and big achievements. we tell ourselves stories about us. +e have to do this and we will increase the sum of human happiness b% starting with ourselves and radiating out to others. we can ma!e ourselves happier b% changing events we encounter and that ma!e us depressed or miserable. we can become happier b% changing the people we see most& the amount of time spend with them has to be changed'. 1, Dialo#ue Richard 6 the reporter' Food morning ;r. Osborne$ than! %ou for being so !ind to me and give me some answers. Mr* ."%orne' I am available for onl% ,H minutes because I am meeting the Compan% e-ecutive. Richard' +ould %ou be so !ind and tell me if there are secrets for successful businessmen because people wonder how %ou managed to become in such a short time a well !nown businessman. Mr* ."%orne: +ell$ first %ou have to be open minded and e-plore ideas$ to aim for the top. :ou must turn %ourself into a business. :ou must use other people)s mone% and e-ploit capital leverage. Richard' 9o %ou thin! that professionals have to be ver% close to %ou4 Mr* ."%orne: :ou need them to get e-cellence and then mone% will come$ no doubt. Cichard: +h% is strateg% important4 Mr* ."%orne: If %ou arrive at a useful business strateg% %ou can be successful and raise profit. Richard' +here are %ou ma!ing the most mone%4 Mr* ."%orne' I am attentive to long term investments when the stoc! mar!et is low$ I build m% investments on e-pertise$ I consider the merits of the emerging mar!ets$ I run m% gainsA Richard' +hat is the !e% to understanding and driving up profitabilit%4 Mr* ."%orne: Competitive segments as parts of our business where we face different competitors or competitive d%namics. Richard' +hat does business re6uire4 Mr* ."%orne: 9ecisions tac!ing and anal%sis. Since 1G0H business has been blessed b% management scientists and anal%tical managers incubated in business schools$ accounting firms and consultancies who can bring anal%sis to bear on an% issue. Richard' Can %ou wor! less$ earn and en*o% more4 Mr* ."%orne: :es$ %our thin!ing has to be strategic$ %ou have to be ambitious and trust %our own values. Richard' 2re %ou happ%4 If so$ what ma!es %ou be happ%4 Mr* ."%orne: I have found two wa%s to be happ%: first to identif% the times when %ou are happiest and e-pand them as much as possible$ and to identif% the times when %ou are least happ% and reduce them as much as possible. Richard' #han! %ou for %our time given and I wish %ou a prosperous life. 1. Enlar#e upon the folloin#' 7* 3appiness is a dut%. +e should choose to be happ%. +e should wor! at happiness. 2nd in doing so$ we should help those closest to us$ and even those who *ust stumble across us$ to share our happiness. 5* #ime is the benign lin! between the past$ present and future. #ime !eeps coming round$ bringing with it the opportunit% to learn$ to deepen a few valued relationships$ to produce a better product or outcome and to add more value to life. +e do not e-ist *ust in the present$ we spring from the past and have a treasure trove of past associations$ and our future is immanent in the present. 8* One good rule for being successful is: Jreali5e that !nowledge is powerJ. Do you a#ree or di"a#ree' 1.2n essential ingredient of a happ% da% is mental stimulation$ as well as a spiritual and artistic one. ,. Dac! of control is the root cause of much unease and uncertaint%. .. Ob*ectives that are too eas% will lead us to be complacent$ accepting mediocre performance. #hose which are too tough lead us to self fulfilling$ self perceptions of failure. /. Dife)s unplanned contribution should be incorporated into our own plan so that it can proceed to an even higher level. 0. (eople with low self esteem and self confidence are a nightmare to live with$ however much mutual love abounds. 1. ;ost of the satisfaction %ou draw from all of %our friends will be focused in %our relationship with a small number of close friends. =. 2 short cut to lasting happiness is to evolve the lifest%le %ou and %our partner want and this re6uires of course a harmonious balance between %our wor! life$ home life and social life. ?. #he impact of the 6ualit% revolution on customer satisfaction and value$ and on the competitive positions of individual firms is trul% great. G. #he information revolution has a long wa% to run. 1H. Cause and effect$ input and output operate in a non linear wa%. :ou do not usuall% get bac! what %ou put in7 %ou ma% sometimes get ver% much less and sometimes get ver% much more. 11. #he real world comprises a mass of influences where cause and effect are blurred$ where comple- feedbac! loops distort inputs$ where e6uilibrium is fleeting$ where there are patterns of repeated but irregular performance$ where firms never compete head to head and prosper b% differentiation$ where a few favoured souls are able to corner the mar!et for high returns. #his principle can help people get a great deal more out of their lives$ to raise their effectiveness and happiness$ to boost profits and what leads to profits. It is a practical tool for ma!ing a more sensible world. <usiness leaders who observe the 1/ principle at wor! and see that ,H per cent of products or revenues are producing ?H per cent of profits and that ?H per cent are contributing onl% ,H per cent of profits do not shrug their shoulders. Sensible and profit ma-imi5ing entrepreneurs do something to correct the imbalance7 the% ma!e the reall% productive ,H per cent of activities a larger proportion$ the% use the ?HB,H principle in the pursuit of progress to improve on realit% as progress relies on finding a better wa% to do ever%thing. "ow we do not prefer life to be 6uiet$ stable or unaccountable. "ow the competition is ver% tough$ and so we strive for solutions and for efficienc% in all domains. 2n% good business as!s for good and trustful professionals developing personal career strategies caring for the genuine clients cost reduction and service improvement good mar!eting strateg% the right management the valuable negotiation stages the appropriate funding finding the best solutions in order to increase profit stic!ing to the rule of the few: the search for the high product 6ualit% using technolog% at its best a good fitting into the world courage in entering a business$ faith in progress$ in the great leaps forward$ in man!ind)s efforts to improve life. creativit% and determination ;ore than these all$ I do thin! that we have to ponder over the following: 9 :od play" dice ith the uni$er"e* /ut they;re loaded dice* And the main o%<ecti$e i" to find out %y hat rule" that ere loaded and ho e can u"e them for our on end"=> Di"cu""ion point"' 1. 3ow can development in business life be carried out4 ,. Is life different for a businessman4 .. +hat do businesses operate with4 /. 3ow important are trust and confidentialit%4 0. +hat do we e-pect from a professional4 Enlar#e upon the folloin#' 1. It is better to ma!e the wrong decision than to ma!e no decision at allK ,. Support an% of %our views regarding true professionalism with e-amples from %our own e-perience. .. Ever%bod% begins at the bottomK /. #ac!ling challenges in business life is not eas% at allK 0. #here will alwa%s be a time for healing.... 10 11 Additional Voca%ulary #o set up in a business a se lansa _n afaceri <id ofertP <idder licitant <ond obliga^iune <usiness forecast progno5P economicP <usiness data processing informaticP de gestiune <usiness assets active comerciale <usiness environment mediu de afaceri <usiness e-penditure cheltuieli de repre5entare <usiness outloo! prespective economice <usiness manager director comercial Corporation earnings veniturile societP^ilor pe ac^iuni Corporation income ta- impo5it asupra veniturilor corpora^iilor Corporation sole corpora^ie individualP Corporate ac6uisition achi5i^ie de firmP Corporate ban!ing servicii bancare pentru firme Corporate bod% persoanP *uridicP Corporate bond obliga^iune emisP de o societate Corporate e6uit% capital socialB fonduri proprii Corporate securities titluri de societate Corporate venturing furni5are de capital de investi^ie de cPtre o companie altei companii E6uit% capital al ac^ionarilor _ntro companie E6uit% shares capital investit _n ac^iuni cu drepturi asupra profitului #o hold a cuprinde$a re^ine$a ^ine sub control$a organi5a$ a men^ine$ a se aplica. 3older de^inPtor$ purtPtor$ proprietar$ concesionar @un! bonds obliga^iuni riscante @oint venture societate mi-tP Interest dobandP Deverageputere$ influen^P$ randament$raport dintre crean^e `i capital$ indice de _ndatorare$ mi*loc de ma*orare a profitului. Deveraged bu%out preluare asistatP$ pe credit. Deveraged management bu%out cumpPrare de catre salaria^i Diabilit% responsabilitate$ rPspundere Securit% titlu de valoare Securit% mar!et bursP de valori Sole trader comerciant pe cont propriu #a!e over preluare #o merge a fu5iona #rader speculator la bursa de valori$ comerciant ;erchandise marfP ;erchant comerciant +illingness bunPvoin^P +illing dispus$ binevoitor 1= T,E C.MPA-Y 2 compan% is a ver% special form of business. It is owned b% the shareholders but has a separate legal e-istence from the people who own it. #he shareholders elect a board of directors to run the compan% on their behalf. If the compan% has , 0H shareholders it is a private one. #he liabilit% is limited to the mone% that the shareholders have used to bu% shares. If the shares are traded on the stoc! e-change we have a public limited compan%. ;embers of the public can bu% these shares b% going through a stoc!bro!er or ban!. In business we must create for ourselves a set of attitudes and values that balance the conflicting factors$ enabling us to act effectivel% with integrit%$ dignit%$ understanding. So we)ll have better relationships with our partners and our life becomes richer. Emotional containment ensures then that the business values are not undermined b% other values from our societ%$ such as we perhaps learned earl% in life. +e then have to !now that there is no social health without economic wealth7 the role of business is to sta% in business$ providing wages$ goods and services into the communit% and meeting the profit needs of the business and the !e% sta!eholders in the business. #he business does not operate in a vacuum7 there are competitors$ there is a level of economic activit%$ there is rapidl% changing technolog%. #he visions we have for our businesses are what ma!es them and us reall% successful. Setting goals and ob*ectives will help us achieve our vision. #he !e% to success and happiness in life is to create a positive vision$ to remain true to one)s own spirit$ to have the energ% of challenge. <ut running a business is never eas%. It)s a ride through a range of ha5ards and difficulties but one thing is sure: life will rarel%$ if ever$ be dull. If %ou do not en*o% running %our business$ %ou can)t e-pect to do it well. Some wa%s to ma!e a business successful are the following: 1. Ideas bad or good are important as the lifeblood of business and vital to its long term success. Ideas are vital to develop new or e-isting products or services or even to ta!e the first step into a new business. ,. Choosing professional advisers is essential and the% can ma!e or brea! %our business. .. >inding and !eeping clients must form an integral part of %our planning if %ou want to grow %our business. /. Cesearch %our target companies does ta!e time$ but it)s well spent. If !nowledge is power$ then researching a compan% can give %ou a much better understanding of what the% do and help %ou to prepare a successful bid. 0. <rand %our business and %ou)ll be set apart and enable %ou to introduce a wider range of products and services more easil%. 1. #eam up with another business to enhance %ours and be competitive on the mar!et. =. Consider a pro*ect based wor!ing which has man% advantages for the emplo%er and emplo%ee. #his means wor!ing for *ust one or two emplo%ers at an% time. ?. <e creative$ have an open mind philosoph% and a II can doJ attitude. 2n% business can benefit from using it creativel%. G. >ocus on creating a winBwin situation. 1H. 8se %our time wisel%$ as it is not elastic and it will not magicall% e-pand to accommodate all we have to do. 1? 11. Ueep %our emplo%ees happ% and remember that a happ% wor!force is a productive one and will contribute to the performance and profits of %our business. 1,. ;a!e powerful presentations b% a good planning and preparation. E-hibitions can be invaluable mar!eting e-ercises for an% business. 1.. Event management is important: organi5ing gatherings$ conferences$ seminars$ training courses. 1/. "etwor!ing for success is a wa% to meet new people$ e-change information and get new business. 10. ;aster the media and %ou ma% get rewards b% being attentive to the interviews. 11. #he success of a business will depend on how well %ou sell products and services. 3ow do %ou persuade people to bu% the product4 #he more wor! %ou put into planning and developing %our sales strateg%$ the easier it will be to close and develop a lo%al customer base. 1=. Dasting customer relationships are ver% important as profitable business starts and ends with the customer. So it)s worth giving them the attention the% deserve. 1?.Ensure that success will come from a website but be careful to a sound strateg%. Ecommerce revolution is on its wa% and the staff has to be well trained in this respect. 1G. ;aintain a positive flow of mone% in %our business b% realistic forecasting which will onl% be of benefit if it is chec!ed and reconciled on a regular basis. ,H. Enter into partnership agreement and ma!e sure that %our partner can contribute to the business and will strengthen it. In business life time is important to be ta!en into consideration as it is our most precious resource. +e have to maintain a balance$ we have to give ourselves time and opportunit% to do things right7 we do not get a second chance with time$ so we must do our best to ma!e ever% minute purposeful and en*o%able. #hen our goals are set as we want them to be and we can reward ourselves for gains. 2 business is a coordinated effort to achieve certain ends summari5ed in the profit and loss. @oining a business means embracing some part of that at least. #he assumption is that ever%one wants to be successful and for this within a compan% it is important to: M consolidate the aims of the team$ the team spirit. M understand the team) effort to strive for achievements. M focus on creating a team climate. M understand the energ% of challenge. M be aware on one)s responsibilit%. 9esire or will is the ver% essence of success. +ithout this intensit% the actions of success have a hollowness$ the hallmar! of Ibut I triedJ. Successful business as!s for good leadership and this is not some m%stical act performed b% the few and onl% able to be performed b% them through some luc! of upbringing or genetics that made them natural leaders. +e can become better leaders than we are7 to achieve this means that we need to do the right things at the right time more often than we usuall% do and we also need to e-amine ourselves. +e also need to have a clear idea of what to do in order to gain the best possible result from others. #he actions identified must be the appropriate actions in what is broadl% called Jwestern societ%J&"orth 2merica$ 8.U.$ Europe$ 2ustralia$ "ew Yealand'. Deadership is to be ta!en into account whenever we have in view an% business7 there are some steps to be followed: 1G 1. #he agreement to success for ever% team member. Ever%one wants to be successful as far as goals are clear and business processes are far from being clums%. Ever%one has positive and negative thoughts in their minds most of the time. +e !now how eas% it is for the negative thoughts: the compan% is not good$ the boss is badA+e represent the positive assertivel% in our mind Iwor! is rewardingJ. <ut we select our thoughts and the% influence us. If a person has negative thoughts about the *ob and the compan%$ wor! performance is suffering. #he negative impact can ma!e the team output less than it should otherwise be. <ut we are responsible for our own thoughts$ so what a manager can do is to point out the conse6uences. It is clear that when the team becomes focused$ gets people organi5ed$ celebrates success$ then bad attitudes disappear. 9efining success entails the idea of challenge which energi5es people. #he team leaders and managers must live as e-emplar% models of how the% e-pect others in their team to act. Each management team member is e-pected to be an I inspiring pla%er.J #he team effort has to be understood properl%. #he team spirit must be a conse6uence of doing other things well. Coordinating the effort is to be achieved b% the profit profile with each team member being accountable for some number on the profile and this will define success for a team. (eople have seen now the standards re6uired. Identif%ing the behaviours of success. 2s the goals have been agreed$ the steps to be followed are to ma!e clear what actions were most li!el% to bring about the goals. In the goalaction principle$ the idea of action becomes clear now$ we have those behaviours that will best fulfill the goal$ derived from the goal and belonging to it. It is important to find the balance between two things in conflict as a crucial act of insight and creativit% for the manager and the team. If the issue is finding sales tactics$ then the problem is one of creativit% for the team to brainstorm possible tactics and then select one or several that best achieves the balance of the re6uired result. (rovide monitoring and feedbac! on progress and performance. #he main concern among the teams was to provide useful guidance on what should be changed to improve the results. <etter reports were being sought$ better information. Celebrate success$ large and small. #eams celebrate success as people have risen to the challenge. #eam results were evident. #he progressive build up of life satisfaction was something that occurred beneath the dail% flu- and it should increase each %ear. It was seen as related to goals and wor! had the potential to be a ma*or component. #eams will remain the core of the business. <efore demanding better performance one have to be sure that this can be achieved. So$ for ever% goal there are tas!s that must be acted out if the goal is to be achieved. Ever%one succeeds if the team succeeds. It is important to recogni5e individual performance$ but from within the framewor! of the team. 2 management team should be a team$ not a collection of individuals with personal accountabilit%. #his means that ever% team member understands that the% can win onl% if the team wins and the team wins b% achieving the targeted operating profit. +ithin that$ each person has his or her role and tas!s within this role. If people can full% perform their own *obs and have the mental$ emotional and ph%sical energ% to assist others$ and if the others accept and appreciate the assistance$ then those people should be encouraged and celebrated within the team. =H 2 management team operates within the framewor! and polic% prescribed b% the strategic plan and is accountable for creating sales revenue and converting it into operating profit. #o develop a manager means to develop the person. #hat is$ to improve business management or business leadership is not merel% an act of adding some s!ills or some !nowledge to the person7 !nowledge alone is not power7 onl% if it is bac!ed b% the abilit% and willingness of how$ the *udgement of when to use that !nowledge is power. Intellectual honest% is an important 6ualit% that must be ta!en into consideration. #hat means being truthful with %ourself and not onl%. +e have wishes and dreams$ sensitivities about ourselves7 so often we do not want to thin! poorl% of ourselves7 it is easier and more comfortable to find reasons be%ond us for the unfortunate things that happen or for results that should have been . Such emotional forces can and do push us to thin! in certain wa%s. #hen$ intellectual honest% comes to help us: a process of conceiving the factors accuratel% as a scientist might$ without the comfort of the e-cuses. It allows us to avoid giving up too earl% and this is one of the hallmar!s of all champions. #here are some situations we meet within a compan%: #here are all !inds of reasons for wanting to be %our own boss. Some people li!e the idea of there being no one in authorit% over them$ telling them what to do$ sa%ing their wor! is not up to standard$ turning down their ideas$ or insisting on methods that seem pointless. Others are attracted b% the thought of deciding their own hours$ or da%s$ of wor!. Cunning %our own business gives %ou the status of being selfemplo%ed$ perhaps also of being a compan% director. #here is the general feeling of independence$ and that %our income and perhaps even %our wa% of life is in %our own hands. Some are attracted to the idea of starting a small enterprise and ma!ing it grow$ much as a gardener tends his plot and ma!es a number of plants come to maturit%$ each in turn creating further growth. If %ou are %our own boss$ sa% some people$ wor! is so much more pleasant. :ou can get someone else to do the less interesting *obs and %ou are not bogged down in anno%ing details. +or! becomes easier$ too$ because %ou can get someone else to do the more difficult tas!s. ;an% others want to set up a little business of their own to occup% their spare time$ and as a pleasant wa% of earning e-tra mone% from wor! the% li!e doing. #hese are *ust a few of the reasons commonl% given. Some have good sense behind them7 others are based on completel% false ideas. ;ost contain some element of truth which gets magnified out of all proportion$ and sei5ed upon without it being borne in mind that there are other points to consider as well. 2s with so much else in life$ running an enterprise of %our own entails disadvantages as well as advantages. It is surprising how rarel% people stop to consider in real detail *ust what the drawbac!s are$ %et this is an essential first step for an%one thin!ing about whether it is even practicable for him to be his own boss. 2n important reason wh% there is such glamour about being in charge of %our own business is that when %ou are wor!ing for someone else$ man% of the pett% irritations of life$ as well as the chore of often having to get down to wor! that %ou do not feel li!e doing at that particular time$ become associated with being an emplo%ee. #here is a feeling that$ if onl% %ou were %our own boss$ life would immediatel% become infinitel% pleasurable and free from ir!some detail. #his is almost entirel% misleading. ;an% of the little anno%ances probabl% have nothing to do with being an emplo%ee: being interrupted when %ou have at last immersed %ourself in some disagreeable tas!$ missing the bus when %ou are in a hurr%$ feeling tired or in other wa%s not reall% up to wor!ing hard at the moment$ and so on. #hese occur *ust as much when %ou are %our own master. In fact$ the% tend to happen much more often$ while at the same time$ their effects can be far more upsetting. =1 #here are ver% real drawbac!s to running %our own business$ though for the right !ind of person$ immeasurable benefits also. 2 compan% has two wa%s of delivering value to clients: either the clients obtain *ust the accumulated wisdom and talents of the specific professionals who are servicing their wor!$ or the clients can get this$ IplusJ all the relevant accumulated wisdom$ e-perience$ tools$ methodologies of the rest of the firm. +hat does it mean for a compan% to have value above and be%ond the talents of individual professionals4 +hat can a firm do that will help a professional to be more successful than he or she would be at a halfwa% decent competitor4 ;a%be: provide professionals with the benefit of shared s!ills and e-periences within the practice group. facilitate access to the s!ills of others in different disciplines. establish procedures to produce well trained *unior professionals. achieve a high level of cross selling and access to clients of other professionals. provide superior support staff and s%stems. instill a s%stem of supportive challenging$ coaching to bring out the best in each professional. create an emotionall% supportive friendl% environment. provide for diversification of personal ris!. establish a powerful brand name that ma!es mar!eting easier. Interesting but more and more in our concern the firm$ the compan% has to be viewed in future. #he strategic challenge for professional firms is not to forecast the future$ but to ensure that the firm is effective at adapting to alread% observable mar!et changes. ;ost professional firms are resistant to change. Old wa%s of doing business suffer from inertia and few firms are either willing or able to implement significant changes in the wa% the% manage their affairs. ;a*or trends are being identified and big schemes are announced as responding to them. <ut a professional firm is not completel% at the merc% of un!nowable fates. :ou can ma!e things happen if %ou want to. +h% plan in an unpredictable world4 <ecause %ou can ma!e sure that the wa% %ou run %our affairs ma!es %ou more adaptable and adaptive. #hrough a combination of planning and ree-amination of current management practices$ firms can become better at listening to the environment and pic!ing up its change signals earl%. #he% can also become better at ensuring that the% have numerous e-periments going on to test new ideas and approaches. >irms should be testing what the mar!et will and will not respond to. #he% must avoid complacenc%$ be adaptive b% constantl% as!ing:J is there a better wa% to do what we do4J >irms are ver% good at figuring out what the% want their people to do differentl%. #he% are not so good at figuring out management s%stems to get them to do it. So$ planning means managing in new and different wa%s. ;an% companies miss a central truth: if %ou haven)t changed %our measures and rewards$ %ou haven)t changed %our strateg%. 2 firm has to be better than the competition in the following wa%s: 2ggressive listening to the mar!et. good tactics: focus groups$ feedbac! surve%$ client panels$ formal mar!et research.. 8sing mar!et intelligence: each practice is activel% gathering mar!et intelligence and is devising new things to do for clients. Caising the level of innovation the management)s *ob is to stimulate e-periments and encourage innovation. Sharing new !nowledge firms must become good at sharing the results of their e-periments. =, (ressure for personal growth through professional performance counseling and practice leadership. ;anagement behaviour management must be perceived as leaders of a changed effort7 stimulating new ideas$ willingness to provide seed capital for those who wish to tr% new things. ;easuring success not onl% b% the volume of wor! performance but b% the t%pe of wor! it brings in. What do you thin! a%out the folloin#' 1. Visionar% companies share a common subset of correct core values ,. Visionar% companies re6uire great charismatic visionar% leaders. .. #he most successful companies e-ist first and foremost to ma-imi5e profits. /. Visionar% companies are great places to wor! for ever%one. 0. 3ighl% successful companies ma!e their best moves b% brilliant and comple- strategic planning. 1. Companies should outside CEOs to stimulate fundamental change. =. #he most successful companies focus on beating competition. ?. #he onl% constant is change. G. >le-ibilit% means drafting several possible scenarios for the future. 1H. Companies emplo%ed bottom up planning. Enlar#e upon' 1. #he >irm of the >uture is so Close to usK ,. 3ow Can :ou ;anage :our ClientsJ (ro*ects4 .. +hen does a (rofessional Compan% ;erger ;a!e Sense4 /. +hat Should a >irm <e #olerant about4 0. 3ow will the 2daptive >irm measure its success4 Dialo#ue ;r. "orman Feneral ;anager of a large compan% is meeting ;r. Clear% a reporter who wants to be informed about the success of the <V: Compan%. ;r.Clear%: Food morning ;r. "orman and than! %ou for the time %ou have allowed to me. ;r."orman: It is m% pleasure and I do not mind sparing some minutes with %ouK ;r. Clear%: I would li!e to write a few lines about %our compan% in the ICapitalulJ maga5ine. ;r. "orman: Our business has increased and as %ou ma% be ac6uainted with$ we have deemed it advisable to open more branches in the countr%. ;r.Clear%: +hat !ind of investment would %ou care for4 ;r. "orman: +e deal with te-tiles. +e enlarged our business b% getting new partners and we e-pect higher dividends. #he 6ualit% of our products has been maintained at a high level. So$ wool prices are e-cellent and the revenue too. If we =. refer to the profit and loss account$ an increase of more than ,HW is to be ta!en into consideration. ;r.Clear%: 3ow did %ou manage that4 ;r. "orman: <% wor!ing with a well trained team$ b% finding good partners$ b% having a stro!e of luc!$ b% !eeping with the new mar!et trends. ;r. Clear%: I do have some 6uestions if %ou don)t mind. Such as: 3ow 6uic!l% can one hope to climb the promotion ladder to partner level4 +hat are salaries based on as %our career progresses4 3ow long do most people sta% in %our compan%4 3ow successful is the compan%4 2re %ou enthusiastic about the development of the compan%4 9o %ou spend mone% on staff training4 +here do %ou intend to e-pand the sales4 +hat persons do %ou wor! with4 ;r. "orman: #he best are being promoted to partners7 unless %ou ma!e partner b% the age of .0$ %ou will basicall% never ma!e it. Salaries reflect the assessment of the emplo%ees. Over a ten %ear period$ less than /HW of those hired are to be retained b% the compan%. #he shareholders are content as the loss is small. :es$ as far as the turnover has increased and we have subsidiaries all over the world. #here are full and part time courses$ most of them being paid b% our compan%. In Eastern Europe. #hose e-perienced on the sales side$ with first class technical !nowledge$ %oung$ full of energ% and new ideas7 those who !now what competition means. Additional Voca%ulary' chartered compan% companie _nfiin^atP pe ba5a unei Carte Cegale *oint stoc! c. societate pe ac^iuni unlimited c. societate cu rPspundere nelimitatP limited c. societate cu rPspundere limitatP parent c. societate mamP wholl% owned c. societate _n propietate integralP unincorporated c. societate ne_nregistratP winding up of a c. _ncetarea activitP^ii unei societP^i greenfield c. societate la _nceput de drum bogus compan% societate ficticP close c. societate _nchisP dormant c. societate inactivP compan% funds capital al firmei compan% identit% imagine de marcP to sta% afloat a se men^ine pe linia de plutire shareholderac^ionar shares ac^iuni$ titluri de valoare preference shares ac^iuni privi`egiate deferred shares ac^iuni cu plata dividendului dupP satisfacerea celorlalte outstanding shares ac^iuni _n circu`a^ie =/ share capital capital social$ _n ac^iuni share mar!et bursP de ac^iuni share prices curs share inde- indice share split divi5are a ac^iunilor to share the profit a _mpPr^i profitul to share one)s views a _mpPrtP`i pPrerile cuiva to share one)s e-perience a _mpPrtP`i e-perien^P to assessa evalua assessment evaluare assessed evaluat turnover cifra de afaceri losspierdere$ deficit to run at a loss a lucra _n pierdere loss ratio rata pierderilor relocation mutare core business activitate de ba5P brea! up lichidare liable responsabil de =0 Dealin# ith a Cu"tomer +hen dealing with a customer %ou ma% encounter some situations: :ou have an angr%
customer because %ou messed up #he f i r s t st ep in d e a l i n g wi t h an% angr% customer$ whatever t h e reason$ is to l i s t e n wh i l e t he % get t h e i r anger out of t he i r s%st em. S%mpathi5e wi t h t h e pr obl em wi t h phrases such as$ ] 3ow f r u s t r a t i n gfor %ou$ ] or ]1 can see how i n f ur i a t i n gt hat must: be]. Once t h e % have e-pressed t h e i r feelings$ and real i 5ed t h a t %ou are l i st eni ng a n d s %mpat he t i c$t he % wi l l cal m down. 2t t hi s point it is wi se$ as well as hones t $ to hol d %our hands up and admit %our mista!e b% sa%i ng s omet hi ng l i !e.I ) m t e r r i b l % sorr%. 1 should have put t he order t h r o ug h manuall% and I c l e a n forgot. I do apol ogi 5e$ especi al l %after i t ] s caused %ou so much t r oubl e] . #h i s wi l l t a!e t h e wind o u t of t he i r s ai l s$ not l east because so few people act ual l %admi t lo t he i r mista!es. So long as %ou offer to put things right: in an% reasonable wa% that suits the customer$ the% are li!el% to end up feeling ver% satisfied. "ot onl% have %ou resolved the problem$ %ou]ve also been honest with them. It should reassure t hem that %ou]re a good organi5ation to do business with: ever%one ma!es the occasional mista!e$ and at least %ou admit to it and put it right magnanimousl%. Some people will advise %ou never to admit blame when dealing with customers in case the% sue %ou. It ma% be wise to ta!e legal advice if %our mista!e has cost them thousands$ but in most cases the%]re not going to sue. If %ou]ve cost them * ust a few pounds$ what]s the problem4 :ou ought to pa% up$ so there should be no 6uestion of suing. >rom a legal point of view$ refusing to admit blame ma% sometimes be wise. >rom an ethical and customer relations standpoint$ it is alwa%s better to admit %our mista!es. :ou have an angr% customer because one of %our team messed up. 3andle t hi s e-actl% as %ou would if it was %ou that had messed up. :ou are responsible for %our team$ and %ou should carr% the can. #he customer doesn] t need to !now which individual in %our team messed up7 i t] s enough to !now that it] s your team. 9on]t ever tr% to pass the buc! when spea!ing to a customer$ tempting though it ma% seem to sa%$ ] I] m afraid a * uni or member of m% department made a mista!e]. :ou wi l l obviousl% need to tal! to the team member in 6uestion privatel%. 3owever$ %ou need to separate the mista!e from the customer] s reaction to i t . If t he customer overreacted wildl% to a minor error of *udgement or an understandable mista!e$ don]t ma!e a big deal of it wi t h %our team member * ust because the customer made a big deal of it with %ou. If %ou]re angr% and upset b% %our e-change wi t h the customer$ wait unti l %ou]ve calmed down before tac!ling the person who made the mista!e. :ou can]t deliver on a promise to a customer #he important thing is to limit the damage$ and there are two !e% wa%s to do this: 1. #he most important thing is to give %our customer as much notice as %ou possibl% can. #he later %ou tell them$ the deeper the hole %ou land them in. (lent% of warning gives them time to find a contingenc% without it becoming a ma*or issue. If %ou]re not sure whether %ou can deliver but it]s loo!ing increasingl% dodg%$ %ou]ll need to e-plain the situation before %ou !now for certain whether %ou]ll have to let them =1 down. #hen the% can choose whether to ta!e the ris! or whether to find an alternative. ,. +hen %ou tell them$ apologi5e profusel% and let them !now that %ou recogni5e how inconvenient it is for them. #hen offer them whatever %ou can to ma!e up for it. #his might mean telling them %ou can deliver part of what the% want$ or the% can have ever%thing the% want but later than the% hoped or to a lower standard. Or %ou might sa%$ ]I can]t do this$ but I can find %ou someone who can]. 2 ma*or customer threatens to go elsewhere unless %ou ma!e concessions %ou can]t afford #he% sa% t hat the%] ll go to %our managerBthe top of %our organi5ationBthe press. #he answer is in t he 6uestion here. If %ou reall% can] t afford the concessions$ %ou can]t afford the customer and %ou]re better off letting them go. <efore %ou do$ however$ ma!e sure that there reall% aren]t an% other concessions chat would suit %ou both. If %ou can]t drop %our prices low enough$ ma%be the% can pa% in installments or on other ver% good terms. If %ou can] t deliver soon enough$ perhaps %ou could deliver part of the order. If there is no meeting ground$ ma!e sure %ou part on friendl% terms. 9on]t tell them the%] ll regret changing supplier. #hat wa%$ the% ma% well come bac! to %ou. If the% were bluffing to get %ou to ma!e concessions$ or if their new supplier lets them down$ %ou want them to feel the% can come bac! to %ou easil%. 2 disgruntled customer threatens to report %ou #he% sa% that the%] ll go to %our managerBtop of %our organi5ationBthe press. Det them. (resumabl% %ou]ve done nothing wrong$ so %ou have nothing to worr% about. 2rguing with them will ma!e it worse$ and loo! as if %ou] re running scared. If %ou sa% to them$ ] If %ou feel %ou want to ta!e it further$ that] s up to %ou$] it]s more li!el% to deter them. 2fter all$ the% were threatening in order to get a response from %ou. #he tactic clearl% hasn]t wor!ed so the% ma% well abandon it. If the customer threatens to go to someone internall%$ from %our immediate boss to the ;9$ forewarn the manager concerned. #he% won]t be too pleased if the% get a call from a customer and loo! a fool because the% don]t have an% of the facts. So brief them full%. If b% an% chance %ou are at fault$ %ou]re still better off ]fessing up. It is better for %our boss to hear it from %ou first than from an angr% customer. 2 customer is wrong Sometimes a customer accuses %ou of doing something that %ou reall% haven]t done. In fact$ ma%be their subse6uent problems have arisen because the% failed to give %ou their full address$ or sign the che6ue. So what do %ou do when the% complain4 Is the customer reall% always right4 :ou need to listen to their complaint$ and s%mpathi5e with their problem *ust as %on would if the complaint were *ustified. :ou can still sa%$ ]3ow frustratingK] or I can see that must have put %ou in a difficult position$] without admitting blame. #actfull% e-plain what has caused the problem$ but don]t ma!e them feel stupid or the% could get defensive. 2void words and phrases such as ]fault] or ]%ou should have . . Five them an e-cuse for their mista!e. >or e-ample$ ]Our deliver% terms are ,? da%s unless %ou specif% e-press deliver%. I !now how eas% it can be to overloo! that sort of thing$ especiall% when %ou]re in a hurr%.] Det them feel their point is valid$ without accepting blame. Sa% for e-ample$ ];a%be we should print our deliver% terms on the order form as well as on the terms and conditions. I]ll suggest that to the department concerned.] == 9on]t offer refunds or replace items *ust to calm a customer down$ in case it implies that %ou were at fault. #his might be an unwise precedent. 3owever$ if %ou reall% want to do something$ describe it as a gesture of appreciation for bringing their problem to %our attention. :ou !now one of %our customers is l%ing to %ou :ou get them occasionall%$ customers who fre6uentl% claim$ for e-ample$ that the goods arrived fault% or damaged when %ou !now for a fact that the% didn]t. +hatever %ou do$ don]t bother arguing. :ou]ve got two options: 1. give the customer the benefit of the doubt ,. stop suppl%ing them and as! them to go elsewhere. :ou]ve alread% got a dishonest customer. If %ou argue with them$ %ou]ll have an angr%$ dishonest customer and that]s worse. #he% ma% spread rumours or damaging gossip about %our organi5ation. So don]t fall out with them. #he other trap to avoid is changing %our s%stems in order to tr% and combat their dishonest%. :ou could inconvenience all %our honest customers$ and ma!e %our own lives more complicated$ *ust for the sa!e of a customer who doesn]t deserve that !ind of effort. So if %ou don]t want to put up with it$ *ust drop the customer. 2n important customer demands more of %our time than %ou can spare If %ou have a ver% tal!ati ve customer who engages %ou in longwinded conversations$ %ou need to find a wa% to get the information %ou need from them and then terminate the conversation without upsetting them. :ou can]t !eep i nt errupt i ng them without sounding rude$ so %ou need to interrupt %ourself. It ma% sound strange$ but it ma!es sense reall%. :ou need to get a word in$ but to do it b% *oining t hei r conversation rather than deflecting it. Once %ou]re in$ then %ou can change the sub*ect$ li!e this: ]I 6uite agree$ the traffic]s getting sill% on the "orth Circular these da%s. <% the wa%$ when do %ou need these delivered b%4] #here] s anot her !i nd of demanding customer$ too: the one who]s on the phone 1H t i mes a da% wi t h endless minor 6ueries. :ou can] t avoid this customer altogether$ and %ou] ll offend them if %ou tr%. :ou *ust need to get them to be less of a nuisance: If someone]s calling several times a da%$ tell them the first time the% call t hat %ou] re ver% bus% at the moment and %ou want to wait unt i l %ou can give them %our full attention. 2s! if %ou can call bac! at the end of the da%. #he% can save all their 6uestions until %ou ring bac!$ and %ou have onl% one call all da%$ at a time of %our choosing. (ut %our voicemail on or have someone field %our calls. :ou do have to t al ! to this customer sometimes$ however$ so don]t wind them up b% ta!ing ages to call bac!. Once the% learn the% can trust %ou to call bac! the same da% albeit at the end of the da% the%] ll start to feel happier about leaving messages. If the customer is on email$ as! them to email %ou instead of calling. E-plain that %ou prefer to have ever%thing in writing so %ou can be sure %ou have all the details$ and %ou don]t forget to follow an%thing up. "ow %ou can deal with the 6ueries at a time that suits %ou. :ou ma% have to spea! to them occasionall% but$ again$ %ou can choose the time. 2 good and previousl% reliable supplier lets %ou down badl%. In t he short term$ %ou need to find another supplier. #he 6uestion is whether in t he long term %ou should change to a new supplier or whether %ou should give t hi s =? one another chance. In the end it] s %our decision$ but here are some considerations to la!e into account: +h% did the% let %ou down4 Is it something t he% shoul d have foreseen and avoided4 Or was it t he !i nd of frea! problem that no one could have anticipated4 3ow did t he% let %ou down4 9id the% give %ou as much warning as possible that trouble was brewing4 9id the% sound sui tabl% concerned at l et t i ng %ou down4 9id the% do an%thing to tr% to mitigate the damage4 3ave t he% ever let %ou down before4 3ave there been other minor incidents$ or is this the first problem in %ears4 +h% were %ou usi ng them in the first place4 +hat is it that ma!es them better t han other suppliers4 Could %ou find another supplier as good as them in all the essentials price$ 6ualit%$ reliabilit%$ service and so on4 Shop around and see what else is available. <% t he t i me %ou]ve thought through all these 6uestions$ %ou should be in a position to decide whether to stic! wi t h this supplier or not. 2nd there]s one other t hi ng %ou can do monitor the service and 6ualit% %ou get from whichever supplier %ou use as a replacement &assuming %ou find another supplier for this order'. #his should give %ou an idea of whether it] s worth moving %our contract. :ou have a (C crisis on %our hands Ever%one loves a drama e-cept perhaps the people caught up in it. Inevitabl%$ then$ man% crises will attract the attention of the press. #he% gather li!e h%enas around the !ill$ each hungr% to get first bite at the stor%. 2nd not onl% do %ou have to deal with the crisis itself but %ou also have to cope with the press$ who will be read% at an% moment to turn on %ou if %ou ma!e a wrong move. #he press can be either a blessing or a curse in a crisis$ and the balance can lie in how %ou handle them. Of course$ sometimes the press are on %our side from the start. If %our buildings have been damaged b% severe weather$ or a lorr% has careered off the road straight through %our shop window$ %ou have the s%mpath% of the media from the outset. <ut the press alwa%s want someone to blame$ and all too often the% will pic! on %ou. If %ou]re ma!ing redundancies$ if %ou]ve polluted the river that runs past the factor% or if an accident has been caused b% fault% e6uipment then the%]ll be sniffing round for evidence to pin the blame on %ou. So what can %ou do4 #he good news is that there is a wealth of advice$ derived from the e-perience of thousands of organi5ations over man% %ears. #here are wa%s to handle the press &and other media' that will at least minimi5e the damage and$ at best$ turn their attitude around to one of support for %our case. So below are the !e% rules for handling a (C crisis. #ell the press what]s going on right from the start. #he more information %ou give them$ t he less t he% wi l l need to di g di e d i r t to get a decent stor%. 9on] t wait u n t i l %ou]ve solved t he crisis !eep t he m posted from the moment the% t u r n tip as!i ng 6uestions. I t ] s no good !eepi ng t he press informed if %ou don] t also !eep %our own people posted. Otherwise disgruntled staff$ who are being !ept in the dar!$ ma% well decide to pass on to the press their own outdated or misunderstood version of the facts. 3onest% can actuall% be a disarmingl% smart polic%. ;an% %ears ago$ the <<C accidentall% double boo!ed two !e% political figures to give one of the prestigious Ceith lectures. One had to be cancelled$ of course$ and the press were f ul l of how and wh% he had been snubbed. #he 9irector Feneral of the <<C adopted a simple =G but ingenious approach when 6uestioned b% the press. 3e * ust said: ] It was a coc! up$ OU4] 3e was open$ honest and wrongfooted the press completel%. +e all have coc! tips from t i me to time$ and t he press understand that as well as an%one. #here are three rules to remember to !eep t hi ngs simple. >irst: the press don]t !now %our organisat i on or %our i ndust r % as well as %ou do$ and the% want to pri nt a clear$ si mpl e stor% &or t hei r readers. So don] t confuse them with unnecessar% det ai l s$ *argon or bac!ground information the% don]t want. @ust !eep %our message uncluttered. If the% as! for more$ give it to them if %ou can. <ut don]t volunteer it. #he second rule of !eeping %our stor% simple is to ma!e sure %ou have onl% one spo!esperson if %ou possibl% can. Otherwise there is a danger that the% ma% contradict each other. One single point of communication means one single$ consistent voice. 2nd the third rule is: never speculate. #his simpl% adds to the confusion. Speculation ma% be reported as fact it often is. So if %ou]re as!ed to guess at the cause of the chemical lea!$ how man% redundancies there are li!el% to be or when the buildi ng will be operational again$ politel% decline to comment. Or *ust sa%$ I don]t !now]. So$ the three rules of !eeping it simple are: 1.don]t give more information than %ou need to ,.have a single$ consistent message delivered b% a single spo!esperson ..never speculate. #hen$ get %our priorities right :ou will horrif% readers$ listeners or viewers if %ou start to tal! about the financial cost of this disaster when people have been !illed or in*ured. <e aware how things loo! to other people <e aware of what the public perception of %our crisis handling will be. It] s not enough to be right %ou have to be seen to be right. Suppose a press stor% brea!s reporting that man% supermar!et eggs are infected with salmonella$ and there is a slight ris! of serious illness. :ou are an egg producer. If %ou react b% insisting that there is no danger at all$ people will *ust thin!$ ]#he% would sa% that$ wouldn]t$ the%4] #here ma% indeed be no danger - or there ma% be. It doesn]t matter. +hat matters is that people will think %ou are tr%ing to cover up the facts for %our own ends7 that %ou]re prepared to lie to people about their health rather than lose profits. So consider how %our version of events$ which people will consider potentiall% ver% biased$ will loo!. It is better to sa% that %ou are ver% concerned about the health scare over eggs %ou have no evidence that there is an% ris! at all$ but %ou]re ta!ing action to find out the facts as fast as possible. Support an% research ma%be donate funds to it and invite inspectors to chec! out %our operation. Sa% %ou would welcome official guidelines on how %our organi5ation can remove an% ris!$ and generall% be seen to be ta!ing the action the public$ wants$ not *ust pa%ing lip service to it. Never 'no comment' +hat do %ou t hi n! when %ou hear an interviewee sa% ]no comment]$ or when a report sa%s t hat ] the compan% declined to comment]4 :ou thin! the%]re guilt%$ don] t %ou4 :ou rec!on the%]ve got something to hide. #hat]s what ever%one thin!s. 2nd it] s what the%] ll t hi n! about %ou$ if %ou sa% ]no comment]. So don]t. If there]s nothing %ou can tell them$ it]s better to sa%$ #in afraid I don]t have an% more information at the moment]. Be positive ?H If %ou seem worried or down beat in interviews$ people will assume %ou]re in trouble. If %ou come across as angr% the% will ta!e a disli!e to %ou. (eople will read a great deal into %our attitude$ so ma!e sure it is alwa%s friendl% and positive$ especiall% when %ou]re tal!ing to the broadcast media. If people have suffered$ it doesn] t do to loo! too cheerful about it$ of course. <ut %ou can still be open and courteous. ;a!e sure %ou show s%mpath% for an% victims of the disaster$ whether or not %ou accept responsibilit%. <e friendl% #he press are onl% doing their *ob. If %ou want them on %our side$ %ou need to accept this and not hold grudges against them the phone and the cafeteria and give them a warm room. #reat them politel% and with respect and be as helpful as %ou can. Fet %our friends on %our side If the press are against %ou$ recruit people outside the compan% who will spea! on %our behalf. Satisfied customers$ trade association contacts$ suppliers$ e- emplo%ees . . . an%one who the press will be interested to tal! to and whom %ou can rel% on to bac! %ou up. #he% will assure the press that %our safet% standards are e-emplar%$ that %ou]re a great compan% to wor! for$ that %ou are !nown for %our reliabilit% or whatever it is %ou need said. Outsiders alwa%s have more credibilit% than insiders. Fo the e-tra mile If %ou]ve made a mista!e$ or are believed to have made a mista!e$ do ever%thing %ou can to put it right. Even if people blame %ou for the crisis itself don] t give an%one an e-cuse to complain about %our response to it. 9o even more than %ou have to give people e-tra time off$ replace their damaged propert% without 6uibble and better than it was before$ pa% to clean up the river and fund a new wildlife reserve along its ban!s. Show that %ou]re sorr% %ou messed up$ but %ou genuinel% want to ma!e ever%thing better. :ou ma% remember a few %ears ago a cross channel ferr% ran aground on a sandban!. 9ue to the vagaries of the tide it was a da% or so before the% could float it off again. ;eantime ever%one was stuc! on board. <ut the ferr% compan% and the crew leapt into action as soon as the disaster struc!. #he% !ept ever%one informed$ refunded the cost of the tic!ets$ gave awa% all the free food and drin! the% could and generall% bent over bac!wards to ma!e up for the discomfort and inconvenience. +hen the ferr% finall% doc!ed$ the press were waiting to interview the passengers as the% disembar!ed. <ut much to their disappointment $ the% couldn]t find a single passenger who had a bad word to sa% about the ferr% operator. #he% all insisted$ ]It was *ust bad luc!$ and the% loo!ed after us beautifull%. Cemember$ %ou don]t have to deal with ver% man% crises $ but the press deal with them for a living. #he% are bound to be smarter than %ou at it$ so don]t tr% to fool them the%]ll ma!e %ou loo! the fool. @ust pla% it straight$ honest and open. Topic" for di"cu""ion' ,. 3ow can %ou discover the wa% the client defines 6ualit%4 .. Can %ou guarantee %our clientsJ satisfaction4 /. 3ow important is listening when %ou deal with difficult clients4 0. +hich is the !e% talent in good selling4 1. +ho decides value4 Enlar#e upon the folloin#' ?1 I9o good wor! and the clients will comeJK I(rofessionals are supposed to care about their clients$ aren)t the%J4 IEualit% must be negotiated continuall%.J I"ew business will be won onl% to the e-tent that the client believes the professional cares and is tr%ing to help.J IContinuous investment must be made in getting better and betterJK Dialo#ue ;r. Slide aims at success in business. 3e is a middle aged$ tal!ative merchant$ a retailer and wholesaler too. 3e has got a large warehouse and a wide range of products. #he storage is done in a new$ modern building. 3ow important 6ualit% is for him might be guessed in the following discussion: ;r. 9aube$ the customer: Food morning to %ou m% friendK ;r. Slide: 3ow are %ou4 I haven)t seen %ou for a monthK ;r. 9aube: +ell$ I was awa% in >rance. "ow I am bac! and I do have plent% of products to bu% for m% store. I would li!e good 6ualit% as %ou have inured me so far. I need to bu% coffee$ tea$ cigarettes$ butter$ *uice$ mineral water$ olives$ sweets$ dair% products$ fresh vegetables. I don)t want them to be damaged$ so please be careful with the pac!aging. #he% ma% be easil% spoiled b% dampness. ;r.Slide: #he% are all well pac!ed$ %ou need not worr%. 2nd the 6ualit% is the e-pected one as far as I will alwa%s be concerned in stoc!ing onl% the best goods. I hate to deal in cheap lines. 2s far as the vegetables are being concerned$ I would li!e to recommend %ou the ones I brought from Craiova. ;r. 9aube: 2re the% ripe enough4 ;r. Slide: :ou will be pleased I do promise %ouK ;r. 9aube: "ow$ what about the pa%ment4 3ow would %ou prefer4 ;r.Slide: 2s %ou wish. Cash or b% chec!. If %ou have a purchase in e-cess of 0 mil.lei the store grants a 1HW discount and ,W additional rebate for cash pa%ment. ;r. 9aube: :ou are ver% !ind. ;r. Slide: #he prices have gone up latel% due to the inflation and to the alignment of the most important products to the European prices&gas$ energ%.' So that I had no choice but to cope with them. Cigarettes and coffee are a lu-ur% and still most of us cannot live without them. <ut the% are worth bu%ing as the 6ualit% is the best one. ;r. 9aube: ;a%be more smo!ers will give up in future or will care more about their healthA. 2nd we)ll drin! less coffee and tr% to be less stresses and nervousA ;r.Slide: :ou see$ even if this rise in wholesale prices entails an immediate increase in the retail ones$ the consumers are not alarmed. #hen retailers will have to change their price labels again and the profits in the lu-ur% trade ma% not be the ones we wish. ;a%be some people living on a present da% salar% or fi-ed income will have to do without a lu-ur% that the% could have still afforded some months ago. #he retail trade can be duller in this respect. 2n%wa%$ let)s not be so pessimistic because things ma% change une-pectedl%. ;r. 9aube: I trust %our products and I will remain %our faithful clientK ?, Additional Voca%ulary: to grant a acorda storage depo5itare subsidi5ed price pre^ subven^ionat brand name marcP de fabricP to boo! an order a _nregistra o comandP sale van5are sale b% sample van5are cu mostrP sale for future deliver% v. la termen sale on hire purchase v. cu plata _n rate sales outletpunct de desfacere sales 6uota cota de vPn5Pri sales records eviden^a van5Prilor sales department serviciul commercial overstoc! depP`ire a stocului price advance ma*orare price alignment aliniere price collapse cPdere price cut reducere price gap decala* price maintenance men^inere price shading reducere micP price free5e _nghe^are price ceiling plafon de pre^uri blan!et price pre^ global bid price pre^ oferit bottom price pre^ul cel mai scP5ut ceiling price pre^ul ma-im flat price pre^ unic floor price pre^ minimal peg price stabili5are purchase price pre^ de cumpPrare sell price pre^ de van5are invoice factura deliver% livrare middleman intermediar% convenience stores maga5ine locale out of stoc! lipse`te din stoc sole selling rights drepturi de van5are e-clusivistP world mar!et price pre^ de pe pia^a mondialP store la%out configura^ia maga5inului ?. -e#otiation" "egotiation is not a science nor is it a branch of technolog%. It is a life s!ill. +e start to negotiate when we are ver% %oung and as we grow older we build up patterns of behaviour that reflect what we feel Iwor!s for usJ. 2nd this will be based partl% upon the !ind of personalit% we ma% have inherited and partl% upon the !ind of personalit% we have lived and grown up. "egotiation in business is no doubt about facts$ costs$ profits$ logical decision ma!ing but also about people$ their emotions&*o%$ surprise$ fear$ doubt$ anger$ sorrow' $ goals and the !ind of human beings the% are. 2n understanding of people)s motivation and how their personalities can affect their behaviour can be vital in discovering how %ou can do business with them better and better. #o negotiate effectivel% one must communicate as such. #he message has to be conve%ed$ received$ understood$ accepted in order to entail the right actions or responses. #he process of transmission is ver% important not all negotiations are conducted face to face but there are other choices too: letters$ the fa-$ the electronic mail$ the phone. Still there might be some problems such as: the% ma% get missed or misunderstood. #o man% personnel managers$ negotiation implies collective bargaining. #o a sales e-ecutive$ it wi l l be thought of in terms of ma!ing a commercial deal. Euantit% surve%ors$ purchasing managers and law%ers all have their own specialist interpretations of what$ in essence$ is a process common to all managerial wor!. In realit%$ all managers negotiate$ if not with outside parties then with each other. #he procedures and language of formal negotiation var% with the t%pe of negotiation involved. 2 setpiece pa% bargaining session has its own s%stem and *argon that differ from those of a meeting of solicitors to settle a claim for libel damages. :et the underl%ing principles and much of the ps%cholog% of the process are the same for all forms of negotiation. It is also eas% for managers to overloo! the fact that much of their informal dail% activit% is$ in effect$ negotiation. 2ll managers spend a large proportion of their time tr%ing to influence and persuade other managers over whom the% have no e-ecutive authorit%. Consider two e-amples: 2 personnel manager attempts to ]sell] the need for a more s%stematic form of emplo%ee consultation to a reluctant office manager. #he compan% has a general polic% of support for emplo%ee involvement practices$ but has not laid down an% specific s%stem or procedure. "either the e-tent to which the personnel manager can use the general polic% to re6uire the office manager]s cooperation$ nor the right of the office manager to re*ect the personnel manager]s suggestions is clearl% defined. #he outcome will be influenced b% their possibl% differing perceptions of the formal position$ and b% the powers of argument or persuasion of the personnel manager. 2 sales e-ecutive tries to persuade the production manager to change a manufacturing schedule to fit in a small order for a special customer. #he production manager has full authorit% to decide production schedules against a wee!l% output plan set b% top management. Officiall%$ the sales manager should ma!e a re6uest through the sales director for an urgent variation to this plan but because the order is onl% a small one$ he approaches the production manager informall% and must$ therefore$ rel% on persuasion. "egotiating s!ills are$ therefore$ a ver% important element in the effective manager]s portfolio of personal competencies. ?/ Cecogni5ing when negotiation is occurring is the first step towards ac6uiring the necessar% s!ills$ and this is aided b% an understanding of the basic principles involved. "egotiation is a process$ not a single s!ill. 2 range of s!ills are involved in handling this process effectivel%$ but to identif% the s!ills relevant to an% negotiating episode$ it is important to recogni5e which elements or principles of negotiation are involved. #here are seven principles common to all forms of negotiation: L "egotiation involves two or more parties who need or thin! the% need each other]s involvement in achieving some desired outcome. #here must be some common interest$ either in the sub*ect matter of the negotiation or in the negotiating conte-t that puts or !eeps the parties in contact. L 2lthough sharing a degree of interest$ the parties start with different opinions or ob*ectives$ and these differences initiall% prevent the achievement of an outcome. L 2t least initiall%$ the parties consider that negotiation is a more satisfactor% wa% of tr%ing to resolve their differences than alternatives such as coercion or arbitration. L Each part% considers that there is some possibilit% of persuading the other to modif% their original position. It is not essential though it is usuall% highl% desirable for each part% to be willing to compromise. <ut negotiation can begin when parties have an initial intention of maintaining their opening positions$ but each has some hope of persuading the other to change. M Similarl% even when their ideal outcomes prove unattainable$ both parties retain hope of an acceptable final agreement. M Each part% has some influence or power real or assumed over the other]s abilit% to act. If one part% is entirel% powerless$ there ma% he no point in the other part% committing itself to a negotiating process. #he matter can be settled unilaterall% b% the part% with the untrammeled power to act. #his power or influence ma%$ however$ be indirect and bear on issues other than those that are the direct sub*ect of negotiation. M #he negotiating process itself is one of interaction between people in most cases b% direct$ verbal interchange. Even when the negotiation is being conducted through correspondence$ there is an essential underl%ing human element. #he progress of all t%pes of negotiation is strongl% influenced b% emotion and attitudes$ not *ust b% the facts or logic of each part%]s arguments. "egotiation is a process of interaction b% which two or more parties who consider the% need to be *ointl% involved in an outcome$ but who initiall% have different ob*ectives$ see! b% the use of argument and persuasion to resolve their differences in order to achieve a mutuall% acceptable solution. It will probabl% be readil% accepted that this definition is relevant to formal negotiations such as pa% bargaining or the settlement of a legal claim for damages. #rade unions and emplo%ers or the solicitors representing two parties to litigation obviousl% accept that the% need *ointl% to evolve a mutuall% satisfactor% outcome$ starting from differing positions. Each part% !nows that the other has some power to influence the outcome. 2 trade union might appl% the sanction of industrial action: an emplo%er might reduce the labor force: the claimant]s solicitors might stop negotiating and ta!e the case to court: the respondent has some defense if this occurs. In the second of these e-amples$ the sales e-ecutive has no direct power to re6uire the production manager to alter production schedules: the production manager can *ust sa% no so where does negotiation come in4 2 willingness at least to consider the re6uest and thereb% become involved in a discussion about a possible *ointl% satisfactor% outcome will stem from several aspects of common interest$ or from a recognition of more subtle forms of power. ?0 #he sales e-ecutive wants the production schedules altered$ the production manager does not$ but both managers$ it is to be hoped$ share an interest in the success of the business. #o disappoint an important customer ma% be of more immediate concern to the sales e-ecutive than to the production manager$ but a good production manager will pa% heed to the importance of good customer service. Similarl%$ the sales e-ecutive will recogni5e the costs and perhaps dela%s to other orders that a change in the production schedule might give rise to. So a common interest in the good of the business enables both to see something in the other]s point of view$ and thus encourages a dialogue$ rather than the simple e-ercise of formal authorit%. It ma% be that the sales e-ecutive &or the customer on whose behalf the re6uest is being made' is !nown b% the production manager to be highl% regarded b% the managing director. It might thus be unwise$ in terms of compan% politics$ for the production manager to run the ris! of being considered unhelpful. <oth managers also !now that the% have to continue to wor! together. +ithout an%thing being said$ both will probabl% be influenced b% !nowing that this longterm wor!ing relationship could be adversel% affected b% mishandling the particular incident. #he production manager ma% have the right to sa% no in other words$ not to negotiate but will wonder whether this would cause avoidable friction. #here ma% also be the thought that b% agreeing some concession$ an obligation ma% be created that might be capitali5ed on at some future date. In the other e-ample$ considerations of a similar !ind might also lead to the office manager]s being willing to discuss the personnel manager]s advice. <oth have an interest in the smooth running of the compan% and in compliance with the compan% polic%: the personnel manager ma% be !nown to have top management bac!ing: the managers have to go on wor!ing together$ and therefore the office manager wi l l have to consider the implications of re*ecting the personnel manager]s advice if emplo%ee relations are then seen to deteriorate. Some !ey point" to ha$e in mind' 2ll managers negotiate with each other$ as well as with customers$ suppliers$ trade unions$ and other outside par ties. "egotiation is about achieving a mutuall% acceptable out come to a situation in which the parties involved initiall% have differing aims. "egotiations are affected b% the emotions and attitudes of the negotiators not *ust b% the logic of the arguments the% use. Consultation needs to be distinguished from negotiation. In negotiation$ the parties accept that *oint agreement is necessar%7 in consultation$ one part% reserves the right to act unilaterall%. "egotiators need to identif% a top line ob*ective the best achievable outcome and a bottom line the lowest$ still acceptable outcome. Over optimism about the probable outcome is often lin!ed to a failure to consider the bottom line. #op and bottom lines ma% each consist of several alternative permutations of the issues under negotiation. (ossible outcomes need to be considered from the other part%]s viewpoint as well as one]s own. It is important to retain credibilit% b% restricting statements about ]final offers] or stic!ingpoints to genuine bottom lines. If possible$ one ob*ective should be to help the other part% to feel satisfied with the outcome7 but an aggressive or damaging claim has to be resisted with vigour. ?1 In planning and conducting negotiations$ positive attention should be paid to the duration of bargaining sessions$ formal presentations$ and individual contributions to the discussion. 2 continuous session should rarel% e-ceed two hours$ a formal presentation 10 to ,H minutes$ and an informal con tribution two to three minutes. 2d*ournments coincident with refreshments should be used to brea! a length% negotiation into twohour segments. 2d*ournments should be used as powerful aids to nego tiation b%: providing time to consider progress or new proposals within the team and avoid snap decisions bringing unconstructive or personali5ed arguments to an end providing an opportunit% for informal$ e-plorator% tal!s between individual members of the two parties. #he purpose of negotiation is to reach agreement$ not to score points in argument. Effective negotiators are good listeners: the% as! 6uestions more often than the% ma!e statements. 3umor$ or goodnatured banter$ can be used to reduce tension and help create a bond between the two parties. It is important to loo! for verbal and nonverbal clues or signals of the other part%]s changes of mood or approach. #here should be a concentration on issues or outcomes of common interest$ rather than on the original differences. #he closer a negotiation is to agreement7 the more sensi tivel% the discussion should be handled. (eriodic$ *ointl% agreed summaries of progress can secure a phased agreement and prevent reversion to earlier argument. (roposals ma% initiall% be put as h%pothetical suggestions. #his ma!es it easier for both parties to avoid the pressure of immediate acceptance or withdrawal. #here is a positive advantage in ma!ing it eas% for the other side to move$ rather than challenging them on a winBlose basis. (roposals are best sold on their advantages to the other part%$ not to one]s own. >ear of losing personal or corporate face can severel% inhibit progress. Compromise should be seen as constructive$ not wea!ness. In assessing the benefits of an agreement$ consideration should be given to factors be%ond the conte-t of the immediate negotiation such as the creation of useful precedents$ and the 6ualit% of longterm relationships. #he final offer and agreement needs to be timed to coincide with a period of constructive discussion - and not be done during a combative phase. It is important to achieve credibilit% for an% statement about an offer]s being final the tone and st%le of such a state ment ma% be as important as its substance. 9evices can be used to brea! a deadloc! in reaching agree ment such as promises of future negotiations on a related topic$ or ma!ing the introduction of a new conditions sub *ect to later review. <efore finali5ing an agreement$ chec! that all aspects have been agreed$ particularl% dates for implementation$ review or completion7 and definitions of terms. Ensure full understanding of what has been agreed through final summaries and b% producing written confirmation. 8nresolved issues should not be ]fudged] b% producing vague or ambiguous forms of words in order to achieve ap parent agreement. ?= 2n agreement is not successful until it has been effectivel% implemented. It is often helpful to include an implementation program as an integral part of a negotiated agreement. 2n implementation program defines what has to be done$ when$ and b% whom. >or some agreements$ implementation ma% be best effect ed b% a *oint team. #hose affected b%$ or re6uired to appl%$ an agreement &though not themselves involved in the actual negotiation' need ade6uate information and e-planation. Such action should be based on defining who needs to !now what$ how$ and b% whom this information should be given$ b% what methods$ and to what timescales. >acetoface discussions are not the onl% form of negotiation: effective use can also be made of correspondence and the telephone. 2n opening letter can help to set the parameters and st%le of later negotiation. 9ealing with all or part of a negotiation b% correspondence ma% well save time$ avoid an emotional confrontation$ provide a record of the negotiation$ and enable carefull% drafted and comple- proposals to be produced. Some negotiators are less resistant to proposals when discussing them on the telephone. #elephone discussions ma% be used to settle minor or simple negotiating points e-tremel% 6uic!l%. "egotiations cannot be conducted through the media$ but the media can be used to influence the attitudes of those concerned$ as well as where appropriate public understanding and support. #he common characteristics of media communications of all !inds are accurac%$ clarit%$ and reasonableness. (ress advertisements offer full control over what is said$ but their status as advertisements ma% reduce their credibilit%. (ress releases provide initial control over content$ but it cannot be guaranteed that the% will be reproduced full%$ or at all. (ress releases need to be written in the st%le of the media to which the% are issued. @ournalists ma% be assisted or persuaded to write news stories. #hese ma% carr% more public credibilit% than compan% statements$ but incur the ris! of error or distortion. Cadio or #V interviews should be seen as opportunities to put across a message in clear$ simple terms$ regardless of the precise 6uestions as!ed. L Commercial negotiations often differ from other forms of bargaining in that the two parties have no wor!ing relation ship outside the issues under negotiation. L Internal mar!et negotiations should focus on the *oint re sponsibilit% of purchaser and provider for the survival and success of the organi5ation the% both wor! for. L #he most common feature of commercial negotiations is bu%ing and selling often to produce a contractuall% bind ing agreement. L In bu%ing and selling$ the balance of power fre6uentl% lies with the bu%er who can choose to deal with an alternative source of suppl%. L Conse6uentl%$ business literature and training programmes concentrate far more on developing selling s!ills than on the e-pertise involved in bu%ing. L Sales techni6ues include the avoidance of direct competi tion b% emphasi5ing the uni6ue 6ualities of the goods or services being sold$ an ?? emphasis on the benefits of a deal to the bu%er$ and encouraging the bu%er to ma!e an im mediate decision. L Feneral bargaining principles include an emphasis on care ful planning$ the trading of concessions$ and the avoidance of impasse. L <ecause most commercial agreements constitute legall% enforceable contracts$ it is important that the% should be in writing$ unambiguous$ and founded on a basis of accurate information. L Degal remedies for breach of contract include in*unctions to enforce performance and also compensation for financial damages. 2lthough some people are better natural negotiators than others$ negotiating s!ills can be ac6uired or improved b% practice$ coaching and training. #here are three main elements involved in improving one]s negotiating abilities !nowledge$ s!ills and attitudes. Effective negotiation demands a !nowledge of the princi ples of the negotiating process$ the conte-t of the particular negotiation$ and its detailed sub*ect matter. #he main t%pes of s!ill involved are anal%tical$ interactive and communicative. 9ifferent approaches are needed to deal effectivel% with dif ferent t%pes of difficult negotiations. "egotiations are strongl% influenced b% underl%ing atti tudes to the process itself$ to the issues and personalities involved in the particular case$ and b% one]s own selfperception and personal needs for recognition and achieve ment. (lanning to improve one]s negotiating s!ills should be an el ement in most personnel professionals] personal develop ment plans. Dialo#ue ;r. "agel is the owner of a beautiful estate located ,H !m far from Sibiu. 2le- >een% came from the 8S2 two months ago and now he is loo!ing for a place to settle with his famil%. 3e met ;r. "agel at a meeting last wee!. ;r. "agel owns several estates and this one is worth bu%ing. <ut he wants to deal directl% with the person willing to become owner. 2. >een%: Food morning ;r. "agel how are %ou toda%4 ;r. "agel: I am ver% tired as I have been loo!ing for some agencies to help me with the sale. It costs a lot$ so I do want to deal with the client and not through a middleman. 2. >een%: I agree and I would li!e to tal! with %ou about this. 3ave %ou thought of a price4 ;r."agel: +ell$ the estate is worth around 0=H HHHN but the price ma% be negotiable. 2. >een%: It is a bit too e-pensive for me. Even if I am a businessman$ I do thin! I cannot afford the price unless %ou drop it. ;r "agel: (rices here have s!%roc!eted latel% and the% are not leveling off. 2. >een%: I can onl% pa% 00H HHH N cash. If %ou agree then I can give %ou the mone% tomorrow. ?G ;r. "agel: I agree onl% if %ou ta!e into consideration the terms regarding the insurance of the house. :ou have to pa% the installments in advance as I had alread% done this so far. 2.>een%: I agree. I thin! we have to meet a notar% and sign the papers. ;r."agel: #herefore$ we can see him at G tomorrow morning. I will bring all the papers and as far as %ou are concerned do not forget to have the mone% with %ouK 2. >eend%: I will. #han! %ou ver% much. :ou are a ver% nice person. ;% famil% is going to be ver% grateful to %ou as the% en*o% this gorgeous land. Additional Voca%ulary' to negotiate a loan a negocia un _mprumut ongoing negotiations tratative _n desfP`urare negotiations in progress tratative _n desfP`urare *oint comun *oint bargaining negocieri commune *oint owner copropietar *oint management conducere colectivP outcome re5ultat$ consecin^P to settle a stabili$ a solu^iona$ a reglementa to claim a pretinde$ a cere$ a revendica to score a _nregistra$ a nota$ a marca$ a ob^ine$ a reali5a scheme plan$ aran*ament$ combina^ie damage daunP$ pre*udiciu to ad*ourn a amana$ a suspenda ad*ournment amanare$ suspendare$ _ntrerupere to ad*ust a adapta$ a a*usta$ a corecta$ a aran*a$ a pune _n ordine$ a aplana ad*ustment a*ustare$ potrivire$ corectare$ adaptare$ aplanare$ acoperire. to involve a implica$ a antrena involvement implicare$participare to enforce a aplica$ a pune _n vigoare enforceable aplicabil enforceabilit% aplicabilitate enforcement aplicare a unei legi to bind a lega$ a _ncheia$ a impune$ a oblige$ a se lega$ a se oblige binding legPturP concession concesie$ recunoa`tere to incur a contracta$ a asuma$ a suporta$ a suferi to induce a convinge$ a determina la$ a impinge la$ a hotPr_ la guaranteed garantat guarantee garan^ie$ siguran^P GH Topic" for di"cu""ion' 1.3ow can %ou be successful in a negotiation4 ,.Can %ou be persuasive with a client4 In what wa%4 ..2re there secrets in communication4 /.3ow can %ou be inventive in negotiating a product4 0.+hat mista!es do %ou have to avoid4 Enlar#e upon' 1.#here is no failure$ but results and onl% resultsK ,.#here is no long lasting success without sacrificesA ..#here are of three !ind of people: those who ma!e things happen$ those who loo! at things to happen$ those who do not understand what is happening. /.Ueep close with those who win and avoid those who loseK 0."ever negotiate without being afraid$ but never be afraid to negotiateK Meetin#" ;eetings have to be an efficient tool to assist us in getting decisions$ information and action. +e discuss$ decide$ decree$ demolish. Sometimes the% can ta!e over our life. Some are efficient$ others are not and for some of us the% have even become a wa% of life. #he ob*ective of a meeting should never be to have a meeting. #he% are a means to an end$ never an end. If handled well$ meetings can be invaluable tools for getting things agreed or discussed. En*o%able meetings that are productive and help to get the *ob done are an ideal that becomes possible with a little effort. 2n unsuccessful meeting ma% do more harm than one which never ta!es place. So$ the success is *udged b% the actions that result from it. 2nd this is lin!ed to running the meeting as the responsibilit% of the whole group not onl% the chairman. There are many rea"on" to call a meetin#' briefing people e-changing and evaluate information negotiating a deal ma!ing decisions ta!ing things through solving a conflict establishing a plan +e hold or attend meetings which serve a number of purposes. (eople have to be sure wh% the meeting is being held. "ot onl% does the meeting need to achieve business but also people have to be satisfied that this has been done. ;eetings are at the ver% heart of management. ;ore and more time is spent in attending them. #he% can be inspiring$ energi5ing and fun. G1 Sometime" meetin#" fail %ecau"e of' interruptions such as nois% rooms$ mobile phones$ messages$ people arriving late. lac! of focus: irrelevant discussions ob*ective not achieved: decisions are not ta!en$ people sa% the% need more time. politics motives are being brought in: confronting discussions poor preparation: research has not been done properl%. poor chairing poor environment: people crammed into a room$ tables covered with tea and coffee cups and room for the papers. poor timing: people arriving late$ meetings starting and ending late. right people absent: people with necessar% input or information are not invited or not available. unnecessar% meetings: %ou need a 6uic! decision wrong people present: the% can ruin a meeting.
What i" important to !no in a meetin#' to clarif% the purpose of the meeting to have meetings onl% if the% are necessar% to invite people who need to give approval$ have the re6uired e-pertise or information$ have the creativit% or intelligence to help the group generate ideas$ will carr% out decisions made$ will support %our issue$ will be directl% affected b% the outcome. to send out a bac!ground information to create an agenda in order to give the start time of the meeting and location$ list participants e-pected to attend$ list issues$ give the order in which the% will be dealt with. to anticipate and prevent problems: problem people$ hot topics$ alliances and politics$ support. the agenda can do half of %our wor! before the meeting even starts: assessing items$ standard items$ have an order for the items$ time each item$ write the agenda. to chair the meeting carefull% and well balanced: bring in 6uiet people$ be open about input$ stimulate a debate or discussion$ listen activel%$ control discussions$ gain agreement and approval b% bringing discussions to an end$ b% letting people !now it is time to ma!e decisions or to agree$ summari5e different viewpoints$ discourage interruptions$ as! for a decision or consensus$ ma!e sure the 6uiet people spea! up$ ta!e a vote if necessar%. to satisf% the participants as well as the agenda. to consider that a compromise could achieve both completion of business as well as satisf%ing the participants. G, to be a good communicator b%: ma!ing people feel good and value them and their opinion$ getting them involved in the meeting$ b% showing %ou understand the wa% someone feels. to handle challenges b% focusing on the issue not the behaviour or opinion of others$ bring in others on %our side$ do not lose temper$ give in and then raise the matter with a higher authorit% or at another time. to announce a finishing time$ to limit the number of items on the agenda to the time allowed. to allocate a tas! owner to each item who will control the conversation and ta!e responsibilit% for an% decision. to summari5e within items$ at the end of them and at the end of the meeting. Type" of Meetin#" Team Meetings Consultancy and client meetings Negotiations I. #eam briefing develops the team meeting into a management information s%stem. #he ob*ective is to ensure that ever% emplo%ee !nows and understands what the% and the others in the organi5ation do and wh%. #eam leaders and their teams get together regularl% to tal! about issues relevant to them and their wor!. #here are some benefits to team briefing such as: it reinforces management it increases commitment it prevents misunderstandings it helps to facilitate change it improves upward communication II. +henever %ou meet a client to present a proposal$ however uncommercial the situation$ something is being sold. So$ the meeting will fail if the client)s re6uirements are not defined ade6uatel% beforehand. (art of our *ob ma% be to help the client to clarif% what he wants. So preparation becomes essential$ a pre meeting is useful to define the problem and agree the client)s re6uirements as clearl% as possible. >irst stage thin!ing has to be used to clarif% what the client wants$ before suggesting solutions. #he following guidelines have to be used: create agreement with the client. identif% the client)s need. present %our solution. e-plain the proposal in detail anticipate an% ob*ections %ou !now the client has. restate the proposal b% summari5ing$ discussing. !eep discussion separate from %our presentation. G. III. 9oing deals is a fundamental wa% to achieve goals7 but it is a means not an end. 2 successful negotiation closes with ever%bod% satisfied$ the negotiator is delighted when the meeting creates genuine agreement. Once %ou recogni5ed a meeting as a forum for negotiation we have established as adversarial situation. 2s a result$ scoring over the opposition becomes an important strateg%. #he negotiation becomes an e-ercise in game pla%ing: secrec%$ bull%ing$ hoodwin!ing. So$ this tacit agreement entails stress$ wastes time and catastrophe ma% follow$ new problems ma% arrive$ commitment will suffer$ promises will be bro!en$ reputations will be bruised. #he responsibilit% will be to see! agreement: a specific plan of action to which all parties can commit themselves. 3ow to hold better meetings Conflict Conflict is undoubtedly one of the most common sources of anxiety in meetings. Many meetings seem to collapse into argu ment, hostility and ritual recrimination almost as a matter of course. Do not regard conflict as inevitable or desirable. You are not powerless in the face of emotional hostility; but, in order to handle it well, you need to distance yourself from it. Begin by trying to locate the source of the problem. ometimes this is obvious! insecurity at a time of great change, stress, a new set of wor"ing relationships or pressure from public exposure. #n other occasions, it may seem to bubble up from nowhere, starting with something small and escalating $uic"ly as it ta"es hold of the group. Conflict thrives on confusion and doubt. ome group members may see" to manipulate it for their own ends or use it to %ustify their cynicism about all matters managerial. A" conflict grows through a group, it becomes more emotional, generali&ed and unfocused. 'oo"ing for a target, it can find the Chair, turning the meeting into an all(purpose )grouse session). *ostility often results from a sense of powerlessness. +t is the feeling of being at the mercy of forces outside our control that is so disabling. ,his is why anger often centres on what has happened in the past, and in particular on what )they) have done! senior management, other teams, department heads , rogue operators] who have buc!ed the s%stem$ engineers or sales staff who are never in the office$ customers$ suppliers$ competitors. <e prepared. If %ou are facing conflict or group resistance$ %ou must give %ourself a single overriding ob*ective: to empower the group to do something practical. Onl% b% focusing their thoughts on the future$ and on what the% can do will %ou transform people]s energ% from conflict into purposeful activit%. 2rm %ourself with a few guiding principles. ;a!e the ob*ective of the meeting clear at the outset. +rite it up on a flip chart and be read% to refer bac! to it fre6uentl%. Challenge people to e-plain the relevance of their remar!s to the meeting]s ob*ectives. Cemember that %our tas! is to control the conversation. Cesist being drawn into the emotional maelstrom$ however hard that ma% be. Slow the conversation down. 9o not mirror the tone$ pitch or speed of others] speech. 9o not interrupt or cut people off in midsentence. Disten to the points people are ma!ing and displa% them openl% on the flip chart. G/ 9o not be tempted to argue$ or to contradict opinions or generali5ations: about what ]the%] do$ or what ]alwa%s] happens. 2 good response to such remar!s would be: ]In what circumstances4 #urn complaints into ob*ectives b% as!ing people to restate them as ]how to] statements. +rite these up on the flip chart and displa% them. Stop people from tal!ing about others who are not at the meeting. Insist that ]the%] are not here and we are$ and that onl% we can address our ob*ectives. >ocus on solutions$ not problems. <e a bro!en recordK Cepeat %our 6uestions to the group$ over and over ]+hat are we tr%ing to do4 +hat can we do about it4 3ow does this relate to our ob*ectives4] <e specific. (eople should !now what contribution the% are being as!ed to ma!e$ and how their contribution will contribute to wider ob*ectives. <eing e-plicit about goals and targets is the onl% wa% to achieve this. If %ou genuinel% consult as!ing for suggestions$ inviting people to participate in finding solutions a great deal of resistance will melt awa%. >ocus on action. 9raw the group]s attention awa% from what others have done or are doing$ towards what we will do in the future. :ou will have to be sensitive about this. 9emonstrating that %ou understand people]s grievances can be useful in winning them over to %our own ideas7 and in rooting out areas for improvement. 3owever$ there will come a point in a ]grouse session] when %ou should start as!ing$ insistentl% but 6uietl%: ]So what are we going to do4] In this wa%$ %ou will divert attention from damaging ]stor%telling] and complaint towards commitment and agreement. <% showing that something can be done$ %ou can show people that the% have power to change things. C.-VERSATI.-' T,E ,EART .? T,E MEETI-: 2t the heart of an% meeting is conversation. It is b% conversing that we e-press our thin!ing and relationships to each other. If we want to improve our meetings$ we must improve the 6ualit% of the conversations that ta!e place in them. T,E DY-AMICS .? C.-VERSATI.- Conversation is a verbal dance. #he word$ from Datin$ has the root meaning of ]to !eep turning with]. Conversation relies for its success on all participants moving. Di!e an% dance$ conversation has rules and standard moves. #hese allow people to move more harmoniousl% together$ without stepping on each other]s toes. 9ifferent !inds of conversation have different conventions. Some are implicitl% understood7 others must be spelled out in detail and rehearsed. #his sense of a conversation is well e-pressed in the word @dialo#ue@* #he purpose of dialogue &from the Free!$ ]meaning through]' is to construct a new$ shared meaning through conversation: a meaning that would not come into being if the conversation did not happen. +e e-plore each other]s perceptions$ offer our own for G0 e-amination and transform our thin!ing in the light of others]. #his$ at its ver% best$ is what conversation can achieve. Tal!in# and li"tenin# #he d%namic of conversation involves two elements: tal!ing and listening. #hese two activities do not happen merel% in se6uence$ but simultaneousl%: each participant in a conversation is both spea!er and listener throughout the conversation. ;ost of us are better at tal!ing than at listening. 2s managers$ we are trained in the techni6ues of presenting$ e-plaining and influencing. Our education mostl% stresses the value of arguing ta!ing a position$ holding it$ defending it$ convincing others of its worth and attac!ing an% argument that threatens it. 2s a result$ our conversations tend not to dance but to push and shove. Ad$er"arial thin!in# In an attempt to impose order on our conversations$ we have invented debate &from the Datin$ ]to beat down]' 9ebate fosters adversarial thin!in#' a form of group thin!ing so common that$ for man% of us$ it is the only wa% an% group can thin!. Instead of enduring a verbal brawl$ we set up a bo-ing match$ in which ideas preferabl% two opposing ideas fight it out according to more or less strict rules. #he idea left standing at the end is considered to be ]true]. ;uch is made in management theor% of the virtue of debate. It is said to be not merel% unavoidable in business$ but positivel% desirable: a recent article in !arvard Business "eview calls it ]creative abrasion]. "o less an authorit% than (eter 9ruc!er has written: 'the understanding that underlies the right decision grows out of the clash and conflict of divergent opinions and out of the serious consideration of competing alternatives'. <% the rules of debate$ if %ou prove the opposing idea to be wrong$ %ou have somehow proved that %ours is correct. #his is clearl% ridiculous: both arguments ma% be wrong7 both ma% be partl% right. :et debate cannot allow us to consider these possibilities or an% others. 2 debate is a conflict of rigid opinions. Opinions are ideas gone cold. #he% are our assumptions about what might$ or should$ be true rather than what is true in specific circumstances. #he% ma% ta!e the form of: stories &about what happened$ what ma% have happened$ wh% it ma% have happened'7 e-planations &for wh% something went wrong$ or wh% we failed'7 *ustifications &for ta!ing action or not'7 wrong ma!ing &I am right$ %ou are wrong'7 gossip &to ma!e us feel better at the e-pense of others'7 generali5ations &to save us the trouble of thin!ing'. +e are so used to voicing and listening to opinions that we can easil% mista!e them for the truth. +henever %ou hear the word ]fact] in a meeting$ %ou can be almost certain that somebod% is voicing an opinion. G1 #he overwhelming limitation of adversarial thin!ing is that it is destructive. #he ]clash and conflict of divergent opinions] actuall% prevents people from e-ploring or developing ideas. #he% are too bus% defending themselves$ too frightened to venture from their corners$ too battlefatigued. It is unusual for an% meeting to avoid adversarial thin!ing. It usuall% appears in one of four forms. Critical thin"ing >or most of us$ to thin! about something is automaticall% to loo! for something wrong with it. #a!e note ne-t time %ou as! an%bod% for their response to an issue: invariabl% their first thoughts will be critical. #he rationale behind critical thin!ing is presumabl% that$ b% loo!ing for the wea!nesses in an idea$ we can strengthen it. <ut we rarel% receive criticism in this wa%7 instead$ we tr% to defend our idea from the criticism or attac! the criticism itself$ in an effort to discredit it. -go thin"ing In adversarial thin!ing$ we become identified with our ideas. Criticism of an idea 6uic!l% becomes an attac! on the person holding it. 9ebate is used as a prete-t for scoring points against others. Ceason gets infected with emotion. ;eetings often devote enormous amounts of energ% to preventing emotion from overwhelming debate$ but the d%namic of debate ma!es emotional conflict inevitable. .igid thin"ing 2ll thin!ing starts from propositions about realit%. 2dversarial thin!ing merel% pits these propositions against each other. It limits itself to their terms and their conse6uences: an% thin!ing that 6uestions the thin!ing behind a proposition$ or stra%s be%ond its boundaries$ can be dismissed as ]irrelevant] &or ]deviant]'. Indeed$ the adversarial mode actuall% serves to entrench propositions rather than adapt or modif% them. Cigid thin!ing is usuall% the result of: conforming to authorit% &]if senior management see it this wa%$ it must be right]'7 the influence of custom &]our profession has thought li!e this for the last two hundred %ears]'7 habit &]this is the wa% we thin! around here]'7 willful ignorance &]thin!ing li!e this saves us the bother of dealing with inconvenient detail or finding out more]'. /olitical thin"ing +hen ideas become identified with individuals$ people reali5e that achieving action is a matter of aligning themselves with ideas$ and with those promoting them. 2s rigid thin!ing limits the growth of ideas$ propositions can onl% be attac!ed or defended. #o attac! an idea is to attac! its sponsor7 to support it is to create an alliance. +e begin to use conversational gambits$ plo%s$ manoeuvres and defence mechanisms$ not to develop the conversation but to pla% politics: creating ]power bases] and undermining ]opponents]$ bureaucratic conniving$ behindthe scenes manipulation and rumourmongering. +e accord adversarial thin!ing enormous prestige. ;anagers G= who can defend their ideas and withstand the onslaught of their peers or$ better still$ their superiors gain status and ma% be promoted on the basis of their ]strong character]. #he% become ]heroes] and the stuff of m%th. 2dversarial thin!ing is selfperpetuating. Di!e other !inds of conflict$ it is c%clical and can escalate easil%. <eing attac!ed for our ideas causes pain7 we respond in !ind and help to pro long the conflict. +e ma% engage in ]preemptive stri!es]$ attac!ing before being attac!ed. 2dversarial thin!ing e-presses our lac! of securit%$ and the need to protect ourselves from future threats. #hus we become loc!ed in a ]cold war] of argument and counterargument. 2lthough we ma% recogni5e that our behaviour is unproductive$ we feel we cannot do an%thing dif ferent. +e do not !now how to7 and we ma% be too frightened to who can defend their ideas and withstand the onslaught of their peers or$ better still$ their superiors gain status and ma% be promoted on the basis of their ]strong character]. #he% become ]heroes] and the stuff of m%th. 2dversarial thin!ing is selfperpetuating. Di!e other !inds of conflict$ it is c%clical and can escalate easil%. <eing attac!ed for our ideas causes pain7 we respond in !ind and help to pro long the conflict. +e ma% engage in ]preemptive stri!es]$ attac!ing before being attac!ed. 2dversarial thin!ing e-presses our lac! of securit%$ and the need to protect ourselves from future threats. #hus we become loc!ed in a ]cold war] of argument and counterargument. 2lthough we ma% recogni5e that our behaviour is unproductive$ we feel we cannot do an%thing dif ferent. +e do not !now how to7 and we ma% be too frightened to 3ow$ then$ can we brea! out of the vicious spiral4 +hat can we do to help meetings evolve be%ond the fruitless and e-hausting ritual of adversarial thin!ing4 (erhaps the first step is to improve our listening. The #entle art of li"tenin# #he 6ualit% of an% conversation depends on the 6ualit% of the listening. Distening is far more than simpl% not spea!ing. #he listener controls the spea!er]s behaviour b% their own: b% maintaining or brea!ing e%e contact$ b% their bod% position$ b% nodding or sha!ing their head$ b% ta!ing notes or doodling$ and so on. Similarl%$ when we spea!$ we demonstrate the 6ualit% of our listening. If we interrupt$ we demonstrate that we have stopped listening$ that we are not interested in listening an% longer. #his$ in turn$ will affect the other]s spea!ing and listening. +e all !now the s%mptoms of poor listening. #he% are so familiar that we even e-pect them and develop tactics to cope with them. #he% include: outright condemnation of an idea7 critici5ing the spea!er]s deliver%7 onl% repl%ing to a part of what somebod% has said7 interrupting7 da%dreaming7 pa%ing attention to a distraction7 holding another conversation at the same time# evading the issue# using emotional words# going to sleep. $e are all a%le& however& to listen effectively. $e listen well when we G? like or admire the speaker# want to trip them up# think they have something interesting to say# e'pect to %e rewarded or punished for listening well# know that we will %e asked to comment# have an overwhelming need to listen# are not distracted# know or have learnt that effective listening improves group %ehaviour and leads to improved results in the meeting. The first step in improving our listening skills is to %ecome aware of the o%stacles. (ome we will have control over# others we may have to endure. Tal!in#' 2rguing ;ultiple conversations 2s!ing an irrelevant 6uestion Changing the sub*ect +andering off the point 8nfamiliar voice patterns 2mbiguit%: double meanings$ wool5 use of language$ *argon Dac! of detail in spea!ing Spea!ing too long /eha$ioral' 2voiding e%econtact Doo!ing bored Sending the wrong signals: headsha!ing$ foottapping :awning >idgeting Cloc!watching Custling papers ;isinterpreting behaviour Crosscultural confusion P"iholo#ical' Sh%ness 2ggressiveness Intimidation Inappropriate use of authorit5 (ersonalit5 clashes <ias >avourism (re*udice: race$ gender$ class$ age$ educational bac!ground Cultural habits Phy"ical' GG "oise Other people Other meetings Submeetings Interruptions from outside #echnical interruptions: phones$ bleepers$ computer malfunctions (oor ventilation >ierce airconditioning E-tremes of temperature 8ncomfortable furniture Sitting too long Inappropriatel% shaped table 9isabilit% not accomodated Conversation is the wa% we thin! together. +hat we sa% is what we thin!. +e are paid to thin!. Our success depends on our results7 we thin! when we want results that are better than the% would be without thin!ing. 2nd %et most of us are not trained to thin!. #hin!ing is not %et regarded as a !e% managerial s!ill. 2s a result$ we have developed a number of damaging misconceptions about thin!ing. #hin!ing is not an alternative to doing. +e can use thin!ing as an e-cuse not to act7 and we can act without thin!ing. #he reason we do both so much is that we regard thin!ing and action as opposed. #he% are not. Effec tive thin!ing improves the effectiveness of our actions7 and our actions are a rich source of good ideas. #hin!ing is not intelligence. #hin!ing unintelligentl% ma% still achieve something. Intelligence without thin!ing is useless. #hin!ing is not a function of education. 3ighl% educated people are not necessaril% good thin!ers7 and man% people with little education can thin! e-tremel% effectivel%. #hin!ing is not being clever. 2n increase of !nowledge is not thin!ing: it is simpl% hoarding. #oo much information can seriousl% hamper our abilit% to thin!. #hin!ing is not onl% the operation of logic. It involves loo!ing$ e-ploring$ choosing$ designing$ evaluating and having hunches. It includes considering priorities$ ob*ec tives$ alternatives$ conse6uences and other people]s opinions. #here is a @apanese proverb: 'None of us are as smart as all of us.' :et most groups of people thin! far less well than an% one of them individuall%. #wo main reasons suggest themselves. 1. +e confuse conversation about the tas! with conversation about process. +e identif% thoughts with people. +e tal! in code. +e use conversation to e-press lo%alties or alliances$ to bid for power$ to protect our position or sense of selfworth. +e persist in old conventions or habits of conversation to feel more comfortable. ,. +e fail to manage the structure of the conversation. 2 wellmanaged conversation will begin with clear ob*ectives and end with clear actions. ;an% conversations have unclear agendas &or hidden agendas'7 others are combinations of several conversations at once. +e allow our conversations to ramble$ to get stuc!$ to be hi*ac!ed or stifled. <ecause the behavioural or ]political] aspects of conversation are so powerful$ we find it difficult to influence the course of conversations productivel% particularl% in a meeting$ when a group of people are involved. #ac!ling these two failings is criticall% important if we want to help ourselves and others to thin! better in meetings. 1HH Thin!in# @hat"@ Serious conversations should see! to distinguish ideas from people. Edward de <ono]s ]Si- #hin!ing 3ats] are becoming increasingl% popular as tools for clarif%ing this distinction. 9e <ono suggests that we label ever% contribution to a conversation b% means of a coloured ]hat] that the spea!er is ]wearing] as the% ma!e it. Chairs can also as! participants deliberatel% to ma!e contributions ]wearing] a particular hat. #he si- ]hats] are: +hite hat: facts and figures. Ced hat: emotion$ feelings$ hunches and intuition 7lac! hat: caution$ *udgement$ fitting propositions to facts. :ellow hat: advantages$ benefits$ savings. Freen hat: creativit%$ new ideas$ e-ploration$ suggestions. <lue hat: thin!ing about thin!ing$ control of the thin!ing process$ ]points of order]. #he beaut% of de <ono]s hats is that we can put them on and ta!e them off ver% easil%. It would be utterl% inappropriate to suggest that someone is a ]redhat thin!er] or a ]blac!hat thin!er]. 2n%bod% can use the hats whenever the% want. Indeed$ using the hats allows people to ma!e remar!s that the% might not ordinaril% ris! ma!ing. +e can use the hats informall% or s%stematicall%. @udging which hat to pic! at which point can become a sophisticated chairing s!ill in itself. Consultancies now e-ist that train managers in the use of the thin!ing hats. The to "ta#e" of thin!in# 6 +e can imagine thin!ing as a process in two stages. >irststage thin!ing is concerned with perception: we recogni)e something because it fits into some pree-isting mental pattern. +e can call these mental patterns ]ideas]. Ideas are arrangements of e-perience in our minds. #he% allow us to ma!e sense of our e-periences7 the% are the means b% which we have e-periences. In firststage thin!ing$ we encode e-perience so that we can use it at the second stage. +e name an ob*ect or event7 we translate comple- activit% into an e6uation7 we simplif% a structure b% drawing a diagram. In secondstage thin!ing$ we ma!e *udgements about our e-perience b% manipulating the code. 3aving named something as$ sa%$ a ]cup]$ we appl% logic$ custom and aesthetics to *udge its effectiveness as a cup. 3aving labelled a downturn in sales as ]a mar!eting problem]$ we use mar!et research$ spreadsheets$ past e-perience and critical scrutin% of the mar!eting depart ment to *udge how best to solve it. ;anaging our thin!ing begins b%: separating the two stages of thin!ing7 becoming conscious of which stage we are in at an% point7 appl%ing onl% the tools and techni6ues appropriate to that stage. +e are highl% s!illed in secondstage thin!ing. +e are taught it at school: we learn verbal and mathematical languages$ we are encouraged to anal%se$ to deduce$ to argue and to evaluate. So sophisticated is our secondstage thin!ing that we can construct computers to do it for us. +e are so good at it that we regard it as the sum total of thin!ing. IE &intelligence 6uotient' is a measure of our abilit% to manipulate language and s%mbols. 1H1 +e are not nearl% so s!illed at firststage thin!ing. +e are taught virtuall% no techni6ues to help us improve our percep tions. :et a change in our firststage thin!ing can have dramatic conse6uences at the second stage. If we decide that the cup is not a cup but a troph% or a vase$ a mug$ a chalice our second stage thin!ing about it will change. Our ]mar!eting problem] ma% actuall% be a ]product 6ualit% problem]$ a ]distribution problem]$ ]a personnel problem]$ a ]macroeconomic problem] or a subtle combination of all five. Secondstage thin!ing is focused on results. >irststage thin!ing is not focused at all$ and this ma!es us uncomfortable. +here secondstage thin!ing is ]deep]$ concentrating our atten tion on a single idea$ firststage thin!ing is ]shallow]$ scanning a wide area of e-perience. It creates an-iet% because it dela%s the moment of deciding$ forces us to suspend *udgement and challenges our current wa% of seeing realit%. +e prefer to ta!e our perceptions for granted$ but no amount of good .secondstage thin!ing will be effective if it is based on limited or fault% perceptions. Food thin!ing pa%s attention at %oth stages of the process. #he great Swiss ps%chologist$ Carl @ung$ developed the two stages of thin!ing into two sets of paired complementar% func tions: sensation and intuition at the first stage7 feeling and thin!ing at the second. @ung himself used this model as the basis of a theor% of personalit% t%pes7 it will be familiar to man% managers as the basis of the ;%ers<riggs t%pe indicator. >irststage thin!ing 6uestions include: 1. ]+hat can we see4] &Sensation'. ,.]+hat might it mean4] &Intuition'. Secondstage 6uestions include: 1. ]+hat can we do4] &#hin!ing'. ,.]+hat shall we do4] &>eeling'. Voca%ulary' to chair a pre5ida chairman pre`edinte to decree a decide$ a emite un decret meeting _ntrunire$ `edin^P to call a meeting a convoca o `edin^P notice of meeting notificare a aunPrii generale to brief a re5uma$ a instrui briefing instruire$ informare briefing conference conferin^P de _ndrumare to e-change a face schimb to establish a stabili$a institui$ a _ntemeia$ a instala establishment institu^ie oficialP$ stabiliment$organi5a^ie publicP sau privatP$ fondare timing sincroni5are outright deschis$ cistit$ total outright loan to a pro*ect _mprumut direct pentru proiect outright grants for research aloca^ii integrale pentru cercetare bias eroare sistematicP$ distorsiune disabilit% neputin^P$ incapacitate disabled incapabil de to trigger a declan`a$ a porni$ a lansa liable rPspun5Ptor$ supus commitment anga*ament 1H, to reinforce a consolida$a _ntPri reinforcement consolidare to share a _mpPr^i to share in a lua parte la to share out a reparti5a$ a distribui Topic" for di"cu""ion' 1.3ow important is conversation in a meeting4 ,.+hich are the s%mptoms of poor listening4 ..+hat happens to a meeting if it is stuc! on a problem4 /.3ow important is timing in a meeting4 0.+hat is adversarial thin!ing4 Enlar#e upon' MI;eetings will not improve b% magic. (eople must want change and be willing to implement it.J MI#hin!ing is an alternative to doingJ. MI2 decision is committing to a course of action: choosing from among a number of alternatives and ma!ing a rational and emotional commitment to that choice.J MI;eetings are the ver% heart of management.J MIFetting agreement is eas%. Fetting ever%one to confirm afterwards about what e-actl% was agreed is the hard partKJ Dialo#ue ;r. <rown is the Feneral ;anager of IImperial IndustriesJ$ an important Compan%. 3e is attending the 2nnual Feneral ;eeting in a huge hall crowded with shareholders$ all ver% e-cited. ;r. Crossl% $ the Sales ;anager is going to preside the meeting. ;r. Crossl%: Food morning and I am glad %ou are here toda%. 3e turns the floor to ;r. <rown who is impatient and read% to convince the audience with facts and figures. ;r. <rown: +e must be ver% pleased with the turnover of the compan% which has enlarged considerabl%. Even if we had to face a tough competition$ I)m glad to tell %ou that we are highl% appreciated on the domestic and foreign mar!ets. +e have fine$ reliable products for the ne-t financial %ear and we do hope to merge with other well !nown companies. One of them will be I #V#J Compan% in the South of Europe. ;r. ;onro$ ;ar!eting ;anager for the IDio-JCompan% in Ferman% : 3ow did %ou succeed in spite of the unsuitable buildings4 It seems to me almost impossible now that I have in front of me the figures. ;r. <rown: It is true that the buildings are in a deplorable condition but we have updated machiner% and highl% trained staff. +e are e-tending within an area of / s6uare miles. #he new location will cost a fortune but it)s worth. "ew openings abroad are to be found and new funds are being e-pected. 1H. ;r. ;onro: I cannot agree with this. 8ntil mone% arrives what is going to happen4 2re %ou aware of this4 3ow can %ou be so optimistic4 ;r.<rown: +e are ver% prompt and efficient$ promising and hard wor!ing. ;r. ;onro: <ut we tal! about huge sums of mone%K ;ore and more e-citement among those present at the meeting as the% are sha!ing their headsA ;r. Crossl%: :ou need not worr% because we)ll manage to carr% on our plan. #he outloo! is good$ we have no unemplo%ment$ the output is high$ we have good forecasts$ the percentage of the business is the e-pected one. ;r. ;onro: +hich are the e-port outlets figuring in mar!eting plans4 Is there an% drawbac! to be e-pected4 ;r. Crossl%: ;ostl% Eastern European outlets$ and as far as drawbac!s are concerned$ I)m thin!ing of a depreciation regarding the dollar an% time. In the end there was a unanimous consent to wait for the further funds and for an outright loan.
Additional Voca%ulary' guidelines directive deput% manager director ad*unct sales manager director commercial acting manager director interimar la%out of a meeting amplasare to ta!e charge a`i asuma responsabilitatea turnovercifra de afaceri merger fu5iune outright loan _mprumut direct outlet pia^P de desfacere slump cri5P funding finan^are boom avant long term pe termen lung medium term pe termen mediu short term pe termen scurt restrictive practices practice anticoncuren^iale leveraged _ndatorat divestitures sci5iune to bail out a salva golden parachutes compensa^ii financiare garantate la% offs$ redundancies concedieri$ disponibili5Pri *oint ventures societP^i mi-te ailing _n dificultate to spin off assets a distribui activele tender offer ofertP publicP de cumpPrare *un! bond obliga^iune speculativP corporate governance conducerea _nterprinderii leveraged bu%outs preluarea controlului prin _mprumut$ cumpPrarea de cPtre salaria^i. to bid a face o ofertP financiarP bu%out cumpPrarea unei firme _n totalitate 1H/ E0 /u"ine"" for the Small /u"ine"" W h a t i " e 0 c o m m e r c e ? 2ll businesses e-ist because the% serve a mar!et. Successful enterprises$ big or small$ !eep their customers b% providing what the% need. In a traditional business it means !nowing %our mar!et$ bu%ing in the necessar% raw components$ combining them in %our own uni6ue wa%$ pricing products to suit the mar!et and distributing them efficientl%. #he final element is collecting the mone%. 2l l of these stages ta!e time to get right$ not to mention the boundless energ%. 8nless %ou are ver% luc!% indeed most traditional businesses ta!e up to three %ears to show a profit on the bottom line. +hat the new technolog% has done is to solve$ for some businesses$ two basic issues which unt il now have been ma*or causes of earl% failure: cash flow and distribution. 8sing the Internet as %our shopfront$ %ou can as! for the mone% before %ou dispatch an% goods or services to customers$ thereb% reducing %our e-posure. In some cases %ou ma% not even need to produce the product unti l an order is received. #he second main benefit of a +eb site is being able to reach potential customers on a global basis with ver% little mar!eting cost. #his ma!es %our brea! even model completel% different from ma!ing profits in a traditional business. :ou could be profitable within a few months rather than having to wait for a couple of %ears or more. <ut ecommerce is also about the bac! end of the business. #he side benefits of installing lin!ed (Cs$ whether the% are all hoo!ed up to the Internet or not$ include a more efficient business in terms of dealing with en6uiries$ product data and pricing issues. #hese benefits e-tend bac! into %our relationship with %our suppliers$ in other words$ obtaining and debt collection. If %our suppliers are themselves on the Internet$ that is even better. 2t the ver% least %ou will no longer need to write letters or send confirmations b% mail for agreement. @ust imagine how much time that would save for the average business. <% lin!ing %our staff together using a compan%wide ]intranetc &people sending each other messages on a private$ compan%onl% s%stem' would abolish the wasteful practice of internal paper memos at a stro!e. 9ecision ma!ing right across the compan% would be improved both in its speed and the discussion of an% relevant issues. +henever %ou need to do some research$ the Internet can provide access to information and mar!et data which unt il now has onl% been available to big companies with big resources and big margins or to members of e-pensive trade associations. "ational statistics$ trade trends$ other people]s prices and terms$ new products$ impending legislation$ competitor details are all available$ often at little or no cost. 2ll %ou need is a little patience and s!ill in !nowing how to search out such information on publicl% available and often free +eb sites. ,i"tory of the Internet #he Internet did not suddenl% come into being overnight. #he s%stem has been in development in one form or another for more than .0 %ears. 8nderstanding how it al l started provides current users wi t h a better appreciation of what it can do. 1H0 When did it all "tart? #he 8S 9epartment of 9efense was concerned in the mid1G1Hs that in the event of a nuclear war the armed forces would not be able to communicate with each other through the usual telephone networ!s. #hese networ!s relied on central control e-changes. Scientists argued that such control e-changes would be the first to be attac!ed in hostilities and therefore could never be the basis of a secure telecommunica tions s%stem. So the% proposed that new technolog% should be developed whereb% messages could be sent directl% from one part% to another without having to go through an e-change. Each sending station or ]node] had e6ual status within the s%stem. ;essages would be pac!aged in electronic parcels and let loose on the networ! to find their own wa% to their destination through the most efficient route. If an% part of the networ! were to be destro%ed$ the message parcel simpl% found an alternative route. #he principles of the new s%stem were tested in the 8U at the "ational (h%sical Daborator% in 1G1? and then later developed b% the (entagon. #he first node was a supercomputer based in 8CD2 &8niversit% of California at Dos 2ngeles' to which four more nodes were lin!ed in 1G1G. >or the first time scientists were able to share computer facilities even though the% were in different locations$ b% e-changing data between the five nodes. <% 1G=, there were .= nodes in the networ! !nown as 2C(2net &2dvanced Cesearch (ro*ects 2genc% net'. #he Internet toda% is largel% a development of 2C(2net. When a" e0mail in$ented? 9uring the trial periods it was noted that scientists were sending each other personal messages as well as academic data and were e-changing ideas of a less formal nature. #he concept of ]email] was born. <% the late 1G?Hs the "ational Science >oundation &"S>'$ a 8S federal agenc%$ had ta!en up the tas! of developing its own networ! for some government emplo%ees using the technolog% of the 2C(2net$ sending messages via new$ higher speed transmission lines. #o distinguish whether the sender was an academic or from the government$ ]edu] or ]gov] was added to the sender]s networ! address. Dater on other codes were developed to distinguish the t%pe of user and were included in their electronic address. ,o did the "y"tem %ecome a$aila%le to the ider orld? 2s other organisations ac6uired computers that could convert messages into pac!ages to be sent electronicall% &and receive them bac!' new commercial networ!s were developed. It was then a fairl% simple idea for some of these organisations to lin! up to create even wider networ!s. In time$ computers bought for businesses and the home came with the necessar% decoding programs to send and receive messages through telephone lines which were in turn lin!ed to other networ!s through Internet Service (roviders &IS(s'. It has been estimated that over ,HH million people are now connected to the Internet via their nodes &computers' and the numbers are growing each month. I" the World Wide We% "omethin# different? 1H1 It can be confusing. #he terms ]Internet]$ ]"et] and ]+orld +ide +eb] are often used to mean the same thing. #o be more accurate$ the +orld +ide +eb is the multimedia part of the Internet. #he +eb is the collective name for all the documents on the Internet that can be accessed through programs stored on %our computer. #hese access programs are called +eb browsers. In essence$ the +eb browser converts electronic information from other computers into displa%ed material that %ou can read or see. 2n%one can create a document and ma!e it available on the +orld +ide +eb for other computer users to read. #his displa%ed material is !nown as a +eb site. The importance of the Internet a" a %u"ine"" tool +hen %ou are running a business %ou need to grasp issues 6uic!l% if %ou are going to !eep ahead. :ou ma% alread% be wondering from the description above what relevance such a s%stem would have for %ou in %our ever%da% business life. E0mail #he Internet provides the facilit% to send and receive written business messages through the telephone networ!. If %ou want %ou can set up %our s%stem to be available to receive messages on a ,/hour basis$ which is important if %ou trade with overseas customers. :ou ma% want to place or receive an order late at night or during the wee!end. Or %ou ma% need a rush order completed to help %ou meet a deadline for one of %our own customers and %ou]ve missed the post. Email sends the message virtuall% instantaneouslv. Data collection 2lmost an% t%pe of information can be found on the +orld +ide +eb. If %ou are not sure where the information is %ou can as! Internet companies called csearch engines] to help %ou find it. If %ou !now the name of the organi5ation that has the information$ %ou can visit its +eb site from the comfort of %our own office and print off or store in a file an% parts or all of it without having to declare %our identit%. Di"cu""ion #roup" Sometimesin bus i nes s $% o u * ust want to t a l ! to someone who has been t hr ougha s i mi l a rcommercial e-per i enceso t h a t % ou can avoi d cost l % errors. 8s i ng t he I nt er net %ou can * oi n ] l i v e ] di scuss i onson %our comput ermoni tor$of t en on a wor l dwi debasis$ and as! 6uest i onsabout %our par t i c ul a rissue. :ou ma% want to !now if there is a mar!et for % o u r pr oduc t sin a f o r e i g nc ount r %.@ o i n a 8S3"E# group or a news gr oup o n l i n e a n d a s ! t hose people who a c t u a l l %l i v e there w h a t t he % t h i n ! . )on# di"tance data tran"fer :ou ma% need to send a /Hpage document wi t h comple- di a gr amsto a pot ent i al cl i ent on another cont i nent .If %ou mai l it this coul d ta!e da%s$ possi bl %wee!s to get there 1H= and even then there is no guarantee it wi l l a r r i v e in one piece. 8si ng t he I nt er net %ou can ] at t ach] t he document to an e mai l and %our cl i ent can pri nt out the document on hi s or her o wn computer wi t h i n seconds. 9evelopments in t he speed of dat a transfer mean t h a t pi ct ur esand mo vi n gimages can be sent b% t he same method. The %uildin# %loc!" of e0commerce Once %ou have realised the potential savings in time and e-pense whi ch even average use of t he Internet can deliver$ %ou wi l l be !een to get started. #he process of getting online is not di fficul t$ but as %ou wi l l discover$ once %ou are connected %ou ma% wel l have to change t he entire wa% %ou do business. 3ere are * us t some of the basic steps %ou wi l l need to t a!e to set up and develop %our own ecommerce business: L bu% sui t abl e computers7 L l i n! them together7 L rent an e-tra telephone li ne&s'7 L choose an IS( and go onl i ne7 L create a +eb site7 Lchoose appropriate mone% collection and securit% software: Ldecide what products %ou can sell online: Lthin! through sending products to overseas customers: Lbe aware of an% legal issues that ma% result: Lcreate a mar!eting strateg% and business plan for ebusiness: Lconsider how ebusiness will affect %our e-isting trade: Ldevelop %our database. It loo!s li!e a simple list. >rom a mechanical viewpoint$ it is. Some e-perts will tell %ou that the% can get %ou online within a da% but a +eb site is not necessaril% an ebusiness. Each step re6uires %ou$ as a small business owner$ to consider all the alternatives currentl% available if %ou want to achieve a profitable and sustainable business. It is not eas%. #he language suppliers use is often confusing as are the claims of speed$ efficienc% and suitabilit% for %our particular business. <ecause the s!ills to help %ou develop ecommerce are all relativel% new$ the costs can var% enormousl%. E6uall%$ because this wa% of doing business is so new$ no one has all the answers. #he advice from both startups and established pla%ers is to ta!e each stage in se6uence. #hin! through how %ou need to organise %our staff to get the best results. It will be a frustrating as well as a rewarding e-perience$ li!e all new businesses$ so be prepared for some hard wor!. >inall%$ do not be afraid to as! socalled e-perts to e-plain what the% mean. #he computer industr% is probabl% the best e-ample in the world of an industr% that li!es to cloud the issue. 2t times the *argon can be overwhelming. So do not suffer in silence. Fet %our new technolog% suppliers to e-plain in simple terms what the new piece of e6uipment can do specificall% for %our business. If %ou do not understand it %ou probabl% won]t use it$ so the investment will have been wasted. Cemember that man% socalled ebusinesses are often nothing more than direct mar!eting operations that happen to ta!e customer orders electronicall%. #he vast ma*orit% of ebusinesses still onl% use the Internet as a wa% to get en6uiries or orders. 2s %ou grow in confidence$ so will %our awareness of how products$ particularl% software$ could enhance what %ou do. 8se the Internet itself to as! for opinions and ideas. 1H? :ou]ll be ama5ed how helpful other ebusiness owners around the world will be when %ou as! for advice. ? r o m " m a l l % u " i n e " " t o % i # % u " i n e " " #here is no doubt that the earl% %ears of the dot.com revolution have been littered with a number of high profile failures. Some of the losses have been spectacular. Such bad news has alwa%s been good news for the newspaper publishing industr% it is alwa%s much more entertaining for readers when things go wrong. <ut there have also been some remar!able success stories that have received less public attention. >inding the right level of funds at the right time for a budding ebusiness on an ongoing basis needs to be planned for. It is li!el% that the funds will not come from the big ban!s as it has done in the past for most small businesses wishing to e-pand their business. The current tradin# %ac!#round for dot*com" +hen two twent% something Cornell 8niversit% graduates floated #heglobe.com on the "ew :or! Stoc! E-change in the late 1GGHs the share price recorded the highest ever oneda% rise on +all Street 1H1 per cent. +ithin 1, months the price had fallen b% GS.0 per cent and the% were both replaced b% a 0H%earold advertising e-ecutive. #he tale of high e-pectations followed b% poor sales and dubious management has been repeated in the 8U. #here is even a +eb site dedicated to trac!ing dot.com failures$ although there are rumours$ ironicall%$ that this too ma% be having financial difficulties. #he availabilit% of investment funds seems to have receded in line with the absence of an% real evidence of future profits. <ut it need not be the same for ever% dot.com business b% an% means. #here are still man% investors in the mar!etplace who are !een to bac! new ebusinesses provided there is a convincing business plan. De$elopin# your e0%u"ine"" plan 2ssuming %ou have a general idea that %ou are going to need more than %ou currentl% have in the ban! to fund the development of %our ebusiness$ the first thing to consider is the main headings of e-pendi ture over$ sa% a five%ear period: L Salaries: list all the salaries %ou wil l need to pa% including an% secretarial help and the estimated outcomes of inflation. L <enefits: add on all the salar%related e-tras li!e "ational Insurance$ cars$ e-penses$ travel$ pensions$ bonuses$ overtime$ recruitment fees. L ;ar!eting: allow for new campaigns and procedures$ ongoing +eb site development$ selling aids$ public relations$ 2S( soft ware$ trading licences. L 9istribution: postage or shipping costs$ pac!aging$ warehousing$ dispatch$ returns allowance$ stoc!s and stoc!s unsold$ insurances$ ta-es if applicable$ percentage per countr% mar!et. L Central support: finance$ legal$ human resources$ professional advice. 1HG L E6uipment: new office hardware$ warehousing plant$ buildings$ cleaning$ securit%$ depreciation$ servicingBleases. #he easiest wa% to approach this is to ta!e %our normal endof%ear list of costs as drafted b% %our accountant and complete a si mi l ar l i st for %our new ebusiness. 9epending on %our mar!et %ou ma% have other more specific costs without which %ou could not trade on the Internet or deliver %our customers] orders. #he ne-t l i st is probabl% several tables showing what sales %ou e-pect to generate from various mar!ets and at what margin: L Sales from the traditional business: static$ growing or declining. L Sales from the ebusiness: speed of ta!eup$ global mar!ets. L Sales from associatesBaffiliationsBagents. L Indirect sales from reciprocal site lin!s. #his section wi l l necessaril% be estimated$ but %ou should err on the side of caution and if possible give sound evidence as to wh% %ou thin! sales will be at the level stated wi t hi n each categor%. It is 6uite possible that there ma% be no sales for some time$ so %ou should come clean and sa% so. 2n overview of %our intended mar!et$ with plausibleestimates of %our share over the first five %ears$ will help to add credibilit% to %our claims that somewhere in all %our figures is a viable business. >rom this first pass through the planning stages %ou should be able to draw %our own conclusions as to whether %ou t hi n! %ou have a viable business idea. If %ou do not believe it$ neither will the investors. Case histories and anecdotal evidence ma% be the onl% thirdpart% support %ou can get as to whether what %ou are proposing wi l l wor! but it is worth compiling as there is unli!el% to be an% other mar!et surve% or industr% statistics %ou could use to support %our plan. Clearl% the most important support %ou could receive for %our plan would be future customers. Cesearch could bring these out in the open$ but do not rel% too heavil% on them as wouldbe customers can be notoriousl% fic!le as soon as %ou as! them for mone% up front to fund %our first %ear. The %u"ine"" model Once %ou have satisfied %ourself t hat what %ou are attempting could actuall% return a sustainable profit$ %ou need to articulate %our business model in terms si mpl e enough for a nonspeci alist to understand. :ou should also provide some evidence that %ou are ahead of the game in business terms and t hat %our sl ant on the idea represents the wa% the mar!et is going within %our particular industr% niche. >or e-ample$ the printing industr% is alread% well advanced in most uses of the Internet so if %ou are in t his field %ou ma% wi sh to highl ight that %ou i nt end to do things using +2( technolog%. Or it could be that %ou suppl% archaeological site maps to academics but that %ou would suppl % them onl i ne as .9. allaround images. +hatever it is$ it needs to add a new dimension to what alread% e-ists. One of the mai n advantages of an% business is it s scalabilit%. Could %our e concept be rolled out to man% mar!ets around t he worl d$ both geographi cal l %and across man% i ndust ri es4 If so it stands a bet t er chance of at t ract i ng development funds. :ou need to have wor!ed out t he est i mat ed numbers of %our mar!et$ both act ual and pot ent i al $ so that an% bac!ers can see the scale of the returns that are possible gi ven the right level of investment. 3ow easil% can %our idea be replicated4 If it can be$ is there an% wa% %ou can protect it through patents$ licences$ t radi ng ri ght s or special e6uipment to protect its growth over the f i r st few %ears] 4 #he t echnolog% needs to be bespo!e whenever possible so that competitors wi l l not be able to replicate easil% what %ou intend to do. 11H Is there an% wa% that %ou can persuade one or two strategic bu%ers to sign a l et ter of i nt ent to wor! wi t h %ou on an e-cl usi ve basi s in the earl% stages4 2 useful wa% forward ma% be to give t hem some e6ui t % options in return for their use of %our idea so that %ou wi l l have at least one big customer even before %ou launch. 2nother wa% to reduce the ri s! of earl% f ai l ur e is to save cash b% leasing rather than bu%i ng e6uipment and going for reciprocal mar!eting whenever possible rather than large scale brandbuilding.It goes wi thout sa%ing that e-cessive salaries and cl ub class ai r tic!ets should not be cpol i c%c in the fi rst few %ears$ if at al l . 9o we real l % !now who our competitors are and what the% charge4 It is not uncommon for a new ebusiness idea to be thought of at around the same ti me b% several people around the world. #here can be no cop%right on an idea. #he !e% t hi ng is to get %our idea to mar!et as soon as possible and bui l d volume. 2ttend seminars$ go to e-hi bitions$ read the trade press and start collecting articles about an%thi ng wi t h even a remote connection to %our big idea. 2t worst %ou could save %oursel f a great deal of t i me and effort if %ou discovered someone else had alread% done i t . 2t best %ou might see a fatal f l aw in the techni cal det ai l of %our competitors] pl an which could propel %our idea into a worldbeater. (erhaps t he most important aspect concerns the senior people who wi l l ta!e da%toda% charge of the business as it grows. #he% wi l l need to be robust$ !now t hei r industr%$ be wel l connected and get on wel l together as a team. +hen it comes to going for funds$ the VC" &venture capitalists' wi l l set great store b% the maturi t% of the team and how the% interact$ as at the end of the da% if there is a problem these are the people who are going to have to !nuc!le down and t ur n it around. ?indin# the fund" #here are man% sources of funds for a business wishing to e-pand. In theor% there is nothing special about ebusinesses. #he high profile stories about raising millions on the mar!ets are reall% the tip of a ver% large iceberg and the vast ma*orit% of companies use the traditional routes to raise capital: L friends and famil%7 L ban!s7 L private investors7 L VCs7 L government agencies7 L *oint ventures with complementar% businesses7 L customer e6uit% partnerships. 2part perhaps from the friends and famil% route$ these sources wi l l certainl% want a detailed business plan and a defensible sales plan on which the% can safel% ma!e a decision. 2ll %our assumptions need to be shown. :ou should also ensure that there are a number of ] safel% factors] built in to the plan so that if things do not grow as fast as %ou said the% would$ %ou have an alternative scenario. <ac!ers are never ver% !een on being as!ed for more mone% at some later stage when things go wrong$ so getting %our sums right in the first place ma!es good sense. 2 further factor to consider is that %our funding can come fr om a variet% of sources: it does not all have to come from a single source. In fact the ma*orit% of e business startups have a combination of private investors$ founders mone%$ local grants$ some mediumterm ban! loans and perhaps one longerterm venture capital arrangement. Each of these sources will have different rates attached and different 111 timescales$ so %our cash flow plan becomes one of the most important business measures %ou will need to use in the first few %ears. Fovernment support should not be sniffed at either. Often government agencies are ver% !een to have a local compan% cshowing the wa%] to the rest of the business communit% and ma!e it relativel% eas% for %ou to 6ualif% for grants. Some can be as much as Z,0H.HHH or more$ which for man% cbusinesses is more than enough to get %ou going in the right direction. Venture capital Of all the sources of funds$ the largest will be either private investors !nown as cbusiness angelsc$ or VCs. (rivate investors ma% want less return and a longer pa%bac! period but ma% insist on some e6uit%. #he% will be interested in how the% could save ta- from their investment$ so %ou need to be prepared to be fle-ible as to how the invest ment is brought into the compan%. #he% are useful investors to have as the% are generall% the easiest people to go to if more funds are re6uired at a later stage and are li!el% to have the least demands in terms of pa%bac! periods$ if the% are convinced %ou have a good idea. VCs$ on the other hand$ tend to be ver% precise about what the% want and when the% want it. #he% will probabl% have a brochure e-plaining the t%pe of businesses the% want to be involved with and the t%pe of funding the% generall% provide. #he% ma% specialise in startups or the% ma% prefer to invest later in the c%cle. #he% could introduce %ou to complementar% business partners with whom the% see s%nergies for %our business. Or the% might provide the missing technical or people management e-pertise to complete %our senior team. :ou could do some initial research b% logging on to the <ritish Venture Capital 2ssociation to see the range of members the% represent. In general the% will not be technical e-perts in %our field but the% have had a lot of e-perience of what wor!s and what does not. So$ when %ou are preparing %our presentation to send them$ %ou need to be as succinct as possible. :our accountant or solicitor might arrange an introduction to the three or four who would he most li!el% to loo! at %our plan s%mpatheticall%. <ut unli!e dealing wit h a ban!$ %ou are in the driving seat. #he VC" will offer the finance if the plan stands up as viable$ so %ou need to consider caref ul l % each offer %ou receive and choose the one %ou thin! can add value to what %ou are doing. 2ll of them wil l be loo!ing for hi gh returns within a three to five %ear period$ so the relationship will not go on for ever$ but it would be better to ta!e the fundi ng from people %ou get on with rather than sacrifice good business empath% for a few less generous terms. #he VC presentation If %our idea is attractive to the VC the% wi l l want to meet %ou and perhaps one other member of %our senior team and have a presentation from %ou about %our e business. ;eetings are normall% scheduled for an hour or so. :ou need to be brief and direct. #his is not the time for wa-ing l%rical about how %ou started %our business ,H %ears ago in a garden shed. :ou need to plan %our presentation carefull% to leave %ourself enough time to go through the basic idea and the figures in %our plan. "o more than a do5en laptop images will be re6uired to get the main ideas across. In this first session the% will give %ou an opportunit% to as! them 6uestions$ so prepare what %ou need to !now beforehand and ma!e a careful note of the answers$ as %ou ma% need to compare what the% sa% with what other VCs tell %ou. If all goes 11, well %ou will be invited bac! for a longer discussion with perhaps an industr% e-pert sitting in and more people from the VC. #his session is to help them get a clearer picture of %our depth of thin!ing and for %ou to see if %ou could wor! with the VC on a medium term basis as the% wi l l probabl% want to put one of their own consultants on %our board and ma% even insist that the% chair it to protect their investment. #he deal 9epending on the amount of mone% re6uired$ the VC will attach a range of terms and conditions to an% funding offered. It wi l l include the percentage of their e6uit%$ which will be based on their initial valuation of %our new ebusiness. It wil l also include how much of the debt %ou need to repa% on an ongoing basis and what happens if %ou default on an% pa%ments. #hese terms ma% change if after due diligence the% find that %our plan is not as watertight as the% thought. So$ if there is an%thing negative wi t hi n the plan or perhaps a mar!et change$ %ou should declare it as soon as %ou can. /ecomin# a dot*com millionaire #%picall%$ if things go well$ %our initial funding of$ sa%. Z1 million wi l l have been enough to get things going. <ut a %ear or so later %ou fi nd that %ou need to establish the brand on a national basis to get the real returns. So$ %ou ma% need to go bac! and as! for Z1H mi l l i on. #wo %ears later the business model is wor!ing well in the 8U hut %ou see an opportunit% to e-pand the concept into Europe$ so %ou go bac! and as! for Z.H million. #he stage after this could well be a flotation or I(O & I ni t i al (ublic Offering' after which %ou ma% wel l reali5e al l %our initial e6uit% and become a dot.com millionaire. 11. Topic" for di"cu""ion' 7* 9o %ou thin! E commerce is being destined to become a big business4 5* +hat is the E revolution about4 8* +hich are the advantages and disadvantages of the E commerce4
Enlar#e upon the folloin#' I+ithin the E business environment the *ourne% from %our first networ!ed computer to %our first million could be a ver% short step.J I#he challenge is one of constant change and tuning to the new. If %ou can wor! these new changes into %our uni6ue e business idea to gain the competitive edge$ %ou stand to increase %our chances of successAuntil another advance is made. 9ealing with those changes will not be eas%. <ut no one ever said running a business would be eas%.J I:our business model should bring %ou sustainable profitJ. Tran"late into En#li"h' 1.d^i trebuie bani pentru a demara o afacere4 <ine_n^eles cP _^i trebuie. ;ul^i4 9epinde de specificul fiecPrei afaceri$ dar nu e greu de aflat ca^i anume nu trebuie decat sP pui pe hartie toate cheltuielile strict necesare `i sP ve5i ce iese. #e po^i tre5i cu o surpri5P foarte plPcutP: po^i sP descoperi cP banii de start nu constituie o problemP chiar a`a de mare `i cP e posibil sP demare5i o afacere de care te vei putea bucura. ,. Orice succes porne`te de la mintea omului `i nici o deci5ie nu poate fi mai bunP decat informa^iile pe care se ba5ea5P. E-istP oameni care fac lucrurile sP se _ntample$ apoi cei care pivesc a`teptand ca lucrurile sP se _ntample `i cei care nu _n^eleg ce se _ntamplP. .. 2ceste investi^ii au fost fPcute cu un scop: pentru a se crea condi^ii bune de muncP iar astfel randamentul va fi mai bun$ dar `i pentru imaginea firmei. Sediile companiilor trebuie sP fie dotate cu sPli de conferin^e$ cu computere `i acces nelimitat la internet$ cu mobilier ergonomic. 11/ "egocierea se ba5ea5P pe principiul ca`tig ca`tig$ ambele pPr^i avand de ca`tigat _n urma discu^iilor. >le-ibilitatea ne va a*uta sP nu capitulPm _n fa^a unor cerin^e pe care nu le acceptPm la _nceput. Vom continua pentru a ca`tiga$ vom ^ine cont `i de nevoile celeilalte pPr^i. Se recurge la manipularea interlocutorilor pentru a ne _ndeplini scopurile. dntr o lume idealP ar fi minunat dacP nar trebui sP renun^Pm la nimic pentru satisfacerea nevoilor nostre$ dar pentru cP acest lucru nu este posibil$ renun^Pm la ceva pentru a ob^ine altceva _n schimb. E-istP cateva lucruri _n care cred persoanele care au success$ ca de pildP : nu e-istP e`ec$ ci doar re5ultate$ lucrurile nu se _mbunPtP^esc din _ntamplare$ ci numai _n urma unor ac^iuni adecvate$ succesul cere sacrificii$ oamenii repre5intP resursa cea mai importantP$ iar ceea ce faci trebuie sP fie util cuiva indifferent cat de bine este fPcut sau cat effort sa depus. (entru directorul general$ anga*atul perfect este cel interesat de clien^i `i care _ncearcP permanent sP _mbunPtP^eascP serviciile companiei. 9acP _^i pasP de anga*at$ vei fi _n afaceri pentru totdeauna. #rebuie sP^i aduci mereu aminte cP ei$ clien^ii sunt cei care _^i plPtesc chitan^ele iar cei care reu`esc sP se concentre5e asupra clien^ilor sunt de fapt anga*a^ii perfec^i. (rin onestitate$ siguran^P$ inteligen^P$ inova^ie$ fle-ibilitate vom evolua. (re^uim inova^ia$ pentru cP modul nostru de a gandi este revolu^ionar. Chiar `i atunci cand suntem pe un drum bPtPtorit _ndrP5nim sP redescoperim noutatea `i valoarea. Eficacitatea `i pasiunea pentru servicii a fiecPruia dintre noi sunt condi^ii cerute de orice companie. Compania 2ugsburg are un pachet larg de beneficii `i indemni5a^ii$ ce include$ subven^ie pentru transport$ ma`inP de serviciu pentru cei din management$ abonamente la o clinicP medicalP$ pre^uri reduse la produsele firmei. 9orim sPi fideli5Pm `i sPi stimulPm pe anga*a^ii firmei `i sP completPm oferta salarialP. Comer^ul electronic mondial are o dinamicP ascendentP pe mPsurP ce tot mai mul^i consumatori `i tot mai multe afaceri se conectea5P la web. (rincipalele bariere _n de5voltarea comer^ului electronic rPman problemele legate de securitate `i _ncredere. (e mPsura cre`terii utili5atorilor casnici de internet$ procedurile legate de autentificare `i criptare a datelor personale primesc o importan^P tot mai mare `i succesul comercian^ilor de pe web depinde de succesul implementPrii. Obstacolul principal pentru o de5voltare mai rapidP este cel financiar. Comania este o ^arP cu constrangeri bugetare$ iar varianta testPrii unor solu^ii la nivel mic$ precum `i luarea unor deci5ii de e-tindere a acestora este destul de potrivitP acum. 110 Tran"late into Romanian' 2 trul% effective client service plan will include a set of activities that will help professionals to !now the client)s business better and in a more organi5ed wa%. 2 good client service plan will include activities meant to deepen the business relationship b% e-panding the amount of client contact. <usiness re6uires decisions: fre6uent$ fast and often without much idea whether the% are right or wrong. +hen a business consistentl% outperforms e-pectations$ there is at least a good chance that it can be multiplied b% ten or a hundred times. In these circumstances most people settle for modest growth. #hose who sei5e the da% become seriousl% rich. In a firm which relies mostl% on firmwide or group rewards$ all the partners or owners share the conse6uences if an individual)s performance is down. 2ccordingl%$ other professionals have a direct incentive to ta!e steps to help that individual or group improve either formall% through practice group leaders or informall% through the efforts of fellow partners. :ou do not need to be a high tech business to benefit from the Internet. #he best success stories have been the more traditional businesses that have found new wa%s to do business b% using the basic technolog% currentl% available. Di!e all new business %ou need to use %our common sense and plan for profits on a gradual basis. <ut unli!e traditional businesses the process of building ecommerce profits will differ both in scale and in the t%pe of mar!ets available. #he more aware %ou are of what is li!el% to happen with %our new ecommerce venture$ the more sensible %our decisions will be. 111 Voca%ulary' <oundless nemPrginit <ottom line de ba5P #o dispatcha trimite$ a re5olva rapid$ promt Cash flow flu- monetar% #o draft a redacta$ a _ntocmi #o e-change a face schimb +eb browser program software pentru navigare pe internet @oint venture societate mi-tP #o displa% a e-pune$ a afi`a Impending imminent E-penditure cheltuialP 2llowance reducere Scalabilit% capacitate de a grada #o hoo! a prinde$ a agP^a 3oo! up program comun$ _nlPn^uire #o !nuc!le down a se apuca de #ip informa^ie Secure _n siguran^P$ care nu pre5intP risc$ garantat #o secure a prote*a$ a asigura #o store a stoca$ a memora Ongoing ne_ntrerupt <ac!er sus^inPtor$girant #o bac! a spri*ini$ a sus^ine$ a gira$a da _ndPrPt #o bac! down a o lPsa mai moale$ a bate _n retragere #o err a gre`i$ a face o eroare #o bud a _ncepe #o litter a murdPri >ic!le nestatornic$ capricios #o highlight a eviden^ia Claims cereri$ revendicPri #o compl% with a se conforma Encasement _ncasare$ platP _n numerar Cental valoare locativP Obsolete demodat$ _nvechit +ould be customers clien^i poten^iali In se6uence _n succesiune$ unul dupP altul Venture capital capital de risc Venture specula^ie$ risc$ac^iune comercialP +atertight irepro`abil$ impecabil$ clar #o default a fi _n restan^P$ _n _ntar5iere cu plata 9iligence ostenealP 9ue cele cuvenite #o slant a denature$a pre5enta tenden^ios Slant punct de vedere$ opinie$ _nclina^ie$ tendin^P Onerous apPsPtor$_mpovPtPtor 11= T,E (.Y .? /EI-: C)IE-TS ?.R )I?E +E +O8D9 2DD DIUE to have lo%al clients who come bac! to us %ear after %ear. Clients who treat us as valued professionals and see! our advice on their most important issues and prob lems. Clients who don]t shop around each time the% thin! about bu%ing our services$ who come bac! because the% will alwa%s get fresh perspectives$ insights$ and ideas from us and because the% trust us. Clients who will enthusiasticall% rec ommend us to others even if we aren]t serving them at that moment. Ceflect for a moment on %our own client relationships. If %ou]re li!e most professionals$ %ou ma% have a few lo%al clients who have drawn %ou into their inner circle of advisers. #he% consult %ou on a broad range of issues and wouldn]t dream of using a com petitor to provide %our service. Others$ though$ are *ust bu%ing %our e-pertiseethe% use %ou because %ou have specific !nowledge and s!ills that %ou deliver at a competitive price. #he ne-t time around$ how ever$ these same clients ma% ver% well turn to someone else. #he% view %ou as a commodit%. Somewhere in the middle$ there are those breadandbutter clients who !eep as!ing %ou bac!$ %ear after %ear$ but never seem to let %ou get ver% close to them. :ou ma% have wor!ed for them for %ears$ but %our influence and the scope of %our wor! is limited7 and although the% feel some lo%alt% to %ou$ it]s not enough to prevent them from switching to someone else if the% see a ma*or economic benefit. *o you wish you had more clients who would draw you into their inner circle+ *o you sometimes feel you're treated like a vendor instead of a respected professional+ $ould you like to compete less on price and more on the value you can add+ Is it getting harder to differentiate %ourself from other professionals in %our field$ be the% other management con sultants$ law%ers$ or accountants4 If %ou answered %es to some or all of these 6uestions$ we wouldn]t be surprised. #he fact is$ most professionals are on a *ourne%edefined b% the role the% pla% with their clientse and few have finished it. +hen it begins$ %ou]re an e-pert for hire who offers information and e-pertise to %our clients on a transaction basis. >urther along$ %ou ma% earn the right to be a stead% supplier$ and %ou]ll be as!ed bac! repeatedl%. +hen %ou]ve reached the final and most rewarding stage$ %ou]ll be come a trusted adviser who consistentl% develops collabora tive relationships with %our clients and provides insight rather than *ust information. 2t this stage %ou will have %reakthrough relationships. <ecause of the broad$ influential role that %ou pla% and the unusual degree of trust that %ou de velop$ these relationships will be of a significantl% higher order than the runofthemill associations that so man% pro fessionals have with their clients. #his developmental *ourne%efrom e-pert for hire to trusted advisereis the focus of what we mean b% stud%ing about clients in general. >rom e-tensive research$ there is a clientvalidated model for suc cessea roadmap of the specific characteristics that underlie e-traordinar% performance with clientsethat will help %ou establish and sustain more of these enduring$ advisor% rela tionships. 11? ?.R:ETI-: C.-VE-TI.-A) WISD.M #he abiding client relationships not onl% bring us immense personal and professional satisfac tion$ but in fact the% ma!e our careers. 8nfortunatel%$ the conventional wisdom about how to develop them and achieve professional success is woefull% inade6uate. I9o good wor!$ act with integrit%$ and the rest will followc has been the timehonored prescription for individuals who sell and deliver services. c>ind an area to speciali5e in$ focus on it$ and ma!e %our name therec could be added to it. Clients toda% are highl% sophisticated$ educated$ and in formed bu%ers who select professionals from increasingl% competitive and mature service industries. In a world of con tinual corporate costcutting and almost unlimited informa tion$ institutional bu%ers have less lo%alt% to suppliers than ever before. Studies have shown$ for e-ample$ that over 0H percent of e-ecutives who switch providers sa% the% were csat isfiedc with them before switching. 2nd though speciali5a tion is important to a point$ the corporate leaders sa% that most of the highl% speciali5ed profes sionals the% deal with are incapable of advising them on broader business issues. :ou have to do far more$ in other words$ than csatisf%c %our clients and do a cgood *obc if %ou want to create longterm lo%alt% and enter into the collabora tive relationships that allow %ou to have a ma*or impact on %our clients and their decisions. W,Y D. S.ME PR.?ESSI.-A)S C.MMA-D E-D1RI-: C)IE-T ).YA)TY? #here is a simple observation the telephones of some professionals we !new never stopped ringingeclients called them$ rather than vice versa. 2t the same time$ we saw others treated li!e vendors b% their clients: these professionals were constantl% challenged on price$ and the% often struggled to get new business through laborious C>(s &re6uests for proposal' that eliminate practicall% all human contact during the client]s decisionma!ing process. +as the difference *ust that the former wor!ed harder$ I were smarter$ and did higher6ualit% wor!4 #hese were the obvious reasons$ and while certainl% relevant$ the% did not provide an%thing near a satisfactor% e-planation for the in tense client lo%alt% we observed. 2fter all$ we also !new man% smart$ hardwor!ing professionals who were not able to de velop so man% lo%al clients. Clearl%$ these 6ualities were necessar% but not sufficient. +e must set out$ then$ to comprehensivel% research and an swer a series of fundamental 6uestions: +h% do some profes sionals manage to develop longterm relationships and become trusted business advisers to their clients while others get called in on a oneoff basis li!e commodities4 +hat 6uali ties do leaders loo! for in the professionalsein fields as di verse as law$ consulting$ finance$ and technolog%e whom the% bring into their inner circle4 3ow do clients define value4 #he starting point ma% be fift% %ears of combined e-perience in advising senior managers in man% organi5a tions around the world. (eople went well be%ond their own per sonal e-perience$ however$ and spo!e at length with the present and past leaders of do5ens of ma*or corporations$ such as Uoda!$ <ellSouth$ Co- Communications$ ;otorola$ 2merican E-press$ Citiban!$ Eli Dill%$ and Feneral Electric$ listening as these chief e-ecutives shared their lifetimes of e- perience in bu%ing services and see!ing advice from profes sionals. Such interviews were e%eopening$ and the% debun!ed man% of the widel% held notions about wh% clients value certain professionals over others. 11G +hat could stri!e us was the dissatisfaction man% clients e-pressed about the outside pro fessionals the% engaged and b% the difficult% the% e-peri enced in finding trul% ob*ective individuals to help them resolve their most important issues. 2 number of well !nown advisers who counsel and consult to leading e-ecutives and politicians$ as well as man% less!nown but highperforming professionals who face the same da%toda% challenges that we all do in tr%ing to build client relation ships are read% to be interviewed. Some of the greatest advisers in histor%$ such as 2ristotle$ #homas ;ore$ *. (. ;organ$ Feorge ;ar shall$ 9avid Ogilv%$ and 3enr% Uissinger are alwa%s as!ed to be studied. It is not eas% to identif% the essence of what it ta!es to become an e-traordinar% professional and consis tentl% provide value to clients. #here are some attributes and attitudes that will enable %ou to develop %our own brea! through client relationships. #he meaning about clients for life has several distinct connotations. #he first is literal: how to develop lifetime clientseor at least longterm onesewhen such a relation ship is mutuall% beneficial for the client and the professional. Second$ is figurative because in some cases a continual relationship ma% not be practical$ realistic$ or even desired. 2 client$ for e-ample$ ma% need the ongoing services of an accountant ever% %ear for man% %ears$ whereas he might call in a management consultant or e-ecutive recruiter onl% once ever% four or five %ears. 2 few professionals ma% also choose a transactional model of serving clients$ where the% wor! on specific issues rather than on a retainer basis &the law firm +achtell$ Dipton$ Cosen V Uat5$ for e-ample$ success full% adopted this approach in the earl% 1G=Hs'. Even a trans actional strateg%$ however$ will succeed or fail based on having repeat clients. Clients$ thus$ can be attitudinally lo%al for lifeethe% re member us for having done an outstanding *ob$ the% call us bac! if the% ever need our particular service again$ and the% enthusiasticall% recommend us to others. C)IE-TS ?.R )I?E' W,. CA- /E-E?IT? +e define a professional as someone who practices an occupation re6uiring a high degree of education and train ing$ and who has clients rather than customers. #his defini tion includes not *ust service professionals$ but also technolog% consultants and sales e-ecutives who sell a com ple- product. It does not include teachers or musicians$ for e-ample$ because the% don]t have individual or organi5a tional clients the wa% consultants and accountants do. #he professionals used as e-amples are drawn from a variet% of fields$ including consulting$ law$ accounting$ advertising$ finance$ medicine$ sales$ and the militar%. 2lthough each profession has specific s!ills and !nowledge that its practitioners must mastereconsumer be havior for an advertiser$ financial reporting re6uirements if %ou]re an accountant$ contract law if %ou]re a law%er$ and so on achieving client leadership is premised on a set of common factors that transcend individual professional re6uirements. 2ll t%pes of professionalseand their clientsecan bene fit from longterm relationships. #hese relationships give %ou the opportunit% to engage in e-tensive client learning$ which greatl% increases %our abilit% to offer tailored solutions$ de velop new ideas$ and provide germane insights rather than generic platitudes. #he% are also the proving grounds where %ou can e-pand %our service offering and therefore %our pro fessional e-perienceea lo%al client who trusts %ou will tr% %ou out in areas that a new client wouldn]t let %ou touch. >inall%$ the positive financial impact of having even *ust a few lifelong advisor% relationships$ if the% are managed profitabl%$ can be enormous. #he distinction between a client and a customer is more than semantic. 1,H Customers$ for e-ample$ bu% a product or serv ice with welldefined characteristics that match their needs$ with little or no negotiation and discussion between bu%er and seller7 the professional]s relationship with a client$ in con trast$ has a consultative aspect to itethere is giveandta!e to clarif% needs$ identif% problems$ and recommend solutions. +hile there doesn]t have to be a personal relationship be tween a customer and the seller of the product or service$ with a client there is t%picall% a close$ personal relationship with a high degree of trust. 2nd finall%$ a professional offers a client an authoritative bod% of !nowledge and e-pertise. So while the customer can have it his wa% at <urger Uing$ a client ta!ing ta- advice can't alwa%s have it his wa% &unless he wants to get into trouble with the ICS'. #he focus on clients$ therefore$ is a deliberate one. If %ou have customers$ %our relationships will tend to be narrow in scope$ whereas if %ou serve clients$ %ou have the opportu nit% to develop the collaborative$ broadgauge relationships that are the focal point. 2 different ap proach is re6uired for sophisticated clients who bu% comple- products and services. >or e-ample$ although we ma% believe that the customer is alwa%s rightea standard prescription for managing customersewe sometimes have to tell our clients how the% are wrong and wh% we disagree with them. W,AT AI -D .? PR.?ESSI .-A) ARE Y .1? #here are three t%pes of professionals to be ta!en into account. #he first group includes service pro fessionalselaw%ers$ management and technolog% consul tants$ accountants$ corporate ban!ers$ financial advisers$ e-ecutive recruiters$ advertising e-ecutives$ and so on. #hese individuals are in an ideal position to become broadbased business advisers to their clients: their services are of high strategic importance to their clients$ and the% are intimatel% involved in the sale and deliver% of the service. If %ou are one of these professionals$ all of the material in this boo! should spea! directl% to %ou. #he second group consists of sales e-ecutives who want to be considered %usiness consultants rather than simpl% sales people. If %ou sell a comple- product or service that is critical to %our client]s business$ such as telecommunications s%s tems$ computer e6uipment$ power plants$ or missioncritical software$ %our client will have a significant need for advice and consultation$ and the opportunit% e-ists for %ou to be come an adviser to him rather than *ust a salesperson. >inall%$ there are professionals who are staff or functional man agers within corporations. 3uman resources or finance specialists who re port to line e-ecutives$ for e-ample$ face the same challenges that outride professionals do in creating value$ and the% are held bac! b% similar barriers. It)s interesting to loo! at some e-traordinar% professionals who have consistentl% engaged clients for life$ identif% how the% add value$ and discuss the barriers that prevent other professionals from achieving the same level of success$ to grasp core attributes of great client advisersethe ingredients for success with clientseand provide specific suggestions for how %ou can cultivate these 6ualities$ to see the ma*or pitfalls that profes sionals can fall into as the% develop and manage client rela tionship. Virtuall% all of the large service firms endeavor to de velop advisor% or consultative relationships with their clients$ emulating those ver% fewe;cUinse% in consulting$ for e-am ple$ or Foldman Sachs in investment ban!ingethat have a histor% and culture of building deep relationships. Stoc!bro !ers are now cfinancial advisersc7 accounting and consulting firms aspire to advise senior management$ not *ust underta!e reengineering pro*ects7 software programmers are referred to as cconsultantsc7 and companies li!e Ceuters don]t *ust sell 1,1 databases but want to be %our cinformation adviser.c Often$ however$ the words cadviserc and cconsultantc lac! substance and have a hollow ring to them. Ironicall%$ *ust at a time when the professions are e-peri encing their greatest growth in histor%$ *ust as so man% are striving to become trusted advisers$ man% clients are in fact dissatisfied with the 6ualit% of the advice the% receive and the attitude of those who give it. It]s getting harder and harder for them to find professionals li!e @ames Uell% and "anc% (eretsman. +h% then4 +hat holds professionals bac! from an undeni abl% attractive role that is highl% valued b% clients4 /ARRIERS T. DEVE).PI-: /REAAT,R.1:, RE)ATI.-S,IPS #hree barriers stand in the wa% of becoming a business adviser to %our clients$ and of e-periencing the client lo%alt% and professional fulfillment that accompan% this role: 1. Most professional service firms demand speciali)ation. If %ou wor! for a large consulting or accounting firm$ %ou might become a reengineering e-pert for the chemical industr% or an auditor for automotive companies. #his is fine for starters$ but the problem is that the more e-pert %ou become in the niche where %our compan% has placed %ou$ the more cvaluableceat least in the short terme %our firm thin!s %ou are. #his becomes a disin centive to providing %ou with other e-periences. +hile there is great benefit in developing a deep e- pertise$ this speciali5ation will eventuall% become a liabil it% if %ou want to pla% a broadergauge role with clients. Some firms recogni5e this issue and tr% to address it b% s%stematicall% diversif%ing the e-perience of their *unior staff$ but man% do not. &#his push for speciali5ation$ b% the wa%$ is pervasive not *ust in the business world but in medicine$ academia$ science$ and other fields.' In addi tion$ while large firms provide tremendous opportuni ties and training for %oung professionals$ the% also have financial and growth goals that must be met &man% are now publicl% held companies'. Sometimes$ these short term pressures override the longterm process necessar% to build deep$ trusted client relationships. ,. ,'pertise is %ecoming automated and reduced to a commodity. Ironicall%$ while service professionals have been ma*or beneficiaries of the late twentiethcentur% infor mation econom%$ there are now signs that man% t%pes of e-pertise are losing value. @ust as the industrial revolu tion replaced s!illed craftsmen with lowwage factor% wor!ers during the earl% nineteenth centur%$ the ce- pertisec sold b% professionals is becoming easil% replica ble$ more widel% available$ and increasingl% cheaper in our Internetspeed$ technolog%driven econom%. 2l read%$ the average incomes of some classes of profession alsedoctors$ for e-ampleeare starting to decline. Several forces combine to diminish the value of e- pertise: L The supply of service professionals is growing significantly. #he historicall% rigid controls on the suppl% of gradu ates have been rela-ed$ and man% individuals with lesser certifications &e.g.$ paralegals$ ph%sicians] assis tants' are doing the wor! formerl% entrusted to de greed professionals such as law%ers or doctors. (rice based competition has become a permanent feature of the mar!et for professional services. In the corporate world$ most ma*or contracts for professional services are now competitivel% bid$ and the competition &for management consulting and advertising services$ for e-ample' can be ferocious. 1,, #he internet and e-pert software now provide unparalleled access to all !inds of e-pertise$ at far lower prices than ever before. ;ar!et research reports that used to cost thousands of dollars or that investment ban!s provided onl% to their bigspending corporate clients can now be obtained free over the Internet. Increasingl%$ professionals are pa%ing to have their ce-pertisec put in front of clients. 2 new +eb site for CE."6 which alread% has the participation of big names such as ;ichael 9ell of 9ell Com puter Corporation$ is charging professional firms N0H$HHH for the privilege of putting their articles or research up on the site. In other areas$ +ebbased sales automation is re ducing the need for e-pensive sales forces7 and mil lions of consumers use ine-pensive software li!e #urbo#a- to do their ta-es and even write wills$ thus avoiding ta- advisers and law%ers. Dabor mobilit% among !nowledge wor!ers is increasing. 8.S. firms$ for e-ample$ are tapping into pools of English spea!ing talent in countries such as India$ South 2frica$ and 2ustralia. Daw school graduates are cross ing over into ad*acent fields$ such as consulting and investment ban!ing. #he effects of these trends are readil% apparent. In fields as diverse as law$ accounting$ consulting$ and tech nolog% services there is significant consolidation occur ring$ with new mergers being announced almost monthl%. +hat used to be the c<ig ?c accounting firms are now the c<ig 0.c Daw firms$ which historicall% en*o%ed longterm retainer relationships with their clients$ are being as!ed to bid competitivel% for wor!7 some even went out of business altogether in the 1GGHs$ and we are now beginning to see a growth in mergers as law firms consolidate. Consulting firms are being as!ed b% ma*or corporations to submit brea!downs of their cost struc ture$ their partnertoassociate ratios$ and their billing schedules so that the profitabilit% of their pro*ects can be managed and reduced. ;an% companies are now con ducting fre6uent$ tough reviews of their advertising agencies$ forcing incumbents to continuall% *ustif% their relationship. #hese and other signs of intense competition and industr% maturation are now widespread. 3ighend ser vices$ such as merger and ac6uisition advisor% wor!$ ma% never become commodities. <ut *ust as we can now put a vacation out to bid on the Internet to see which airline wants to sell us a tic!et at the best price$ we believe the da% is not far awa% when this will be done for services as well. Imagine as!ing doctors to cbidc to conduct a rou tine surgical procedure or inviting law%ers to compete for %our estate planning business. .. Many professionals are held %ack %y stereotypes a%out what clients want them to %e and how they should %ehave. 3ere are t%pical statements we have heard from these profes sionals: L c;% *ob is to provide answers.c L cI need to become as e-pert as possible in one specific sub*ect area within m% field and then to ma!e m% name in it.c L c+hen I meet prospective clients$ I need to demon strate m% e-pertise. 2fter all$ that]s what the%]re bu% ing from me.c L cIf I wor! in a new industr% or function$ I will be igno rant of basic concepts. I will add little value$ and clients will re*ect me.c L c#his is a professional$ business relationship. #he per sonal side is separate. >urthermore$ m% lo%alt% is to the greater goals of the institution$ not to the individ ual.c L cClients will ta!e advantage of %ou. :ou have to stic! up for %our own interests.c 1,. #here is some validit% to all these statements. #he% are incomplete$ however. In contrast$ consider these comments from clients who have spent a lifetime using professionals: L c#he reall% good professionals as! great 6uestions. Often$ the% enable solutions rather than suppl% them.c L c#he best business advisers have a good understand ing of m% industr%$ but also breadth.. Some of the best insights I have gotten have come from professionals who bring analogies from other fields.c L cFood professionals are great listeners. #he% hear what %ou mean$ not necessaril% what %ou sa%.c L cIt]s ver% tough finding ]honest bro!ersJ who are unbi ased and not pushing their own agenda with %ou. Ever%one wal!s in here wanting something.c L cInvestment ban!ers cannot be true advisers. #he% are too focused on the deals.c L cOur consultants alwa%s end the session with a half hour presentation on ]ne-t steps$] the e-ecution of which cannot$ of course$ be accomplished without the consultants. +hat I reall% value instead are wor!ing sessions which advance our thin!ing.c L cOur law%ers focus on ever% detail with e6ual empha sis. #hat]s OU to a point$ but the% rarel% pull bac! and help us see the big picture.c ;an% professionals$ in short$ focus on providing an swers$ being perceived as ce-perts$c doing great anal%sis$ and speciali5ing more and more during their careers. Clients$ in contrast$ see! professionals who can as! the right 6uestions$ provide !nowledge breadth as well as depth$ demonstrate bigpicture thin!ing as well as anal%sis$ and listen rather than *ust tell. (rofessor @. <rian Euinn of 9artmouth]s 2mos #uc! School of <usiness$ who has spent nearl% fort% %ears advising business and political leaders$ including several 8.S. presi dents$ puts his own slant on the issue of stereot%pes: cI used to believe that solving the problem was paramount. In realit%$ when the good advisers deliver their recommendations$ most of them have alread% been implemented. I reali5e now that the process of problem solving is more important than the solution.c Clients do value professionals who can pla% a broad advi sor% role. #heodore Sorensen$ in his boo! The -ennedy .egacy& reports that *ust a few da%s before his inauguration$ @ohn >. Uenned% was presented with a list of ,0H items re6uiring a de cision from him. 3e apparentl% blurted out$ c"ow I !now wh% I!e had Sherman 2damsKc &2dams was (resident Eisen hower]s trusted adviser'. #he fact is$ clients at an% level$ whether the% are presidents of nations or corporate managers$ appreciate someone who can help them put there issues in perspective$ solve problems$ and ma!e better$ faster decisions. T,E I-:REDIE-TS ?.R /REAAT,R.1:, RE)ATI.-S,IPS #here are seven !e% attributes that$ when blended to gether in the right 6uantities and in the right manner$ facili tate the development of insight and the formation of deep$ trusting relationships. #hese characteristics are a blend of in nate talent$ ac6uired s!ill$ and attitude$ and it]s pointless to tr% to determine e-actl% which is which. #hat]s wh% we use the more general term cattributec to describe them. Empath%$ for e-ample$ is definitel% something %ou develop at a %oung age &a ctalentc'$ %et we !now that people can improve their empathetic abilit% late in 1,/ life. "ative abilit% certainl% counts$ but hard wor! and openness to change can improve an% of these 6ualities$ an assertion borne out b% the e-periences of the man% great professionals we]ve studied. #here is a natural$ logical progression to the develop ment of these attributes and to the order in which the% usu all% come into pla% in building an advisor% relationship. #he two foundational attributes for an% professional who aspires to serve clients are selfless independence and empathy. Freat ad visers have an attitude of complete financial$ intellectual$ and emotional independence. #he% balance this independence$ however$ with selflessnessethe% are dedicated$ lo%al$ and focus on their client]s agenda$ not their own. It is a fine line to draw: on the one hand$ being responsive to a client]s needs and problems and$ on the other$ maintaining ob*ectivit% and honest% at all times. #his selfless independence illustrates wh% clients are different from customers. #he second attribute$ empath%$ is what opens the door to learning. Empath% fuels %our abilit% to discern a client]s emotions and thoughts$ and to appreciate the conte-t within which that client operates. It enables %ou to diagnose what the problem reall% is and later underpins a learning relation ship with %our client. 9r. ;ichael Formle%$ a Dondonbased ph%sician and renowned diagnostician who treats several members of the <ritish ro%al famil%$ provides an apt medical metaphor when he tells us$ ]:ou can]t *ust chop the patient up into little pieces and then e-amine each one of them under the microscope. :ou have to understand the whole conte-t of his dail% life.c #he ne-t three attributes concern %our abilit% to thin! and reason. :ou simpl% have to have something valuable to sa% before %ou can develop the long term professional rela tionship. 2 passion for learning drives the professional to de velop a core e-pertise and then to become a deep generalist b% continuall% broadening her !nowledge. (ynthesis is the abilit% to see the big picture$ to draw out the themes and patterns in herent in masses of data and information. It includes related s!ills$ such as critical thin!ing and problem solving. #he abil it% to s%nthesi5e sets the business adviser apart from the sub *ect matter e-pert who relies mainl% on anal%sis. /udgment is oftenebut not alwa%sethe culmination of a particular en gagement or advice session$ drawing on all the learning and s%nthesis %ou have underta!en. Conviction and integrity constitute two important charac ter attributes that are common to all of the e-traordinar% professionals we have studied. +hen credibilit% of content has been established$ trust can follow$ and the depth of a client]s trust in %ou will be ver% much governed b% his assess ment of %our character. Conviction comes into pla% as the adviser begins to offer opinions$ recommendations$ and *udgments in earnest. Con viction$ however$ does not e-ist in a vacuum7 it is based on a set of compelling$ e-plicit personal beliefs and values. (roperl% harnessed$ it is a powerful force that can motivate and energi5e both professional and client. #he attribute of integrit% comprises a constellation of s!ills and behaviors that build trust$ including discretion$ consistenc%$ reliabilit%$ and the abilit% to discern right from wrong. +ithout this trust$ it is unli!el% %ou will develop a col laborative relationship. :our client will alwa%s !eep %ou at arm]s length and treat %ou li!e a supplier. #here are other 6ualities$ of courseemotivation$ opti mism$ tenacit%$ determination$ anal%tical s!ills$ and so one that are valuable for professionals and indeed necessar% to be a successful e-pert. #he seven we have identified$ however$ are the ones that trul% stand out and ma!e a difference in a professional]s effectiveness. #he% enable %ou to go be%ond e-pertise and become a broadbased 1,0 adviser. #hese are the 6ualities that foster the development of the insights and rela tionships that lead to consistent value creation for clients$ and the% are the characteristics that great advisers themselves have intuitivel% developed. If %ou want$ in short$ to become an e-traordinar% professional who commands unwavering client lo%alt%$ %ou need especiall% to develop and strengthen these attributes. /ecomin# an Inte#rated Profe""ional #hese attributes build on and interact with each other to create a whole that is greater than the sum of the parts. Ca sual observers might call an individual who has successfull% integrated them a cseasoned professionalc or someone who reall% chas a head on her shoulders.c 9rawing on his thirt% eight %ears as a successful client adviser$ @ames Uell% articu lates this state of integration and its benefits: II have come to accept that I am constantl% learning$ and will never$ ever !now it all. I]ve learned to become an intense observer of peopleeI !now that situations are never 6uite what the% seem at first. I accept that sometimes I]m wrong$ but that]s the cost of intellectual boldness$ of daring to be right. I have a constant sense of being surrounded b% e-pert resources that I can call onethe%]re ever%where. +hen %ou get %our ego out of it and allow %ourself to rela- and observe$ %ou reall% do get into the flow of events and ideas. I]m wor!ing for m% clients$ but I]m also feeling 6uite independent from theme I]m driven not because I]m being paid but b% a desire to help m% clients$ to learn$ to satisf% a higher pur pose. #he ideas and solutions come 6uite freel% in this state. #his happened *ust last wee!eI was the last spea!er at a threeda% conference for a group of top e-ecutives. +hen I was %ounger$ I would have prepared a canned speech da%s in advance. #his time I listened intensel% for the first two da%s. I observed the participants carefull%. I opened up m% mind to the variet% of ideas that were being presented and discussedeeven though I didn]t li!e some of them. On the third morning$ I got up earl% and too! out a pen and paper.J Characteri"tic" of a Succe""ful Client Ad$i"er L Clients often as! %ou for advice$ both on sub*ects directl% within %our field of e-pertise and in pe ripheral areas that happen to be of concern. L ;ost of %our client relationships are longterm ones. #he vast ma*orit% of %our clients would en thusiasticall% recommend %ou to someone else. L #here is strong mutual trust$ on a professional and a personal level$ between %ou and %our clients. L :ou collaborate e-tensivel% with %our clients to de fine the product or service %ou deliver to them and match it to their needs. L :ou fre6uentl% approach %our clients with unso licited ideas and suggestions. L :our clients believe %ou consistentl% deliver value in e-cess of %our fees. #he% rarel% if ever shop around to see if the% can get the !ind of services %ou offer more cheapl% elsewhere. #3ESE <8ID9I"F <DOCU attributes are fundamental and straightforward. #he realit%$ however$ is that most profession als don]t practice or activel% develop them. Or the% delude themselves into thin!ing that the% have alread% mastered them. Often$ what the% thin! passes for insight is$ to their clients$ merel% e-pertise. 1,1 #he% forget that this %ear]s insight has a ver% limited shelf life and can 6uic!l% revert to simple e-pertiseedebt underwriting and reengineering consulting used to be valueadded services$ for e-ample. "ow the% are virtual commodities. T,E IMP.RTA-CE .? AEE- (1D:ME-T Consultants$ attorne%s$ ban!ers$ accountants$ and other professionals are involved in highris!$ highsta!es decisions ever% da%: Should the case go to trial or be settled out of court4 Should a microchip manufacturer invest another 1 billion dollars to increase production capacit%4 9o the compan% fi nancial statements represent the actual condition of the busi ness4 2 !een *udgment is one of the most valuable asset a professional can have. >ew clients$ for obvious reasons$ go bac! to a professional whose *udgment is poor. ;an% of the e-ecutives we have interviewed$ in fact$ remember all too clearl% the poor *udgments offered b% some of their advisers$ even though the incidents occurred %ears ago. Food *udgment$ in contrast$ is invaluable to clients. +in <ischoff$ chairman of the <ritish merchant ban! Schroders$ recalls a seminal decision he made and how the accurate *udgment of his adviser contributed to Schroders] interna tional success: It was in the earl% 1G?Hs$ and we felt we needed tore capitali5e our 8.S. ban!$ which engaged in commercial lending. +e were convinced we could issue debt to do this. I went to see the head of +arburgs fa ma*or <ritish merchant ban!g$ 9avid Schole%$ to see! advice. In the space of an hour he delivered an une6uivocal set of *udgments. Issuing debt would be all but impossible$ he of fered$ 6uic!l% turning the conversation to the topic of Schroders] overall strateg%$ and the need for us to assess it in detail at this critical *uncture. +e were alread% considering underta!ing a strate gic review$ and Schole%]s advice was important encour agement. +e subse6uentl% made a series of important decisions$ including eventuall% selling the 8.S. ban! in stead of recapitali5ing it$ as well as ma!ing other strate gic choices that enabled us to prosper as an institution. #hat short$ singular conversation$ and the rapidfire but incisive views provided b% Schole%$ became a significant influence on our thin!ing. Instinctivel%$ Schole% did several things when as!ed to advise Schroders. >irst$ he made a rapid$ intuitive *udgment about the feasibilit% of issuing debt. #he situation fit a pattern in his e-perience$ and he !new what the answer was without hesitating. In the process$ he thought two or three steps ahead$ and was able to visuali5e the chain of events following a h%pothetical debt issue b% Schroders$ and the negative con se6uences that could ensue. In effect$ he helped <ischoff avoid a potentiall% bad *udgment. Second$ he reframed the 6uestion <ischoff was as!ing. #he right 6uestion wasn]t cShould we recapitali5e our 2merican ban!4c but cShould we be in the 8.S. ban!ing business at all4c Since that time$ Schroders] mar!et value has increased fifteenfold$ from about N.HH million to N0 billion toda%. ?IV E (1D :ME-T TRAPS T. AV.ID <efore we loo! at the specific practices that allow great professional advisers to arrive at high6ualit% *udgments$ we have to understand how to avoid bad *udgments. >irst$ bad *udgments can be deadl% for an organi5ation7 second$ the% will ruin %our reputation as a professionale%our clients will never forget the poor decisions %ou recommend7 and third$ it]s ver% common to ma!e mista!es of 1,= *udgment$ since so man% factors can cloud our decision ma!ing. #he fact is$ avoiding bad decisions is onehalf of the battle: even if %ou don]t ma!e particularl% good ones$ %ou can muddle along and survive$ whereas a poor *udgment can put %ou out of business$ for good. #he e-ceptional professional$ therefore$ constantl% e-amines his client]s thin!ing and behavior to help prevent these wrong turns. 3ere are five of the most important *udgment traps that professionals should be aware of as the% advise their clients: I. +ea! (remises: Starting Out on the +rong >oot ;an% clients approach a problem or decision with wrong or partial facts at the outset$ resulting in a chain reac tion of fault% thin!ing. #he two most common errors that bias clients are anchoring0 the decision ma!er allows himself to get canchoredc on a specific starting numbereand avail a%ility& the tendenc% to use the most available$ recent$ or vivid information. If two real estate appraisers$ for e-ample$ are as!ed to as sess a house that is alread% for sale$ their valuations will var% based on what selling price the%]re given. #he appraiser who thin!s the house is for sale at N,HH$HHH will assign a lower val uation than the second appraiser who is told it]s on the mar !et for N,0H$HHH$ even though it]s the same house. +here %ou start often determines where %ou end up. Clients can get anchored in man% wa%s. Incumbent cor porations in deregulated industries li!e telecommunications and utilities$ for e-ample$ often get anchored in their old growth paradigms. Compared to their historic growth rates of . percent or / percent a %ear$ achieving 0 percent or 1H percent now seems wondrousl% high. <ut the new standard$ in order for a compan% to be considered a cgrowthc business$ is more li!e 10 percent annual growth. <ecause man% of these companies are anchored on the old standards$ the% end up being ac6uired. +hatever happens to be the most available$ recent$ and vivid data can also bias us. #his perception bias can operate when managers go out and tal! to *ust a few customers and then draw sweeping conclusions about their compan%]s prod ucts and positioning. <ad personnel decisions are often rooted in this *udgment trap ewe sometimes pic! people we alread% !now for a *ob rather than the most 6ualified candidate. , . Co n f i rm ati o n : Se ei n g + h at :o u +an t t o See ;an% people start out wanting to confirmeconsciousl% or unconsciousl%e what the% alread% believe and tend to ig nore subse6uent evidence that contradicts their beliefs. #he confirmation trap is often triggered during mergers or ac6uisitions. Some %ears ago$ two large professional serv ice firms decided to pursue a merger$ which$ if completed$ would have resulted in large financial pa%outs to manage ment. 2 subse6uent stud% commissioned to assess the cul tural compatibilit% of the two companies pointed out ver% ma*or differences in the two cultures$ and an unbiased observer would have concluded that the organi5ations were vir tuall% incompatible and shouldn]t merge. Some partners who read the report$ however$ came to the opposite conclu sionethat there was a strong cultural fit. #he% ignored the differences that the stud% cited$ or reframed them as cstrengthsc that would actuall% aid the merger. 2s a result$ the two firms went through significant postmerger trauma as their different cultures clashed$ resulting in bitter conflicts and an e-odus of partners. 1,? .. Overconfidence: 1nde re " ti matin# What It Ta !e " to Succ eed Overconfidence is probabl% the most common and fatal *udgment trap. In his boo!$ $hen 1iants (tum%le& historian Cobert Sobel chronicles famous business blunders b% ma*or corporations. 3e sums up b% sa%ing$ cIf there is an% single moral to the tales fabout corporate failuresg it is that for all but one of these entities failure was preceded b% great suc cess.c <usiness success$ Sobel cautions$ can breed overconfi dence and complacenc%. Clearl%$ the 9ecca record e-ecutive was suffering from a ma*or case of over confidence &and ma%be incompetence as well' when he so brus6uel% turned down the <eatles. 2 famous historical e- ample of overconfidence is Ferman%]s invasion of Cussia dur ing +orld +ar II. 2dolf 3itler$ buo%ed b% eas% victories over (oland$ >rance$ and other European countries$ became filled with hubris as the war progressed. 3e then ignored the warnings of his generals and insisted on invading Cussia nearl% a month too late. 3is armies were virtuall% destro%ed b% the combination of the severe Cussian winter and the un e-pectedl% large number of Cussian troops that Stalin was able to mobili5e. Several other classic *udgment traps that are related to overconfidence include an overreliance on rules of thum% and a misunderstanding of %ase-rates. Cules of thumb include c+hen writing an ad$ use sentences of no more than twelve words$c or cSummer is the best time of %ear to sell %our house.c +e tend to simplif% our e-periences and reduce them to eas%toremember rules and guidelines. (roblems arise when these cherished rules *ust don]t appl%. >or e-am ple$ Dong #erm Capital$ a hedge fund manager$ had lever aged N11H billion worth of securities with *ust N/.? billion in capital &the underl%ing value of the derivatives was estimated atNl trillion'. #he compan% bet large sums of mone% that the %ields on twent%nine%ear government bonds would con verge with the %ields on thirt%%ear bondsesomething that had alwa%s happened in the past &this e-pected convergence was a crule of thumbc'. In @ul% and 2ugust of 1GG? the %ields actuall% diverged and Dong #erm Capital lost virtuall% all of its capital$ nearl% causing a global panic in the process. ;isunderstanding or ignoring the underl%ing statistics regarding an event is also common. >or e-ample$ most stud ies on the success of corporate ac6uisitions demonstrate that 0H to 1H percent of ac6uisitions are considered failures within five %ears. #he figure is even higher for crossborder mergers$ which onl% succeed .H percent of the time. :et man% e-ecu tives pa% no attention to these sobering statistics. /. (r ior Commitments: ;a!ing "ew$ I nappropr iate Commitments <ased on (revious Ones (rior investments or decisions can undul% influence the formulation of new commitments: once we ta!e a stand or position$ we often resist changing our mind. #his phenomenon ma% e-plain wh% (resident Uenned% gave the goahead for the <a% of (igs incursioneit was alread% planned$ orga ni5ed$ and read% to go when he was elected. Companies fre 6uentl% ignore an analogous rule of financeedon]t consider sun! investments when ma!ing new oneseand the% mista! enl% pour good mone% after bad. In his classic boo! 2nfluence The 3sychology of 3ersuasion& Cobert Cialdini cites man% e-amples of how even ver% small prior commitments can induce level headed individuals to agree to things that ma!e no sense. In one stud%$ for e-am ple$ 1,G homeowners consented to have large billboards encour aging traffic safet% installed on their front lawns$ simpl% because the% had previousl% agreed to put a small stic!er bearing a similar message in the corner of a windowK 0. Froupthin!: <elieving #hat It]s c8s 2gainst #hemc #he author Irving @anis$ in a boo! entitled 1roupthink& identifies eight s%mptoms that can distort *udgments and be haviors. #hese include: L 2n illusion of invulnerabilit%$ which leads to e-cessive ris! ta!ing L 2n unflinching belief in the moralit% and #ightness of the group L Stereot%ped views of adversaries as either evil or in competent$ and therefore not worth dealing with Corporate organi5ations often suffer from groupthin!$ and it can lead their managers to ma!e poor *udgments. +hen ;e-ico deregulated its longdistance telephone mar !et$ for e-ample$ several large 8.S. telecommunications com panies entered the ;e-ican mar!et believing the% could easil% dislodge the national phone compan%. #he% held its management in disdain and considered it a stodg%$ unworth% competitor. #o their surprise$ the% sustained heav% losses as the national compan% beat them at ever% turn with innovative mar!eting and pricing strategies. 9uring +orld +ar I$ this attitude resulted in the slaugh ter of tens of thousands of soldiers in #ur!e%. In The Broken 4ears 5ustralian (oldiers in the 1reat $ar& <ill Fammage describes the first 2ustralian soldiers who went into action at Fallipoli: c#he% thought themselves the e6ual to twent% #ur!s$ the% bowed to no man$ and with the eagerness of chil dren the% restlessl% awaited their glor%.c +ithin nine months the% had suffered appalling casualties and were forced to creep awa% in defeat. ,o to A$oid /ad <ud#ment" :ou need to be constantl% vigilant for signs that %our client is about to fall into one of these *udgment traps. 9o %ou see a client using rules of thumb that are shopworn and out dated4 3as %our client alread% made up his mind and *ust wants %our stamp of approval4 9o %ou have clients who rush to *udgment based on too much cintuitionc and too few facts$ or who grossl% underestimate what it will ta!e to succeed4 3ere are some specific actions %ou can ta!e as an outside professional to help %our client avoid lapses in *udgment: L 2lwa%s vigorousl% challenge %our clients] assumptions. +hat ma!es their starting number right4 +hat would *ustif% a number that was 0H percent less or 0H percent more4 9o their customers reall% onl% bu% on price4 9o their products reall% have the highest 6ualit%4 Intro duce as much contradictor% information as %ou can and as! lots of cdiscontinuingc 6uestions whose an swers might undermine the initial premise. L Ueep %ourself uptodate on !e% statistics and research in %our fielde remember$ there]s a lot of fol!lore out there. <eware of accepted wisdom: the cdogs of the 9owc stoc!bu%ing strateg%$ for e-ampleepopular for man% %ears with investorsehas wor!ed poorl% during the last five %ears. &#his popular investment strateg% involves bu%ing the ten stoc!s in the 9ow @ones Indus trial 2verage with the highest dividend %ields during the previous %ear7 holding them 1.H for one %ear7 and then going through the same selection process again for the following %ear$ pic!ing a new group of ten'. L <e careful how %ou as! and frame 6uestions. c9o %ou feel the mar!et is saturated now4c is a leading 6ues tion7 a better phrasing would be c+hat is the mar!et potential4c ;an% professionals as! 6uestions that are biased and reflect what they thin! or what the% feel their clients already believe. L #r% to identif% independent thin!ers who can help challenge %our clients] thin!ing. #hese can be outside spea!ers$ for e-ample$ or perhaps midlevel managers who see the need for change more clearl% than top management does. L >inall%$ don]t ever let %ourself be used simpl% to con firm something a client alread% believese%our collu sion ma% help undo the client. 2n assignment li!e this ma% help out with shortterm boo!ings$ but it won]t build %our reputation as a professional with integrit% and an independent point of view. &#he e-ception would be the case of a legal advocate who commits to demonstrating the truth of her client]s stor% in court'. W,AT IS S.1-D (1D:ME-T? +hat is sound *udgment and how does a professional develop it4 +e are concerned with a definition of *udgment that is the abilit% to arrive at opinions about issues7 the power of comparing and deciding7 good sense. #he elements that contribute to sound *udgment can be e-pressed in a formula with three basic parts: /udgment 6 78acts9 : 7,'perience9 : 73ersonal ;alues9 #he facts about the issue at handetoo few and %ou]ll be hip shooting$ too man% and %ou]ll ris! overanal%5ing the situa tionerepresent the first ma*or input. E-perience$ which fuels intuition$ is the mechanism b% which the adviser adds to and processes these facts. Food decision ma!ers then filter the resulting options through a strong set of personal beliefs and values. 3istoricall%$ good *udgment was associated with age and e-perience. #he elders in a societ% were considered the wis est$ and therefore the% were consulted on the most important decisions. #oda%$ there are several$ contradictor% schools of thought on what constitutes good *udgment and decision ma!ing. ;ost researchers in the field embrace the cognitive model and believe that solid *udgments can onl% be reached through a highl% logical$ stepb%step$ rational process$ focus ing almost e-clusivel% on the factual inputs described in our *udgment formula. ;an% popular boo!s have been written that propose this approach$ and the%]re filled with elaborate$ 6uantitative tables and charts$ which decision ma!ers are supposed to use in order to come to sound conclusions. 8n fortunatel%$ research into decision ma!ing in the real world clearl% demonstrates that good decision ma!ers rarel% under ta!e this much rational anal%sis. 2nother$ smaller group of scholars believes that *udg ment is essentiall% intuitive$ and that most realworld deci sions are made with little anal%sis. <ased on our own research into professionals and the clients who emplo% them$ we be lieve that the best decision ma!ers blend these two ap proachesecognitive and intuitiveeand the% add a third dimension$ which is the personal value s%stem. 1.1 ?IVE STEPS T. :..D (1D:ME-T Freat professionals e-cel at a number of specific prac tices that underpin sound *udgment. #he%: L >rame problems appropriatel% at the outset L Engage in creative but selective fact gathering L 8se intuition: the% leverage their personal e-perience to find similar patterns and relevant analogs L >ilter their *udgments through a clear set of personal beliefs and values L 2re honest enough to learn from e-perience I. >ra me the (roble m #he first critical step is to identif% the right problem and frame it correctl%. 9iagnosing the wrong problem is one of the most common mista!es that professionals ma!e$ regard less of their field. ;an% corporate e-ecutives will as! consultants to help creorgani5e$c when the real problemefor e-ample$ ineffective communication or poor leadershipe often has nothing to do with organi5ational structure. (rofessor @oseph <ower of 3arvard <usiness School$ who activel% consults to industr% leaders$ told the following stor% about problem framing$ or rather$ reframing I#he head of a large compan% called me in to advise on a ma*or revitali5ation program that he wanted to launch. 3e had identified a host of problems with his or gani5ation structure$ distribution networ!$ technolog% platforms$ and so on. 3e was also going to engage a large consulting firm to help with the effort. I sat in on the !ic!off meeting with the CEO and his fifteen top e-ecutives. >or two hours the CEO wa-ed elo6uent about the need to change$ and the new program he was about to launch. #here was little discussion$ and the meeting ended. 2fterward$ I sat with the CEO and he as!ed me for m% reaction. I loo!ed at him and said$ c9id %ou see the faces in that room4 #here isn]t one of %our top e-ecutives who bu%s into %our program. I thin! that]s %our real problem.c Initiall%$ he was stunned$ but then he nodded his head. 3e began to smile. c:ou]re right$c he said 6uietl%. c#he%]re not on board at all$ are the%4c Ironicall%$ that was the end of the consulting assign ment for both me and the large firm he had lined up. In his mind$ the engagement had been a success and was over. #he real problem had been identified and he set to wor! fi-ing it$ personall%. #he consultants were a bit stunned$ but to me it was a good outcome. #he CEO sub se6uentl% replaced half his senior team with outsiders$ and the% went on to be 6uite successful.J ,. Engage in Creative but Selective >act Fathering 3orserace handicappers use historical data on horses to set the odds for each race. In a classic stud%$ a group of pro fessional handicappers was as!ed to ma!e predictions for var ious races. In the stud% the% were given increasingl% more facts about each horse and then$ after absorbing the new batch of facts$ as!ed to predict its performance. >or the first round$ the% were given onl% five facts on each horse7 for the second round$ ten7 the third round$ twent%7 and finall%$ fort% pieces of information on which to ma!e a *udgment. +hat happened4 2fter each round$ the handicappers] confidence in their *udgments increased. <ut their accurac% sta%ed 1., the sameK 2fter a minimum threshold of !e% facts is reached$ having more information does not increase the 6ualit% of de cision ma!ing. In certain business situations where time is of the essence$ gathering more information can actuall% decrease the 6ualit% of decisions because !e% actions are dela%ed as managers conduct more and more anal%sis. +hile somewhat counterintuitive$ the idea that more in formation and e-pertise isn]t alwa%s helpful has been born out in a variet% of settings. In our largest corporations$ for e-ample$ the careful review and anal%sis of decisions b% large numbers of internal staff e-perts and e-ternal professional advisers often decreases rather than increases the 6ualit% and robustness of decision ma!ing. #his ma% happen be cause e-cessive anal%sis screens out promising creative ideas that do not stand up to the scrutin% of traditional financial benchmar!s. .. 8se I n t u i t i o n to Deverage >acts and (e rs ona l E-pe rie nce Intuition is a powerful tool for ma!ing *udgments. @ust loo! at this e-ample: a fire chief leads his men into a house where a !itchen fire is burning. It is a relativel% small fire and shouldn]t be a problem for the halfdo5en trained fire fight ers arra%ed to put it out. Suddenl%$ the chief has a terrible feeling about the fire. +ithout thin!ing$ he orders his men to evacuate immediatel%. #he% rush outside$ and as the% leave the house$ the entire first floor collapses in an e-plosive inferno. #he% have *ust escaped with their lives. +hen a post mortem is done on the situation$ the chief believes that his csi-th sensec perceived the danger and saved him and his men. J Cesearcher and author Far% Ulein$ who studies decision ma!ing under pressure$ recorded this case$ and he !nows that it wasn]t the chiefs e-trasensor% perception that saved the da% &Ulein]s boo! (ources of 3ower e'amines how people ma!e decisions in real life as opposed to the laborator%'. 8sing innovative interview techni6ues$ Ulein reveals the real reason: the chief]s e-periencebased intuition. #he fireman sensed that$ even though the fire was small$ it was generating an unusuall% large amount of heat. >urthermore$ there was ver% little noiseeit was too 6uiet for such a hot fire. In fact$ what had happened was that the basement was on fire$ and what seemed li!e a !itchen fire was actuall% a huge basement conflagration lea!ing upstairs. Subconsciousl%$ the chief compared this fire to similar fires in his e-perience. It didn]t fit established patterns$ and this set off warning bells. 3e !new something was wrongehe didn]t !now e-actl% what %et. So he ordered a retreat to ree-amine the situation from a safe vantage point. #he e-ample of the !itchen fire illustrates the first !e% component of intuition: the su%conscious analysis of 'patterns.
+e often e-perience it as cgood feel$c but a better description would be ce-perience feel.c 2fter we have seen man%$ man% similar cases$ we develop an abilit% to sense whether a new e- ample fitseor diverges frome the patterns we have come to recogni5e. Chess grandmasters function ver% much the same wa%. #he% spend most of their time stud%ing games and posi tions$ and the% develop the abilit% to rapidl% si5e up an% situa tion the% encounter on the chessboard. 2s %ou can see$ developing %our powers of observation$ a theme we high lighted in the previous two chapters on learning and s%nthe sis$ will help sharpen %our *udgment s!ills. In order to leverage %our e-perience$ %ou have to cultivate the abilit% to observe intensel% what is going on around %ou. #he second step in using intuition involves imagining how the decision will pla% out. Various researchers use e- pressions li!e cmental simulationc or cimagining the out comec to describe this. Ver% s!illed professionals can rapidl% simulate scenarios in their minds. <ain V Compan% CEO Orit Fadiesh implicitl% 1.. refers to this when she tells us: c#he good client advisers alwa%s !eep three or four moves ahead. #he% are constantl% imagining steps two$ three$ four$ and five of the process while their clients are still focused on step one.c #he intuitive part of *udgment also involves the abilit% to identif% analogs0to be able to sa%$ c#his here is li!e that over there.c 2nalogies are also an important tool for s%nthesis. 3ere$ we are tr%ing to use analo gies to ma!e better *udgments$ to enhance our understand ing of the immediate decision we have to ma!e. 2merican militar% advisers during +orld +ar II$ for e-ample$ might have foreseen the attac! on (earl 3arbor if the% had studied the histor% of the Cusso@apanese war. In that situation$ the war was also preceded b% a (earl 3arboreli!e attac! on the Cussian fleet at (ort 2rthur in 1GH0. /. Incorpor ate :our (er sonal Values and Standards Food *udgment$ or at least *udgment that is consistent with %our own character$ is also based on having a strong$ e- plicit set of personal beliefs and values that guide %our de cisions . #he following stor%$ told b% the chief e-ecutive of a N, billion compan%$ illustrates the power of an adviser]s per sonal value s%stem. :ou ma% not agree with the values$ but %ou can]t argue with the result: ISome %ears ago$ we faced a class action suit from a group of dealers$ which potentiall% was going to cost us N0H million. +e believed we had done nothing wrong$ but our law%ers advised us that if it went to court$ we stood onl% a 0H0H or worse chance of winning. 2 ma*or distributor$ who used to be the chairman of m% compan%$ originated the suit. 3e had died *ust shortl% after the suit was filed$ and on his deathbed he had his sons swear the% would not relent in their pursuit of the lawsuit. One of m% longstanding advisers is a minister who e-cels at ta!ing principles from the scriptures and appl% ing them to business problems. I e-plained the situation to him$ and he gave me this advice: he told me to go see the sons of the ma*or distributor &who had *ust died' and tell them that we were donating N,HH$HHH to a charit% of their choice cto honor their father.c c3e was the founder$c I was to tell him$ and cthis is to honor him.c I did this$ and the% accepted. #hen m% adviser told me to go around and personall% visit each distributor who was a part% to the lawsuit. 3e told me to as! them what their issues reall% were and what the% needed. I spent si- wee!s traveling to see them. 2t the end of this$ I offered to settle for something li!e N, million over three %ears. Eventuall% the% settled for N1 million up front. #his ad vice saved the compan% tens of millions of dollars and helped reestablish the lo%alt% of our !e% distributors.J #he pharmaceutical compan% ;erc!]s development of ;ecti5an$ a drug for river blindness$ is another e-ample of how a clear set of personal values can and should influence business decision ma!ing. In The .eadership Moment& (rofessor ;ichael 8seem of the +harton School of <usiness chron icles the stor% of Co% Vagelos$ who was the head of ;erc!]s laboratories in the 1G?Hs. Vagelos made a personal decision to support development of a revolutionar% drug that could cure or forestall the spread of river blindness$ which is caused b% a devastating parasite infection affecting 1H million people in developing nations. #he problem was that none of the cus tomers for ;ecti5an could afford to pa% for it. Vagelos advised ;erc!]s management committee$ and later$ when he became CEO$ its board of directors$ to support the production and distribution of ;ecti5anefor free$ for ever. #his was a huge and ris!% decision that b% 1GG= cost 1./ ;erc! N,HH million in lost income. :et Vagelos never hesi tated. 2 ph%sician himself$ he deepl% espoused a personal mis sion to cpreserve and improve human life.c 3is own beliefs and values were carefull% factored into his decision ma!ing. 0. 9on]t <e ;isled b% :our E-perience On "ovember ,.$ 1G01$ Iv% Deague rivals 9artmouth and (rinceton pla%ed a hotl% contested football game. #he game was mar!ed b% fierce rivalr% and ver% rough pla% on the field. (rinceton]s star pla%er bro!e his nose and a 9artmouth pla%er bro!e his leg. 2fterward$ a bitter dispute erupted about the wa% the game was pla%ed$ with each side accusing the other of unsportsmanli!e conduct. 2 ps%chologist from 9artmouth$ 2lbert 3astorf$ and a researcher from (rinceton$ 3adle% Cantril$ teamed up to stud% the incident. #he% surve%ed students who had seen the game$ and the% showed a film of the game to students at both colleges who had not at tended the match. (redictabl%$ each side reported that the other team had committed the most infractions. Even with the benefit of ob*ective evidenceea film that recorded ever% thingethe students couldn]t agree. #he researchers con cluded$ cIt seems clear that the ]game] was actuall% man% different games. It is inaccurate and misleading to sa% that different people have different ]attitudes] concerning the same ]thing.] >or the ]thing] simpl% is not the same for differ ent people.c 2s this e-ample illustrates$ although it would seem ver% natural for us to learn from e-perience$ memories are cre constructedc after the fact and sometimes not ver% accuratel%. Cesearchers in the legal field$ for e-ample$ have found that e%ewitnessc accounts can be ver% unreliable. In short$ we lend to see what we want to see. (h%sicians can be particularl% susceptible to this phe nomenon. 2 stud% done man% %ears ago as!ed a group of e- perienced doctors to assess who among 0HH children needed tonsillectomies. #he% concluded that about 0H percent needed to have their tonsils removed. #he% then separated out the 0H percent whose tonsils were deemed health% and as!ed another group of doctors to e-amine them. 2gain$ *ust under 0H percent were deemed in need of surger% to remove their tonsils. #he chealth%c children were again culled from this group and assessed b% %et a third group of doctors. In credibl%$ nearl% 0H percent were still diagnosed with un health% tonsils re6uiring removalK #here are three ma*or pitfalls that prevent us from learn ing from e-perience: L $e claim credit for all successes. "ot all good things are due to our genius7 luc! and happenstance affect a lot of outcomes. +e have to recogni5e this and develop a measured understanding of our capabilities. L $e minimi)e and dismiss failures. Often$ we will reframe events with hindsight so the% are more favorable to us$ or we simpl% forget them. #his !eeps us from learning. L $e distort actual events& in our favor. Di!e the students at 9artmouth and (rinceton$ we allow personal biases to color our recollections. :ou can enhance %our abilit% to learn from e-perience b% doing a few simple things. >irst of all$ !eep trac! of %our advice. Si- or twelve months after the fact$ as! %ourself if %ou would give the same advice$ or if$ perhaps$ %ou would sa% or do something different. Second$ thin! about how past events might have turned out differentl%. Cesearch has shown that %ou can reduce hindsight biases b% loo!ing at how the results of decisions could have been different. It]s not enough to sa%$ c+h% did things turn out the wa% the% did4c :ou also have to as!$ c3ow else might it have turned out$ and wh%4c 1.0 TEC,-I&1ES T. DEVE).P /ETTER (1D:ME-T <ased on our observations of professionals who have great *udgment$ here are some suggestions for improving %our own decisionma!ing abilit%: Overinvest in pro%lem identification. Dac! of upfront investment in thorough understanding of the issues that the client faces is one of the biggest mista!es professionals ma!e. 2t least 0H percent of the time$ the cproblemc presented b% %our client will change and evolve from the one %ou discussed at %our initial meeting. It is a dangerous mista!e to accept %our client]s first cproblem statementc at face value. ,'amine alternative pro%lem definitions. <e creative in e-amining all the root causes of the issue at hand. 3arvard]s @oseph <ower$ in our earlier e-ample$ correctl% identified that his client]s first problem was e-ecutive alignment and bu%in$ not anti6uated processes or information s%stems. Make sure the pro%lem is really apriority. Fiven the strateg%$ goals$ and current situation of the organi5ation or individual %ou]re dealing with$ does it ma!e sense to wor! on this problem4 2 few %ears ago$ a ma*or ban! had lost nearl% N0HH mil lion in *ust twelve months. ;anagement began soliciting multimilliondollar bids to develop a ccultural changec program. +as this reall% the place to start$ given the huge losses and other associated problems of cost efficienc% and strategic positioning that the ban! faced4 5sk <disconfirming< =uestions. 2s we mentioned earlier$ %ou can avoid the confirmation *udgment trap b% as!ing 6uestions and collecting data that %ou suspect might dis prove the initial h%pothesis. >or e-ample$ the 8nited States decided to drop the atom bomb on @apan in 1G/0 be cause of a firm belief that the @apanese would never surren der. 8.S. officials believed that an invasion of mainland @apan$ which would cost an estimated 1 million 2llied casu alties$ was the onl% other viable option. <ut what if the fol lowing 6uestion had been seriousl% pursued: cShort of dropping the atom bomb or invading the mainland$ what event could lead the @apanese to surrender4c #his line of in 6uir%$ if advanced in a thorough manner$ might have re vealed other options to the 2llies$ including the obvious one of *ust waiting for a few more wee!s$ since constant 2meri can firebombing had alread% destro%ed a large number of @apanese cities. *evelop %oth standard and outlandish alternatives. +e often put boundaries around our thin!ing$ and this severel% limits the range of alternatives or possibilities we are able to con sider. +hat if we do nothing4 +hat if we do the opposite of what ever%one is suggesting4 2n outlandish alternative pro posed at a 9re-el <urnham brainstorming session in 1G?. was the concept of an cair fundc for corporate ac6uisitions a fund with no mone% in it. 2t first$ the idea seemed absurd. <ut it eventuall% evolved and developed into the chighl% con fidentc letter that 9re-el would send out prior to a ta!eover. <asicall%$ the letter stated that 9re-el was highl% confident the financing could be raised in the high%ield bond mar!et. #here was no mone% available %et$ *ust the promise of billions of dollars soon to materiali5e. ,ngage in prospective hindsight. #r% stating a 6uestion about the future in two different wa%s: L 3ow li!el% is it that our closest competitor will ta!e ten points of mar!et share awa% from us in the ne-t two %ears and surpass us in revenue4 Five reasons wh% this might occur. 3ere is a slightl% different version of this 6uestion: 1.1 L (retend it is two %ears from now. Our closest competi tor has increased its mar!et share b% ten points and surpassed us in revenue. E-plain how and wh% this has happened. +hen a h%pothetical event is stated as a realit%eas in the second 6uestion abovee people are far more creative in com ing up with reasons for wh% it could happen$ and the 6ualit% of their thin!ing improves dramaticall%. >nderstand your client's tolerance for risk and uncertainty. Ever% client has different levels of tolerance for ris!$ and this tolerance will var% from situation to situation. Several %ears ago$ for e-ample$ a leading European travel compan% commissioned a group of consultants to review its 8.S. operations. 2lthough the firm]s 8.S. office was at a serious disadvantage against bigger pla%ers$ and losing mone%$ the consultants believed that with a great deal of wor! and further investment it could grow and achieve greater mar!et clout and economies of scale$ finall% becoming profitable. #heir conclusions bothered the CEO$ however$ and he as!ed a friend$ a former top e-ecutive in the travel business who had retired$ to come see him. Sitting over lunch the ne-t wee!$ his friend said$ cIt all comes down to what management reall% wants here. So what do %ou reall% want out of %our 8.S. operations4 2nd what ris!s will %ou tolerate4c #he CEO paused$ since no one had bothered to as! him these 6ues tions in 6uite this wa%. 3e replied$ cI basicall% need to show the flag in the 8nited States. #he business doesn]t have to be bigein fact it can be ver% smallewe *ust need a visible pres ence. 2nd I can]t ris! it ever losing an% mone%. I *ust cannot af ford it an%moreethe government won]t put up with the losses.c #he CEO declined the followon consulting contract and instead spent a month downsi5ing the 8.S. office to the point where it could brea! even under an% circumstances. #he CEO was happ%$ and so were his shareholders$ who were more interested in national representationecshowing the flagcethan mar!et share. #he consultants$ in short$ had mis*udged their client]s appetite for ris! and misunderstood his business ob*ectives in the 8nited States. ,nhance your a%ility to reach for patterns in your e'perience. :ou can deepen %our effective e-perience b% learning from other$ more seasoned peers. Fet them to share stories and an ecdotes. :ou might consider 6uestions li!e: c+hat was the most difficult client %ou ever had4 +hat was the most aw! ward professional moment of %our career$ and how did %ou handle it4 3ave %ou ever ta!en on a case that seemed hopeless4 +h%4c Stories are a powerful means of enhancing %our e-perience. /EC.MI-: A :..D T,I-AER Food *udgment flourishes$ first of all$ in the absence of bad *udgments. Freat professionals help their clients avoid the man% subtle *udgment traps that can lead to poor deci sions. #hen the% activel% e-ploit each part of the *udgment e6uation in a balanced fashion. #he% combine !nown facts with their e-perience and assess the alternatives through the lens of their beliefs and values$ b% becoming a deep generalist$ cultivating %our powers. Do You ,a$e :ood (ud#ment? L +hen %our clients face tough choices$ the% often use %ou as a sounding board. #he% share their dilemmas with %ou. L :ou]re right more than 0H percent of the time. 1.= L :ou have the confidence to ma!e *udgments rela tivel% 6uic!l%. :ou identif% and marshal the !e% facts and perspectives that %ou need$ but it doesn]t bother %ou if %ou don]t have all the facts. L If %ou]re as!ed b% a client to *udge an issue where %ou lac! e-perience and important information$ %ou]re not afraid to come out and sa% %ou *ust don]t !now. L :ou]re honest about %our trac! record at giving ad vice and ma!ing recommendations. :ou]ve made mista!es and learned from them. L :ou]re ver% aware of %our clients] tolerance for ris! and loss$ having discussed this openl% with them. Of s%nthesis$ and developing good *udgment$ %ou will be well on the road to becoming a good thinker& a person aptl% defined b% Vincent Cuggiero in his boo! The 5rt of Thinking Food thin!ers produce both more ideas and better ideas than poor thin!ers. #he% become more adept in using a variet% of invention techni6ues$ enabling them to discover ideas. ;ore specificall%$ good thin!ers tend to see the problem from man% perspectives before choosing an% one$ to consider man% different investiga tive approaches$ and to produce man% ideas before turn ing to *udgment. In addition$ the% are more willing to ta!e intellectual ris!s$ to be adventurous and consider outrageous or 5an% ideas$ and to use their imaginations and aim for originalit%. I> :O8 2CE able not onl% to demonstrate sound *udgment %ourself but also help %our clients arrive at their own good *udgments$ %our value as an adviser will increase significantl%. <% developing a reputation among %our clients as a good thin!er$ %ou will be as!ed bac! b% them again and again. W,AT M.-EY CA--.T /1Y Creatin# Tru"t throu#h Inte#rity E8ES#IO": 2s not commercial credit %ased primarily upon money or property + *. (IEC(O"# ;OCF2": No& sir& the first thing is character. E8ES#IO": Before money or property + *. (IEC(O"# ;OCF2": Before money or anything else. Money cannot %uy it. . . . Because a man 2 do not trust could not get money from me on all the %onds in Christendom. @. (. ;OCF2"]S ?@?A Congression Testimony] 2;ECIC2 is slowl% becoming a lowtrust societ%. In 1G1H$ 0? percent of 2mericans surve%ed felt that cmost people could be trusted$c but when as!ed the same 6uestion in 1GG.$ onl% .= percent replied in the affirmative. Evidence of low trust is ever%where: politicians routinel% lie$ litigation proliferates$ and the confidence we have in a variet% of pro fessional figuresedoctors$ law%ers$ consultants$ stoc!bro !ers$ *ournalists$ and otherseappears to be at a low ebb. Even our trust in respected institutions such as local police$ the ><I$ clerg%$ and the militar% has waned in recent %ears. 1.? 2 lac! of trust in business and personal dealings carries man% costs. Corporate managers and public officials$ for e- ample$ are reluctant to share information that could empower their organi5ations$ resulting in sharpl% reduced emplo%ee lo%alt%. #ransaction costs$ such as legal fees and overl% detailed contracting$ are ma*or e-penses for both cor porations and individuals. 2nd because of a fear that the% will be sued$ man% emplo%ers refuse to give recommendations for former emplo%eesethe two parties$ in essence$ don]t trust each other. Service professionals$ who have historicall% en*o%ed a reputation for unimpeachable integrit%$ have contributed their fair share to the diminution of trust that clients place in them. Stories are reported in the presseand also occa sionall% circulated among clientseabout investment ban!s whose client lo%alties are a function of deal si5e rather than prior commitments7 about consultants who oversell and put ine-perienced staff on pro*ects7 of law%ers who create con flicts of interest b% allowing themselves to become finan ciall% intertwined with their clients7 and so on. Ditigation against large professional service firms$ once rare$ has become commonplace. #he basic patterns are all fairl% familiar b% now: confi dential information is misused7 a client]s interests are put last rather than first7 standards are compromised in order to re tain client business7 and conflicts of interest are not disclosed. 2s the service industries become more competitive$ there is an increasing tendenc% to compromise principles in order to meet growth and profitabilit% ob*ectives. Integrit%$ ine-orabl% followed b% a decline in trust$ is the casualt%. Freat professionals$ however$ never concede their in tegrit% in order to win. #he% ma% be bold and determined in pursuit of their ob*ectives$ but integrit% and their clients] needsenot selling the ne-t assignment$ not earning a large bonus$ not pleasing their bossecome first. 2nd if there ever is a conflict between the two ebetween what a client wants and what the professional]s integrit% dictatese integrit% al wa%s wins out. Y.1R M.ST P.WER?1) A))Y #rust is especiall% important in situations where there is a chigh degree of dependence on someone elseeprecisel% the situation when a client hires a professional for advice or bu%s a comple- product or service from him. #rust between a client and a professional is both a necessit% and an important asset for both parties: if there is mutual trust$ ever%thing wor!s better$ faster$ and more smoothl%. +hen a client trusts her professional adviser$ a number of positive things happen: L +hen %ou suggest additional wor! to %our client$ she believes %ou are proposing the wor! because %ou hon estl% believe it will help her$ not because %ou need more business. L :our client will be willing to bu% services from %ou that e-tend be%ond %our core e-pertise. #rust allows %ou to increase the depth and breadth of the relationship. L If %ou ma!e an honest mista!e or slip up in some wa%$ %our client will most li!el% forgive %ou and won]t hold it against %ou. L :ou will be able to wor! with %our client on a more in formal basis$ leading to a more rela-ed and creative process. #here will be a decreased need to carefull% document and chec! ever%thing %ou do. L +hen %ou ma!e recommendations$ the% will have more impact. :our client will believe that %our words are bac!ed with integrit% and that %our onl% agenda is to help solve her problem. 1.G #rust$ in other words$ is a professional]s most powerful all%. #rust is worth a fortune &it is$ literall%$ if we]re tal!ing about !eeping a client for life'$ %et %ou can]t purchase it$ a fact noted b. (. ;organ when he testified before Congress in 1G1,. +hat is trust$ e-actl%4 +e !now it]s missing in man% aspects of our societ%$ and we !now how powerful it can be when it]s present$ but it]s easier to articulate the feeling of trust than the elements that actuall% create it. #rust is comple-: in some situations$ it means cI believe %ou are competent to per form this servicec7 in others$ cI !now %ou will act in m% inter ests$ not %ours.c 2uthor Cobert Shaw proposes a general definition of trust: c2 belief that those on whom we depend will meet our e-pectations of them.c ,arry ,op!in"' ?ran!lin Roo"e$elt @" Mo"t Tru"ted Ad$i"er 3arr% 3op!ins$ who served as an adviser to >ran!lin Coosevelt from 1G.1 to 1G/0$ was one of the most remar!able political advisers in 8.S. histor%. ;uch of his success was based on a relationship of e-traordinar% trust that he devel oped not *ust with the 8.S. president but with other world leaders at the time$ such as +inston Churchill and @oseph Stalin. 3op!ins$ who had almost no formal position in the +hite 3ouse during +orld +ar II$ was influential in both the success of the "ew 9eal and the effective conduct of the war. #he trust he engendered$ added to his native abilities$ en abled him to pla% a highl% unusual role in both increasing Coosevelt]s effectiveness as president and in facilitating a highl% productive relationship among the 2llied war leaders. Secretar% of the 2rm% Feorge ;arshall$ who was not prone to h%perbole$ said that 3op!ins crendered a service to this countr% which will never even vaguel% be appreciated.c 2 professional social wor!er b% training$ 3op!ins as a %oung man showed little hint of the greatness he would achieve as the most important adviser to a famous 8.S. presi dent. 3e headed the >ederal Emergenc% Celief 2dministra tion and the +or!s (rogress 2dministration during the mid1G.Hs and was secretar% of commerce from 1G.? to 1G/H. Ironicall%$ it was when 3op!ins abandoned an% personal po litical aspirations that his power increased e-ponentiall%. 3e had a bout with cancer$ then was diagnosed with a chronic$ wasting intestinal ailment that doctors believed would be fatal. <ecause of his health$ he gracefull% stepped down as commerce secretar% in 1G/H$ but soon after Coosevelt was re elected$ he as!ed 3op!ins to move into the +hite 3ouse and become his informal adviser. It was during the war %ears$ when he held no ma*or post$ that 3op!ins established a uni6ue relationship with Coosevelt. Diving in a guestroom at the +hite 3ouse$ 3op!ins *oined Coosevelt for virtuall% all his meals and attended ever% important meeting with him. Coosevelt got to !now 3op!ins intimatel%$ reinforcing their personal chemistr% and a sense that the% shared man% of the same values. <ased on Coosevelt]s deep trust in 3op!ins$ he sent him as his personal emissar% to Dondon in @anuar% 1G/1$ to meet with Churchill &Coosevelt and Churchill did not %et !now each other per sonall%$ although the% had met once %ears earlier'. 3op!ins and Churchill spent two wee!s together$ including three wee!ends in the countr%side at Che6uers$ the prime minis ter]s countr% estate$ where the% tal!ed$ dran!$ and rela-ed to gether. #he relationship 3op!ins established with Churchill during this trip built a foundation of trust that allowed 3op!ins to create an unusual lin! between the two leaders. ;oreover$ as 3op!ins]s biographer$ Cobert Sherwood$ notes$ cthere was b% now an intimac% between the two men which developed to such a degree that it is no e-aggeration to sa% that Churchill reposed the same confidence in 3op!ins that Coosevelt did.c 2fter %et a second visit with Churchill$ Sherwood tells us$ cthere was started at this time correspondence without precedent: an informal$ offthe record but none the less official correspondence between the heads of two governments through a third part%$ 3op!ins$ in whose discretion and Budgment each 1/H had complete confidence. #ime and time again$ when the (rime ;inister wanted to sound out the (resident]s views on some new move$ he would ad dress a private cable to 3op!ins . . . 3op!ins e-ercised impeccable discretion. 9espite being priv% to virtuall% ever% state secret and private conversation of the president$ he never$ everenot even onceebetra%ed the confidences placed in him. 3e never lea!ed news or used his information for personal gain. In @ul% 1G/1$ shortl% after the Fermans had invaded Cussia$ Coosevelt sent 3op!ins to meet with Stalin in ;oscow to assess the situation. It was a his toric set of meetings$ the first between Stalin and a direct rep resentative of the 8.S. president. Ver% little was reported in the newspapers$ however. 9uring the press conferences he held afterward$ 3op!ins revealed virtuall% nothing about the substance of their tal!s$ even though to do so would have enhanced his prestige and highlighted the powerful and unprecedented role he was pla%ing. Coosevelt !new that 3op!ins was as silent as a tomb$ and it magnified his abilit% to trust him. 3op!ins]s reliabilit% and consistenc% further reinforced Coosevelt]s belief in his integrit%. 3e never overstepped his bounds7 if Coosevelt sent him on a mission to meet with a for eign leader$ he !new that 3op!ins would assiduousl% adhere to the agenda and limits that had been set for him. 2fter ever% meeting$ 3op!ins would carefull% draw up a detailed memo for the president that succinctl% laid out the !e% points and issues to consider. 3op!ins didn]t believe in political patronage$ and he was incorruptible. +hen he administered relief funds for Coosevelt as head of the >ederal Emergenc% Celief 2dminis tration$ he did it strictl% b% the boo!$ favoring no particular state or constituenc%. 2 few times$ Coosevelt had to intervene to satisf% some political all% whom 3op!ins had treated too impartiall%. 3op!ins never profited from his position of enor mous influence7 when he died in 1G/0$ his estate was worth onl% a few hundred dollars. :et this had been a man who had personall% overseen the disbursement of NG billion in aid dur ing the 9epression and who had been a director of the lend lease program during +orld +ar II$ which allocated over N0H billion in militar% spending. In "oosevelt and !opkins& Cobert Sherwood sums up 3op!ins the adviser: c3op!ins did not originate polic% and then convince Coosevelt it was right. 3e had too much intel ligence as well as respect for his Chief to attempt the role of mastermind. 3e made it his *ob to provide a sounding board for discussions of the best means of attaining the goals that the (resident set for himself. Coosevelt li!ed to thin! out loud$ but his greatest difficult% was finding a listener who was both understanding and entirel% trustworth%. #hat was 3op !ins. <ecause he had set aside his own personal ambitions for formal office$ 3op!ins]s agenda was Coosevelt]s agenda. #his$ together with his unwavering integrit%$ made it eas% for Coosevelt to trust him. If we loo! at 3arr% 3op!ins and his relationship with Coosevelteindeed$ if we e-amine an% business relationship with a high degree of trusteseveral factors stand out that uni6uel% affect the level of trust that a client has in %ou. #he first ma*or 6ualit% that underpins trust is integrit%. #he dis cretion$ consistenc%$ and reliabilit% that %ou demonstrate$ and %our sense of right and wrongethese will influence$ more than *ust about an%thing else$ the degree of trust people place in %ou. 3op!ins e-hibited these 6ualities to Coosevelt on a dail% basis$ alwa%s coming through for the president$ never forgetting a commitment$ as incorruptible on the last da% of his tenure as on the first. 3op!ins]s strong performance at ever% tas! Coosevelt gave him illustrates an additional factor that builds trust: competence. In a business setting$ a client]s trust will natu rall% be influenced b% whether or not he thin!s %ou]re competent to do the *ob %ou]ve promised. #he ris! of trusting someone is a final consideration$ and that perceived ris! will raise or lower the total amount of trust that a client has in %ou. 1/1 #hese three factorseintegrit%$ competence$ and ris!e can be combined into a trust formula: ,rust 0 1+ntegrity 2 Competence3 .is" :our clients] perception of each factor in the e6uation will raise or lower the trust the% place in %ou. I-TE:RITY' T,E /ACA/.-E .? TR1ST Integrit% is a state of wholeness in which %ou act in accor dance with a set of coherent values or principles. In other words$ %ou !now what]s right$ %ou]re clear about what %ou be lieve in$ and %ou consistentl% follow %our beliefs. Integrit% has several main dimensions to it. #he first$ ac cording to :ale law professor Stephen Carter$ is discernment between right and wrong. = @ust acting consistentl% with %our beliefs is not enough7 %ou have to have beliefs that are ethical and moral. 2dolph 3itler$ for e-ample$ passed man% of the tests of integrit%ehe acted on his beliefs 6uite consistentl%e but he had evil$ wrong beliefs. #here was no discernment. In 9ante]s 2nferno& which is the first part of his *ivine Comedy& the cfalse counselorsc are found in the eighth circle of hell$ one of the lowest$ *ust below common thieves. #hese false counselors are spiritual thieves$ who advised others to commit fraud. #he% used their intellect to rob people of their integrit%$ and as a result must wal! for eternit% en veloped in painful flames. 8sing one]s intellectual powers to deceive and encourage wrongdoing was$ for 9ante$ an espe ciall% egregious crime. !onesty is an important manifestation of discernment. ,.W Y.1 CA- /1I)D TR1ST #rust is li!e a fine Oriental rug that is carefull% woven over man% months or even %ears$ rather than an edifice that is set up overnight. Dots of small things go into building trust. 3ere are some areas to consider: 7* ?ace Time ith Client" cOne of m% few client relationships that went badl%$c Spencer Stuart]s 2ndrea de Cholno!% tells us$ cwas due to lac! of face time. #he client told me that he *ust hadn]t seen enough of me$ that it didn]t seem li!e I had the energ% in the assignment. I immediatel% called up ever% single one of m% other clients and too! them out to lunchK :ou]ve got to in vest$ continuall%$ in facetoface time with clients.c #here is simpl% no substitute for meeting with a client and allowing time so that the two of %ou can come to !now each other personall%. #he purpose is not to ma!e the client li!e %ouewe]re not tal!ing about cschmoo5ing.c 2nd there]s no guarantee that if %ou spend time together the trust will in crease. If$ however$ there is personal chemistr%$ as well as shared values and interests$ personal time together will bring this out$ and it will subtl% facilitate the development of trust. >ace time provides an opportunit% for %our client to see %our sterling 6ualities firsthand. It amplifies %our competence and integrit%. 1/, 5* Settin# and Re$iein# EBpectation" +e said earl% on that a client]s satisfaction is a function of e-pectations versus actual &or perceived' performance. #rust wor!s the same wa%: %ou ma% ver% well fulfill %our commit ments on time$ but if %ou and %our client don]t agree on what a particular commitment was in the first place$ %our perceived integrit% will suffer and trust will diminish. 8* Carefully Ma!in# Promi"e" #he worst !ind of professional is someone who con stantl% promises things and never delivers. #his !ind of credi bilit% gap$ once established$ is almost insuperable. Dewis Smedes$ an ordained minister$ beautifull% sums up the mean ing of a promise in a sermon entitled c#he (ower of (romisesc: c+hen a person ma!es a promise$ he stretches himself out into circumstances that no one can control and controls at least one thing: he will be there no matter what the circumstances turn out to be.c 3ere are some suggestions for how to !eep commit ments: L 9on]t be cavalier with promises. 9on]t sa%$ cDet]s have lunchc or cI]ll call soandso for %ouc unless %ou reall% mean it. <eing !nown as a person of %our word is a powerful thing. 9on]t dilute %our integrit% with thoughtless commitments. L If necessar%$ ma!e conditional agreements. If an event or occurrence could get in the wa% of a promise$ state it clearl% up front. #his wa% there will be no surprises. L If %ou can]t !eep a promise$ let the other person !now as earl% as possible. #he longer %ou wait to reveal the bad news$ the worse things get. If %ou have built up trust b% !eeping %our previous commitments$ then that client will probabl% understand. L Dearn to sa% no. <us%$ successful people are the ones who are alwa%s as!ed to do things. <e selective about what %ou commit to. C* Demon"tratin# )oyalty Do%alt% means having an allegiance to %our client and putting her agenda before %our own. +hen clients e-peri ence a sense of lo%alt% from %ou$ it reinforces their percep tion of %our integrit% and strengthens their abilit% to trust %ou. Someone who feels third or fourth on %our list of priori ties$ who gets the impression that she]s *ust one of do5ens or hundreds of clients$ is never going to trust %ou ver% deepl%. #hin! about how %ou feel when a doctor barel% recogni5es %ou and has to visibl% reorient himself as he wal!s into the e- amining room. Ever%one wants to feel speciale%our clients are no different. It]s also important never to critici5e an%one who is not present. :ou win the trust of the people %ou]re with b% show ing lo%alt% to those who aren]t there. If someone is indiscreet and tells %ou a piece of gossip or confidential information$ it becomes difficult to trust that individual. If he or she is alwa%s critici5ing other people$ it ma!es %ou wonder$ +hat will this person sa% about me to others4 1/. D* -urturin# Tru"t on a Daily /a"i" #here is no doubt that one dramatic event can establish a great deal of trust. >or e-ample$ when Feorge +ashington voluntaril% relin6uished the presidenc% after his second term had e-pired$ he instilled a deep public trust both in himself and in the new 2merican government. >ew if an% ma*or heads of state before him had ever stepped down of their own free will. +hat reall% cements and develops a sense of trust$ however$ is the daily nurturing of %our relationships. Stephen Cove%]s metaphor for this reservoir of trust is the emotional ban! account. +hen an action reinforces trust$ %ou have made a deposit7 when %ou do something to undermine trust$ such as letting someone down$ %ou ma!e a withdrawal. :ou have to ma!e lots of deposits$ regularl%$ to sustain trust. E* There Are -o FMinorF Commitment" 2t <eth Israel 3ospital in <oston$ legendar% chief of sur ger% 9r. +illiam Silen tells his residents$ cI don]t !now what the difference is between ]ma*or] and ]minor] surger%. I *ust !now that no one performs ]minor] surger% on meC< In a sim ilar vein$ there is no such thing as a minor commitment. Each promise %ou ma!e$ large or small$ should be treated with the same seriousness. cCharacter is made in the small moments of our lives$c offered nineteenthcentur% clerg%man (hillips <roo!s. It]s all the little things that %ou doeoften when no one is loo!inge that constitute %our character and define %our integrit%. G* Anoin# What You Stand ?or <% definition$ integrit% is a wholeness or completeness that is underpinned and bounded b% a set of beliefs and val ues. +hat are %our principles4 +hat do %ou stand for4 +hat guides %our professional and personal life4 +here do %ou draw the line when %our beliefs are challenged or threat ened4 Daw professor and bestselling author 2lan 9ershowit5 told us this stor% about clarit% of principles and integrit%: cSeveral %ears ago I helped a large law firm win a ver% impor tant case. #o celebrate$ the partners too! me out to dinner to a private club. I learned that the club did not allow women in side the door$ however$ a practice that violated one of m% basic beliefs about e6ualit% between the se-es and nondiscrimination. +hen I refused to go to the club$ the% said ]but there]s no other good place to eat.] I insisted$ and we ended up holding the victor% dinner at ;c9onalds.c 2* /ein# Prepared t o Tal! on TV 2ll professionals are faced with ethical and moral dilem mas *ust about ever% wee! of their lives. Some are relativel% minor. Should I fl% first class or econom%4 Should I put hotel laundr% on m% e-pense report4 Some are ma*or. Should I agree to an accounting practice that I feel is wrong4 #here are no simple rules for how to conduct %ourself. 3emingwa%]s 6uip that cI onl% !now that moral is what %ou feel good after and immoral is what %ou feel bad afterc can ta!e %ou onl% so far. One good principle to follow as a professional is what we call the clightofda%c test. +hatever action %ou ta!e$ be it sta% ing in a certain class of hotel or meeting with a client]s com petitor$ would %ou be comfortable discussing it with %our client the ne-t morning in the full light of da%4 +hat if %ou were interviewed on television and as!ed about something %ou did4 +ould %ou feel comfortable e-plaining it4 1// c2n%thing related to issues of integrit%$ trust$ and ethics are fatal flawsc commented Cebecca Fuerra$ the vice presi dent for human resources at e<a%$ the online auction house. Spea!ing to The New 4ork Times& she emphasi5ed that while failure in one]s past was OU$ 6uestions about character were unacceptable to her compan%. 2nother wa% of loo!ing at this is that %ou shouldn]t have an% secrets. <% secrets we don]t mean confidential client in formation$ which %ou are dut%bound to protect. Cather$ %ou should have nothing to hide7 %ou should be comfortable sharing details of %our professional conduct with a client$ without embarrassment or defensiveness. H* Reducin# Your Client@" Ri"! Cecall that the amount of trust a client has in %ou will go up or down depending on the ris! he perceives. :ou can do several things to reduce this ris!. >irst of all$ %ou have to demonstrate consistenc% and reliabilit% right from the start$ even for the smallest of things. Showing integrit% itself$ in other words$ reduces ris!. Second$ %ou can either implicitl% or e-plicitl% guarantee %our wor!. 2 guarantee doesn]t have to ta!e the form of a cer tificate that %our clients mail in to %ou. ;ore li!el%$ it will be an understanding between %ou and %our client. :ou want %our clients to feel that if the% are not satisfied at an% time with %our wor!$ %ou will rectif% it as best %ou caneperiod. #he words cwe]ll wor! on this until %ou]re satisfiedc can be the occasional reminder of the fact that %ou]ll stand behind %our wor! and strive to address an% issues the% ma% have with %our performance. W , E - T R 1 S T IS ) .S T Sometimes$ even though %ou feel %ou have demon strated a high level of integrit% and competence$ trust is lost. 3ere are some principles to remember about losing trust: Clients don't inform you when they stop trusting you. #rust can vanish rapidl% and m%steriousl%$ and %ou]re alwa%s the last to !now. <ecause the s%mptoms of a loss of trust can be so var ied$ and because some of them can also signif% other prob lems or issues$ it]s alwa%s hard to pinpoint when %our client stops trusting %ou. (erhaps %ou lose a followon assignment that %ou were sure %ou would win7 or suddenl% the client throws %our business open for a competitive bid. Often$ a client can]t even articulate that she]s lost trust in %ou. She feels a vague dissatisfaction$ and she stops sharing informa tion with %ou and turning to %ou for advice. :ou have to watch and listen ver% carefull%. It]s useful to hold a fran! and open discussion with %our client when the engagement ends$ something that is easier to do if %ou set the e-pectation$ right up front$ that %ou]ll be having this discus sion three or si- months down the road. 8nfortunatel%$ b% the time %ou discover that the trust has dried up$ it ma% be too late to do an%thing about it. Clients don't care why you let them down. 8nless a catastrophe has occurrede an earth6ua!e or a death in the famil%e clients$ li!e most people$ don]t particularl% care what the reason was that caused %ou not to deliver on a commitment. :ou ma% believe %ou had perfectl% good reason to let them down$ and the e-cuses are m%riad: %ou caught a cold$ the wor! too! longer than %ou had planned$ another client had an emergenc%$ %our computer crashed$ %ou forgot to 1/0 write it down in %our agenda$ %ou wrote it down in the wrong agenda$ %our secretar% forgot to tell %ou about it$ and so on. <ut %our client doesn]t reall% care$ and tr%ing to e-plain it won]t help. It]s better to sa%$ cI let %ou down$ I]m sorr%$ and it won]t hap pen again.c If %ou have built up a reservoir of trust with %our client$ he ma% let it pass. (ometimes& repairing a lapse in trust can enhance your relationship. If %ou let a client down$ %ou ma% be able to recover her confidence. 3ow %ou react to the incident and the wa% in which %ou go about remediating it are criticall% important. Several %ears ago$ a management consultant conducting an assignment for a large +est Coast compan% carelessl% left a draft cop% of his report on a <2C# train in San >rancisco. 2n unscrupulous passenger found it$ contacted the client$ and demanded N0H$HHH in ransom for the return of the docu ment. 2ll hell bro!e loose: the compan% threatened not *ust to terminate its relationship with the consultants$ but to file a ma*or lawsuit as well. #he consulting firm went into action immediatel%. Its president flew out to California the ne-t da% and met with the CEO of the client compan%. 3e apologi5ed for the incident$ offering no e-cuses. 3e informed the CEO that the consultant had been disciplined and that the firm was assigning a tas! force of partners to develop new policies and procedures to minimi5e the possibilit% that such an inci dent could reoccur. #hen he offered to conduct a ma*or stud% for the client$ free of charge$ on a !e% issue the compan% faced. #he client accepted$ and the relationship contin ued successfull% for another four %ears. #his anecdote illustrates some cardinal rules for dealing with a breach of trust: L 2dmit that %ou]ve made a mista!e. Own up to the lapse. L 9on]t ma!e e-cuseseno one wants to hear them. ,a$e You De$eloped Tru"t ith Your C l i e n t " ? L Sometimes$ %ou conduct assignments based on a minimum of documentation. Once %ou and %our client have agreed on the ob*ectives and deliver ables$ %our client trusts %ou to follow through. L Clients ma% remind %ou of something %ou]re sup posed to do$ but the% rarel% cchec! upc on %ou. L Clients as! %ou to tac!le issues that are of ma*or importance to them. L If on a rare occasion %ou slip up and miss a com mitment$ %our clients are ver% forgiving. L #here is a 6ualit% of openness to %our client relationships. <oth %ou and %our clients feel free to bring up touch% or aw!ward sub*ects with each other. L :our clients have become familiar with %our partic ular s!ills as well as %our values and beliefs. #he% can predict how %ou will react to a particular situa tion or dilemma. L Clients] trust in %ou e-tends be%ond their belief that %ou will do good wor!7 it is a deeper$ broader trust based on both professional competence and personal integrit%. L (rovide valueadded compensation to the client. Some clients might value having the fee reduced7 for others$ such as the client in the e-ample above$ a free piece of wor! can he appropriate. 1/1 L Dearn from the incident$ and let %our client !now that %ou are learning from it. #ell them what %ou]re going to do to ma!e sure it doesn]t happen again. #here ma% be situations where %ou feel that %ou are 1HH percent in the right and that the client is absolutel% in the wrong. Even in these cases$ !eep in mind that the client per ceives that %ou have let him down. :ou ma% have to wal! awa% from the relationship$ but be careful about how %ou deal with it7 %ou don]t want to leave burned bridges behind %ou. If there has been good communication between %ou and the client$ however$ and e-pectations have been set$ %ou should be able to avoid this !ind of confrontation. 9EE( (ECSO"2D and professional trust$ which boils down to a client]s belief in %our integrit% and %our competence$ is a hallmar! of the longterm relationships that great profession als are able to develop. Clients e-pect and will forgive occa sional errors of *udgment$ but lapses of integrit% are a red flag to ever%one around %ou. 2s the fifthcentur% religious leader St. 2ugustine wrote in his essa% On .ying. c+hen regard for the truth has been bro!en down or even slightl% wea!ened$ all things will remain doubtful.c Set high standards of con duct for %ourself. #irelessl% develop %our reputation for in tegrit% and honest%$ and it will become one of %our biggest assets as a professional. T,E S.1) .? T,E :REAT PR.?ESSI.-A) This is the true Boy of life& the %eing used %y a purpose recogni)ed %y yourself as a mighty one# the %eing thoroughly worn out %efore you are thrown on the scrap heap# the %eing a force of nature instead of a feverish& selfish little clod of ailments and grievances complaining that the world will not devote itself to making you happy. FEOCFE <EC"2C9 S32+$ Man and (uperman FCE2# (CO>ESSIO"2DS become e-traordinar% client ad visers b% developing some important attributes. #hese attributes encompass the im portant talents$ s!ills$ and attitudes that enable professionals in an% field to build and sustain longterm$ broadgauge client relationships on a consistent basis. #he great advisers we]ve studied also possess certain out loo!s that frame and inform their wor!. +e call these out loo!s the soul of the great professional. #he% are not so much personal characteristics as the% are wa%s of loo!ing at the world. If %ou cultivate them$ %our abilit% to add value will be enhanced$ and %ou]ll become a more appealing person to %our clientse someone the% will both respect and en*o% spending time with. In addition$ %ou]ll be better able to shape and manage %our own career. #hese outloo!se the elements of this soul0can be discerned in virtuall% all of the professionals we have studied who command strong client lo%alt%. :reat Profe""ional" ,a$e an A%undance Mentality 2n abundance mentalit% allows %ou to see the possibili ties and opportunities inherent in ever% situation. 1 #he opposite is a scarcity mentalit%$ which focuses on limitations and ris!s. 1/= (rofessionals with an abundance mentalit%: L 2lwa%s loo! for opportunities$ growth$ and e-pansion L Constantl% generate new ideas L 2re positive and upbeat in their demeanor L >eel that there are rewards enough to go around for ever%oneethe% !now that a crising tidec lifts all boats L 2re willing to invest time and mone% in the short term in order to earn more later on. (rofessionals with a scarcit% mentalit%$ in contrast$ have ver% different attitudes. #he%: L 2re primaril% concerned with what might go wrong and what won]t wor! L >ocus on the ris!s of new proposals rather than the po tential rewards L <elieve that life is a 5erosum game$ with a limited amount of opportunit% to go around L 2re concerned with cgetting their fair sharec at all times L +on]t ma!e investments that don]t show an immedi ate return If %ou were a client$ whom would %ou rather spend time with4 #here]s no contest here: all of us would prefer a posi tive$ energi5ing individual to someone who alwa%s sees the dar! side of things. Some situations$ such as a ta- audit$ ma% benefit from the scarcit% mentalit% we]ve described. <ut in general$ clients prefer and benefit from the e-pansive thin! ing of the professional who sees abundance$ not scarcit%. 9on]t confuse an abundance mentalit% with la-ness$ la5i ness$ or imprudence. #he professionals who perceive abun dance often have a health% dissatisfaction with the wa% things are done toda%. #he% !now there]s often a better solution. Di!e strong organi5ational leaders$ the% push and stretch for new ideas and innovations7 the% don]t wait for them to float down from the s!%. #hat]s wh% clients li!e having them around so much: these professionals constantl% energi5e$ motivate$ and inspire others. #he sources of %our fundamental outloo! on lifeeabun dance versus scarcit%eare varied and comple-. :our earl% childhood e-periences and upbringing clearl% have a strong influence on this dimension of %our personalit%. Someone who suffers ph%sical or emotional deprivation as a child$ for e-ample$ ma% alwa%s harbor a deepseated sense of scarcit%. 2 lac! of love and affection damages selfesteem$ ma!ing it hard to have an abundance outloo!. #here is no doubt an el ement of personal cconstitutionc involvedesome individuals *ust seem to be born with more resilience against the vicissi tudes of lifeebut famil% and parental role models are also an important influence on %our adult attitudes of either abun dance or scarcit%. +e believe that the education %ou receive pla%s a critical role as well. Economics and engineering$ which are t%pical bac!grounds of man% professionals in business$ are founded on principles of scarcit%. <oth disciplines are concerned with the optimal use of scarce resources. #he% focus on the tradeoffs that have to be madeefor e-ample$ cguns versus butter$c a graph recogni5able to man% readers$ which is found in man% introductor% economics te-tboo!s. #he liberal arts$ in contrast$ are premised on abundance. #he liberal arts per spective sees a world of nearl% infinite ideas and resources$ a world where tradeoffs are not alwa%s necessar%. It also raises important philosophical 6uestions. Ca*at Fupta$ ;cUinse%]s worldwide managing director$ sa%s that he reads poetr% at the end of each partners] meet ing: c2t first$ that too! people b% surprise. 1/? <ut over time$ po etr% has affected what we]re doing. (oetr% helps us reflect on the important 6uestions: +hat is the purpose of our busi ness4 +hat are our values4c #he European Cenaissance$ which was a time of enor mous scientific as well as artistic ferment and innovation$ e- emplifies the power of the liberal arts perspective. #he concept of humanism& which fueled the Cenaissance$ was based on a belief in the potential of human beings and their abilit% to reach self fulfillment without recourse to higher powers or supernatural means. #he most accomplished and inventive figures of the period$ from "iccolo ;achiavelli to Deonardo 9aVinci$ were consummate liberal arts scholars$ e6uall% at home with art$ science$ mathematics$ philosoph%$ histor%$ and literature. 9oes this mean %ou have to stud% liberal arts to become an accomplished professional and develop lifelong clients4 :es and no. +hat we have found is that the best client advis ers$ regardless of what the% ma*ored in at college or studied in graduate school$ become deep generalists. #he% read widel%$ ta!e an interest in a variet% of sub*ects and disciplines$ and cultivate personal in terests as well as professional e-pertise. Cecall (eter 9ruc!er$ for e-ample$ who has a passion for @apanese art$ or 9avid Ogilv%$ who had a deep interest in >rench culture &he eventu all% went to live in >rance'. #he ris! of burrowing too deepl% into one discipline li!e economics$ engineering$ or account ing is that %ou will begin to adopt a scarcit% mentalit%. <road !nowledge and learning$ in contrast$ open the wa% for an out loo! of abundance. :reat Profe""ional" ,a$e a Mi""ion .rientation #he individuals who have had a significant impact on histor%efigures such as @esus$ <uddha$ @oan of 2rc$ Fandhi$ and 2braham Dincolnehad clear missions that led them to perform at e-traordinar% levels. #he great advisers we]ve loo!ed at in this boo! also had welldeveloped personal mis sions. >or #homas ;ore$ it was fulfilling Fod]s wor! in this life7 for "iccolo ;achiavelli$ it was creating a stable$ unified Italian state7 for @. (. ;organ$ it was establishing an orderl% financial s%stem in the absence of regulator% agencies. Fertrude <ell]s mission was to promulgate an understanding of the 2rab world among +esterners and ensure peaceful co habitation of the Ira6is and the <ritish. Earl% on$ Feneral Feorge ;arshall was driven b% a desire to create a profes sional$ respected 8.S. 2rm% founded on principles of e-cel lence$ efficienc%$ compassion$ and hard wor!7 later$ his mission became no less than ensuring that the 8nited States !ept the world safe for democrac%. >or most of us$ our personal missions are perhaps more downtoearth but no less sincere$ sacred$ and important to us. +hen %ou as! great professionals what drives them in their careers$ %ou will hear phrases such as cma!ing a differ ence to m% clients] businessc7 cenriching management prac tice through m% ideasc7 cbeing a teachereteaching and e-plaining the importance of people]s rightsc7 ceducating managers so the% lead more successful$ effective livesc7 or simpl% cpracticing e-cellence in ever%thing I do.c >red <rown$ who descends from the famed <rown <rothers 3arriman ban!ing famil%$ is an e-ample of an e- traordinar% adviser who has a clear mission that drives his dail% behavior. 2 highl% successful personal financial consul tant$ <rown has authored several boo!s on financial manage ment. 3e writes a wee!l% newspaper column entitled c;one% and Spirit$c and he has a waiting list of clients. 3e could well afford a troph% house and latemodel lu-ur% cars$ but his relativel% modest home in the Southwest and his utilitarian Subaru suit him *ust fineehe prefers to live his values of moderation and balance rather than flaunt his achievements through flash% possessions. 8sing a powerful$ uni6ue ap proach to financial management that blends cuttingedge fi nancial e-pertise with a deep understanding of each client]s personal$ familial$ professional$ and spiritual life$ 1/G <rown has developed an intensel% lo%al following of individuals and families who come bac! to him %ear after %ear. <rown charges an hourl% rate that is a fraction of what the mar!et could bear$ but this is a conscious choice he has made that is consistent with his mission of helping people lead bet ter lives through improved financial management. c<% charg ing what I do$c <rown tells us$ cI am able to serve a ver% broad clienteleeI get the millionaires but also people who are scraping b% and desperatel% need help *ust to survive.c #he opposite of a mission orientation is the strictl% ma terial orientation. :our main focus becomes mone%$ title$ pro motion$ or publicit%. +hen a professional has no sense of mission$ he or she ris!s becoming a mercenar%e someone that ;achiavelli cautioned against five hundred %ears ago when he wrote$ c;ercenaries are disunited$ thirst% for power$ undisciplined$ and dislo%al.c ;achiavelli urged the creation of national militiaseciti5ens] armies with an overriding pur pose and an intense lo%alt% to their home stateea revolu tionar% concept at the time but now the accepted norm. #he author Victor >ran!l$ who survived the "a5i con centration camp at 2uschwit5 during +orld +ar II$ wrote that c"othing is more li!el% to help a person overcome or endure troubles than the consciousness of having a tas! in life.c 2 mission orientation not onl% helps %ou overcome difficulties$ but it will give %ou great strength in practicing the seven attributes. It will be easier for %ou to be an empathetic listener7 %our conviction will intensif%7 %our integrit% will be strengthened7 and it will be far easier to practice self less independence. :reat Profe""ional" Channel Ad$er"ity into Wi"dom and Confidence #he e-traordinar% client advisers we]ve profiled have all gone through difficult e-periences. #he%]ve made mista!es$ suffered reversals of fortune$ and even been humiliated. +hereas man% people become embittered$ c%nical$ or dis trustful as a result of these setbac!s$ the reall% great profession als get stronger. #he% become wiser$ more confident$ and humble. #heir comfort 5ones e-pand$ enabling them to tac!le an everbroader variet% of situations and client assignments. Daura 3erring]s stor% illustrates how e-traordinar% set bac!s can create resolve and determination. In less than ten %ears$ 3erring]s firm$ #he I;(2C# Froup$ has grown to 1,H professionals who deliver a variet% of relocation support ser vices$ from counseling to resume preparation. It had an in auspicious beginning$ however. #he concept got its start when 3erring$ originall% a famil% therapist$ pointed out to a >ortune 0HH e-ecutive that relocation was one of the toughest personal issues facing his emplo%ees. Challenged to develop a solution$ 3erring invested N.1H$HHH and months of time to create a program called ;omentum. @ust after the compan% placed a ma*or order for her services$ however$ its relocation manager vetoed the idea$ leaving 3erring with no business. cI had double mortgaged m% house$c she tells us$ cand sold some real estate m% husband and I owned. I was deepl% in debt$ with no cash flow. (anic set in.c She goes on to sa%: I was unable to go home and tell m% husband what had happened. So I went to the phone boo!$ and began loo!ing through the :ellow (ages for other companies that I could sell the program to. I called the vice presi dent of mar!eting at 8nited Van Dines and told him I thought he should have the first shot at bu%ing our ser vices. 3e agreed to meet the ne-t da%. 3e loved the ma terials so much that he immediatel% placed an order for 1H$HHH tapes$ boo!s$ and related serviceseit was a N1 million sale. I was ecstatic. #wo da%s later$ however$ he called me bac! with terrible news. c+e]ve decided to de velop this 10H internall%$c he told me. c+e can]t go forward with the order.c 8nfortunatel%$ I didn]t have a signed contract. Shortl% afterward$ 3erring flew to a relocation confer ence being held in >loridaeher last hopeebut after arriv ing$ she learned she couldn]t activel% mar!et to an% of the participants. #here$ after three fruitless da%s wal!ing the floors of the conference hall$ she finall% met a top @ohnson V @ohnson e-ecutive who was literall% wal!ing out the door. In trigued with her new &but still untested' service$ he invited 3erring to come to his office to ma!e a presentation. cFar% Forran$c 3erring concludes$ cwas the @V@ e-ecutive. 3e be came our first client$ and thirteen %ears later he is still one of our best and largest clients.c +hen as!ed about how this and other difficult e-peri ences affected her$ 3erring replies: c#he other da% I too! m% %oung niece to a club I belong to in St. Douis. +hen we wal!ed in$ a lot of people came over and greeted me. ;% niece was a bit shoc!edeshe said to me$ ]Ever%one !nows %ouedo %ou ever marvel at how far %ou]ve come4 2nd I told her that I !now what it]s li!e to be invisi%le& and therefore I never ta!e the end result for grantede%ou]ve got to earn it. #here]s alwa%s someone out there who is better and smarter than %ou are. #here]s alwa%s someone]s uncle who knows more. :ou *ust have to !eep driving toward %our goals. I believe that failure is not a possibilit%.c 3erring]s account$ and how it steeled rather than dimin ished her resolve and determination$ is t%pical of great pro fessionals. Consultant @ames Uell% tells another stor% of earl%career trauma: +hen I finished business school$ (rofessor 9ic! Van cil hired me with the idea of building a facult%based con sulting firm fwhich under Uell%]s leadership became the ;2C Froup$ a N1,0 million strateg% consul ting businessg. #he second %ear we did so well that we e-tended emplo% ment offers to a do5en top ;<2 graduates from around the countr%. <ut suddenl% our bac!log of business *ust died. It was earl% summer$ and we were going to go ban! rupt if we too! on all these new hires. I had to call each one of them up$ tell them what had happened$ and rescind the offers. It was one of the worst da%s of m% professional life. 2lthough it ma% seem that Uell% &who was twent%si- at the time' e-ercised poor *udgment in hiring so man% new people$ he learned from the episode. 3e could have become gunsh%$ retrenched$ and never made a bold hiring move again. Instead$ he assimilated the e-perience in a balanced$ constructive wa%. 3is subse6uent careful management of rev enues$ bac!log$ and professional staffing at the ;2C Froup resulted in twent%five %ears of continual growth and prof itabilit% under his leadershipea far better record than most consulting firms can show. :reat Profe""ional" Alay" Vie .ld C l i e n t " A" -e C l i e n t " 2 marriage re6uires constant wor! and investmente*ust as! an% Couple that has successfull% been together for fifteen or twent% %ears. +hen a couple divorces$ the partners will often loo! bac! and describe a long period of mutual neglect prior to the eruption of real acrimon%. If one spouse is wor! ing in a demanding occupation$ for e-ample$ it ma% seem as if his or her *ob gets all the time and attention$ leaving little energ% for the other person. #he bases for successful marriages and successful long term client relationships are similar. +hen %ou]ve been wor! ing with a client for man% %ears$ the tendenc% is to ta!e each other for granted. If %ou]re li!e the vast ma*orit% of profes sionals$ most of %our mar!eting and promotional resources go to new$ prospective clients rather than to %our e-isting clients. 2s benign neglect sets in$ 101 %our longterm client ma% become intrigued b% other professionals in %our field competitors whose ideas seem newer and fresher$ who are court ing him aggressivel%. @ust as in a marriage$ the antidote to wandering clients is constant reinvestment that revitali5es the relationship. +hen we loo! at professionals who have longterm$ broadbased client relationships$ who inspire great client lo% alt%$ the% all have a similar approach: the% treat each assign ment as if it were the first one for that client. #he% bring the same energ%$ creativit%$ and drive to their longterm clients as the% do to the new client the% are tr%ing to impress. #he% communicate constantl%$ and the flow of ideas never stops. Even if the% aren]t wor!ing on an assignment for the client at that moment$ the% are in touch at least two or three times a %ear. #he courtship$ so to spea!$ never stops. :reat Profe""ional" En#a#e in Continual Self0reneal ;ost professionals focus on their income statemente their annual tall% of e-penses and revenues$ leading to a fig ure that represents their total income for that %ear. #his is true whether %ou wor! for a large firm or on %our own. If %ou invested a lot in a client proposal that fell through$ %our %ear end bonus ma% be reduced. If %ou sold a large piece of follow on business$ %our bonus ma% be larger than usual. #he focus is this %ear]s sacrifices and rewards. If %ou earnestl% develop the attributes and outloo!s we]ve been discussing$ however$ %ou will naturall% build %our balance sheet assets. *eep generalists& for e-ample$ ma!e in vestments in learning and ac6uiring !nowledge that ma% have no immediate pa%bac! but bring rewards two or three %ears down the road. :our personal capitalethe sum of %our talents$ s!ills$ e- periences$ and !nowledgeecan be developed in man% wa%s. #his personal development can but doesn]t have to occur through dramatic actions$ such as ta!ing a formal sabbatical or ma!ing a career change. Often$ professionals embed it in their dail% routines$ indulging in leisurel% reading$ selfstud%$ and the gradual cultivation of new areas of interest. 3arvard Daw School professor 2lan 9ershowit5$ for e- ample$ after writing a series of ver% successful nonfiction boo!s$ recentl% published his first novel. Cenowned manage ment consultant Cam Charan *ust followed up several %ears of wor! on how effective corporate boards function with a boo! on growth strategies. 2lthough part of the preInternet generation$ financial consultant >red <rown is going up learning curve and setting up an interactive $e% site& which may not yield significant results for a year or two& to e' tend the reach of a steep his innovative financial counseling. !ow do you know when it's time to push into new areas+ 3eter *rucker counsels that it's time for a change <$hen the harder you work& the less you seem to accomplish0or when you're sure that you know all the answers& and you've stopped asking& '$hat are the right =uestions+' < D /ust as successful professionals take a long-term view of client relationships& they also have a multiyear perspective on their own personal and professional development. They fol low Thomas More's inBunction to <live as if you are to die tomorrow& study as if you were to live forever.< $hen you focus on %uilding your %alance sheet0on self-renewal0 remem%er that your income statement may take some hits. This is why it's so important to cultivate =ualities such as inde pendence and conviction. $ithout them it will %e difficult to navigate the inevita%le s=ualls that are part of asset %uilding. 1reat professionals successfully develop and integrate the seven core attributes into a powerful whole$ and then in 10, #he Ingredients for <rea!through Celationships 10.
The Soul of the :reat Profe""ional6 fuse ever%thing the% do with their soul of abundance$ mis sion$ and self renewal. #his combination of attributes and outloo!s$ summari5ed in the accompan%ing illustration$ en ables professionals to create broadbased$ abiding client rela tionships that engender collaboration and insight. T.PICS ?.R DISSC1SSI.- 1. +hat happens when client lo%alties shift unpredictabl%4 ,. +hat do professionals focus on 4 .. Can %ou anticipate client needs4 /. +hat ma!es %ou a deep generalist4 0. 3ow important is !een *udgment4 1. Is overconfidence a *udgment trap4 =. Can we use intuition to leverage facts and personal e-perience4 ?. 9o %ou have a good *udgment4 G. +hat do the lac! of trust in business and personal dealings entail4 1H. 3ow can %ou build trust in a low trusted world4 11. Can overconfidence be considered the most common *udgment trap4 1,. Can %ou be misled b% e-perience4 1.. 3ow can %ou improve %our own decision ma!ing abilit%4 E-)AR:E .-' 1. 2 professional adviser should be independentl% wealth%7 then he would be ob*ective$ independent. ,. #he great client advisers are constant learners not wedded to past concepts$ the% help accelerate learning within the organi5ations the% serve. .. One cool *udgment is worth a thousand hast% councils. #he thing to do is to suppl% light and not heat. Unowledge 9epth and <readth Selfless . Independence 5%undance 10/ /. Clients don)t care wh% %ou let them down$ the% don)t inform %ou when the% stop trusting %ou. 0. (rinces li!e to be helped$ but not surpassed. +hen %ou counsel someone$ %ou should appear to be reminding him of something he had forgotten$ not the light he was unable to see. Tip" on Mana#in# Relation"hip Value
If %ou want to !eep a relationship on an even !eel$ manage it as %ou would an% other activit% that matters to %ou. L Create trust. #rust is created when people see tangible evidence that one]s words and actions are in harmon%. So avoid ma!ing commitments %ou ma% be unable to honor$ and alwa%s do what %ou have committed to do. #rust is also created when %ou ac!nowledge and demonstrate respect for the other part%]s core interests. L Communicate. #he different parties should communicate their interests$ their capabilities$ and their concerns to each other. >or e-ample$ if %ou agreed to complete a customer surve% for the mar!eting vice president within thirt% da%s but have hit a log*am$ communicate that information to him. L "ever sweep mista!es under the rug. ;ista!es are bound to happen. 2c!nowledging and addressing theme6uic!l%eis alwa%s the best course of action. L 2s! for feedbac!. If ever%thing appears to be going as planned$ never assume that the other side sees it the same wa%. <e proactive in uncovering problems. #he other side will respect %ou for it. 2s! 6uestions such as these: cIs ever%thing happening as %ou e-pected4c c2re the parts reaching %our plant on schedule4c c9id m% report cover all important points4c -e#otiation "egotiation is a means b% which people deal with their differences. +hether such differences involve the purchase of a new car$ a labor contract dispute$ the terms of a sale$ a comple- alliance between two companies or a peace accord$ resolutions are sought through negotiations. #o negotiate is to see! mutual agreement through dialogue. "egotiation became an ever present feature of our lives both at home and at wor!. 2 business negotiation ma% be a formal affair that ta!es place across the bargaining table where %ou haggle over price and performance or the comple- terms of a partnership venture. It ma% be less formal such as a meeting between %ou and several emplo%ees whose collaboration is needed to get a *ob done. +hether a supervisor$ manager or e-ecutive %ou will probabl% spend a good part of %our da% negotiating with people inside or outside %our organi5ation. If %ou are closing a sale or getting a subordinate to agree to certain performance goals %ou are negotiating too. MMM #he basic t%pes of negotiation %ou]re li!el% to encounter are the following: 100 L 2 distributive negotiation which pits two or more parties in competition for a fi-ed amount of value. 3ere$ each side]s goal is to claim as much value as possible$ as in the sale of a rug at a street ba5aar. Value gained b% one part% is unavailable to others. L Integrative negotiation is about creating and claiming value. #hrough collaboration and information sharing$ the parties loo! for opportunities to satisf% the !e% ob*ectives of each$ recogni5ing that the% will probabl% have to give ground on other ob*ectives. L #he negotiator]s dilemma describes the situation faced b% people who enter an% t%pe of bargaining situation. #he% must determine which game to pla%: aggressivel% claim the value currentl% on the table &and possibl% come out the loser'$ or wor! with the other side to create even better opportunities that can be shared. L "o matter which t%pe of negotiation %ou]re faced with$ it]s bound to be more comple- if it is multi phased or involves multiple parties. If %our negotiation is multi phased$ use the earl% phases to build trust and to become familiar with the other parties. If man% parties are involved$ consider the benefits of forming a coalition to improve %our bargaining power. +hen people don)t have the power to force a desired outcome$ the% negotiate but onl% when the% believe it is to their advantage to do so. 2 negotiated solution is advantageous onl% under certain condition$ that is when a better option is not available. 2n% successful negotiation must have a fundamental framewor! based on !nowing the following: the alternative to negotiation$ the minimum threshold for a negotiated deal$ how fle-ible a part% is willing to be and what trade offs it is willing to ma!e. +e consider three concepts important for establishing this framewor!: <2#"2 &best alternative to a negotiated agreement'$ reservation price and YO(2 &5one of possible agreement'. M<2#"2 is the best alternative to a negotiated agreement. It is one]s preferred course of action in the absence of a deal. Unowing %our <2#"2 means !nowing what %ou will do or what will happen it %ou fail to reach agreement. 9on]t enter a negotiation without !nowing %our <2#" 2. L It %our <2#"2 is wea!$ do what %ou can to improve it. 2n%thing that strengthens %our <2#"2 improves %our negotiating position. L Identit% the other side]s <2#"2. &>it is strong$ thin! of what %ou can do to wea!en it. M Ceservation price is the price at which the rational negotiator will wal! awa%. 9on]t enter a negotiation without a clear reservation price. M YH(2 is the 5one of possible agreement. It is the area in which a deal will satisf% all parties. #his area e-ists when the parties have different reservation prices$ as when a home bu%er is willing to pa% up to N,=0$HHH and the home seller is willing to ta!e an offer that is at least N,0H$HHH. M Value creation through trades is possible when a part% has something he or she values less than does the other part%e and vice versa. <% trading these values$ the parties lose little but gain greatl%. MMMMM If %our aim is to be an effective negotiator$ ta!e the time and ma!e the effort needed to become full% prepared. #here are nine preparator% steps: 101 1. Unow what a good outcome would be from %our point of view and that of the other side. "ever enter into a negotiation without first as!ing %ourself: what would be a good outcome for me4 #hen as! the same 6uestion from the perspective of the other side. ,. Doo! for opportunities to create value in the deal. :ou can identif% areas of common ground$ compromise$ opportunities for favorable trades. .. Unow %our <2#"2 and reservation price. ;a!e an effort to estimate those benchmar!s for the other side. /. If %our <2#"2 isn]t strong$ find wa%s to improve it. Food negotiators wor! to improve their <2#"2 before and during deliberations with the other side. 0. >ind out if the person or team %ou]re dealing with has the authorit% to ma!e a deal. :ou find real advantages to negotiate with the person who has the power to sign on the dotted line: all of %our reasoning is heard directl% b% the decision ma!er$ the benefits of the good relationship build at the bargaining table are li!el% to be reflected in the deal and its implementation$ there are fewer chances of disputes or misinterpretation of particular provisions.. 1. Unow those with whom %ou]re dealing. Dearn as much as %ou can about the people and the culture on the other side and how the%]ve framed the issue. =. If a future relationship with the other side matters$ gather the e-ternal standards and criteria that will show %our offer to be fair and reasonable. ?. 9on]t e-pect things to follow a linear path to a conclusion. <e prepared for bumps in the road and periodic dela%s. G. 2lter the agenda and process moves in %our favor. Dearning about the issues and about the other side is alwa%s limited b% time$ the cost of gathering information and the fact that some information will be deliberatel% hidden. +e have to be prepared to learn as negotiations unfold. MMMMM #he first challenge in negotiation is to get the other side to the table. #his won]t happen unless the other side sees that it is better off negotiating than going with the status 6uo. Encourage negotiation b% uttering incentives$ ma!ing the status 6uo e-pensive$ and b% enlisting the help of allies. Once %ou]ve gotten the other side to the table$ get things off to a good start b% relieving tension$ ma!ing sure that all parties agree with the agenda and the process$ and setting the right tone. Several tactics are particularl% useful in distributed &or winlose' deals: M Establish an anchor$ an initial position around which negotiations ma!e ad*ustments. h It an initial anchor is unacceptable to %ou$ steer the conversation awa% from numbers and proposals. >ocus instead on interests$ concerns$ and generalities. #hen$ after some time has passed and more information has surfaced$ put %our number or proposal on the table$ and support it with sound reasoning. M ;a!e concessionar% moves if %ou must. <ut remember$ man% interpret a large concessionar% move as an indicator that %ou]re capable of conceding still more. 2 small concession$ on the other hand$ is generall% seen as an indication that the bidding is approaching the reservation price and that an% succeeding concessions will be smaller and smaller. 10= #actics for distributive &winwin' negotiations are fundamentall% different from those *ust described since value creation is one of the goals. So concentrate on these tactics: L 2ctive listening: !eep %our e%es on the spea!er$ ta!e notes as appropriate$ don)t allow %ourself to thin! about an%thing but what the spea!er is sa%ing$ resist the urge to formulate %our response until after the spea!er has finished$ pa% attention to the spea!er)s bod% language$ as! 6uestions to get more information and to encourage the spea!er to continue$ repeat in %our own words what %ou)ve heard to ensure that %ou understand and to let the spea!er !now that %ou)ve processed his or her words. L E-ploiting complementar% interests L (ac!aging options for more favorable deals Some of the 6uestions in negotiation are organi5ed under three categories: price$ procedures$ and people. 1. Should I ever state m% acceptable range4 &Some negotiators will as! %ou to state a monetar% range of what %ou are willing to pa%'. Should I tell the other side m% real bottom line4&%ou can reveal %our bottom line onl% if %ou)ve reached it' ,. Is it ever acceptable to bid against m%self to ma!e two moves in a row4 &@ust sa%: wait$ %ou seem to be as!ing me to ma!e another move here. I made the last offer7 I don)t want to bid against m%self7 give me %our offer'. .. Is it smart or fair to bluff4& as long as what %ou bring to the table has real value$ %ou need not reveal all the circumstances that ma!e %ou willing to conclude a deal. :ou ma% describe the ma*or pro*ects for which %ou have been responsible if negotiating the terms of a *ob offer' /. Is it better to reach agreement issues b% issue or wait until the end4 &It)s better to aim for tentative agreements or agreed upon ranges for each issue$ one at a time'. 0. Is it better to deal with difficult or eas% issues first4 &9ealing with easier issues will build momentum$ deepen the parties) commitments to the process$ enable the parties to become familiar with each other)s negotiation and communication st%les before hitting the tough stuff'. 1. +hat if there is an une-pected turn in the road before or after an agreement4 &:ou have to determine if a deal still ma!es sense or if %ou need to undo the deal that has been negotiated' =. +hat happens when %ou pit a collaborative negotiator against a positional hard bargainer4 &if the collaborative negotiator is effective$ he should be able to tease out some of the interests underl%ing the hard bargainer)s positions' ?. 3ow should I respond if the other side see!s to change something in its offer after a deal has been reached4 &e-press surprise or disappointment' G. +hat should I do when the negotiator on the other side has a temper tantrum4&help him regain control$ the right response will depend upon how angr% or upset %ou feel$ the value of the deal'. 1H. I don)t believe what the other side is sa%ing. +hat should I do4&%ou re6uire that the% provide bac! up documentation and that the deal be e-plicitl% contingent on its accurac%' 11. +hen is it appropriate to negotiate$ over the telephone or b% email4 Or is it essential to insist on a face to face meeting4 & email communication is devoid of emotions7 for an ine-perienced negotiator this can be a big plus' 10? 1,. 3ow should I react when the other side challenges m% credentials$ status$ authorit% to ma!e a deal4&the best approach is to shift the discussion to general ground rules'. MMMMM Typical %arrier" to ne#otiated a#reement" and hat you can do to o$ercome or eliminate them L 9iehard bargainers will pull for ever% advantage and tr% to ma!e ever% concession come from %ou. :ou can deal with these people if %ou understand the game the% are pla%ing$ withhold useful information from them &the%]ll onl% use it against %ou' unless the% demonstrate a willingness to reciprocate$ and ma!e it clear that %ou don]t mind wal!ing awa%. If %ou don]t want to wal! awa%eor cannotedo whatever %ou can to strengthen %our position and %our alternative to a deal. L Dac! of trust is a serious impediment to ma!ing a deal. "evertheless$ agreements are possible if %ou ta!e precautions$ re6uire enforcement mechanisms$ build incentives for compliance into the deal$ and insist on compliance transparenc%. L It]s difficult to ma!e a dealeand impossible to create valueein the absence of information. +hat are the other side]s interests4 +hat does it have to offer4 +hat is it willing to trade4 Ironicall%$ fear of advantaging the other side encourages parties to withhold the information needed to create value for both sides. Each is reluctant to be the first to open up. #his is the negotiator]s dilemma. #he solution to this dilemma is cautious$ mutual$ and incremental information sharing. Structural impediments include the absence of important parties at the table$ the presence of others who don]t belong there but get in the wa%$ and lac! of pressure to move toward an agreement. Cemedies to these impediments were provided. Spoilers are people who bloc! or undermine negotiations. Several tips were offered for neutrali5ing or winning over these individuals$ including the creation of winning coalitions. Cultural and gender difference can be barriers to agreement$ particularl% when one of the parties brings to the table a set of assumptions that the other side fails to notice: assumptions about who will ma!e !e% decisions$ what is of value$ and what will happen if agreement is reached. "egotiators who represent organi5ations with conflicting cultures &e.g.$ entrepreneurial versus bureaucratic' are also li!el% to e-perience problems in reaching agreements. Communication problems can also create barriers .:ou can diffuse them b% insisting that each team be led b% an effective communicator and b% practicing active listening$ documenting progress as it is made$ and establishing real dialogue between parties. 9ialogue can eliminate or lower all of the barriers. ;ental errors b% negotiators can result in no deal or a bad deal. L Escalationethat is$ irrational escalationeis the continuation of a previousl% selected course of action be%ond the point where it continues to ma!es sense. Some people commit this error because the% cannot stand losing. Others fall pre% to auction fever. 10G L (artisan perception is the ps%chological phenomenon that causes people to perceive truth with a builtin bias in their own favor or toward their own point of view. L Irrational e-pectations are an error insofar as the% eliminate 5ones of possible agreement. 1. Overconfidence in negotiating is dangerous. It encourages negotiators to overestimate their strengths and underestimate their rivals. It is reinforced b% groupthin!$ a mode of thin!ing driven b% consensus that tends to override the motivation to realisticall% appraise alternative courses of action. #he antidote to both overconfidence and groupthin! is to have one or more ob*ective outsiders e-amine one]s assumptions. 8nchec!ed emotions are fre6uentl% observed in business negotiations$ and generall% result in selfin*ur%. 2mong the remedies recommended are a coolingoff period and the use of an ob*ective moderator. In the absence of a moderator we have to do the following: determine what is ma!ing the other negotiator angr%. +hat does this deal or this dispute mean to him4 listen ver% carefull% when he gets angr%. respond to what appears to be the emotional problem. remember that people are most often angered and frustrated at a personal level b% perceived deception$ unfairness$ humiliation or loss of pride and lac! of respect. :ou can avoid these land mines b% focusing discussion on the issues and the problems instead of on individuals and their personalities. #he relationship value that is part of so man% of toda%]s agreements$ both between separate entities and between emplo%ees of the same organi5ation. L >latter organi5ations and the desire of companies to build longterm lin!s with suppliers are two important reasons wh% relationships matter in man% of toda%]s negotiations. L Celationship value moderates e-treme valueclaiming behavior. "egotiating parties understand that tr%ing too hard to claim value toda% will ris! losing opportunities for claiming value in future transactions. L (arties who perceive no relationship value will aggressivel% claim value. L Even when both parties recogni5e a relationship value$ there is li!el% to be an imbalance in how strongl% each part% feels about that value. #his can lead to manipulation of the part% to whom the relationship matters most. L "egotiators must separate the deal from the broader relationship. MMMMM (eople and organi5ations represent their own interests but in man% other cases$ the% are represented b% others. #hese others ma% be independent agents contracted to represent one of the parties. #he% ma% be non independent agents emplo%ees charged with representing their companies7 or the% ma% be officials of an organi5ation whose responsibilit% is to represent the interests of their members. L 2n agent is a person charged with representing the interests of another &a principal' in negotiations with a third part%. L (eople engage agents to represent them in negotiations when the agent has greater e-pertise and when the% want to reduce the ris! of damaging their relationship with the other side. Information as%mmetries$ divided interests$ and conflicts of interest are three important problems in the agentBprincipal relationship. 11H Information as%mmetr% means that one part% has more information than the other. If the principal has much more information than the agent$ the agent ma% have a difficult time representing the principal]s interests7 in the reverse situation$ the agent ma% discover valuecreating opportunities that the principal does not understand or appreciate. "ot ever% organi5ation is of one mind as to its core interests. #his fact puts those who represent the organi5ation into a difficult position. (rincipals face the problem of preventing agents from putting agent interests ahead of their own. Incentive s%stems that align the agent]s interests with those of the principal can help$ especiall% when combined with oversight and communication. MMMMM It]s one thing to develop one]s individual negotiating s!ills. 9eveloping the negotiating s!ills of an organi5ation at man% levels is a ver% different challenge$ but one with great potential rewards. L #he discipline of continuous improvement can develop the effectiveness of an organi5ation]s internal capabilities and$ over time$ improve bottomline results. #his same discipline can be applied to the negotiation process. L #he first step toward continuous improvement in negotiations is to treat negotiation as a process with a fairl% universal set of process steps: prenegotiations$ preparation$ negotiations$ agreement or non agreement$ postmortem learning$ and learning capture. Dearning capture feeds bac! to the ne-t negotiating e-perience. #he second step is to organi5e to learn from the process as it ta!es place$ and at the conclusion of the negotiation itself. L 2n organi5ation can improve its overall negotiating s!ill and turn that s!ill into an important capabilit% b% doing the following: providing training and preparation for negotiators$ clarif%ing organi5ational goals and e-pectations from an% agreement and clarif%ing when negotiators should wal! awa%$ insisting that ever% negotiating team develop a <2#"2 and wor! to improve it$ developing mechanisms for capturing and reusing lessons learned from previous negotiations$ and developing negotiating performance measures and lin!ing them to rewards. <ecause organi5ational competence is the sum of the competences of an organi5ation]s individual members$ we have to !now the characteristics of effective negotiators. #hese define the goals that management should aim for in developing organi5ationwide capabilities. 2n effective negotiator L 2ligns negotiating goals with organi5ational goals L (repares thoroughl% and uses each negotiating phase to prepare further L 8ses negotiating sessions to learn more about the issues at sta!e and the other side]s <2#"2 and reservation price L 3as the mental de-terit% to identif% the interests of both sides$ and the creativit% to thin! of valuecreating options that produce winwin situations L Can separate personal issues from negotiating issues L Can recogni5e potential barriers to agreement L Unows how to form coalitions L 9evelops a reputation for reliabilit% and trustworthiness 9ifficulties in Communication Communication is the medium of negotiation. :ou cannot ma!e progress without it. (oor communication renders the simple treacherous and the difficult impossible. Communication problems cause deals to go sour and disputes to ripen. 111 +hen %ou suspect that communication is causing the negotiation to go oft trac!$ tr% the following tactics: L 2s! for a brea!. Cepla% in %our mind what has been communicated$ how$ and b% whom. Doo! for a pattern. 9oes the confusion or misunderstanding arise from a single issue4 +ere important assumptions or e-pectations not articulated4 2fter the brea!$ raise the issue in a non accusator% wa%. Offer to listen while the other side e-plains its perspective on the issue. Disten activel% ac!nowledging their point of view. E-plain %our perspective. #hen$ tr% to pinpoint the problem. If the spo!esperson of %our negotiating team seems to infuriate the other side$ have someone else act as spo!esperson. 2s! the other side to do the same if their spo!esperson drives %our people up the wall. @ointl% document progress as it is made. #his is particularl% important in multiphase negotiations. It will solve the problem of someone sa%ing$ cI don]t remember agreeing to that.c In multipart% negotiations$ certain sta!eholders ma% prefer Jno dealJ as the outcome. #he% ma% have the power to bloc! or sabotage %our negotiations. #he% are called spoilers. #he% ma% have seats at the table or the% ma% not. #he president of the 8S2 ma% negotiate a trade deal with a foreign nation$ but two or three powerful senators ma% bloc! ratification in Congress. 2n influential e-ecutive who has the ear of !e% board members can sometimes accomplish the same result. #his barrier can be anticipated b% identif%ing all !e% sta!eholders$ their respective interests and the power of each to affect the agreement and its implementation. #hen it)s important to identif% potential spoilers and consider the necessit% of sweetening the deal in a wa% that would neutrali5e their incentive to sabotage an agreement. ;an% internal negotiations aim to create change within the organi5ation7 change is a necessar% condition of vitalit% but it often creates winners and losers. 2nd those who see themselves as potential losers do what the% can to resist or undermine change. Some people en*o% advantages that the% view as threatened b% change. #he% ma% perceive change as a threat to their livelihoods$ per!s$ wor!place social arrangements$ status in the organi5ation. 2n%time the% e-pect resistance and possible sabotage. Cesistance ma% be passive$ in the form of non commitment to the goals and the process for reaching them$ or active indirect opposition or subversion. Some tips for dealing with resistance and possible sabotage: X alwa%s tr% to answer the 6uestion: where and how will this change create pain or loss in the organi5ation4 X identif% people who have something to lose and tr% to anticipate how the% will respond. X communicate the Iwh%J of change to potential resisters. X emphasi5e the benefits of change to potential resisters. #hose benefits might be greater future *ob securit%$ higher pa%. X help resisters find new roles that represent genuine contributions . X remember that some resist change because it represents a loss of control over their dail% lives. :ou can return some of that control b% ma!ing them active partners in %our change program. X built a coalition with sufficient strength to overpower the spoilers. 11, The Poer of Dialo#ue 9ialogue is a powerful mode of communication and an effective antidote to most$ if not all$ of the human barriers identified in this chapter. It is a timetested communication form in which parties e-change views and ideas with the goal of reaching amicable agreement. 9ialogue is usuall% the ver% best wa% to peel bac! the la%ers of problems$ bring undisclosed concerns to center stage$ develop solutions$ and reach common understandings. #hough the practice of dialogue between two or more individuals undoubtedl% goes bac! into the mists of time$ (lato$ through his Socratic dialogues$ helped the +estern world appreciate its power. (lato]s purpose was not to tell us what he thought directl%$ but to teach us how to toss ideas bac! and forth in a logical process that eventuall% leads to the truth and common understanding. #hat same logical process ma!es negotiations run more smoothl%$ draws out the best ideas$ and builds agreement around them. 9ialogue can also help %ou give direction without telling people what to do in so man% wordsewhich is what managers in toda%]s participator% organi5ations must learn to do. >or such managers$ negotiating with people is as important as directing them. >or e-ample$ instead of sa%ing$ c3ave the inventor% report on m% des! at . (.;. tomorrow$c tr% something li!e this: ;anager: +hat progress have %ou made on the inventor% report4 Emplo%ee: It]s almost read%. I onl% have one section to complete. ;anager: Food. 9o %ou see an% problem in getting it all wrapped up b% tomorrow afternoon4 Emplo%ee: "o$ not if %ou need it b% then. ;anager: :es$ I do need it b% . (.;. at the latest. Emplo%ee: :ou can count on it. +hat wor!s between managers and their people can also wor! between negotiating parties if the% start slowl%$ practice active listening$ and graduall% develop the level of trust that problem solving re6uires. T.PICS ?.R DISC1SSI.-' 1. +hat are some of the impediments to ma!ing a deal4 ,. Is information necessar% in creating value4 .. +hat are spoilers4 /. 9oes dialogue help people give direction4 0. +hen do people negotiate4 1. 3ow can %ou be more fle-ible in a negotiation4 =. Is it important to be prepared for changes on both sides: new people and unanticipated developments4 ?. 3ave %ou ever felt that %our ideas were ignored during meetings4 G. +hat happens when communication is poor4 1H. +hat tactics can be useful in distributed deals4 11. 11. +hat is the first challenge in negotiations4 1,. +hich are the most fre6uent errors made in dealings4 1.. +hat does active listening help %ou to do4 1/. +h% is the two wa% e-change of information important4 10. +hat happens when one or another part% has better alternatives elsewhere4
Accountin# 11/ #he purpose of accountin# is to provide information about the economic affairs of an organi5ation. #his information ma% be used in a number of wa%s: b% the organi5ation]s managers to help them plan and control the organi5ation]s operations7 b% owners and legislative or regulator% bodies to help them appraise the organi5ation]s performance and ma!e decisions as to its future7 b% owners$ lenders$ suppliers$ emplo%ees$ and others to help them decide how much time or mone% to devote to the organi5ation7 b% governmental bodies to determine how much ta- the organi5ation must pa%7 and occasionall% b% customers to determine the price to be paid when contracts call for costbased pa%ments. 2ccounting provides information for all these purposes through the maintenance of files of data$ anal%sis and interpretation of these data$ and the preparation of various !inds of reports. ;ost accounting information is historicalthat is$ the accountant observes the things that the organi5ation does$ records their effects$ and prepares reports summari5ing what has been recorded7 the rest consists of forecasts and plans for current and future periods. 2ccounting information can be developed for an% !ind of organi5ation$ not *ust for privatel% owned$ profitsee!ing businesses. One branch of accounting deals with the economic operations of entire nations. C#M/45Y 6+545C+4' ,4,-M-5, 2mong the most common accounting reports are those sent to investors and others outside the management group. #he reports most li!el% to go to investors are called financial "tatement"$ and their preparation is the province of the branch of accounting !nown as financial accountin#. #hree financial statements will be discussed: the balance sheet$ the income statement$ and the statement of cash flows. ,he balance sheet. 2 balance sheet describes the resources that are under a compan%]s control on a specified date and indicates where these resources have come from. It consists of three ma*or sections: &1' the a""et": valuable rights owned b% the compan%7 &,' the lia%ilitie": the funds that have been provided b% outside lenders and other creditors in e-change for the compan%]s promise to ma!e pa%ments or to provide services in the future7 and &.' the oner"@ e+uity: the funds that have been provided b% the compan%]s owners or on their behalf. #he list of assets shows the forms in which the compan%]s resources are lodged7 the lists of liabilities and the owners] e6uit% indicate where these same resources have come from. #he balance sheet$ in other words$ shows the compan%]s resources from two points of view$ and the following relationship must alwa%s e-ist: total assets e6uals total liabilities plus total owners] e6uit%. #his same identit% is also e-pressed in another wa%: total assets minus total liabilities e6uals total owners] e6uit%. In this form$ the e6uation emphasi5es that the owners] e6uit% in the compan% is alwa%s e6ual to the net a""et" &assets minus liabilities'. 2n% increase in one will inevitabl% be accompanied b% an increase in the other$ and the onl% wa% to increase the owners] e6uit% is to increase the net assets. 2ssets are ordinaril% subdivided into current a""et" and noncurrent assets. #he former include cash$ amounts receivable from 110 customers$ inventories$ and other assets that are e-pected to be consumed or can be readil% converted into cash during the ne-t operating c%cle &production$ sale$ and collection'. "oncurrent assets ma% include noncurrent receivables$ fi-ed assets &such as land and buildings'$ and longterm investments. #he liabilities are similarl% divided into current liabilities and noncurrent liabilities. ;ost amounts pa%able to the compan%]s suppliers &accounts pa%able'$ to emplo%ees &wages pa%able'$ or to governments &ta-es pa%able' are included among the current liabilities. "oncurrent liabilities consist mainl% of amounts pa%able to holders of the compan%]s longterm bonds and such items as obligations to emplo%ees under compan% pension plans. #he difference between total current assets and total current liabilities is !nown as net current assets$ or wor!ing capital. #he owners] e6uit% of an 2merican compan% is divided between paidin capital and retained earnin#". (aidin capital represents the amounts paid to the corporation in e-change for shares of the compan%]s preferred and common "toc!. #he ma*or part of this$ the capital paid in b% the common shareholders$ is usuall% divided into two parts$ one representing the par value$ or stated value$ of the shares$ the other representing the e-cess over this amount. #he amount of retained earnings is the difference between the amounts earned b% the compan% in the past and the dividends that have been distributed to the owners. 2 slightl% different brea!down of the owners] e6uit% is used in most of continental Europe and in other parts of the world. #he classification distinguishes between those amounts that cannot be distributed e-cept as part of a formal li6uidation of all or part of the compan% &capital and legal re"er$e"' and those amounts that are not restricted in this wa% &free reserves and undistributed profits'. #he income statement is usuall% accompanied b% a statement that shows how the compan%]s retained earnin#" has changed during the %ear. "et income increases retained earnings7 net operating loss or the distribution of cash dividends reduces it. ,he statement of cash flows. Companies also prepare a third financial statement$ the statement of cash flows. Ca"h flo" result from three ma*or groups of activities: &1' operatin# acti$itie"$ &,' in$e"tin# acti$itie"$ and &.' financin# acti$itie". #he income statement differs from the cash flow statement in other wa%s$ too. Cash was received from the issuance of bonds and was paid to shareowners as dividends7 neither of those figured in the income statement. Cash was also paid to purchase e6uipment7 this added to the plant and e6uipment asset but was not subtracted from current revenues because it would be used for man% %ears$ not *ust this one. Cash from operations is not the same as net income &revenues minus e-penses'. >or one thing$ not all revenues are collected in cash. Cevenue is usuall% recorded when a customer receives merchandise and either pa%s for it or promises to pa% the compan% in the future &in which case the revenue is recorded in accounts receivable'. Cash from operating activities$ on the other hand$ reflects the actual cash collected$ not the inflow of accounts receivable. Similarl%$ an e-pense ma% be recorded without an actual cash pa%ment. #he purpose of the statement of cash flows is to throw light on management]s use of the financial 111 resources available to it and to help the users of the statements to evaluate the compan%]s li6uidit%$ its abilit% to pa% its bills when the% come due. Consolidated statements. ;ost large corporation" in the 8nited States and other industriali5ed countries own other corporations. #heir primar% financial statements are consolidated statements$ reflecting the total assets$ liabilities$ owners] e6uit%$ net income$ and cash flows of all the corporations in the group. #hus$ for e-ample$ the consolidated balance sheet of the parent corporation &the corporation that owns the others' does not list its investments in its "u%"idiarie" &the companies it owns' as assets7 instead$ it includes their assets and liabilities with its own. Some subsidiar% corporations are not wholl% owned b% the parent7 that is$ some shares of their common stoc! are owned b% others. #he e6uit% of these minorit% shareholders in the subsidiar% companies is shown separatel% on the balance sheet. >or e-ample$ if 2n% Compan%$ Inc.$ had minorit% shareholders in one or more subsidiaries$ the owners] e6uit% section of its 9ec. .1$ 1G$ balance sheet might appear as follows: #he consolidated income statement also must show the minorit% owners] e6uit% in the earnings of a subsidiar% as a deduction in the determination of net income. >or e-ample: Disclosure and auditing re$uirements. 2 corporation]s obligations to issue financial statements are prescribed in the compan%]s own statutes or b%laws and in public laws and regulations. #he financial statements of most large and mediumsi5e companies in the 8nited States fall primaril% within the *urisdiction of the federal Securitie" and EBchan#e Commi""ion &SEC'. #he SEC has a good deal of authorit% to prescribe the content and structure of the financial statements that are submitted to it. Similar authorit% is vested in provincial regulator% bodies and the stoc! e-changes in Canada7 disclosure in the 8nited Uingdom is governed b% the provisions of the Companies 2ct. 2 compan%]s financial statements 11= are ordinaril% prepared initiall% b% its own accountants. Outsiders review$ or audit$ the statements and the s%stems the compan% used to accumulate the data from which the statements were prepared. In most countries$ including the 8nited States$ these outside auditors are selected b% the compan%]s shareholders. #he audit of a compan%]s statements is ordinaril% performed b% professionall% 6ualified$ independent accountants who bear the title of certified public accountant &C(2' in the 8nited States and chartered accountant &C2' in the 8nited Uingdom and man% other countries with <ritishbased accounting traditions. #heir primar% tas! is to investigate the compan%]s accounting data and methods carefull% enough to permit them to give their opinion that the financial statements present fairl% the compan%]s position$ results$ and cash flows. MEAS1REME-T PRI-CIP)ES In preparing financial statements$ the accountant has several measurement s%stems to choose from. 2ssets$ for e-ample$ ma% be measured at what the% cost in the past or what the% could be sold for now$ to mention onl% two possibilities. #o enable users to interpret statements with confidence$ companies in similar industries should use the same measurement concepts or principles. In some countries these concepts or principles are prescribed b% government bodies7 in the 8nited States the% are embodied in cgenerall% accepted accounting principlesc &F22('$ which represent partl% the consensus of e-perts and partl% the wor! of the >inancial 2ccounting Standards <oard &>2S<'$ a private bod%. #he principles or standards issued b% the >2S< can be overridden b% the SEC. In practice$ however$ the SEC generall% re6uires corporations within its *urisdiction to conform to the standards of the >2S<. 4sset value. One principle that accountants ma% adopt is to measure assets at their $alue to their owners. #he economic value of an asset is the ma-imum amount that the compan% would be willing to pa% for it. #his amount depends on what the compan% e-pects to be able to do with the asset. >or business assets$ these e-pectations are usuall% e-pressed in terms of forecasts of the inflows of cash the compan% will receive in the future. If$ for e-ample$ the compan% believes that b% spending N1 on advertising and other forms of sales promotion it can sell a certain product for N0$ then this product is worth N/ to the compan%. +hen cash inflows are e-pected to be dela%ed$ value is less than the anticipated cash flow. >or e-ample$ if the compan% has to pa% interest at the rate of 1H percent a %ear$ an investment of N1HH in a one%ear asset toda% will not be worthwhile unless it will return at least N11H a %ear from now &N1HH plus 1H percent interest for one %ear'. In this e-ample$ N1HH is the present value of the right to receive N11H one %ear later. (resent value is the ma-imum amount the compan% would be willing to pa% for a future inflow of cash after deducting interest on the investment at a specified rate for the time the compan% has to wait before it receives its cash. Value$ in other words$ depends on three factors: 11? &1'the amount of the anticipated future cash flows$ &,' their timing$ and &.' the interest rate. #he lower the e-pectation$ the more distant the timing$ or the higher the interest rate$ the less valuable the asset will be. Value ma% also be represented b% the amount the compan% could obtain b% selling its assets. #his sale price is seldom a good measure of the assets] value to the compan%$ however$ because few companies are li!el% to !eep man% assets that are worth no more to the compan% than their mar!et value. Continued ownership of an asset implies that its present value to the owner e-ceeds its mar!et value$ which is its apparent value to outsiders. 4sset cost. 2ccountants are traditionall% reluctant to accept value as the basis of asset measurement in the going concern. 2lthough monetar% assets such as cash or accounts receivable are usuall% measured b% their value$ most other assets are measured at cost. #he reason is that the accountant finds it difficult to verif% the forecasts upon which a generali5ed value measurement s%stem would have to be based. 2s a result$ the balance sheet does not pretend to show how much the compan%]s assets are worth7 it shows how much the compan% has invested in them. #he historical cost of an asset is the sum of all the e-penditures the compan% made to ac6uire it. #his amount is not alwa%s easil% measurable. If$ for e-ample$ a compan% has built a special purpose machine in one of its own factories for use in manufacturing other products$ and the pro*ect re6uired logistical support from all parts of the factor% organi5ation$ from purchasing to 6ualit% control$ then a good deal of *udgment must be reflected in an% estimate of how much of the costs of these logistical activities should be ccapitali5edc &i.e.& placed on the balance sheet' as part of the cost of the machine. 5et income. >rom an economic point of view$ income is defined as the change in the compan%]s wealth during a period of time$ from all sources other than the in*ection or withdrawal of investment funds. Income is the amount the compan% could consume during the period and still have as much real wealth at the end of the period as it had at the beginning. >or e-ample$ if the value of the net assets &assets minus liabilities' has gone from N1$HHH to N1$,HH during a period and dividends of N1HH have been distributed$ income measured on a value basis would be N.HH &N1$,HH minus N1$HHH$ plus N1HH'. 2ccountants generall% have re*ected this approach for the same reason that the% have found value an unacceptable basis for asset measurement: Such a measure would rel% too much on estimates of what will happen in the future$ estimates that would not be readil% susceptible to independent verification. Instead$ accountants have adopted what might be called a transactions approach to income measurement. #he% recogni5e as income onl% those increases in wealth that can be substantiated from data pertaining to actual transactions that have ta!en place with persons outside the compan%. In such s%stems$ income is measured when wor! is performed for an outside customer$ when goods are delivered$ or when the customer 11G is billed. Cecognition of income at this time re6uires two sets of estimates: &1' revenue estimates$ representing the value of the cash that the compan% e-pects to receive from the customer7 and &,' expense estimates$ representing the resources that have been consumed in the creation of the revenues. Cevenue estimation is the easier of the two$ but it still re6uires *udgment. #he main problem is to estimate the percentage of gross sales for which pa%ment will never be received$ either because some customers will not pa% their bills &cbad debtsc' or because the% will demand and receive credit for returned merchandise or defective wor!. E-pense estimates are generall% based on the historical cost of the resources consumed. "et income$ in other words$ is the difference between the value received from the use of resources and the cost of the resources that were consumed in the process. 2s with asset measurement$ the main problem is to estimate what portion of the cost of an asset has been consumed during the period in 6uestion. Some assets give up their services graduall% rather than all at once. #he cost of the portion of these assets the compan% uses to produce revenues in an% period is that period]s depreciation e-pense$ and the amount shown for these assets on the balance sheet is their historical cost less an allowance for depreciation$ representing the cost of the portion of the asset]s anticipated lifetime services that has alread% been used. #o estimate depreciation$ the accountant must predict both how long the asset will continue to provide useful services and how much of its potential to provide these services will be used up in each period. 9epreciation is usuall% computed b% some simple formula. #he two most popular formulas in the 8nited States are "trai#ht0line depreciation$ in which the same amount of depreciation is recogni5ed each %ear$ and declinin#0char#e depreciation$ in which more depreciation is recogni5ed during the earl% %ears of life than during the later %ears$ on the assumption that the value of the asset]s service declines as it gets older. #he role of the independent accountant &the auditor' is to see whether the compan%]s estimates are based on formulas that seem reasonable in the light of whatever evidence is available and whether these formulas are applied consistentl% from %ear to %ear. 2gain$ what is creasonablec is clearl% a matter of *udgment. 9epreciation is not the onl% e-pense for which more than one measurement principle is available. 2nother is the cost of goods sold. #he cost of goods available for sale in an% period is the sum of the cost of the beginning in$entory and the cost of goods purchased in that period. #his sum then must be divided between the cost of goods sold and the cost of the ending inventor%: 2ccountants can ma!e this division b% an% of three main inventor% costing methods: &1' first in, first out &>I>O'$ &,' last in, first out &DI>O'$ or &.' average cost. #he DI>O method is widel% used in the 8nited States$ where it is also an acceptable costing method for income ta- purposes7 companies in most other countries measure inventor% cost and the cost of goods sold b% some variant of the >I>O or average cost methods. 2verage cost is ver% similar in its results to >I>O$ so onl% >I>O and DI>O need be described. Each purchase of goods constitutes a single batch$ ac6uired at a specific price. 8nder >I>O$ the cost of goods sold is determined b% adding the costs of various batches of the goods available$ starting with the oldest batch in the beginning inventor%$ continuing with the ne-t 1=H oldest batch$ and so on until the total number of units e6uals the number of units sold. #he ending inventor%$ therefore$ is assigned the costs of the most recentl% ac6uired batches. >or e-ample$ suppose the beginning inventor% and purchases were as follows: #he compan% sold 1$GHH units during the %ear and had 1$1HH units remaining in inventor% at the end of the %ear. #he >I>O cost of goods sold is: #he ending inventor% consists of 1$1HH units at a >I>O cost of N0.0H each &the price of the last 1$1HH units purchased'$ or N1$H0H. 8nder DI>O$ the cost of goods sold is the sum of the most recent purchase$ the ne-t most recent$ and so on$ until the total number of units e6uals the number sold during the period. In the e-ample$ the DI>O cost of goods sold is: #he DI>O cost of the ending inventor% is the cost of the oldest units in the cost of goods available. In this simple e-ample$ assuming the compan% adopted DI>O at the beginning of the %ear$ the ending inventor% cost is the 1$HHH units in the beginning inventor% at N0 each &N0$HHH'$ plus 1HH units from the first purchase during the %ear at N0.,0 each &N0,0'$ a total of N0$0,0. /roblems of measurement. 2ccounting income does not include all of the compan%]s holding gains or losses &increases or decreases in the mar!et values of its assets'. >or e-ample$ construction of a superhighwa% ma% increase the value of a compan%]s land$ but neither the income statement nor the balance sheet will report this holding gain. Similarl%$ introduction of a successful new product increases the compan%]s anticipated future cash flows$ and this increase ma!es the compan% more valuable. #hose additional future sales show up neither in the conventional income statement nor in the balance sheet. 2ccounting reports have also been critici5ed on the grounds that the% confuse monetar% measures with the underl%ing 1=1 realities when the price" of man% goods and services have been changing rapidl%. >or e-ample$ if the wholesale price of an item has risen from N1HH to N10H between the time the compan% bought it and the time it is sold$ man% accountants claim that N10H is the better measure of the amount of resources consumed b% the sale. #he% also contend that the N0H increase in the item]s wholesale value before it is sold is a special !ind of holding gain that should not be classified as ordinar% income. +hen inventor% purchase prices are rising$ DI>O inventor% costing !eeps man% gains from the holding of inventories out of net income. If purchases e6ual the 6uantit% sold$ the entire cost of goods sold will be measured at the higher current prices7 the ending inventor% will be measured at the lower prices shown for the beginningof%ear inventor%. #he difference between the DI>O inventor% cost and the replacement cost at the end of the %ear is an unreali5ed &and unreported' holding gain. In the inventor% e-ample cited earlier$ the DI>O cost of goods sold &N1H$,=0' e-ceeded the >I>O cost of goods sold &NG$=0H' b% N0,0. In other words$ DI>O !ept N0,0 more of the inventor% holding gain out of the income statement than >I>O did. >urthermore$ the replacement cost of the inventor% at the end of the %ear was N1$H0H &1$1HH N0.0H'$ which was *ust e6ual to the inventor%]s >I>O cost7 under DI>O$ in contrast$ there was an unreali5ed holding gain of N0,0 &N1$H0H minus the N0$0,0 DI>O inventor% cost'. #he amount of inventor% holding gain that is included in net income is usuall% called the cinventor% profit.c #he implication is that this is a component of net income that is less crealc than other components because it results from the holding of inventories rather than from trading with customers. +hen most of the changes in the prices of the compan%]s resources are in the same direction$ the purchasing power of mone% is said to change. Conventional accounting statements are stated in nominal currenc% units &dollars$ francs$ lire$ etc.'$ not in units of constant purchasing power. Changes in purcha"in# poerthat is$ changes in the average level of prices of goods and serviceshave two effects. >irst$ net monetar% assets &essentiall% cash and receivables minus liabilities calling for fi-ed monetar% pa%ments' lose purchasing power as the general price level rises. #hese losses do not appear in conventional accounting statements. Second$ holding gains measured in nominal currenc% units ma% merel% result from changes in the general price level. If so$ the% represent no increase in the compan%]s purchasing power. In some countries that have e-perienced severe and prolonged inflation$ companies have been allowed or even re6uired to restate their assets to reflect the more recent and higher levels of purchase prices. #he increment in the asset balances in such cases has not been reported as income$ but depreciation thereafter has been based on these higher amounts. Companies in the 8nited States are not allowed to ma!e these ad*ustments in their primar% financial statements. MA-A:ERIA) ACC.1-TI-: 2lthough published financial statements are the most widel% visible products of business accounting s%stems and the ones with which the public is most concerned$ the% are onl% the tip of the iceberg. ;ost accounting data and most accounting reports are generated solel% or mainl% for the compan%]s managers. Ceports to mana#ement ma% be either summaries of past events$ forecasts of the 1=, future$ or a combination of the two. (reparation of these data and reports is the focus of mana#erial accountin#$ which consists mainl% of four broad functions: &1' budgetary planning$ &,' cost finding$ &.' cost and profit analysis$ and &/' performance reporting. Budgetary planning. #he first ma*or component of internal accounting s%stems for management]s use is the company@" s%stem for establishing budgetar% plans and setting performance standards. #he setting of performance standards re6uires also a s%stem for measuring actual results and reporting differences between actual performance and the plans. ?i#ure 7' /ud#et plannin# and performance reportin#* #he simplified diagram in ?i#ure 7 illustrates the interrelationships between these elements. #he planning process leads to the establishment of e-plicit plans$ which then are translated into action. #he results of these actions are compared with the plans and reported in comparative form. ;anagement can then respond to substantial deviations from plan$ either b% ta!ing corrective action or$ if outside conditions differ from those predicted or assumed in the plans$ b% preparing revised plans. 2lthough plans can be either broad$ strategic outlines of the compan%]s future or schedules of the inputs and outputs associated with specific independent programs$ most business plans are periodic plansthat is$ the% refer to compan% operations for a specified period of time. #hese periodic plans are summari5ed in a series of pro*ected financial statements$ or budgets. #he two principal budget statements are the profit plan and the cash forecast. #he profit plan is an estimated income statement for the budget period. It summari5es the planned level of selling effort$ shown as selling e-pense$ and the results of that effort$ shown as sales revenue and the accompan%ing cost of goods sold. Separate profit plans are ordinaril% prepared for each ma*or segment of the compan%]s operations. 1=. ?i#ure 5' Relation"hip of company profit plan to re"pon"i%ility "tructure* #he details underl%ing the profit plan are contained in departmental sales and cost budgets$ each part identified with the e-ecutive or group responsible for carr%ing out that part. ?i#ure 5 shows the essence of this relationship: the compan%]s profit plan is reall% the integrated product of the plans of its two ma*or product divisions. #he arrows connecting the two divisional plans represent the coordinative communications that tie them together on matters of mutual concern. #he e-hibit also goes one level farther down$ showing that division <]s profit plan is reall% a coordinated s%nthesis of the plans of the division]s mar!eting department and manufacturing department. 2rrows again emphasi5e the necessar% coordination between the two. Each of these departmental plans$ in turn$ is a summar% of the plans of the ma*or offices$ plants$ or other units within the division. 2 complete representation of the compan%]s profit plan would re6uire an e-tension of the diagram through several la%ers to encompass ever% single responsibilit% centre in the entire compan%. ;an% companies also prepare alternative budgets for operating volumes other than the volume anticipated for the period. 2 set of such alternative budgets is !nown as the fle-ible budget. #he practice of fle-ible budgeting has been adopted widel% b% factor% management to facilitate evaluation of cost performance at different volume levels and has also been e-tended to other elements of the profit plan. #he second ma*or component of the annual budgetar% plan$ the cash forecast or ca"h %ud#et$ summari5es the anticipated effects on cash of all the compan%]s activities. It lists the anticipated cash pa%ments$ cash receipts$ and amount of cash on hand$ month b% month throughout the %ear. In most companies$ responsibilit% for cash management rests mainl% in the head office rather than at the divisional level. >or this reason$ divisional cash forecasts tend to be less important than divisional profit plans. Compan%wide cash forecasts$ on the other hand$ are *ust as important as compan% profit plans. (reliminar% cash forecasts are used in deciding how much mone% will be made available for the pa%ment of dividends$ for the purchase or construction of buildings and e6uipment$ and for other programs that do not pa% for themselves immediatel%. #he amount of shortterm borrowing or shortterm investment of temporaril% idle funds is then generall% geared to the re6uirements summari5ed in the final$ ad*usted forecast. Other elements of the budgetar% plan$ in addition to the profit plan and the cash forecast$ include capital e-penditure budgets$ personnel budgets$ production budgets$ and budgeted balance sheets. #he% all serve the same purpose: to help management decide upon a course of action and to serve as a point of reference against which to measure subse6uent performance. (lanning is a management 1=/ responsibilit%$ not an accounting function. #o plan is to decide$ and onl% the manager has the authorit% to choose the direction the compan% is to ta!e. 2ccounting personnel are nevertheless deepl% involved in the planning process. >irst$ the% administer the budgetar% planning s%stem$ establishing deadlines for the completion of each part of the process and seeing that these deadlines are met. Second$ the% anal%5e data and help management at various levels compare the estimated effects of different courses of action. #hird$ the% are responsible for collating the tentative plans and proposals coming from the individual departments and divisions and then reviewing them for consistenc% and feasibilit% and sometimes for desirabilit% as well. >inall%$ the% must assemble the final plans management has chosen and see that these plans are understood b% the operating e-ecutives. Cost finding. 2 ma*or factor in business planning is the cost of producing the compan%]s products. Cost finding is the process b% which the compan% obtains estimates of the costs of producing a product$ providing a service$ performing a function$ or operating a department. Some of these estimates are historicalhow much did it cost4while others are predictivewhat will it cost4 #he basic principle in cost finding is that the cost assigned to an% ob*ectan activit% or a productshould represent the amount of cost that ob*ect causes. #he most full% developed methods of cost finding are used to estimate the costs that have been incurred in a factory to manufacture specific products. #he simplest of these methods is !nown as process costing. In this method$ the accountant first accumulates the costs of each separate production operation or process for a specified period of time. #he total of these costs is then restated as an average b% dividing it b% the total output of the process during the same period. (rocess costing can be used whenever the output of individual processes is reasonabl% uniform or homogeneous$ as in cement manufacturing$ flour milling$ and other relativel% continuous production processes. 2 second method$ *ob order costing$ is used when individual production centres or departments wor! on a variet% of products rather than *ust one during a t%pical time period. #wo categories of factor% cost are recogni5ed under this method: prime costs and factor% overhead costs. (rime costs are those that can be traced directl% to a specific batch$ or *ob lot$ of products. #hese are the direct labour and direct materials costs of production. Overhead costs$ on the other hand$ are those that can be traced onl% to departmental operations or to the factor% as a whole and not to individual *ob orders. #he salar% of a departmental supervisor is an e-ample of an overhead cost. 9irect materials and direct labour costs are recorded directl% on the *ob order cost sheets$ one for each *ob. 2lthough not traceable to individual *obs$ overhead costs are generall% assigned to them b% means of overhead ratesi.e.& the ratio of total overhead cost to total production volume for a given time period. 2 separate overhead rate is usuall% calculated for each production department$ and$ if the operations of a department are varied$ it is often subdivided into a set of more homogeneous cost centres$ each with its own overhead rate. Separate overhead rates are sometimes used even for individual processing machines within a department if the machines differ widel% in such factors as power 1=0 consumption$ maintenance cost$ and depreciation. <ecause output within a cost centre is not homogeneous$ production volume must be measured b% something other than the number of units of product$ such as the number of machine hours or direct labour hours. Once the overhead rate has been determined$ a provision for overhead cost can be entered on each *ob order cost sheet on the basis of the number of direct labour hours or machine hours used on that *ob. >or e-ample$ if the overhead rate is N. a machine hour and @ob "o. =1,? used 1HH machine hours$ then N1$?HH would be shown as the overhead cost of this *ob. ;an% production costs are incurred in departments that don]t actuall% produce goods or provide salable services. Instead$ the% provide services or support to the departments that do produce products. E-amples include maintenance departments$ 6ualit% control departments$ and internal power plants. Estimates of these costs are included in the estimated overhead costs of the production departments b% a process !nown as allocationthat is$ estimated service department costs are allocated among the production departments in proportion to the amount of service or support each receives. #he departmental overhead rates then include provisions for these allocated costs. 2 third method of cost finding$ activit%based costing$ is based on the fact that man% costs are driven b% factors other than product volume. #he first tas! is to identif% the activities that drive costs. #he ne-t step is to estimate the costs that are driven b% each activit% and state them as averages per unit of activit%. ;anagement can use these averages to guide its efforts to reduce costs. In addition$ if management wants an estimate of the cost of a specific product$ the accountant can estimate how man% of the activit% units are associated with that product and multipl% those numbers b% the average costs per activit% unit. >or e-ample$ suppose that costs driven b% the number of machine hours average N1, per machine hour$ costs driven b% the number of production batches average N1HH a batch$ and the costs of !eeping a product in the line average N1HH a %ear for each !ind of material or component part used. Ueeping in the line a product that is assembled from si- component parts thus incurs costs of 1 N1HH S N1HH a %ear$ irrespective of volume and even if the product is not made at all during the period. If annual production amounts to 1H$HHH units$ the unit co"t of product maintenance is N1HHB1H$HHH S N.H1 a unit. If this product is manufactured in batches of 1$HHH units$ then batchdriven costs average N1HHB1$HHH S N.1H a unit. 2nd$ if a batch re6uires 10 machine hours$ hourdriven costs average 10 N1,B1$HHH S N.1? a unit. 2t the 1H$HHHunit volume$ then$ the cost of this product is N.H1 i N.1H i N.1? S N../ a unit plus the cost of materials. (roduct cost finding under activit%based costing is almost alwa%s a process of estimating costs before production ta!es place. #he method of process costing and *ob order costing can be used either in preparing estimates before the fact or in assigning costs to products as production proceeds. Even when *ob order costing is used to tall% the costs actuall% incurred on individual *obs$ the overhead rates are usuall% predeterminedthat is$ the% represent the average planned overhead cost at some production volume. #he main reason for this is that actual overhead cost averages depend on the total volume and efficienc% of operations and not on an% one *ob alone. #he relevance of *ob order cost information will be impaired if these e-ternal fluctuations are allowed to change the amount of overhead cost assigned to a particular *ob. ;an% s%stems go even farther than this. Estimates of the average costs of each t%pe of material$ each operation$ and each product are prepared routinel% and identified as standard costs. #hese are then readil% available whenever estimates are needed and 1=1 can also serve as an important element in the compan%]s performance reporting s%stem$ as described below. Similar methods of cost finding can be used to determine or estimate the cost of providing services rather than ph%sical goods. ;ost advertising agencies and consulting firms$ for e-ample$ maintain some form of *ob cost records$ either as a basis for billing their clients or as a means of estimating the profitabilit% of individual *obs or accounts. #he methods of cost finding described in the preceding paragraphs are !nown as full$ or absorption$ costing methods$ in that the overhead rates are intended to include provisions for all manufacturing costs. <oth process and *ob order costing methods can also be adapted to variable costing in which onl% variable manufacturing costs are included in product cost. Variable costs are those that will be greater in total in the upper portions of the compan%]s normal range of volumes than in the lower portion. #otal fiBed co"t"$ in contrast$ are the same at all volume levels within the normal range. 8nit cost under variable costing represents the average $aria%le co"t of ma!ing the product. #he main argument for the variable costing approach is that average variable cost is more relevant to shorthori5on managerial decisions than average full cost. In deciding whether to manufacture goods in large lots$ for e-ample$ management needs to estimate the cost of carr%ing larger amounts of finished goods in inventor%. ;ore variable costs will have to be incurred to build the inventor% to a higher level7 fi-ed manufacturing costs presumabl% will be unaffected. >urthermore$ when a management decision changes the compan%]s fi-ed costs$ the change is unli!el% to be proportional to the change in volume7 therefore$ average fi-ed cost is seldom a valid basis for estimating the cost effects of such decisions. Variable costing eliminates the temptation to assume without 6uestion that average fi-ed cost can be used to estimate changes in total fi-ed cost. +hen variable costing is used$ supplemental rates for fi-ed overhead production costs must be provided to measure the costs to be assigned to endof%ear inventories because generall% accepted accounting principles in the 8nited States and in most other countries re6uire that inventories be measured at full product cost for e-ternal financial reporting. Cost and profit analysis. 2ccountants share with man% other people the tas! of anal%5ing cost and profit data in order to provide guidance in managerial decision ma!ing. Even if the anal%tical wor! is done largel% b% others$ the% have an interest in anal%tical methods because the s%stems the% design must collect data in forms suitable for anal%sis. ;anagerial decisions are based on comparisons of the estimated future results of the alternative courses of action that the decision ma!er is choosing among. Cecorded historical accounting data$ in contrast$ reflect conditions and e-perience of the past. >urthermore$ the% are absolute$ not comparative$ in that the% show the effects of one course of action but not whether these were better or worse than those that would have resulted from some other course. >or decision ma!ing$ therefore$ historical accounting data must be e-amined$ modified$ and placed on a comparative basis. Even estimated data$ such as budgets and standard costs$ must be e-amined to see whether the estimates are still valid and relevant to managerial comparisons. #o a large e-tent$ this *ob of review and restatement is an accounting responsibilit%. 2ccordingl%$ a ma*or part of the 1== accountant]s preparation for the profession is devoted to the stud% of methods and principles of anal%sis for managerial decision ma!ing. /erformance reporting. Once the budgetar% plan has been adopted$ accounting]s ne-t tas! is to prepare information on the results of compan% activities and ma!e it available to management. #he manager]s main interest in this information centres on three 6uestions: 3ave his or her own actions had the results e-pected$ and$ if not$ wh% not4 3ow successful have subordinates been in managing the activities entrusted to them4 +hat problems and opportunities seem to have arisen since the budgetar% plan was prepared4 >or these purposes$ the information must be comparative$ relating actual results to the level of results that management regards as satisfactor%. In each case$ the standard for comparison is provided b% the budgetar% plan. ;uch of this information is contained in periodic financial reports. 2t the top management and divisional levels$ the most important of these is the comparative income statement. #his shows the profit that was planned for this period$ the actual results received for this period$ and the differences$ or variances$ between the two. It also gives an e-planation of some of the reasons for the difference between a planned and an actual income. #he report in this e-hibit emplo%s the widel% used profit contribution format$ in which divisional results reflect sales and e-penses traceable to the individual divisions$ with no deduction for head office e-penses. Compan% net income is then obtained b% deducting head office e-penses as a lump sum from the total of the divisional profit contributions. 2 similar format can be used within the division$ reporting the profit contribution of each of the division]s product lines$ with divisional head6uarters e-penses deducted at the bottom. <% far the greatest number of reports$ however$ are cost or sales reports$ mostl% on a departmental basis. 9epartmental sales reports usuall% compare actual sales with the volumes planned for the period. 9epartmental cost performance reports$ in contrast$ t%picall% compare actual costs incurred with standards or budgets that have been ad*usted to correspond to the actual volume of wor! done during the period. #his practice reflects a recognition that volume fluctuations generall% originate outside the department and that the department head]s responsibilit% is ordinaril% limited to minimi5ing cost while meeting the deliver% schedules imposed b% higher management. >or e-ample$ a factor% department]s output consists entirel% of a single product$ with a standard materials cost of N. a unit and standard labour cost of N11. ;aterials cost represents three pounds of raw materials at N1 a pound7 standard labour cost is two hours of labour at N? an hour. Overhead costs in the department are budgeted at N1H$HHH a month plus N, a unit. 8nder normal conditions$ volume is =$HHH units a month$ but during October onl% 1$HHH units were produced. #he cost standards for the month would be as follows:
#he actual cost this month was N1=$?0H for materials &1=$HHH pounds at N1.H0'$ N1H1$,0H for labour &1,$0HH hours at N?.1H an hour'$ and N,.$HHH for 1=? overhead. 2 summar% report would show the following:
#hese variances ma% be anal%5ed even further in order to identif% the underl%ing causes. #he labour variance$ for e-ample$ can be seen to be the result of both high wage rates &N?.1H instead of N?.HH' and high labour usage &1,$0HH hours instead of 1,$HHH'. #he factor% accountant ordinaril% would measure the effect of the rate change in the following wa%:
In most cases$ the labour rate variance would not be reported to the department head$ because it is not sub*ect to his or her control. Standard costing s%stems no longer have the central importance the% commanded in man% industries up to the 1G=Hs. One reason is that significant changes in management technolog% have shifted the focus of cost control from the individual production department to larger$ more interdependent groups. @ustintime production s%stems re6uire changes in factor% la%outs to reduce the time it ta!es to move wor! from one station to the ne-t. #he% also reduce the number of partl% processed units at each wor! station$ thereb% re6uiring greater stationtostation coordination. 2t the same time$ management]s emphasis has shifted from cost control to cost reduction$ 6ualit% enhancement$ and closer coordination of production and customer deliveries. ;ost large manufacturing companies and man% service companies have launched programs of total 6ualit% control and continuous improvement$ and man% have replaced standard costs with a more fle-ible approach using prior period results as current performance standards. ;anagement is also li!el% to focus on the amount of s%stem waste b% identif%ing and minimi5ing activities that contribute nothing to the value that customers place on the product. Ceducing setup time$ inspection time$ and time spent moving wor! from place to place while maintaining or improving 6ualit% are some of the results of these programs. 2dvances in computerbased models have enabled companies to tie production schedules more closel% to customer deliver% schedules while increasing the rate of plant utili5ation. Some of these changes actuall% increase variances from standard costs in some departments but are underta!en because the% benefit the compan% as a whole. #he overall result is that control s%stems are li!el% to focus in the first instance on operational controls &real time signals to operating personnel that some immediate remedial action is re6uired'$ 1=G with afterthefact anal%sis of results focusing on aggregate comparisons with past performance and the planned results of current improvement programs. .T,ER P1RP.SES .? ACC.1-TI-: SYSTEMS 2ccounting s%stems are designed mainl% to provide information that managers and outsiders can use in decision ma!ing. #he% also serve other purposes: to produce operating documents$ to protect the compan%]s assets$ to provide data for compan% ta- returns$ and$ in some cases$ to provide the basis for reimbursement of costs b% clients or customers. #he accounting organi5ation is responsible for preparing documents that contain instructions for a variet% of tas!s$ such as pa%ment of customer bills or preparing emplo%ee pa%rolls. It also must prepare documents that serve what might be called private information purposes$ such as the emplo%ees] own records of their salaries and wages. ;an% of these documents also serve other accounting purposes$ but the% would have to be prepared even if no information reports were necessar%. ;easured b% the number of people involved and the amount of time re6uired$ document preparation is one of accounting]s biggest *obs. 2ccounting s%stems must provide means of reducing the chance of losses of assets due to carelessness or dishonest% on the part of emplo%ees$ suppliers$ and customers. 2sset protection devices are often ver% simple7 for e-ample$ man% restaurants use numbered meal chec!s so that waiters will not be able to submit one chec! to the customer and another$ with a lower total$ to the cashier. Other devices entail a partial duplication of effort or a division of tas!s between two individuals to reduce the opportunit% for unobserved thefts. #hese are all part of the compan%]s s%stem of internal controls. 2nother important element in the internal control s%stem is internal auditing. #he tas! of internal auditors is to see whether prescribed data handling and asset protection procedures are being followed. #o accomplish this$ the% usuall% observe some of the wor! as it is being performed and e-amine a sample of past transactions for accurac% and fidelit% to the s%stem. #he% ma% insert a set of fictitious data into the s%stem to see whether the resulting output meets a predetermined standard. #his techni6ue is particularl% useful in testing the validit% of the programs that are used to process data through electronic computers. #he accounting s%stem must also provide data for use in the completion of the compan%]s taB returns. #his function is the concern of ta- accounting. In some countries financial accounting must obe% rules laid down for ta- accounting b% national ta- laws and regulations$ but no such re6uirement is imposed in the 8nited States$ and tabulations prepared for ta- purposes often diverge from those submitted to shareholders and others. c#a-able incomec is a legal concept rather than an accounting concept. TaB la" include incentives to encourage companies to do certain things and discourage them from doing others. 2ccordingl%$ what is cincomec or ccapitalc to a ta- agenc% ma% be far different from the accountant]s measures of these same concepts. >inall%$ accounting s%stems in some companies must provide cost data in the forms re6uired for submission to customers who have agreed to reimburse the companies for the costs the% have incurred on the customers] behalf. /an!" and /an!in# 1?H #he principal t%pes of ban!ing in the modern industrial world are commercial ban!ing and central ban!ing. 2 commercial ban!er is a dealer in money and in substitutes for mone%$ such as chec!s or bills of e-change. #he ban!er also provides a variet% of financial services. #he basis of the ban!ing business is borrowing from individuals$ firms$ and occasionall% governmentsi.e.& receiving cdepositsc from them. +ith these resources and also with the %an!@" own capital$ the ban!er ma!es loans or e-tends credit and also invests in securities. #he ban!er ma!es profit b% borrowing at one rate of interest and lending at a higher rate and b% charging commissions for services rendered. 2 ban! must alwa%s have cash balances on hand in order to pa% its depositors upon demand or when the amounts credited to them become due. It must also !eep a proportion of its assets in forms that can readil% be converted into cash. Onl% in this wa% can confidence in the ban!ing s%stem be maintained. (rovided it honours its promises &e.g.& to provide cash in e-change for deposit balances'$ a ban! can create credit for use b% its customers b% issuing additional notes or b% ma!ing new loans$ which in their turn become new deposits. #he amount of credit it e-tends ma% considerabl% e-ceed the sums available to it in cash. <ut a ban! is able to do this onl% as long as the public believes the ban! can and will honour its obligations$ which are then accepted at face value and circulate as mone%. So long as the% remain outstanding$ these promises or obligations constitute claims against that ban! and can be transferred b% means of chec!s or other negotiable instruments from one part% to another. #hese are the essentials of deposit ban!ing as practiced throughout the world toda%$ with the partial e-ception of socialistt%pe institutions. 2nother t%pe of ban!ing is carried on b% central ban!s$ ban!ers to governments and clenders of last resortc to commercial ban!s and other financial institutions. #he% are often responsible for formulating and implementing monetar% and credit policies$ usuall% in cooperation with the government. In some casese.g.& the 8.S. >ederal Ceserve S%stemthe% have been established specificall% to lead or regulate the ban!ing s%stem7 in other casese.g.& the <an! of Englandthe% have come to perform these functions through a process of evolution. Some institutions often called ban!s$ such as finance companies$ savings ban!s$ investment ban!s$ trust companies$ and homeloan ban!s$ do not perform the ban!ing functions described above and are best classified as financial intermediaries. #heir economic function is that of channelling savings from private individuals into the hands of those who will use them$ in the form of loans for building purposes or for the purchase of capital assets. #hese financial intermediaries cannot$ however$ create mone% &i.e.& credit' as the commercial ban!s do7 the% can lend no more than savers place with them. ,he development of ban"ing systems <an!ing is of ancient origin$ though little is !nown about it prior to the 1.th centur%. ;an% of the earl% cban!sc dealt primaril% in coin and bullion$ much of their business being mone% changing and the suppl%ing of foreign and domestic coin of the correct weight and fineness. 2nother important earl% group of ban!ing institutions was the merchant ban!ers$ who dealt both in goods and in %ill" of eBchan#e$ 1?1 providing for the remittance of mone% and pa%ment of accounts at a distance but without shipping actual coin. #heir business arose from the fact that man% of these merchants traded internationall% and held assets at different points along trade routes. >or a certain consideration$ a merchant stood prepared to accept instructions to pa% mone% to a named part% through one of his agents elsewhere7 the amount of the bill of e-change would be debited b% his agent to the account of the merchant ban!er$ who would also hope to ma!e an additional profit from e-changing one currenc% against another. <ecause there was a possibilit% of loss$ an% profit or gain was not sub*ect to the medieval ban on usur%. #here were$ moreover$ techni6ues for concealing a loan b% ma!ing forei#n eBchan#e available at a distance but deferring pa%ment for it so that the intere"t charge could be camouflaged as a fluctuation in the e-change rate. 2nother form of earl% ban!ing activit% was the acceptance of deposits. #hese might derive from the deposit of mone% or valuables for safe!eeping or for purposes of transfer to another part%7 or$ more straightforwardl%$ the% might represent the deposit of mone% in a current account. 2 balance in a current account could also represent the proceeds of a loan that had been granted b% the ban!er$ perhaps based on an oral agreement between the parties &recorded in the ban!er]s *ournal' whereb% the customer would be allowed to overdraw his account. En#li"h ban!ers in particular had b% the 1=th centur% begun to develop a deposit ban!ing business$ and the techni6ues the% evolved were to prove influential elsewhere. #he Dondon goldsmiths !ept mone% and valuables in safe custod% for their customers. In addition$ the% dealt in bullion and foreign e-change$ ac6uiring and sorting coin for profit. 2s a means of attracting coin for sorting$ the% were prepared to pa% a rate of interest$ and it was largel% in this wa% that the% began to supplant as deposit ban!ers their great rivals$ the cmone% scriveners.c #he latter were notaries who had come to speciali5e in bringing together borrowers and lenders7 the% also accepted deposits. It was found that when mone% was deposited b% a number of people with a goldsmith or a scrivener a fund of deposits came to be maintained at a fairl% stead% level7 over a period of time$ deposits and withdrawals tended to balance. In an% event$ customers preferred to leave their surplus mone% with the goldsmith$ !eeping onl% enough for their ever%da% needs. #he result was a fund of idle cash that could be lent out at interest to other parties. 2bout the same time$ a practice grew up whereb% a customer could arrange for the transfer of part of his credit balance to another part% b% addressing an order to the ban!er. #his was the origin of the modern chec!. It was onl% a short step from ma!ing a loan in specie or coin to allowing customers to borrow b% chec!: the amount borrowed would be debited to a loan account and credited to a current account against which chec!s could be drawn7 or the customer would be allowed to overdraw his account up to a specified limit. In the first case$ interest was charged on the full amount of the debit$ and in the second the customer paid interest onl% on the amount actuall% borrowed. 2 chec! was a claim against the ban!$ which had a corresponding claim against its customer. 2nother wa% in which a ban! could create claims against itself was b% issuing %an! note". #he amount actuall% issued depended on the ban!er]s *udgment of the possible demand for specie$ and this depended in large part on public confidence in the ban! itself. In Dondon$ goldsmith ban!ers were probabl% developing the use of the ban! note about the same time as that of the chec!. &#he first ban! notes issued in Europe were b% the <an! of Stoc!holm in 1111.' Some commercial ban!s are still permitted to issue their own notes$ but in most countries this has become a prerogative of the central ban!. In /ritain the chec! soon proved to be such a convenient means of 1?, pa%ment that the public began to use chec!s for the larger part of their monetar% transactions$ reserving coin &and$ later$ notes' for small pa%ments. 2s a result$ ban!s began to grant their borrowers the right to draw chec!s much in e-cess of the amounts of cash actuall% held$ in this wa% ccreating mone%ci.e.& claims that were generall% accepted as means of pa%ment. Such mone% came to be !nown as cban! mone%c or ccredit.c E-cluding ban! notes$ this mone% consisted of no more than figures in ban! ledgers7 it was acceptable because of the public]s confidence in the abilit% of the ban! to honour its liabilities when called upon to do so. +hen a chec! is drawn and passes into the hands of another part% in pa%ment for goods or services$ it is usuall% paid into another ban! account. 2ssuming that the overdraft techni6ue is emplo%ed$ if the chec! has been drawn b% a borrower$ the mere act of drawing and passing the chec! will create a loan as soon as the chec! is paid b% the borrower]s ban!er. Since ever% loan so made tends to return to the ban!ing s%stem as a deposit$ deposits will tend to increase for the s%stem as a whole to about the same e-tent as loans. On the other hand$ if the mone% lent has been debited to a loan account and the amount of the loan has been credited to the customer]s current account$ a deposit will have been created immediatel%. One of the most important factors in the development of ban!ing in England was the earl% legal recognition of the negotiabilit% of credit instruments or bills of e-change. #he chec! was e-pressl% defined as a bill of e-change. In continental Europe$ on the other hand$ limitations on the negotiabilit% of an order of pa%ment prevented the e-tension of deposit ban!ing based on the chec!. Continental countries developed their own s%stem$ !nown as giro pa%ments$ whereb% transfers were effected on the basis of written instructions to debit the account of the pa%er and to credit that of the pa%ee. The %u"ine"" of %an!in# #he business of ban!ing consists of borrowing and lending. 2s in other businesses$ operations must be based on capital$ but ban!s emplo% comparativel% little of their own capital in relation to the total volume of their transactions. #he purpose of capital and reserve accounts is primaril% to provide an ultimate cover against losses on loans and investments. In the 1nited State" capital accounts also have a legal significance$ since the laws limit the proportion of its capital a ban! ma% lend to a single borrower. Similar arrangements e-ist elsewhere. 675C,+#5 #6 C#MM-.C+4' B458 #he essential characteristics of the ban!ing business ma% be described within the framewor! of a simplified balance sheet. 2 ban!]s main lia%ilitie" are its capital &including reserves and$ often$ subordinated debt' and deposits. #he latter ma% be from domestic or foreign sources &corporations and firms$ private individuals$ other ban!s$ and even governments'. #he% ma% be repa%able on demand &sight deposits or current accounts' or repa%able onl% after the lapse of a period of time &time$ term$ or fi-ed deposits and$ occasionall%$ savings deposits'. 2 ban!]s a""et" include cash &which ma% be held in the form of credit balances with other ban!s$ usuall% with a central ban! but also$ in var%ing degrees$ with correspondent ban!s'7 li+uid a""et" &mone% at call and short notice$ da%toda% mone%$ shortterm government paper such as treasur% bills and notes$ and commercial bills of e-change$ 1?. all of which can be converted readil% into cash without ris! of substantial loss'7 in$e"tment" or securities &substantiall% mediumterm and longer term government securitiessometimes including those of local authorities such as states$ provinces$ or municipalitiesand$ in certain countries$ participations and shares in industrial concerns'7 loans and advances made to customers of all !inds$ though primaril% to trade and industr% &in an increasing number of countries$ these include term loans and also mortgage loans'7 and$ finall%$ the ban!]s premises$ furniture$ and fittings &written down$ as a rule$ to 6uite nominal figures'. 2ll ban! %alance "heet" must include an item that relates to contingent liabilities &e.g.& bills of e-change cacceptedc or endorsed b% the ban!'$ e-actl% balanced b% an item on the other side of the balance sheet representing the customer]s obligation to indemnif% the ban! &which ma% also be supported b% a form of securit% ta!en b% the ban! over its customer]s assets'. ;ost ban!s of an% si5e stand prepared to provide acceptance credits &also called ban!ers] acceptances'7 when a ban! accepts a bill$ it lends its name and reputation to the transaction in 6uestion and$ in this wa%$ ensures that the paper will be more readil% discounted. Depo"it"* #he bul! of the resources emplo%ed b% a modern ban! consists of borrowed mone% &that is$ deposits'$ which is lent out as profitabl% as is consistent with safet%. Insofar as an increase in deposits provides a ban! with additional cash &which is an asset'$ the increase in cash supplements its loanable resources and permits a more than proportionate increase in its loans. 2n increase in deposits ma% arise in two wa%s. &1' +hen a ban! ma!es a loan$ it ma% transfer the sum to a current account$ thus directl% creating a new deposit7 or it ma% arrange a line of credit for the borrower upon which he will be permitted to draw chec!s$ which$ when deposited b% third parties$ li!ewise create new deposits. &,' 2n enlargement of government e-penditure financed b% the central ban! ma% occasion a growth in deposits$ since claims on the government that are e6uivalent to cash will be paid into the commercial ban!s as deposits. In the first instance$ with the increase in ban! deposits goes a related increase in the potential liabilit% to pa% out cash7 in the second case$ the increase in deposits with the commercial ban!s is accompanied b% a corresponding increase in commercial ban! holdings of mone% claims that are e6uivalent to cash. #a!ing one ban! in isolation$ an increase in its loans ma% result in a direct increase in deposits. #his ma% occur either as a result of a transfer to a current account &as above' or a transfer to another customer of the same ban!. Once again$ there is an increase in the potential liabilit% to pa% out cash. On the other hand$ if there has been an increase in loans b% another ban! &including an increase in central ban! loans to the government'$ this ma% give rise to increased deposits with the first ban!$ matched b% a corresponding claim to cash &or its e6uivalent'. >or these reasons a ban! can generall% e-pect that$ if there is an increase in deposits$ there will also be some net ac6uisition of cash or of claims for receipt of cash. It is in this wa% that an increase in deposits usuall% provides the basis for further ban! lending. E-cept in countries where ban!s are small and insecure$ ban!s as a whole can usuall% depend on their current account debits being largel% offset b% credits to current accounts$ though from time to time an individual ban! ma% e-perience mar!ed fluctuations in its deposit totals$ and all ban!s in a countr% ma% be sub*ect to seasonal variations. Even when deposits are repa%able on demand$ there is usuall% a degree of inertia in the deposit structure that prevents 1?/ sharp fluctuations7 if mone% is accepted contractuall% for a fi-ed term or if notice must be given before its repa%ment$ this inertia will be greater. On the other hand$ if a significant proportion of total deposits derives from foreign sources$ there is li!el% to be an element of volatilit% arising from international conditions. In ban!ing$ confidence on the part of the depositors is the true basis of stabilit%. Confidence is steadier if there e-ists a central ban! to act as a clender of last resort.c 2nother means of maintaining confidence emplo%ed in some countries is deposit insurance$ which protects the small depositor against loss in the event of a ban! failure. Such protection was the declared purpose of the cnationali5ationc of ban! deposits in Ar#entina between 1G/1 and 1G0=7 ban!s receiving deposits acted merel% as agents of the governmentowned and government controlled central ban!$ all deposits being guaranteed b% the state. Re"er$e"* Since the ban!er underta!es to provide depositors with cash on demand or upon prior notice$ it is necessar% to hold a cash re"er$e and to maintain a csafec ratio of cash to deposits. #he safe ratio is determined largel% through e-perience. It ma% be established b% convention &as it was for man% %ears in England' or b% statute &as in the 8nited States and elsewhere'. If a minimum cash ratio is re6uired b% law$ a portion of a ban!]s assets is in effect fro5en and not available to meet sudden demands for cash from the ban!]s customers. In order to provide more fle-ibilit%$ re6uired ratios are fre6uentl% based on the average of cash holdings over a specified period$ such as a wee! or a month. In addition to holding part of the ban!]s assets in cash$ a ban!er will hold a proportion of the remainder in assets that can 6uic!l% be converted into cash without significant loss. "o ban!er can safel% ignore the necessit% of maintaining ade6uate reserves of li6uid assets7 some prefer to limit the sum of loans and investments to a certain percentage of deposits$ not allowing their loandeposit ratio to run for an% length of time at too high a level. 8nless a ban! held cash covering 1HH percent of its demand deposits$ it could not meet the claims of depositors if the% were all to e-ercise in full and at the same time their rights to demand cash. If that were a common phenomenon$ deposit ban!ing could not long survive. >or the most part$ the public is prepared to leave its surplus funds on deposit with the ban!s$ confident that the% will be repaid if needed. <ut there ma% be times when une-pected demands for cash e-ceed what might reasonabl% have been anticipated7 therefore$ a ban! must not onl% hold part of its assets in cash but also must !eep a proportion of the remainder in assets that can be 6uic!l% converted into cash without significant loss. Indeed$ in theor%$ even its less li6uid assets should be selfli6uidating within a reasonable time. 2 ban! ma% mobili5e its assets in several wa%s. It ma% demand repa%ment of loans$ immediatel% or at short notice7 it ma% sell securities7 or it ma% borrow from the central ban!$ using paper representing investments or loans as securit%. <an!s do not precipitatel% call in loans or sell mar!etable assets$ because this would disrupt the delicate debtorcreditor relationships and increase an% loss of confidence$ probabl% resulting in a run on the ban!s. Cead% cash ma% be obtainable in this wa% onl% at a ver% high price. <an!s must either maintain their cash reserves and other li6uid assets at a high level or have access to a clender of last resort$c such as a central ban!$ able and willing to provide cash against the securit% of eligible assets. In a number of countries$ the commercial ban!s have at times been re6uired to maintain a minimum li6uid assets ratio. <ut central ban!s impose such re6uirements less as a means of 1?0 maintaining appropriate levels of commercial ban! li6uidit% than as a techni6ue for influencing directl% the lending potential of the ban!s. 2mong the assets of commercial ban!s$ investments are less li6uid than money0mar!et assets such as call mone% and treasur% bills. <% maintaining an appropriate spread of maturities$ however$ it is possible to ensure that a proportion of a ban!]s investments is regularl% approaching redemption$ thereb% producing a stead% flow of li6uidit% and in that wa% constituting a secondar% li6uid assets reserve. Some ban!s$ particularl% in the 8nited States and Canada$ have at times favoured the cdumbbellc distribution of maturities$ a significant proportion of the total portfolio being held in longdated maturities with a high %ield$ a small proportion in the middle ranges$ and another significant proportion in shortdated maturities. >ollowing redemption$ the ban!s usuall% reinvest all or most of the proceeds in longerterm maturities that in due course become increasingl% shortterm. Interestrate e-pectations fre6uentl% modif% the shape of a maturit% distribution$ and$ in times of great uncertaint% with regard to interest rates$ ban!s will tend to hold the bul! of their securities at short term$ and something li!e a #distribution ma% then be preferred &mainl% shorts$ supported b% small amounts of medium to longer dated paper'. Investments and mone%mar!et assets merge into each other. #he dividing line is arbitrar%$ but there is an essential difference: the li6uidit% of investments depends primaril% on mar!etabilit% &though sometimes it also depends on the readiness of the government or its agent to e-change its own securities for cash'7 the li6uidit% of mone%mar!et assets$ on the other hand$ depends partl% on mar!etabilit% but mainl% on the willingness of the central ban! to purchase them or accept them as collateral for a loan. #his is wh% mone%mar!et assets are more li6uid than investments. I-D1STRIA) ?I-A-CE 'ong(term and medium(term lending. <an!s that do a great deal of longterm lending to industr% must ensure their li6uidit% b% maintaining relativel% large capital funds and a relativel% high proportion of longterm borrowings &e.g.& time deposits$ or issues of bonds or debentures'$ as well as valuing their investments ver% conservativel%. Such ban!s$ notabl% the ?rench %an=ues d'affaires and the :erman commercial ban!s$ have developed special means of reducing their degree of ris!. Ever% investment is preceded b% a thorough technical and financial investigation. #he initial advance ma% be an interim credit$ later converted into a participation. Onl% when mar!et conditions are favourable is the original investment converted into mar!etable securities$ and an issue of shares to the public is arranged. One function of these ban!s is to nurse an investment along until the venture is well established. Even assuming its ultimate success$ a ban! ma% be obliged to hold such shares for long periods before being able to li6uidate them. In addition$ the% often retain an interest in a firm as an ordinar% investment as well as to ensure a degree of continuing control over it. #he longterm provision of industrial finance in <ritain and the Commonwealth countries is usuall% handled b% specialist institutions$ with the commercial ban!s providing onl% part of the necessar% capital. In (apan the longterm financial needs of industr% are met partl% b% special industrial ban!s &which also issue debentures as well as 1?1 accepting deposits' and partl% b% the ordinar% commercial ban!s. In Ferman% the commercial ban!s customaril% handle longterm finance. Since +orld +ar II the commercial ban!s in the 8nited States have developed the socalled term loan$ especiall% for financing industrial capital re6uirements. #he attempt to populari5e the term loan began in the economic depression of the 1G.Hs$ when the ban!s tried to e-pand their business b% offering finance for a period of %ears. ;ost term loans have an effective maturit% of little more than five %ears$ though some run for 1H %ears or more. #he% are usuall% arranged between the customer and a group of lending ban!s$ sometimes in cooperation with other institutions such as insurance companies$ and are normall% sub*ect to a formal term loan agreement. <an!s in <ritain$ western Europe$ the Commonwealth$ and @apan began during the 1G1Hs to give term loans both to industr% and to agriculture. Short0term lendin#* Shortterm loans are the core of the ban!ing business even in countries where commercial ban!s ma!e longterm loans to industr%. ;uch shortterm lending consists in the provision of wor!ing capital$ but the ban!s also provide temporar% finance for fi-ed capital development$ aiding a customer until longterm finance can be found elsewhere. ;uch of this shortterm lending is done b% overdraft$ particularl% in the 8nited Uingdom and a number of the Commonwealth countries$ or b% wa% of ccurrent account lendingc in man% western European countries. #he overdraft permits a depositor to overdraw an account up to an agreed limit. In theor%$ overdrafts are repa%able on demand or after reasonable notice has been given$ but often the% are allowed to run on indefinitel%$ sub*ect to a periodic review. 2n advance is reduced or repaid whenever the account is credited with deposits and recreated when new chec!s are drawn upon it$ interest being paid onl% on the amount outstanding. 2n alternative method of short term lending is to debit a loan account with the amount borrowed$ crediting the proceeds to a current account7 interest is usuall% pa%able on the whole amount of the loan$ which normall% is for a fi-ed period of time. &In <ritain arrangements are sometimes more fle-ible$ and the term of the loan ma% be set b% oral agreement.' In a number of countries$ including the 8nited States$ the 8nited Uingdom$ >rance$ Ferman%$ and @apan$ shortterm finance is often made available on the basis of discountable papercommercial bills or promi""ory note". Some of this paper is usuall% rediscountable at the central ban!$ thus becoming virtuall% a li6uid asset$ unli!e a ban! advance or loan. Credit ma% be offered with or without formal securit%$ depending on the reputation and financial strength of the borrower. In man% countries$ a customer ma% use a number of ban!s$ and these institutions usuall% freel% e-change information about *oint credit ris!s. In <ritain and The -etherland"$ however$ most concerns tend to use a single ban!ing institution for most of their needs. #raditionall% ban!ers too! the view that the liabilities of a ban! &in particular$ its deposits' were more or less stable and concerned themselves primaril% with the investment of these funds. Since the late 1G0Hs and ]1Hs$ especiall% in "orth 2merica and latterl% in the 8nited Uingdom$ there has been a change in emphasis. <an!s began to find it more difficult to obtain deposits. Interest rates rose to high levels$ and ban!s were obliged to compete with each other and with other institutions for funds. 2t the same time$ there was little point in pa%ing a high rate of interest for mone% unless it could be emplo%ed profitabl%. <an!ers began to relate the cost of 1?= borrowed mone% directl% to the return on loans and investments. (reviousl% the main limitation on a ban!]s e-pansion had been its abilit% to find profitable new business$ but now the determining factor became the availabilit% of funds to lend out. #he essence of assets and liabilities management$ as it came to be called$ was deciding what !inds of new mone% to bu% and what to pa% for it. In the 8nited States the liabilities side of ban! balance sheets now included$ inter alia& in much larger proportion than during the 1G1Hs$ repurchase agreements &under which securities are sold sub*ect to an agreement to repurchase at a stated date'$ federal funds purchases &on the assets side$ federal funds sales'$ e-cess balances of commercial ban!s and other depositor% institutions ®ularl% traded throughout the 8nited States'$ negotiable certificates of deposit &which can be traded on a secondar% mar!et'$ and$ for the larger ban!s$ Eurocurrency borrowings$ mostl% Eurodollars &dollar balances held abroad'. In the 8nited Uingdom$ cboughtc mone% consisted of wholesale &i.e.& large' deposits &on which mone% mar!et rates were paid'$ negotiable certificates of deposit$ interban! borrowings$ and Eurocurrenc% purchases. #his bought mone% could then be used to finance the loan demand$ including term loans$ long favoured in the 8nited States but a more recent innovation in the 8nited Uingdom and elsewhere$ where the% were developed considerabl% in the 1G=Hs. 2lthough much of the lending financed b% bought mone% was b% wa% of term loans$ these could be crolled over$c with an interest rate ad*ustment$ ever% three or si- months$ and there could therefore be a measure of interestrate matching and also sometimes a matching of maturities. In less sophisticated environments than "orth 2merica and the 8nited Uingdom$ there was again an increasing emphasis on bought mone% to meet an% e-pansion in loan demands &much of which was now term lending'$ with an ad*ustment at the margin when more funds were needede.g.& wholesale deposits$ certificates of deposit$ interban! borrowings$ and purchases of Eurocurrencies. ,he principles of central ban"ing #he principles of central ban!ing grew up in response to the recurrent <ritish financial crises of the 1Gth centur% and were later adopted in other countries. ;odern mar!et economies are sub*ect to fre6uent fluctuations in output and emplo%ment. 2lthough the causes of these fluctuations are various$ there is general agreement that the abilit% of ban!s to create new mone% ma% e-acerbate them. 2lthough an individual ban! ma% be cautious enough in maintaining its own li6uidit% position$ the e-pansion or contraction of the mone% suppl% to which it contributes ma% be e-cessive. #his raises the need for a disinterested outside authorit% able to view economic and financial developments ob*ectivel% and to e-ert some measure of control over the activities of the ban!s. 2 central %an! should also be capable of acting to offset forces originating outside the econom%$ although this is much more difficult. .-/#5+B+'+,+- #6 C-5,.4' B458 #he first concern of a central ban! is the maintenance of a soundl% based commercial ban!ing structure. +hile this concern has grown to comprehend the 1?? operations of all financial institutions$ including the several groups of nonban! financial intermediaries$ the commercial ban!s remain the core of the ban!ing s%stem. 2 central ban! must also cooperate closel% with the national government. Indeed$ most governments and central ban!s have become intimatel% associated in the formulation of polic%. Relation"hip" ith commercial %an!"* One source of economic instabilit% is the suppl% of mone%. Even in relativel% wellcontrolled ban!ing s%stems$ ban!s have sometimes e-panded credit to such an e-tent that inflationar% pressures developed. Such an overe-pansion in ban! lending would be followed almost inevitabl% b% a period of undue caution in the ma!ing of loans. >re6uentl% the turning point was associated with a financial crisis$ and ban! failures were not uncommon. Even toda%$ failures occur from time to time. Such crises in the past often threatened the e-istence of financial institutions that were essentiall% sound$ and the authorities sometimes intervened to prevent complete collapse. #he willingness of a central ban! to offer support to the commercial ban!s and other financial institutions in time of crisis was greatl% encouraged b% the gradual disappearance of wea!er institutions and a general improvement in ban! management. #he dangers of e-cessive lending came to be more full% appreciated$ and the ban!s also became more e-perienced in the evaluation of ris!s. In some cases$ the central ban! itself has gone out of its wa% to educate commercial ban!s in the canons of sound finance. In the 8nited States the ?ederal Re"er$e Sy"tem e-amines the boo!s of the commercial ban!s and carries on a range of fran!l% educational activities. In other countries$ such as India and Pa!i"tan$ central ban!s have also set up departments to maintain a regular scrutin% of commercial ban! operations. #he most obvious danger to the ban!s is a sudden and overwhelming run on their cash resources in conse6uence of their liabilit% to depositors to pa% on demand. In the ordinar% course of business$ the demand for cash is fairl% constant or sub*ect to seasonal fluctuations that can be foreseen. It has become the responsibilit% of the central ban! to protect ban!s that have been honestl% and competentl% managed from the conse6uences of a sudden and une-pected demand for cash. In other words$ the central ban! came to act as the clender of last resort.c #o do this effectivel%$ it was necessar% that the central ban! be permitted either to bu% the assets of commercial ban!s or to ma!e advances against them. It was also necessar% that the central ban! have the power to issue mone% acceptable to ban! depositors. <ut if a central ban! was to pla% this role with respect to commercial ban!s$ it was onl% reasonable that it or some related authorit% be allowed to e-ercise a degree of control over the wa% in which the ban!s conducted their business. ;ost central ban!s now ta!e a continuing da%toda% part in the operations of the ban!ing s%stem. #he /an! of En#land$ for e-ample$ has been increasingl% in the mar!et to ensure that the ban!s have a stead% suppl% of cash$ even during periods of credit restriction. It also lends regularl% to the discount houses$ supplementing their resources whenever the commercial ban!s feel the need to call bac! mone% the% have on loan to them. In the 8nited States the >ederal Ceserve S%stem has operated in a similar wa% b% bu%ing 1?G and selling securities on the open mar!et and b% lending to dealers in government securities on the basis of repurchase agreements. #he >ederal Ceserve ma% also discount paper submitted b% the commercial ban!s through the >ederal Ceserve ban!s. #he various techni6ues of credit control in use are discussed in greater detail below. #he evolution of those wor!ing relations among ban!s implies a communit% of outloo! that in some countries is relativel% recent. #he whole concept of a central ban! as responsible for the stabilit% of the ban!ing s%stem presupposes mutual confidence and cooperation. >or this reason$ contact between the central ban! and the commercial ban!s must be close and continuous. #he latter must be encouraged to feel that the central ban! will give careful consideration to their views on matters of common concern. Once the central ban! has formulated its polic% after a full consideration of the facts and of the views e-pressed$ however$ the commercial ban!s must be prepared to accept its leadership. Otherwise$ the whole basis of central ban!ing would be undermined. ,he central ban" and the national economy. Relation"hip" ith other countrie"* Since no modern econom% is selfcontained$ central ban!s must give considerable attention to trading and financial relationships with other countries. If goods are bought abroad$ there is a demand for foreign currenc% to pa% for them. 2lternativel%$ if goods are sold abroad$ foreign currenc% is ac6uired that the seller ordinaril% wishes to convert into the home currenc%. #hese two sets of transactions usuall% pass through the ban!ing s%stem$ but there is no necessar% reason wh%$ over the short period$ the% should balance. Sometimes there is a surplus of purchases and sometimes a surplus of sales. Shortperiod dise6uilibrium is not li!el% to matter ver% much$ but it is rather important that there be a tendenc% to balance over a longer period$ since it is difficult for a countr% to continue indefinitel% as a permanent borrower or to continue building up a command over goods and services that it does not e-ercise. Shortperiod dise6uilibrium can be met ver% simpl% b% diminishing or building up balances of foreign e-change. If a countr% has no balances to diminish$ it ma% borrow$ but normall% it at least carries wor!ing balances. If the commercial ban!s find it unprofitable to hold such balances$ the central ban! is available to carr% them7 indeed$ it ma% insist on concentrating the bul! of the countr%]s foreigne-change resources in its hands or in those of an associated agenc%. Dongperiod e6uilibrium is more difficult to achieve. It ma% be approached in three different wa%s: price movements$ e-change re$aluation &appreciation or depreciation of the currenc%'$ or e-change controls. (rice levels ma% be influenced b% e-pansion or contraction in the suppl% of ban! credit. If the monetar% authorities wish to stimulate imports$ for e-ample$ the% can induce a relative rise in home prices b% encouraging an e-pansion of credit. If additional e-ports are necessar% in order to achieve a more balanced position$ the authorities can attempt to force down costs at home b% operating to restrict credit. #he ob*ective ma% be achieved more directl% b% revaluing a countr%]s eBchan#e rate. 9epending on the circumstances$ the rate ma% 1GH be appreciated or depreciated$ or it ma% be allowed to cfloat.c 2ppreciation means that the home currenc% becomes more valuable in terms of the currencies of other countries and that e-ports conse6uentl% become more e-pensive for foreigners to bu%. Depreciation involves a cheapening of the home currenc%$ thus lowering the prices of e-port goods in the world]s mar!ets. In both cases$ however$ the effects are li!el% to be onl% temporar%$ and for this reason the authorities often prefer relative stabilit% in e-change rates even at the cost of some fluctuation in internal prices. Euite often governments have resorted to e-change controls &sometimes combined with import licensing' to allocate foreign e-change more or less directl% in pa%ment for specific imports. 2t times$ a considerable apparatus has been assembled for this purpose$ and$ despite clea!agesc of various !inds$ the s%stem has proved reasonabl% efficient in achieving balance on e-ternal pa%ments account. Its chief disadvantage is that it interferes with normal mar!et processes$ thereb% encouraging rigidities in the econom%$ reinforcing vested interests$ and restricting the growth of world trade. +hatever method is chosen$ the process of ad*ustment is generall% supervised b% some central authorit%the central ban! or some institution closel% associated with itthat can assemble the information necessar% to ensure that the proper responses are made to changing conditions. Economic fluctuation"* 2s noted above$ monetar% influences ma% be an important contributor% factor in economic fluctuation". 2n e-pansion in ban! credit ma!es possible$ if it does not cause$ the relative overe-pansion of investment activit% characteristic of a boom. Insofar as monetary policy can assist in mitigating the worst e-cesses of the boom$ it is the responsibilit% of the central ban! to regulate the amount of lending b% ban!s and perhaps b% other financial institutions as well. #he central ban! ma% even wish to influence in some degree the direction of lending as well as the amount. 2n even greater responsibilit% of the central ban! is that of ta!ing measures to prevent or overcome a slump. Rece""ion"$ when the% occur$ are often in the nature of ad*ustments to eliminate the effects of previous overe-pansion. Such ad*ustments are necessar% to restore economic health$ but at times the% have tended to go too far7 depressive factors have been reinforced b% a general lac! of confidence$ and$ once this has happened$ it has proved e-tremel% difficult to stimulate recover%. In these circumstances$ prevention is li!el% to be far easier than cure. It has therefore become a recogni5ed function of the central ban! to ta!e steps to preclude$ if possible$ an% such general deterioration in economic activit%. >or the central ban! to be effective in regulating the volume and distribution of credit so that economic fluctuations ma% be damped$ if not eliminated$ it must at least be able to regulate commercial ban! li6uidit% &the suppl% of cash and cnear cashc'$ because this is the basis of ban! lending. ;onetar% authorities in a number of countries have begun to resort increasingl% to the management of monetar% aggregates as a basic polic%. #his does not mean an uncritical acceptance of monetarist philosoph% but rather what the 8.S. economist and ban!er (aul 2. Volc!er has called cpractical monetarism.c In addition to the >ederal Ceserve in the 8nited States$ a growing number of western European countries have adopted the practice of setting growth targets for the mone% suppl% and sometimes other monetar% targets as well &li!e domestic credit e-pansion'$ usuall% setting some range of allowable variation. @apan has had reservations and has preferred to indicate monetar% 1G1 pro*ections or forecasts$ partl% because of the difficult% of changing a set target should it become necessar%. "or is there an% great degree of consensus as to which target or aggregate to emplo%. In general terms$ choice of a particular aggregate as a basis for reference would be lin!ed to the theoriesmore or less e-pliciton which the actions of a particular central ban! are based and also on the state of the countr%]s econom% and its financial environment. +here there are publicl% declared targets$ these can have an important effect b% the ver% fact of being announced. #here is now little dispute about the broad ob*ectives$ though the techni6ues of control are various and depend to some e-tent on environmental factors. It would be incorrect to suppose$ however$ that the actions of the central ban! can$ unaided$ achieve a high degree of stabilit%. It can b% wise guidance contribute to that end$ but monetar% action is in no sense a panacea7 at all times$ the degree to which it is li!el% to be effective depends on the provision of an appropriate fiscal environment /an!in# "er$ice"* 2nother responsibilit% of the central ban! is to ensure that ban!ing services are ade6uatel% supplied to all members of the communit% that need them. Some areas of a countr% ma% be cunderban!edc &e.g.& the rural areas of India and the northern and more remote parts of "orwa%'$ and central ban!s have attempted$ directl% or indirectl%$ to meet such needs. In >rance$ this need underla% the earl% e-tension of branches of the <an! of >rance to the dEpartements. In India the authorities encouraged the opening of cpioneerc branches b% the former Imperial <an! of India and its successor$ the State <an! of India$ latterl% b% all the nationali5ed ban!s$ and particularl% their e-tension to rural and semirural areas. In (a!istan$ officials of the State <an! of (a!istan pla%ed an active part in the foundation of the semipublic "ational <an! of (a!istan with a similar ob*ective in view. 2 different sort of problem arises when the business methods of e-isting ban!s are unsatisfactor%. In such circumstances$ a s%stem of ban! inspection and audit organi5ed b% the central ban!ing authorities &as in India and (a!istan' or of ban! ce-aminationsc &as in the 8nited States' ma% be the appropriate answer. 2lternativel%$ the supervision of ban! operations ma% be handed over to a separate authorit%$ such as >rance]s <an!ing Control Commission or South 2frica]s Cegistrar of <an!s. In developing countries$ central ban!s ma% encourage the establishment and growth of specialist institutions such as savings institutions and agricultural credit or industrial finance corporations. #hese serve to improve the mechanism for tapping e-isting li6uid resources and to supplement the flow of funds for investment in specific fields. Re"pon"i%ilitie" to the #o$ernment* 1G, Central ban!s have over the %ears ac6uired a number of welldefined responsibilities to their respective national governments. Some$ notabl% the <an! of England$ developed into central ban!s after being$ in origin$ ban!ers to the government. ;ore recentl% it has become a matter of course for a new central ban! to accept responsibilit% for the financial affairs of its government. #he reasons are self evident. Fovernment transactions have become of increasing importance in influencing the wor!ings of the econom%$ and the institution that holds the government]s account is in a strategic position to cushion the commercial ban!s against the impact of large movements of cash originating in this wa%. 2s ban!er to the government$ furthermore$ the central ban! has an obvious responsibilit% to provide routine ban!ing services$ such as arranging loan flotations and supervising their service$ renewal$ and redemption. #he central ban! also usuall% issues the currenc%. E6uall% important are its responsibilities as an adviser on the probable monetar% conse6uences of an% proposed action. In this role the central ban! should scrutini5e the government]s proposals with a certain amount of ob*ectivit% and state its point of view with vigour. One ma% cite a nowfamous dictum of ;ontagu "orman as governor of the <an! of England: 2 think it is of the utmost importance that the policy of the Bank and the policy of the 1overnment should at all times %e in harmony--in as complete harmony as possi%le. 2 look upon the Bank as having the uni=ue right to offer advice and to press such advice even to the point of <nagging<# %ut always of course su%Bect to the supreme authority of the 1overnment. ;an% central ban!s are now nationali5ed$ reflecting the increasingl% general recognition of the significance of the central ban!]s role as a servant$ if not a creature$ of the government. #his development is also$ in a wa%$ a final recognition of the central ban! as a responsible public institution whose ma*or function is to serve the communit% as a whole$ untrammelled b% narrow dictates of profit and loss. ;ost central ban!s$ nevertheless$ ma!e ver% handsome profits. ,-C*5+97- #6 C.-D+, C#5,.#' Central ban!s have developed a variet% of techni6ues for influencing$ regulating$ and controlling the activities of commercial ban!s. #hese ma% be divided into &1' the socalled classical$ or indirect$ techni6ues and &,' various direct controls. #he classical techni6ues ma!e use of openmar!et purchases or sales b% the central ban! of certain t%pes of assets that are invariabl% associated with fluctuations in interest rates. 9irect$ or 6uantitative$ credit controls are emplo%ed to influence the cash and li6uidit% bases of commercial ban! lending b% means of free5ing or unfree5ing their li6uid resources7 sometimes ceilings are imposed on ban! loans. .pen0mar!et operation"* 1G. #he wa% in which openmar!et operations influence the cash reserves and$ through them$ the general li6uidit% of the commercial ban!s is essentiall% simple. If the central ban! bu%s securities in the open mar!et$ the cash it offers in e-change adds to the reserves of the ban!s7 if the central ban! sells securities in the open mar!et$ the cash necessar% to pa% for them is either withdrawn from the ban!s] reserves or obtained b% diminishing holdings of other assets &with the possibilit% of capital losses in conse6uence of these sales'. It does not matter whether this bu%ing and selling ta!es place between the central ban! and the commercial ban!s directl% or between the central ban! and other financial sectors$ including the public at large$ since these are the customers of the commercial ban!s. Openmar!et operations are invariabl% associated with related changes in one or more cstrategicc rates of interest$ the most influential of these rates being the minimum rate at which the central ban! does business &the ban! rate$ or the di"count rate'$ since other rates tend to move in s%mpath% with it. #he central ban! see!s to achieve an appropriate and consistent structure of interest rates. If a particular rate structure is desired &e.g.& prior to a new issue of government securities or in order to change the emphasis of institutional investment between$ sa%$ longterm and short term securities'$ it ma% be necessar% to precondition the mar!et b% means of open mar!et operations. #o achieve its purposes the central ban! must possess &if it is selling' or be willing to absorb &if it is bu%ing' the appropriate t%pes of securities. In Dondon the specialist ban!s !nown as di"count hou"e" effectivel% put to wor! the revolving fund of cash that circulates through the <ritish ban!ing s%stem. If temporaril% there is an inade6uate suppl% of cash$ the <an! of England either lends on a shortterm basis or bu%s some of the assets held b% the discount mar!et. &>rom 1G?H there was a shift in emphasis from lending to openmar!et operations$ especiall% b% dealing in ban!ers] acceptances.' 2lternativel%$ the <an! of England ma% bu% assets from the clearing ban!s &the large *ointstoc! ban!s'$ which then ma!e the relevant mone%s available to the mar!et. On the other hand$ if the discount mar!et is oversupplied with funds$ the <an! of England sells treasur% bills$ in this wa% mopping up the e-cess of cash. #hese transactions are !nown as smoothingout operations. In addition$ the <an! of England is also responsible for managing the national debt$ and$ whether the ob*ect is to influence the flows of mone% or not$ such transactions in fact have monetar% effects. In the 8nited States the >ederal Ceserve S%stem regulates the mone% suppl%. +ithin the >ederal Ceserve S%stem$ the ?ederal .pen Mar!et Committee is the most important single polic%ma!ing bod%. It is presided over b% the chairman of the <oard of Fovernors$ with the president of the >ederal Ceserve <an! of "ew :or! as its permanent vice chairman. #he main responsibilit% of the Open ;ar!et Committee is to decide upon the timing and amount of openmar!et purchases or sales of government securities. Since openmar!et operations must obviousl% be consistent with other aspects of monetar% and credit polic%$ it is in the committee that broad agreement is reached on matters such as changes in discount rates or reserve re6uirements. One of the big differences between Dondon and "ew :or! is that the central ban!ing authorities in "ew :or! maintain direct relationships more or less continuousl% with the nonban! government securities dealers as well as with the commercial ban!s. #he >ederal Ceserve <an! of "ew :or! ma% ma!e temporar% accommodation available to some .0 primar% dealers &including certain ban!s' under 1G/ a repurchase agreement$ whereb% securities are sold to the ban! under an agreement that the% be repurchased after a stipulated time. #hese agreements are made onl% for the purpose of suppl%ing reserves to the ban!ing s%stem$ but from the dealer]s standpoint the% are helpful in financing portfolios. Such repos$ as the% are called$ ma% also be done with foreign official accounts. Since earl% 1G11 the ban! has also been prepared to mop up mone% b% underta!ing reverse repurchase agreements$ in which the dealers act as intermediaries for large commercial ban!s with temporaril% surplus mone% that the% are prepared to place against bills$ sub*ect to the ban!]s repurchasing them a few da%s later7 the commercial ban! concerned lends the dealer the mone% to finance the holding of the bill. Similar arrangements are also made b% the >ederal Ceserve directl% with ban! dealers. 2ll member ban!s of the >ederal Ceserve S%stem$ and now also other depositor% institutions$ have direct access to the discount service of their >ederal Ceserve <an!$ of which there is one in each of 1, districts. #his is a privilege$ however$ and not a right. In the earl% %ears of the s%stem$ the ban!s would sell discountable paper to the >ederal Ceserve$ but now the% usuall% borrow against a pledge of government securities held in safe custod% with the >ederal Ceserve <an! in 6uestion. #he >ederal Ceserve lends for a number of purposes but alwa%s at a time of general stress. It is assumed that$ as the pressure abates$ borrowing ban!s will repa% their indebtedness as 6uic!l% as possible. 8nder ordinar% conditions$ the continuous use of >ederal Ceserve credit b% a member ban! over a considerable period is not regarded as appropriate. Direct control of a""et"* #he socalled classical techni6ues of credit controlopenmar!et operations and discount polic%can be emplo%ed onl% where there is a sufficientl% developed comple- of mar!ets in which to bu% and sell assets of the t%pe that commercial ban!s ordinaril% hold. 9irect credit controls have a wider range of application. #he% ma% be used either as a substitute for the classical techni6ues or as a supplement to them. 9irect controls are more li!el% to be resorted to when the money mar!et is undeveloped$ because then a central ban! can onl% impose its authorit% b% means of direct action. #his is often the situation facing a newl% established central ban!. Cather than wait for the slow evolution of a mone% mar!et$ the authorities ma% provide the central ban! from the start &as in (a!istan$ the (hilippines$ Sri Dan!a$ and ;ala%sia' with ver% full powers to control the ban!ing s%stem. #he aim in imposing a direct$ 6uantitative regulation of credit is to curb inflationary pressures that ma% result from an e-pansion of commercial ban! lending. #his can be done in four main wa%s: &1' the commercial ban!s ma% be re6uired to maintain stated minimum reserve ratios of cash to deposits$ a stated li6uid assets ratio$ or some combination of both7 &,' part of the cash resources of the commercial ban!s ma% be immobili5ed at the discretion of the central ban!7 &.' ceilings ma% be imposed on the amount of accommodation to be made available to the commercial ban!s at the central ban! &sometimes referred to as cdiscount 6uotasc'7 and &/' a ceiling ma% be prescribed for commercial ban! lending itself. 1G0 Minimum re"er$e re+uirement"* #he variation of minimum cash reserve re6uirements as a direct means of 6uantitative credit control has become increasingl% general in recent %ears. #he practice has largel% derived from e-perience in the 8nited States. In its origin the 8.S. insistence on stated minimum reserve re6uirements for commercial ban!s was simpl% a means of prescribing minimum standards of sound behaviour. Onl% later did such ratios come to be seen as a useful supplementar% 6uantitative credit control. #he power granted b% the /an!in# Act of 1G.0 to the >ederal Ceserve S%stem to determine the cash reserves of the commercial ban!s in the 8nited States was emplo%ed for the first time during the boom of 1G.1.=$ and periodic variation of minimum reserve re6uirements subse6uentl% came to be recogni5ed as an appropriate techni6ue for controlling the mone% suppl%. #he >ederal Ceserve <oard]s decisions were sometimes sub*ect to considerable criticism$ but$ as it became more e-perienced in the use of this techni6ue$ variation in reserve re6uirements combined with other measures came to be regarded as a useful means of cushioning the econom% against a recession. #he variation of reserve re6uirements did not prove as effective in preventing inflation$ largel% because of the government]s insistence that the >ederal Ceserve simultaneousl% support the prices of government bonds through openmar!et operations. #his insistence was abandoned b% the #reasur% in ;arch 1G01. Since then$ much greater emphasis has been placed on the use of openmar!et operations$ which had become more effective$ and the importance of var%ing minimum reserve re6uirements as a means of controlling the credit base has diminished in the 8nited States. #he techni6ue is still widel% used$ however$ in man% countries. In some countries$ the authorities re6uire the maintenance of minimum li6uid assets ratios. #his is often combined with minimum re6uirements for cash reserves$ as in India$ Pa!i"tan$ and Ferman%$ though not alwa%s &in >rance$ for e-ample$ until 1G1= there were no minimum cash reserve re6uirements'. +here prescribed minima relate to li6uid assets and not to cash as such$ reserves are held in the form of earning assetsan important distinction from the point of view of the commercial ban!s. 2n important step toward a uniform and e-plicit minimum li6uidit% ratio for the Dondon clearing ban!s was ta!en in 1G01$ when the governor of the <an! of England indicated to the ban!s that a li6uidit% ratio of from ., to ,? percent would be regarded as normal and that it would be undesirable for the ratio to be allowed to fall below ,0 percent. <% 1G0= a fairl% rigid .Hpercent minimum was in place &it was reduced to ,? percent in 1G1.'. 2fter 1G/1 the Dondon clearing ban!s &but not the Scottish ban!s' also observed a more or less fi-ed cash ratio of ? percent. 2 new element was introduced in 1G1H$ when the <an! of England launched its s%stem of cspecial depositsc as a means of reinforcing other methods of credit control. Calls were made from time to time on the Dondon clearing ban!s to deposit with the <an! of England b% a specified date some specified percentage of their gross deposits7 similar arrangements applied to the Scottish ban!s$ but the calls were smaller. #his s%stem lasted until 1G=1$ when a new 1,.0percent minimum reserve ratio &e-cluding till cash' was introduced. #his ratio related to celigible liabilitiesc &primaril% sterling deposits of up to two %ears maturit%$ including sterling certificates of deposit'. #he ban!s could also be re6uired to place special deposits with the <an! of England. #hese arrangements were replaced in 2ugust 1G?1 b% a voluntar% holding of operational funds with the <an! of England b% the Dondon clearing ban!s &cfor clearing purposesc' and a uniform re6uirement of H.0 percent of an institution]s eligible liabilities that would be applied to all ban!s and licensed 1G1 depositta!ers with eligible liabilities averaging more than 1H$HHH$HHH. 2ll ban!s that were eligible acceptors were also normall% re6uired to hold an average e6uivalent to 1 percent of their eligible liabilities either as secured mone% with discount houses or as secured call mone% with mone% bro!ers and giltedged *obbers$ but the amount held in the form of secured mone% with a discount house was not normall% to fall below / percent of eligible liabilities. #his mone% became !nown as cclub mone%.c #he use of variable minimum reserve re6uirements as a means of credit control can$ if carried far enough$ produce results$ especiall% when the re6uirements include the holding of cash balances. It is more useful as an anti inflationar% weapon than as a means of countering recession$ since it cannot overcome a possible unwillingness of the ban!s to lend or of their customers to borrow. It is a somewhat clums% techni6ue$ however$ and cannot ma!e ade6uate allowance for the special needs of different institutions. Immo%iliIation of ca"h re"ource" 2 second group of direct 6uantitative credit controls involves !eeping a portion of the cash resources of commercial ban!s immobili5ed at the discretion of the central ban!. #wo leading e-amples of this techni6ue were the use of the #reasur% 9eposit Ceceipt 	C' in the 8nited Uingdom during and after +orld +ar II and the cspecial account procedurec adopted in 2ustralia in 1G/1. <oth were means of immobili5ing the increased li6uidit% deriving from wartime government e-penditure. #he direct issue of #reasur% 9eposit Ceceipts at a nominal rate of interest to ban!s in the 8nited Uingdom began in @ul% 1G/H. #he% were not negotiable in the mar!et or transferrable between ban!s$ but the% could be tendered in pa%ment for government bonds &and ta- certificates'7 hence$ during the war %ears the% had a limited degree of li6uidit%. #he <an! of England communicated to the ban!s collectivel% the amount of the wee!l% call$ which was divided among them in proportion to their deposits. 2fter the war$ #9C]s were replaced b% treasur% bills7 in order to reduce the conse6uent high li6uidit% of the ban!s$ there was a cforced fundingc of 1$HHH$HHH$HHH of treasur% bills in "ovember 1G01$ which were re6uired to be invested in Serial >unding Stoc!s. #he special account procedure introduced in Au"tralia in 1G/1 had a similar ob*ective. #he surplus investable funds of the 2ustralian trading ban!s$ defined as the amount b% which each ban!]s total assets in 2ustralia at an% time e-ceeded the average of its total assets in 2ustralia in 2ugust 1G.G$ were re6uired to be placed in special deposit accounts with the Commonwealth <an! &then the central ban!' at a nominal rate of interest. 2 ban! was not to withdraw an% sum from its special account e-cept with the consent of the Commonwealth <an!7 during the war %ears$ the ban! generall% directed the trading ban!s to lodge in their special accounts each month an amount e6ual to the increase in their total assets in 2ustralia during the preceding month$ although as a rule a lodgment was not re6uired if it was !nown that a rise in assets would be followed b% an earl% fall. Degislation in 1G/0 adopted the special account procedures as a means of general credit control &e.g.& to curb inflation'$ but the provisions were made more fle-ible. In 1G0. a more complicated formula was introduced$ and in 1G1H the s%stem was abandoned in favour of minimum reserve ratios. 1G= Direct control of loans. Accommodation ceilin#"* Some countries have tried limiting the amount of accommodation that the central ban! ma% ma!e available to the commercial ban!s. #he difficult% in this t%pe of 6uantitative credit control is to ma!e it effective while also allowing for changes in the econom%7 its most obvious use is as a means of chec!ing inflation$ but$ if the upward pressures on prices are strong$ there is a temptation to increase the ceilings so that the restraint then becomes little more than a temporar% chec!. 8suall%$ it is onl% when a control begins to be felt and to affect ban! profits that the ban!s become reall% sensitive to changes in credit polic% and the implementation of the control becomes trul% effective. #he postwar e-perience of >rance is a case in point. 3lafonds& or cceilings$c were first introduced in >rance in 1G/?. Cediscount ceilings &or discount 6uotas' were fi-ed for each ban!$ though some categories of paper were e-cluded. Ceilings could be increased or &after 1G0=' reduced. >rom the authorities] point of view$ the chief difficult% in operating this control was the persistent building up of pressure against the ceilings. #his was met partl% b% upward revisions in the ceilings themselves and partl% b% instituting a number of safet% valves. #he degree of elasticit% re6uired constituted the chief wea!ness of the ceiling techni6ue. #he central ban! was constantl% under pressure to ad*ust the ceilings upward. Some upward revisions were unavoidable$ but the problem was to decide which claims were legitimate and which not. ;uch bilateral bargaining too! place between the /an! of ?rance and individual commercial ban!s$ but the ban!s continued to complain that the strictness of the control was e-cessive and that the techni6ue was lac!ing in fle-ibilit%. #he inade6uacies of the plafonds techni6ue in its original form became apparent when prices began to rise rapidl% during the Uorean +ar boom$ and even the builtin safet% valves failed full% to accommodate the pressures on ban! li6uidit%. #he need to strengthen the mechanism was obvious$ and this was attempted in 1G01. (reviousl%$ rediscounts had fre6uentl% e-ceeded the ceilings during the month and were onl% brought within the plafonds b% special action &e.g.& through openmar!et purchases'. #he situation was brought under control b% introducing a secondar% ceiling to which a penalt% rate of interest was applied. #his was e-tended in 1G0? to permit rediscounts even be%ond the secondar% ceiling$ provided a further penalt% was paid7 each application$ however$ was scrutini5ed b% the <an! of >rance. #he s%stem lasted until about the spring of 1G1/$ though it did not finall% disappear until 1G1?$ when it was largel% replaced b% <an! of >rance operations in the open mar!et. 2fter earl% 1G1=$ ban!s also were sub*ect to minimum reserve re6uirements. 3lafonds& or discount 6uotas$ also are emplo%ed in Ferman%. #he% were introduced in +est Ferman% in 1G0, and strengthened in 1G00. Euotas ma% be reduced periodicall% &after 1G1/ the% were also used to discourage institutions from borrowing abroad'. 2gain there were safet% valves &although less generous than in >rance' and the possibilit% of e-tra accommodation &Dombard credits' at a higher rate. In some circumstances$ supplementar% 6uotas might be approved for up to si- months. 2 ban! might also raise funds through the mone% mar!et$ though li!el% at higher cost. 9iscount 6uotas are still an important tool of credit control in Ferman%. Other countries have emplo%ed this techni6ue$ including Seden$ where for a time the central ban! imposed formal or informal ceilings on ban!s and sometimes on finance companies. 1G? If the ban!s failed to observe the ceiling$ a penalt% was applied based on the amount of the e-cess borrowing and its duration. In ?inland$ commercial ban!s have at times been able to borrow limited amounts from the <an! of >inland b% wa% of traditional credit 6uotas. <e%ond these 6uotas$ funds could formerl% be obtained as supra6uota credit at a higher rate$ but ban!s now are forced into the official callmone% mar!et. Denmar!$ too$ has permitted borrowing from the central ban! in tranches$ with higher &penalt%' rates appl%ing after the first tranche of the loan 6uota has been resorted to$ a practice that can be e-pensive. :eneral ceilin#" on credit* 2ttempts have been made to prescribe a general ceiling within which the 6uantit% of commercial ban! lending must be held. #his is even more difficult to achieve. One e-ample of such an attempt was the adoption of a crising ceilingc b% Chile in 1G0.. 2ll ban!s were re6uired not to e-pand the volume of their loans to businesses and individuals b% more than 1.0 percent a month$ using as their basis the average of a ban!]s advances on selected dates in 1G0.. Certain t%pes of loans were forbidden$ and ban! resources were to be directed to productive and distributive activities that reall% contributed to the e-pansion of the national econom%. <an!s were also re6uired to provide information on the destination of their loans. In succeeding %ears$ ad*ustments were made on several occasions in the ma-imum permitted credit increase$ e-pressed either as a percentage of advances or sometimes as a total for the ban!ing s%stem as a whole. In 1G0G all 6uantitative credit restrictions were removed$ and ban!s were permitted to advance funds up to their financial capacit%$ provided that the% operated within the general ban!ing law. #here was no evidence the controls had been effective$ but the ma*or problem in Chile was budgetar% rather than monetar%. 2 temporar% ceiling on loans was imposed b% agreement in Canada &in 1G010,'$ The -etherland" &1G0=0?'$ and >rance &1G0? 0G'. #he 8nited Uingdom had considerable e-perience with this t%pe of ceiling$ introducing it as a temporar% measure in 1G00$ when the ban!s were as!ed to bring their advances down b% an average of 1H percent. Dater an attempt was made to impose a true ceiling$ re6uiring that ban! advances not e-ceed the average of the period October 1G01 to September 1G0=. #his was continued until @ul% 1G0?. 2gain$ in 1G11$ the authorities indicated the ban!s must aim at chec!ing the rate of rise in ban! advances7 this came to be interpreted as a re6uest that the level of advances at the end of 1G11 be no higher than in the previous @une. #he ban!s also were not to encourage an increase in the volume of commercial bills. #he re6uest was modified in ;a% 1G1, and largel% withdrawn in October7 but it was made again in ;a% 1G10$ when the clearing ban!s were re6uested not to increase their advances to the private sector$ at an annual rate of more than about 0 percent$ in the 1, months to mid;arch 1G11 &li!ewise with commercial bills'. Other financial institutions were re6uested to observe a comparable degree of restraint. >or 1, months after ;arch 1G11$ advances and discounts$ allowing for seasonal factors$ were not permitted to rise above levels set for ;arch 1G11. #his represented an intensification of the credit s6uee5e because prices were rising. #he credit restriction led to a falling off in business confidence$ and$ conse6uentl%$ toward the end of 1G11$ ban! lending was well below the official ceiling. In 2pril 1G1=$ authorities announced a change in techni6ues$ with an emphasis on ma!ing calls to special deposits$ but the ceilings returned again in "ovember 1G1=. #here was to be no increase in ban! advances to the private sector &e-cluding e-ports and shipbuilding' e-cept for seasonal reasons. In ;a% 1G1? a new 1GG ceiling was instituted for all such lending &including that for e-ports and shipbuilding'7 the clearing ban!s were as!ed to restrict the total of this lending$ after seasonal ad*ustment$ to 1H/ percent of the "ovember 1G1= figure$ with priorit% to be given to finance for e-ports and for activities directl% related to improving the balance of pa%ments. #he restrictions also e-tended to other t%pes of credit. Credit became even tighter &in ;arch 1G1G' when the ceiling was reduced to G? percent of the "ovember 1G1= level. #he ban!s had considerable difficult% in meeting this re6uirement and agreed merel% to cdo their best.c 2dvances increased above the ceiling$ and$ as a penalt%$ the interest paid b% the <an! of England on special deposits was halved. "ot until late 1G1G did it become clear that the authorities were prepared to abandon their long campaign to get ban! loans down to the target figure. #he ceiling was subse6uentl% replaced b% minimum reserve re6uirements. #he s%stem of 6uantitative credit control re6uires$ for its successful implementation$ the full cooperation of the ban!ing communit%. In the 8nited Uingdom$ where ban!s base much of their lending on the overdraft techni6ue$ the s%stem was ver% unpopular. In >rance$ however$ the encadrement du crEdit& as it is called$ temporaril% imposed in 1G0?0G$ was revived during the first half of 1G=.. Sub*ect to certain e-clusions &e.g.& certain investment credits$ agricultural credits$ e-port credits$ the financing of energ% savings and innovation$ leasing transactions$ and special medium term construction loans'$ the mechanism chosen was to permit a certain percentage rate of growth in ban! credits in relation to a particular month in the previous %ear$ these limits being fi-ed 6uarterl% and sub*ect to variation from time to time. Subse6uentl%$ in earl% 1G=0$ reference was made to a fi-ed base defined as e6ual to an inde- of 1HH$ in relation to which the inde- might be increased &or decreased' and credit e-panded &or contracted'. #he s%stem was further refined to var% the rate of change of credits within different financial sectors$ and it has been sub*ect in the interests of fle-ibilit% to man% amendments over the %ears. In effect$ there has been a combination of 6uantitative and 6ualitative credit controls. In addition to regulating the 6uantit% of credit$ central ban!s have sometimes attempted to influence the directions in which the commercial ban!s lend. 2 loose s%stem of control prevailed in the 8nited Uingdom during +orld +ar II and afterward$ based initiall% on directives from the Capital Issues Committee and later on re6uests from the /an! of En#land. 2 highl% formali5ed techni6ue was emplo%ed in 2ustralia during the war and earlier postwar %ears7 detailed and specific instructions were given to the trading ban!s$ marginal cases being referred to the central ban!. #he s%stem of Voluntar% Credit Cestraint in the 8nited States in 1G01 was similar. #he more formal controls seemed to be no more effective than the looser s%stem emplo%ed in the 8nited Uingdom. Selective controls have been imposed on consumer installment finance in the 8nited States and elsewhere &e.g.& b% stipulating the percentage of deposit that is re6uired and the length of the term over which repa%ments ma% be made'. Even when these are not varied in order to serve as a control over credit$ there is a case for insisting on such re6uirements for prudential reasons. In the 8nited States$ under the Securitie" EBchan#e Act of 1G./$ the >ederal Ceserve can var% the margins that purchasers of securities must pa% in cash$ thereb% limiting the credit available for this purpose. ,HH The "tructure of modern %an!in# "y"tem" #he ban!ing s%stems of the world have man% similarities$ but the% also differ$ sometimes in 6uite material respects. #he principal differences are in the details of organi5ation and techni6ue. #he differences are graduall% becoming less pronounced because of the growing efficienc% of international communication and the tendenc% in each countr% to emulate practices that have been successful elsewhere. <an!ing s%stems ma% be classified in terms of their structure as unit ban!ing$ branch ban!ing$ or h%brids of the two. >or e-ample$ unit ban!ing prevails in large areas of the 8nited States. In other countries it is more usual to find a small number of large commercial ban!s$ each operating a highl% developed networ! of branches. #his is the s%stem used in England and +ales$ among others. E-amples of h%brid s%stems include those of >rance$ Ferman%$ and India$ where ban!s that are national in scope are supplemented b% regional or local ban!s. Some of these h%brid s%stems are slowl% changing their character$ the ban!s becoming fewer in number and individuall% larger$ with a larger number of branches. 75+, B458+5:! ,*- 75+,-D ,4,- <an! organi5ation in the 1nited State" during the %ears after +orld +ar II was still passing through a phase of structural development that man% other countries had completed some decades earlier. 9evelopment in the 8nited States has been sub*ect to constraints not found elsewhere. #he federal Constitution permits both the national and state governments to regulate ban!ing. Some states prohibit branch ban!ing$ largel% because of the political influence of small local ban!ers$ thus encouraging the establishment and retention of a large number of unit ban!s. Even in its earl% %ears$ the 8nited States had an unusuall% large number of ban!s. 2s the frontiers of settlement were pushed rapidl% westward$ ban!s sprang up across the countr%. One reason for this was the demand for capital in the e-panding frontier econom%. #here was also an obvious need for a large number of ban!s to serve the diverse and rapidl% e-panding demands of a growing and constantl% migrating population. It must be remembered$ too$ that at this time communications between the frontiers of settlement and the established centres of commerce and finance were still inade6uatel% developed. 2s long as communications remained imperfect$ the e-istence of large numbers of competing institutions is not difficult to e-plain. #he subse6uent failure of ban! mergers or amalgamations to produce a concentration of financial resources in the hands of large ban!ing units can be attributed in part to the character of the federal Constitution as noted above. 2mong the people$ moreover$ there was a widespread distrust of monopol% and a deeprooted fear that a cmone% trustc might develop. #his went hand in hand with a political philosoph% that emphasi5ed the virtues of individualism and free competition7 restrictions on branching$ merging$ and on the formation of holding companies were a feature of both the state and the federal ban!ing laws. +here permitted$ however$ ban! branches are numerous in the 8nited States &especiall% in California and in "ew :or!'7 in states in which branching is prohibited$ one often finds local ban! monopolies in small towns. Interstate ban!ing is prohibited b% federal law$ but large ban!ing organi5ations have provided financial ,H1 services &e.g.& through loan offices and offices of nonban! subsidiaries' for man% %ears across state lines. 2 number of states have passed limited interstate or reciprocal ban!ing laws$ so that ban!s in other states with similar laws can ac6uire or merge with local ban!s. #he ban!ing s%stem of the 8nited States would not wor! without a networ! of correspondent ban! relationships$ which are more highl% developed there than in an% other countr%. >rom the 1G=Hs there was an acceleration in the evolution of 8.S. ban!ing patterns. 8nregulated financial institutions &and some nonfinancial institutions' moved into traditional ban!ing activities7 at the same time$ depositor% institutions began offering a fuller range of financial services. ;one% mar!et mutual funds$ for e-ample$ secured access to openmar!et interest rates for investors with relativel% small amounts of mone%. Securities firms and insurance companies moved aggressivel% into providing a range of li6uid financial instruments. Di!ewise$ large manufacturing and retail firms moved into the commercial and retail lending businessese.g.& b% ac6uiring a savings and loan association$ a securities bro!erage house$ an industrial loan compan%$ a consumer ban!ing business$ or even a commercial ban!. ;eanwhile$ depositor% institutions developed a number of new services$ most notabl% the "egotiable Order of +ithdrawal &"O+' account$ an interestbearing savings account with a near substitute for chec!s. #hese appeared first in 1G=, in "ew England and after 1G?H spread to the whole nation7 the% were offered both b% commercial ban!s and b% thrift institutions. Share drafts at credit unions also became a means of pa%ment$ and after 1G=? the automatic transfer services of commercial ban!s permitted savings account funds to be transferred automaticall% to cover overdrafts in chec!ing accounts. Socalled Super"O+ accounts &with no interest rate ceilings and unlimited chec!ing facilities with a minimum balance' were subse6uentl% introduced$ along with mone%mar!et deposit accounts$ free of interest rate restrictions but with limited chec!ing. Capid changes in financial structure and the suppl% of financial services posed a host of 6uestions for regulators$ and$ after much discussion$ the 9epositor% Institutions 9eregulation and ;onetar% Control 2ct was passed in 1G?H. #he ob*ect was to change some of the rulesman% of them obsoleteunder which 8.S. financial institutions had operated for nearl% half a centur%. #he principal ob*ectives were to improve monetar% control and e6uali5e more nearl% its cost among depositor% institutions7 to remove impediments to competition for funds b% depositor% institutions$ while allowing the small saver a mar!et rate of return7 and to e-pand the availabilit% of financial services to the public and reduce competitive ine6ualities among financial institutions offering them. #he ma*or changes were: &1' 8niform >ederal Ceserve re6uirements were phased in on transaction accounts &demand deposits$ "O+ accounts$ telephone transfers$ automatic transfers$ and share drafts' at all depositor% institutionscommercial ban!s &whether >ederal Ceserve members or not'$ savings and loan associations$ mutual savings ban!s$ and credit unions. &,' #he >ederal Ceserve <oard was authori5ed to collect all data necessar% for the monitoring and control of mone% and credit aggregates. &.' 2ccess to the discount window at >ederal Ceserve ban!s was widened to include an% depositor% institution issuing transaction accounts or nonpersonal time deposits. &/' #he ?ederal Re"er$e was to price its services$ to which all depositor% institutions would now have access. &0' Cegulation E$ which had long set interestrate ceilings on deposits$ was to be phased out over a si-%ear period. &1' 2n attempt was made to grasp the nettle of the state usur% laws. &=' "O+ accounts were authori5ed on a nationwide basis and could be offered b% all depositor% institutions. Other services were e-tended. &?' #he permissible activities of thrift institutions were broadened considerabl%. &G' 9eposit ,H, insurance at commercial ban!s$ savings ban!s$ savings and loan associations$ and credit unions was raised from N/H$HHH to N1HH$HHH. &1H' #he ctruth in lendingc disclosure and financial regulations were simplified to ma!e it easier for creditors to compl%. B.45C* B458+5:! ,*- 75+,-D 8+5:D#M If the 8nited States ban!s can be ta!en as representative of a unit ban!ing s%stem$ the /riti"h s%stem is the protot%pe of %ranch %an!in#. Its development was lin!ed to the growth of transportation and communications$ for otherwise ban!s cannot clear chec!s drawn on other ban!s and effect remittances speedil% and efficientl%. #he Scots favoured branch ban!ing from the ver% beginning &the <an! of Scotland was founded in 11G0'$ but at first the% were not ver% successfullargel% because of poor communications and the difficult% of suppl%ing branches with ade6uate amounts of coin. "ot until after the "apoleonic +ars$ when the road s%stem of Scotland had been greatl% improved$ did branch ban!ing begin to develop vigorousl% there. 2s the Industrial Cevolution progressed and as the si5e of businesses increased$ the structure of English ban!ing underwent a corresponding change. Freater resources were re6uired for lending$ and ban!s also needed more e-tensive interconnections in order to provide an increasing range of services. +here ban!s remained small$ the% were fre6uentl% unable to ta!e the strain of the larger demand7 the% tended to become overe-tended and often failed. #he growth in si5e of ban!s was also greatl% encouraged b% legislation that encouraged *ointstoc! ownership$ beginning in 1?,1. @ointstoc! ownership$ which reduced the ris! to an% individual$ must be distinguished from limited liabilit%$ which did not become widel% accepted until the failure of the Cit% of Flasgow <an! in 1?=? demonstrated the need for a legal device to protect the stoc!holder. #he earl% *oint stoc! ban!s tended to remain locali5ed in their business interests7 it was onl% graduall% &with the spread of limited liabilit% and disclosure of accounts' that amalgamations began to convert the ban!ing s%stem in England and +ales into its highl% concentrated modern form. #he main movement was completed before +orld +ar I$ though there was to be a further degree of concentration in the %ears after +orld +ar II. <% these means$ <ritish ban!s were able to attract deposits from all parts of the countr% and to spread the ban!ing ris! over a wide range of industries and areas. *YB.+D Y,-M 2 third group of ban!ing s%stems differs from the unit ban!ing s%stem of the 8nited States and also from the branch ban!ing s%stems of countries that have followed the <ritish model &such as 2ustralia$ Canada$ "ew Yealand$ and South 2frica'. #his group is characteri5ed b% the e-istence of a small number of ban!s with branches throughout the countr%$ holding a significant part of total deposits$ along with a relativel% large number of smaller ban!s that are regional or local in emphasis. ,H. Such s%stems e-ist in >rance$ Ferman%$ and India. @apan has a small number of large cit% ban!s with branch networ!s but a larger number of local ban!s. ?rance* <an!ing institutions in ?rance were classified after +orld +ar II into three main groups: deposit ban!s$ %an=ues d'affaires &or investment ban!s'$ and institutions that were either speciali5ed or operated mainl% outside >rance. "ew ban!ing legislation in 1G11 greatl% reduced the importance of the distinction between deposit ban!s and %an=ues d'affaires. #here was also &1' a further concentration of ban!ing resources$ as a result of several large mergers and also of greater financial integration through sharee-change agreements and interloc!ing directorates$ and &,' the conversion of a number of %an=ues d'affaires into deposit ban!s$ which hived off their investment interests into separate investment or holding companies. >urther legislation in 1G?, nationali5ed the remaining large and mediumsi5ed ban!s &.1 in all$ plus two financial holding companiesthose of Indosue5 and (aribas'7 the largest deposit ban!s had alread% been nationali5ed after +orld +ar II. 2nother new law in 1G?/ abolished the old divisions between the several categories of ban!s$ which were now defined simpl% as Eta%lissements de crEdit& able to receive deposits from the public$ underta!e credit operations &including loans'$ and provide means of pa%ment. #he intention was to move cautiousl% toward a s%stem of cuniversal ban!ing.c #he new law was e-tended to cover the Caisse "ationale de Crjdit 2gricole$ the %an=ues populaires& the crEdit mutuel& the central organi5ations of the cooperatives and the savings ban!s &and thereb% institutions affiliated with them'$ and semipublic institutions li!e the Crjdit >oncier and the Crjdit "ational$ but not the Caisse des 9jpkts et Consignations nor the central ban!ing institutions. 2ll the regional ban!s and some local ban!s have branches. #he balanced character of the regional economies often provides these ban!s with a good portfolio of ris!s7 the% serve not onl% a prosperous agriculture but also a number of local industries. Some of the local ban!s are also ver% sound institutions$ despite their small si5e. #he survival of a h%brid s%stem in >rance$ despite the longrun trend toward centrali5ation$ reflects certain characteristics of >rench societ%. #hese included$ until recentl%$ a strong emphasis on small business$ together with a preference for individual and personal service. (articularism in some parts of >rance manifests itself in support for local institutions$ and the local ban!er also often has the advantage of special !nowledge of local industries and people$ which ma!es possible the acceptance of ris!s that the big ban!s decline. :ermany* 2n even more direct conflict between the forces favouring concentration and those wor!ing against it ma% be seen in Ferman%$ where ban!ing grew in the latter part of the 1Gth centur% along with industr%. #he ban!s were inclined to rel% mainl% on their own capital resources and did not at first tr% to attract deposits from the public. "ot until 1?=/ did the Deut"che /an! 2.F. begin to see! deposits through offices speciall% opened for the purpose. #his was done to provide cheap finance for traders$ the deposits being invested in mercantile bills that were regarded as both safe and li6uid. In pursuit of deposits$ the ban!s built up a widespread networ! of branch offices$ which were also used to establish and maintain industrial contacts throughout ,H/ the countr%. #he unification of Ferman% in 1?=1 removed the political obstacles to a more integrated ban!ing s%stem$ and the selection of /erlin as the capital made that cit% the countr%]s financial centre. >our of the largest ban!s were alread% established there7 the new Ceichsban! was set up in 1?=1. In addition$ the larger and more enterprising of the provincial ban!s were attracted to the capital. #he <erlin stoc! e-change rapidl% displaced that of >ran!furt am ;ain as the countr%]s leading securities mar!et. #he <erlin ban!s e-tended their influence b% developing correspondent relationships and subse6uentl% b% ac6uiring a financial interest in the provincial ban!s and being represented on their boards. Each of the big <erlin ban!s came to be associated with a group of provincial ban!s more or less under its control. 2t the same time$ all of the ban!s$ <erlin and provincial ali!e$ e-panded their business b% opening branches. 9uring +orld +ar I the degree of centrali5ation increased7 b% 1G1? the big <erlin ban!s held more than 10 percent of total deposits. In the earl% 1G,Hs there were amalgamations$ and branch s%stems became much larger. <an! failures and the financial crisis of 1G.1 resulted in further consolidation until the Ferman ban!ing s%stem was dominated b% three giants. <ut there were countervailing forces. (robabl% the most important of these was the establishment of publicl% owned ban!ing institutions$ such as the communal savings ban!s and their central institutions$ the 1iro)entralen& which became of increasing importance after +orld +ar II. Ferman savings ban!s$ which were permitted to have chec!s drawn on them from 1GHG and which had giro clearing from the 1G,Hs$ now offer a wide range of services$ especiall% to lower income groups and smaller businesses. #he large commercial ban!s have concerned themselves more with big business and with wealth% individuals. #he savings ban!s now compete in wholesale ban!ing as well. 2 number of them$ together with their 1iro)entralen& are to all intents and purposes cuniversal ban!s$c li!e the <ig #hree and the larger regional ban!s. #he <ig #hree &the 9eutsche <an!$ the Dre"dner /an!$ and the CommerI%an!' remain unchallenged onl% in stoc! e-change and foreign ban!ing business. Of the private ban!ers$ onl% about a halfdo5en are of an% si5e. #he bigger private ban!s are important in the fields of investment and wholesale ban!ing$ while the smaller ones flourish in the leading stoc!e-change cities$ such as 9lsseldorf and >ran!furt am ;ain. ;an% of these private ban!ers$ however$ are not ban!ers in the true sense7 the% subsist mainl% on stoc!e-change transactions$ investment services$ portfolio management$ and insurance and mortgage bro!erage. #here are also consumer finance institutions$ mortgage and other specialist ban!s$ and a large number of cooperatives. Cegional and private ban!s are often within the sphere of influence of the <ig #hree. In some cases the latter have a financial interest in these ban!s$ and in some cases the% own them. #he <ig #hree also have shares in certain of the private mortgage ban!s. #here are also ccooperation agreements$c and a number of mergers have ta!en place. In these several wa%s$ much more integration e-ists than appears on the surface. +hile ban!ing in :ermany remains a h%brid s%stem$ a trend toward greater concentration is evident. India* 8ntil the 1G0Hs$ ban!ing in India was carried on b% a large number of ban!s$ man% of them 6uite small. India is still primaril% an agricultural countr%$ with an economic and social structure based largel% on the village. #he integration of ban!ing has been impeded b% poor communications$ b% illiterac%$ and b% the barriers of ,H0 language and caste. <an!ing and credit have remained largel% in the hands of the so called indigenous ban!er and the village mone%lender. 2lthough their influence has been greatl% reduced in recent %ears$ the% still remain important in man% an up countr% area. #he indigenous ban!er$ who is also a merchant$ offers genuine ban!ing services: accepting deposits and remitting funds7 ma!ing loans 6uic!l% and with a minimum of formalit%7 and$ b% means of the hundi &a credit instrument in the form of a bill of e-change'$ financing a still significant$ if declining$ portion of India]s internal trade and commerce. Efforts were made to eliminate the mone%lender b% developing a networ! of rural credit cooperatives. +hen progress proved to be slow$ a more successful alternative was found in re6uiring ban!s to open cpioneerc branches in rural areas. #he first branches were those of the semipublic Imperial <an! of India and its nationali5ed successor$ the State <an! of India &and its subsidiaries'. ;an% smaller ban!s began to disappear$ sometimes b% merger and sometimes as a result of failure. <etween 1G0, and 1G1= the number of creportingc ban!s fell from 01= to GH. "ationali5ed ban!s$ including the State <an! of India and its seven subsidiaries$ the 1/ large commercial ban!s ta!en over in 1G1G$ and the si- additional ban!s nationali5ed in 1G?H$ accounted for more than GH percent of aggregate deposits in commercial ban!s. <an!ing services are also provided b% chit funds$ which accept and pa% interest on monthl% deposits against which it is possible to draw onl% b% wa% of loan$ and b% "idhis$ mutual loan societies that have developed into semiban!ing institutions but deal onl% with their member shareholders. #he main path of ban!ing development in India is the e-pansion of ban! branches into the underban!ed areas. #he authorities have sought to e-pand the number of branches but to avoid their concentration in the larger towns and cities and$ in particular$ to provide the rural areas with ade6uate facilities. #he ultimate ob*ective is to encourage the mobili5ation of deposits on a massive scale throughout the countr%$ a formidable challenge in a countr% of 0=0$HHH villages$ and a stepping up of lending to wea! sectors of the econom%. (apan* <an!ing business in (apan is largel% concentrated in the hands of the big ban!s &some of which are speciali5ed'$ though a number of small ban!s still survive. #he principal classes of ban!s are cit% ban!s and regional ban!s$ but it should be noted that the distinction has no legal basis$ though the% are separatel% supervised. <oth belong to the >ederation of <an!ers] 2ssociations of @apan. #he cit% ban!s service mainl% manufacturing industr% and commerce$ particularl% the big firms$ while the regional ban!s are based on a prefecture$ though some e-tend their operations into neighbouring prefectures$ collecting deposits and lending to local businesses and smaller firms. #he regional ban!s have cit% ban! correspondents$ not onl% to hold surplus balances but also for assistance in investing their funds$ especiall% in the callmone% mar!et. In addition$ a cit% ban! ma% introduce certain of its large customers to a regional ban! &e.g.& a big compan% having a local factor%'. Cit% correspondents in @apan do not$ however$ provide the wide range of ancillar% services common in the 8nited States. Since +orld +ar II there has been much stabilit% in @apanese ban!ing$ but the cit% ban!s have suffered a relative decline in the importance of their business in competition with other institutions$ especiall% the agricultural cooperatives$ which attract the larger part of the #reasur%]s pa%ments owing to government purchases of the rice crop. #here has also been a relative increase in the importance of the life insurance ,H1 companies and the trust funds$ which have attracted si5able funds from the general public. In"urance In"urance is a method of coping with ri"!. Its primar% function is to substitute certaint% for uncertaint% as regards the economic cost of lossproducing events. Insurance ma% be defined more formall% as a s%stem under which the insurer$ for a consideration usuall% agreed upon in advance$ promises to reimburse the insured or to render services to the insured in the event that certain accidental occurrences result in losses during a given period. Insurance relies heavil% on the Fla of lar#e num%er"*F In large homogeneous populations it is possible to estimate the normal fre6uenc% of common events such as deaths and accidents. Dosses can be predicted with reasonable accurac%$ and this accurac% increases as the si5e of the group e-pands. >rom a theoretical standpoint$ it is possible to eliminate all pure ris! if an infinitel% large group is selected. >rom the standpoint of the insurer$ an in"ura%le ri"! must meet the following re6uirements: 1. #he ob*ects to be insured must be numerous enough and homogeneous enough to allow a reasonabl% close calculation of the probable fre6uenc% and severit% of losses. ,. #he insured ob*ects must not be sub*ect to simultaneous destruction. >or e-ample$ if all the buildings insured b% one insurer are in an area sub*ect to flood$ and a flood occurs$ the loss to the insurance underwriter ma% be catastrophic. .. #he possible loss must be accidental in nature$ and be%ond the control of the insured. If the insured could cause the loss$ the element of randomness and predictabilit% would be destro%ed. /. #here must be some wa% to determine whether a loss has occurred and how great that loss is. #his is wh% insurance contracts specif% ver% definitel% what events must ta!e place$ what constitutes loss$ and how it is to be measured. >rom the viewpoint of the insured person$ an insurable ris! is one for which the probabilit% of loss is not so high as to re6uire e-cessive premiums. +hat is ce-cessivec depends on individual circumstances$ including the insured]s attitude toward ris!. 2t the same time$ the potential loss must be severe enough to cause financial hardship if it is not insured against. Insurable ris!s include losses to propert% resulting from fire$ e-plosion$ windstorm$ etc.7 losses of life or health7 and the legal liabilit% arising out of use of automobiles$ occupanc% of buildings$ emplo%ment$ or manufacture. 8ninsurable ris!s include losses resulting from price changes and competitive conditions in the mar!et. (olitical ris!s such as war or currenc% debasement are usuall% not insurable b% private parties but ma% be insurable b% governmental institutions. Ver% often contracts can be drawn in such a wa% that an cuninsurable ris!c can be turned into an cinsurablec one through restrictions on losses$ redefinitions of perils$ or other methods. ,H= In"urance In"urance is a method of coping with ri"!. Its primar% function is to substitute certaint% for uncertaint% as regards the economic cost of lossproducing events. Insurance ma% be defined more formall% as a s%stem under which the insurer$ for a consideration usuall% agreed upon in advance$ promises to reimburse the insured or to render services to the insured in the event that certain accidental occurrences result in losses during a given period. Insurance relies heavil% on the Fla of lar#e num%er"*F In large homogeneous populations it is possible to estimate the normal fre6uenc% of common events such as deaths and accidents. Dosses can be predicted with reasonable accurac%$ and this accurac% increases as the si5e of the group e-pands. >rom a theoretical standpoint$ it is possible to eliminate all pure ris! if an infinitel% large group is selected. >rom the standpoint of the insurer$ an in"ura%le ri"! must meet the following re6uirements: 1. #he ob*ects to be insured must be numerous enough and homogeneous enough to allow a reasonabl% close calculation of the probable fre6uenc% and severit% of losses. ,. #he insured ob*ects must not be sub*ect to simultaneous destruction. >or e-ample$ if all the buildings insured b% one insurer are in an area sub*ect to flood$ and a flood occurs$ the loss to the insurance underwriter ma% be catastrophic. .. #he possible loss must be accidental in nature$ and be%ond the control of the insured. If the insured could cause the loss$ the element of randomness and predictabilit% would be destro%ed. /. #here must be some wa% to determine whether a loss has occurred and how great that loss is. #his is wh% insurance contracts specif% ver% definitel% what events must ta!e place$ what constitutes loss$ and how it is to be measured. >rom the viewpoint of the insured person$ an insurable ris! is one for which the probabilit% of loss is not so high as to re6uire e-cessive premiums. +hat is ce-cessivec depends on individual circumstances$ including the insured]s attitude toward ris!. 2t the same time$ the potential loss must be severe enough to cause financial hardship if it is not insured against. Insurable ris!s include losses to propert% resulting from fire$ e-plosion$ windstorm$ etc.7 losses of life or health7 and the legal liabilit% arising out of use of automobiles$ occupanc% of buildings$ emplo%ment$ or manufacture. 8ninsurable ris!s include losses resulting from price changes and competitive conditions in the mar!et. (olitical ris!s such as war or currenc% debasement are usuall% not insurable b% private parties but ma% be insurable b% governmental institutions. Ver% often contracts can be drawn in such a wa% that an cuninsurable ris!c can be turned into an cinsurablec one through restrictions on losses$ redefinitions of perils$ or other methods. 8inds of insurance ,H? /.#/-.,Y +57.45C- #wo main t%pes of contractshomeowner]s and commercialhave been developed to insure against loss from accidental destruction of propert%. #hese contracts &or forms' t%picall% are divided into three or four parts: insuring agreements$ identification of covered propert%$ conditions and stipulations$ and e-clusions. ,omeoner@" in"urance* 3omeowner]s insurance covers individual$ or nonbusiness$ propert%. Introduced in 1G0?$ it graduall% replaced the older method of insuring individual propert% under the cstandard fire polic%.c
Peril" in"ured* In homeowner]s policies$ of which there are several t%pes$ coverage can be call ris!c or cnamed peril.c 2llris! policies offer insurance on an% peril e-cept those later e-cluded in the polic%. #he advantage of these contracts is that if propert% is destro%ed b% a peril not specificall% e-cluded the insurance is good. In named0peril policies$ no coverage is provided unless the propert% is damaged b% a peril specificall% listed in the contract. In addition to protection against the loss from destruction of an owner]s propert% b% perils such as fire$ lightning$ theft$ e-plosion$ and windstorm$ homeowner]s policies t%picall% insure against other t%pes of ris!s faced b% a homeowner such as legal liabilit% to others for in*uries$ medical pa%ments to others$ and additional e-penses incurred when the insured owner is re6uired to vacate the premises after an insured peril occurs. #hus the homeowner]s polic% is multiperil in nature$ covering a wide variet% of ris!s formerl% written under separate contracts.
Property co$ered* 3omeowner]s forms are written to cover damage to or loss of not onl% an owner]s dwelling but also structures &such as garages and fences'$ trees and shrubs$ personal propert% &e-cluding certain listed items'$ propert% awa% from the premises &such as boats'$ mone% and securities &sub*ect to dollar limits'$ and losses due to forger%. #he% also cover removal of debris following a loss$ e-penditures to protect propert% from further loss$ and loss of propert% removed from the premises for safet% once an insured peril has occurred.
)imitation" on amount reco$era%le* Cecover% under homeowner]s forms is limited to loss due directl% to the occurrence of an insured peril. Dosses caused b% some intervening source not insured b% the polic% are not covered. >or e-ample$ if a flood or a landslide$ which usuall% are e-cluded perils$ severel% damages a house that subse6uentl% is destro%ed b% fire$ the homeowner]s recover% from the fire is limited to the value of the house alread% damaged b% the flood or landslide. Cecover% under homeowner]s forms ma% be on the basis of either full replacement cost or actual cash value &2CV'. 8nder the former$ the owner suffers no ,HG reduction in loss recover% due to depreciation of the propert% from its original value. #his basis applies if the owner too! out coverage that is at least e6ual to a named percentagefor e-ample$ ?H percentof the replacement value of the propert%. If the insurance amount is less than ?H percent$ a coin"urance clause is triggered$ the operation of which reduces the recover% amount to the value of the loss times the ratio of the amount of insurance actuall% carried to the amount e6ual to ?H percent of the value of the propert%. 3owever$ the reduced recover% will not be less than the cactual cash valuec of the propert%$ defined as the full replacement cost minus an allowance for depreciation$ up to the amount of the polic%. >or e-ample$ assume that a propert% is valued at N1HH$HHH new$ has depreciated ,H percent in value$ insurance of N1H$HHH is ta!en$ and a N1H$HHH loss occurs. #he actual cash value of the loss is N?$HHH &N1H$HHH minus ,H percent depreciation'. #he operation of the coinsurance clause would limit recover% to 1B? of the loss$ or N=$0HH. 3owever$ since the actual cash value of the loss is N?$HHH$ this is the amount of the recover%. Cecover% under homeowner]s forms is also limited if more than one polic% applies to the loss. >or e-ample$ if two policies with e6ual limits are ta!en out$ each contributes onehalf of an% insured loss. Doss pa%ments also are limited to the amount of an insured person]s in"ura%le intere"t. #hus$ if a homeowner has onl% a onehalf interest in a building$ the recover% is limited to onehalf of the insured loss. #he coowners would need to have arranged insurance for their interest.
EBcluded peril"* 2mong the eBcluded peril" &or e-clusions' of homeowner]s policies are the following: loss due to free5ing when the dwelling is vacant or unoccupied$ unless stated precautions are ta!en7 loss from weight of ice or snow to propert% such as fences$ swimming pools$ doc!s$ or retaining walls7 theft loss when the building is under construction7 vandalism loss when the dwelling is vacant be%ond .H da%s7 damage from gradual water lea!age7 termite damage7 loss from rust$ mold$ dr% rot$ contamination$ smog$ and settling and crac!ing7 loss from animals or insects7 loss from earth movement$ flood$ war$ or spoilage &e.g.& chemical deterioration'7 loss from neglect of the insured to protect the propert% following a loss7 and losses arising out of business pursuits. Special forms for business ris!s are available. 8nder named0peril forms$ onl% losses from the perils named in the polic% are covered. #he named perils are sometimes defined narrowl%7 for e-ample$ theft claims are not paid if the propert% is merel% lost and theft cannot be established. Earth6ua!e and flood loss$ while e-cluded from the basic homeowner]s forms$ ma% usuall% be covered b% endorsement. Condition"* 3omeowner]s policies ma% include the following conditions: &1' Owners are re6uired to give immediate written notice of loss to the insurer or the insurer]s agent. &,' #he insured must provide proof of the amount of loss. #his suggests that owners should !eep accurate records of the items in a building and of their original ,1H cost. &.' #he insured must cooperate with the insurer in settling a loss. &/' #he insured must pa% the premium in advance. &0' #he insurer has a right of subrogation &i.e.& of pursuing liable third parties for an% loss'. #his prevents an owner from collecting twice$ once from the insurer and once from a liable third part%. &1' 2 mortgagee]s interest in a propert% can be protected. &=' #he polic% ma% be canceled b% the insurer upon due notice$ usuall% 1H da%s. If the insurer cancels$ a pro rata refund of premium must be returned to the insured7 if the insured cancels$ a lessthanproportionate return of a premium ma% be recovered from the insurer. &?' >raud b% the insured$ including misrepresentation or concealment of material facts concerning the ris!$ is ground for denial of benefits b% the insurer. 2lso available is a form called renter]s insurance$ which provides personal propert% insurance for tenants. /u"ine"" property in"urance* Insurance for business propert% follows a pattern that is similar in man% wa%s to the one for individual propert%. 2 commonl% used form is the cbuilding and personal propert% coverage formc &<(('. #his form permits a business owner to cover in one polic% the buildings$ fi-tures$ machiner% and e6uipment$ and personal propert% used in business and the personal propert% of others for which the business owner is responsible. Coverage also can be e-tended to insure newl% ac6uired propert%$ propert% on newl% ac6uired premises$ valuable papers and records$ propert% temporaril% off the business premises$ and outdoor propert% such as fences$ signs$ and antennas. Direct lo""e"* Coverage on the <(( form can be written on a scheduled basis$ whereb% specific items of propert% are listed and insured$ or on a blan!et basis$ whereb% propert% at several locations can be insured for a single sum. (erils insured under the <(( are listed in the polic%. 2llris! coverage is also written$ sub*ect to specified e-clusions. Dosses ma% be settled on a replacementcost coverage on the <(( b% endorsement. Otherwise recover% is on an actual cash value basis that ma!es an ad*ustment for depreciation. Coverage for business personal propert% with constantl% changing values is available on a reporting form. #he business owner reports values monthl% to the insurer and pa%s premiums based on the values reported. In this wa%$ onl% the insurance actuall% needed is purchased. Indirect lo""e"* 2n entirel% different branch of the insurance business has been developed to insure losses that are indirectl% the result of one of the specified perils. 2 prominent e-ample of this t%pe of insurance is business income insurance. #he insurer underta!es to reimburse the insured for lost profits or for fi-ed charges incurred as a result of direct damage. >or e-ample$ a retail store might have a fire and be completel% shut down for one month and partiall% shut down for another month. If the ,11 fire had not occurred$ sales would have been much higher$ and therefore substantial revenues have been lost. In addition$ fi-ed costs such as salaries$ ta-es$ and maintenance must continue to be paid. 2 business income polic% would respond to these losses. >orms of indirect insurance include the following: &1' contingent business income insurance$ designed to cover the conse6uential losses if the plant of a supplier or a ma*or customer is destro%ed$ resulting in either reduced orders or reduced deliveries that force a shutdown of the insured firm$ &,' e-tra e-pense insurance$ which pa%s the additional cost occasioned b% having e-tra e-penses to pa%$ such as rent on substitute facilities after a disaster$ and &.' rent and rental value insurance$ covering losses in rents that the owner of an apartment house ma% incur if the building is destro%ed. Cental income insurance pa%s for rent lost when a peril destro%s an owner]s propert% that has been rented to others. M4.+5- +57.45C- Marine in"urance is actuall% transportation insurance. 2fter insurance coverage on ocean vo%ages had been developed$ it was a natural step to offer insurance on inland trips. #his branch of insurance became !nown as inland marine. In man% polic% forms$ the distinction between inland and ocean marine has disappeared7 it is common to cover goods from the time the% leave the warehouse of the shipper$ even if this warehouse is situated at a substantial distance from the nearest seaport$ until the% reach the warehouse of the bu%er$ which li!ewise ma% be located far inland. .cean marine in"urance* Ocean marine contracts are written to cover four ma*or t%pes of propert% interest: &1' the vessel or hull$ &,' the cargo$ &.' the freight revenue to be received b% the ship owner$ and &/' legal liabilit% for negligence of the shipper or the carrier. 3ull insurance covers losses to the vessel itself from specified perils. 8suall% there is a provision that the marine hull should be covered onl% within specified geographic limits. Cargo insurance is usuall% written on an open contract basis under which shipments$ both incoming and outgoing$ are automaticall% covered for the interests of the shipper$ who reports periodicall% the values e-posed and pa%s a premium based upon these values. <% means of a negotiable open cargo certificate$ which is attached to the bill of lading$ insurance coverage is automaticall% transferred to whoever has legal title to the goods in the course of their movement from seller to bu%er. >reight revenue ma% be insured in several different wa%s. If there is an obligation b% the shipper to pa% the carrier]s freight bill regardless of whether the goods are delivered$ the value of the freight is declared a part of the value of the cargo and is insured as part of this value. If the freight revenue is contingent upon safe deliver% of the goods$ the carrier insures the freight as a part of the regular hull coverage. ;a*or clauses or provisions that are fairl% standardi5ed are &1' the perils clause$ &,' the crunning downc clause$ or C9C$ &.' the cfree of particular average$c or >(2$ clause$ &/' the general average clause$ &0' the sue and labour clause$ &1' the abandonment clause$ &=' coinsurance$ and &?' e-press and implied warranties. Each of these will be discussed in turn. ,1, Peril" clau"e* 8ntil 1G=? the main insuring clause of modern ocean marine policies was preserved almost unchanged from the original 1==G Dlo%d]s of Dondon form. #he clause is as follows: Touching the adventures and perils which we the assurers are contented to %ear and do take upon us in this voyage they are of the seas& men-of-war& fire& enemies& pirates& rovers& thieves& Bettisons& letters of mart and countermart& surprisals& takings at sea& arrests& restraints& and detainments of all kings& princes& and people& of what nation& condition& or =uality soever& %arratry of the master and mariners& and of all other perils& losses& and misfortunes& that have or shall come to the hurt& detriment& or damage of the said goods and merchandises& and ship& etc.& or any part thereof. 2lthough the clause reads as if it were an allris! agreement$ courts have interpreted it to cover onl% the perils mentioned. Essentiall%$ the clause insures the vo%age from perils cofc the sea. (erils on the sea$ such as fire$ are not covered unless specificall% mentioned. >urthermore$ although the perils clause indicates coverage from cenemies$ pirates$ rovers$ thieves$c the polic% does not cover losses from war. &+ar ris! insurance is offered in some nations through governmental agencies.' In 1G=?$ at the re6uest of the 8" Conference on #rade and 9evelopment$ the 1==G language was moderni5ed and a revised insuring clause was proposed. #he new form restricts coverage on losses from poor pac!ing$ places the burden of proof of seaworthiness on the shipper rather than on the carrier$ and e-cludes losses resulting from insolvenc% of the common carrier$ with the burden of proof placed on the shipper that the carrier is financiall% sound. #he revised form has not been adopted b% all insurers. RDC clau"e* #he C9C$ or crunning downc clause$ provides coverage for legal liabilit% of either the shipper or the common carrier for claims arising out of collisions. &Collision loss to the vessel itself is part of the hull coverage.' #he C9C clause covers negligence of the carrier or shipper that results in damage to the propert% of others. 2 companion clause$ the protection and indemnit% clause &( and I'$ covers the carrier or shipper for negligence that causes bodil% in*ur% to others.
?PA clau"e* #he >(2$ or cfree of particular average$c clause e-cludes from coverage partial losses to the cargo or to the hull e-cept those resulting from stranding$ sin!ing$ burning$ or collision. 8nder its provisions$ losses below a given percentage of value$ sa% 1H percent$ are e-cluded. In this wa% the insurer does not pa% for relativel% small losses to cargo. #he percentage deductible varies according to the t%pe of cargo and its susceptibilit% to loss.
:eneral a$era#e clau"e* ,1. #he general average clause in ocean marine insurance obligates the insurers of various interests to share the cost of losses incurred voluntaril% to save the vo%age from complete destruction. Such sacrifices must be made voluntaril%$ must be necessar%$ and must be successful. >or e-ample$ if a shipper]s cargo is voluntaril% *ettisoned in a storm in order to save the vessel from total loss$ the general average clause re6uires the insurers of the hull and of all other cargo interests to ma!e a contribution to the loss of the shipper whose goods were sacrificed. Other t%pes of losses ma% also be covered. It has been held$ for e-ample$ that losses suffered from efforts to put out a fire on shipboard$ which result in damage to specific goods$ can be included in a general average claim. Similarl%$ losses from salvage efforts to free a stranded vessel ma% 6ualif% under a general average claim to which all interests must contribute.
Sue and la%our clau"e* #he sue and labour clause re6uires the ship owner to ma!e ever% attempt to reduce or save the e-posed interests from loss. 8nder the terms of the clause$ the insurer pa%s for an% necessar% costs incurred in carr%ing out the re6uirements of the sue and labour clause. #hus$ if a ship is stranded$ under the sue and labour clause the hull owner would be re6uired to hire salvors to attempt to save the ship. Such e-penses are paid even if the salvage attempts fail. A%andonment clau"e* If salvaging or rehabilitating a ship or cargo following a marine loss costs more than the goods are worth$ the loss is said to be constructivel% total. 8nder such conditions$ the ocean marine polic% permits the insured to abandon the damaged ship or cargo to the insurer and ma!e a claim for the entire value. In this case$ the salvage belongs to the insurer$ who ma% dispose of it in an% wa%. 2bandonment is not permitted in other forms of propert% insurance. Coin"urance* 2lthough there is no coin"urance clause as such in the ocean marine polic%$ losses are settled as though a 1HH percent coinsurance clause e-isted. #hus$ if an insured ta!es out coverage e6ual to 0H percent of the true replacement cost of the goods$ onl% 0H percent of an% partial loss ma% be recovered.
Warrantie"* In the field of ocean marine insurance there are two general t%pes of arrantie" that must be considered: e-press and implied. E-press warranties are promises written into the contract. #here are also three implied warranties$ which do not appear in written form but bind the parties nevertheless. E-amples of e-pressed warranties are the >CVS warrant% and the stri!e$ riot$ and civil commotion warrant%. #he >CVS$ or Ffree of capture and "eiIure6F arranty e-cludes war as a cause of loss. #he stri!e$ riot$ and civil commotion warrant% states that the insurer will pa% no losses resulting from stri!es$ wal!outs$ ,1/ riots$ or other labour disturbances. #he three implied warranties relate to the following conditions: seaworthiness$ deviation$ and legalit%. 8nder the first$ the shipper and the common carrier warrant that the ship will be seaworth% when it leaves port$ in the sense that the hull will be sound$ the captain and crew will be 6ualified$ and supplies and other necessar% e6uipment for the vo%age will be on hand. 2n% losses stemming from lac! of seaworthiness will be e-cluded from coverage. 8nder the deviation warrant%$ the ship ma% not deviate from its intended course e-cept to save lives. Clauses ma% be attached to the ocean marine polic% to eliminate the implied warranties of seaworthiness or deviation. #he implied warrant% of legalit%$ however$ ma% not be waived. 8nder this warrant%$ if the vo%age itself is illegal under the laws of the countr% under whose flag the ship sails$ the insurance is void. +nland marine insurance. 2lthough there are no standard forms in inland marine insurance$ most contracts follow a t%pical pattern. #he% are usuall% written on a namedperil basis covering such perils of transportation as collision$ derailment$ rising water$ tornado$ fire$ lightning$ and windstorm. #he policies generall% e-clude losses resulting from pilferage$ stri!e$ riot$ civil commotion$ war$ dela% of shipments$ loss of mar!ets$ illegal trade$ or lea!age and brea!age. #he scope of inland marine is greatl% e-tended b% means of cfloaterc policies. #hese are used to insure certain t%pes of movable propert% whether or not the propert% is actuall% in transit. <usiness floater policies are purchased b% *ewelers$ launderers$ dr% cleaners$ tailors$ upholsterers$ and other persons who hold the propert% of others while performing services. (ersonal propert% floaters are used to cover$ on a comprehensive basis$ an% item of personal propert% owned b% a private individual. #he% ma% also cover the propert% of visitors$ or the propert% of servants while on the premises of the insured. #he% e-clude certain t%pes of propert% for which other contracts have been designed$ such as automobiles$ aircraft$ motorc%cles$ animals$ or business and professional e6uipment. '+4B+'+,Y +57.45C- )ia%ility in"urance arises mainl% from the operation of the law of ne#li#ence. Individuals who$ in the e%es of the law$ fail to act reasonabl% or to e-ercise due care ma% find themselves sub*ect to large liabilit% claims. Court *udgments have been issued for sums so large as to re6uire a lifetime to pa%. #here are at least four ma*or t%pes of liabilit% insurance contracts: &1' liabilit% arising out of the use of automobiles$ &,' liabilit% arising out of the conduct of a business$ &.' liabilit% arising from professional negligence &applicable to doctors$ law%ers$ etc.'$ and &/' personal liabilit%$ including the liabilit% of a private individual operating a home$ carr%ing on sporting activities$ and so on. (racticall% all liabilit% contracts falling in these four categories have some common elements. One is the insuring clause$ in which the insurer agrees to pa% on behalf of the insured all sums that the insured shall become ,10 legall% obligated to pa% as damages because of bodil% in*ur%$ sic!ness or disease$ wrongful death$ or in*ur% to another person]s propert%. #he liabilit% polic% covers onl% claims that an insured becomes legall% obligated to pa%7 voluntar% pa%ments are not covered. It is often necessar% to resort to legal or court action to determine the amount of these damages$ although in a vast ma*orit% of cases the damages are settled out of court b% negotiation between the parties. 2ll liabilit% insurance contracts contain clauses that obligate the insurer to conduct a court defense and to pa% an% settlement$ including premiums on bonds$ interest on *udgments pending appeal$ medical and surgical e-penses that are necessar% at the time of the accident$ and other costs. Diabilit% insurance has sometimes been termed defense insurance because of this provision. #he insurer agrees to defend a suit even though it is false or fraudulent$ so long as it is a suit stemming from a peril insured against. #he insured is re6uired to cooperate with the insurer in all court actions b% appearing in court$ if necessar%$ to give testimon%. 'imits of liability. (racticall% all liabilit% insurance policies contain limitations on the ma-imum amount of a *udgment pa%able under the contract. >urther$ the cost of defense$ supplementar% pa%ments$ and punitive damages ma% or ma% not be paid in addition to the *udgment limits. Separate limits often appl% to claims for propert% damage and bodil% in*ur%. 2n annual aggregate limit ma% also be purchased$ which puts a ma-imum on the amount an insurer must pa% in an% one polic% period. Dimits ma% appl% on a peroccurrence or a claimsmade basis. In the former$ which gives the most comprehensive coverage$ the polic% in force in %ear one covers a negligent act that too! place in %ear one$ no matter when a claim is made. If the polic% is made on a claimsmade basis$ the insurance in force when a claim is presented pa%s the loss. 8nder this polic%$ a claim can be made for losses that occur during the polic% period but have their origins in events preceding its starting date7 the period of time before this date for which claims can be made is$ however$ restricted. >or an additional premium the discover% period can be e-tended be%ond the end of the polic% period. #he claimsmade basis for liabilit% insurance is considered much more restrictive than a peroccurrence polic%. Diabilit% insurance contracts have in common the fact that the definition of cthe insuredc is broad. 2n automobile liabilit% polic%$ for e-ample$ includes not onl% the owner but an%one else operating the car with permission. In business liabilit% insurance$ all partners$ officers$ directors$ or proprietors are covered b% the polic% regardless of their direct responsibilit% for an% act of negligence. Other parties ma% be included for an e-tra premium. 2nother element common to all liabilit% insurance policies is certain eBclu"ion". (olicies covering business activities almost invariabl% e-clude liabilit% arising out of the personal activities of the insured. Each !ind of liabilit% contract tends to e-clude the liabilit% for which another contract has been devised: a personal liabilit% coverage in the homeowner]s contract$ for e-ample$ e-cludes automobile liabilit% because a special contract has been created for this particular t%pe of liabilit%. 2nother common element in liabilit% policies is "u%ro#ation: the insurer retains the right to bring an action against a liable third part% for an% loss this third part% has caused. Business liability insurance. ,11 <usiness liabilit% contracts commonl% written include the following: liabilit% of a building owner$ landlord$ or tenant7 liabilit% of an emplo%er for acts of negligence involving emplo%ees7 liabilit% of contractors or manufacturers7 liabilit% to members of the public resulting from fault% products or services7 liabilit% as a result of contractual agreements under which liabilit% of others is assumed7 and comprehensive liabilit%. #he latter contract is designed to be broad enough to encompass almost an% t%pe of business liabilit%$ including automobiles. #here has been increasing use of coverage for liabilit% stemming from defective products$ because some court *udgments have awarded huge compensations. <usiness liabilit% contracts ma% be written to cover loss even if the act that produced the claim was not accidental. #he onl% re6uirement is that the result of the act be accidental or unintended. #hus if a contractor is ma!ing an e-cavation that produces large amounts of dust and this dust causes loss to neighbouring propert%$ the contractor]s liabilit% polic% would respond to claims for loss$ even though the act that produced the dust was a deliberate act. /rofessional liability insurance. Unown as malpractice$ or errorsandomissions$ in"urance6 profe""ional lia%ility contracts are distinguished from general business liabilit% policies because of the speciali5ed nature of the liabilit%. (rofessional persons re6uiring liabilit% contracts include phy"ician" and surgeons$ law%ers$ accountants$ engineers$ and insurance agents. Important differences between professional and other liabilit% contracts are the following: 1. "o distinction is made between bodil% in*ur% or propert% damage liabilit%$ and there is no limit on the number of claims per accident but rather a limit of liabilit% per claim. #his recogni5es the fact that one negligent act on the part of a professional person ma% involve more than one part%$ each of whom could bring a legal action against the professional person. #hus a doctor might administer the wrong medicine to a number of patients$ each of whom could bring a legal action. ,. Claims against a professional person ma% have an adverse effect upon his or her reputation. #he polic% therefore permits the insured to carr% an% action to court$ since an outofcourt settlement might conceivabl% impl% guilt in the e%es of the professional]s public or clientele. .. In professional liabilit% insurance there is an e-clusion for an% agreement guaranteeing the result of an% treatment. Suits stemming from clients] dissatisfaction with the service performed are thus not covered. /ersonal liability insurance. #he most common form of personal liabilit% insurance is issued as part of the homeowner]s liabilit% insurance polic%. It is an allris! agreement and contains relativel% few e-clusions. #he polic% covers an% act of negligence of the insured or residents of the home that results in legal liabilit%. It ma% also include medical pa%ments insurance covering accidental in*ur% to guests and other nonresidents without regard to the 6uestion of negligence. ,1= Automo%ile in"urance* "earl% half of all propert%liabilit% insurance written in the 8nited States is in the area of automo%ile in"urance. Set up as a comprehensive contract in most parts of the world$ automobile insurance covers liabilit%$ collision loss of the vehicle$ all other t%pes of loss &called comprehensive loss'$ and medical e-penses incurred b% the driver$ passengers$ and other persons. Coverage usuall% applies to an%one driving the car with permission of the owner. #hus$ drivers are insured whether driving their own or someone else]s car. 2utomobile liabilit% coverage is mandated b% law in man% countries up to specified monetar% limits. #he polic% states what happens if the driver is covered b% other automobile policies that ma% cover the loss. It also covers the liabilit% of persons$ such as parents$ who have legal responsibilit% for actions of the driver. Coverage includes legal defense costs$ usuall% in addition to the polic% liabilit% limits. ;an% policies e-clude coverage for the time the automobile is driven in a foreign countr%. #heft insurance* #heft generall% covers all acts of stealing. #here are three ma*or t%pes of insurance contracts for burglar%$ robber%$ and other theft. /ur#lary is defined to mean the unlawful ta!ing of propert% within premises that have been closed and in which there are visible mar!s evidencing forcible entr%. Such narrow definition is necessar% to restrict burglar% coverage to a particular class of criminal act. Ro%%ery is defined as that t%pe of unlawful ta!ing of propert% in which another person is threatened b% either force or violence. In the robber% peril$ therefore$ the element of personal contact is necessar%. (erhaps the most common of all burglar% coverages is on safes. Often the loss in the form of damage to the safe itself from the use of e-plosives and other devices is as great as the loss of the mone%$ *ewelr%$ or securities it contains. 2ccordingl%$ the polic% covers both t%pes of claims. 2nother common burglar% polic% applies to mercantile open stoc!. In this t%pe of polic%$ there is usuall% a limit applicable on an% article of *ewelr% or an% article contained in a showcase where susceptibilit% to loss is high. In order to prevent underinsurance$ the mercantile open stoc! polic% is usuall% written with a coin"urance re6uirement or with some minimum amount of coverage. 2nother common theft polic% for business firms is a comprehensive crime contract covering emplo%ee dishonest% as well as losses on mone% and securities both inside and outside the premises$ loss from counterfeit mone% or mone% orders$ and loss from forger%. #his polic% is designed to cover in one pac!age most of the crime perils to which an average business is sub*ect. 2 broad form of crime protection for individuals is offered both as a separate contract and as part of a chomeowner]s polic%.c It covers all losses of personal propert% from theft and m%sterious disappearance. A$iation in"urance* A$iation in"urance normall% covers ph%sical damage to the aircraft and legal liabilit% arising out of its ownership and operation. Specific policies are also available to cover the legal liabilit% of airport owners arising out of the operation of ,1? hangars or from the sale of various aviation products. #hese latter policies are similar to other t%pes of liabilit% contracts. (erhaps the ma*or underwriting problem is the ccatastrophicc e-posure to loss. #he largest passenger aircraft ma% incur losses of N.HH$HHH$HHH or more$ counting both liabilit% and ph%sical damage e-posures. #he number of aircraft of an% particular t%pe is not large enough for the accurate prediction of losses$ and each t%pe of aircraft has its special characteristics and e6uipment. #hus a great deal of independent individual underwriting is necessar%. Cate ma!ing is comple- and speciali5ed. It is further complicated b% rapid technological change and b% the constant appearance of new ha5ards. (olicies are written to cover liabilit% of the owner or operator for bodil% in*ur% to passengers or to persons other than passengers and for propert% damage. ;edical costs$ including loss of income$ are usuall% paid to passengers suffering permanent total disabilit% without the re6uirement of proving negligence. #his t%pe of coverage has been called admitted liabilit% insurance. Wor!er"@ compen"ation in"urance* Wor!er"@ compen"ation insurance$ sometimes called industrial in*ur% insurance$ compensates wor!ers for losses suffered as a result of wor!related in*uries. (a%ments are made regardless of negligence. #he schedule of benefits ma!ing up the compensation is determined b% statute. #he scope of emplo%ment in*ur% laws$ originall% limited to persons in forms of emplo%ment recogni5ed as ha5ardous$ has$ as the result of associating the right to compensation with the e-istence of a contract of service$ been graduall% e-tended to clerical emplo%ment. "evertheless$ the large e-ception of agricultural emplo%ees continues in some #hird +orld countries$ Canada$ much of the 1nited State"$ and the countries of eastern Europe. Other classes of e-ception are emplo%ees in ver% small underta!ings and domestic servants. #he e-clusion of emplo%ees with middleclass salaries persists in parts of the former <ritish Empire. In a few countries$ wor!ing emplo%ers are permitted to insure themselves as well as their emplo%ees. #he notion of emplo%ment in*ur% was at first confined to in*uries of accidental origin$ but during the ,Hth centur% it was e-tended to include occupational diseases in increasing number. #o entitle the wor!er to benefit$ the accident must occur during emplo%ment$ and man% laws also re6uire the accident to have been caused b% the emplo%ment in some wa%7 however$ the trend seems to be toward accepting the former condition as sufficient. >ollowing the Ferman law of 1G,0$ some .H countries included accidents occurring on the wa% to and from wor!. In*uries due to the emplo%ee]s willful misconduct are generall% e-cluded. Occupational diseases are covered to some e-tent b% virtuall% all national laws.
Cla""e" of %enefit"* >our classes of %enefit" are provided b% compulsor% insurance$ and$ e-cept for certain diseases$ a right to them is ac6uired without an% 6ualif%ing period of ,1G previous emplo%ment. >irst is a medical %enefit$ which includes all necessar% treatment and the suppl% of artificial limbs. If its duration is limited$ the ma-imum is li!el% to be one %ear. Second is a temporar% incapacit% benefit$ which lasts as long as the medical benefit e-cept that a waiting period of a few da%s is fre6uentl% prescribed. #he benefit varies from countr% to countr%$ ranging from 0H percent of the emplo%ee]s wage to 1HH percent7 the most common benefits are 11 ,B. percent and =0 percent. #hird is a permanent incapacit% benefit$ which$ unless the degree is ver% small$ in which case a lump sum is paid$ ta!es the form of a pen"ion. If the incapacit% is total$ the pension is usuall% e6ual to the temporar% incapacit% benefit. If the incapacit% is partial$ the pension is proportionatel% smaller. In some 1H countries an additional pension is granted if the victim needs constant attendance. In cases of death$ the pensions are distributed to the widow &or invalid widower' and minor children$ and$ if the ma-imum total has not then been attained$ other dependents ma% receive small pensions. #he ma-imum is the same as for total incapacit%. In a growing number of industriali5ed countries &2ustria$ >rance$ Ferman%$ Ireland$ Israel$ #he "etherlands$ and Swit5erland' the fourth t%pe of benefit s%stematic arrangements for retraining and rehabilitation of seriousl% in*ured personsis provided$ and emplo%ers ma% even be re6uired to provide emplo%ment to such persons. ?inancin# and admini"terin# employment in<ury in"urance* 2lmost all s%stems of emplo%ment in*ur% insurance are financed b% emplo%ers] contributions e-clusivel%$ and in almost all these s%stems the contribution is proportional to the ris! represented b% the class of activit% in which the emplo%er is engaged. 8suall% the insurance institution adapts the contribution to the accident e-perience of the underta!ing individuall% or to an% special preventive measures it ma% have ta!en. On the other hand$ mainl% for simplicit%$ but partl% perhaps in order to subsidi5e basic but dangerous industries$ a uniform contribution rate for all classes of activit% has been established in several countries. Social insurance against emplo%ment in*ur%$ as against other ris!s$ is in most countries administered b% institutions under the *oint management of emplo%ers and emplo%ees and often of government representatives as well7 in eastern Europe$ however$ the administration is entrusted to trade unions. 9isputes are settled b% arbitral organs without resort to the courts. In the 8nited States an emplo%er ma% compl% with the provisions of most wor!ers] compensation laws in three wa%s: b% purchasing a private wor!ers] compensation and emplo%er liabilit% polic% from a commercial insurer$ b% purchasing coverage through a state fund set up for this purpose$ or b% setting aside reserves sufficient to cover the ris!s involved. ;ost wor!ers] compensation benefits are financed b% the first two methods. State laws in the 8nited States are not uniform with respect to the amount of the monetar% compensation or length of time for which income pa%ments are made. >or e-ample$ onl% about half the states give lifetime income benefits for occupational in*uries. In others there is a statutor% limitation of between /HH and 0HH wee!s of pa%ments. 2gain$ most states provide ,,H li6uidating damages for an in*ur% that is permanent but does not totall% incapacitate the wor!er$ such as the loss of an arm or leg. #he si5e of these li6uidating damages varies greatl%. ;ost state laws also provide complete medical benefits$ including rehabilitation e-penses$ and survivors] benefits in the event of the wor!er]s death. Co"t"* >ollowing the publication in the earl% 1G=Hs of about /H studies revealing inade6uacies in wor!ers] compensation in the 8nited States$ most states passed laws increasing the number of wor!ers covered$ raising wee!l% benefits to e6ual or e-ceed 11 ,B. percent of the average wee!l% wage$ and ma!ing other improvements. Compensable claims now include those involving bac! pain$ stress$ and heart conditions traceable to emplo%ment conditions. ;an% claims also involve court litigation$ which greatl% magnifies settlement costs. >or emplo%ers$ these and other factors have increased the average cost of benefits from less than 1 percent of wages before 1G1H to ,.. percent in 1GG,. Credit in"urance* #he use of credit in modern societies is so various and widespread that man% t%pes of insurance have grown up to cover some of the ris!s involved. E-amples of these ris!s are the ris! of bad debts from insolvenc%$ death$ and disabilit%7 the ris! of loss of savings from ban! failure7 the ris! attaching to home loan debts when installments are not paid for various reasons$ resulting in foreclosure with subse6uent loss to the creditor7 and the ris! of loss from e-port credit because of war$ currenc% restrictions$ cancellation of import licenses$ or other political causes. Merchandi"e credit in"urance* Credit insurance for domestic bu%ers and sellers is available in the 8nited States$ Canada$ ;e-ico$ and most European countries. It is sold onl% to manufacturers$ wholesalers$ and certain service agencies$ not to retailers. #he insurance is designed to enable the seller to recover a certain percentage of losses from insolvenc% of the debtor$ but the contracts list a number of conditions under which the creditor ma% initiate a claim regardless of the 6uestion of insolvenc%. #he polic% is designed primaril% to meet the needs of those sellers whose business is concentrated on a few bu%ers$ insolvenc% of an% one of which would seriousl% *eopardi5e the financial stabilit% of the seller. EBport credit in"urance* 2 special form of credit insurance is available to e-porters against losses from both commercial and political ris!s. In the 8nited States$ for e-ample$ e-port credit insurance is written through a consortium of insurance companies organi5ed b% the >oreign Credit Insurance 2ssociation &>CI2'. #he EBport0Import /an! of the 1nited State" assumes the ultimate liabilit% for loss$ while the >CI2 serves as the underwriting agenc%. Coverage is usuall% limited to GH or G0 percent of the account. (rior approval from the >CI2 is usuall% re6uired before e-port credit insurance is granted. In some cases$ the e-porter is re6uired to purchase coverage on all credit ,,1 sales in a given countr% as a device to reduce adverse selection. E-port credit insurance is used more widel% in some countries than in others. In the 8nited Uingdom appro-imatel% one6uarter of all e-port sales are covered$ compared with about 1 percent in the 8nited States. E-port sales are not eligible for insurance if the% are made for cash or financed directl% or indirectl% through governmentguaranteed loans. Title in"urance* Title in"urance is a contract guaranteeing the purchaser of real estate against loss from undiscovered defects in the title to propert% that has been purchased. Such loss ma% stem from unmar!etabilit% of the propert% because of defective title or from costs incurred to cure defects of the title. #he need for title insurance arises from the fact that real estate transactions are comple- and technical. 2n% legal error$ no matter how detailed or minute$ ma% cause a defect in the title that impairs its mar!etabilit%. E-amples of such defects are forgeries$ invalid or undiscovered wills$ defective probate proceedings$ or transfers of propert% b% persons lac!ing full legal capacit% to contract. Mi"cellaneou" in"urance* Special casualt% forms are issued to cover the ha5ards of sudden e-plosions from e6uipment such as steam boilers$ compressors$ electric motors$ fl%wheels$ air tan!s$ furnaces$ and engines. <oiler and machiner% insurance has several distinctive features. 2 substantial portion of the premium collected is used for inspection services rather than loss protection. Second$ the boiler polic% provides that its coverage will be in e-cess of an% other applicable insurance. In this sense$ it ma% be loo!ed upon as an cumbrella polic%c to fill in gaps in the insured]s program. #hird$ the polic% lists the specific losses that will be paid$ such as the loss of the boiler or machiner% itself due to accident$ e-pediting e-penses$ propert% damage liabilit%$ bodil% in*ur% liabilit%$ defense settlement and supplementar% pa%ments$ business interruption$ outage &interruption of service'$ power interruption$ conse6uential loss due to spoilage of goods$ and furnace e-plosion. #he polic% will satisf% each of these claims in the order in which the% appear$ up to the limit of the coverage. #he e-tensive use of plate #la"" in modern architecture has produced a special comprehensive insurance that covers not onl% plate glass but glass signs$ motionpicture screens$ halftone screens and lenses$ glass bric!s$ glass doors$ and so forth. It ma% be written to cover loss from an% source e-cept fire or nuclear radiation. Increasing international business activit% has caused greater use of policies generall% termed differenceinconditions insurance &9IC'. #he 9IC polic% insures propert% and liabilit% losses not covered b% basic insurance contracts. It can be written to insure almost an% peril$ including earth6ua!e and flood$ sub*ect to deductibles and stated e-clusions. It is often written on an all ris! basis. 2n international business firm ma% use the 9IC to secure uniform coverage for all countries in which it operates and to obtain higher polic% limits than those available from domestic insurers in the various foreign countries. ,,, 7.-,Y*+/ Suret% contracts are designed to protect businesses against the possible dishonest% of their emplo%ees. Suret% and fidelit% bonds fill the gap left b% theft insurance$ which alwa%s e-cludes losses from persons in a position of trust. 2 bond involves three contracting parties instead of two. #he three parties are the principal$ who is the person bonded7 the obligee$ the person who is protected7 and the suret%$ the person or corporation agreeing to reimburse the obligee for an% losses stemming from failures or dishonest% of the principal. #he bond covers events within the control of the person bonded$ whereas insurance in the strict sense covers loss from random events generall% outside the direct control of the insured. In bonding$ the suret% alwa%s has the right to tr% to collect its losses from the person bonded$ whereas in insurance the insurer ma% not attempt to recover losses from the insured. Of course$ under propert% and liabilit% policies the insurer ma% attempt to recover from liable third parties under the right of subrogation$ but subrogation rights are often not possible to enforce in practice. <onds are not usuall% cancelable b% the insurer$ whereas most insurance contracts$ e-cept life$ are cancelable b% the insurer upon due notice. >idelit% bonds are written to cover the obligee$ usuall% an emplo%er$ against loss from dishonest acts of emplo%ees7 suret% bonds cover not onl% dishonest% but also incapacit% to perform the wor! agreed upon. Suret% bonds are normall% written on principals who are acting in an independent or semiindependent capacit%$ such as building contractors or public officials$ whereas fidelit% bonds are written on emplo%ees acting under the guidance and supervision of their emplo%er. >inall%$ suret% bonds are often issued with the re6uirement of collateral$ whereas fidelit% bonds are not. #he suret% bond is an instrument through which the superior credit of the suret% is substituted for the uncertain credit of the principal7 hence$ if the suret% is as!ed to bond a principal of somewhat doubtful credit$ the re6uirement of cash collateral is fre6uentl% imposed. Ma<or type" of fidelity %ond"* >idelit% bonds differ according to whether specific persons are named as principals or whether all emplo%ees or persons are covered as a group. #he latter are most fre6uentl% used b% emplo%ers with a large number of emplo%ees$ because the% offer automatic coverage on given classes of wor!ers$ including new emplo%ees$ and greater ease of administration$ including simpler claims procedures. >idelit% bonds are usuall% written on a continuous basisthat is$ the% are effective until canceled and have no e-piration date. #he penalt% of the bond &the ma-imum amount pa%able for an% one loss' is unchanged from %ear to %ear and is not cumulative. #he bonds specif% a discover% period &usuall% two %ears' limiting the time for discovering losses after a bond is discontinued. +hen a new bond is put into effect$ it can be written to cover losses that have occurred but are undiscovered before the effective issue date of the bond. 2 salvage clause also is included$ stating the wa% in which an% salvage recovered b% the suret% from the principal is to be divided between the suret% and the ,,. obligee. #his clause is significant$ because the obligee ma% have losses in e-cess of the penalt% of the bond. Some salvage clauses re6uire that an% salvage be paid to the obligee up to the full amount of all losses$ and others provide that an% salvage be divided between the suret% and the obligee on a pro rata basis$ in the proportion that each part% has suffered loss. Ma<or type" of "urety %ond"* #here are various classes of suret% bonds. Contract construction bonds are written to guarantee the performance of contractors on building pro*ects. <onds are particularl% important in this field because of the general practice of awarding commercial building contracts to the lowest bidder$ who ma% promise more than can actuall% be performed. #he suret% who is e-perienced in this field is in a position to ma!e sounder *udgment about the liabilit% of the various bidders than an%one else and bac!s up its *udgment with a financial guarantee. Court bonds include several different t%pes of suret% bonds. >iduciar% bonds are re6uired for courtappointed officials entrusted with managing the propert% of others7 e-ecutors of estates and receivers in ban!ruptc% are fre6uentl% re6uired to post fiduciar% bonds. Other t%pes of suret% bonds include official bonds$ lost instrument bonds$ and license and permit bonds. (ublic official bonds guarantee that public officials will faithfull% and honestl% discharge their obligations to the state or to other public agencies. Dost instrument bonds guarantee that if a lost stoc! certificate$ mone% order$ warehouse receipt$ or other financial instrument falls into unauthori5ed hands and causes a loss to the issuer of a substitute instrument$ this loss will be reimbursed. Dicense and permit bonds are issued on persons such as owners of small businesses to guarantee reimbursement for violations of the licenses or permits under which the% operate. '+6- 45D *-4',* +57.45C- )ife in"urance* )ife in"urance ma% be defined as a plan under which large groups of individuals can e6uali5e the burden of loss from death b% distributing funds to the beneficiaries of those who die. >rom the individual standpoint life insurance is a means b% which an estate ma% be created immediatel% for one]s heirs and dependents. It has achieved its greatest acceptance in Canada$ the 8nited States$ <elgium$ South Uorea$ 2ustralia$ Ireland$ "ew Yealand$ #he "etherlands$ and @apan$ countries in which the face value of life insurance policies in force generall% e-ceeds the national income. In the 8nited States in 1GGH nearl% NG./ trillion of life insurance was in force. #he assets of the more than ,$,HH 8.S. life insurance companies totaled nearl% N1./ trillion$ ma!ing life insurance one of the largest savings institutions in the 8nited States. ;uch the same is true of other wealth% countries$ in which life insurance has become a ma*or channel of saving and investment$ with important conse6uences for the national econom%. Dife insurance is relativel% little used in poor countries$ although its acceptance has been increasing. ,,/ Type" of contract"* #he ma*or t%pes of life insurance contracts are term$ whole life$ and universal life$ but innumerable combinations of these basic t%pes are sold. Term in"urance contracts$ issued for specified periods of %ears$ are the simplest. (rotection under these contracts e-pires at the end of the stated period$ with no cash value remaining. +hole life contracts$ on the other hand$ run for the whole of the insured]s life and graduall% accumulate a cash value. #he cash value$ which is less than the face value of the polic%$ is paid to the polic%holder when the contract matures or is surrendered. 1ni$er"al life contracts$ a relativel% new form of coverage introduced in the 8nited States in 1G=G$ have become a ma*or class of life insurance. #he% allow the owner to decide the timing and si5e of the premium and amount of death benefits of the polic%. In this contract$ the insurer ma!es a charge each month for general e-penses and mortalit% costs and credits the amount of interest earned to the polic%holder. #here are two general t%pes of universal life contracts$ t%pe 2 and t%pe <. In t%pe2 policies the death benefit is a set amount$ while in t%pe< policies the death benefit is a set amount plus whatever cash value has been built up in the polic%. Dife insurance ma% also be classified$ according to t%pe of customer$ as ordinar%$ group$ industrial$ and credit. #he ordinar% insurance mar!et includes customers of whole life$ term$ and universal life contracts and is made up primaril% of individual purchasers of annualpremium insurance. #he group insurance mar!et consists mainl% of emplo%ers who arrange group contracts to cover their emplo%ees. #he industrial insurance mar!et consists of individual contracts sold in small amounts with premiums collected wee!l% or monthl% at the polic%holder]s home. Credit life insurance is sold to individuals$ usuall% as part of an installment purchase contract7 under these contracts$ if the insured dies before the installment pa%ments are completed$ the seller is protected for the balance of the unpaid debt. Insurance ma% be issued with a premium that remains the same throughout the premiumpa%ing period$ or it ma% be issued with a premium that increases periodicall% according to the age of the insured. (racticall% all ordinar% life insurance policies are issued on a levelpremium basis$ which ma!es it necessar% to charge more than the true cost of the insurance in the earlier %ears of the contract in order to ma!e up for much higher costs in the later %ears7 the socalled overcharges in the earlier %ears are not reall% overcharges but are a necessar% part of the total insurance plan$ reflecting the fact that mortalit% rates increase with age. #he insured is not overpa%ing for protection$ because of the claim on the cash values that accumulate in the earl% %ears7 the polic%holder ma% borrow on this value or ma% recapture it completel% b% lapsing the polic%. #he insured does not$ however$ have a claim on all the earnings that accrue to the insurance compan% from investing the funds of its polic%holders. <% combining term and whole life insurance$ an insurer can provide man% different !inds of policies. #wo e-amples of such cpac!agec contracts are the famil% income polic% and the mortgage protection polic%. In each of these$ a base polic%$ usuall% whole life insurance$ is combined with term insurance calculated so that the amount of protection declines as the polic% runs its course. In the case of the mortgage protection contract$ for e-ample$ the amount of the decreasing term insurance is designed roughl% to appro-imate the amount of the mortgage on a propert%. 2s the mortgage is paid off$ the amount of insurance declines correspondingl%. 2t the end of the mortgage period the decreasing term insurance e-pires$ leaving the base polic% still in force. Similarl%$ in a famil% income polic%$ the ,,0 decreasing term insurance is arranged to provide a given income to the beneficiar% over a period of %ears roughl% corresponding to the period during which the children are %oung and dependent. Some whole life policies permit the insured to limit the period during which premiums are to be paid. Common e-amples of these are ,H%ear life$ .H%ear life$ and life paid up at age 10. On these contracts$ the insured pa%s a higher premium to compensate for the limited premiumpa%ing period. 2t the end of the stated period$ the polic% is said to be cpaid up$c but it remains effective until death or surrender. #erm insurance is most appropriate when the need for protection runs for onl% a limited period7 whole life insurance is most appropriate when the protection need is permanent. #he uni$er"al life plan$ which earns interest at a rate roughl% e6ual to that earned b% the insurer &appro-imatel% the rate available in longterm bonds and mortgages'$ ma% be used as a convenient vehicle b% which to save mone%. #he owner can var% the amount of death protection as the need for it changes in the course of life. #he polic% offers fle-ibilit% and saves the owner commission e-pense b% eliminating the need for dropping one polic% and ta!ing out another as protection re6uirements change. Settlement option"* #he death proceeds or cash values of insurance ma% be settled in various wa%s. #he insured ma% ta!e the cash value and lapse the polic%. 2 beneficiar% ma% ta!e a lump sum settlement of the face amount upon the death of the insured. #he beneficiar% ma%$ instead$ elect to receive the proceeds over a given number of %ears or in some fi-ed amount$ such as N1HH a month$ for as long as the proceeds last. #he mone% ma% be left with the insurer temporaril% to draw interest. Or the proceeds ma% be used to purchase a life annuit%$ which in effect is another insurance polic% guaranteeing regular pa%ments for the life of the insured. .ther pro$i"ion"* Dife insurance policies contain various clauses that protect the rights of beneficiaries and the insured. (erhaps the best!nown is the incontestable clause$ which provides that if a polic% has been in force for two %ears the insurer ma% not afterward refuse to pa% the proceeds or cancel the contract for an% reason e-cept nonpa%ment of premiums. #hus$ if the insured made a material misrepresentation when the polic% was originall% obtained$ and this misrepresentation is not discovered until after the contestable period$ beneficiaries ma% still receive the value of the polic% so long as the premiums are maintained. 2nother protective clause is the suicide clause$ which states that after a given period$ usuall% two %ears$ the insurer ma% not den% liabilit% for subse6uent suicide of the insured. If suicide occurs within the period$ the insurer tenders to the beneficiar% onl% the premiums that have been paid. If the age of the insured was misstated when the polic% was ta!en out$ the misstatement ofage clause provides that the amount pa%able is the amount of insurance that would have been purchased for the premium had the correct age been stated. ;an% life insurance policies$ !nown as participating policies$ return dividends to the insured. #he dividends$ which ma% amount to ,H percent of the premiums$ ma% be ,,1 accumulated in cash left with the insurer at interest$ used to bu% additional life insurance$ used to reduce premium pa%ments$ or used to pa% up the contract sooner than would otherwise have been possible.
Special rider"* #he insured ma%$ at a nominal charge$ attach to the contract a waiverof premium rider under which premium pa%ments will be waived in the event of total and permanent disabilit% before the age of 1H. 8nder the disabilit% income rider$ should the insured become totall% and permanentl% disabled$ a monthl% income will be paid. 8nder the double indemnit% rider$ if death occurs through accident$ the insurance pa%able is double the face amount. Pri$ate health in"urance* In man% countries health in"urance has become a governmental institution. In some$ doctors and other professional staff are emplo%ed$ directl% or indirectl%$ b% a government agenc% on a fulltime or parttime salaried basis$ and health facilities are owned or operated b% the government. #his has been the practice in 2ustralia$ <ra5il$ Canada$ Chile$ Freece$ Ireland$ ;e-ico$ "ew Yealand$ Sweden$ #ur!e%$ and the countries of eastern Europe. In other countries the government pa%s for medical care provided b% private ph%sicians7 these countries include 2ustria$ 9enmar!$ #he "etherlands$ "orwa%$ and Spain. In some countries private health insurance programs e-ist along with$ or as part of$ the government program. Various combinations of programs are possible$ and it is difficult to summari5e all the arrangements that actuall% e-ist. #he 8nited States provides governmentrun medical services in veterans] hospitals and mental hospitals$ and it also has a governmental health insurance program for citi5ens age 10 and over &;edicare' under the Social Securit% 2ct amendments of 1G10$ but most health insurance in the 8nited States still consists of private programs. ;uch private health insurance in the 8nited States is operated on a group basis$ generall% through groups of emplo%ees whose pa%ments ma% be subsidi5ed b% their emplo%er. Type" of policie"* #he ma*or t%pes of health insurance coverage are hospitali5ation$ surgical$ regular medical$ ma*or medical$ disabilit% income$ dental$ and longterm care. 3ealth insurance contracts are not highl% standardi5ed. #he polic% provisions discussed below should be considered as t%pical$ not universal or invariant. ,o"pitaliIation in"urance indemnifies for room and board in the hospital$ laborator% fees$ use of special facilities$ nursing care$ and certain medicines and supplies. #he contracts contain specific limitations on coverage$ such as a ma-imum number of da%s in the hospital and ma-imum allowances for room and board. Surgical e-pense insurance covers the surgeon]s charge for given operations or medical procedures$ usuall% up to a ma-imum for each t%pe of operation. Cegular medical insurance contracts indemnif% the insured for e-penses such as ph%sicians] home or office visits$ medicines$ and other medical e-penses. Ma<or medical contracts are distinguished from other health insurance policies b% offering coverage without man% specific limitations7 usuall% there is onl% a ma-imum per person$ a deductible amount$ and a percentage deductible$ called coin"urance$ under which the ,,= insured usuall% pa%s ,H percent of each medical bill above the deductible amount. Di"a%ility income coverage provides periodic pa%ments when the insured is unable to wor! as a result of accident or illness. #here is normall% a waiting period before the pa%ments begin. 9efinitions of disabilit% var% considerabl%. 2 strict definition of disabilit% re6uires that one be unable to perform each and ever% dut% of one]s regular occupation for a given period$ sa% two %ears$ and thereafter be unable to perform the duties of an% occupation for which one is reasonabl% fitted b% training or e-perience. ;ore liberal definitions of disabilit% re6uire onl% the inabilit% to perform the duties of one]s usual occupation. 9ental insurance$ usuall% sold on a group plan and sponsored b% an emplo%er$ covers such dental services as fillings$ crowns$ e-tractions$ bridgewor!$ and dentures. ;ost policies contain relativel% low annual limits of coverage$ such as N,$0HH$ as well as deductibles and coinsurance provisions. Some policies limit benefits to a percentage of the cost of services. Dongterm care insurance &D#C' has been developed to cover e-penses associated with old age$ such as care in nursing homes and home care visits. D#C insurance$ though relativel% new$ is alread% attracting strong interest because of the rapid growth of the elderl% population in the 8nited States. (olicies specif% a ma-imum limit per da% plus an overall ma-imum benefit amount$ with the result that the insurance t%picall% covers the e-penses of a ma-imum of four or five %ears in a nursing home. 2 common provision is a ,Hda% waiting period before benefits begin. Some policies e-clude certain conditions such as 2l5heimer]s disease and do not cover custodial care. >or an additional premium$ some D#C policies offer an inflation provision$ which increases the dail% benefit b% some percentage$ such as 0 percent a %ear. Renea%ility* 2n important condition of health insurance is that of renewabilit%. Some contracts are cancelable at an% time upon short notice. Others are not cancelable during the %ear]s term of coverage$ but the insurer ma% refuse to renew coverage for a subse6uent %ear or ma% renew onl% at higher rates or under restrictive conditions. #hus the insured ma% become ill with a chronic disease and discover that upon renewal the polic% e-cludes all future coverage for this disease. Onl% policies that are both noncancelable and guaranteed renewable assure continuous coverage$ but these are much more e-pensive.
Pro%lem"* (rivate health insurance contracts are in general 6uite restricted in coverage$ to the point that man% consider them to be inade6uate for modern conditions. #he% also lend themselves to abuses such as overutili5ation of coverage$ multiple policies$ and insuring for more than 1HH percent of the e-pected loss. 3ealth insurance$ b% its ver% e-istence$ helps to escalate rising medical care costs7 for e-ample$ insured medical losses tend to run higher than noninsured losses because ph%sicians often charge according to cabilit% to pa%$c and insurance increases this abilit%. #hrough insurance it is also easier to pass on rising hospital costs to the patient. >inall%$ since there is a tendenc% for those most li!el% to have losses to ta!e out health insurance$ an element of adverse selection e-ists. Careful underwriting to screen out those who are tr%ing to ta!e advantage of the insurance mechanism to pa% ,,? for !nown bills is considered essential$ but this undoubtedl% denies coverage to man% who need protection. :roup in"urance* Froups have alwa%s been important in the insurance field$ from the burial societies of the Comans and the insurance funds of the medieval guilds to the fraternal and religious insurance plans of modern times. In the ,Hth centur% private insurance companies have written increasingl% large amounts of group insurance$ particularl% in life insurance$ health insurance$ and annuities. In 1GGH more than G0 percent of the industrial labour force in the 8nited States was covered b% group life and health insurance plans established b% emplo%ers. ;uch of the impetus for these emplo%ee benefit plans came from the labour unions$ which pressed for such cfringe benefitsc in bargaining with emplo%ers. Froup insurance is widel% used throughout the world$ both in the form of private plans and as social insurance plans. Social securit% plans with group coverage e-ist in more than 1/H nations. (rivate group plans are generall% offered wherever private life and health insurance companies operate. Froup life insurance is the most commonl% offered plan7 group health plans are government operated in man% nations. In man% countries$ group pension plans are common as a supplement to social insurance pension schemes. Froup insurance has been especiall% popular in (apan$ where man% emplo%ees serve a compan% for life. 2ll @apanese life insurance companies offer group life insurance. 3ealth insurance is provided b% the government. >unded group pensions became popular after a 1G1, ta- law made contributions ta-deductible for @apanese emplo%ers. In addition$ virtuall% all @apanese emplo%ers provide lumpsum retirement allowances to their wor!ers.
:roup life in"urance* 8nder group life in"urance an emplo%er signs a master contract with the insurance compan% outlining the provisions of the plan. Each emplo%ee receives a certificate that gives evidence of participation in the plan. #he amount of insurance depends on the emplo%ee]s salar% or *ob classification7 usuall% the emplo%er pa%s a portion of the premium and the emplo%ee pa%s the rest$ but sometimes the emplo%er pa%s the entire cost of the plan. 2 ma*or advantage of group life insurance to an emplo%ee is that usuall% coverage ma% be obtained regardless of health. 2n emplo%ee who leaves the group ma%$ without a medical e-amination$ convert the group coverage to an individual polic%. #he premiums on group life insurance are considerabl% less than on comparable individual policies$ mainl% because the selling and administrative costs are minimal. :roup health in"urance* ;a*or t%pes of health in"urance written on a group basis include insurance against the losses occasioned b% hospitali5ation$ surgical e-pense$ and disabilit%. 3ospitali5ation insurance is designed to cover dail% room and board and other e-penses. Surgical e-pense insurance usuall% provides specified allowances for ph%sicians] charges for various operations. Cegular medical e-pense coverage is generall% aimed at covering part of the costs of medicines and doctor calls. ;a*or ,,G medical insurance offers the insured a large monetar% coverage$ designed to meet catastrophic costs of illness or accident with few restrictions as to the t%pe of medical e-pense for which reimbursement is allowed. #he insured must bear a percentage of an% loss$ usuall% ,H percent. #emporar% disabilit% income offers the insured a wee!l% indemnit% for a period of up to si- months if the insured is temporaril% disabled and unable to wor!. Dongterm disabilit% e-tends the income for periods longer than si- months. 2ccidental death and dismemberment insurance offers an insured or a beneficiar% a lump sum7 it is used widel% as a form of travel accident insurance. 8nder the t%pical group health insurance contract$ the insured person en*o%s several elements of protection not obtainable in individual contracts. Cancellation of coverage is not permitted unless coverage for the entire group is canceled. #he insured en*o%s protection against rate increases unless the rate for all members of the class is increased. #%picall% the group protection ma% be converted to some !ind of individual polic%$ or the insured ma% transfer to another group plan. #he insurer tends to be liberal on claims settlement because the t%pical premium under a group plan is large enough for the insurer to be unwilling to *eopardi5e the good will of the clientele through miserl% claims treatment. ;ost group insurance plans re6uire that certain conditions be met. Sometimes there must be a minimum number of persons covered$ such as 1H or ,0. #he group must also have some reason for e-istence other than to obtain insurance. #he most usual t%pes of groups are emplo%ees of a common emplo%er$ members of a labour organi5ation$ debtors of a common creditor$ or members of a professional or trade association. ;ention must also be made of nonprofit prepa%ment plans &e.g.& the <lue Cross<lue Shield plans and health maintenance or#aniIation" f3;Osg in the 8nited States'$ which resemble the above plans in most respects but are not operated b% insurance companies. #hese plans often indemnif% the hospital or the ph%sician$ on the basis of services performed$ rather than the patient. 3ealth insurance plans ma% also be established independentl% b% large emplo%ers$ labour unions$ communities$ or cooperatives. Outside the 8nited States this !ind of health insurance has been ta!en over b% government programs. In Sweden$ before the enactment of the compulsor% insurance program in 1G00$ =H percent of the population was covered b% private plans. In Freat <ritain$ before the "ational 3ealth Service was instituted in 1G/?$ about half the population was privatel% covered. In #he "etherlands about half the population was so covered before the government program began$ and there were still man% private funds run b% various groups. In spite of the success of private group health insurance in the 8nited States$ it is estimated that in 1GG, appro-imatel% .= million people were without health insurance coverage. ;an% attempts over the %ears to establish universal national health insurance in the 8nited States have failed.
:roup annuitie"* 2n annuit% in the literal sense is a series of annual pa%ments. ;ore broadl% it ma% be defined as a series of e6ual pa%ments over e6ual intervals of time. 2 life annuit%$ a subclass of annuities in general$ is one in which the pa%ments are guaranteed for the lifetime of one or more individuals. 2 group annuit% differs from an individual annuit% in that the annuit% pa%ments are based upon the assumed length of lives of members of a given group. #he si5e of the pa%ments depends on several factors: the assumed interest rate$ the life e-pectanc% of the individual or of the individuals ma!ing up the group$ the length of the period during which pa%ments are guaranteed$ the length of time elapsing before the pa%ments begin$ and the number of ,.H lives on which the pa%ments are continued. >or e-ample$ if pa%ments to an annuitant aged 10 are to be guaranteed for ,H %ears$ the% will be substantiall% smaller than if the% are guaranteed onl% for the remainder of the person]s life. #he t%pical group life annuit% is sponsored b% an emplo%er$ who ma% pa% all or part of the cost. 8nder the usual arrangement$ ever% emplo%ee receives each %ear a credit with the life insurance compan% for an annuit% purchased to begin at age 10. #he final pension received is made up of the sum of the individual annuities purchased throughout the wor!er]s life. 2s a rule$ an irrevocable claim to these annuit% rights is gained onl% after the person has wor!ed with the emplo%er for a given number of %ears or has reached a given age. #he basic advantage of an annuit% is that it provides an income for life that is larger than the amount that the holder would receive b% putting mone% out at simple interest. It is the reverse of life insurance$ in that the insurer pa%s premiums to the insured7 it resembles insurance in that the pa%ment is based on life e-pectanc%. #he problem of inflation has led to e-perimentation with variable annuities in order to protect annuitants against decreases in purchasing power. #he ma*or distinguishing characteristic of a variable annuit% is that the pa%ments var% according to underl%ing trends in the stoc! mar!et. >unds paid in for the variable annuit% are invested in common stoc! rather than in bonds$ mortgages$ or other fi-edinterest investments as is true of regular annuities. In simplified terms$ if the stoc! mar!et rises 1H percent in one %ear$ the annuitant ma% e-pect pa%ments to go up b% appro-imatel% 1H percent in the following %ear. Conversel%$ if the stoc! mar!et drops 1H percent$ the annuitant will suffer a 1H percent reduction in income. #o the e-tent that the stoc! mar!et reflects changes in the cost of living$ the annuitant]s income is automaticall% ad*usted for these changes each %ear7 and$ if the stoc! mar!et also reflects increases in productivit% in the econom%$ then the annuitant ma% e-pect to receive a share in such increases in the productivit% as the econom% ma% gain. Some variable annuit% plans are tied directl% to a costofliving inde-. In order to finance the increased benefits$ the emplo%er invests a portion of the funds in e6uities such as common stoc! and real estate. 2n assumption is made that there will be a sufficient gain from this source to enable the emplo%er to pa% the increased cost of living$ but the emplo%ee is not e-pected to suffer reductions in annuit% pa%ments. #he problem of ad*usting retirement benefits to changes in the econom% has been of concern in man% countries. Some governments have pegged the price of government bonds to the costofliving inde-. Cetired individuals purchasing government bonds ma% then receive automatic increases in interest pa%ments if the cost of living rises. #heir interest will not fall below a specified amount. Social securit% legislation in most parts of the world is geared in various wa%s to changes in the cost of living. In some cases benefits are directl% tied to a price inde-. In other cases the legislature from time to time must be as!ed to ma!e ad*ustments in social securit% benefits. ,.1 +nsurance practice 75D-.;.+,+5: 45D .4,- M48+5: #he two basic functions in insurance are underwriting and rating$ which are closel% related to each other. 8nderwriting deals with the selection of ris!s$ and rating deals with the pricing s%stem applicable to the ris!s accepted. 1nderritin# principle"* 8nderwriting has to do with the selection of sub*ects for insurance in such a manner that general compan% ob*ectives are met. #he main ob*ective of underwriting is to see that the ris! accepted b% the insurer corresponds to that assumed in the rating structure. #here is often a tendenc% toward adverse selection$ which the underwriter must tr% to prevent. 2dverse selection occurs when those most li!el% to suffer loss are covered in greater proportion than others. #he insurer must decide upon certain standards$ terms$ and conditions for applicants$ pro*ect estimated losses and e-penses through the anticipated period of coverage$ and calculate reasonabl% accurate rates to cover these losses and e-penses. Since man% factors affect losses and e-penses$ the underwriting tas! is comple- and uncertain. <ad underwriting has resulted in the failure of man% insurers. In some t%pes of insurance ma*or underwriting decisions are made in the field$ and in other t%pes the% are made at the home office. In the field of life insurance the agent]s *udgment is not accepted as final until the homeoffice underwriter can ma!e a decision$ for the life insurance contract is usuall% noncancelable$ once written. In the field of propert% and liabilit% insurance$ on the other hand$ the contract is cancelable if the homeoffice underwriter later finds the ris! to be unacceptable. It is not uncommon for a propert% and liabilit% insurer to accept large ris!s onl% to cancel them at a later time after the full facts are anal%5ed. #he insurance underwriter must tread a thin line between undue strictness and undue la-it% in the acceptance of ris!. #he underwriter]s position is not unli!e that of the credit manager in a business corporation$ in which unreasonabl% strict credit standards discourage sales but overl% wea! credit standards invite losses. 2n important initial tas! of the underwriter is to tr% to prevent adverse selection b% anal%5ing the ha5ards that surround the ris!. #hree basic t%pes of ha5ards have been identified as moral$ ps%chological$ and ph%sical. 2 moral ha5ard e-ists when the applicant ma% either want an outright loss to occur or ma% have a tendenc% to be less than careful with propert%. 2 ps%chological ha5ard e-ists when an individual unconsciousl% behaves in such a wa% as to engender losses. (h%sical ha5ards are conditions surrounding propert% or persons that increase the danger of loss. 2n underwriter ma% suspect the e-istence of a moral ha5ard on applications submitted b% persons with !nown records of dishonest% or when e-cessive coverage is sought or the replacement value of the propert% e-ceeds its value as a profitma!ing enterprise. 8nderwriters are aware that fire losses are more li!el% to occur during business depressions. #he underwriter can detect moral ha5ard in various wa%s: 2n applicant]s credit ma% be chec!ed7 courthouse and police records ma% reveal a criminal histor% or a histor% of ban!ruptc%7 and other insurance companies can be 6ueried for information when it is suspected that an individual is tr%ing to obtain an e-cessive amount of coverage or has been turned down b% other insurers. #he ps%chological t%pe of ha5ard can ta!e a number of forms. Some ,., persons are said to be caccidentpronec because the% have far more than their share of accidents$ suggesting that unconsciousl% the% want them. It is well !nown that persons appl%ing for annuities tend to have longer than average lives$ and conse6uentl% a special mortalit% table is used for annuitants. Certain t%pes of insanit% have to be watched fornotabl% the impulse to set fires. (h%sical ha5ards include such things as woodframe construction in buildings$ particularl% in areas where such properties are densel% concentrated. Earth6ua!e insurance rates tend to be high where geologic faults e-ist &as in San >rancisco$ which is built almost directl% over such a fault'. Each !ind of insurance has its characteristic ha5ards. In fire in"urance the ph%sical ha5ards are anal%5ed according to four ma*or factors: t%pe of construction$ the protection rating of the cit% in which the propert% is located$ e-posure to other structures that ma% spread a conflagration$ and t%pe of occupanc%. In underwriting automo%ile in"urance$ the underwriter considers the following factors: the age$ se-$ and marital status of the driver and members of the driver]s household7 length of driving e-perience7 occupation7 stabilit% of emplo%ment and residence7 ph%sical impairments7 accident and conviction record7 e-tent of use of alcohol and drugs7 customar% use of the vehicle7 age$ condition$ and maintenance of the vehicle7 and records of insurance cancellation or refusal. In some cases tests of emotional maturit% are administered. Some underwriters even consider such factors as the school records of student drivers and whether or not driving courses have been ta!en. #he ha5ards considered in the underwriting of general liabilit% insurance depend on the t%pe of business and the record of the person appl%ing for coverage. In the field of contractin#$ for e-ample$ the underwriter is interested in the t%pe of e6uipment owned or rented b% the applicant7 the applicant]s losses in the past$ attitude toward safe practice$ cooperation with building inspectors$ and financial position and credit standing7 the stabilit% of supervisor% emplo%ees7 and the degree to which the applicant has been a successful contractor in the past. Rate ma!in#* Closel% associated with underwriting is the ratema!ing function. If$ for e-ample$ the underwriter decides that the most important factor in discriminating between different ris! characteristics is age$ the rates will be differentiated according to age. #he rate is the price per unit of e-posure. In fire in"urance$ for e-ample$ the rate ma% be e-pressed as N1 per N1HH of e-posed propert%7 if an insured has N1$HHH of e-posed propert%$ the premium will thus be N1H. #he rate reflects three ma*or elements: the loss cost per unit of e-posure$ the administrative e-penses$ or cloading$c and the profit. In propert% insurance$ appro-imatel% onethird of the premium covers e-penses and profit$ and twothirds covers the e-pected cost of loss pa%ments. #hese percentages var% somewhat according to the particular t%pe of insurance. Cates are calculated in the following wa%. 2 polic%$ for instance$ ma% be written covering a class of automobiles with an e-pected loss fre6uenc% of 1H percent ,.. and an average collision loss of N/HH. #he e-penses of the insurer are to average .0 percent of the premium$ and there must be a profit of 0 percent. #he pure loss cost per unit is 1H percent of N/HH$ or N/H. #he gross premium is calculated b% the formula .B f1 &, i 3'g$ in which . e6uals the loss cost per unit$ , e6uals the e-pense ratio$ and 3 e6uals the profit ratio. In this case the gross premium would be N/HBf1 &..0 i .H0'g$ or N11.1=. >our basic standards are used in rate ma!ing: &1' the structure of rates should allocate the burden of e-penses and costs in a wa% that reflects as accuratel% as possible the differences in ris!in other words$ rates should be fair7 &,' a rate should produce a premium ade6uate to meet total losses but should not bring unreasonabl% large profits7 &.' the rate should be revised often enough to reflect current costs7 and &/' the rate structure should tend to encourage loss prevention among those who are insured. Some e-amples will illustrate the nature and application of the criteria outlined above. In life insurance$ the rate is generall% more than ade6uate to meet all reasonabl% anticipated losses and e-penses7 in other words$ the insured is charged an e-cessive premium$ part of which is then returned as a dividend according to actual losses and e-penses. #he re6uirement that the rate reflect fairl% the ris! involved is much more difficult to achieve. In wor!ers] compensation insurance$ the rate is e-pressed as a percentage of the emplo%er]s pa%roll for each occupational class. #his ma% seem fair enough$ but an emplo%er with relativel% highpaid wor!ers has fewer emplo%ees for a given amount of pa%roll than one whose wor!ers are paid a lower wage. If the two emplo%ers fall into the same occupational class and have the same total pa%roll$ the% are charged the same premium even though one ma% have a larger number of wor!ers than the other and hence greater e-posure to loss. >airness ma% be an elusive goal. Insurance rates are revised onl% slowl%$ and$ since the% are based upon past e-perience$ the% tend to remain out of date. In life insurance$ for e-ample$ the mortalit% tables used are changed onl% ever% several %ears$ and rate ad*ustments are reflected in dividends. In automobile insurance$ rates are revised annuall% or even more often$ but the% still tend to be out of date. #wo basic ratema!ing s%stems are in use: the manual$ or classrating$ method and the individual$ or meritrating$ method. Sometimes a combination of the two methods is used. 2 manual rate is one that applies uniforml% to each e-posure unit falling in some predetermined class or group$ such as people of the same age$ wor!ers of one emplo%er$ drivers meeting certain characteristics$ or all residences in a given area. (resumabl% the members of each class are so homogeneous as to be indistinguishable so far as ris! characteristics are concerned. ;erit rating is used to give recognition to individual characteristics. In commercial buildings$ for e-ample$ fire insurance rates depend on such individual characteristics as the t%pe of occupanc%$ the number and t%pe of safet% features$ and the 6ualit% of housecleaning. In an attempt to reflect the true 6ualit% of the ris!$ a percentage charge or credit ma% be applied to the base rate for each of these features. 2nother e-ample is found in emplo%er group health insurance plans where the premium or the rate ma% be ad*usted annuall% depending on the loss e-perience or on the amount of claims service provided. In order to obtain broader and statisticall% sounder rates$ insurers often pool loss and claims e-perience b% setting up rating bureaus to calculate rates based on industr%wide e-perience. #he% ma% have an agreement that all member companies must use the rates thus developed. #he rationale for such agreements is that the% help insurers meet the criteria of ade6uac% and fairness. Cating bureaus are used e-tensivel% in fire$ marine$ wor!ers] compensation$ automobile$ and crime insurance. ,./ 1nderritin# cycle* (rofits in propert% and liabilit% insurance have tended to rise and fall in fairl% regular patterns lasting between five and seven %ears from pea! to pea!7 this phenomenon is termed the underwriting c%cle. Stages of the underwriting c%cle ma% be described as follows: initiall%$ when profits are relativel% high$ some insurers$ wishing to e-pand sales$ start to lower prices and become more lenient in underwriting. #his leads to greater underwriting losses. Cising losses and falling prices cause profits to suffer. In the second stage of the c%cle$ insurers attempt to restore profits b% increasing rates and restricting underwriting$ offering coverage onl% to the safest ris!s. #hese restrictions ma% be so severe that insurance in some lines becomes unavailable in the mar!etplace. Insurers are able to offset a portion of their underwriting loses through earnings on investments. Eventuall% the increased rates and reduced underwriting losses restore profits. 2t this point$ the underwriting c%cle repeats itself. #he general effect of the underwriting c%cle on the public is to cause the price of propert% and liabilit% insurance to rise and fall fairl% regularl% and to ma!e it more difficult to purchase insurance in some %ears than in others. #he competition among insurers caused b% the underwriting c%cle tends to create cost bargains in some %ears. #his is especiall% evident when interest rates are high$ because greater underwriting losses will$ in part$ be offset b% greater investment earnings. Rein"urance* 2 significant insurance practice is that of reinsurance$ whereb% ris! ma% be divided among several insurers$ reducing the e-posure to loss faced b% each insurer. Ceinsurance is effected through contracts called treaties$ which specif% how the premiums and losses will be shared b% participating insurers. #wo main t%pes of treaties e-ist pro rata and e-cessofloss treaties. In the former$ all premiums and losses ma% be divided according to stated percentages. In the latter$ the originating insurer accepts the ris! of loss up to a stated amount$ and above this amount the reinsurers divide an% losses. Ceinsurance is also fre6uentl% arranged on an individual basis$ called facultative reinsurance$ under which an originating insurer contracts with another insurer to accept part or all of a specific ris!. Ceinsurance enlarges the abilit% of an originating insurer to accept ris!$ since unwanted portions of the ris! can be passed on to others. Ceinsurance stabili5es insurer profits$ evens out loss ratios$ reduces the capital needed to underwrite business$ and offers a wa% for insurers to divest themselves of an entire segment of their ris! portfolio. '-:4' 4/-C, #6 +57.45C- :o$ernment re#ulation* #he insurance business is sub*ect to e-tensive government re#ulation in all countries. In European countries insurance regulation is a mi-ture of central and local ,.0 controls. In :ermany central authorit% over insurance regulation is provided b% the >ederal Insurance Supervisor% 2uthorit% &<2V'$ which e-ercises tight control of premiums$ reserves$ and investments of insurers. #he <2V]s regulation of life insurance$ for e-ample$ allows no more than ,H percent of investments in e6uities. In the 1nited Ain#dom$ regulation generall% allows the managing agenc% fairl% complete libert% of action and is concerned onl% with final business results. In this the 8nited Uingdom differs from most other European countries$ in which the purpose of insurance supervision is to regulate more closel% the conditions in which insurers operate. In the countries of the European Community &EC7 under articles 0G1H of the #reat% of Come' an attempt is being made to obtain greater uniformit% among national insurance statutes. #his is intended to facilitate the operations of insurers across national borders. Cate regulation$ however$ remains within the *urisdiction of individual countries. 2lthough 1GG, was established as the goal %ear for completing the harmoni5ation process for insurance in the EC$ separate regulation in the various countries continues. ;an% legal and regulator% barriers to e-pansion of insurance operations in various countries in the world still e-ist. E-amples include strict licensing re6uirements$ prohibiting of unadmitted insurance$ mandator% hiring of local nationals$ re6uirements that insurers ma!e local investments or enter into *oint ventures with local insurers$ prohibition of free e-change of currencies or repatriation of profits$ and onerous ta-ation. 2n important legal force influencing insurance regulation in such countries as >rance$ <elgium$ Eg%pt$ Freece$ Ital%$ Debanon$ Spain$ #ur!e%$ and the former >rench 2frican colonies is the -apoleonic Code. #he influence of the code ma% be seen$ for e-ample$ in the matter of thirdpart% liabilit%$ in which the burden of proof ma% be upon the defendant rather than upon the plaintiff. In some countries not all classes of insurance are regulated. In #he "etherlands onl% life insurance is regulated$ and in <elgium onl% life$ industrial in*ur%$ and thirdpart% motor vehicle liabilit% insurance. In some countries the scope of supervision ma% embrace man% aspects of the insurance business$ but in the 8nited Uingdom and The -etherland" onl% financial matters are sub*ect to regulation. In several European countries insurers ma% not write both life insurance and general insurance &propert% and liabilit% insurance'. ;inimum capital re6uirements var%$ depending on the t%pe of business written$ usuall% being highest for life insurance. In most European countries policies are submitted to supervisor% authorities for approval or for information. In some countries standard clauses or forms of contracts must be used7 for instance$ in Seden insurers must use a standard compulsor% motor vehicle thirdpart% liabilit% polic%$ and in SitIerland a standard contract for war ris!s and life insurance is re6uired. Insurance is often compulsor%. In general$ laws fre6uentl% re6uire individuals to carr% thirdpart% liabilit% insurance and industrial in*ur% insurance. >ire insurance is re6uired on immovable propert% in Ferman%. 2 number of countries re6uire aviation insurance &for accident and sic!ness' on airline passengers and crews. 2lthough individuals generall% have the freedom to select whichever insurer the% wish$ there are restrictions on bu%ing insurance from foreign insurers. In some countries bu%ers must use domestic insurers for compulsor% coverages but are free to ta!e out insurance from foreign insurers when coverage is not available from domestic insurers. In other countries certain t%pes of insurance ma% not be placed in foreign countries. 2bout half the ,.1 countries of the world prohibit cnonadmittedc insurance$ defined as insurance written b% an insurer not authori5ed to do business in that countr%. In the 8nited States most regulation of insurance is in the hands of the individual states$ although the federal government also has authorit% over insurers when it is deemed that state regulation fails to regulate effectivel% activities such as unfair trade practices$ misleading advertising$ bo%cotts$ and monopolistic practices. States regulate four main aspects: rate ma!ing$ minimum standards for financial solvenc%$ investments$ and mar!eting practices.In rate ma!in#$ three basic re6uirements must be met: rates must be ade6uate to cover e-pected losses$ must not be e-cessive$ and must not be unfairl% discriminator% among different classes of ris!. In meeting minimum standards of financial solvenc%$ state laws specif% minimum capital re6uirements$ accounting practices$ minimum securit% deposits with state insurance commissioners$ and procedures for li6uidating insolvent insurers. In investments$ states limit the t%pes and 6ualit% of securities in which insurers ma% invest their assets. In mar!eting$ states regulate advertising$ licensing of agents$ polic% forms and wording$ service and process procedures for handling claim disputes$ e-pense allowances for ac6uiring new business$ and other agenc% and insurer operations$ including being admitted to do business in the state. ;an% states maintain a special division to register and handle consumer complaints. Contract la* In general$ an insurance contract must meet four conditions in order to be legall% valid: it must be for a legal purpose7 the parties must have a legal capacit% to contract7 there must be evidence of a meeting of minds between the insurer and the insured7 and there must be a pa%ment or consideration. #o meet the re6uirement of legal purpose$ the insurance contract must be supported b% an insurable interest &see further discussion below'7 it ma% not be issued in such a wa% as to encourage illegal ventures &as with marine insurance placed on a ship used to carr% contraband'. #he re6uirement of capacit% to contract usuall% means that the individual obtaining insurance must be of a minimum age and must be legall% competent7 the contract will not hold if the insured is found to be insane or into-icated or if the insured is a corporation operating outside the scope of its authorit% as defined in its charter$ b%laws$ or articles of incorporation. #he re6uirement of meeting of minds is met when a valid offer is made b% one part% and accepted b% another. #he offer is generall% made on a written application for insurance. In the field of propert% and liabilit% insurance$ the agent generall% has the right to accept the insured]s offer for coverage and bind the contract immediatel%. In the field of life insurance$ the agent generall% does not have this power$ and the contract is not valid until the home office of the insurer has e-amined the application and has returned it to the insured through the agent. #he pa%ment or con"ideration is generall% made up of two partsthe premiums and the promise to adhere to all conditions stated in the contract. #hese ma% include$ for e-ample$ a warrant% that the insured will ta!e certain lossprevention measures in the care and preservation of the covered propert%. ,.= Warrantie"* In appl%ing for insurance$ the applicant ma!es certain representations or arrantie". If the applicant ma!es a false representation$ the insurer has the option of voiding the contract. Concealment of vital information ma% be considered misrepresentation. In general$ the misrepresentation or concealment must concern a material factdefined as a fact that would$ if it were !nown$ cause the insurer to change the terms of the contract or be unwilling to issue it in the first place. If the agent of the insurer as!s the applicant a 6uestion the answer to which is a matter of opinion and if the answer turns out to be wrong$ the insurer must demonstrate bad faith or fraudulent intent in order to void the contract. If$ for e-ample$ in answer to an agent]s 6uestion$ the applicant reports no histor% of serious illness$ in the mista!en belief that a past illness was minor$ the court ma% find the statement to be an honest opinion and not a misrepresented fact. 2 basic principle of propert% liabilit% insurance contracts is the principle of "u%ro#ation$ under which the insurer ma% be entitled to recover% from liable third parties. In fire in"urance$ for e-ample$ if a neighbour carelessl% sets fire to the insured]s house and the insurance compan% indemnifies the insured for the loss$ the compan% ma% then bring a legal action in the name of the insured to recover the loss from the negligent neighbour. #he principle of subrogation is complemented b% another basic principle of insurance contract law$ the principle of indemnit%. 8nder the principle of indemnit% a person ma% recover no more than the actual cash loss7 one ma% not$ for e-ample$ recover in full from two separate policies if the total amount e-ceeds the true value of the propert% insured. In"ura%le intere"t* Closel% associated with the above legal principles is that of in"ura%le intere"t. #his re6uires that the insured be e-posed to a personal loss if the peril insured against should occur. Otherwise it would be possible for a person to ta!e out a fire insurance polic% on the propert% of others and collect if the propert% burned. 2n% financial interest in propert%$ or reasonable e-pectation of having a financial interest$ is sufficient to establish insurable interest. 2 secured creditor such as a mortgagee has an insurable interest in the propert% on which mone% has been lent. In the field of personal insurance one is held to have an unlimited interest in one]s own life. 2 corporation ma% ta!e life insurance on the life of a !e% e-ecutive. 2 wife ma% insure the life of her husband$ and a father ma% insure the life of a minor child$ because there is a sufficient pecuniar% relationship between them to establish an insurable interest.In life insurance the insurable interest must e-ist at the time of the contract. Continued insurable interest$ however$ need not be demonstrated. 2 divorced woman ma% continue life insurance on the life of her former husband and legitimatel% collect the proceeds upon his death even though she is no longer his wife. In the field of propert% insurance$ on the other hand$ the insurable interest must be demonstrated at the time of the loss. If an individual insures a home but later sells it$ no recover% can be made if the house burns after the sale$ because the insured has suffered no loss at the time of the fire. ,.? )ia%ility la* In most countries$ an individual ma% be held legall% liable to another for acts or omissions and be re6uired to pa% damages. Diabilit% insurance ma% be purchased to cover these contingencies. Degal liabilit% e-ists when an individual commits a legal in*ur% that wrongl% encroaches on another person]s rights. Such in*uries include slander$ assault$ and ne#li#ent acts. 2 negligent act involves failure to behave in a manner e-pected when the results of this failure cause a financial loss to others. 2n act ma% be classed as negligent even if it is unintentional. "egligence ma% be imputed from one person to another. >or e-ample$ a master is liable not onl% for his own acts but also for the negligent acts of servants or others legall% representing him. It is not uncommon for a municipalit% to re6uire that businesses using cit% propert% assume what would otherwise have been the cit%]s negligence for the use of its propert%. Statutes ma% impute liabilit% on individuals when no liabilit% would e-ist otherwise7 thus a parent ma% be legall% liable for the acts of a minor child who is driving the famil% automobile. In commonlaw countries such as the 8nited States and the 8nited Uingdom$ three defenses ma% be used in a negligence action. #hese are a""umed ri"!$ contri%utory ne#li#ence$ and the fellow servant doctrine. 8nder the assumed ris! rule$ the defendant ma% argue that the plaintiff has assumed the ris! of loss in entering into a given venture and understands the ris!s. Emplo%ers formerl% used the assumed ris! doctrine in suits b% in*ured emplo%ees$ arguing that the emplo%ee understood and assumed the ris!s of emplo%ment in accepting the *ob. #he contributor% negligence defense is fre6uentl% used to defeat negligence actions. If it can be shown that one part% was partl% to blame$ then that part% ma% not collect from an% negligence of the other part%. Some courts have applied a substitute doctrine !nown as comparative negligence. 8nder this$ each part% is held responsible for a portion of the loss corresponding to the degree of blame attached to that part%7 a person who is *udged to be ,H percent to blame for an accident ma% be re6uired to pa% ,H percent of the in*ured person]s losses. #he fellow servant defense has been used at times b% emplo%ers7 an emplo%er would argue in some cases that the in*ur% to an emplo%ee was caused not b% the emplo%er]s negligence but b% the negligence of another emplo%ee. 3owever$ wor!ers] compensation statutes in some countries have nullified such common law defenses in industrial in*ur% cases. In man% countries$ the courts have tended to appl% increasingl% strict standards in ad*udicating negligence. #his has been termed the trend toward strict liabilit%$ under which the plaintiff ma% recover for almost an% accidental in*ur%$ even if it can be shown that the defendant has used cdue carec and thus is not negligent in the traditional sense. In the 8nited States$ manufacturers of polio vaccine that was found to have caused polio were re6uired to pa% large damage claims although it was demonstrated that the% had ta!en all normal precautions and safeguards in the manufacture of the vaccine. *istorical development of insurance Insurance in some form is as old as historical societ%. Socalled %ottomry contracts were !nown to merchants of <ab%lon as earl% as /HHH.HHH <C. <ottomr% was also practiced b% the 3indus in 1HH <C and was well understood in ancient ,.G Freece as earl% as the /th centur% <C. 8nder a bottomr% contract$ loans were granted to merchants with the provision that if the shipment was lost at sea the loan did not have to be repaid. #he interest on the loan covered the insurance ris!. 2ncient Roman la recogni5ed the bottomr% contract in which an article of agreement was drawn up and funds were deposited with a mone% changer. ;arine insurance became highl% developed in the 10th centur%. In Come there were also burial societies that paid funeral costs of their members out of monthl% dues. #he insurance contract also developed earl%. It was !nown in ancient Freece and among other maritime nations in commercial contact with Freece. -ngland. >ire insurance arose much later$ obtaining impetus from the Freat >ire of Dondon in 1111. 2 number of insurance companies were started in England after 1=11$ during the socalled bubble era. ;an% of them were fraudulent$ getrich6uic! schemes concerned mainl% with selling their securities to the public. "evertheless$ two important and successful English insurance companies were formed during this period the Dondon 2ssurance Corporation and the Co%al E-change 2ssurance Corporation. #heir operation mar!ed the beginning of modern propert% and liabilit% insurance. "o discussion of the earl% development of insurance in Europe would be complete without reference to )loyd@" of )ondon$ the international insurance mar!et. It began in the 1=th centur% as a coffeehouse patroni5ed b% merchants$ ban!ers$ and insurance underwriters$ graduall% becoming recogni5ed as the most li!el% place to find underwriters for marine insurance. Edward Dlo%d supplied his customers with shipping information gathered from the doc!s and other sources7 this eventuall% grew into the publication .loyd's .ist& still in e-istence. Dlo%d]s was reorgani5ed in 1=1G as a formal group of underwriters accepting marine ris!s. &#he word underwriter is said to have derived from the practice of having each ris! ta!er write his name under the total amount of ris! that he was willing to accept at a specified premium.' +ith the growth of <ritish sea power$ Dlo%d]s became the dominant insurer of marine ris!s$ to which were later added fire and other propert% ris!s. #oda% Dlo%d]s is a ma*or reinsurer as well as primar% insurer$ but it does not itself transact insurance business7 this is done b% the member underwriters$ who accept insurance on their own account and bear the full ris! in competition with each other. 7nited tates. #he first 2merican insurance compan% was organi5ed b% /en<amin ?ran!lin in 1=0, as the (hiladelphia Contributionship. #he first life insurance compan% in the 2merican colonies was the (resb%terian ;inisters] >und$ organi5ed in 1=0G. <% 1?,H there were 1= stoc! life insurance companies in the state of "ew :or! alone. ;an% of the earl% propert% insurance companies failed from speculative investments$ poor management$ and inade6uate distribution s%stems. Others failed after the Freat Chicago >ire in 1?=1 and the San >rancisco earth6ua!e and fire of ,/H 1GH1. #here was little effective regulation$ and rate ma!ing was difficult in the absence of cooperative development of sound statistics. ;an% problems also beset the life insurance business. In the era following the 8.S. Civil +ar$ bad practices developed: dividends were declared that had not been earned$ reserves were inade6uate$ advertising claims were e-aggerated$ and office buildings were erected that sometimes cost more than the total assets of the companies. #hirt%three life insurance companies failed between 1?=H and 1?=,$ and another /? between 1?=. and 1?==. 2fter 1G1H life insurance en*o%ed a stead% growth in the 8nited States. #he annual growth rate of insurance in force over the period 1G1HGH was appro-imatel% ?./ percentamounting to a 1,1fold increase for the ?H%ear period. (ropert% liabilit% insurance had a somewhat smaller increase. <% 1G?G some .$?HH propert% liabilit% and ,$,=H life insurance companies were in business$ emplo%ing nearl% two million wor!ers. In 1G?= 8.S. insurers wrote about .= percent of all premiums collected worldwide. <apan. Insurance in @apan is mainl% in the hands of private enterprise$ although government insurance agencies write crop$ livestoc!$ forest fire$ fisher%$ e-port credit$ accident and health$ and installment sales credit insurance as well as social securit%. (rivate insurance companies are regulated under various statutes. ;a*or classes of propert% insurance written include automobile and wor!ers] compensation &which are compulsor%'$ fire$ and marine. Cates are controlled b% voluntar% rating bureaus under government supervision$ and @apanese law re6uires rates to be creasonable and nondiscriminator%.c (olic% forms generall% resemble those of +estern nations. (ersonal insurance lines are also well developed in @apan and include ordinar% life$ group life$ and group pensions. 3ealth insurance$ however$ is incorporated into @apanese social securit%. @apan]s rapid industriali5ation after +orld +ar II was accompanied b% an impressive growth in the insurance business. #oward the end of the ,Hth centur%$ @apan ran!ed number one in the world in life insurance in force. It accounted for about ,0 percent of all insurance premiums collected in the world$ ran!ing second behind the 8nited States. #he number of domestic insurers is relativel% small7 foreign insurers operate in @apan but account for less than . percent of total premiums collected. ;orldwide operations. <ecause of the great e-pansion in world trade and the e-tent to which business firms ma!e investments outside their home countries$ the mar!et for insurance on a worldwide scale has e-panded rapidl% in the ,Hth centur%. #his development has re6uired a worldwide networ! of offices to provide bro!erage services$ underwriting assistance$ claims service$ and so forth. #he ma*orit% of the world]s insurance businesses are concentrated in Europe and "orth 2merica. #hese companies must service a large part of the insurance needs of the rest of the world. ,/1 #he legal and regulator% hurdles that must be overcome in order to do so are formidable. In 1GGH the 1H leading insurance mar!ets in the world in terms of the percentage of total premiums collected were the 8nited States &.0.1 percent'7 @apan &,H.0 percent'7 the 8nited Uingdom &=.0 percent'7 Ferman% &1.? percent'7 >rance &0.0 percent'7 the Soviet 8nion &,.1 percent'7 Canada &,.. percent'7 Ital% &,., percent'7 South Uorea &,.H percent'7 and Oceania &1.? percent'. ;a*or world trends in insurance include a gradual movement awa% from nationalism of insurance$ the development of worldwide insurance programs to cover the operations of multinational corporations$ increasing use of reinsurance$ increasing use b% corporations of selfinsurance programs administered b% wholl% owned insurance subsidiaries &captive companies'$ and increasing use of mergers among both insurers and bro!erage firms. ,/, Economic Theory Economic Theory Introduction Economic theor% is the name commonl% given to the more general and abstract parts of economics$ the principles. #hese parts are no less practical than concretedescriptive or applied economics but are less directl% related to immediate problems. #he mechanics of price relations or of mar!ets afford a general e-planation of the organi5ation of production and distribution insofar as this is actuall% wor!ed out and controlled through competitive bu%ing and sellingwhich would largel% be true even in a planned or socialistic econom% that stopped short of complete militar% regimentation. #his branch of the stud% bears somewhat the same relation to economic politics that pure ph%sics bears to the engineering sciences. 3ence the problems of value and distribution have continued to hold their place among the central concerns of economists. 3owever$ there has been a notableone might sa% a revolutionar%change in the general character of the anal%sis. #he older classical economists centered their attention on the longrun relations between value and costs and were generall% content to dispose of shortrun variations of price b% merel% invo!ing the formula of suppl% and demand. #his was used without careful anal%sis of the shortrun situation$ particularl% of the role of demand. +or! directed toward filling in this gap had important effects in changing the whole conceptual picture. Enlarged theories of production$ distribution$ consumption$ business fluctuations$ and other economic elements have been introduced and continuall% reconsidered from a variet% of viewpoints.
1tility and $alue One purpose of value theor% in economics is to e-plain how the prices of goods and services are determined. #his is onl% a step$ however$ in the anal%sis of a deeper problem. #he modern industrial econom% is characteri5ed b% a high degree of interdependence of its parts. #he supplier of components or raw materials$ for e-ample$ must deliver the desired 6uantities of his products at the right moment and in the desired specifications. In economies such as those of +estern Europe$ "orth 2merica$ and @apan$ the coordination of these activities is done through the price s%stem. #he relative prices of the various inputs &e.g.$ labour$ materials$ and machiner%' tend to determine the proportions in which the% will be used. (rices also affect the relative outputs of the various final products$ and the% determine who will consume them. Value theor%$ therefore$ studies the structure of these decisions$ anal%5es the influence of prices$ and e-amines the efficienc% of the resulting allocation of resources. Value theor% is also applied b% business firms and government agencies in their decisions that relate to pricing and the allocation of resources. ,/. T,E.RIES .? VA)1E Co"t0of0production analy"i"* ;odern value theor% began with 2dam Smith &1==1'$ 9avid Cicardo &1?1='$ and a number of other writers$ who are generall% lumped together as the classical school. #hese writers sought to e-plain pricing primaril% on the basis of cost of production. #hat is$ if commodit% 2 costs twice as much to produce as commodit% <$ the price of 2 will be pushed toward a level twice as high as that of <. If this were not the caseif$ for e-ample$ 2 sold for three times the price of <then the greater profitabilit% of investment in 2 would cause its production to increase and drive down its price$ while the production of < would decline$ thus raising its price. (rices would finall% be driven to the ,:1 ratio of the costs of production. #he classical economists were well aware of the oversimplification in this e-planation$ but$ as with most theoretical anal%sis$ its strength la% in the amount it was able to e-plain with a ver% simple model. &It is highl% misleading to interpret the classical anal%sis literall%$ as a picture of its authors] views of the comple- world of realit%.' It was soon recogni5ed$ however$ that the costofproduction anal%sis considered onl% part of the relevant problem. Since cost depends on the 6uantit% produced &e.g.& costs per unit ma% decline as production of an item increases'$ the anal%sis must ta!e into account the demand for the product. #he anal%sis of demand was made possible b% the theor% of utilit%$ developed b% 3.3. Fossen in Ferman% &1?0/'$ Uarl ;enger in 2ustria &1?=1'$ Djon +alras in >rance &1?=/=='$ and +.S. @evons in England &1?=1'. #he role of utilit% anal%sis in value theor% will be discussed later. It need onl% be added at this point that modern value theor%$ following the lead of the English economist 2lfred ;arshall & 3rinciples of ,conomics& ?th ed.$ 1G,H'$ considers prices to be determined simultaneousl% b% cost and demand considerations. #he anal%sis also recogni5es the comple- interdependencies in the s%stem$ with demands and supplies of various commodities affecting one another.
#3EOCIES O> 8#IDI#: #here are two sides to the anal%sis of price and value: the suppl% side and the demand side. If cost can be said to underlie the suppl% relationship that determines price$ the demand side must be ta!en to reflect consumer tastes and preferences. c8tilit%c is a concept that has been used to describe these tastes. 2s alread% indicated$ the costofproduction anal%sis of value given above is incomplete$ because cost itself depends on the 6uantit% produced. #he cost anal%sis$ moreover$ applies onl% to commodities the production of which can be e-panded and contracted. #he price of a firstfolio Sha!espeare has no relation to cost of production7 it must depend in some sense on its utilit% to purchasers as it affects their bids. Mar#inal utility* #he classical economists suggested that this leads to a parado-. #he% argued that utilit% could not e-plain the relative price of fine *ade and bread$ because the latter was for man% consumers essential to life$ and hence its utilit% must surel% be greater than that of *ade. :et the price of bread is far lower than that of *ade. #he theor% of marginal utilit% that flowered toward the end of the 1Gth centur% supplied ,// the !e% to the parado- and provided the basis for toda%]s anal%sis of demand. ;arginal utilit% was defined as the value to the consumer of an additional unit of some commodit%. If$ for e-ample$ the consumer is offered a choice between ,, and ,. slices of bread for his famil%$ marginal utilit% measures how much more valuable ,. slices are than ,,. It is clear that the magnitude of the marginal utilit% varies with the magnitude of$ sa%$ the smaller of the alternatives. #hat is$ for a famil% of four$ the difference between seven and eight slices of bread per da% can be substantial$ if the famil% will still be hungr% in either case. <ut the difference in value between .1 and ., slices ma% be negligible. If .1 slices offer enough for ever%one to fill his stomach$ a .,nd slice ma% be worth ver% little. ;oreover$ the difference in value between 1,, and 1,. slices ma% be negativea 1,.rd slice ma% *ust add to the famil%]s disposal problem. #hese observations lead directl% to the plausible notion that marginal utilit% in some sense diminishes with the base from which one starts the calculation. +ith onl% seven or eight slices the marginal utilit% &incremental value' of an eighth slice is high. +ith .1 or ., slices it is lower$ and so on. #he less scarce a commodit%$ the lower is its marginal utilit%$ because its possessor in an% case will have enough to satisf% his most pressing uses for it$ and an increment in his holdings will onl% permit him to satisf%$ in addition$ desires of lower priorit%. #he consumer will be motivated to ad*ust his purchases so that the price of each and ever% good will be appro-imatel% e6ual to its marginal utilit% &that is$ to the amount of mone% he is willing to pa% for an additional unit'. If the price of an item is ( dollars$ for e-ample$ and the consumer is considering bu%ing$ sa%$ 1H units$ at which point the marginal utilit% of the good to him is ; &which is greater than ('$ the consumer will be better off if he purchases 11 rather than 1H units$ since the additional unit costs him ( dollars. 3e will !eep revising his purchase plans upward until he reaches the point where the marginal utilit% of the item falls to ( dollars. In sum$ the consumer]s selfinterest will lead him &without conscious calculation' to purchase an amount such that the marginal utilit% is as close as possible to mar!et price. So long as the consumer selects a bundle of purchases that gives him the most benefit &pleasure$ utilit%' for his mone%$ he must end up with 6uantities such that the marginal utilit% of each commodit% in the bundle is appro-imatel% e6ual to its price. It now becomes eas% to e-plain the parado- underl%ing the relationship between the prices of *ade and bread. <ecause a piece of fine *ade is scarce$ its marginal utilit% is high$ and consumers are willing to pa% comparativel% high prices for it. #he e-planation is perfectl% consistent with a utilit% anal%sis of demand$ so long as one relates price to the marginal utilit% of the item rather than to its total utilit%. 2 famil%]s bread ma% be ver% valuable to it$ but$ if it has enough$ the marginal utilit% of the bread will be small$ and this will be reflected in its low price. >igure 1: Celationship between marginal utilit% and 6uantit% #he relationship between price and marginal utilit% is important not because it e-plains issues li!e the *ade bread parado- but ,/0 because it enables one to anal%5e the relationship between prices and 6uantities demanded. It also$ as a practical matter$ permits one to *udge how well an% portion of the price mechanism is wor!ing as a device to secure the efficient satisfaction of the wants of the public$ within the limits set b% available resources. #he conclusion that at an% price the consumer will purchase the 6uantit% at which marginal utilit% is e6ual to price ma!es it possible to draw a demand curve showingto a reasonable degree of appro-imationhow the amount demanded will var% with price. 2 curve based on the previous e-ample of bread consumption is given in >igure 1. #his shows that if the famil% gets 1H slices per da% the marginal utilit% of bread will be nine cents &point 2'. One ma% reverse the 6uestion and as! how much the famil% would purchase at an% particular price$ sa% three cents. #he graph indicates that at this price the 6uantit% would be .H slices$ because onl% at that 6uantit% is marginal utilit% e6ual to the three cent price &point <'. #hus the curve in >igure 1$ to a reasonable degree of appro-imation$ ma% be able to do double dut%: it ma% serve as a marginalutilit% curve relating marginal utilit% to 6uantit% and$ at the same time$ as a demand curve relating 6uantit% demanded to price. Con"umer"@ "urplu". >igure 1 leads to an important conclusion about the consumer]s gains from his purchases. #he diagram shows that the difference between 1H and 11 slices of bread is worth nine cents to the consumer &marginal utilit% S nine cents'. Similarl%$ a 1,th slice of bread is worth eight cents &see the shaded bars'. #hus$ the two slices of bread together are worth 1= cents$ the area of the two rectangles together. Suppose the price of bread is actuall% three cents$ and the consumer$ therefore$ purchases .H slices per da%. #he total value of his purchases to him is the sum of the areas of all such rectangles for each of the .H slices7 i.e.& it is &appro-imatel%' e6ual to all of the area under the demand curve7 that is$ the area defined b% the points HC<E. #he amount the consumer pa%s$ however$ is less than this area. 3is total e-penditure is given b% the area of rectangle HC<9GH cents. #he difference between these two areas$ the 6uasi triangular area 9<E$ represents how much more the consumer would be willing to spend on the bread over and above the GH cents he actuall% pa%s for it$ if he were forced to do so. It represents the absolute ma-imum that could be e-tracted from the consumer for the bread b% an unscrupulous merchant who had cornered the mar!et. Since$ normall%$ the consumer onl% pa%s 6uantit% HC<9$ the area 9<E is a net gain derived b% the consumer from the transaction. It is called consumers] surplus. Virtuall% ever% purchase %ields such a surplus to the bu%er. #he concept of consumers] surplus is important for public polic%$ because it offers at least a crude measure of the public benefits of various t%pes of economic activit%. In deciding whether a government agenc% should build a dam$ for e-ample$ one ma% estimate the consumers] surplus from the electricit% the dam would generate and see! to compare it with the surplus that could be %ielded b% alternative uses of the resources needed to construct and operate the dam. 1tility mea"urement and ordinal utility* 2s originall% conceived$ utilit% was ta!en to be a sub*ective measure of strength of feeling. 2n item that might be described as worth c/H utilsc was to be interpreted to %ield ctwice as much pleasurec as one valued at ,H utils. It was not long before the usefulness of this concept was 6uestioned. It was critici5ed for its ,/1 sub*ectivit% and the difficult% &if not impossibilit%' of 6uantif%ing it. 2n alternative line of anal%sis developed that was able to accomplish most of the same purposes but without as man% assumptions. >irst introduced b% the economists >.:. Edgeworth in England &1??1' and Vilfredo (areto in Ital% &1?G1G='$ it was brought to fruition b% Eugen Sluts!% in Cussia &1G10' and @.C. 3ic!s and C.9.F. 2llen in Freat <ritain &1G./'. #he idea was that to anal%5e consumer choice between$ sa%$ two bundles of commodities$ 2 and <$ given their costs$ one need !now onl% that one is preferred to another. #his ma% at first seem a trivial observation$ but it is not as simple as it sounds. >igure ,: Commodities O and : In the following discussion$ it is assumed for simplicit% that there are onl% two commodities in the world. >igure , is a graph in which the a-es measure the 6uantities of two commodities$ O and :. #hus$ point 2 represents a bundle composed of seven units of commodit% O and five units of commodit% :. #he assumption is made that the consumer prefers to own more of either or both commodities. #hat means he must prefer bundle C to bundle 2$ because C lies directl% to the right of 2 and hence contains more of O and no less of :. Similarl%$ < must be preferred to 2. <ut one cannot sa%$ in general$ whether 2 is preferred to 9 or vice versa$ since one offers more of O and the other more of :. >igure .: Indifference curves #he consumer ma% in fact not care whether he receives 2 or 9that is$ he ma% be indifferent &see >igure .'. 2ssuming that there is some continuit% in his preferences$ there will be a locus connecting 2 and 9$ an% point on which &E or 2 or 9' represents bundles of commodities of e6ual interest to this consumer. #his locus &II] in >igure .' is called an indifference curve. It represents the consumer]s sub*ective trade off between the two commoditieshow ,/= much more of one he will have to get to ma!e up for the loss of a given amount of another. #hat is$ one ma% treat the choice between bundle 9 and bundle E as involving the comparison of the gain of 6uantit% >9 of O with the loss of >E of :. If the consumer is indifferent between 9 and E$ the gain and loss *ust offset one another7 hence$ the% indicate the proportion in which he is willing to e-change the two commodities. In mathematical terms$ >E divided b% >9 represents the average slope of the indifference curve over arc E97 it is called the marginal rate of substitution between O and :. >igure . also contains other indifference curves$ some representing combinations preferred to 2 &curves l%ing above and to the right of 2' and some representing combinations to which 2 is preferred. #hese are li!e contour lines on a map$ each such line being a locus of combinations that the consumer considers e6uall% desirable. Conceptuall%$ through ever% point in the diagram there is an indifference curve. >igure .$ with its famil% of indifference curves$ is called an indifference map. #his map obviousl% does no more than ran! the available possibilities7 it indicates whether one point is preferred to another but not b% how much it is preferred. It is eas% to show that at an% point such as E the slope of the indifference curve$ roughl% >E divided b% E9$ e6uals the ratio of the marginal utilit% of O to the marginal utilit% of : for the corresponding 6uantities. >or in moving from E to 9 the consumer gives up >E of :$ a loss valued$ b% definition$ at appro-imatel% >E multiplied b% the marginal utilit% of :$ and he gains >9 of O$ a gain worth >9 multiplied b% the marginal utilit% of O. Celative marginal utilities can be measured in this wa% because their ratio does not measure sub*ective 6uantitiesrather$ it represents a rate of e-change of two commodities. #he marginal utilit% of O measured in mone% terms tells one how much of the commodit% used as mone% the consumer is willing to give for more of the commodit% O but not what ps%chic pleasure the consumer gains.
(CICES 2"9 I"CO;ES One other t%pe of information is needed to complete the anal%sis of consumer choice: the prices of O and : and the amount the consumer has available to spend. In what follows$ it will be assumed that the consumer spends all his mone% on the available commodities &savings bonds being among the commodities'. If ( O and ( : are the prices of commodities O and :$ respectivel%$ and ; represents the amount of mone% available for spending$ the condition that all of the mone% is spent %ields the e6uation or$ solving for : in terms of O$ ,/? &,'#his is obviousl% the e6uation of a straight line with slope and with % intercept. #he line$ called the budget line$ or price line$ represents all the combinations of O and : that the consumer can afford to bu% with income ; at the given prices. E6uilibrium of the consumer. >igure /: Indifference curves and a price line >igure / combines this price line and the indifference curves$ permitting direct anal%sis of the consumer purchase decision. Dine ((] is the price line corresponding to e6uation &,' above. 2n% point C on that line represents a combination of O and : that a given consumer can afford to purchase7 however$ C is not an optimal choice. #his can be seen b% comparing C with S on the same price line. Since S lies on a higher indifference curve than C$ the former is the preferred position$ and$ since S costs no more than C &the% are on the same price line$ so each costs ; dollars'$ S gives the consumer more for his mone%. It is at #$ however$ the point of tangenc% between the price line and an indifference curve$ that the consumer reaches his highest indifference curve7 this is$ therefore$ the optimal point for him$ given his pattern of tastes as shown b% the shapes of his indifference curves. #his is the solution of the choice problemeit e-plains$ in principle$ the consumer]s purchase decision on the basis of his given preferences$ with no assumptions as to degrees of measurable utilit%. #he tangenc% at the solution point has a significant interpretation. It was noted above that the slope of the indifference curve is the ratio of the marginal utilities of the two commodities. It follows that$ at the optimal point #$ a dollar of e-penditure must offer the same utilit% whether spent on O or on :. If this is not soas at point C in >igure /$ where the consumer gets more for his mone% b% spending a dollar on : rather than on Oit will pa% him to reallocate his e-penditures between the two commodities accordingl%$ moving toward S from C. Chan#e" in price" and income"* ,/G >igure 0: &2' (ositive and &<' negative incomeconsumption curves #he diagram becomes more illuminating when one investigates how the consumer]s decision is affected b% a change in his income or in the price of a commodit%. E6uation &,' indicates that a change in income$ ;$ does not affect the slope of the price line$ onl% its intercept. #hus$ as the person]s income increases$ the price line undergoes a se6uence of parallel shifts &>igure 0'. >or each such line there will be a point of tangenc%$ #$ with an indifference curve$ showing the consumer]s optimal bundle of purchases with the corresponding income. #he locus of these points &# 1 $ # , $ # . . . .' ma% be called the incomeconsumption curve7 it shows how the consumer]s purchases var% with his income. "ormall% the curve will have a positive slope$ as EE] does in >igure 02$ meaning that as a person grows wealthier he will bu% more of each commodit%. <ut the slope can be negative for some stretches &FF] in >igure 0<'. In that case$ O is said to be an inferior good of which the consumer bu%s less as his income rises. >igure 1: (riceconsumption curve #he diagram can also be used to show what happens as the price of O varies. >rom e6uation &,' it can be seen that the :intercept is not affected b% an increase in the price of O but that the slope of the price line grows. #hus$ as ( O rises$ the price line shifts from ((] to (C] in >igure 1. #his means that$ as ( O rises$ ; dollars will bu% as much of good : as before &the position of point ( at which all ; dollars are spent on commodit% : does not change'$ but that ; dollars will now bu% less of good O$ so that the position of point (] must move toward the left. Once again$ b% following the points of tangenc% between indifference curves and the price lines for various values of ( O $ one contains a locus 88]$ the priceconsumption curve$ showing how the consumer]s purchases var% with ( O . ,0H Income and "u%"titution effect". >igure =: Income effect and substitution effect It is useful to divide the effects of the price change conceptuall% into two parts. 2n increase in the price of O obviousl% affects the relative cost of O and :. <ut it also decreases the consumer]s overall purchasing power. #he effect on purchases of this reduction of purchasing power is called the income effect of the price change. Its effect via the relative price change is called the substitution effect. #he division can be carried out graphicall% as follows: let the price of O increase so that the price line in >igure = moves from ((] to (C]$ and assume an imaginar% intermediate price line$ DD]$ with the slope of (C] but tangent to the indifference curve that was attained with the old price line ((]. #he imaginar% price line has the following properties: &1' it involves the same real income as ((] &tangenc% points # and S are the same indifference curve'$ and &,' it involves the same relative prices as the new price line since their slopes are the same. #he rise in price has$ in the figure$ caused the demand for O to fall from C to 2 &the 6uantities of O corresponding to tangenc% points # and 8'. It has been possible to divide the total effect$ C2$ into two parts$ the income effect$ <2$ and the substitution effect$ C<. #his brea!down is important$ because a number of interesting and important theorems can be proved about the substitution effect. #wo of these theorems will illustrate the point. 8nder the normal assumptions of demand theor% it can be proved that a rise in the price of O must$ via the substitution effect$ wor! to reduce the demand for O7 the second theorem states the surprising result that$ considering onl% substitution effects$ a dollar rise in the price of O must change the demand for : b% precisel% the same amount as a dollar rise in the price of : changes the demand for O. Similar relationships have been shown to hold when there are more than two commodities involved. Price #he price s%stem$ as it e-ists in western Europe and the 2mericas$ is a means of organi5ing economic activit%. It does this primaril% b% coordinating the decisions of consumers$ producers$ and owners of productive resources. ;illions of economic agents who have no direct communication with each other are led b% the price s%stem to suppl% each other]s wants. In a modern econom% the price s%stem enables a consumer to bu% a product he has never previousl% purchased$ produced b% a firm of ,01 whose e-istence he is unaware$ which is operating with funds partiall% obtained from his own savings. (rices are an e-pression of the consensus on the values of different things$ and ever% societ% that permits e-changes among men has prices. <ecause prices are e-pressed in terms of a widel% acceptable commodit%$ the% permit a read% comparison of the comparative values of various commoditiesif shoes are N10 per pair and bread .H cents per loaf$ a pair of shoes is worth 0H loaves of bread. #he price of an%thing is its value in e-change for a commodit% of wide acceptabilit% &mone%': the price of an automobile ma% be some 0H ounces of gold or ,0 pieces of paper bearing the picture of an eminent statesman. 2 s%stem of prices e-ists because individual prices are related to each other. If$ for e-ample$ copper rods cost /H cents a pound and the process of drawing a rod into wire costs ,0 cents a pound$ then$ if the price of wire e-ceeds 10 cents$ it will be profitable to produce wire7 and if the price of wire falls below 10 cents$ it will be ruinous to produce wire. Competition$ therefore$ will hold the price of wire about ,0 cents per pound above that of rods. 2 variet% of such economic forces ties the entire structure of prices together. #he s%stem of prices can be arranged to reward or penali5e an% !ind of activit%. Societ% discourages the production of electric shoestringt%ing machines b% the simple e-pedient of ma!ing such a machine]s attainable selling price less than the prices of the resources necessar% to produce it. Societ% stimulates people of large athletic promise to learn golf &rather than polo or cric!et' b% the immense pri5es &S prices' that are given to tournament winners. #he air in man% cities is dirt% because no one is charged a price for dirt%ing it and no one can pa% a price for having it cleaned. #3E <2SIC >8"C#IO"S O> ECO"O;IC S:S#E;S Ever% economic s%stem has three functions. In a decentrali5ed &usuall% private enterprise' economic s%stem$ the price mechanism is the instrument b% which these functions are performed.
Product and +uantity* One function is to determine what is to be produced and in what 6uantit%. Even a primitive econom% must choose between food and shelter$ weapons and tools$ priests and hunters. In a modern econom% the potential variet% of goods and services that ma% be produced is immense. Consider simpl% the 1H$HHH new boo! titles that are published each %ear or the hundreds of colours of paint or the thousands of st%les of clothing that are producedeach of these actual collections being much smaller than modern technolog% permits. 2 price s%stem weighs the desires of consumers in terms of the prices the% are willing to pa% for various 6uantities of each commodit% or service. #he pa%ment of N1$HHH for the services of a s!illed surgeon &a price much influenced b% the number of surgeons' reflects the great importance of his services to the bu%erpatient$ whereas the offer of =0 cents for a month]s use of an additional telephone outlet reflects the minor convenience it provides. Of course the offers of consumers are influenced b% their wealth as well as their desires$ but for an% one consumer relative desires are proportional to price offers. 8niversal laws are most uncommon in social life. Economists nonetheless place immense confidence in the proposition that the consumer will bu% less of an% ,0, commodit% when its price rises. #his law of demand is b% no means a necessar% fact of life7 rather it is an empirical rule to which there are no !nown$ reliable e-ceptions. <read$ caviar$ education$ narcoticsa man will bu% more of each when its price falls. #hese demand prices are the guides to producers that in effect tell them which commodities to produce and in what 6uantities. Production* #he second function an econom% must perform is to decide how the desired goods are to be produced. #here is more than one wa% not onl% to s!in a cat but also to grow wheat$ train law%ers$ refine petroleum$ and transport baggage. #he efficient production of goods re6uires that certain obvious rules be followed: no resource should be used in producing one thing when it could be producing something more valuable elsewhere7 and each product should be made with the smallest possible amount of resources. 2 functioning price s%stem steers resources into their most important use b% appealing to the desires of their owners for large incomes. >or e-ample$ the person capable of being a surgeon is drawn to this occupation from$ sa%$ that of a high school teacher b% the promise of annual earnings &S price of labour' much more than those of the high school teacher. Capital is drawn from a faltering trade to a booming new industr% in which it receives a higher return. #his same price s%stem see!s to achieve production efficienc% through the sanction of competition. If one firm$ for instance$ can produce shoes with fewer resources than its rivals$ it will ma!e larger profits7 so it is stirred to discover more efficient combinations of inputs and location of plant$ to devise wage s%stems to stimulate its wor!ers$ to use computers to reduce inventories$ and so forth without end. 9istribution. #he third function of an econom% is to determine who gets the product. >amil% 2 gets N0$HHH worth of goods this %ear$ famil% < five times as muchhow is the division to be decided4 #he incomes of individuals are determined b% the 6uantities of resources &labour s!ills$ capital in all its forms' the% own and the prices the% receive for the use of these resources. +or!ers are incited b% the price s%stem to ac6uire new s!ills and to e-ercise them diligentl%$ and families are encouraged to savings &capital accumulation' b% the pa%ment of interest or dividends. #he inheritance of both personal abilit% and wealth also enter into the distribution of income. If the price s%stem is wor!ing reasonabl% well &some of the common failures will be noted later'$ it performs all of these economic functions with remar!able subtlet% and precision. Societ% desires not onl% the correct amount of wheat but also that it be consumed more or less evenl% over the crop %ear$ with a surplus to carr% over in case of a partial failure of the ne-t %ear]s crop. #he price s%stem provides a seasonal price pattern that encourages the holding of inventories rather than earl% splurging and richl% rewards speculators who correctl% anticipate a crop failure and hold grain that will alleviate it. In the same wa%$ the desires of ever% si5able group of consumers &or resource owners' are registered through the price s%stem7 entrepreneurs are incited b% price offers to provide opera and musical comed%$ !osher food$ and (ersian delicacies. One might almost sa% that the price s%stem is devoted to minorit% ,0. rule$ since the onl% pressure toward uniformit% is in the possibilit% of lowering costs of production b% standardi5ing goods. 3igh prices in a properl% functioning price s%stem thus serve as incentives to produce more and consume less$ and lower prices serve as corresponding deterrents. In addition the price s%stem is a method of communicating information. 3erbert Spencer once stated$ rather ponderousl%$ that onl% b% constant iteration can alien truths be impressed upon reluctant minds: the price s%stem$ with its capacit% for infinite repetition$ is well suited to this sometimes unpleasant tas!. 2 higher price of steel scrap$ for e-ample$ tells thousands of owners and collectors of scrap that more scrap is wanted and that more e-haustive search for abandoned rails$ boilers$ radiators$ and machines is worth underta!ing. 2 higher price of gasoline tells thousands of automobile drivers that gasoline should be used more sparingl%$ and the message is repeated each time each driver purchases more gasoline. #3E +OCUI"FS O> #3E (CICE S:S#E; #he comple-it% and variet% of tas!s performed b% the price s%stem will be illuminated b% an e-amination of three specific economic problems. The choice of occupation. Individuals must be distributed among occupations in such a wa% as to serve two basic purposes. >irst$ the labourer must be placed where he is most productive ma!ing certain that Enrico >ermi becomes a ph%sicist rather than a chef and that there are not too man% plumbers and too few electricians. Second$ the individual wor!er should be given an occupation that is congenial to him: since he will spend a large part of his life at wor!$ it will be a better life if he can choose the t%pe he prefers. #he price of labour is the instrument b% which wor!ers are distributed among occupations: wages in rapidl% growing occupations and rapidl% growing parts of the nation are higher than in corresponding emplo%ment in declining occupations and areas. #he choice of occupation involves$ however$ much more than simpl% a comparison of wage rates. #he following are a few of the complications: &1' #he wages of an occupation must as a rule be sufficient to compensate the costs of training. &,' #he wages of an occupation must be sufficient to compensate special disadvantages &such as a large chance of unemplo%ment'. &.' +ages must be higher in large cities than in small because living costs are higher in large cities. &/' +ages must compensate wor!ers for their additional s!ill as the% ac6uire e-perience &the% usuall% reach a pea! of earnings between ages /H and 00' and thereafter decline as the wor!er]s efficienc% declines. &0' +ages will reflect differences in ta-ation$ fringe benefits &pensions$ vacations'$ etc. 2ccordingl% the wage structure even for a single occupation in a single cit% is elaborate. +hen a single wage &price' is imposed upon an occupation$ labourers are no longer properl% distributed b% wages7 for e-ample$ a cit% school s%stem that pa%s all teachers of given e-perience the same wage finds it difficult to staff its less attractive schools. #he preferences of the individual wor!er cannot be given full pla%$ or each person would become president of the corporation at a sumptuous salar%. :et the labourer ma% choose to live in California rather than ;aine7 then the price s%stem will incite emplo%ers to move their operations to California$ where the% can hire this labourer more cheapl%. #he labourer ma% prefer to wor! long hours or short hours$ and emplo%ers are induced b% wage offers to cater to the labourer]s diverse ,0/ preferences. In fact it is e6uall% appropriate to spea! of the wor!er bu%ing conditions of wor! and of the emplo%er bu%ing the services of the wor!er. #he conservation of resources. 2 societ% has some resources that can be replaced b% investment: timber is now largel% grown as a commercial crop. >armland is a more ancient e-ample: the fertilit% of soil can be increased b% prudent cultivation. Other resources are not replaceable$ such as coal and petroleum. 3ow does the price s%stem conserve these e-haustible resources4 #he method of using a resource is independent of the pattern over time of income and e-penditures that the owner of the resource desires. Suppose that a farm will have a value of N1HH$HHH if it is maintained at a constant level of fertilit% and %ields a %earl% income of N1H$HHH forever but that it can be cultivated &cminedc' intensivel% to %ield N1,$HHH a %ear for five %ears at the cost of a much reduced %ield thereafter$ with a value of NGH$HHH. Even if the farmer is in urgent need of immediate funds and does not e-pect to live more than five %ears$ he will still cultivate the farm at the uniform rate. Onl% then is it worth its ma-imum value to him$ and onl% then &b% sale or mortgage' can he obtain the largest possible funds even in the near future. In short$ one need not adapt his e-penditure pattern to his income pattern so long as he can borrow or lend. If the growth of consumption or the decline of reserves threaten the e-haustion of supplies of a resource$ then the price of that resource will rise and promise to rise more in the future$ and this rise will serve to reduce current consumption and to reward the owner of the resource for holding bac! much of the suppl% for the future. #his rise in price will therefore also stimulate bu%ers to find more economical wa%s of using the commodit% &for e-ample$ burning the fuel more efficientl%' and stimulate producers to find new supplies or substitute products. #he price s%stem will$ therefore$ ensure that the suppl% of the resource will be stretched out so that the resource will be available in both the present and the future. DI;I#2#IO"S 2"9 >2ID8CES O> #3E (CICE S:S#E; #he price s%stem is an e-traordinaril% powerful instrument in organi5ing an economic s%stem$ but it is sub*ect to three broad classes of limitations. Pri$ate and pu%lic price control. Sometimes prices are not permitted to do their wor!. ;onopolies are able to e-ert control over prices7 and the% use it$ sensibl% enough$ to raise their profits above the level allowed b% competition. #he monopolist &or group of colluding enterprises' sets prices at a level such that prices are above costs or$ to use words of identical significance$ such that resources earn more in the monopoli5ed industr% than the% can earn elsewhere. #he basis of the monopol% is its abilit% to prevent outsiders from entering the industr% to share in the unusual profits and$ b% the act of producing$ actuall% serve to eliminate them. #he fi-ing of prices b% monopolists reduces the income of societ%. #his is$ in fact$ the onl% wellestablished criticism &on grounds of efficienc%' to be levied against monopolies: there is no reason to assume that the% will ma!e products less suited to consumer tastes or innovate more slowl% or pa% lower wages or otherwise misallocate resources. <ut the basic inefficienc% led$ first in the 8nited States in 1?GH and then ,00 increasingl% in European nations$ to governmental policies to maintain or restore competition. (ublic price control has two aspects. 2 large part of public regulation is intended to correct monopolistic pricing &or other failures of the price s%stem'7 this includes most publicutilit% regulation in the 8nited States &transportation$ electricit%$ and gas$ etc.'. +hatever the success of these endeavoursand on the whole there has been a substantial decline in confidence in the regulator% bodiesthe% are usuall% instructed to achieve the goals of an efficient price s%stem. Other public price controls are designed to serve ends outside the reach of the price s%stem. (rices of farm products are regulated &raised' in most nations with the intention of improving farmers] incomes$ and the fi-ing of interest rates paid b% ban!s is underta!en to improve ban! earnings. Such policies are invariabl% defended on various economic and ethical grounds but reflect primaril% the political strength of large and well organi5ed producer groups.
E-ternalities and the price s%stem. 2 second class of limitations consists of things that should be done but are not performable b% a price s%stem. Even when prices are freel% established b% competition$ there is a class of economic relationships called ce-ternalitiesc not efficientl% controlled b% prices. #hese ma% be illustrated b% the air pollution caused b% automobiles. Since no single automobile ma!es a significant contribution to air pollution$ the owner has no incentive to bear the cost of installing antipollution devices even though all drivers would be better off if each did so. :et if there are man% automobiles in a region$ it would be prohibitivel% e-pensive for drivers to contract with one another to have each install devices in his automobile to reduce pollution. #he e-ternal effects of an% one automobile]s e-haust fumes are so diffuse and affect an% one person so triflingl% that the% cannot be regulated b% the price s%stem. #he class of ce-ternalitiesc is as broad as the class of actions that have effects upon people who are not parties to the contracts governing the actions. 2n attractive garden pleases passersb%$ but the% cannot be charged a portion of its cost. 2 new piece of scientific !nowledge will prove useful to un!nown persons. #hese two e-amples indicate that some e-ternalities are economicall% trivial and some are highl% important. +hen the price s%stem cannot deal with diffused effects$ other social controls often ta!e its place. #he state invo!es a whole arsenal of policies to deal with e-ternalities$ of which the following are onl% e-amples: &1' #he state ma% subsidi5e activities that do not end in a product that can be sold. #hus basic scientific research that does not lead to patentable processes is subsidi5ed. &,' Individuals ma% be compelled to act uniforml% in areas where contracts would be too e-pensive7 traffic laws$ 5oning laws$ and compulsor% vaccination are e-amples. &.' #he state ma% itself underta!e an activit% that cannot be financed b% sale of services$ the most obvious e-ample being national defense. 2n interesting t%pe of e-ternalit% is the problem of highwa% congestion. 2n% one person]s presence on a highwa% at a time and place of pea! densit% has onl% a negligible effect upon others$ so that$ e-cept on toll roads$ private contracts have not been feasible. #he state itself has not been able to deal effectivel% with highwa% congestion. ;ore highwa%s can be built until no highwa% is ever crowded$ but this would be intolerabl% e-pensive. #he state has lac!ed a method of inducing drivers to ,01 shift to less crowded hours and routes b% charging fees to those drivers who impose high congestion costs b% driving at pea! times. Cecent developments in technolog% ma% ma!e it feasible to use the price s%stem to reduce congestion. >or e-ample$ cameras at appropriate points could photograph automobile licenses and a computer could accumulate the charges based on route and time for each automobile. #hen onl% a person for whom travel at pea! times was worth$ for e-ample$ ,0 cents per mile would impose &and pa% for' the congestion he created. Imperfect !noled#e and ta"te"* 2 third class of limitations to which the price s%stem is sub*ect has to do with the control of !nowledge and tastes. #o the e-tent that an economic actor$ whether a consumer$ a labourer$ or an investor$ is poorl% informed$ he is li!el% to ma!e decisions whose conse6uences are much different from those he desired and e-pected. +hat follows relates onl% to consumer decisions$ but parallel issues arise in labour mar!ets$ securities mar!ets$ etc. 2 consumer can satisf% his desires onl% if he ma!es intelligent purchasesthat is$ onl% if the goods he bu%s are what he believes them to be. 3ow can the consumer !now whether the meat is free of disease or whether the washing machine will function well and long or whether the fabric of the garment is one s%nthetic fibre or another4 #o ascertain these facts personall%$ the consumer would have to be a versatile scientist e6uipped with a superb laborator%and then he would need to spend so much time testing goods that he would have little time to en*o% them. In some measure the consumer does e-periment in his bu%ing: whenever he bu%s a thing repeatedl%$ e-perience tells him much concerning its properties. 9irect e-perience is a sufficient guide in bu%ing celer% or hiring domestic servants$ but usuall% the purchase of information ta!es a less direct form. #he cit%]s premier department store can sell at prices somewhat higher than less well!nown retailers7 and the difference represents the pa%ment of a price for reliabilit%$ responsibilit%$ and the guarantee of 6ualit%. In parallel fashion the consumer bu%s the washing machine of a compan% that made his e-cellent refrigerator. Occasionall%$ information is bought directl%: the advice of a law%er$ the !nowledge of an appraiser$ the taste of an interior decorator. #he most important and controversial method of informing consumers is b% advertising. ;an% critics are outraged b% the selfserving statements of sellers$ some of whom indubitabl% provide irrelevance and deception rather than information. :et the informational content of advertising ma% not be as deficient as its critics believe: advertising itself meets two mar!et tests. In the first place$ the direct sale of information b% consumer advisor% services has never become important$ although there are no obstacles to entering this business. In the second place$ there has been a general$ sustained improvement in the 6ualit% of consumer goods over time: the automobile tire goes man% more miles than formerl%7 the airplane flies more safel%. "evertheless$ recent public polic% has paid great attention to increasing the safet% of products and to raising the accurac% of advertising claims. Unowledge is sometimes difficult to distinguish from taste: does the consumer who persists in smo!ing cigarettes have inade6uate !nowledge or simpl% different comparative values for the pleasures and ris!s of smo!ing4 Censorship$ in an% event$ is fairl% common in ever% economic s%stem: no societ% allows %oung children or incompetents full freedom of action or allows the unlimited sale of narcotics. Since the price s%stem never forbids an effective demand &a demand bac!ed b% a ,0= willingness to pa% the suppl% price'$ some form of restriction of prices is$ therefore$ necessar% if certain tastes are to be forbidden or restricted. Compulsor% school attendance can be viewed as$ in effect$ a form of censorship7 and so are the controls on sale of firearms and the ta-es on tobacco and li6uor. "O"C2(I#2DIS# (CICE S:S#E;S #he foregoing discussion has been confined to the price s%stem as it e-ists in capitalist economies. #he Communist countries have prices$ but not autonomous price s%stems7 in those countries the direction of economic activit% is largel% in the hands of the central authorities$ and prices are used mainl% as a mar!eting device. "one of the three allocative functions of an econom%determination of what will be produced$ of how it will be produced$ and of who will get the productis performed b% the price mechanism in the socialist economies. #he relative scarcities that mone% prices measure e-ist$ of course$ in all countries and would e-ist in a world where no mone% or e-changes were allowed. Cobinson Crusoe had a problem of allocating his time between sleep$ garnering food$ building shelter$ etc.7 and he confronted implicit costs of e-tending an% one activit%$ for more food meant less of other things. #he economist calls these implicit e-change ratios cshadow prices$c and the% appear in all areas of life in which deliberate choices are made. (rice s%stems are therefore the result of scarcit%. #he basic proposition of economics$ that scarcities are essentiall% ubi6uitous$ is often phrased as cthere is no such thing as a free lunchc7 and it reminds one that the price of the lunch ma% be future patronage$ a reciprocal lunch$ or a boring monologue. #he tas! of economic organi5ation is the tas! of devising price s%stems that allow a societ% to achieve its basic goals. ;ar!et structure: competition$ oligopol%$ monopol% +hen economists use such words as ccompetitionc and cmonopol%c the% have in mind certain comple- relations among firms in an industr%. 2n industr%$ as economists define it$ is a group of sellers of closesubstitute products who suppl% a common group of bu%ers. >or the econom% as a whole an industr% would include all sellers having this relation. #hus one can recogni5e a cigarette or automobile or aluminum industr%in all$ hundreds of industries. #:(ES O> ;2CUE# S#C8C#8CES 9ifferent industries have different mar!et structuresthat is$ different mar!et characteristics that determine the relations of sellers to one another$ of sellers to bu%ers$ and so forth. (robabl% the most important aspects of mar!et structure are &1' the degree of concentration of sellers in an industr%$ &,' the degree of product differentiation$ and &.' the ease or difficult% with which new sellers can enter the industr%. Concentration of "eller"* ,0? Seller concentration refers to the number of sellers in an industr% together with their comparative shares of industr% sales. +hen the number of sellers is 6uite large$ and each seller]s share of the mar!et is so small that in practice he cannot$ b% changing his selling price or output$ perceptibl% influence the mar!et share or income of an% competing seller$ economists spea! of atomistic competition. 2 more common situation is that of oligopoly& in which the number of sellers is so few that the mar!et share of each is large enough for even a modest change in price or output b% one seller to have a perceptible effect on the mar!et shares or incomes of rival sellers$ and to cause them to react to the change. In a broader sense$ oligopol% e-ists in an% industr% in which at least some sellers have large shares of the mar!et$ even though there ma% be an additional number of small sellers. +hen a single seller supplies the entire output of an industr%$ and thus can determine his selling price and output without concern for the reactions of rival sellers$ a single-firm monopoly e-ists.
Product differentiation* #he structure of a mar!et is also affected b% the e-tent to which those who bu% from it prefer some products to others. In some industries the products are regarded as identical b% their bu%ersas$ for e-ample$ basic farm crops. In others the products are differentiated in some wa% so that various bu%ers prefer various products. "otabl%$ the criterion is a sub*ective one7 the bu%ers] preferences ma% have little to do with tangible differences in the products but are related to advertising$ brand names$ and distinctive designs. #he degree of product differentiation as registered in the strength of bu%er preferences ranges from slight to fairl% large$ tending to be greatest among infre6uentl% purchased consumer goods and cprestige goods$c particularl% those purchased as gifts. Ea"e of entry. Industries var% in the ease with which new sellers can enter them. #he barriers to entr% consist of the advantages that sellers alread% established in an industr% have over the potential entrant. Such a barrier is generall% measurable b% the e-tent to which established sellers can persistentl% elevate their selling prices above minimal average costs without attracting new sellers. #he barriers ma% e-ist because costs for established sellers are lower than the% would be for new entrants$ or because the established sellers can command higher prices from bu%ers who prefer their products to those of potential entrants. #he economics of the industr% also ma% be such that new entrants would have to be able to command a substantial share of the mar!et before the% could operate profitabl%. #he effective height of these barriers varies. One ma% distinguish three rough degrees of difficult% in entering an industr%: %lockaded entry& which allows established sellers to set monopolistic prices$ if the% wish$ without attracting entr%7 impeded entry& which allows established sellers to raise their selling prices above minimal average costs without attracting new sellers$ but not as high as a monopolist]s price7 and easy entry& which does not permit established sellers to raise their prices at all above minimal average costs without attracting new entrants. ,0G Classification of industries. #his discussion of mar!et characteristics suggests a general wa% of classif%ing industries according to their mar!et structures: 8nder atomistic competition$ in which entr% is generall% eas%$ there are no barriers to entr%. <% the same to!en$ product differentiation among sellers is obviousl% inconsistent with singlefirm monopol%. #he comparative importance of these t%pes of mar!et structure differs among various sectors of the econom%. In the manufacturing sector in the 8nited States$ which includes about /HH industries$ singlefirm monopolies are almost completel% absent. <ut in more than half of the manufacturing industries there is enough seller concentration for them to 6ualif% as oligopolies. #he remaining industries are more or less atomistic in their mar!et structure. 2n appreciable degree of product differentiation is found in about half of the oligopolistic industries and in about half of the atomistic industries. Ver% strong product differentiation is usuall% found among oligopolistic industries. Eas% entr% is t%pical of atomistic industries$ impeded entr% of oligopolies. Entr% is probabl% bloc!aded in a minor fraction of the latter$ generall% those with ver% high seller concentration. #he proportions of oligopolistic and atomistic manufacturing industries are about the same in the 8nited Uingdom as in the 8nited States. #he incidence of oligopolies is slightl% higher in @apan and progressivel% higher in >rance$ Ital%$ Canada$ and Sweden. Singlefirm monopolies in manufacturing are found in a few industries in some of these countries$ but the% are t%picall% under government ownership. In the publicutilit% sector in the 8nited States$ singlefirm monopolies are t%picall% found in industries suppl%ing gas$ electricit%$ and telephone and telegraph service. Oligopol%$ fre6uentl% highl% concentrated$ is t%pical in the radio and television and transportation industries7 entr% into these industries is usuall% ver% difficult or bloc!aded. #he significance of such structural conditions is lessened$ however$ b% the fact that these industries are sub*ect to various degrees of public regulation. #he situation is much the same in other +estern countries$ e-cept that public utilities are fre6uentl% under government ownership. In the distributive trades &wholesaling and retailing'$ a number of 8nited States industries are fairl% atomistic$ while a somewhat larger number are relativel% unconcentrated oligopolies in which a few large sellers suppl% about half the industr%]s output and a ver% large number of small sellers suppl% the remainder. (roduct differentiation is important. Entr% is relativel% eas%. #he servicetrade industries in the 8nited States displa% a similar range of characteristics. In the distributive and servicetrade sectors in other +estern countries$ oligopol% is less fre6uent and atomistic industries are proportionall% more important. #he residential construction industries in the 8.S. and elsewhere are relativel% atomistic in structure$ have significant product differentiation$ and are eas% to enter. Industries in the agricultural sectors of +estern countries generall% are t%picall% atomistic in structure$ with eas% entr%. <ut the significance of these structural conditions is lessened b% governmental interference designed to modif% the wor!ing of mar!et forces. ;2CUE# CO"98C# 2"9 (EC>OC;2"CE 3ow do sellers behave in determining their selling prices$ outputs$ advertising costs$ and so forth7 and in what wa%s does this mar!et behaviour differ among ,1H industries with different t%pes of mar!et structure4 2n educated la%man might as!$ for e-ample$ whether sellers cut their selling prices in order to ta!e customers awa% from each other until some roc!bottom mar!et price is reached *ust high enough to allow them minimal interest returns on their investments or whether$ on the other hand$ the% agree with each other to set a uniform higher price well above their production costs$ sharing the mar!et and reaping e-cessive profits. It is helpful to distinguish the related ideas of market conduct and market performance. ;ar!et conduct refers to the price and other mar!et policies pursued b% sellers$ in terms both of their aims and of the wa% in which the% coordinate their decisions and ma!e them mutuall% compatible. ;ar!et performance refers to the end results of these policiesthe relationship of selling price to costs$ the si5e of output$ the efficienc% of production$ progressiveness in techni6ues and products$ and so forth. (ure competition. ;ar!et conduct and performance in atomistic industries provide good standards against which to measure behaviour in other t%pes of industr%. #he atomistic categor% includes both pure competition and monopolistic competition. In pure competition$ a large number of small sellers suppl% a homogeneous product to a common bu%ing mar!et. In this situation no individual seller can perceptibl% influence the mar!et price at which he sells but must accept a mar!et price that is impersonall% determined b% the total suppl% of the product offered b% all sellers and the total demand for the product of all bu%ers. #he large number of sellers precludes the possibilit% of a common agreement among them$ and each must therefore act independentl%. 2t an% going mar!et price$ each seller tends to ad*ust his output to that 6uantit% that will %ield him the largest aggregate profit$ assuming that the mar!et price will not change as a result. <ut the collective effect of such ad*ustments b% all sellers will cause the total suppl% in the mar!et to change significantl% so that the mar!et price falls or rises. #heoreticall%$ the process will go on until a mar!et price is reached at which the total output that sellers wish to produce is e6ual to the total output that all bu%ers wish to purchase. #his wa% of reaching a provisional e6uilibrium price is what 2dam Smith was referring to when he wrote of prices being determined b% cthe invisible handc of the mar!et If the provisional e6uilibrium price is high enough to allow the established sellers profits in e-cess of a normal interest return on investment$ then added sellers will be drawn to enter the industr%$ and suppl% will increase until a final e6uilibrium price is reached that is e6ual to the minimal average cost of production &including an interest return' of all sellers. Conversel%$ if the provisional e6uilibrium price is so low that established sellers incur losses$ some will tend to withdraw from the industr%$ and suppl% will decline until the same sort of longrun e6uilibrium price is reached. #he longrun performance of a purel% competitive industr% therefore embodies these features: &1' industr% output is at a feasible ma-imum and industr% selling price at a feasible minimum7 &,' all production is underta!en at minimum attainable average costs$ since competition forces them down7 and &.' income distribution is not influenced b% the receipt of an% e-cess profits b% sellers. #his performance has often been applauded as ideal from the standpoint of general economic welfare. <ut the applause$ for several reasons$ should not be ,11 un6ualified. (ure competition is trul% ideal onl% if all or most industries in the econom% are purel% competitive and if in addition there is free and eas% mobilit% of productive factors among industries. Otherwise$ the relative outputs of different industries will not be such as to ma-imi5e consumer satisfaction. #here is also some 6uestion whether producers in purel% competitive industries will generall% earn enough to plow bac! some of their earnings into improved e6uipment and thus maintain a satisfactor% rate of technological progress. >inall%$ some purel% competitive industries have been afflicted with cdestructive competitioncthe coal industr% and the basic agricultural industries$ for e-ample. >or some historical reason such an industr% accumulates e-cess capacit% to the point where sellers suffer chronic losses$ and the situation is not corrected b% the e-it of people and resources from the industr%. #he invisible hand of the mar!et wor!s too slowl% for societ% to accept. In some cases$ notabl% in agriculture$ government has intervened to restrict suppl% or raise prices. Deaving these 6ualifications aside$ however$ the mar!et performance of pure competition furnishes some sort of a standard to which the performance of industries of different structure ma% be compared.
;onopolistic competition. In the more comple- situation of monopolistic competition &atomistic structure with product differentiation' mar!et conduct and performance ma% be said to follow roughl% the tendencies attributed to pure competition. #he principal differences are the following. >irst$ individual sellers$ because of the differentiation of their products$ are able to raise or lower their individual selling prices slightl%7 the% cannot do so b% ver% much$ however$ because the% remain strongl% sub*ect to the impersonal forces of the mar!et operating through the general level of prices. Second$ rivalr% among sellers is li!el% to involve sales promotion costs as well as the e-pense of altering products to appeal to bu%ers. #his is a competitive game that all will pla% but that nobod%$ on the average$ will win$ and the longrun e6uilibrium price will reflect the added costs involved. In return$ however$ bu%ers will get more variet%. #hird$ since not ever% seller is li!el% to be e6uall% successful in his salespromotion and product policies$ some will receive profits in e-cess of a basic interest return on their investment7 such profits will come from their success in winning bu%ers. ;onopolistic competition ma%$ li!e pure competition$ include industries that are afflicted with what has been called above destructive competition. #his ma% result not onl% from a failure to get rid of e-cess capacit% but also from the entr% of too man% new firms despite the danger of losses. Monopoly* +hile singlefirm monopolies are rare$ e-cept for those sub*ect to public regulation$ it is useful to e-amine the monopolist]s mar!et conduct and performance to establish a standard at the other pole from pure competition. 2s the sole supplier of a distinctive product$ the monopolist can set an% selling price provided he accepts the sales that correspond to that price. Since the mar!et demand will generall% be less the higher the price he sets$ the monopolist presumabl% will set that price that produces the greatest profits$ given the relationship of production costs to output. <% restricting output he can raise his selling price significantl%an option not opens to sellers in atomistic industries. ,1, #he monopolist will generall% charge prices well in e-cess of production costs and reap profits well above a normal interest return on investment. 3is output will be substantiall% smaller$ and his price higher$ than if he had to meet established mar!et prices as in pure competition. #he monopolist ma% or ma% not produce at minimal average cost$ depending on his costoutput relationship7 if he does not$ there are no mar!et pressures to force him to do so. If the monopolist is sub*ect to no threat of entr% b% a competitor$ he will presumabl% set a selling price that ma-imi5es profits for the industr% he monopoli5es. If he faces onl% impeded entr%$ he ma% elect to charge a price sufficientl% low to discourage entr% but above a competitive priceif this will ma-imi5e his longrun profits.
.li#opoly* ;ar!et conduct and performance in oligopolistic industries generall% combine monopolistic and competitive tendencies$ with the relative strength of the two tendencies depending roughl% on the detailed mar!et structure of the oligopol%. "ivalry among sellers. In the simplest form of oligopolistic industr%$ sellers are few and ever% seller supplies a sufficientl% large share of the mar!et so that an% feasible and modest change in his policies will appreciabl% affect the mar!et shares of all his rival sellers and induce them to react or respond. >or e-ample$ if seller 2 reduces his selling price below the general level of prices being charged b% all sellers sufficientl% to permit him to capture significant numbers of customers from his rivals if the% hold their selling prices unchanged$ the% ma% react b% reducing their prices b% a similar amount$ so that none gains at the e-pense of others and the group has probabl% reduced its combined profits. Or seller 2]s rivals ma% retaliate b% reducing their selling prices more than he did$ thus forcing a further reaction from him. Conversel%$ if seller 2 increases his selling price above the general level being charged b% all sellers &thus tending to lose at least some of his customers to his rivals'$ the% ma% react b% holding their prices unchanged$ in which event seller 2 will probabl% retract his increase and bring his price bac! to the previous level. <ut his rivals ma% also react b% raising their prices as much as seller 2 raised his$ in which case the general level of prices in the industr% rises and the combined profits of all sellers are probabl% increased. 2n% seller 2 in an oligopol% will therefore determine whether or not to alter his price or other mar!et polic% in the light of his con*ectures about the reactions of his rivals. Correspondingl%$ his rivals will determine their reactions in the light of their con*ectures about what seller 2 will do in response. #he process is not li!el% to bring the industr% price level down to minimal average cost &as in atomistic competition'. ;an% different ce6uilibriumc levels between the competitive and monopolistic limits are possible$ depending on further circumstances. #hus in an oligopol% viable collusive agreements among rival sellers are 6uite possible. #he% ma% be e-press agreements established b% contract or tacit understandings that develop as a pattern of reactions among sellers to changes in each others] prices or mar!et policies becomes customar%. In the 8nited States$ e-press collusive agreements are forbidden b% law$ but tacit agreements or cgentlemen]s understandingsc are common in oligopolies. In numerous other +estern countries$ formal collusive agreements &often called cartels if comprehensive in scope' are legal. ,1. +hether tacit or e-plicit$ legal or illegal$ one ma% sa% that oligopolistic prices tend to be cadministeredc b% sellers$ in the senses mentioned above$ as distinct from being determined b% impersonal mar!et forces. (ellers' dual aims. #he var%ing mar!et performance of oligopolies results from the fact that individual sellers intrinsicall% have two conflicting aims. One common desire is to establish among themselves a monopolistic level of price &and of selling costs$ etc.'$ which will ma-imi5e their combined profits$ giving them the largest cprofit piec to divide. <ut each seller also has a fundamental antagonism toward rival sellers and wants to ma-imi5e his own profits even at the e-pense of theirs. #he relative strengths of these conflicting aimsthe ma-imi5ing of combined profits and the ma-imi5ing of individual profitswill li!el% depend on how concentrated the oligopol% is$ because when sellers are fewer and their individual mar!et shares larger$ their rivals] reactions are stronger deterrents to independent actions. #his is wh% various sorts of mar!et performance are to be e-pected in oligopolistic industries. +hen the entr% of other sellers is bloc!aded$ collusive or interdependent behaviour ma% lead to a full monopol% price. If entr% is onl% impeded$ the resulting price ma% be far enough below the full monopol% level to discourage further entr%. <ut prices are not alwa%s what the% seem. 2n announced price that is well above cost ma% be undercut b% clandestine price reductions to individual bu%ers$ bringing the average of actual selling prices down somewhat. If an oligopolistic industr% is made up of a ccorec of a few large interdependent sellers plus a ccompetitive fringec of several or numerous 6uite small sellers$ the competition of the small sellers ma% induce the large ones to limit the e-tent to which the% raise their prices. (rice behaviour approaching full monopol% pricing seems to be found mainl% in oligopolies having ver% high seller concentration and bloc!aded entr%. +here these characteristics are less pronounced$ prices and profits tend to be lower$ though the% are li!el% to be somewhat above the competitive level. 2 few economists maintain that oligopolistic prices in general do not significantl% differ from atomisticall% competitive prices$ but the bul! of statistical evidence does not support them. In oligopolies in which product differentiation is important$ salespromotion costs and the costs of product improvement or development will displa% roughl% the same variet% of tendencies found in pricing. +here there are a few large interdependent sellers$ these costs ma% be restricted to about the same level as those of a singlefirm monopolist7 on the other hand$ rivalr% in sales promotion and product development ma% be sufficient to raise them higher. Oligopolists ma% also arrive collusivel% at relativel% high uniform selling prices but simultaneousl% engage in independent nonprice competition &perhaps more so where seller concentration is lower'. ,1/ +OCU2<DE CO;(E#I#IO" Definition and attri%ute"* Since the character of mar!et performance varies among industries along with their mar!et characteristics$ efforts have been made to devise some practical standard for identif%ing the sorts of mar!et structure that engender sociall% satisfactor% performance in a given industr%. #he term wor!able competition was coined to denote competition that ma% be considered as leading to a reasonable or sociall% acceptable appro-imation to ideal performance in the circumstances of a particular industr%. #he limits of such an appro-imation are of course debatable$ and so the idea of wor!able competition must remain elusive because it is basicall% sub*ective. +ithout entering into a comple- theoretical discussion of the relationship of individualindustr% performance to overall welfare$ it is plausible to suggest the following principal attributes of wor!able performance in an industr%: &1' In the long term$ selling price on the average should be e6ual to or not significantl% above average costs of production$ so that profits do not appreciabl% e-ceed a normal interest return on investment. (rices should be responsive to basic reductions in costs. &,' In so far as average costs of production are affected b% the scales or capacities of plants and firms$ the preponderance of industr% output should be from plants and firms of the most efficient scale or with closel% comparable technical efficienc%. &.' #he industr% should not have chronic e-cess capacit%i.e.& significant plant capacit% that is persistentl% unused even in periods of high general economic activit%. &/' #he industr%]s salespromotion costs should not be substantiall% greater than needed to !eep bu%ers informed of the availabilit%$ characteristics$ and prices of products. &0' #he industr% should be ade6uatel% progressive in introducing more economical production techni6ues and improved productsbalancing the costs of progress with the gains. +hile the first three of these attributes are easier to appraise than the others$ certain generali5ations are possible concerning the wor!abilit% of different mar!et structures: &1' 8nregulated singlefirm monopolies tend to generate unwor!able mar!et performance$ mainl% in the form of output restriction$ prices well above costs$ and conse6uent e-cess profits. #he% have undesirable effects on the uses to which resources are put and on income distribution. &,' Oligopolies with high seller concentration and also ver% high barriers to entr% tend toward unwor!able performance$ li!e that of singlefirm monopol%. In general$ however$ the% do not show significant degrees of technical inefficienc% resulting from inefficient plant scales or e-cess capacit%. &.' Oligopolies with fairl% high seller concentration but onl% moderate barriers to entr% are also prone to unwor!able performance of the sort *ust mentioned$ but not to as high a degree. &/' Oligopolies with onl% moderate seller concentration and moderatetolow barriers to entr% tend toward wor!able performance both in pricecost relations and in technical efficienc%$ e-cept that some of them ma% have recurrent chronic e-cess capacit% due to periodic overentr%. &If cartels are legali5ed and their provisions are not rigorousl% controlled b% government$ the last two categories of oligopol% ma% have the same sort of unwor!able performance as do ver% highl% concentrated oligopolies.' &0' Industries of atomistic structure tend generall% toward wor!able performance unless the% suffer from destructive competition as described above. (roduct differentiation and promotion. ,10 In industries with significant differentiation of products among sellersand especiall% in oligopolies of this sortthere is a tendenc% for minor but significant fractions of income to be devoted to persuasive &as distinct from informational' advertising and other sales promotion and also to more or less idle variations of product design$ with the result that resources are in a sense cwastedc and costs increased. <% the criteria of wor!able competition$ a purel% rational societ% would presumabl% favour industries with moderate to low seller concentration$ moderate to low barriers to entr%$ and without e-treme product differentiationall this from the standpoint of enhancing overall material welfare. #he argument that oligopolistic and atomistic industries generall% need legal protection from destructive competition ma% be discarded on the basis of evidence. (rice and other mar!et warfare in such industries has been e-tremel% rare in industrial countries in the last 0H %ears. (roduction: the output of the factors of production In economics$ the theor% of production is an effort to e-plain the principles b% which a business firm decides how much of each commodit% that it sells &its coutputsc or cproductsc' it will produce$ and how much of each !ind of labour$ raw material$ fi-ed capital good$ etc.$ that it emplo%s &its cinputsc or cfactors of productionc' it will use. #he theor% involves some of the most fundamental principles of economics. #hese include the relationship between the prices of commodities and the prices &or wages or rents' of the productive factors used to produce them and also the relationships between the prices of commodities and productive factors$ on the one hand$ and the 6uantities of these commodities and productive factors that are produced or used$ on the other. #he various decisions a business enterprise ma!es about its productive activities can be classified into three la%ers of increasing comple-it%. #he first la%er includes decisions about methods of producing a given 6uantit% of the output in a plant of given si5e and e6uipment. It involves the problem of what is called shortrun cost minimi5ation. #he second la%er$ including the determination of the most profitable 6uantities of products to produce in an% given plant$ deals with what is called shortrun profit ma-imi5ation. #he third la%er$ concerning the determination of the most profitable si5e and e6uipment of plant$ relates to what is called longrun profit ma-imi5ation. ;I"I;IY2#IO" O> S3OC#C8" COS#S #he production function. 3owever much of a commodit% a business firm produces$ it endeavours to produce it as cheapl% as possible. #a!ing the 6ualit% of the product and the prices of the productive factors as given$ which is the usual situation$ the firm]s tas! is to determine the cheapest combination of factors of production that can produce the desired output. #his tas! is best understood in terms of what is called the production function$ i.e.& an e6uation that e-presses the relationship between the 6uantities of factors emplo%ed and the amount of product obtained. It states the amount of product that can be obtained from each and ever% combination of factors. #his relationship can be written mathematicall% as y S f &' 1 $ ' , $ . . . $ ' n # k 1 $ k , $ . . . $ k m 9. 3ere$ y denotes the 6uantit% of output. #he firm is presumed to use n variable factors of production7 that is$ factors li!e hourl% paid production wor!ers and raw materials$ the 6uantities of ,11 which can be increased or decreased. In the formula the 6uantit% of the first variable factor is denoted b% ' 1 and so on. #he firm is also presumed to use m fi-ed factors$ or factors li!e fi-ed machiner%$ salaried staff$ etc.$ the 6uantities of which cannot be varied readil% or habituall%. #he available 6uantit% of the first fi-ed factor is indicated in the formal b% k 1 and so on. #he entire formula e-presses the amount of output that results when specified 6uantities of factors are emplo%ed. It must be noted that though the 6uantities of the factors determine the 6uantit% of output$ the reverse is not true$ and as a general rule there will be man% combinations of productive factors that could be used to produce the same output. >inding the cheapest of these is the problem of cost minimi5ation. #he cost of production is simpl% the sum of the costs of all of the various factors. It can be written: in which p 1 denotes the price of a unit of the first variable factor$ r 1 denotes the annual cost of owning and maintaining the first fi-ed factor$ and so on. 3ere again one group of terms$ the first$ covers variable cost &roughl%c direct costsc in accounting terminolog%'$ which can be changed readil%7 another group$ the second$ covers fi-ed cost &accountants] coverhead costsc'$ which includes items not easil% varied. #he discussion will deal first with variable cost. >igure ?: Iso6uant diagram of hours of labour and feet of gold wire used per month. #he principles involved in selecting the cheapest combination of variable factors can be seen in terms of a simple e-ample. If a firm manufactures gold nec!lace chains in such a wa% that there are onl% two variable factors$ labour &specificall%$ goldsmithhours' and gold wire$ the production function for such a firm will be y S f &' 1 & ' , 7 k'$ in which the s%mbol k is included simpl% as a reminder that the number of chains producible b% ' 1 feet of gold wire and ' , goldsmithhours depends on the amount of machiner% and other fi-ed capital available. Since there are onl% two variable factors$ this production function can be portra%ed graphicall% in a figure !nown as an iso6uant diagram &>igure ?'. In the graph$ goldsmithhours per month are plotted hori5ontall% and the number of feet of gold wire used per month verticall%. Each of the curved lines$ called an iso6uant$ will then represent a certain number of nec!lace chains produced. #he data displa%ed show that 1HH goldsmithhours plus GHH feet of gold wire can produce ,HH nec!lace chains. <ut there are other combinations of variable inputs that could also produce ,HH nec!lace chains per ,1= month. If the goldsmiths wor! more carefull% and slowl%$ the% can produce ,HH chains from ?0H feet of wire7 but to produce so man% chains more goldsmithhours will be re6uired$ perhaps 1.H. #he iso6uant labelled c,HHc shows all the combinations of the variable inputs that will *ust suffice to produce ,HH chains. #he other two iso6uants shown are interpreted similarl%. It is obvious that man% more iso6uants$ in principle an infinite number$ could also be drawn. #his diagram is a graphic displa% of the relationships e-pressed in the production function. Su%"titution of factor". #he iso6uants also illustrate an important economic phenomenon: that of factor substitution. #his means that one variable factor can be substituted for others7 as a general rule a more lavish use of one variable factor will permit an unchanged amount of output to be produced with fewer units of some or all of the others. In the e-ample above$ labour was literall% as good as gold and could be substituted for it. If it were not for factor substitution there would be no room for further decision after y& the number of chains to be produced$ had been established. #he shape of the iso6uants shown$ for which there is a good deal of empirical support$ is ver% important. In moving along an% one iso6uant$ the more of one factor that is emplo%ed$ the less of the other will be needed to maintain the stated output7 this is the graphic representation of factor substitutabilit%. <ut there is a corollar%: the more of one factor that is emplo%ed$ the less it will be possible to reduce the use of the other b% using more of the first. #his is the propert% !nown as cdiminishing marginal rates of substitution.c #he marginal rate of substitution of factor 1 for factor , is the number of units b% which ' 1 can be reduced per unit increase in '$ output remaining unchanged. In the diagram$ if feet of gold wire are indicated b% ' 1 and goldsmithhours b% ' , $ then the marginal rate of substitution is shown b% the steepness &the negative of the slope' of the iso6uant7 and it will be seen that it diminishes steadil% as ' , increases because it becomes harder and harder to economi5e on the use of gold simpl% b% ta!ing more care. #he remainder of the anal%sis rests heavil% on the assumption that diminishing marginal rates of substitution are characteristic of the production process generall%.
>igure G: Iso6uant diagram for two factors of production$ ' 1 and ' , ,1? #he cost data and the technological data can now be brought together. #he variable cost of using ' 1 $ ' , units of the factors of production is written p 1 ' 1 i p , ' , $ and this information can be added to the iso6uant diagram &>igure G'. #he straight line labelled v , $ called the v , isocost line$ shows all the combinations of input that can be purchased for a specified variable cost$ v , . #he other two isocost lines shown are interpreted similarl%. #he general formula for an isocost line is p 1 ' 1 i p , ' , S v& in which v is some particular variable cost. #he slope of an isocost line is found b% dividing p , b% p 1 and depends onl% on the ratio of the prices of the two factors. #hree isocost lines are shown$ corresponding to variable costs amounting to v 1 $ v , $ and v . . If ,HH units are to be produced$ e-penditure of v 1 on variable factors will not suffice since the v 1 in socost line never reaches the iso6uant for ,HH units. 2n e-penditure of v . is more than sufficient7 and v , is the lowest variable cost for which ,HH units can be produced. #hus v , is found to be the minimum variable cost of producing ,HH units &as v . is of .HH units' and the coordinates of the point where the v , isocost line touches the ,HHunit iso6uant are the 6uantities of the two factors that will be used when ,HH units are to be produced and the prices of the two factors are in the ratio p , Bp 1 . It ma% be noted that the cheapest combination for the production of an% 6uantit% will be found at the point at which the relevant iso6uant is tangent to an isocost line. #hus$ since the slope of an iso6uant is given b% the marginal rate of substitution$ an% firm tr%ing to produce as cheapl% as possible will alwa%s purchase or hire factors in 6uantities such that the marginal rate of substitution will e6ual the ratio of their prices. #he iso6uantisocost diagram &or the corresponding solution b% the alternative means of the calculus' solves the shortrun cost minimi5ation problem b% determining the leastcost combination of variable factors that can produce a given output in a given plant. #he variable cost incurred when the leastcost combination of inputs is used in con*unction with a given outfit of fi-ed e6uipment is called the variable cost of that 6uantit% of output and denoted VC&y'. #he total cost incurred$ variable plus fi-ed$ is the shortrun cost of that output$ denoted SCC&y'. Clearl% SCC&y' S VC&y' i C&-'$ in which the second term s%mboli5es the sum of the annual costs of the fi-ed factors available. ;arginal cost. #wo other concepts now become important. #he average variable cost$ written 2VC&y'$ is the variable cost per unit of output. 2lgebraicall%$ 2VC&y' S VC&y'By. #he marginal variable cost$ or simpl% marginal cost f;C&y'g is$ roughl%$ the increase in variable cost incurred when output is increased b% one unit7 i.e.& ;C&y' S VC&y i 1' VC&y'. #hough for theoretical purposes a more precise definition can be obtained b% regarding VC&y' as a continuous function of output$ this is not necessar% in the present case. ,1G >igure 1H: 2verage variable costs &2VC' and marginal variable costs &;C' in relation to output. #he usual behaviour of average and marginal variable costs in response to changes in the level of output from a given fi-ed plant is shown in >igure 1H. In this figure costs &in dollars per unit' are measured verticall% and output &in units per %ear' is shown hori5ontall%. #he figure is drawn for some particular fi-ed plant$ and it can be seen that average costs are fairl% high for ver% low levels of output relative to the si5e of the plant$ largel% because there is not enough wor! to !eep a wellbalanced wor! force full% occupied. (eople are either idle much of the time or shifting$ e-pensivel%$ from *ob to *ob. 2s output increases from a low level$ average costs decline to a low plateau. <ut as the capacit% of the plant is approached$ the inefficiencies incident on plant congestion force average costs up 6uite rapidl%. Overtime ma% be incurred$ outmoded e6uipment and ine-perienced hands ma% be called into use$ there ma% not be time to ta!e machiner% off the line for routine maintenance7 or minor brea!downs and dela%s ma% disrupt schedules seriousl% because of inade6uate slac! and reserves. #hus the 2VC curve has the flatbottomed 8shape shown. #he ;C curve$ as might be e-pected$ falls faster and rises more rapidl% than the 2VC curve. ;2OI;IY2#IO" O> S3OC#C8" (CO>I#S #he average and marginal cost curves *ust deduced are the !e%s to the solution of the secondlevel problem$ the determination of the most profitable level of output to produce in a given plant. #he onl% additional datum needed is the price of the product$ sa% p H . #he most profitable amount of output ma% be found b% using these data. If the marginal cost of an% given output &y' is less than the price$ sales revenues will increase more than costs if output is increased b% one unit &or even a few more'7 and profits will rise. Contrariwise$ if the marginal cost is greater than the price$ profits will be increased b% cutting bac! output b% at least one unit. It then follows that the output that ma-imi5es profits is the one for which ;C&y' S p H . #his is the second basic finding: in response to an% price the profitma-imi5ing firm will produce and offer the 6uantit% for which the marginal cost e6uals that price Such a conclusion is shown in >igure 1H. In response to the price$ p H $ shown$ the firm will offer the 6uantit% yM given b% the value of y for which the ordinate of the ;C curve e6uals the price. If a denotes the corresponding average variable cost$ net revenue per unit will be e6ual to p H a& and the total e-cess of revenues over variable ,=H costs will be yM&p H a'$ which is represented graphicall% b% the shaded rectangle in the figure.
Mar#inal co"t and price. #he conclusion that marginal cost tends to e6ual price is important in that it shows how the 6uantit% of output produced b% a firm is influenced b% the mar!et price. If the mar!et price is lower than the lowest point on the average variable cost curve$ the firm will ccut its lossesc b% not producing an%thing. 2t an% higher mar!et price$ the firm will produce the 6uantit% for which marginal cost e6uals that price. #hus the 6uantit% that the firm will produce in response to an% price can be found in >igure 1H b% reading the marginal cost curve$ and for this reason the marginal cost curve is said to be the shortrun suppl% curve for the firm. #he shortrun suppl% curve for a productthat is$ the total amount that all the firms producing it will produce in response to an% mar!et pricefollows immediatel%$ and is seen to be the sum of the shortrun suppl% curves &or marginal cost curves$ e-cept when the price is below the bottoms of the average variable cost curves for some firms' of all the firms in the industr%. #his curve is of fundamental importance for economic anal%sis$ for together with the demand curve for the product it determines the mar!et price of the commodit% and the amount that will be produced and purchased. One pitfall must$ however$ be noted. In the demonstration of the suppl% curves for the firms$ and hence of the industr%$ it was assumed that factor prices were fi-ed. #hough this is fair enough for a single firm$ the fact is that if all firms together attempt to increase their outputs in response to an increase in the price of the product$ the% are li!el% to bid up the prices of some or all of the factors of production that the% use. In that event the product suppl% curve as calculated will overstate the increase in output that will be elicited b% an increase in price. 2 more sophisticated t%pe of suppl% curve$ incorporating induced changes in factor prices$ is therefore necessar%. Such curves are discussed in the standard literature of this sub*ect. Mar#inal product. It is now possible to derive the relationship between product prices and factor prices$ which is the basis of the theor% of income distribution. #o this end$ the marginal product of a factor is defined as the amount that output would be increased if one more unit of the factor were emplo%ed$ all other circumstances remaining the same. 2lgebraicall%$ it ma% be e-pressed as the difference between the product of a given amount of the factor and the product when that factor is increased b% an additional unit. #hus if M3 1 &' 1 ' denotes the marginal product of factor 1 when ' 1 units are emplo%ed$ then M3 1 &' 1 ' S f&' 1 i 1$ ' , $ . . . $' n 7k' f&' 1 $ ' , . . . $' n 7 k'. #he marginal products are closel% related to the marginal rates of substitution previousl% defined. If an additional unit of factor 1 will increase output b% f 1 units$ for e-ample$ then one more unit of output can be obtained b% emplo%ing 1Bf 1 more units of factor 1. Similarl%$ if the marginal product of factor , is f , $ then output will fall b% one unit if the use of factor , is reduced b% 1Bf , units. #hus output will remain unchanged$ to a good appro-imation$ if 1Bf 1 units of factor 1 are used to replace 1Bf , units of factor ,. #he marginal rate of substitution is therefore f , Bf 1 $ or the ratio of the marginal products of the two factors. It has alread% been shown that the marginal rate of substitution also ,=1 e6uals the ratio of the prices of the factors$ and it therefore follows that the prices &or wages' of the factors are proportional to their marginal products. #his is one of the most significant theoretical findings in economics. #o restate it briefl%: factors of production are paid in proportion to their marginal products. #his is not a 6uestion of social e6uit% but merel% a conse6uence of the efforts of businessmen to produce as cheapl% as possible. >urther$ the marginal products of the factors are closel% related to marginal costs and$ therefore$ to product prices. >or if one more unit of factor 1 is emplo%ed$ output will be increased b% M3 1 &' 1 ' units and variable cost b% p 1 7 so the marginal cost of additional units produced will be p 1 BM3 1 &' 1 '. Similarl%$ if additional output is obtained b% emplo%ing an additional unit of factor ,$ the marginal cost will be p , BM3 , &' , '. <ut$ as shown above$ these two numbers are the same7 whichever factor i is used to increase output$ the marginal cost will be p i FM3 i &' i ' and$ furthermore$ the firm will choose its output level so that the marginal cost will be e6ual to the price$ p H . #herefore it has been established that p 1 S p H M3 1 &' 1 '$ p , S p H M3 , &' , '$ . . . $ or the price of each factor is the price of the product multiplied b% its marginal product$ which is the value of its marginal product. #his$ also$ is a fundamental theorem of income distribution and one of the most significant theorems in economics. Its logic can be perceived directl%. If the e6ualit% is violated for an% factor$ the businessman can increase his profits either b% hiring units of the factor or b% la%ing them off until the e6ualit% is satisfied$ and presumabl% the businessman will do so. #he theor% of production decisions in the short run$ as *ust outlined$ leads to two conclusions &of fundamental importance throughout the field of economics' about the responses of business firms to the mar!et prices of the commodities the% produce and the factors of production the% bu% or hire: &1' the firm will produce the 6uantit% of its product for which the marginal cost is e6ual to the mar!et price and &,' it will purchase or hire factors of production in such 6uantities that the price of the commodit% produced multiplied b% the marginal product of the factor will be e6ual to the cost of a unit of the factor. #he first e-plains the suppl% curves of the commodities produced in an econom%. #hough the conclusions were deduced within the conte-t of a firm that uses two factors of production$ the% are clearl% applicable in general. ;2OI;IY2#IO" O> DO"FC8" (CO>I#S Relation"hip %eteen the "hort run and the lon# run* #he theor% of longrun profitma-imi5ing behaviour rests on the shortrun theor% that has *ust been presented but is considerabl% more comple- because of two features: &1' longrun cost curves$ to be defined below$ are more varied in shape than the corresponding shortrun cost curves$ and &,' the longrun behaviour of an industr% cannot be deduced simpl% from the longrun behaviour of the firms in it because the roster of firms is sub*ect to change. It is of the essence of longrun ad*ustments that the% ta!e place b% the addition or dismantling of fi-ed productive capacit% b% both established firms and new or recentl% created firms. 2t an% one time an established firm with an e-isting plant will ma!e its short run decisions b% comparing the ruling price of its commodit% with cost curves corresponding to that plant. If the price is so high that the firm is operating on the ,=, rising leg of its shortrun cost curve$ its marginal costs will be highhigher than its average costsand it will be en*o%ing operating profits$ as shown in >igure 1H. #he firm will then consider whether it could increase its profits b% enlarging its plant. #he effect of plant enlargement is to reduce the variable cost of producing high levels of output b% reducing the strain on limited production facilities$ at the e-pense of increasing the level of fi-ed costs. In response to an% level of output that it e-pects to continue for some time$ the firm will desire and eventuall% ac6uire the fi-ed plant for which the shortrun costs of that level of output are as low as possible. #his leads to the concept of the longrun cost curve: the longrun costs of an% level of output are the shortrun costs of producing that output in the plant that ma!es those shortrun costs as low as possible. #hese result from balancing the fi-ed costs entailed b% an% plant against the shortrun costs of producing in that plant. #he longrun costs of producing y are denoted b% DCC&y'. #he average longrun cost of y is the longrun cost per unit of y falgebraicall% D2C&y' S DCC&y'Byg. #he marginal longrun cost is the increase in longrun cost resulting from an increase of one unit in the level of output. It represents a combination of shortrun and longrun ad*ustments to a slight increase in the rate of output. It can be shown that the longrun marginal cost e6uals the marginal cost as previousl% defined when the costminimi5ing fi-ed plant is used.
)on# run co"t cur$e"* Cost curves appropriate for longrun anal%sis are more varied in shape than shortrun cost curves and fall into three broad classes. In constantcost industries$ average cost is about the same at all levels of output e-cept the ver% lowest. Constant costs prevail in manufacturing industries in which capacit% is e-panded b% replicating facilities without changing the techni6ue of production$ as a cotton mill e-pands b% increasing the number of spindles. In decreasingcost industries$ average cost declines as the rate of output grows$ at least until the plant is large enough to suppl% an appreciable fraction of its mar!et. 9ecreasing costs are characteristic of manufacturing in which heav%$ automated machiner% is economical for large volumes of output. 2utomobile and steel manufacturing are leading e-amples. 9ecreasing costs are inconsistent with competitive conditions$ since the% permit a few large firms to drive all smaller competitors out of business. >inall%$ in increasingcost industries average costs rise with the volume of output generall% because the firm cannot obtain additional fi-ed capacit% that is as efficient as the plant it alread% has. #he most important e-amples are agriculture and e-tractive industries. CCI#ICIS;S O> #3E #3EOC: #he theor% of production has been sub*ect to much criticism. One ob*ection is that the concept of the production function is not derived from observation or practice. Even the most sophisticated firms do not !now the direct functional relationship between their basic raw inputs and their ultimate outputs. #his ob*ection can be got around b% appl%ing the recentl% developed techni6ues of linear programming$ which emplo% observable data without recourse to the production function and lead to practicall% the same conclusions. On another level the theor% has been charged with e-cessive simplification. It assumes that there are no changes in the rest of the econom% while individual firms and industries are ma!ing the ad*ustments described in the theor%7 it neglects changes ,=. in the techni6ue of production7 and it pa%s no attention to the ris!s and uncertainties that becloud all business decisions. #hese criticisms are especiall% damaging to the theor% of longrun profit ma-imi5ation. On still another level$ critics of the theor% maintain that businessmen are not alwa%s concerned with ma-imi5ing profits or minimi5ing costs. #hough all of the criticisms have merit$ the simplified theor% of production does nevertheless indicate some basic forces and tendencies operating in the econom%. #he theorems should be understood as conditions that the econom% tends toward$ rather than conditions that are alwa%s and instantaneousl% achieved. It is rare for them to be attained e-actl%$ but it is *ust as rare for substantial violations of the theorems to endure. Onl% the simplest aspects of the theor% were described above. +ithout much difficult% it could be e-tended to cover firms that produce more than one product$ as almost all firms do. +ith more difficult% it could be applied to firms whose decisions affect the prices at which the% sell and bu% &monopol%$ monopolistic competition$ monopson%'. #he behaviour of other firms that recogni5e the possibilit% that their competitors ma% retaliate &oligopol%' is still a theor% of production sub*ect to controvers% and research. 9istribution: the shares of the factors of production #he factors of production$ as suggested earlier$ are the economic resources$ both human and other$ which$ if properl% utili5ed$ will bring about a flow or output of goods and services. #he factors are commonl% classified into three groups: capital$ labour$ and land. #he first$ in the simplest sense$ refers to all the cproducedc instruments of productionthe factories$ their e6uipment$ their stoc!s of raw materials and finished goods$ houses$ trade facilities$ and so on7 the owners of capital receive their income in various possible forms$ profits and interest being the usual ones. #he factor of labour represents all those productive resources that can be applied onl% at the cost of human effort7 the wage &or salar%' is the form of pa%ment for use of this factor. #he factor of land represents resources whose suppl% is low in relation to demand and cannot be increased as the result of production7 the income derived from the ownership of this factor is !nown as economic rent. 9istribution$ in economics$ generall% refers to &1' e-planations of how prices for the services of the different factors of production are determined7 &,' e-planations of how the total product of the econom% is divided among the various factors$ and &.' descriptions of the wa%s in which the income is divided among various income classes or groups of persons. C2(I#2D 2"9 I"#ECES# Capital in economics is a word of man% meanings. #he% all impl% that capital is a cstoc!c b% contrast with income$ which is a cflow.c In its broadest possible sense$ capital includes the human population7 nonmaterial elements such as s!ills$ abilities$ and education7 land$ buildings$ machines$ e6uipment of all !inds7 and all stoc!s of goodsfinished or unfinishedin the hands of both firms and households. In the business world the word capital usuall% refers to an item in the balance sheet representing that part of the net worth of an enterprise that has not been produced through the operations of the enterprise. In economics the word capital is generall% confined to crealc as opposed to merel% cfinancialc assets. 9ifferent as the two concepts ma% seem$ the% are not unrelated. If all balance sheets were consolidated in a closed economic s%stem$ all debts would be cancelled out because ,=/ ever% debt is an asset in one balance sheet and a liabilit% in another. +hat is left in the consolidated balance sheet$ therefore$ is a value of all the real assets of a societ% on one side and its total net worth on the other. #his is the economist]s concept of capital. 2 distinction ma% be made between goods in the hands of firms and goods in the hands of households$ and attempts have been made to confine the term capital structure to the former. #here is also a distinction between goods that have been produced and goods that are gifts of nature7 attempts have been made to confine the term capital to the former$ though the distinction is hard to maintain in practice. 2nother important distinction is between the stoc! of human beings &and their abilities' and the stoc! of nonhuman elements. In a slave societ% human beings are counted as capital in the same wa% as livestoc! or machines. In a free societ% each man is his own slavethe value of his bod% and mind is not$ therefore$ an article of commerce and does not get into the accounting s%stem. In strict logic persons should continue to be regarded as part of the capital of a societ%7 but in practice the distinction between the part of the total stoc! that enters into the accounting s%stem$ and the part that does not$ is so important that it is not surprising that man% writers have e-cluded persons from the capital stoc!. 2nother distinction that has some historical importance is that between circulating and fi-ed capital. >i-ed capital is usuall% defined as that which does not change its form in the course of the process of production$ such as land$ buildings$ and machines. Circulating capital consists of goods in process$ raw materials$ and stoc!s of finished goods waiting to be sold7 these goods must either be transformed$ as when wheat is ground into flour$ or the% must change ownership$ as when a stoc! of goods is sold. #his distinction$ li!e man% others$ is not alwa%s eas% to maintain. "evertheless$ it represents a rough approach to an important problem of the relative structure of capital7 that is$ of the proportions in which goods of various !inds are found. #he stoc! of real capital e-hibits strong complementarities. 2 machine is of no use without a s!illed operator and without raw materials for it to wor! on. #he classical theor% of capital. 2lthough ancient and medieval writers were interested in the ethics of interest and usur%$ the concept of capital as such did not rise to prominence in economic thought before the classical economists &2dam Smith$ 9avid Cicardo$ "assau Senior$ and @ohn Stuart ;ill'. 2dam Smith laid great stress on the role pla%ed b% the accumulation of a stoc! of capital in facilitating the division of labour economics and in increasing the productivit% of labour in general. 3e recogni5ed clearl% that accumulation proceeds from an e-cess of production over consumption. 3e distinguished between productive labour$ which creates ob*ects of capital$ and unproductive labour &services'$ the fruits of which are en*o%ed immediatel%. 3is thought was strongl% coloured b% observation of the annual agricultural c%cle. #he end of the harvest saw societ% with a given stoc! of grain. #his stoc! was in the possession of the capitalists. 2 certain portion of it the% reserved for their own consumption and for the consumption of their menial servants$ the rest was used to feed cproductive labourersc during the ensuing %ear. 2s a result$ b% the end of the ne-t harvest the barns were full again and the stoc! had replaced itself$ perhaps with something left over. #he stoc! that the capitalists did not reserve for their own use was the cwages fundcthe more grain there was in the barn in October the sharper the competition of capitalists for wor!ers$ and the higher real wages would be in the %ear to come. #he picture is a crude one$ of course$ and does ,=0 not indicate the comple-it% of the relationship between stoc!s and flows in an industrial societ%. #he last of the classical economists$ @ohn Stuart ;ill$ was forced to abandon the wagesfund theor%. "evertheless$ the wages fund is a crude representation of some real but comple- relationships$ and the theor% reappears in a more sophisticated form in later writers. #he classical economists distinguished three categories of incomewages$ profit$ and rentand identified these with three factors of productionlabour$ capital$ and land. 9avid Cicardo especiall% made a sharp distinction between capital as cproduced means of production$c and land as the coriginal and indestructible powers of the soil.c In modern economics this distinction has become blurred. The Au"trian "chool. 2bout 1?=H a new school developed$ sometimes called the 2ustrian school from the fact thatman% of its principal members taught in Vienna$ but perhaps better called the ;arginalist school. #he movement itself was thoroughl% international$ and included such figures as +illiam Stanle% @evons in England and Djon +alras in >rance. #he socalled 2ustrian theor% of capital is mainl% based on the wor! of Eugen <mhm<awer!. 3is 3ositive Theory of Capital &1??G' set off a controvers% that has not %et subsided. In the 2ustrian view the economic process consisted of the embodiment of coriginal factors of productionc in capital goods of greater or lesser length of life that then %ielded value or utilit% as the% were consumed. <etween the original embodiment of the factor and the final fruition in consumption la% an interval of time !nown as the period of production. In an e6uilibrium population it can easil% be shown that the total population &capital stoc!' e6uals the annual number of births or deaths &income' multiplied b% the average length of life &period of production'. #he longer the period of production$ therefore$ the more capital goods there will be per unit of income. If the period of production is constant$ income depends directl% on the amount of capital previousl% accumulated. 3ere is the wages fund in a new form. 8nfortunatel%$ the usefulness of <mhm<awer!]s theor% is much impaired b% the fact that it is confined to e6uilibrium states. #he great problems of capital theor% are d%namic in character$ and comparative statics throws onl% a dim light on them. Mar#inali"t and Aeyne"ian theorie". #he ;arginalist school culminated in the wor! of three men(.3. +ic!stead in England$ Unut +ic!sell in Sweden$ and Irving >isher in the 8nited States. #he last two especiall% gave the 2ustrian theor% clear mathematical e-pression. (erhaps the greatest contribution of the 2ustrian theor% was its recognition of the importance of the valuation problem in the relation of capital to interest. >rom the mere fact that ph%sical capital produces an income stream$ there is no e-planation of the phenomenon of interest$ for the 6uestion is wh% the value of a piece of ph%sical capital should be less than the total of future values that are e-pected to accrue from it. #he theor% also ma!es a contribution to the problem of rational choice in situations involving waiting or maturing. #he best e-ample is that of slowl% maturing goods such as wines or timber. #here is a problem here of the best time to draw wine or to cut down a tree. 2ccording to the marginal theor% this is at the time when the rate of net value growth of the item is *ust e6ual to the rate of interest$ or the rate of return in alternative investments. #hus$ if a tree or a wine is increasing in value at the rate of = percent per annum when the rate of interest is 1 percent it still pa%s to be patient and ,=1 let it grow or mature. #he longer it grows$ however$ the less the rate of value growth$ and when the rate of value growth has fallen to the rate of interest$ then is the time to reap the fruits of patience. &see also 2nde': profit ma-imi5ation' #he contributions of @ohn ;a%nard &Dord' Ue%nes to capital theor% are incidental rather than fundamental. "evertheless$ the IUe%nesian revolutionc had an impact on this area of economic thought as on most others. It overthrew the traditional assumption of most economists that savings were automaticall% invested. #he great contribution of Ue%nes$ then$ is the recognition that the attempt to save does not automaticall% result in the accumulation of capital. 2 decision to restrict consumption is onl% a decision to accumulate capital if the volume of production is constant. If abstention from consumption itself results in a diminution of production$ then accumulation &production minus consumption' is correspondingl% reduced. Dater thin!ing. #he theor% of capital was not a matter of primar% concern to economists in the late ,Hth centur%$ though some revival of interest occurred in the late 1G0Hs. "evertheless$ certain problems remain of perennial interest. #he% ma% be grouped as follows. !eterogeneous goods. >irst are the problems involved in measuring aggregates of goods. Ceal capital includes ever%thing from screwdrivers to continuous striprolling mills. 2 single measure of total real capital can be achieved onl% if each item can be e-pressed in a common denominator such as a given monetar% unit &e.g.& dollars$ sterling$ francs$ pesos$ etc.'. #he problem becomes particularl% complicated in periods of rapid technical change when there is change not onl% in the relative values of products but in the nature of the list itself. Onl% appro-imate solutions can be found to this problem$ and no completel% satisfactor% measure is ever possible. 2 related problem that has aroused considerable interest among accountants is how to value capital assets that have no fi-ed price. In the conventional balance sheet the value of some items is based on their cost at an earlier period than that of others. +hen the general level of prices is changing this means that different items are valued in monetar% units of different purchasing power. #he problem is particularl% acute in the valuation of inventor%. 8nder the more conventional c>I>Oc & >irst In$ >irst Out' s%stem$ inventor% is valued at the cost &purchase price' of the latest purchases. #his leads to an inflation of inventor% values$ and therefore of accounting profits$ in time of rising prices &and a corresponding deflation under falling prices'$ which ma% be an e-aggeration of the longrun position of the firm. #his ma% be partiall% avoided b% a competing s%stem of valuation !nown as DI>O & Dast In$ >irst Out'$ in which inventor% is valued at the purchase price of the earliest purchases. #his avoids the fluctuations caused b% shortrun pricelevel changes$ but it fails to record changes in real longrun values. #here seems to be no completel% satisfactor% solution to this problem$ and it is wise to recogni5e the fact that an% single figure of capital value that purports to represent a comple-$ man%dimensional realit% will need careful interpretation. ,== ,he accumulation process. 2 second problem concerns the factors that determine the rate of accumulation of capital7 that is$ the rate of investment. It has been seen that investment in real terms is the difference between production and consumption. #he classical economist laid great stress on frugalit% as the principal source of capital accumulation. If production is constant it is true that the onl% wa% to increase accumulation is b% the reduction of consumption. Ue%nes shifted the emphasis from the reduction of consumption to the increase of production$ and regarded the decision to produce investment goods as the principal factor in determining the rate of growth of capital. In modern theories of economic development great stress is laid on the problem of the structure of productionthe relative proportions of different !inds of activit%. #he advocates of cbalanced growthc emphasi5e the need for a developing countr% to invest in a wide range of related and cooperative enterprises$ public as well as private. #here is no point in building factories and machines$ the% sa%$ if the educational s%stem does not provide a labour force capable of using them. #here is also$ however$ a case to be made for cunbalanced growth$c in the sense that growth in one part of the econom% fre6uentl% stimulates growth in other parts. 2 big investment in mining or in h%droelectric power$ for e-ample$ creates strains on the whole societ%$ which result in growth responses in the complementar% sectors. #he relation of inflation to economic growth and investment is an important though difficult problem. #here seems to be little doubt that deflation$ mainl% because it shifts the distribution of income awa% from the profit ma!er toward the rentier and bondholder$ has a deleterious effect on investment and the growth of capital. In 1G.,$ for instance$ real investment had practicall% ceased in the 8nited States. It is less clear at what point inflation becomes harmful to investment. In countries where there has been long continuing inflation there seems to be some evidence that the structure of investment is distorted. #oo much goes into apartment houses and factories and not enough into schools and communications. Capital and time. 2 third problem that e-ists in capital theor% is that of the period of production and the time structure of the economic process. #his cannot be solved b% the simple formulas of the 2ustrian school. "evertheless$ the problem is a real one and there is still a need for more useful theoretical formulations of it. 9ecisions ta!en toda% have results e-tending far into the future. Similarl%$ the data of toda%]s decisions are the result of decisions that were ta!en long in the past. #he e-isting capital structure is the embodiment of past decisions and the raw material of present decisions. #he incompatibilit% of decisions is fre6uentl% not discovered at the time the% are made because of the lapse of time between the decision and its conse6uences. It is tempting to regard the c%clical structure of human histor%$ whether the business c%cle or the war c%cle$ as a process b% which the conse6uences of bad decisions accumulate until some !ind of crisis point is reached. #he crisis &a war or a depression' redistributes power in the societ% and so leads to a new period of accumulating$ but hidden$ stress. In this process$ distortion in the capital structure is of great importance. ,=? Capital and income. 2 fourth problem to be considered is the relationship that e-ists between the stoc!s and the flows of a societ%$ or in a narrower sense the relation between capital and income. Income$ li!e capital$ is a concept that is capable of man% definitions7 a useful approach to the concept of income is to regard it as the gross addition to capital in a given period. >or an% economic unit$ whether a firm or an individual$ income ma% be measured b% that h%pothetical amount of consumption that would leave capital intact. In real terms this is practicall% identical with the concept of production. #he total flow of income is closel% related to both the 6uantit% and the structure of capital7 the total real income of a societ% depends on the si5e and the s!ills of its population$ and on the nature and the e-tent of the e6uipment with which the% have to wor!. #he most important single measure of economic wellbeing is real income per person7 this is closel% related to the productivit% of labour$ and this in turn is closel% related to capital per person$ especiall% if the results of investment in human resources$ s!ills$ and education are included in the capital stoc!. Intere"t* 3istoricall%$ the concept of capital has been so closel% bound to the concept of interest that it seems wise to ta!e these two topics together$ even though in the modern view it is capital and income rather than capital and interest that are the related concepts. Interest as a form of income ma% be defined as income that is received as a result of the possession of contractual obligations for pa%ment on the part of another. Interest$ in other words$ is income that is received as a result of the ownership of a bond$ a promissor% note$ or some other instrument that represents a promise on the part of some other part% to pa% sums in the future. #he obligations ma% ta!e man% forms. In the case of the perpetuit%$ the underta!ing is to pa% a certain sum each %ear or other interval of time for the indefinite future. 2 bond with a date of maturit% usuall% involves a promise to pa% a certain sum each %ear for a given number of %ears$ and then a larger sum on the terminal date. 2 promissor% note fre6uentl% consists of a promise to pa% a single sum at a date that is some time in the future. If a 1 $ a , $ . . . a n are the sums received b% the bondholder in %ears 1$ , . . . n$ and if 3 H is the present value in %ear G$ or the sum for which the bond is purchased$ the rate of interest r in the whole transaction is given b% the e6uation #here is no general solution for this e6uation$ though in practice it can be solved easil% b% successive appro-imation$ and in special cases the e6uation reduces to much simpler forms. In the case of a promissor% note$ for instance$ the e6uation reduces to the form ,=G where a n is the single promised pa%ment. In the case of a perpetuit% with an annual pa%ment of a& the formula reduces to #hus if one had to pa% N,HH to purchase a perpetual annuit% of N0 per annum$ the rate of interest would be , 1B, percent. It should be observed that the dimensions of the rate of interest are those of a rate of growth. #he rate of interest is not a price or ratio of e-change7 it is not itself determined in the mar!et. +hat is determined in the mar!et is the price of contractual obligations or cbonds.c #he higher the price of a given contractual obligation$ the lower the rate of interest on it. Suppose$ for instance$ that one has a promissor% note that is a promise to pa% one N1HH in one %ear]s time. If I bu% this for N1HH now$ the rate of interest is 5ero7 if I bu% it for NG0 now the rate of interest is a little over 0 percent7 if I bu% it for NGH now$ the rate of interest is about 11 percent. #he rate of interest ma% be defined as the gross rate of growth of capital in a contractual obligation. 2 distinction is usuall% made between interest and profit as forms of income. In ordinar% speech$ profit usuall% refers to income derived from the ownership of aggregates or assets of all !inds organi5ed in an enterprise. #his aggregate is described b% a balance sheet. In the course of the operations of the enterprise$ the net worth grows$ and profit is the gross growth of net worth. Stoc!s$ as opposed to bonds$ usuall% impl% a claim on the profits of some enterprise. The development of interest theory. In ancient and medieval times the main focus of in6uir% into the theor% of interest was ethical$ and the principal 6uestion was the moral *ustification of interest. On the whole$ the ta!ing of interest was regarded unfavorabl% b% both classical and medieval writers. 2ristotle regarded mone% as cbarrenc and the medieval schoolmen were hostile to usur%. "evertheless$ where interest fulfilled a useful social function elaborate rationali5ations were developed for it. 2mong the classical economists$ the focus of attention shifted awa% from ethical *ustification toward the problem of mechanical e6uilibrium. #he 6uestion then became this: Is there an% e6uilibrium rate of interest or rate of profit in the sense that where actual rates are above or below this$ forces are brought into pla%$ tending to change them toward the e6uilibrium4 #he classical economists did not provide an% clear solution for this problem. #he% believed that the rate of interest simpl% followed the rate of profit$ for people would not borrow or incur contractual obligations unless the% could earn something more than the cost of the borrowing b% investing the proceeds in enterprises or aggregates of real capital. #he% believed that the growth of capital itself would tend to reduce the rate of profit because of the competition of the capitalists. #his doctrine is important in the ;ar-ian d%namics in which the struggle of capital to avoid a falling rate of profit is seen as a critical factor leading$ for instance$ to unemplo%ment$ foreign investment$ and imperialism. In the framewor! of classical economics$ the wor! of "assau Senior deserves mention. 3e raised the 6uestion whether profit or interest were cpaid forc an%thing7 that is$ whether there was an% identifiable contribution to the general product of ,?H societ% that would not be forthcoming if this form of income were not paid. 3e identified such a function and called it abstinence. Uarl ;ar- denied the e-istence of an% such function and argued that the social product must be attributed entirel% to acts of labour$ capital being merel% the embodied labour of the past. On this view$ profit and interest are the result of pure e-ploitation in the sense that the% consist of an income derived from the power position of the capitalist and not from the performance of an% service. "on;ar-ist economists have generall% followed Senior in finding some function in societ% that corresponds to these forms of income. #he ;arginalists generall% held that profit and interest were related to the marginal productivit% of the e-tension of the period of production. <mhm<awer! assumed that croundaboutc processes of production would generall% be more productive than processes with shorter periods of production7 he thought there was a productivit% of cwaitingc &to use the term of 2lfred ;arshall' and saw the rate of interest as an inducement to the capitalist to e-tend the period of production2 low rate of interest leads to concentration on longer$ more roundabout processes$ and a high rate of interest on shorter$ less roundabout processes. #here is a limit$ however$ on the period of production imposed b% the e-isting stoc! of accumulated capital. If one embar!s on a long process with insufficient capital$ he will find that he has e-hausted his resources before the end of the process and before the fruits can be gathered. It is the business of the rate of interest to prevent this$ and to ad*ust the roundaboutness of the processes used to the capital resources available. #he ;arginalists] theor% of interest reached its clearest e-pression in the wor! of Irving >isher. 3e saw an e6uilibrium rate of interest as determined b% the interaction of two sets of forces: the impatience of consumers on the one hand$ and the returns from e-tending the period of production on the other. @ohn ;a%nard Ue%nes brought a new approach. 3is li6uidit% preference theor% of interest is a shortrun theor% of the price of contractual obligations &cbondsc'$ and it is essentiall% an application of the general theor% of mar!et price. If people as a whole decide that the% want to hold a larger proportion of their assets in the form of mone%$ and if new mone% is not created to satisf% this desire$ there will be a net desire to sell securities and the price of securities will fall. #his is the same thing as a rise in the rate of interest. Conversel%$ if people want to get rid of mone% the price of securities will rise and the rate of interest will fall. #his$ then$ is the theor% of the cmar!etc rate of interest$ b% contrast with the ;arginalists] theor%$ which concerns itself with whether or not there is a longrun e6uilibrium rate of interest. #he controvers%$ therefore$ between the li6uidit% preference theor%which regards interest as a cbribec to prevent people holding mone% rather than bondsand the time preference theor%which regards interest as a bribe to persuade people to postpone en*o%ments to the futurecan be resolved b% placing the former in the short run and the latter in the long run Contemporary =uestions. #he middle of the ,Hth centur% saw a considerable shift in the focus of concern relating to the theor% of interest. Economists seemed to lose interest in the e6uilibrium theor%$ and their main concern was with the effect of rates of interest as a part of monetar% polic% in the control of inflation. It was recogni5ed that the monetar% authorit% could control the rate of interest in the short run. #he controvers% la% mainl% between the advocates of cmonetar% polic%c and the advocates of c fiscal polic%.c If ,?1 inflation is regarded as a s%mptom of a desire on the part of a societ% to consume and invest more in total than its resources permit$ it is clear that the problem can be attac!ed either b% diminishing investment or b% diminishing consumption. On the whole$ the attac! of the advocates of monetar% polic% is on the side of diminishing investment$ through raising rates of interest and ma!ing it harder to obtain loans$ though the possibilit% that high rates of interest ma% restrict consumption is not overloo!ed. #he alternative would seem to restrict consumption b% raising ta-es. #his has the disadvantage of being politicall% unpopular. #he mounting concern with economic growth$ however$ has raised considerable doubts about the use of high rates of interest as an instrument to control inflation. #here is some doubt whether high interest rates in fact restrict investment7 if the% do not$ the% are ineffective$ and if the% do$ the% ma% be harmful to economic growth. #his is a serious dilemma for the advocates of monetar% polic%. On the other hand$ it must be admitted that the t%pe of fiscal polic% that might be most desirable theoreticall% has achieved ver% limited public support. #he ethics of interest. #he problem of the ethics of interest is still unresolved after man% centuries of discussion7 as long as the institution of private propert% is accepted$ the usefulness of borrowing and lending can hardl% be denied. In the long historic process of inheritance$ widowhood$ gain and loss$ b% which the distribution of the ownership of capital is determined$ there is no reason to suppose that the actual ownership of capital falls into the hands of those best able to administer it. ;uch of the capital of an advanced societ%$ in fact$ tends to be owned b% elderl% widows$ simpl% because of the greater longevit% of the female. Societ%$ therefore$ needs some machiner% for separating the control of capital from its ownership. >inancial instruments and financial mar!ets are the principal agenc% for performing this function. If all securities too! the form of stoc!s or e6uities$ it might be argued that contractual obligations &bonds'$ and therefore interest as a form of income$ would not be necessar%. #he case for bonds and interest$ however$ is the case for speciali5ation. #here is a demand for man% different degrees of ownership and responsibilit%$ and interestbearing obligations tap a mar!et that would be hard to reach with e6uit% securities7 the% are also peculiarl% well adapted to the obligations of governments. #he principal *ustification for interest and interestbearing securities is that the% provide an eas% and convenient wa% for s!illed administrators to control capital that the% do not own and for the owners of capital to relin6uish its control. #he price societ% pa%s for this arrangement is interest. #here remains the problem of the sociall% optimum rate of interest. It could be argued that there is no point in pa%ing an% higher price than one needs to and that the rate of interest should be as low as is consistent with the performance of the function of the financial mar!ets. #his position$ of course$ would place all the burden of control of economic fluctuations on the fiscal s%stem$ and it is 6uestionable whether this would be acceptable politicall%. #he ancient problem of cusur%$c in the form of the e-ploitation of the ignorant poor b% mone%lenders$ is still important in man% parts of the world. #he remed% is the development of ade6uate financial institutions for the needs of all classes of people rather than the attempt to prohibit or even to limit the ta!ing of interest. #he comple- structure of lending institutions in a developed societ%ban!s$ building societies$ land ban!s$ cooperative ban!s$ credit unions$ and so ontestifies to the realit% of the ,?, service that the lender provides and that interest pa%s for. #he democrati5ation of creditthat is$ the e-tension of the power of borrowing to all classes in societ%is one of the important social movements of the ,Hth centur%. +ages are income derived from human labour. #echnicall% the% cover all pa%ments for the use of labour$ mental or ph%sical$ but in ordinar% usage the term e-cludes income of the selfemplo%ed and is restricted to compensation of emplo%ees. Occasionall% fringe benefits are included$ but generall% the% are not. #he term is not full% s%non%mous with labour costs$ which ma% include such items as cafeterias or meeting rooms maintained for the convenience of emplo%ees &such items are part of capital'. +ages$ in economic terms$ however$ do include remuneration in the form of e-tra benefits$ such as paid vacations$ holida%s$ and sic! leave$ as well as wage supplements in the form of pensions and health insurance paid for b% the emplo%er. 2 wor!er in covered industries also receives the protection of governmentall% provided unemplo%ment compensation$ oldage pensions$ and industrial accident compensation. Fovernment services provided for wor!ers are of even greater significance in European countries than in the 8nited States and must be ta!en into account when comparisons of earnings are made Classical theories. #heories of wage determination and the share of labour in the gross national product have varied from time to time and have changed as the economic environment has changed. #he bod% of thought referred to toda% as wage theories could not have emerged until the old feudal s%stem had disappeared and the modern econom% with its modern institutions had come into e-istence. 2dam Smith$ in The $ealth of Nations &1==1'$ failed to propose a definitive theor% of wages$ but he anticipated several theories that were developed b% others later. Smith thought that wages were determined in the mar!etplace through the law of suppl% and demand. +or!ers and emplo%ers would naturall% follow their own selfinterest7 labour would be attracted to the *obs where labour was needed most$ and the result would be the greatest overall benefit to the wor!ers and to societ%. <ut Smith gave no precise anal%sis of the suppl% of and demand for labour7 he discussed man% elements that were involved but did not weave them into a consistent theoretical pattern. (u%sistence theory. Subsistence theories emphasi5e the suppl% aspects and neglect the demand aspects of the labour mar!et. #he% hold that change in the suppl% of wor!ers is the basic force that drives real wages to the minimum re6uired for subsistence. Elements of a subsistence theor% appear in The $ealth of Nations& where Smith wrote that the wages paid to wor!ers had to be enough to allow them to live and to reproduce themselves. Smith was more optimistic$ however$ than the <ritish classical economists$ such as 9avid Cicardo and #homas ;althus$ who followed him$ for he implied thatat least in an advancing nationthe wage level would have to be above subsistence to permit the population to grow enough to suppl% the additional wor!ers needed. Cicardo maintained a more rigid view. 3e wrote that the cnatural pricec of labour was the price necessar% to enable the labourers to subsist and to perpetuate the race without increase or diminution. Cicardo]s statement was consistent with the ;althusian theor% of population$ which held that population ad*usts to the means of supporting it. #he mar!et price of labour could not var% from the natural price for ,?. long: if wages rose above subsistence$ the number of wor!ers would increase and bring the wage rates down7 if wages fell below subsistence$ the number of wor!ers would decrease and bring the wage rates up. 2t the time that these economists wrote$ most wor!ers were actuall% living near the subsistence level$ and population appeared to be tr%ing to outrun the means of subsistence. #he subsistence theor% seemed to fit the facts7 and$ although Cicardo said that the natural price of labour was not fi-ed and might be changed if custom and habit moderated population increases in relation to food suppl% and other items necessar% to maintain labour$ later writers tended to subscribe to the basic idea and not to admit e-ceptions. #heir infle-ible and inevitable conclusion earned the theor% the name ciron law of wages.c $ages-fund theory. Smith said that the demand for labour could not increase e-cept in proportion to the increase of the funds destined for the pa%ment of wages. Cicardo maintained that an increase in capital would result in an increase in demand for labour. Statements such as these foreshadowed the wagesfund theor%$ which held that a predetermined fund of wealth e-isted for the pa%ment of wages. #he si5e of the fund could be changed over periods of time$ but at an% given moment the amount was fi-ed$ and the average wage could be determined simpl% b% dividing the fund b% the number of wor!ers. Smith thought of the fund as surplus income of wealth% men be%ond the needs of their families and tradewhich the% would use to emplo% others. Cicardo thought of it in terms of capitalfood$ clothing$ tools$ raw materials$ machiner%$ etc.$ necessar% to give effect to labour. Cegardless of the ma!eup of the fund$ the obvious conclusion was that when the fund was large in relation to the number of wor!ers$ wages would be high. +hen it was relativel% small$ wages would be low. If population increased too rapidl% in relation to food and other necessities &as outlined b% ;althus'$ wages would be driven to the subsistence level. #herefore$ it would be to the advantage of labour to help promote the accumulation of capital to enlarge the fund rather than to discourage it b% forming labour organi5ations and ma!ing e-orbitant demands. 2lso$ it followed that legislation designed to raise wages would not be successful$ for$ with onl% a fi-ed fund to draw upon$ increases gained b% some wor!ers could be maintained onl% at the e-pense of others. #his theor% was generall% accepted for 0H %ears b% economists$ including such well!nown figures as "assau +illiam Senior and @ohn Stuart ;ill. +.#. #hornton$ >.9. Donge$ and >rancis 2. +al!er were largel% responsible for discrediting the theor% during the decade following 1?10. #he% pointed out that the demand for labour was not determined b% a fund but was derived from the consumer demand for products. #he proponents of the wagesfund doctrine had been unable to prove that there was a determinate wage fund$ or an% fund maintaining a predetermined relationship with capital or with the portion of the proceeds of labour]s product paid out in wages. 2ctuall% the amount paid out depended upon a number of factors$ including the bargaining power of labour. :et$ in spite of these telling criticisms$ the wagesfund theor% continued to e-ercise an important influence until the end of the 1Gth centur%. ;ar-ian surplusvalue theor%. Uarl ;ar- accepted Cicardo]s labour theor% of value$ but he subscribed to a subsistence theor% of wages for a different reason than that given b% the classical ,?/ economists. In ;ar-]s mind$ it was not the pressure of population that drove wages to the subsistence level but rather the e-istence of a large arm% of unemplo%ed$ which he blamed on the capitalists. 3e stated that the e-change value of an% product was determined b% the amount of labour time sociall% necessar% to create it. 3e held that under the capitalistic s%stem$ labour was merel% a commodit% and could get onl% its subsistence. #he capitalist$ however$ could force the wor!er to spend more time on his *ob than was necessar% to earn his subsistence$ and the e-cess product$ or surplus value$ thus created$ was ta!en b% the capitalist. >rom the point of view of classical theor%$ ;ar-]s argument appeared persuasive$ although the term clabour time sociall% necessar%c hid some serious ob*ections. #he fatal blow came when the labour theor% of value and ;ar-]s subsistence theor% of wages were found to be invalid. +ithout them$ the surplusvalue theor% collapsed. Cesidualclaimant theor%. #he residualclaimant theor% holds that$ after all other factors of production have received their share of the product$ the amount left goes to the remaining factor. 2dam Smith implied such a theor% for wages$ since he said that rent would be deducted first and profits ne-t. >rancis 2. +al!er in 1?=0 wor!ed out a residual theor% of wages in which the shares of the landlord$ capitalist$ and entrepreneur were determined independentl% and subtracted$ thus leaving the remainder for labour in the form of wages. It should be noted$ however$ that an% of the factors of production ma% be selected as the residual claimant$ assuming that independent determinations ma% be made for the shares of the other factors. It is doubtful$ therefore$ that such a theor% has much value as an e-planation of wage phenomena. <argaining theor%. #he bargaining theor% of wages holds that wages$ hours$ and wor!ing conditions are determined b% the relative bargaining strength of the parties to the agreement. Smith hinted at such a theor% when he noted that emplo%ers had greater bargaining strength than emplo%ees$ because it was easier for emplo%ers to combine in opposition to emplo%ees] demands and also because emplo%ers were financiall% able to withstand the loss of income for a longer period than the emplo%ees. #his idea was developed to a considerable e-tent b% @ohn 9avidson$ who argued$ in 1?G?$ that the determination of wages is an e-tremel% complicated process involving numerous influences that interact to establish the relative bargaining strength of the parties. #here is no one factor or single combination of factors that determines wages$ and there is no one rate that necessaril% prevails. <ecause there are man% possibilities$ there is a range of rates within which an% number of rates ma% e-ist simultaneousl%. #he upper limit of the range is set b% the rate be%ond which the emplo%er refuses to hire certain wor!ers. #his rate is influenced b% such considerations as the productivit% of the wor!ers$ the competitive situation$ the si5e of the investment$ and the emplo%er]s estimate of future business conditions. #he lower limit of the range is set b% the rate below which the wor!ers will not offer their services to the emplo%er. #his rate is influenced b% such considerations as minimum wage legislation$ the wor!ers] standard of living$ their appraisal of the emplo%ment situation$ and their !nowledge of rates paid to others. "either the upper nor the lower limit is fi-ed$ and either ma% ,?0 move upward or downward. #he rate or rates within the range are determined b% relative bargaining power. #he bargaining theor% is ver% attractive to labour organi5ations$ for$ contrar% to the subsistence and wagesfund theories$ it provides a ver% cogent reason for the e-istence of unions. #he bargaining strength of a union is much greater than that of the members acting as individuals. 2lso there are situations &bilateral monopol%$ for instance' under which theoretical anal%sis arrives at a range of wage rates rather than a determinate rate. #he actual rate must depend upon relative bargaining power. It should be observed$ however$ that historicall% labour was able to improve its situation before its bargaining power became more effective through organi5ation. >actors other than the relative bargaining strength of the parties must have been at wor!. #he bargaining theor% often gives an e-cellent e-planation of a shortrun situation$ such as the e-istence of certain wage differentials$ but over the long run it fails to provide an ade6uate understanding of the changes that have ta!en place in the average level of wages. ;arginalproductivit% theor% and its critics. #oward the end of the 1Gth centur%$ marginalproductivit% anal%sis was applied not onl% to labour but to other factors of production as well. It was not a new idea as an e-planation of wage phenomena$ for Smith had observed that a relationship e-isted between wage rates and the productivit% of labour$ and @ohann 3einrich von #hlnen$ a Ferman economist$ had wor!ed out a marginalproductivit% t%pe of anal%sis for wages in 1?,1. #he 2ustrian economists made important contributions to the marginal idea after 1?=H7 and$ building on these grounds$ a number of economists in the 1?GHs$ including (hilip 3enr% +ic!steed in England and @ohn <ates Clar! in the 8nited States$ elaborated the idea into the marginalproductivit% theor% of distribution. It is li!el% that the disturbing conclusions drawn b% ;ar- from classical economic theor% inspired this development. In the earl% 1G.Hs refinements to the marginalproductivit% anal%sis$ particularl% in the area of monopolistic competition$ were made b% @oan Cobinson in England and Edward 3. Chamberlin in the 8nited States. 2s applied to wages$ the marginalproductivit% theor% holds that emplo%ers will tend to hire wor!ers of a particular t%pe until the addition made b% the last &marginal' wor!er to the total value of the product is e6ual to the addition to total cost caused b% the hiring of one more wor!er. #he wage rate is established in the mar!et through the demand for$ and suppl% of$ the t%pe of labour$ and the operation of competition assures the wor!ers that the% will receive a wage e6ual to the marginal product. 8nder the law of diminishing marginal productivit%$ the contribution of each additional wor!er is less than that of his predecessor$ but wor!ers of a particular t%pe are assumed to be ali!e$ ma!ing them interchangeable$ and an% one could be considered the marginal wor!er. 2ll receive the same wage$ and$ therefore$ b% hiring to the margin$ the emplo%er ma-imi5es his profits. 2s long as each additional wor!er contributes more to total value than he costs in wages$ it pa%s the emplo%er to continue hiring. <e%ond the margin$ additional wor!ers would cost more than their contribution and would subtract from attainable profits. #he theor% also provides an e-planation of wage differentials. +age differentials are caused b% differences in marginal product. #he wages of s!illed wor!ers are higher than those of uns!illed wor!ers because there are fewer s!illed wor!ers$ and their marginal product$ therefore$ is higher. ,?1 #he marginalproductivit% theor% of wages became the prevailing wage theor%$ and$ although it has been attac!ed b% man% and discarded b% some$ no acceptable alternative has been devised. #he chief basis for criticism of the theor% is that it rests on unrealistic assumptions$ such as the e-istence of homogenous groups of wor!ers whose !nowledge of the labour mar!et is so complete that the% will alwa%s move to the best *ob opportunities. +or!ers are$ in fact$ not homogenous7 usuall% the% have little !nowledge of the labour mar!et7 and because of home ties$ seniorit%$ and other considerations$ the% do not often move 6uic!l% from one *ob to another. #he assumption that emplo%ers are able to measure productivit% accuratel% and compete freel% in the labour mar!et also is farfetched. Even the assumption that all emplo%ers attempt to ma-imi5e profits ma% be doubted. #he profit motive does not affect charitable institutions or government agencies. >or the theor% to operate properl%$ labour and capital must be full% emplo%ed so that increased production can be secured onl% at increased cost7 capital and labour must be easil% substitutable for each other7 and the situation must be completel% competitive. Obviousl% these assumptions do not fit the real world$ and some critics feel that the results of the theor% are so misleading that the theor% should be abandoned. #he proponents argue$ however$ that productivit% gives a rough appro-imation of wages$ and that although productivit% ma% not provide the immediate e-planation in a particular case$ it certainl% indicates longrun trends. #he theor%$ therefore$ has important uses$ and if the difficulties are !ept in mind$ it can be a valuable tool. In a modern econom%$ monopolistic or near monopolistic conditions e-ist in some important areas$ particularl% where there are onl% a few large producers &such as in the automobile industr%' on one side of the bargaining table and powerful labour organi5ations on the other. 8nder such circumstances$ the marginal productivit% anal%sis cannot determine wages precisel%7 it can show onl% the positions that the union &as a monopolist of labour suppl%' and the emplo%er &as a monopsonist$ or single purchaser of labour services' will strive to reach$ depending upon their current policies. Purcha"in#0poer theory* #he purchasingpower theor% of wages involves the relation between wages and emplo%ment and the business c%cle and is not$ therefore$ a theor% of wage determination. It stresses the importance of spending through consumption and investment as an influence upon the activit% of the econom%. #he theor% gained prominence during the Freat 9epression of the 1G.Hs$ when it became apparent that lowering wages might not increase emplo%ment as previousl% had been assumed. @ohn ;a%nard Ue%nes$ the <ritish economist$ maintained in his 1eneral Theory of ,mployment& 2nterest and Money &1G.1'$ that &1' depressional unemplo%ment could not be e-plained merel% b% frictions in the labour mar!et that interrupted the smooth movement of the econom% toward full emplo%ment e6uilibrium and &,' the assumption that call other things remained e6ualc presented a special case that had no real applicabilit% to the e-isting situation. Ue%nes related changes in emplo%ment to changes in consumption and investment$ and he pointed out that stable e6uilibrium could e-ist with less than full emplo%ment. <ecause wages ma!e up such a large percentage of the national income$ changes in wages usuall% have an important effect upon consumption. It is possible that lowering wages will reduce consumption and that$ with the decline in demand for ,?= goods and services$ the demand for labour ma% also fall$ thus decreasing emplo%ment rather than improving it. +hether this will be the result$ however$ depends upon several considerations$ particularl% the reaction upon prices. If wages fall more rapidl% than prices$ labour]s real wages will be drasticall% reduced$ and consumption will fall$ accompanied b% increased unemplo%ment$ unless total spending is maintained b% increased investment. Entrepreneurs ma% loo! upon the lower wage costs in relation to prices as an encouraging sign toward greater profits$ in which case the% ma% increase their investments and emplo% more people at the lower rates$ thus maintaining or even increasing total spending and emplo%ment. If emplo%ers loo! upon the falling wages and prices as an indication of further declines$ however$ the% ma% contract their investments or do no more than maintain them. In this case$ total spending and emplo%ment will decline. If wages fall less rapidl% than prices$ labour]s real wages will increase$ and consumption ma% rise. If investment is at least maintained$ total spending in terms of constant dollars will increase$ thus improving emplo%ment. If entrepreneurs loo! upon the shrin!ing profit margin as a danger signal$ however$ the% ma% reduce their investments7 and$ if the result is a reduction in total spending$ emplo%ment will fall. If wages and prices fall the same amount$ there should be no change in consumption and investment7 and$ in that case$ emplo%ment will remain unchanged. #he purchasingpower theor% involves ps%chological considerations as well as those that ma% be measured more ob*ectivel%. +hether it can be used effectivel% to control the business c%cle depends upon political as well as economic factors$ because government e-penditures are a part of total spending$ ta-es ma% affect private spending$ etc. #he applicabilit% of the theor% is to the whole econom% rather than to the individual firm. D2"9 2"9 CE"# Cent in economics is speciall% defined. 2ccording to the neoclassical economist 2lfred ;arshall$ rent is the income derived from the ownership of land and other free gifts of nature. 3e$ and others after him$ chose this definition for technical reasons$ even though it is somewhat more restrictive than the meaning given the term in popular usage. 2part from renting land$ it is of course possible to rent &in other words$ to pa% mone% for the temporar% use of an% propert%' houses$ automobiles$ television sets$ and lawn mowers on the understanding that the rented item is to be returned to its owner in essentiall% the same ph%sical condition. #he more restrictive use of the term became popular rather earl% among writers on economic matters. >or the classical economists of the 1?th and 1Gth centuries$ societ% was divided into three groups: landlords$ labourers$ and businessmen &or the cmone%ed classesc'. #his division reflected more or less the sociopolitical structure of Freat <ritain at the time. #he concern of economic theorists was to e-plain what determined the share of each class in the national product. #he income received b% landlords as owners of land was called rent. It was observed that the demand for the product of land would ma!e it profitable to e-tend cultivation to soils of lesser and lesser fertilit%$ as long as the addition to the value of output would cover the costs of cultivation on the least fertile acreage cultivated. On land of greater fertilit%intramarginal landthe costs of cultivation per unit of output would be below that price. #his difference between cost and price could be appropriated b% the owners of land$ who benefitted in this wa% from the fertilit% of the soila cfree gift of nature.c ,?? ;arginal land &the least fertile cultivated' earned no rent. Since$ therefore$ it was differences in fertilit% that brought about the surplus for landowners$ the return to them was called differential rent. It was also observed$ however$ that rent emerged not onl% as cultivation was pushed to the ce-tensive marginc &to less fertile acreage' but also as it was pushed to the cintensive marginc through more intensive use of the more fertile land. 2s long as the additional cost of cultivation was less than the addition to the value of the product$ it paid to appl% more labour and capital to an% given piece of land until the net value of the output of the last unit of labour and capital hired had fallen to the level of its incremental cost. #he intensive margin would e-ist even if all land were of e6ual fertilit%$ as long as land was in scarce suppl%. It can be called scarcit% rent$ therefore$ to contrast it with differential rent. 3owever$ because the return to an% factor of production$ not onl% to land$ can be determined in the same wa% as scarcit% rent$ it was often as!ed wh% the return to land should be given a special name and special treatment. 2 *ustification was found in the fact that land$ unli!e other factors of production$ cannot be reproduced. Its suppl% is fi-ed no matter what its price. Its suppl% price is effectivel% 5ero. <% contrast$ the suppl% of labour or capital is responsive to the price that is offered for it. +ith this in mind$ rent was redefined as the return to an% factor of production over and above its suppl% price. +ith the suppl% price of land 5ero$ the whole of its return is rent$ so defined. #he return to an% other factor ma% also contain elements of rent$ as long as the return stands above the ne-tmostlucrative emplo%ment open to the factor. >or e-ample$ a singer]s emplo%ment outside the opera ma% bring a great deal less than the opera actuall% pa%s. 2 large part of what the opera pa%s must therefore be called rent. #he opera singer]s specific talent ma% be nonreproducible7 li!e land$ it is a cfree gift of nature.c 2 particularl% effective machine also$ though its suppl% can be increased in time b% productive effort$ ma% for a period also earn a 6uasirent$ until suppl% has caught up with demand. +here its suppl% is artificiall% restricted b% a monopol%$ the 6uasirent ma% in fact continue indefinitel%. 2ll monopol% profits$ it has been argued$ should therefore be classified as 6uasirent. Once this point has been reached in the argument$ there is perhaps no logical barrier to e-tending the meaning of rent to cover all propert% returns. 2fter all$ profits and interest can persist onl% as long as there is no glut of capital. #he possibilit% of producing capital would presage such a glut$ one that has been staved off onl% b% new scarcities created b% technical progress. FE"EC2D #3EOCIES O> 9IS#CI<8#IO" #he theor% of distribution deals with the wa% in which a societ%]s product is distributed among the members of that societ%. It involves three distinguishable sets of 6uestions. >irst$ how is the national income distributed among persons4 3ow man% persons earn less than N1H$HHH$ how man% between N1H$HHH and N,H$HHH$ how man% between N,H$HHH and N.H$HHH$ and so on4 2re there regularities in these statistics4 Is it possible to generali5e about them4 #his is the problem of personal distribution. Second$ what determines the prices of the factors of production4 +hat are the influences governing the wage rate for a specific !ind of labour4 +h% is the general wage level of a countr% not lower or higher than it is4 +hat determines the rate of interest4 +hat determines profits and rents4 #hese 6uestions have to do with functional distribution. #hird$ how is the national income distributed proportionall% among the factors of production4 +hat determines the share of labour in the national ,?G income$ the share of capital$ the share of land4 #his is the problem of distributive shares. 2lthough the three sets of problems are obviousl% interrelated$ the% should not be confused with one another. #he theoretical approaches to each of them involve 6uite different considerations. #he basic idea in neoclassical distribution theor% is that incomes are earned in the production of goods and services and that the value of the productive factor reflects its contribution to the total product. #hough this fundamental truth was alread% recogni5ed at the beginning of the 1Gth centur% &b% the >rench economist @.<. Sa%$ for instance'$ its development was impeded b% the difficult% of separating the contributions of the various inputs. #o a degree the% are all necessar% for the final result: without labour there will be no product at all$ and without capital total output will be minimal. #his difficult% was solved b% @.<. Clar! &c. 1GHH' with his theor% of marginal products. #he marginal product of an input$ sa% labour$ is defined as the e-tra output that results from adding one unit of the input to the e-isting combination of productive factors. Clar! pointed out that in an optimum situation the wage rate would e6ual the marginal product of labour$ while the rate of interest would e6ual the marginal product of capital. #he mechanism tending to produce this optimum begins with the profitma-imi5ing businessman$ who will hire more labour when the wage rate is less than the marginal product of additional wor!ers and who will emplo% more capital when the rate of interest is lower than the marginal product of capital. In this view$ the value of the final output is separated &imputed' b% the marginal products$ which can also be interpreted as the productive contributions of the various inputs. #he prices of the factors of production are determined b% suppl% and demand$ while the demand for a factor is derived from the demand of the final good it helps to produce. #he word derived has a special significance since in mathematics the term refers to the curvature of a function$ and indeed the marginal product is the &partial' derivative of the production function. One of the great advantages of the neoclassical$ or marginalist$ theor% of distribution is that it treats wages$ interest$ and land rents in the same wa%$ unli!e the older theories that gave diverging e-planations. &(rofits$ however$ do not fit so smoothl% into the neoclassical s%stem.' 2 second advantage of the neoclassical theor% is its integration with the theor% of production. 2 third advantage lies in its elegance: the neoclassical theor% of distributive shares lends itself to a relativel% simple mathematical statement. 2n illustration of the mathematics is as follows. Suppose that the production function &the relation between all h%pothetical combinations of land$ labour$ and capital on the one hand and total output on the other' is given as E S f &D$U' in which E stands for total output$ D for the amount of labour emplo%ed$ and U for the stoc! of capital goods. Dand is subsumed under capital$ to !eep things as simple as possible. 2ccording to the marginal productivit% theor%$ the wage rate is e6ual to the partial derivative of the production function$ or EB D. #he total wage bill is & EB D' D. #he distributive share of wages e6uals &DBE' & EB D'. In the same wa% the share of capital e6uals &UBE' & EB U'. #hus the distribution of the national income among labour and capital is full% determined b% three sets of data: the amount of capital$ the amount of labour$ and the production function. On closer inspection the magnitude &DBE' & EB D'$ which can also be written & EBE'B& DBD'$ reflects the percentage increase in production resulting from the addition of 1 percent to the amount of labour emplo%ed. #his magnitude is called the elasticit% of production with respect to labour. In the same wa% the share of capital e6uals the elasticit% of production with respect to capital. 9istributive shares are$ in this view$ uni6uel% determined b% technical data. If ,GH an additional 1 percent of labour adds H.=0 percent to total output$ labour]s share will be =0 percent of the national income. #his proposition is ver% challenging$ if onl% because it loo!s upon income distribution as independent of trade union action$ labour legislation$ collective bargaining$ and the social s%stem in general. Obviousl% such a theor% cannot e-plain all of the real economic world. :et its logical structure is admirable. +hat remains to be seen is the degree to which it can be used as an instrument for understanding the real economic world. Critici"m" of the neocla""ical theory* "eturns to scale. "eoclassical theor% assumes that the total product E is e-actl% e-hausted when the factors of production have received their marginal products7 this is written s%mbolicall% as E S & EB D' D i & EB U' U. #his relationship is onl% true if the production function satisfies the condition that when D and U are multiplied b% a given constant then E will increase correspondingl%. In economics this is !nown as constant returns to scale. If an increase in the scale of production were to increase overall productivit%$ there would be too little product to remunerate all factors according to their marginal productivities7 li!ewise$ under diminishing returns to scale$ the product would be more than enough to remunerate all factors according to their marginal productivities. Cesearch has indicated that for countries as a whole the assumption of constant returns to scale is not unrealistic. >or particular industries$ however$ it does not hold7 in some cases increasing returns can be e-pected$ and in others decreasing returns. #his situation means that the neoclassical theor% furnishes at best onl% a rough e-planation of realit%. One difficult% in assessing the realism of the neoclassical theor% lies in the definition and measurement of labour$ capital$ and land$ more specificall% in the problem of assessing differences in 6ualit%. In macroeconomic reasoning one usuall% deals with the labour force as a whole$ irrespective of the s!ills of the wor!ers$ and to do so leaves enormous statistical discrepancies. #he ideal solution is to ta!e ever% !ind and 6ualit% of labour as a separate productive factor$ and li!ewise with capital. +hen the historical development of production is anal%5ed it must be concluded that b% far the greater part of the growth in output is attributable not to the growth of labour and capital as such but to improvements in their 6ualit%. #he stoc! of capital goods is now often seen as consisting$ li!e wine$ of vintages$ each with its own productivit%. #he fact that a good deal of production growth stems from improvements in the 6ualit% of the productive inputs leads to considerable fle-ibilit% in the distribution of the national income. It also helps to e-plain the e-istence of profits. (u%stitution pro%lems. 2nother difficult% arises from the fact that marginal productivit% assumes that the factors of production can be added to each other in small 6uantities. If one must choose between adding one big machine or none at all to production$ the concept of the marginal product becomes unwor!able. #his clumpinessc creates indeterminac% in the distribution of income. >rom the viewpoint of the individual firm$ this ob*ection to neoclassical theor% is more serious than from the macroeconomic viewpoint since in ,G1 terms of the national econom% almost all additions to labour and capital are ver% small. 2 related problem is that of substitution among factors. #he production function implies that land$ labour$ and capital can be combined in var%ing proportions$ that ever% conceivable input mi- is possible. <ut in some cases the input mi- is fi-ed &e.g.& one operator at one machine'$ and in that situation the neoclassical theor% brea!s down completel% because the marginal product for ever% factor is 5ero. #hese cases of fi-ed proportions are scarce$ however$ and from a macroeconomic viewpoint it is safe to sa% that a fle-ible input mi- is the rule. #his is not to sa% that substitution between labour and capital is so fle-ible in the national econom% that it can be assumed that a 1 percent increase in the wage rate will reduce emplo%ment b% a corresponding 1 percent. #hat would follow from the neoclassical theor% described above. It is not impossible$ but it re6uires a ver% special form of the production function !nown as the Cobb9ouglas function. #he pioneering research of (aul 3. 9ouglas and Charles +. Cobb in the 1G.Hs seemed to confirm the rough e6ualit% between production elasticities and distributive shares$ but that conclusion was later 6uestioned7 in particular the assumption of eas% substitution of labour and capital seems unrealistic in the light of research b% Cobert ;. Solow and others. #hese investigators emplo% a production function in which labour and capital can replace each other but not as readil% as in the Cobb9ouglas function$ a change that has two ver% important conse6uences. >irst$ the effect of a wage increase on the share of labour is not completel% offset b% changes in the input mi-$ so that an increase in wage rates does not lead to a proportionate reduction in total emplo%ment7 and second$ the factor of production that grows fastest will see its share in the national income diminished. #he latter discover%$ made b% @.C. 3ic!s &1G.,'$ is e-tremel% significant. It e-plains wh% the remuneration of capital &interest$ not profits' has shrun! from ,H percent or more a centur% ago to less than 1H percent of the national income in modern times. In a societ% where more and more capital is emplo%ed in production$ a continuall% smaller proportion of the income goes to the owners of capital. #he share of labour has gone up7 the share of land has gone down dramaticall%7 the share of capital has graduall% declined7 and the share of profits has remained about the same. #his picture of the historical development of income distribution fits roughl% into the frame of neoclassical theor%$ although one must also ma!e allowance for the shortrun effects of inflation and the longrun effects of technological progress Ceturns to the factors of production. #he demand side of the mar!ets for productive factors is e-plained in large degree b% the theor% of marginal productivit%$ but the suppl% side re6uires a separate e-planation$ which differs for land$ labour$ and capital.
"ent. #he suppl% of land is uni6ue in being rather inelastic7 that is$ an increase in rent does not necessaril% increase the amount of available land. Dandowners as a group receive what is left over after the other factors of production are paid. In this sense$ rent is a residual$ and a good deal of the histor% of the theor% of distribution is concerned with the issue whether rent should be regarded as part of the cost of production or not &as in Cicardo]s famous dictum that the price of corn is not high because of the rent of land but that land has a rent because the price of corn is high'. ,G, <ut inelasticit% of suppl% is not characteristic onl% of land7 special !inds of labour and the si5e of the total labour force also tend to be unresponsive to variations in wages. #he Cicardian issue$ moreover$ was important in the conte-t of an agrarian societ%7 it lac!s significance now$ when land has so man% different uses. $ages. In anal%5ing the earnings of labour$ it is necessar% to ta!e account of the imperfections of the labour mar!et and the actions of trade unions. Imperfections in the mar!et ma!e for a certain amount of indeterminac% in which considerations of fairness$ e6uit%$ and tradition pla% a part. #hese affect the structure of wagesi.e.& the relationships between wages for various !inds of labour and various s!ills. #herefore one cannot sa% that the income difference between a carpenter and a ph%sician$ or between a ban! cler! and a truc! driver$ is completel% determined b% marginal productivit%$ although it is true that in the long run the wage structure is influenced b% suppl% and demand. #he role of the trade unions has been a sub*ect of much debate. #he naive view that unions can raise wages b% their efforts irrespective of mar!et forces is$ of course$ incorrect. In an% particular industr%$ e-aggerated wage claims ma% lead to a loss of emplo%ment7 this is generall% recogni5ed b% union leaders. #he opposite view$ that trade unions cannot influence wages at all &unless the% alter the basic relationship between suppl% and demand for labour'$ is held b% a number of economists with respect to the real wage level of the econom% as a whole. #he% agree that unions ma% push up the mone% wage level$ especiall% in a tight labour mar!et$ but argue that this will lead to higher prices and so the real wage rate for the econom% as a whole will not be increased accordingl%. #hese economists also point out that high wages tend to encourage substitution of capital for labour &the cornerstone of neoclassical theor%'. #hese factors do indeed operate to chec! the power of trade unions$ although the e-treme position that the unions have no power at all against the iron laws of the mar!et s%stem is untenable. It is safe to sa% that basic economic forces do far more to determine labour]s share than do the policies of the unions. #he main function of the unions lies rather in modif%ing the wage structure7 the% are able to raise the bargaining power of wea! groups of wor!ers and prevent them from lagging behind the others. 2nterest and profit. #he earnings of capital are determined b% various factors. Capital stems from two sources: from saving &b% households$ financial institutions$ and businesses' and from the creation of mone% b% the ban!s. #he creation of mone% depresses the rate of interest below what ma% be called its natural rate. 2t this lower rate$ businessmen will invest more$ the capital stoc! will increase$ and the marginal productivit% of capital will decline. 2lthough this chain of reactions has drawn the attention of monetar% theorists$ its impact on income distribution is probabl% not ver% important$ at least not in the long run. #here are also other factors$ such as government borrowing$ that ma% affect the distribution of income7 it is difficult to sa% in what direction. #he basic and predominant determinant is marginal productivit%: the continuous accumulation of capital depresses the rate of interest. One t%pe of earning that is not e-plained b% the neoclassical theor% of distribution is profit$ a circumstance that is especiall% aw!ward because profits form a ,G. substantial part of national income &,H,0 percent'7 the% are an important incentive to production and ris! ta!ing as well as being an important source of funds for investment. #he reason for the failure to e-plain profit lies in the essentiall% static character of the neoclassical theor% and in its preoccupation with perfect competition. 8nder such assumptions$ profit tends to disappear. In the real world$ which is not static and where competition does not conform to the theoretical assumptions$ profit ma% be e-plained b% five causes. One is uncertaint%. 2n essential characteristic of business enterprise is that not all future developments can be foreseen or insured against. >ran! 3. Unight &1G,1' introduced the distinction between ris!$ which can be insured for and thus treated as a regular cost of production$ and uncertaint%$ which cannot. In a free enterprise econom%$ the willingness to cope with the uninsurable has to be remunerated$ and thus it is a factor of production. 2 second wa% of accounting for profits is to e-plain them as a premium for introducing new technolog% or for producing more efficientl% than one]s competitors. #his d%namic element in profits was stressed b% @oseph Schumpeter &1G11'. In this view$ prices are determined b% the level of costs in the least progressive firms7 the firm that introduces a new product or a new method will benefit from lower costs than its competitors. 2 third source of profits is monopol% and related forms of mar!et power$ whether deliberate as with cartels and other restrictive practices or arising from the industrial structure itself. Some economists have developed theories in which the main influence determining distributive shares is the relative cdegree of monopol%c e-erted b% various factors of production$ but this seems a bit onesided. 2 fourth source of profits is sudden shifts in demand for a given productsocalled windfall profits$ which ma% be accompanied b% losses elsewhere. >inall%$ there are profits arising from general increases in total demand caused b% a certain !ind of inflationar% process when costs$ especiall% wages$ lag behind rising prices. Such is not alwa%s the case in modern inflations. Dynamic influence" on di"tri%ution. 3rices. "eoclassical theor% throws light upon the longrun changes in distribution of income. It fails to ta!e account of the shortrun impact of business fluctuations$ of inflation and deflation$ of rapidl% rising prices. #his failure is an omission$ though it is true that distributive shares do not fluctuate as much as emplo%ment$ prices$ and the state of business generall%. #his lagging in the behaviour of shares can be understood b% remembering that the% are determined b% the 6uotient of the real remuneration of the factor and its productivit%7 both variables move$ according to marginal productivit% theor%$ in the same direction. :et inflation and deflation do have a certain impact upon distribution: if purchasing power shrin!s$ profits are the first income categor% to suffer7 ne-t come wages$ particularl% through the effects of unemplo%ment. In a depression$ the recipients of fi-ed mone% incomes &such as interest and pensions' gain from lower prices. In an inflation the opposite happens. #he traditional inflationar% se6uence was that as prices rose$ profits would increase$ with wages lagging behind7 this would tend to diminish the share of labour in the national income. E-perience since +orld +ar II$ however$ has been different7 in man% countries wage levels tended to run ahead in the inflationar% spiral and profits lagged behind$ although most entrepreneurs eventuall% succeeded in shifting the burden of wage inflation onto the consumers. #he result of the postwar inflation was a slight acceleration of the increase in the share of labour$ while the shares of ,G/ capital and land decreased faster than the% would have in the absence of inflation. (rofits as a whole held their own. #he struggle among the various participants in the economic process no doubt added fuel to the inflationar% fires.
Technology. 2nother d%namic influence is technological progress. #he concept of the production function assumes a constant technolog%. <ut in realit% the growth of production is much less the conse6uence of increased 6uantities of labour and capital than of improvements in their 6ualit%. #his element in increased production is distributed in a wa% not full% e-plained b% neoclassical theor%. (art of the change in distribution that is caused b% technological progress can be anal%5ed as resulting from changes in the elasticities of production. If goes up$ technological change is said to be ccapital using$c and the share of capital will increase. #his is what$ in fact$ ma% have happened7 the change in technolog% has offset$ though it has not neutrali5ed$ the decline in the share of capital caused b% the emplo%ment of a higher amount of capital per wor!er. <ut another part of the fruits of technological progress is garnered b% profit receivers$ probabl% 6uite a substantial part. <usinessmen who are 6uic! innovators ma!e high profits7 in a rapidl% changing societ%$ profits tend to be high$ a circumstance that is fortunate because profits are the mainspring of economic change. #he high rate of growth e-perienced b% the post+orld +ar I +estern world stemmed from this profitinnovationprofit ne-us. (ersonal income and neoclassical theor%. #he neoclassical theor% endeavours to e-plain the prices of productive factors and the distributive shares received b% them. It does not come to grips with a third categor% of distribution$ that of personal income$ which is much more affected b% institutional arrangements and b% characteristics of the social structure. (rofits in particular ma% be shared in various wa%s: the% ma% accrue to stoc!holders$ to wor!ers$ to management$ or to the government7 or the% ma% be retained in the corporation. +hat happens depends on dividend polic%$ ta- polic%$ and the e-istence of profitsharing arrangements with wor!ers. "eoclassical theor% has little to sa% on these matters or on the fact that in presentda% capitalist societ% the managers of big business are virtuall% in a position to fi- their own personal incomes. ;anagers have so much power visnvis the stoc!holders and their total share of profits is so relativel% little that their abilit% to pa% themselves high salaries is limited onl% b% the conventions of the business world. #hese high incomes cannot be e-plained b% the categories of the neoclassical theor%$ and the% do not constitute an argument against the theor%. #he% ma% well argue for changes in societ%]s institutions$ but that is a matter on which the neoclassical theor% of distribution does not pontificate. 2 great deal of change could occur in the legal and social order without an% disturbance to the theor%. ,G0 Con"umption In economics the word consumption means the using up of goods and services. In modern economic terms it means$ specificall%$ cfinalc consumption as distinguished from the using up of goods to produce other goods in a manufacturing industr%. >inal consumption must also be distinguished from the purchase b% industr% of fi-ed assets such as buildings and machiner%$ which is !nown as capital formation or investment. On the other hand$ consumption e-penditure b% private persons is understood to include the purchase of durable goods$ such as furniture or vehicles$ as well as wor!s of art that ma% increase in value over a period of time. #he ac6uisition of such goods should actuall% be considered asset formation rather than consumption and should be classified with the ac6uisition of other assets such as houses$ schools$ roads$ and hospitals. In modern industrial economies$ consumption as previousl% defined accounts for =H or ?H percent of total national e-penditure. Even in the +estern capitalist countries a significant part of total consumption is determined directl% b% the e-penditure of public authorities. Some of the benefits of this part of consumption$ such as e-penditure on defense or on public health$ are widel% diffused7 others are directed b% common consent to the benefit of particular sections of the communit%. #hese consist in part of speciali5ed services such as education or medical care7 but other servicessuch as unemplo%ment compensation$ state pensions for the elderl%$ and assistance to families deprived of the support of a wage earnerare designed to create greater e6ualit% in levels of consumption than would otherwise be obtained. (2##EC"S O> "2#IO"2D CO"S8;(#IO" #he wa%s in which people spend their incomes show much uniformit% among countries at the same economic level. E-penditure patterns in the 8nited Uingdom$ for e-ample$ are t%pical of western Europe. In 1G/G the pattern was still affected b% postwar shortages and rationing$ but the level of total consumption was not ver% different from what it had been before the war. In the decades that followed$ private consumption e-penditure per person &measured at constant prices' doubled. In addition there was a great increase in public services such as health and education. :et the broad distribution of e-penditures remained stri!ingl% constant in spite of the introduction of man% new commodities and considerable changes in their relative prices. #he percentage of total e-penditure devoted to food fell$ a phenomenon that usuall% accompanies a rising standard of living$ and the largest proportionate increases were in the purchase and maintenance of private motor vehicles$ of furniture and household goods$ and of radio$ television$ and electrical goods. #hese three categories represent in part net additions to private wealth in the form of durable goods and also reflect the effect of technical progress. 2s in other industrial countries$ much of the improvement in living standards has ta!en the form of more travel$ better communication services$ and the ac6uisition of laboursaving e6uipment. In most of the industriali5ed countries there has been a compound rate of increase in the total volume of consumption e-penditure per person of 1H to 1, percent per %ear$ the main e-ceptions to this being the 8nited Uingdom and @apan$ where consumption has grown at double this rate. <ut the pattern of change is similar in almost all countries. >ood consumption has grown less rapidl% than total consumption$ particularl% in the Scandinavian countries$ Ferman%$ and the countries of "orth 2merica$ where the rate of increase has been about = percent per %ear7 ,G1 e-penditure on clothing has been growing at about the same rate as total consumption. Increases in rent outla%s reflect higher energ% costs in all of the industriali5ed countries. #he ac6uisition of durable goods continues at a ver% high rate in all countries. Comparable data on consumption in the poorer countries of the world are much harder to obtain and are usuall% less reliable$ but it is probable that$ e-pressed as a proportion of total consumption$ food e-penditure is about twice as important in much of 2sia$ 2frica$ and Datin 2merica as it is in western Europe and "orth 2merica. In the most economicall% advanced countries$ food e-penditure represents onl% one6uarter to onethird of the total$ whereas in countries where the total e-penditure per household is less than the e6uivalent of N1$0HH$ the proportion rises to onehalf or even greater. It should be noted that in the rural regions of poor countries the housing e-penditure is minimal7 in these areas shelter is rudimentar% and largel% selfprovided >ood consumption varies in character from countr% to countr%. #his variation is due in part to climatic factors$ and it also reflects differences in national food habits. #he diet that is normall% eaten in northern Europe and in Scandinavia is relativel% low in fruit and vegetables but it contains a high proportion of mil!$ fats$ and sugar. In >rance the consumption of vegetables and meat is relativel% high. >ruit and vegetable consumption is generall% high in southern Europe$ while mil! consumption in this area is low. In the ;editerranean countries food grains are generall% preferred to potatoes and sugar as sources of carboh%drates. <ut aside from these regional variations$ the influence of general living standards is evident. #he "orth 2merican diet$ for e-ample$ with its low grain and potato consumption and high consumption of sugar$ meat$ eggs$ and fats is attributable more to a high standard of living than to an% regional peculiarities of taste. #hese characteristics can be observed in the diets of the wealthier classes of most countries. #he influence of the general standard of living is also shown in the relative priorities that are accorded to the increased consumption of particular foods as incomes increase. #hese priorities are measured b% economic statisticians in the form of income elasticities of e-penditure$ defined as the percentage increase in the consumption of an item divided b% the percentage increase in income that ma!es the increased consumption possible. #hese elasticities are usuall% calculated for a given countr% b% comparing the budgets of wealth% households with those of poor families. In countries such as the 8nited States and Freat <ritain$ the consumption of cereal foods actuall% decreases as incomes increase. In the less developed countries the elasticities are usuall% considerabl% higher$ particularl% for fruit and for products of animal origin. In these countries the consumption of carboh%drate foods is also increasing fairl% rapidl% as incomes rise.
#3EOCIES O> CO"S8;EC <E32VIO8C >actors influencing consumers. Model of consumer %ehavior. #he theor% and measurement of consumer behaviour forms an important part of modern economic theor%. It was first developed during the 1Gth centur% on the basis of the following conceptions: that the purchase of an% commodit% gives the ,G= consumer a positive satisfaction or utilit%7 the additional satisfaction derived from additional purchases of the same commodit% declines as the consumer]s suppl% of that commodit% increases7 and with a given amount of mone% to spend$ the consumer distributes the e-penditure among commodities to ma-imi5e the total satisfaction or utilit% attainable from all those purchases. #his rather crude model of consumer behaviour has undergone considerable refinement b% modern mathematical economists. #he advantage of this approach$ which has had a strong and enduring effect on the theoretical and empirical wor! of economists$ is that it separates the main economic variables influencing consumer behaviourthat is$ income and pricesfrom all the remaining influences$ such as individual preferences$ social pressures$ customs$ and habits$ but at the same time it unites them in a single anal%tical apparatus. Critics have often ob*ected that the model assumes a rational person bent on scrupulousl% ma-imi5ing his satisfaction and that the model is thus part of a mechanistic stream of thought that has been substantiall% undermined b% ,Hthcentur% advances in ps%cholog%. Still$ the onl% useful criterion of an% h%pothesis is the range of situations in which the derivative model is shown validl% to predict events. >or e-ample$ it is useful to assume that the leaves of a tree attempt to ma-imi5e the amount of sunlight the% receive$ since the assumption implies that leaves are denser on the sunn% side of trees than on the shad% side$ which can be chec!ed from e-perience$ or that billiard pla%ers ma!e their shots as if the% !new the mathematical formulas of mechanics. Similarl%$ to assume that consumers behave as if the% were rational utilit% ma-imi5ers helps to provide accurate predictions of a broad range of mar!et phenomena7 e.g.& a fall in the price of a commodit% will generall% lead to increased consumption of that commodit%$ and an increase in consumer income will lead to increased consumption of most commodities. Onl% persistent discrepancies between predictions and events re6uire a modification of the model]s assumptions7 some e-amples of such cases are discussed below. 2ncome as determinant. #he theor% points to the income of consumers as the most important single determinant of their consumption patterns. It follows that in an% communit% both the average income level and the distribution of incomes are important influences on total consumption. 2 communit% in which incomes are e6uall% distributed consumes fewer lu-ur% goods and fewer low6ualit% goods than one containing a few wealth% individuals and man% poor people. 2mong wealth% people in earl% 1Gthcentur% England$ a dinner with five main protein dishesfish$ meat$ game$ poultr%$ and ragout with truffleswas described as the minimum$ while in poor %ears the families of agricultural labourers ate mainl% oatmeal and potatoes7 toda% the standardi5ed produce of modern agriculture is part of most diets. #he classic model of consumers] behaviour implicitl% assumes that the individual en*o%s a constant income. In practice it ma% fluctuate according to the season$ from %ear to %ear$ or more generall% over a lifetime. In the short run the consumption of some commodities is much affected b% these income fluctuations$ while the consumption of others is affected ver% little. +ageearning households commonl% have a wee!l% house!eeping allowance$ out of which the necessities of food and clothing are bought$ while the variable e-cess of earnings is spent on tobacco$ alcoholic drin!s$ and entertainment. #he e-pected average level of future income therefore influences consumption habits as much as actual present income$ and commodities ma% be divided into two classes. #he first consists of goods people ,G? bu% when temporaril% affluent but give up when temporaril% poor$ and the second consists of goods for which the pleasure of a temporaril% higher level of consumption would not be worth the financial or ps%chological cost of giving them up in the future. Consumers can also be influenced b% their previous incomes. 2 person who owns an e-pensive car ma% continue to use it after his income falls$ though at the lower level of income the individual would not choose to replace it with a similarl% e-pensive vehicle in the long run. #his ma% be a rational decision$ in the sense that the value of the car in use ma% be greater than what it is worth in the secondhand automobile mar!et7 or it ma% be irrational$ in the sense that an e-pensive habit that should have been abandoned is continued be%ond the point where it can rationall% be supported. #he distinction is largel% sub*ective and cannot be clearl% made b% an outside observer. Over the life c%cle as a whole$ consumption patterns are mar!edl% different in various occupations. In most of the uns!illed or semis!illed occupations$ the course of earnings is fairl% stable: a %oung wor!er of ,1 ma% earn as much as an older person. <ut in man% of the professions an individual of 0H or 1H ma% earn man% times the income of a person of ,17 this gives the %oung wage earner a strong incentive to incur considerable debt with the e-pectation of amorti5ing it steadil% throughout life$ so that the t%pical consumption pattern of the occupation can be achieved earlier than otherwise. #his applies particularl% to such ma*or purchases as houses$ household furniture and e6uipment$ and vehicles. ;anual wor!ers$ on the other hand$ whose e-pectations are little greater than their present consumption$ generall% prefer to rent living space rather than to own a house and are unwilling to raise their current consumption standards b% incurring commitments of a longer term than that of ordinar% installment credit.
Nonrational influences. #o be full% rational and consistent$ consumers need to have access to sufficient information on goods and their prices so that the% can choose those with the lowest unit price for a given 6ualit%. <ut consumers do not alwa%s behave this wa%. "atural pearls are sold at a much higher price than cultured pearls$ though the difference between them is demonstrable onl% b% dissection or with Ora%s$ and their 6ualit% in use is identical. <randname drugs sell better and at higher prices than unbranded drugs that are manufactured from the same standard formula. #o some e-tent this is due to what an 2merican economist$ #horstein Veblen$ called the desire for conspicuous consumption: part of the attraction of the good is simpl% its high price. It is also the result of consumers] ignorance$ made more acute b% the increasing sophistication of commodities whose 6ualities must be measured in man% dimensions. If it is costl% in time for the individual to become full% informed about the comparative 6ualities of competing products$ it is not wholl% irrational for the consumer to ta!e the mar!et price as an indicator of 6ualit%. #he lac! of information has given rise to consumers] organi5ations in most industriali5ed countries7 these organi5ations test and report on a wide range of products for their subscribers. #he influence of modern advertising techni6ues must also be considered. Insofar as advertising informs the consumer of the range of alternatives$ it can be argued that advertising merel% increases the consumer]s information7 and insofar as advertising consciousl% or subconsciousl% changes consumer preferences$ it remains one of the man% factors determining consumer preferences that the economist ta!es as given. 2dvertising$ however$ cannot persuade the public to bu% whatever the producer ,GG offers. 2dvertising is li!el% to be most effective in influencing consumers to choose one of several almost identical products being offered$ such as toothpaste$ cigarettes$ or gasoline. <ut it ma% also raise the demand for the group of competing products as a whole. In addition$ it can be argued that the total effect of modern advertising is to shift the preferences of consumers in favor of lu-ur% goods rather than necessities$ in favor of consumption rather than saving$ and in favor of emplo%ment rather than leisure.
2ttitudes toward necessities and lu-uries. #he distinction between necessities and lu-uries is imprecise. #he dividing line varies with the income and social class of the classifier and shifts as technolog% develops and as social values change. Onl% in the most undeveloped communities can necessities be defined purel% in terms of ph%siological needs. 2dam Smith wrote in 1==1: <% necessaries I understand not onl% the !ind of commodities which are indispensabl% necessar% for the support of life$ but whatever the custom of the countr% renders it indecent for creditable people$ even of the lowest order$ to be without. . . . 8nder necessaries$ therefore$ I comprehend not onl% those things which nature$ but those things which the established rules of decenc% have rendered necessar% to the lowest ran! of people. 2ll other things I call lu-uries7 without meaning b% this appellation to throw the smallest degree of reproach upon the temperate use of them. <eer and ale$ for e-ample$ in Freat <ritain$ and wine$ even in the wine countries$ I call lu-uries. 2 man of an% ran! ma%$ without an% reproach$ abstain totall% from tasting such li6uors. "ature does not render them necessar% for the support of life$ and custom nowhere renders it indecent to live without them. In the 1Gth centur%$ with the development of more mathematical methods of reasoning based on a utilitarian calculus$ the distinction came to be phrased differentl%. "ecessities were defined as those commodities the demand for which has an income elasticit% less than unit%$ and lu-uries as those with an income elasticit% greater than unit%. #hese definitions impl% that as a wor!er]s income increases the e-penditure on necessities increases less than$ and the e-penditure on lu-uries more than$ proportionatel%. <ut even with the elasticit% approach the distinction must var% over time. In 1G0H the demand for television sets had high income elasticit%$ whereas now$ in some countries$ television often is regarded as a necessit%. Economists of the earl% 1Gth centur% all believed that the living standards of the wor!ing classes in capitalist societies would remain close to a subsistence level$ meaning that lu-uries would be more or less permanentl% denied them. <ut in modern industriali5ed economies even the poor consume goods that the earl% economists would not have considered necessar%.
"ole of lu'uries. #he historical and social role of lu-ur% consumption is a sub*ect of much interest. In the ;editerranean cit%states during the Cenaissance$ the demand for lu-uries provided a mainspring for the speciali5ation of s!illed labour and for the development of foreign travel and longdistance trade. #he du!e of ;ilan$ >ilippo ;aria Visconti$ possessed valuable English dogs$ leopards from all parts of the East$ and hunting birds from northern Europe. Some writers have argued that the lu-urious consumption of the rich benefits the poor through the provision of emplo%ment .HH opportunities that would not otherwise e-ist. 2 subtler version of this idea was proposed b% 2dam Smith$ who contrasted the uselessness of menial labour emplo%ed b% the rich for personal services with the benefits flowing from the emplo%ment of craftsmen who created lu-urious products of enduring merit that eventuall% became available to societ% as a whole: #he houses$ the furniture$ the clothing of the rich$ in a little time$ become useful to the inferior and middling ran!s of people. . . . +hat was formerl% a seat of the famil% of Se%mour is now an inn upon the <ath road. #he marriagebed of @ames the >irst . . . was$ a few %ears ago$ the ornament of an alehouse at 9unfermline. <ut Smith and most of the economists who succeeded him believed that if the mone% spent on lu-urious consumption b% the rich was invested in useful production$ societ% would benefit as a whole. #he Industrial Cevolution brought an increasing demand for funds for productive investment and made possible a more rapid rise in general standards of living than the world had !nown before. #he classical economists thus argued that all lu-ur% consumption involved a selfish diversion of labour and capital and acted as a bra!e on human progress. #his view was not seriousl% challenged until the English economist @.;. Ue%nes published his 1eneral Theory of ,mployment& 2nterest and Money in 1G.0.1. +riting at a time when millions of wor!ers were unemplo%ed$ Ue%nes argued that the consumption of lu-uries was sociall% desirable if it provided *obs that would otherwise not e-ist. 3e also suggested that capitalism might be outrunning its investment opportunities$ so that in the long run the problem of finding emplo%ment for capital itself would arisea difficult% that might be postponed if the wealth% spent more on themselves: In so far as millionaires find their satisfaction in building might% mansions to contain their bodies when alive and p%ramids to shelter them after death$ . . . the da% when abundance of capital will interfere with abundance of output ma% be postponed. In industrial countries since +orld +ar II$ this pessimistic view has been overborne b% a seemingl% endless e-pansion in consumer industries. 2s fast as consumers accumulate durable goods$ the% become technologicall% or conventionall% obsolete and are replaced b% new goods. Instead of see!ing more leisure$ previousl% thought to be a main benefit of technical progress$ the populations of the industriali5ed countries seem to prefer to wor! in order to bu% more lu-uries. #o this e-tent the desire for leisure and the demand for lu-uries are in direct competition. (tandards of consumption. In Communist countries$ public consumption has long been treated as more important than private lu-ur%. In the last part of the ,Hth centur% this emphasis seemed to be giving wa% to the aim of catching up with the standards of consumption that prevail in capitalist countries. In the undeveloped countries of the #hird +orld$ the tension between the demand for lu-uries and the low standard of living gives rise to acute economic and social problems. #he rapid growth of international travel and communications since +orld +ar II has led the literate and s!illed classes of ever% nation to see! similar standards of private consumption regardless of their national environment. #his$ in undeveloped countries$ leads either to a highl% unbalanced distribution of the national income or to the emigration of the s!illed population. #hus the increasing awareness of the consumption habits of the most fortunate sections of the world]s population is both a spur and a hindrance to general progress. .H1
-conomic fluctuations! stability and instability <8SI"ESS C:CDES >igure 11: +holesale price inde-es for 8nited States$ Freat <ritain$ Ferman%$ and >rance$ 1=GH1G/H. <usiness c%cles are best defined as fluctuations in the general level of economic activit%$ or more specificall%$ in the levels of emplo%ment$ production$ and prices. >igure 11 shows fluctuations in wholesale prices in four +estern industriali5ed countries over the period from 1=GH to 1G/H. #hough some regularities in price movements are apparent$ it is possible to as! whether the movements are regular enough to be called c%cles. #he word c%cle derives from the Free! word for circle. 2n ob*ect moving around a circle returns to its starting point7 a wave motion$ with upward and downward curves$ ma% also be considered a c%cle. #he various movements characteristic of economic activit% are not alwa%s as regular as waves$ and for this reason some prefer to call them fluctuations. #here are man% t%pes of economic fluctuations. <ecause of the comple-it% of economic phenomena$ it ma% be that there are as man% t%pes of fluctuations or c%cles as there are economic variables. #here are dail% c%cles in commuter traffic or the consumption of electricit%$ to cite onl% two e-amples. 2lmost ever% aspect of economic life displa%s seasonal variations: sales of coal or ice$ deposits in savings ban!s$ monetar% circulation$ agricultural production$ purchases of clothing$ travel$ and so on. 2s one lengthens the span of observation$ one finds new !inds of fluctuations such as the hog c%cle and the wheat c%cle$ the inventor% c%cle$ and the construction c%cle. >inall%$ there are movements of general economic activit% that e-tend over periods of %ears. ;odern economic histor% has recorded a number of periods of difficult times$ often called depressions$ during which the business econom% was mar!ed b% sudden stoc! mar!et declines$ commercial ban!ruptcies$ ban! failures$ and mounting unemplo%ment. Such crises were once loo!ed upon as pathological incidents or catastrophes in economic life$ rather than as a normal part of it. #he notion of a cc%clec implies a different view. /uglar's eight-year cycle. .H, #he first authorit% to e-plore economic c%cles as periodicall% recurring phenomena was probabl% a >rench ph%sician$ Cljment @uglar$ in 1?1H. Other writers who developed @uglar]s approach suggested that the c%cles recur ever% nine or 1H %ears$ and distinguished three phases$ or periods$ of a t%pical c%cle: prosperit%$ crisis$ and li6uidation. Subse6uent anal%sis has tended to designate 1?,0$ 1?.1$ 1?/=$ 1?0=$ 1?11$ 1?=.$ 1??,$ 1?GH$ 1GHH$ 1GH=$ 1G1.$ 1G,H$ and 1G,G as initial %ears of crisis. If that is correct$ then the average interval between them was eight %ears$ rather than nine or 1H as suggested b% @uglar. In the %ears since 1G,G$ the regularit% of business fluctuations has been somewhat offset b% government antic%clical policies. #he socalled @uglar c%cle has often been regarded as the true$ or ma*or$ economic c%cle$ but several smaller c%cles have also been distinguished. Close stud% of the interval between the pea!s of the @uglar c%cle suggests that partial setbac!s occur during the e-pansion$ or upswing$ and that there are partial recoveries during the contraction$ or downswing. #hese smaller c%cles generall% coincide with changes in business inventories$ lasting an average of /H months. Other small c%cles result from changes in the demand for and suppl% of particular agricultural products such as hogs &three to four %ears'$ cotton &two %ears'$ and beef &five %ears in the "etherlands'. 3ide and leather production fluctuates in an 1?month c%cle. -ondratev's waves. Donger c%cles have also been studied. #he construction industr% has been found to have c%cles of 1= to 1? %ears in the 8nited States and ,H to ,, %ears in England. >inall%$ there are the long waves$ or socalled Uondratev c%cles$ named for a Cussian economist$ "i!olai 9. Uondratev$ who showed that in the ma*or +estern countries during the 10H %ears from 1=GH to 1G/H it was possible to distinguish three periods of slow e-pansions and contractions of economic activit% averaging 0H %ears in length 1. 1=G,1?0H E-pansion: 1=G,1?10 ,. %ears Contraction: 1?100H .0 %ears ,. 1?0HG1 E-pansion: 1?0H=. ,. %ears Contraction: 1?=.G1 ,. %ears .. 1?G11G/H E-pansion: 1?G11G,H ,/ %ears Contraction: 1G,H/H ,H %ears Onl% these three Uondratev waves have been observed. Some students of business c%cles have anal%5ed them b% statistical methods$ in the hope of finding regularities that are not immediatel% apparent. One speculative theor% has held that the larger c%cles were built up from smaller ones. #hus$ two seasonal c%cles would produce a two%ear c%cle$ two of which would produce a four %ear c%cle7 two four%ear c%cles would become an eight%ear$ or @uglar$ c%cle$ and so on. #he h%pothesis is not widel% accepted. 3atterns of depressions and upswings. C%cles of var%ing lengths are closel% bound up with economic growth. In 1Gthcentur% Ferman%$ for e-ample$ upswings in total economic activit% were associated with the growth of the railroad$ metallurg%$ te-tile$ and building industries. (eriodic crises brought slowdowns in growth. #he crisis of 1?=. led to a wave of financial and industrial ban!ruptcies7 recover% started in 1?==$ when iron production ceased to fall$ and b% 1??H a new upswing was under wa%. #he recession of 1??, was .H. less severe than the previous one$ but a slump that began in 1?GH led to a serious depression$ with complaints of overproduction. #he %ear 1?GH was also one of financial crisis in England and the 8nited States. #he <ritish ban!ing house of <aring <rothers failed$ partl% because of a revolution in 2rgentina. English pigiron production fell from ?$.HH$HHH tons in 1??G to 1$=HH$HHH in 1?G,$ and unemplo%ment increased. #hat depression might have been less severe but for the international financial crisis$ especiall% intense in the 8nited States$ where in 1?G. a stoc! mar!et panic led to widespread ban! failures. #he recession of 1GHH was followed b% an unusuall% vigorous upsurge in almost all of the +estern economies. 8.S. pigiron production increased b% more than 10H percent during the e-pansion$ which lasted until 1GH=7 building permits more than doubled7 and freight traffic rose b% more than 0H percent. (rices rose more and more rapidl% as the 8.S. econom% approached full emplo%ment. *eviations from cycle patterns. C%cles are compounded of man% elements. 3istorical fluctuations in economic activit% cannot be e-plained entirel% in terms of combinations of c%cles and subc%cles7 there is alwa%s some factor left over$ some element that does not fit the pattern of other fluctuations. It is possible$ for e-ample$ to anal%5e a particular fluctuation into three principal components: a long component or trend7 a ver% short$ seasonal component7 and an intermediate component$ or @uglar c%cle. <ut these components cannot be found e-actl% recombined in another fluctuation because of a residual element in the original fluctuation that does not have a c%clical form. If the residual is small$ it might be attributed to errors of calculation or of measurement. Or$ the residual might be regarded as the result of such accidental events as epidemics$ floods$ earth6ua!es$ riots$ stri!es$ revolutions$ or wars$ which obviousl% cannot be fitted into a recurring pattern. On a more sophisticated statistical level$ it can be treated as crandom movement.c If the random element is alwa%s present$ it becomes an essential element of the anal%sis to be dealt with in terms of probabilit%. 2 more rigorous anal%sis has to go even further. One difficult% in separating out the components of economic movements is that the components are not perfectl% independent of each other. #he determination of a long component or trend assumes that the @uglar component is alread% !nown. In the same wa%$ determining the @uglar component re6uires isolating it from the longterm component. (robabl% onl% the seasonal component can be isolated independentl% of the others$ and that because it is immediatel% related to such noneconomic factors as climate or custom. #o avoid such difficulties$ researchers have tried loo!ing for chidden periodicities$c using a mathematical techni6ue !nown as harmonic anal%sis$ or >ourier series. #wo alternative methods are open to them: the% ma% assume a certain periodicit% and tr% to fit the statistical data to the resulting e6uation$ or the% ma% as! mathematicians to suppl% all of the possible periodicities contained in the data and then determine which are the most probable. >or practical purposes$ it would be useful to !now the t%pical shape of a c%cle and how to recogni5e its pea! and trough. 2 great amount of wor! has been done in what ma% be called the morpholog% of c%cles. In the 8nited States$ 2rthur >. <urns and +esle% C. ;itchell have based such studies on the assumption that at an% specific time there are as man% c%cles as there are forms of economic activit% or variables to be studied and have tried to measure these in relation to a creference c%cle$c which the% artificiall% constructed as a standard of comparison. #he ob*ect in such studies .H/ was to describe the shape of each specific c%cle$ to anal%5e its phases$ to measure its duration and velocit%$ and to measure the amplitude or si5e of the c%cle. In stud%ing various c%cles$ it has been possible to construct clead and lag indicatorscthat is$ statistical series with c%clical turning points consistentl% leading or lagging behind the turns in general business activit%. Cesearchers using these methods have identified a number of series$ each of which reaches its turning point from two to 1H months before the turns in general business activit%$ and another group of series$ which has followed the turns in business b% two to seven months. E-amples of leading series include published data for new business orders$ residential building contracts$ the stoc! mar!et inde-$ business failures$ and the length of the average wor!wee!. #hese and other leading indicators are widel% used in economic forecasting. 9%namic anal%ses of c%cles. 2 satisfactor% e-planation of c%cles must isolate the forces and relationships that tend to produce these recurrent movements. #here have been man% theories of the business c%cle. 2n understanding of them re6uires anal%sis of some of the factors that can cause c%clical movements. One such factor is the relationship between investment and consumption. 2n% new e-pendituree.g.& on building a road or a factor%generates several times as much income as the e-penditure itself. #his is so because those who are paid to build the road or factor% will spend more of what the% receive7 their e-penditures will thus become income for others$ who will in their turn spend most of what the% receive. Ever% new act of investment will$ thus$ have a stimulating effect on aggregate income. #his relationship is !nown as the investment multiplier. Of itself$ it cannot produce c%clical movements in the econom%7 it merel% provides a positive impulse in an upward direction #o the relationship between investment and consumption must be added that between consumer demand and investment. 2n increase in demand for refrigerators$ for e-ample$ will eventuall% re6uire increased investment in the facilities for producing them. #his relationship is !nown as the accelerator# and it implies that an increase in national income will stimulate investment. 2s with the multiplier$ it cannot of itself e-plain c%clical movements7 it merel% accounts for a fundamental instabilit%. It can be shown$ however$ that the multiplier and accelerator in combination ma% produce ver% strong c%clical movements. #hus$ when an increase in investment occurs$ it raises income b% some larger amount$ depending on the value of the multiplier. #hat increase in income ma% in turn induce a further increase in investment. #he new investment will stimulate a further multiplier process$ producing additional income and investment. In theor%$ the interaction might continue until a point is reached at which such resources as labour and capital are being full% utili5ed. 2t that pointwith no increase in emplo%ment and$ therefore$ no rise in consumer demandthe operation of the accelerator would cease. #hat halt in demand$ plus the lac! of new capital$ would cause new investment to decline and wor!ers to be laid off. #he process thus would go into reverse. #he fluctuations in national income could ta!e various forms$ depending on the characteristics of the econom% and the wa% in which the population allocated its income between consumption and savings. Such spending habits$ of course$ affect both the levels of consumer demand and capital .H0 investment. #his theoretical anal%sis does not e-plain actual economic fluctuations7 it is merel% an aid to understanding them. #he anal%sis can be made more realistic b% ta!ing into account three other factors. >irst$ since the theoretical$ wideswinging c%cles engendered b% the interaction of the multiplier and the accelerator are observed to occur onl% within narrow limits$ one ma% assume that although the econom% has an inherent tendenc% to swing ver% widel% there are limits be%ond which it cannot go. #he upper limit to the swings would be the point at which full emplo%ment or full capacit% is reached7 the lower limit is more difficult to define$ but it would be established when the forces that ma!e for longterm economic growth begin to operate. #hus$ the upswing of a c%cle stops when it meets the upper limit7 and the downswing stops at the lower limit$ resulting in continuous c%clical movements with an overall upward trenda pattern corresponding to the one found in histor%. #he occurrence of time lagsthe inevitable dela%s between ever% decision and its effectsprovides another reason for e-pecting c%clical fluctuations to occur in an% economic process. #his phenomenon is illustrated$ for e-ample$ in the relation between the action of a thermostat and the temperature of a room. 2 fall in room temperature causes the thermostat to turn on the heater7 but there is a lag in time until the room warms up sufficientl% to cause the thermostat to turn the heat off$ whereupon the temperature begins to fall again. #he shape of the curve of the temperature c%cle will depend on the responsiveness of the thermostat and on the time re6uired to raise the temperature of the room. <% ma!ing various ad*ustments$ it is possible to minimi5e the c%cle$ but it can never be eliminated entirel%. In economic life$ there are man% such time lags: between the decision to invest and the completion of the pro*ect7 between the farmer]s decision to raise hogs and the arrival of por! chops at the store7 between prices at the time of a decision and prices at the time the action is completed. Candom shoc!s$ or what economists call e-ogenous factors$ constitute the third t%pe of phenomena affecting business c%cles. #hese are such e-ternal disturbances to the s%stem as weather changes$ une-pected discoveries$ political changes$ wars$ and so on. It is possible for such e-ternal impulses to cause c%clical motions within the s%stem$ in much the same wa% that stri!ing a roc!ing horse with a stic! will cause the horse to roc! bac! and forth. #he length of the c%cle will be determined b% the internal relationships of the s%stem$ but its intensit% is governed b% the e-ternal impulse. Theorie" of economic fluctuation. #he anal%tic concepts above ma% be found in most of the realistic attempts to e-plain economic fluctuations. #heories of the business c%cle$ or$ more properl%$ of economic fluctuations$ ma% be classified in two groups: those that ascribe c%clical movements to e-ternal forces &e-ogenous factors'7 and those that attribute the fluctuations to internal forces &endogenous factors'. 5gricultural theories. (erhaps the oldest theories of the business c%cle are those that lin! their cause to fluctuations of the harvest. Since crops depend upon soil$ climate$ and other natural factors that in turn ma% be affected b% biological or meteorological c%cles$ such c%cles will transmit their effects through the harvests to the rest of the econom%. #he .H1 1Gthcentur% English economist +illiam Stanle% @evons thought he had found the !e% to such a process in the behaviour of sunspots$ which seemed to displa% a 1H%ear c%cle. 3is naive e-planation could not long withstand critical e-amination. It had a certain interest$ however$ in suggesting a causal factor that was completel% detached from the economic s%stem and one that could not be influenced b% it in turn. 3sychological theories. 2 number of writers have e-plored mass ps%cholog% and its conse6uences for economic behaviour. Individuals are strongl% influenced b% the beliefs of the group or groups to which the% belong. #here are times when the general mood is optimistic$ and others when it is pessimistic. 2n English economist$ 2rthur C. (igou$ in his 2ndustrial 8luctuations &1G,='$ put forward a theor% of cnoncompensated errors.c 3e pointed out that if individuals behave in a completel% autonomous wa% their errors in e-pectations will tend to offset each other. <ut if the% imitate each other$ their errors will accumulate until the% ac6uire a global magnitude that ma% have powerful economic effects. #his followthecrowd tendenc% obviousl% operates as a factor in the ups and downs of the stoc! e-changes$ financial booms and crashes$ and the behaviour of investors. One can sa%$ however$ that the ps%chological factor is not enough to e-plain economic fluctuations7 moods of optimism and pessimism must themselves rest upon economic factors. 3olitical theories. Some observers have maintained that economic fluctuations result from political events. It is obvious that such events as the "apoleonic +ars$ +orld +ars I and II$ and even the Uorean +ar of 1G0H0. have had strong economic conse6uences. Even the imposition of a ta- or an import restriction ma% have some d%namic effect upon the econom%. #he 6uestion is whether such political factors are capable of producing c%clical movements. Technological theories. Ever since the Industrial Cevolution at the end of the 1?th centur%$ technical innovations have followed each other without end but not without pause. #here have been periods of innovation and 6uieter periods in which the innovations were being absorbed. #he world has passed through the era of steam$ the era of petroleum$ and the era of electricit% and has entered the era of atomic energ%. It is possible that if a rh%thm could be found in these waves of change$ the same rh%thm might be responsible for corresponding movements in the econom%. <ut it is e6uall% possible that the technical innovations themselves have been dictated b% the prior needs of the econom%.
*emographic theories. Even population has been postulated as a cause of economic fluctuations. #here are$ undeniabl%$ c%clical movements of population7 it is possible to find fluctuations in the rates of marriage$ birth$ mortalit%$ and migration7 but the e-tent to which such fluctuations ma% have been caused b% economic conditions is not clear. .H=
Monetary theories. Some writers have ascribed economic fluctuations to the e-istence of mone%. Changes in the mone% suppl% do not alwa%s conform to underl%ing economic changes$ and it is not difficult to see how this lac! of coordination could produce disturbances in the economic s%stem. #hus$ an increase in the total 6uantit% of mone%$ if it is not matched b% an increase in economic activit%$ will tend to produce higher prices7 the higher prices in turn ma% stimulate an investment boom$ and so on. #he ban!ing s%stem$ with its abilit% to e-pand the suppl% of credit in a time of boom and to contract the suppl% of credit in time of recession$ ma% in this wa% amplif% small economic fluctuations into ma*or c%cles of prosperit% and depression. Some theorists have emphasi5ed the influence of the rate of interest: if the rate fi-ed b% the ban!ing s%stem does not correspond to the cnaturalc rate dictated b% the re6uirements of the econom%$ the disparit% ma% of itself induce an e-pansion or contraction in economic activit%. >nderconsumption theories. In a progressive econom%$ production tends to e-pand more rapidl% than consumption. #he disparit% results from the une6ual distribution of income7 the rich do not consume all their income$ while the poor do not have sufficient income to meet their consumption needs. #his imbalance between output and sales has led to theories that the business c%cle is caused b% overproduction or underconsumption. <ut the basic$ underl%ing cause is societ%]s inade6uate provision for an even flow of savings out of the e-cess of what is produced over what is consumed. In other words$ saving is out of step with the re6uirements of the econom%7 it is improperl% distributed over time. 2nvestment theories. #he fact that changes in the suppl% of savings$ or loanable funds$ are not closel% coordinated with changes in the rest of the econom% lies at the heart of the numerous theories that lin! investment imbalance to the business c%cle. Savings accumulate when there is no immediate outlet for them in the form of new investment opportunities. +hen times become more favourable$ these savings are invested in new industrial pro*ects$ and a wave of investment occurs that sweeps the rest of the econom% along with it. It is in this conte-t that the tools of anal%sisthe accelerator and the multiplierfind their application: the new investment creates new income$ which in turn acts as a further stimulus to investment. 2n earl% observer of this phenomenon$ a Cussian economist$ ;i!ha%l #ugan<aranovs!%$ in 1?G/ published a stud% of industrial crises in England in which he maintained that the c%cle of investment continues until all the capital funds have been used up. <an! credit e-pands as the c%cle progresses. 9isproportions then begin to develop among the various branches of production as well as between production in general and consumption. #hese imbalances lead to a new period of stagnation and depression. S#2<IDIY2#IO" #3EOCIES 2"9 (ODICIES .H? #he ultimate ob*ective of research into the problems of economic instabilit% &including fluctuations in output$ emplo%ment$ and prices' is to provide the foundation for stabili5ation polic%that is$ for the s%stematic use of fiscal and monetar% policies to improve an econom%]s performance. #he main tas!s$ therefore$ are to e-plain how levels of prices$ output$ and emplo%ment are determined and$ on a more applied level$ to furnish predictions of changes in these variablespredictions on which stabili5ation polic% can be based. Ue%nesian anal%sis. #he problems of economic stabilit% and instabilit% have$ naturall%$ been of concern to economists for a ver% long time. <ut$ as a special field of investigation$ it emerged most strongl% from the confluence of two developments of the depression decade of the 1G.Hs. One was the development of national income statistics7 the other was the reorientation of theoretical thin!ing often referred to as the cUe%nesian revolution.c #o understand wh% the theoretical contributions of @ohn ;a%nard Ue%nes are regarded as so important$ one must e-amine the wor!ings of a modern econom%. Such an econom% comprises millions of people engaged in millions of distinct activities7 these activities include the production$ distribution$ and consumption of all of the different goods and services that a modern econom% provides. Some of the economic units are large$ with hierarchies of e-ecutives and other managerial specialists who coordinate the productive activities of thousands or tens of thousands of people. 2side from these relativel% small islands of preplanned and coordinated activit%$ most of the population pursues its m%riad economic tas!s without an% overall supervised direction. It resembles an immensel% complicated$ continuousl% changing pu55le that is continuall% being solved and solved again through the mar!et s%stem. 2 brea!down in the coordination of activities$ such as occurred in the depression decade of the 1G.Hs$ is ver% rarein fact$ it happened on that scale onl% onceor this s%stem of organi5ation would not survive. #he wa% in which the economic pu55le is solved without an%one thin!ing about it has been the broad main theme of economic theor% since the time of the English economist 2dam Smith &1=,.GH'.
The pro%lem of coordination. If one singles out a particular household from the millions of economic units and studies it over a period of time$ one can draw up a budget of that household]s transactions. #he budget will come out as a long list of amounts sold and amounts bought. If at an% time this economic unit had tried to do something different from what it actuall% did &cutting down$ sa%$ on meat purchases to bu% another pair of shoes'$ the solution of the economic pu55le would have been correspondingl% different. 2t the prevailing prices the suppl% of meat would have e-ceeded the demand$ and the demand for shoes would have e-ceeded the suppl% #he point is that$ if the econom% is to function as a coordinated s%stem$ the activities of each economic unit must be somehow controlledand controlled 6uite precisel%. #his is done through price incentives. <% raising the price of a good &relative to the prices of ever%thing else'$ an% economic unit can$ generall% spea!ing$ be made to demand less of it or to suppl% more of it7 b% lowering the price$ it can be made to demand more or to suppl% less. #hrough the conflu- of prices$ an individual .HG unit is thus led to fit its activities into the overall pu55le of mar!et demands and supplies. If economic units could not be controlled in this fashion$ the mar!et organi5ed s%stem could not possibl% functionIn an% given situation there e-ists$ theoreticall%$ one and onl% one list of prices that will ma!e the pu55le come out e-actl% right. <ut the amounts that economic units choose to suppl% or demand of various goods at an% given price list depend on numerous factors$ all of which change over time: the si5e of the population and labour force7 the stoc! of material resources$ technolog%$ and labour s!ills7 ctastesc for particular consumer goods7 and attitudes toward consumption as against saving$ toward leisure as against wor!$ and so on. Fovernment policiesta- rates$ e-penditures$ welfare policies$ mone% suppl%$ the debtalso belong among the determinants of demand and suppl%. 2 change in an% of these determinants will mean that the list of prices that previousl% would have e6uilibrated all of the different mar!ets must be changed accordingl%. If prices are crigid$c the s%stem cannot ad*ust and coordination will brea! down. 3rice fle'i%ility. >or coordination of activities to be preserved &or restored' when the econom% is disturbed b% changes in these determinants$ something still more is re6uired: each separate price must move in a direction that will restore e6uilibrium. #his necessit% for prices to ad*ust in certain directions ma% be e-pressed as a communications re6uirement. #o put it in somewhat e-treme form: for a given economic unit to plan its activities so that the% will cmeshc with those of others$ it must have information about the intentions of ever%one else in the s%stem. +hen one of the determinants underl%ing mar!et supplies and demands changes so as to dise6uilibrate the s%stem$ ensuing price movements must communicate the re6uisite information to ever%one concerned.' One ma% suppose$ for e-ample$ that in some period of political crisis the suppl% of crude oil from the ;iddle East is cut off. #he immediate result will be a worldwide e-cess demand for oil and oil products of large proportionsthat is$ suppl% will fall far short of demand at going prices. 2t the same time$ those who derive their income from ;iddle East oil production will have their incomes reduced$ and e-cess supplies will emerge in the mar!ets for the goods on which those incomes previousl% were spent. >or the s%stem to ad*ust$ orders will have to go out to all demanders to cut down on their consumption of oil and for all other suppliers of oil to increase their output so that the gap between demand and suppl% can be closed. #his is$ in effect$ what a rise in the world price of oil and oil products will accomplishmillions of gasoline and heating oil users the world over will respond to the pinch of higher prices$ and the higher prices will also create a profit incentive for suppl% to be increased. &>alling prices will$ in an analogous manner$ close the gaps in the mar!ets in which the initial disturbance caused e-cess supplies to develop.' (rices that are not rigid for some institutional reason will move in response to e-cess demands and e-cess supplies. +hen demand e-ceeds suppl%$ disappointed bu%ers will bid up the price7 when suppl% e-ceeds demand$ unsuccessful suppliers will bid it down. #his mechanism solved the e-cess demand for the oil problem in the illustration above. #he 6uestion$ however$ is whether throughout the s%stem as a whole it will alwa%s act so as to move each of the prices toward its general e6uilibrium value. Ue%nes said no. 3e maintained that there can be conditions under which e-cess demands &or supplies' will not be ceffectivel%c communicated so that$ although .1H certain prices are at dise6uilibrium levels$ no process of bidding them awa% from these inappropriate levels will get started. #his is the flaw in the traditional conception of the operation of the price s%stem that prompted Ue%nes to introduce the concept of ceffective demand.c #o preUe%nesian economists the implied distinction between ceffectivec and &presumabl%' cineffectivec demand would have had no anal%tical meaning. #he logic of traditional economic theor% suggested two possibilities that might ma!e the price s%stem inoperative: &1' that$ in some mar!ets$ neither demanders nor suppliers respond to price incentives$ so that a cgapc between demand and suppl% cannot be closed b% price ad*ustments and &,' that$ for various institutional reasons$ prices in some mar!ets are crigidc and will not budge in response to the competitive pressures of e-cess demands or e-cess supplies. Ue%nes discovered a third possibilit% that$ he argued$ was responsible for the depth and duration of severe depressions: under certain conditions$ some prices ma% show no tendenc% to change even though desires to bu% and to sell do not coincide in the respective mar!ets and even though no institutional reasons e-ist for the prices to be rigid (ay's .aw. ;an% writers before Ue%nes raised the 6uestion of whether a capitalist economic s%stem$ rel%ing as it did on the profit incentive to !eep production going and maintain emplo%ment$ was not in danger of running into depressed states from which the automatic wor!ings of the price mechanism could not e-tricate it. <ut the% tended to formulate the 6uestion in wa%s that allowed traditional economics to provide a demonstrable$ reassuring answer. #he answer is !nown in the economic literature as Sa%]s Daw of ;ar!ets$ after the earl% 1Gthcentur% >rench economist @ean<aptiste Sa%. >or western Europe$ the 1Gth centur% was a period of rapid economic growth interrupted b% several sharp and deep de pressions. #he growth was made possible in large measure b% new modes of organi5ing production and new technologies$ such as the spreading use of steam power. +as it possible that output might grow so great that there would not be a mar!et for it all4 Sa%]s Daw denied the possibilit%. cSuppl% creates its own demand$c ran the answer. ;ore precisel%$ the law asserted that the sum of all e-cess supplies$ evaluated at mar!et prices$ must be identicall% e6ual to the sum of the mar!et values of all e-cess demands. It could be neither more nor less. In the theoretical s%stem of traditional economics$ an% ine6ualit% between these sums would 6uic!l% wor! itself out 2n important special case should be noted. #he good in e-cess demand might$ for instance$ be mone%. One possibilit%$ then$ is e-cess suppl% for all the other goods$ matched b% an e-cess demand for mone%. 2 situation with e-cess demand for mone% matched b% an e-cess suppl% of ever%thing else is one in which the level of all mone% prices is too high relative to the e-isting stoc! of mone%. If this is the onl% trouble$ however$ Sa%]s Daw suggests a relativel% simple remed%: increase the mone% suppl% to whatever e-tent re6uired to eliminate the e-cess demand. #he alternative is to wait for the deflation to wor! itself out. 2s the general level of prices declines$ the crealc value of the mone% stoc! increases7 this too$ will$ in the end$ eliminate the e-cess demand for mone%. ;odel of a Ue%nesian depression. .11 2nvoluntary unemployment. 2nother possible cause of a general depression was suggested b% Ue%nes. It ma% be approached in a highl% simplified wa% b% lumping all occupations together into one labour mar!et and all goods and services together into a single commodit% mar!et. #he aggregative s%stem would thus include simpl% three goods: labour$ commodities$ and mone%. #he #able provides a rough outline &a full treatment would be both technical and length%' of the development of a cUe%nesianc depression. One ma% begin b% assuming &line 1' that the s%stem is in full emplo%ment e6uilibrium that is$ prices and wages are at their e6uilibrium levels and there is no e-cess demand. "e-t the model ma% be put on the path to disaster b% postulating either &1' some disturbance causing a shift of demand awa% from commodities and into mone% or &,' a reduction in the mone% suppl%. Either event will result in the situation described in the #able as State ,$ but the one assumed is a reduction in the mone% suppl% b%$ sa%$ 1H percent. #he result is shown in the righthand column of the #able$ where the 6uantit% of commodities supplied minus the 6uantit% demanded multiplied b% the price level &p' is e6ual in value to the e-cess demand for mone%. If mone% wages and mone% prices could immediatel% be reduced in the same proportion &1H percent'$ output and emplo%ment could be maintained$ and profits and wages would be unchanged in crealc terms. If mone% wages are initiall% infle-ible$ however$ business firms cannot be induced to lower prices b% 1H percent and maintain output. In this e-ample the% maintain prices in the neighbourhood of the initial price levelprices$ then$ are also cinfle-iblecand deal with the e-cess suppl% b% cutting bac! output and la%ing off wor!ers. Ceducing suppl% eliminates the e-cess suppl% of commodities b% throwing the burden of e-cess suppl% bac! on the labour mar!et. #hus$ output and emplo%ment &which are c6uantitiesc' give wa% before prices do. #his brings us to State . where$ as in the #able$ the e-cess suppl% of labour times the mone% wage rate &w' e6uals the e-cess demand for mone% in value. If$ with the s%stem in this state$ mone% wages do not give wa% and the mone% suppl% is not increased$ the econom% will remain at this level of unemplo%ment indefinitel%. One should recall that the onl% e-planation for persistent unemplo%ment that the preUe%nesian economics had to offer was that mone% wages were ctoo highc relative to the mone% stoc! and tended to remain rigid at that level. ;one% wages might$ nevertheless$ give wa% so that$ graduall%$ both wages and prices go down b% 1H percentthat is to sa%$ a reduction of the si5e that would have solved the entire problem had it occurred immediatel% &%efore unemplo%ment could develop'. #his is shown in the last line of the #able$ which represents &albeit crudel%' what Ue%nes described as a state of cinvoluntar% unemplo%mentc and e-plained in terms of a failure of ceffective demand.c In State /$ it is assumed$ the e-cess demand for mone% is 5ero. 3ence there is$ at least temporaril%$ no tendenc% for mone% income either to fall further or to rise. #he prevailing level of mone% income is too low to provide full emplo%ment. #he e-cess suppl% of labour and the corresponding e-cess demand for commodities &of the same mar!et value' show State / to be a dise6uilibrium state. #he 6uestion is wh% the state tends to persist. +h% is there no tendenc% for income and output to increase and to absorb the unemplo%ment4 Specificall%$ wh% does not the e-cess demand for commodities induce this e-pansion of output and absorption of unemplo%ment4 <asicall%$ the answer is that the unemplo%ed do not have the cash &or the credit' to ma!e the e-cess demand for commodities effective. #he traditional economic theor% would postulate that$ when actual output is !ept at a level below that .1, of demand$ competition between unsuccessful potential bu%ers would tend to raise prices$ thereb% stimulating an e-pansion. <ut this does not occur. #he unemplo%ed lac! the means to engage in such bidding for the limited volume of output. #he e-cess demand for commodities is not effective. It fails to produce the mar!et signals that would induce ad*ustments of activities in the right direction. <usiness firms$ on their side of the mar!et$ remain unwilling to hire from the pool of unemplo%edeven at low wagesbecause there is nothing to indicate that the resulting increment of output can actuall% be sold at remunerative prices. Ue%nes called this cinvoluntar% unemplo%ment.c It was not a happ% choice of phrase since the term is neither selfe-planator% nor ver% descriptive. Some earlier anal%sts of the unemplo%ment problem had$ however$ tended to stress the !ind of deadloc! that might develop if wor!ers held out for wages e-ceeding the mar!et value of the product attributable to labour or if business firms insisted on tr%ing to ce-ploitc labour b% refusing to pa% a wage corresponding to the value of labour]s product. +ith the term cinvoluntar% unemplo%ment$c Ue%nes wanted to emphasi5e that a thoroughl% intractable unemplo%ment situation could develop for which neither part% was to blame in this sense. 3is theor% envisaged a situation in which both parties were willing to cooperate$ %et failed to get together. 2n effective demand failure might be described as ca failure to communicate#he failure of the mar!et s%stem to communicate the necessar% information arises because$ in modern economies$ mone% is the onl% means of pa%ment. In offering their labour services$ the unemplo%ed will not demand pa%ment in the form of the products of the individual firms. If the% did$ the e-cess demand for products would be effectivel% communicated to producers. #he wor!er must have cash in order to e-ercise effective demand for goods. <ut to obtain the cash he must first succeed in selling his services. ,ffects of %usiness contraction. +hen business begins to contract$ the first manifestation is a decrease in investment that causes unemplo%ment in the capital goods industries7 the unemplo%ed are deprived of the cash wage receipts re6uired to ma!e their consumption demands effective. 8nemplo%ment then spreads to consumer goods industries. In e-pansion$ the opposite occurs: an increase in investment &or in government spending' leads to rehiring of wor!ers out of the pool of unemplo%ed. Ceemplo%ed wor!ers will have the cash with which to e-ert effective demand. 3ence business will pic! up also in the consumer goods industries. #hus the theor% suggests the use of fiscal polic% &an increase in government spending or a decrease in ta-es' to bring the econom% out of an unemplo%ment state that is due to a failure of effective demand 2nother observation ma% be made on Ue%nes]s doctrine of effective demand. #he fact that the persistence of unemplo%ment will put pressure on wages also turns out to be a problem. #he assumption in the foregoing discussion was that mone% wages were at the e6uilibrium level. 8nemplo%ment will tend to drive them down. (rices will tend to follow wages down$ since declining mone% earnings for the emplo%ed will mean a declining volume of e-penditures. In short$ both wages and prices will tend to move awa% from$ rather than toward$ their ccorrectc e6uilibrium values. Once the econom% has fallen into such a situation$ Ue%nes pointed out$ wage rigidit% ma% actuall% be a blessinga parado-ical conclusion from the standpoint of traditional economics .1. -ational income accountin#* The circular flow of income and e'penditure. 2 proper understanding of income and e-penditure theor% re6uires some ac6uaintance with the concepts used in national income accounting. #hese accounts provide 6uantitative data on national income and national product. Celiable information on these was$ for the most part$ not available to economists wor!ing on problems of economic instabilit% before the 1G.Hs. ;odern economics differs from earlier wor! most mar!edl% in its 6uantitative$ empirical orientation. #he development of national income accounting made this possible #he definitions of the ma*or components of national income and product ma%$ accordingl%$ be introduced in the course of e-plaining income and emplo%ment theor%. #he basic characteristic of the national income accounts is that the% measure the level of economic activit% in terms of both product supplied and of income generated. Correspondingl%$ national income anal%sis divides the economic s%stem into distinct sectors. #he simplest approach uses two sectors: a business sector and a household sector. 2ll product is regarded as created b% the business sector &thus$ self emplo%ed persons have to be treated as businesses in earning their income and as households in disposing of it'. >inal goods output is divided into two components: consumer goods produced for sale to households and investment goods for sale to firms. Similarl%$ all income is generated in the business sector and none of it in the household sector &nonmar!et activities$ such as the wor! of homema!ers or home improvements$ are not counted in national product and income'. #he level of income generated e6uals the mar!et value of final goods output. "e-t is the household sector. 2ll resources in the econom% ultimatel% belong to households. #he households$ therefore$ have claim to all of the income generated through the utili5ation of these resources b% firms in creating the national product. "ot all of the income is$ however$ actuall% paid out to households$ since corporations retain part of their earnings. In building a simple model of the econom%$ one can disregard the cgross business savingc item of the national income accounts and deal with income as if it were all paid out &which means adopting the fiction that retained earnings are first paid out to shareholders who then reinvest the same amount in the same firms'. #he households$ finall%$ dispose of their income in two wa%s: as e-penditure on consumption goods and as saving. #he foregoing discussion has made two accounting statements involving income. >irst$ income generated &:' e6uals the value of consumption goods output &C s ' plus the value of investment goods output &I': : C s i I. Second$ consumption goods e-penditures &C d ' plus savings &S' e6ual income disposal : C d i S. <oth e6ualities hold simpl% because of the wa% that the variables are defined in the national income accounts. #he% hold true$ moreover$ whatever the actual level of income happens to be. Such e6ualities$ which are true simpl% b% definition$ are called identities &and are mar!ed as such b% using the sign instead of the usual e6ualit% sign'. 2nother accounting convention ma% be noted here. Investment &I' is defined to include an% discrepanc% between consumer goods produced and consumer goods sold. If production e-ceeds sales$ the unsold goods are part of inventor% investment7 if sales e-ceed output$ inventor% investment is negative$ and I is reduced b% the corresponding amount. It follows that C s and C d must be identicall% e6ual$ so that it becomes unnecessar% to distinguish between them b% superscript. Since income .1/ generated is identicall% e6ual to income disposal$ finall%$ it is clear that actual investment must alwa%s e6ual actual saving: I S. Investment is the value of additions to the s%stem]s stoc! of capital. Saving is the increase in the value of the household sector]s wealth. >or the s%stem as a whole$ the two must be e6ual. >igure 1,: #he circular flow of income e-penditures >igure 1, shows the circular flow of income and e-penditures connecting the two sectors. Investment and consumption e-penditures add up to the aggregate demand for final goods output. #he value of final goods output is paid out b% the business sector as income to the household sector. #he ma*or part of income goes bac! to the business sector as e-penditures on consumption goods7 the remainder is allocated b% households to saving. Corresponding to the countercloc!wise mone% flow &but not shown' is the cloc!wise flow of the things that the mone% is paid for: labour and other resource services from households to firms in e-change for mone% income7 consumer goods and services in e-change for consumption e-penditures from firms to households7 and e6uities$ bonds$ and other debt instruments issued b% firms in return for the funds saved b% households. >igure 1, shows a brea! in the flow of saving as it passes into investment. >rom the accounting standpointwhere investment necessaril% e6uals savingthere is no rationale for this. It has been done here to focus attention on the point in the circular flow that$ in the incomee-penditure theor%$ represents the causal ne-us in the incomedetermining process. #his theor%$ in its simplest form$ is the ne-t topic. 5 simple incomee'penditure model . <ecause accounting identitiesbetween gross national product and gross national income$ between saving and investment$ and so one-press relationships that must hold whatever the level of income$ the% cannot be used to e-plain what determines the particular level of income in a given period or what causes the level of income to change from one period to the ne-t. #he e-planation of what happens must be based on statements about the behaviour of the participants in the economic s%stem7 in the present conte-t$ this means the behaviour of firms and households. #he following oversimplified model of an econom% assumes that the business sector will be satisfied to maintain any given level of output as long as aggregate demand &that is$ e-penditures on final goods' e-actl% e6uals the volume of income generated at that level of output. If$ in a given period$ aggregate demand e-ceeds the income pa%ments made b% firms in producing that period]s output$ firms will be e-panding in the ne-t period7 if aggregate demand falls short of the income pa%ments made$ firms will contract in the ne-t period. #he naovetj of this suppl% h%pothesis is evident from the fact that the behaviour of firms is described without an% reference to the costs of their inputs or to the price of their outputs7 the business sector passivel% adapts output and income generated to the level of aggregate demand. In this model$ the level of income is entirel% determined b% aggregate demand. >irms will act so as to maintain that income flow if$ and onl% if$ the e-act same amount that the% pa% out .10 as incomes ccomes bac! to themc in the form of spending on final goods output. If aggregate demand shrin!s$ production and emplo%ment will decline and there will be downward pressure on the price level7 if aggregate demand swells$ there will be an inflationar% problem. In the s%stem of >igure 1,$ all of the income generated accrues to households. 3ouseholds allocate their income to consumption and saving. +ith consumption there is no problemit constitutes spending on final goods. Saving$ however$ does not constitute spending on final goods output. #his part of the income generated b% the business sector does not automaticall% come bac! to it in the form of revenue from sales. Saving$ therefore$ ma% be treated as a leakage from the circular flow. Investment$ which consists of spending of capital b% the business sector on new plant and e6uipment and on desired additions to inventories$ is$ in the same terminolog%$ an inBection into the circular flow. If$ for e-ample$ investment and saving each amount to N,H$HHH$HHH per %ear$ the lea!age and the in*ection will balance. <ut if saving is N,H$HHH$HHH per %ear and the in*ection of investment e-penditures is onl% N1H$HHH$HHH per %ear$ there will be a dise6uilibrium. 8nsold goods will accumulate at an annual rate of N1H$HHH$HHH. #he business sector$ however$ will not rest content with this state of affairs but will act to reduce output$ emplo%ment$ and &perhaps' prices. 3ouseholds will be forced to reduce their consumption spending. #he reduction of income will go on until the planned &or desired' rates of saving and investment become e6ual. 2 similar argument will show that$ if the lea!age of planned saving were to fall short of the in*ection of planned investment$ the level of income would rise. +hen income is at a level such that there is no ongoing tendenc% for it to change in either direction$ the s%stem is in cincome e6uilibrium.c #he simple s%stem depicted in >igure 1, is in income e6uilibrium when the condition shown b% this e6uation is fulfilled: I S S. #his is not$ however$ the accounting identit% discussed earlier. #he s%mbols I and S now refer to planned$ or desired$ magnitudes$ which ma% ver% well be une6ual. +hen planned investment e-ceeds planned saving$ income will be rising. +hen planned saving e-ceeds planned investment$ income will be falling. 2n e6uivalent wa% of stating the above ce6uilibrium conditionc is to write : S C i I. In this e6uation the lefthand side is actual income and the righthand side is planned aggregate demand. #his is the simplest class of incomedetermination model. It ma!es no allowance for international trade or government economic activit%. #hose ma% be treated in the same wa% that saving and investment were treatedas lea!ages or in*ections. #hus e-ports constitute spending b% foreign nationals on domestic goods an in*ection. Imports constitute spending out of domestic income on foreign goodsa lea!age. #a-es are ta!en out of the circular flowa lea!agewhereas government e-penditures are an in*ection. #he effects of these lea!ages and in*ections on the level of income are analogous to those of saving and investment. If income is initiall% at an e6uilibrium level$ an increase in a lea!age &if not at the same time offset b% a decrease in another lea!age or an increase in an in*ection' will cause income to fall. 2n increase in an in*ection ¬ offset b% a decrease in another in*ection or an increase in a lea!age' will cause income to rise. 2n income e6uilibrium is reached when the sum of all lea!ages is balanced b% the sum of all in*ections. .11 The multiplier. #he simple incomee-penditure model of the econom% is not a complete model. It suffices to show onl% the direction of the change in income that would result from$ sa%$ a decline in planned investment &or a rise in ta-es or a decline of e-ports'. It does not show the e'tent of the income change. #o do this the model must be e-panded to include a description of how consumers spend their incomes. >or the sa!e of the e-position$ one ma% assume that the spending of households varies according to the si5e of their incomes. 2 simple wa% of putting this is the following e6uation: C S a i %y. In this e6uation the coefficient a is a constant indicating the amount that households will spend on consumption independentl% of the level of income received in the current period$ and the coefficient % gives the fraction of each dollar of income that will be spent on consumption goods. If one were able to obtain reliable 6uantitative information on the volume of investment spending being planned and on the coefficients a and % of the cconsumption functionc above$ one could then calculate the value of aggregate demand &C i I' for ever% possible level of income :. Onl% one of these alternative levels of income is an e6uilibrium one7 that is$ one for which aggregate demand will ensure that all of the income paid out b% firms ccomes bac!c to the business sector as spending on final goods. #he e6uilibrium condition is: : S C i I. >igure 1.: Celation between income and aggregate demand >igure 1. shows how the level of income in the s%stem is determined$ on the assumption that investment is N,H$HHH$HHH$ that the coefficient a is N,H$HHH$HHH$ and that the coefficient % &the fraction of each dollar of income that consumers will spend' is H.1. #he hori5ontal a-is measures income$ the vertical$ aggregate demand &C i I'. #he line drawn at a /0 angle &from H' contains all of the points at which suppliers might be in e6uilibrium7 i.e.& the points in the space at which aggregate demand would have the same value as income. #he investment schedule &mar!ed I S I H ' is drawn parallel to the income a-is at height ,H$ showing that investment spending does not depend on income. #he consumption function &mar!ed C S a i %y' starts at ,H on the vertical a-is &the value of a' and rises 1H cents for each dollar of income &the value of %' to the right. #he aggregate demand schedule &mar!ed C i I H ' is obtained b% the vertical summation of the C and I H schedules. It contains all of the points at which demanders would be in e6uilibrium$ showing$ for each level of income$ the volume of spending on final goods that the% would be satisfied to maintain. .1= #he onl% position that demanders and suppliers will both be satisfied to maintain is given b% the intersection of the aggregate demand schedule with the /0 line. In >igure 1. this point &p: circumfle-q H ' is found at an income level of N1HH$HHH$HHH. >or this simple s%stem$ which has but one lea!age and one in*ection$ the e6uilibrium level of income ma% e6uall% well be regarded as determined b% the condition that planned saving e6uals planned investment. Since saving is defined as household income not spent on consumption &i.e.& : C S'$ one obtains &b% substituting a i %y for c' the saving schedules S S a i &1 %' :$ which in >igure 1. is shown to intersect the investment schedule at : S N1HH$HHH$HHH. >igure 1. shows what will happen if this e6uilibrium is disturbed. Consider a &temporar%' situation in which income is running at more than N1HH$HHH$HHH per %ear. 2t all levels of income to the right of p: circumfle-q H aggregate demand &C i I H ' is seen to fall below suppl% as given b% the /0 line. &2lso$ saving e-ceeds investment.' #he business sector will not be willing to maintain this state of affairs but will contract. 5n e'cess supply of final goods is associated with falling income. Similarl%$ at income levels to the left of p: circumfle-q H $ where investment e-ceeds saving$ aggregate demand will e-ceed suppl%. 5n e'cess demand for final goods is associated with rising income. >inall%$ >igure 1. shows how much income would fall as a result of a decline in investment b% N1H$HHH$HHH per %ear &cf. the dotted lines'. #he decline in investment is shown b% the shift of the investment schedule from I H to I 1 $ which results in a downward shift of the aggregate demand schedule from C i I H to C i I 1 . #he new income e6uilibrium &p: circumfle-q 1 ' is found at : S N=0$HHH$HHH. #hus a change in investment spending & I' of N1H$HHH$HHH is found to lead to a change in income & :' of a larger amount$ here N,0$HHH$HHH$ which is to sa%$ b% a multiple of ,.0. #he reason is that$ when the N1H$HHH$HHH is transmitted to households as income$ households will increase their consumption spending b% N1$HHH$HHH &% N1H$HHH$HHH'. #his rise in consumption spending again raises income$ and of this additional income 1H percent is also spent on consumptionand so on. Each time$ /H percent of the increment to income clea!sc into saving. #he relationship between the initial change in cautonomous spendingc & I' and the change in the level of income & :'$ which will have ta!en place once this process has run its course$ is given b%: where$ following Ue%nes$ the e-pression &1 %1' is called the c;ultiplier.c #he model of income determination presented above is e-ceedingl% simple7 it captures little of the comple-it% of a modern industriali5ed econom%. It does$ however$ suggest one approach to the problem of stabili5ing the econom% at a high level of income and emplo%ment. 2ssuming that the consumption function is fairl% stable &i.e.& that the level of consumption spending associated with an% level of income can$ with a fair degree of accurac%$ be predicted on the basis of past e-perience'$ fluctuations in income ma% be attributed to changes in the other variables. 3istorical statistics show investment spending b% private business to have been the most volatile of the ma*or components of national income7 changes in investment$ therefore$ tend &as in the e-ample above' to be the focus of concern for one school of economists. #he implication is that the government can manipulate cin*ectionsc and clea!agesc so as to offset changes in private investment. #hus a drop in investment might be offset b% a corresponding increase in government e-penditures &increasing an in*ection' or a decrease in ta-es &decreasing a lea!age'. #hese measures belong to fiscal polic%. .1? ;onetar% polic%. 2nother point of view holds that the fiscal approach presented above is misleading because it ignores the part pla%ed b% monetar% factors in determining the level of economic activit%. #he following discussion presents an alternative model$ which$ though e6uall% simplistic$ suggests that primar% reliance be put on monetar% polic%. c;one%c in what follows ma% be ta!en to refer to currenc% &coins and notes' plus the chec!ing deposit liabilities of commercial ban!s. >or the sa!e of brevit%$ the model developed in the preceding section will be referred to as the income model. #he naive 6uantit% theor% model that will be e-plained here ma% be labelled the mone% model. #he income model dealt with changes in mone% income in terms of the demand for and suppl% of output. #he mone% model focusses on the suppl% of and demand for mone%. #he income model e-plained the determination of the level of income in terms of relationships between its component flows. #he mone% model emphasi5es the relationship between mone% suppl% and income. #he structure of the income model was based on the distinction between household and business &and government' sectors. In the mone% model$ the distinction is between the ban!ing sector &suppl%ing the mone%' and the nonban!ing sectors &the demanders'. #he concept of income is the same in both models. In the mone% model$ the suppl% of mone% is treated with the same simplicit% that was accorded investment in the income modelas cautonomousl%c determined$ which is to sa% that it is not affected b% other factors: ; s S ;. #his assumes that the central ban! is able completel% to control the stoc! of mone%$ which is held at whatever level the ban! desires. #he d%namic relationship in the income model was the consumption function. 3ere it is the mone% demand function. #he amount of mone% demanded is assumed to var% with income &and$ in this naive version of 6uantit% theor%$ with nothing else'. #he simplest relationship between income and the demand for mone% would be: ; d S k:. 3ere$ k is a constant. Since : is a flow &measured per %ear' and ; d a stoc! &the average stoc! of mone% over the %ear'$ k has the dimension of a cstorage period.c If k S 1B/$ for e-ample$ the e6uation states that the nonban!ing public desires on the average to hold a cash balance that is e6ual to the total of three months] income. >igure 1/: Celation between mone% demand and income .1G Since there is a determined amount of mone% in the s%stem$ it can be in e6uilibrium onl% when the nonban!ing sector is satisfied to hold e-actl% the amount of mone% that e-ists$ no more and no less: ; d S ; s . #he s%stem represented b% these three e6uations is shown in >igure 1/. #he determination of income in the s%stem is shown b% assuming ; s S N,0$HHH$HHH and k S 1B/. #he amount of mone% demanded is e6ual to suppl% when income is N1HH$HHH$HHH. 2 reduction of the mone% suppl% to N,H$HHH$HHH will cause income to decline to a level of N?H$HHH$HHH per %ear. >igure 1/ shows what will happen if income temporaril% e-ceeds the figure of N1HH$HHH$HHH per %ear. #o the right of p: circumfle-q H $ the amount of mone% demanded e-ceeds the e-isting stoc! of it. #he wa% for an individual to build up his cash balance is to reduce his disbursements below his receipts. <ut his spending &to the e-tent that it is spending on final goods at least' is somebod% else]s income. 2 general attempt to build up cash balances cannot succeedit does not induce an increase in the mone% suppl% in this modelbecause it will result in a decline of income throughout the s%stem. #his decline will continue to whatever level is re6uired to ma!e the nonban!ing sector bring the amount of mone% it demands into line with the amount in e-istence. 5n e'cess demand for money is associated with falling income. Similarl%$ if the amount of mone% demanded falls short of the amount supplied$ an individual ma% decide to reduce his cash balance b% increasing his disbursementsbut the mone% sta%s in the s%stem7 incomes will rise all around. 5n e'cess supply of money is associated with rising income. #he stabili5ation polic% that this model suggests is obvious: if the relationship between income and the demand for mone% is stable$ the s%stem can be maintained in e6uilibrium b% !eeping the mone% suppl% constant or$ in a growing econom%$ b% allowing the mone% stoc! to grow at roughl% the same rate as real output. If the relationship between income and the demand for mone% is found to shift about over time$ the mone% stoc! should be made to grow more rapidl% in periods of increasing demand for mone% and more slowl% in periods of decreasing demand. Comparisons of the income and mone% models. 2lthough the two models seem to have nothing in commonthe crucial variables of one do not even appear in the othertheir descriptions of what happens during income level movements are not contradictor%. >alling income is associated with an e-cess suppl% of goods and services in the income model$ with an e-cess demand for mone% in the mone% model. Cising income is associated with an e-cess demand for goods in the first model$ with an e-cess suppl% of mone% in the other. Evidentl% the two models give onl% partial descriptions of what is going on: one model loo!s at the process from the crealc side onl% and the other from the cmonetar%c side. <ut an e-cess demand for goods on one side will be associated with an e-cess suppl% of mone% on the other$ and vice versa$ so in this respect the two are consistent. #he controvers% between the two schools of thought represented b% the models has mainl% to do with two issues. One issue is which set of polic% instrumentsfiscal or monetar%provides the best means of stabili5ing the econom%. #he other$ more fundamental$ issue concerns the causes of income movements. 2s seen above$ changes in investment were the main cause of income movements in the income model7 changes in the mone% stoc! were the main cause in the mone% model. Simplistic as the two models are$ the% embod% the conflicting h%potheses of the two contending schools. Incomee-penditure theorists attribute the instabilit% of income .,H primaril% to events that influence the business sector]s e-pectations with regard to the profitabilit% of new investment$ thus influencing investment. #he modern 6uantit% theorists see the irregular time path of the mone% stoc! as the most important factor. #he gross features of economic histor% do not contradict either h%pothesis. (rivate investment has indeed been the most volatile component of Fross "ational (roduct. Similarl%$ the movements of the mone% stoc! have conformed to those of mone% income: rapid inflation has been associated with a rapid growth of the mone% suppl%7 severe recessions$ with a decline in the mone% suppl%7 and mild recessions$ with a slowdown in the growth of the mone% suppl%. &c;ildc recessions ma% be thought of as recessions during which total emplo%ment stagnates$ and the growth in unemplo%ment$ therefore$ is largel% due to the growth of the labour force.' #he controvers% has in large measure come to concern the direction of causation one side maintains that shifts in investment cause income changes and infers that these in turn induce changes in the mone% stoc! which go in the same direction7 the other side maintains that changes in the si5e or rate of growth of the mone% stoc! cause income changes that in turn will tend to fall most heavil% on the investment component of income. #he problem of resolving this controvers% is twofold. >irst$ the theoretical issue is less clearcut than implied above. Each side ac!nowledges that neither investment nor the mone% suppl% is autonomous and that each affects the other. #he 6uestion has become$ therefore$ which model is cmost nearl% truec and which model$ conse6uentl%$ should be regarded as a cfirst appro-imationc in guiding stabili5ation polic%. Second$ the empirical methods at the disposal of economists are not %et ade6uate for settling such issues. 2ttempts have been made to compare the performance of the two models b% testing whether the best predictions of income are obtained b% using actual data for cautonomous e-pendituresc and assuming that consumption will obe% the consumptionincome relation that has generall% obtained in the past or b% using actual mone% stoc! figures and assuming that mone% demand will obe% the relation to income that has generall% obtained in the past. #hese attempts have bogged down in disagreements on various statistical matters and must be *udged inconclusive. #he% have shown$ however$ that even with consumption functions and mone% demand functions that are a good deal more creasonablec than the naive relationships above$ the predictions of both models are too inaccurate for the purposes of stabili5ation polic%. Each model emphasi5es one set of disturbances &crealc or cmonetar%c$ respectivel%' that will cause income to change. Each gives a partial view of the process of incomelevel movements. +hat is needed$ therefore$ is a third model e-plaining the lin!ages between crealc and cmonetar%c forces that these two simple models leave out. Interestrate polic%. #he third model brings a cruciall% importantbut hitherto generall% neglectedelement into the picture of the economic s%stem7 namel%$ financial mar!ets. >or simplicit%$ the model has onl% one financial mar!et7 there is onl% one class of financial instruments &referred to as csecuritiesc' and onl% one %ield &a single interest rate'. #he standard securit% ma% be thought of as a bond promising to pa% annuall% a fi-ed number of dollars. #he interest rate is the value of the coupon e-pressed as a percentage of the mar!et price of the bond. Conse6uentl%$ if e-cess .,1 demand for bonds brings their price up$ the interest rate falls7 if e-cess suppl% sends the bond price down$ the interest rate rises #he wor!ing of the financial mar!et is depicted in the model as follows. Investment b% the business sector is assumed to be financed through the issue of securities. #he higher the interest rate that firms must pa% on their securities$ the smaller will be the investment program that the% see as promising to be profitable. #hus investment will be discouraged b% a rise and encouraged b% a fall in the interest rate. 3ouseholds$ in deciding how to divide their income between consumption and saving$ will consider the amount of future consumption that can be gained b% abstaining from consumption now &i.e.& b% saving'. #he higher the rate of interest$ the larger the amount that can be spent on future consumption per dollar not spent in the present. #hus saving is encouraged b% a rise and discouraged b% a fall in the interest rate. Coins$ notes$ and some chec!ing deposits are assets on which interest is not paid. 2n individual who holds them has the alternative of converting some part of his mone% holdings into interestbearing form. #hus the amount of mone% demanded will tend to diminish when the interest rate rises and to increase when it falls. #he ban!ing s%stem creates mone% b% bu%ing assets from the public$ pa%ing for the assets through the issuance of additional monetar% liabilities &e.g.& chec!ing deposits'. <an!s must decide whether turning part of their cash reserves to an incomeearning use is worth the ris!s of decreased cli6uidit%c entailed b% lower ban! reserves. 3ence there is a tendenc% for the mone% suppl% to increase when the interest rate rises and to decrease when it falls In this model$ then$ the interest rate acts as a price in controlling the behaviour of the individual agents whose activities are to be coordinated. #he interest rate itself is determined b% the demand for and suppl% of mone% and securities. 2n increase in planned investment will be associated with the issuance of a large volume of securities. It will tend$ therefore$ to create an e-cess suppl% of securities$ to lower securities prices$ and to raise the rate of interest. Similarl%$ an increase in planned saving will tend to create an e-cess demand for securities$ to raise their prices$ and to lower the rate of interest. 2n increased demand for mone% will$ in part$ reduce the demand for and increase the suppl% of securities7 it tends to create an e-cess suppl% of securities and to raise the interest rate. 2n increase in the suppl% of mone% will tend to reduce the rate of interest #hese 6ualitative propositions are the framewor! of the new model$ integrating the two previous models as follows: &1' I S I&r'7 &,' C S C&:$r'7 &.' S S : C7 &/' S S I7 &0' ; d S ; d &:$r'7 &1' ; s S ; s &r'7 and &=' ; d S ; s . 3ere$ E6uations 1 through / restate the income model with the modification that investment is no longer simpl% cautonomousc but depends on the current level of the interest rate &r'. E6uations 0 through = restate the mone% model with the modification that the demand for mone% and the suppl% of mone% also depend on the interest rate. #wo conditions now have to be simultaneousl% fulfilled for the s%stem to be in e6uilibrium: desired saving must e6ual desired investment &E6uation /'$ and the amount of mone% that individuals and firms desire to hold must e6ual the amount that the ban!ing sector desires to suppl% &E6uation ='. Onl% a partial account of the wa%s in which this model wor!s can be given here. #he following illustrative e-amples begin with the s%stem in e6uilibrium at full emplo%ment. #he first illustration adopts the view of someone who has learned the income model and hence is thoroughl% imbued with the idea that rising income results from an e-cess of planned investment over planned saving. >aced with the proposition$ drawn from the mone% model$ that an increase in the mone% suppl% will .,, also cause income to rise$ he will as! how such a change in the mone% suppl% can cause a discrepanc% between saving and investment when there was none to begin with. #he answer is that an increase in ; s will mean that there is an e-cess suppl% of mone% and a corresponding e-cess demand for commodities and securities$ but the immediate impact of e-cess demand will be felt almost e-clusivel% in the securities mar!et. #he e-cess demand for securities drives the rate of interest downand this encourages investment and discourages saving. 2t that point$ conse6uentl%$ a cgapc opens up between desired saving and investment. >or the second illustration$ consider instead someone who has learned the mone% model and who$ conse6uentl%$ !nows that income falls when the amount of mone% demanded e-ceeds the suppl%. In Ue%nes]s wor! the cdisturbancec given the most pla% is some unspecified event that ma!es business firms ta!e a dar!er view of the returns to be e-pected from new investment. 3ence$ the amount of investment that the% will want to underta!e at the prevailing interest rate declines. #he 6uestion is how such a change in planned investment can cause a discrepanc% between mone% demand and mone% suppl% when there was none to begin with. #he simplest answer is that a decline in planned investment will be associated with a reduction in the amount of securities floated on the mar!et and thus with the emergence of an e-cess demand for securities. #his drives securities prices up$ which is to sa% that the interest rate falls. 2t a lower rate of interest$ individuals will desire larger mone% balances than before7 in addition$ the ban!s will tend to reduce the mone% stoc! somewhat. 2t that point$ conse6uentl%$ a gap will open between the amount of mone% demanded and the amount supplied. #he anal%sis of the conse6uences of government fiscal action is somewhat more complicated. If the government tries to stimulate the econom% through increased e-penditures$ the effects will be felt in at least two wa%s. >irst$ the increased spending is an cin*ectionc added to commodit% demand and ma% be treated$ therefore$ from the ;odel 2 standpoint in the same wa% as an increase in private investment. Second$ however$ this spending ma% be financed through increased ta-es$ through government borrowing$ through creation of new mone%$ or through some combination of the three. #he strongest effects are gained b% following the third alternative$ the creation of new mone%. #he e-cess demand for goods and services created b% the increase in spending will then be matched b% an e-cess suppl% of mone%$ which$ as seen above$ will drive down the interest rate and cause increased investment$ etc. #o the direct stimulus of the spending program$ this method of pa%ing for it adds the indirectl% achieved stimulus of increased private investment. &"eedless to sa%$ the double effect on mone% income is not alwa%s desirable. #he fact that this method of financing government spending has almost alwa%s been heavil% resorted to in wartime accounts for the historical association of large inflations with wars.' #he method of the second alternative$ government borrowing$ consists of financing the increase in spending through the issue of government bonds. #his creates an e-cess suppl% of securities$ driving up the interest rate. 2t the higher interest rate$ mone% demand is lessened and mone% suppl% somewhat increased$ but the conse6uent e-cess suppl% of mone% will be of smaller magnitude than that entailed b% creating new mone%. #he higher interest rate will also discourage private investment. #hus the indirect effects of government borrowing are seen to involve a decrease in private investment partiall% offsetting the initial increase in government spending. #he si5e of this offset has become one of the ma*or issues between cmonetaristc and cincomee-penditurec economists. #he monetarists argue that the offset is so nearl% complete that fiscal action will be largel% ineffectual unless it is accompanied b% an increase in the mone% suppl%$ but an .,. increase in the mone% suppl% will have almost as powerful effects without an% simultaneous fiscal action. #he other side concedes that fiscal action will be more powerful when financed through changes in the mone% suppl% but maintains that counterc%clical variations in government spending financed through borrowing must still be regarded as an important stabili5ation method. The FnaturalF rate of intere"t and effecti$e demand* The thought of -nut $icksell. 2round the turn of the centur%$ the Swedish economist Unut +ic!sell contributed greatl% to the understanding of the function of the rate of interest in the mechanism determining income and pricelevel movements. 2ssuming an econom% initiall% in fullemplo%ment e6uilibrium$ +ic!sell anal%5ed the various wa%s in which the s%stem might depart from that position because of discrepancies between the prevailing mar!et rate of interest and what he termed the cnatural rate.c #he latter rate$ h%pothetical rather than directl% observable$ ma% be thought of as the interest rate level that would have to prevail for the s%stem to remain at full emplo%ment with stable prices. In illustrating the use made of this concept$ one should distinguish between processes initiated b% crealc disturbances &the first two e-amples below' and those initiated b% cmonetar%c disturbances &the third e-ample'. #he first e-ample is one in which business firms see increased opportunities for profitable investment. #he s%stem is alread% at full emplo%ment$ and hence an increase in spending on investment without a corresponding decrease in spending for consumption would spell inflation. +hat !ind of ad*ustment will maintain stable prices4 2 rise in the interest rate will &1' moderate the increase in investment spending and &,' cause households to divert some of their income from consumption into increased saving. #he h%pothetical level of the interest rate that will e-actl% match the net increase in investment with the decrease in consumption &increase in saving' is the new value of +ic!sell]s cnatural rate.c <ut the ad*ustment of the mar!et rate ma%$ for several reasons$ come to a halt after going onl% part of the wa% to the new natural rate level. 2t some level of the mar!et rate below natural rate$ where planned investment still e-ceeds the savings that households provide for its financing$ the ban!s ma% step in and finance the difference through e-pansion of the mone% suppl%. #hus inflation results. In +ic!sell]s theor% there is inflationar% pressure on the s%stem associated with a mar!et rate below the natural level and$ in the version of it given here$ with an increase in the mone% suppl%. #he second e-ample involves a change in public behaviour in that households desire to save more and consume less$ out of an% given level of income. #he decreased demand for consumption goods threatens to cause deflation &or unemplo%ment'. #o prevent this it is necessar% to switch resources over to investment goods production$ which re6uires a lowering of the interest rate. #hus an increase in saving means that the natural rate of interest declines. #he ad*ustment of the mar!et rate of interest ma% again be incomplete if falling rates induce ban!s$ sa%$ to reduce their new lending below scheduled loan repa%ments$ thus reducing the mone% suppl%. (art of the saving done b% households then goes$ directl% or indirectl%$ into reducing the private sector]s indebtedness to ban!s rather than into financing investment. #hus deflationar% pressure on the s%stem is$ in +ic!sell]s theor%$ associated with a mar!et .,/ rate of interest above the natural rate and$ in this e-ample$ with a decreased suppl% of mone%. #he third e-ample is one in which ban!s desire to e-pand their loans and$ thereb%$ their monetar% liabilitiescreating a cmonetar%c disturbance. Since crealc incentives to save and to invest have not changed$ the natural rate of interest has not changed. #he increased suppl% of ban! credit will$ however$ drive the mar!et rate down. It goes below the natural rate$ the mone% suppl% is increased in the process$ and inflation is the result. -eynes and $icksell. Ue%nes first too! up +ic!sell]s idea in his Treatise on Money &1G.H'. In +ic!sell]s writings$ discrepancies between the natural and mar!et rates had invariabl% been associated with e-pansion or contraction of ban! credit. Ue%nes emphasi5ed that such discrepancies ma% develop and continue without e-pansion or contraction of the mone% suppl%$ because of speculation in the securities mar!ets. >or e-ample$ if the natural rate has decreased and the mar!et rate starts to edge down in response to an e-cess of the household savings offered in demand for securities over the suppl% of new securities mar!eted to finance investment$ securities prices will rise. #his$ Ue%nes suggested$ will cause some speculators in coldc securities to enter the mar!et and suppl% savers with securities from their holdings. #he e-cess demand pressure on the mar!et is thus relieved and the rise in prices &fall of the mar!et rate' halted. #he motive for these transactions is the speculators] hope that the% can bu% bac! their securities at lower prices later. In the meantime$ the speculators hold their funds in the form of read% mone%7 there has been an increase in the amount of mone% demanded rather than$ as +ic!sell assumed$ a decrease in the mone% suppl%. #he +ic!sellUe%nes theor% was an important contribution to the theor% of the incomedetermination process. :et there is nothing in its main elements that should have startled a pre+ic!sellian traditional economist. #he natural rate is essentiall% the interest rate that would prevail in general e6uilibrium$ and a mar!et rate different from the natural rate is a dise6uilibrium interest rate. #raditional economics was clear enough as to the conse6uences that will follow if one or more of the prices in the s%stem cgets stuc!c at a dise6uilibrium level. #he +ic!sellUe%nes theor%$ therefore$ ma% be regarded as a particular application of previousl% familiar principles. Ue%nes returned to the +ic!sellian theme in The 1eneral Theory of ,mployment& 2nterest and Money &1G.1'$ but in that revolutionar% wor! he gave the theor% a genuinel% novel twist: he argued that the s%stem might be seriousl% out of e6uilibrium even though the prevailing interest rate was e-actl% at the +ic!sellian natural level. #his might happen because the interest rate mechanism cannot ensure that the plans of households and business firms with regard to future consumption and production will mesh with each other. #here might$ for e-ample$ be an increase in household savingthat is$ a decrease in the demand for current consumption goods and an increase in the planned demand for future goods. Coordination of household and business activities re6uires that business firms respond b% shifting resources out of the production of present consumption goods and into investment activities that la% the groundwor! for increased output in the future. 3ouseholds$ in carr%ing out their saving decisions$ do not place contractual orders with producers for future deliveries of particular goods and services. #hus the future demands implicit in current saving decisions ma% not be effectivel% communicated to producers$ as efficient coordination .,0 would re6uire. If producers draw up their investment plans on the basis of forecasts of future demand that do not correspond to the spending that households are prepared to underta!e in the future$ there will be an e-cess demand &or e-cess suppl%' for future output. Such effective demand failure is not the result of changes in interest rates or in the suppl% of mone%. #he logical wa% of dealing with itwhen it occursis through fiscal polic% measures. #he effective demand doctrine is the signal contribution of Ue%nesian economics to income and emplo%ment theor%. It is thus no coincidence that Ue%nesian economics has become associated with an emphasis on the use of fiscal$ rather than monetar%$ stabili5ation policies. d .,1 MICR.EC.-.MICS A-D MACR.EC.-.MICS ;an% economists speciali5e in a particular branch of the sub*ect. >or e-ample$ there are labour economists$ energ% economists$ monetar% economists$ and international economists. +hat distinguishes these economists is the segment of economic life in which the% are interested. Dabour economics deals with problems of the labour mar!et as viewed b% firms$ wor!ers$ and societ% as a whole. 8rban economics deals with cit% problems: land use$ transport$ congestion$ and housing. 3owever$ we need not classif% branches of economics according to the area of economic life in which we as! the standard 6uestions what$ how$ and for whom. +e can also classif% branches of economics according to the approach or methodolog% that is used. #he ver% broad division of approaches into microeconomic and macroeconomic cuts across the large number of sub*ect groupings cited above. ;icroeconomic anal%sis offers a detailed treatment of individual decisions about particular commodities. >or e-ample$ we might stud% wh% individual households prefer cars to bic%cles and how producers decide whether to produce cars or bic%cles. +e can then aggregate the behavior of all households and all firms to discuss total car purchases and total car production. +ithin a mar!et econom% we can discuss the mar!et for cars. Comparing this with the mar!et for bic%cles$ we ma% be able to e-plain the relative price of cars and bic%cles and the relative output of these two goods. #he sophisticated branch of microeconomics !nown as general e6uilibrium theor% e-tends this approach to its logical conclusion. It studies simultaneousl% ever% mar!et for ever% commodit%. >rom this it is hoped that we can understand the complete pattern of consumption$ production$ and e-change in the whole econom% at a point in time. If %ou thin! this sounds ver% complicated %ou are correct. It is. >or man% purposes$ the anal%sis becomes so complicated that we tend to lose trac! of the phenomena in which we were interested. #he interesting tas! for economics$ a tas! that retains an element of art in economic science$ is to devise *udicious simplifications which !eep the anal%sis manageable without distorting realit% too much. It is here that microeconomists and macroeconomists proceed down different avenues. ;icroeconomists tend to offer a detailed treatment of one aspect of economic behaviour but ignore interactions with the rest of the econom% in order to preserve the simplicit% of the anal%sis. 2 microeconomic anal%sis of miners) wages would emphasi5e the characteristics of miners and the abilit% of mine owners to pa%. It would largel% neglect the chain of indirect effects to which a rise in miners) wages might give rise. >or e-ample$ car wor!ers might use the precedent of the miners) pa% increase to secure higher wages in the car industr%$ thus being able to afford larger houses which burned more coal in heating s%stems. +hen microeconomic anal%sis ignores such indirectl% induced effects it is said to be partial anal%sis. In some instances$ indirect effects ma% not be too important and it will ma!e sense for economists to devote their effort to ver% detailed anal%ses of particular industries or activities. In other circumstances$ the indirect effects are too importantT to be swept under the carpet and an alternative simplification must be found. ;acroeconomics emphasi5es the interactions in the econom% as a whole. It .,= deliberatel% simplifies the individual building bloc!s of the anal%sis in order to retain a manageable anal%sis of the complete interaction of the econom%. >or e-ample$ macroeconomists t%picall% do not worr% about the brea!down of consumer goods into cars$ bic%cles$ televisions$ and calculators. #he% prefer to treat them all as a single bundle called Tconsumer goods) because the% are more interested in stud%ing the interaction between households) purchases of consumer goods and firms) decisions about purchases of machiner% and buildings. ;acroeconomics is the stud% of the econom% as a whole. ;acroeconomics is concerned not with the details e the price of cigarettes relative to the price of bread$ or the output of cars relative to the output of steel e but with the overall picture. #he distinction between microeconomics and macroeconomics is more than the difference between economics in the small and economics in the large$ which the Free! prefi-es micro and macro suggest. #he purpose of the anal%sis is also different. 2 model is a deliberate simplification to enable us to pic! out the !e% elements of a problem and thin! about them clearl%. 2lthough we could stud% the whole econom% b% piecing together our microeconomic anal%sis of each and ever% mar!et$ the resulting model would be so cumbersome that it would be hard to !eep trac! of all the economic forces at wor!. ;icroeconomics and macroeconomics ta!e different approaches to !eep the anal%sis manageable. ;icroeconomics places the emphasis on a detailed understanding of particular mar!ets. #o achieve this amount of detail or magnification man% of the interactions with other mar!ets are suppressed. In sa%ing that a ta- on cars reduces the e6uilibrium 6uantit% of cars we ignore the 6uestion of what the government does with the revenue. If government has to borrow less mone% it is possible that interest rates and the e-change rate will fall and that improved international competitiveness of 8.U car producers will increase the e6uilibrium output of cars in the 8.U. ;icroeconomics is a bit li!e loo!ing at a horse through a pair of binoculars. It is great for details but sometimes we get a clearer picture of the whole race b% using the na!ed e%e. <ecause macroeconomics is concerned primaril% with the interaction of different parts of the econom%$ it relies on a different simplification to !eep the anal%sis manageable. ;acroeconomics simplifies the building bloc!s in order to focus on how the% fit together and influence one another. #he main issues in macroeconomics: 1.Inflation Jthe annual inflation rate is the percentage increase per annum in the average price of goods and services. +hat causes inflation4 #he mone% suppl%4 #rade unions4 +h% do people mind so much about inflation4 9oes it cause unemplo%ment4 ,.1nemployment* It is a measure of the number of people registered as loo!ing for wor! but without a *ob. #he unemplo%ment rate is the percentage of the labour force that is unemplo%ed. #he labour force is the number of people wor!ing or loo!ing for wor!. It e-cludes all those from rich landowners to heroin addicts who are neither wor!ing nor loo!ing for wor!. .+h% has it increased so much42re wor!ers pricing themselves out of *obs b% greed% wage claims4 Is high unemplo%ment necessar% to !eep inflation under control$ or could the government create more *obs4 .,? 8*.utput and :roth .Ceal gross national product measures the total income of the econom%. It tells us the 6uantit% of goods and services the econom% as a whole can afford to purchase. Increases in real gross national product are called economic growth. +hat determines the level of real F"(4 +h% do some countries grow faster than others4 /. Macroeconomic policy* 2lmost ever% da% the newspapers and television refer to the problems of inflation$ unemplo%ment$ and slow growth. #hese issues are widel% discussed7 the% help determine the outcome of elections$ and ma!e some people interested in learning more about macroeconomics. #he government has a variet% of polic% measures through which it can tr% to affect the performance of the econom% as a whole. It levies ta-es$ commissions spending$ influences the mone% suppl%$ interest rates$ and the e-change rate$ and it sets targets for the output and prices of nationali5ed industries. +hat the government can and should do is the sub*ect of livel% debate both within the field of economics and in the countr% at large. 2s usual$ it is important to distinguish between positive issues relating to how the econom% wor!s and normative issues relating to priorities or value *udgements. Economic :roth #here is general agreement amongst economists concerned with the problems of less developed countries &D9Cs' that a distinction should be made between economic growth and economic development. Economic growth is defined as an increase in the productive capacit% of an econom% over time$ giving rise to an increase in real "ational Income &"I'. If the rate of growth of income is greater than the rate of growth of population$ income per capita will also rise. Economists distinguish between the Fross 9omestic (roduct &F9(' and the Fross "ational (roduct &F"(' of an econom%. F9( is the total final output of goods and services produced within an econom% for an% given %ear$ b% both residents and nonresidents. F"( is e6ual to F9( plus net factor &or propert%' incomes from abroad &that is$ the difference between returns to the inhabitants of the countr% from propert% located overseas minus the returns accruing to foreigners from their propert% located within the reporting countr%'. >or most D9Cs$ net propert% income from abroad is li!el% to be negative and thus F9( will be greater than F"(. <oth domestic product and national product can be e-pressed in net terms &that is$ after allowing for capital depreciation' and either at mar!et prices or factor costs &that is$ including and e-cluding respectivel%$ indirect ta-es net of subsidies'. "et "ational (roduct &""(' at factor cost is identical to "ational Income. >or man% D9Cs$ economic growth has been rapid and sustained for much of the postSecond +orld +ar period. +orld <an! pro*ections for the 1G?Hs predicted that higher rates of economic growth would be difficult to reach and sustain and that there would occur a widening in both the relative and absolute gaps between the richest and the poorest countries$ including the gap between the middle and low income D9Cs. .,G In the earl% %ears of the evolution of development economics as a distinct area of stud%$ economic growth and economic development were generall% seen as being s%non%mous. #he deficiencies of using F"( per capita as an indicator of economic welfare &and b% implication$ the level of economic development' were recognised b% economists$ however$ and over time it became increasingl% evident that economic growth on its own$ although undoubtedl% a necessar% condition$ was certainl% not a sufficient condition to ensure increases in economic$ let alone social$ welfare.+ithin the concept of economic development was some notion of progress. Economic development meant growth plus structutal and institutional change which involved the move towards certain normative goals or ob*ectives.Frowth without development was a possibilit% if increases in per capita incomes were not accompanied either b% structural changes or b% the diffusion of the gains in real income among all sectors of the population. Voca%ulary Commoditygoods sold in large 6uantities Consumption using$consuming Cum%ersome large and difficult to move *e%ate formal discussion$ contest between two spea!ers ,conomicsstud% of macro and micro economics ,conomyfinancial state of a countr% 1ain increase of possessions$ increase in amount or power !ousing accomodation 2ncomemone% received during a given period 2ssue giving out shares$ outgoing$ result$ outcome .evy mone% collected b% authorities Managea%le that can be managed$easil% controlled Overseas abroad$ across the sea 3urchasesomething which has been bought "ate charge for service or wor!.mar!et price (u%sidy mone% given to support unprofitable enterprises (upplyproviding something To accrue to come as a natural growth or development To cite to mention To deal with to do business To distort to give a false account of To ensure to ma!e sure$ guarantee ..H To e'changeto give one thing for another To increase( to ma!e$ to become greater To levy to demand pa%ment of ta-es and dues To owe to have to pa% mone% To purchase to bu% To su%sidise to help or support financiall% To trade to bu% and sell Trade buisness of bu%ing and selling Transaction e-change of goods or services for mone% $elfare condition of having good health$ comfortable living and wor!ing conditions The Medium of EBchan#e ;one%$ the medium of e-change$ is used in one half of almost all e-change. +or!ers e-change labour services for mone%. (eople bu% or sell goods in e-change for mone%. +e accept mone% not to consume it directl% but because it can subse6uentl% be used to bu% things we do wish to consume. ;one% is the medium through which people e-change goods and services. #o see that societ% benefits from a medium of e-change$ we should imagine a barter econom%. 2 barter econom% has no medium of e-change. Foods are traded directl% or swapped for other goods. In a barter econom% the seller and the bu%er each must want something the other has to offer. Each person is simultaneousl% a seller and a bu%er. In order to see a film$ %ou must hand over in e-change a good or service that the cinema manager wants. #here has to be a double coincidence of wants. :ou have to find a cinema where the manager wants what %ou have to offer in e-change. #rading is ver% e-pensive in a barter econom%. (eople must spend a lot of time and effort finding others with whom the% can ma!e mutuall% satisfactor% swaps. Since time and effort are scarce resources$ a barter econom% is wasteful. #he use of mone% e an% commodit% generall% accepted in pa%ment for goods$ services$ and debts e ma!es the trading process simpler and more efficient. Money #he unit of account is the unit in which prices are 6uoted and accounts are !ept. In <ritain prices are 6uoted in pounds sterling7 in >rance$ in >rench francs. It is usuall% convenient to use the units in which the medium of e-change is measured as the unit of account as well. 3owever there are e-ceptions. 9uring she rapid ..1 Ferman inflation of 1G,,e,. when prices in mar!s were changing ver% 6uic!l%$ Ferman shop!eepers found it more convenient to use dollars as the unit of account. (rices were 6uoted in dollars even though pa%ment was made in mar!s$ the Ferman medium of e-change. ;one% is a store of value because it can be used to ma!e purchases in the future. #o be accepted in e-change$ mone% has to be a store of value. "obod% would accept mone% as pa%ment for goods supplied toda% if the mone% was going to be worthless when the% tried to bu% goods with it tomorrow. <ut mone% is neither the onl% nor necessaril% the best store of value. 3ouses$ stamp collections$ and interest bearing ban! accounts all serve as stores of value. Since mone% pa%s no interest and its real purchasing power is eroded b% inflation$ there are almost certainl% better wa%s to store value. >inall%$ mone% serves as a standard of deferred pa%ment or a unit of account over time. +hen %ou borrow$ the amount to be repaid ne-t %ear is measured in pounds sterling. 2lthough convenient$ this is not an essential function of mone%. 8U citi5ens can get ban! loans specif%ing in dollars the amount that must be repaid ne-t %ear. #hus the !e% feature of mone% is its use as a medium of e-change. >or this$ it must act as a store of value as well. 2nd it is usuall%$ though not invariabl%$ convenient to ma!e mone% the unit of account and standard of deferred pa%ment as well. Different Aind" of Money In prisonerofwar camps$ cigarettes served as mone%. In the nineteenth centur% mone% was mainl% gold and silver coins. #hese are e-amples of commodit% mone%$ ordinar% goods with industrial uses &gold' and consumption uses &cigarettes' which also serve as a medium of e-change. #o use commodit% mone%$ societ% must either cut bac! on other uses of that commodit% or devote scarce resources to producing additional 6uantities of the commodit%. <ut there are less e-pensive wa%s for societ% to produce mone%. 2 to!en mone% is a means of pa%ment whose value or purchasing power as mone% greatl% e-ceeds its cost of production or value in uses other than as mone%. 2 Z1H note is worth far more as mone% than as a . - 1 inch piece of high 6ualit% paper. Similarl%$ the monetar% value of most coins e-ceeds the amount %ou would get b% melting them down and selling off the metals the% contain. <% collectivel% agreeing to use to!en mone%$ societ% economi5es on the scarce resources re6uired to produce mone% as a medium of e-change. Since the manufacturing costs are tin%$ wh% doesn)t ever%one ma!e r1H notes4 #he essential condition for the survival of to!en mone% is the restriction of the right to suppl% it. Societ% enforces the use of to!en mone% b% ma!ing it legal tender. #he law sa%s it must be accepted as a means of pa%ment. In modern economies to!en mone% is supplemented b% IO8 mone%. 2n IO8 mone% is a medium of e-change based on the debt of a private firm or individual. 2 ban! deposit is IO8 mone% because it is a debt of a ban!. +hen %ou have a ban! deposit the ban! owes %ou mone%. <an! deposits are a medium of e-change because the% are generall% accepted as pa%ment.
.., Voca%ulary ,'change-giving one thing for another To trade-to do business b% bu%ing and selling (wap-an e-change Barter-interchange of goods or services without the intervention of mone%. Commodity-goods sold in large 6uantities. (hare-a small part of a compan%)s capital To purchase-to bu% 3urchase-something which has been bought Bearer-person who holds a che6ue or certificate Bear market-period when share prices are falling To defer-to put to a later date *eferred payments-pa%ments postponed to a later date /an! or#aniIation ... #he wa% in which a ban! is organi5ed and operates is determined b% its ob*ectives and b% the t%pe of econom% in which it conducts its business. 2 ban! ma% not necessaril% be in business to ma!e a profit. Central ban!s$ for e-ample$ provide a countr% with a number of services$ while development ban!s e-ist to increase the economic growth of a countr% and raise the living standard of its population. On the other hand$ the aim of commercial ban!s is to earn profits. #he% therefore provide and develop services that can be sold at a price that will %ield a profit. 2 commercial ban! which provides the same range of services %ear after %ear is less li!el% to be successful than one which assesses changes in the demand for its products and which tries to match products to its customers) needs. "ew services are constantl% being introduced and developed b% commercial ban!s$ and the full service philosoph% of man% ban!s means that the% are a!in to financial supermar!ets$ offering a wide variet% of services. 3owever$ not ever% ban! ma% want to offer ever% !ind of financial service. ;an% ban!s offer a combination of wholesale and retail ban!ing. #he former provides largescale services to companies$ government agencies and other ban!s. #he latter mainl% provides smallerscale services to the general public. <oth t%pes of ban!ing$ however$ have three essential functions$ which are: L depo"it"6 payment"6 credit" #hese three functions are the basis of the services offered b% ban!s. #he% ma!e it possible for ban!s to generate profits and to achieve their operating aims. Several factors have combined to ma!e ban!ing an international business. #hese include the growth of multinational companies and of international capital mar!ets$ the increased competition between the ban!s themselves$ and important improvements in communications and transportation .#he ma*or ban!s of the world have established e-tensive international operations b% ac6uiring ban!s in other countries$ b% e-tending their own branch networ! abroad and b% establishing correspondent relationships with foreign ban!s so as to develop profitable *oint operations. #he operations of these ma*or commercial ban!s are d%namic and rapidl% changing$ and their organi5ation is of a global nature. TEKT7 +illiam Sands meets 9avid <lac! an e-mate and tries to describe him the structure of the ban! where he is the president. William: I can show %ou an organi5ation chart 9avid$ in the bac! of the annual report$which we can run through$ *ust to ma!e things a little clearer: Da$id :#hat)s O.U William: +e were reorgani5ed earlier this %ear$ so the organi5ation is still fairl% new. 2ctuall%$ as %ou can see$ we have split into si- line divisions. #he first of these$ the <an!ing 9ivision$ consists of three geographic groups: Froup One #he 2mericas$ Froup #wo Europe$ and Froup #hree 2frica$ 2sia and the ;iddle East. 2ll these groups are offering a full range of international ban!ing services. #hen we have the (rivate <an!ing 9ivision which serves consumers in the domestic and international mar!ets. ../ #he #reasurer)s 9ivision has a wide spread of operations which includes investment portfolio management$ commercial paper$ government and municipal bonds$ foreign e-change$ bullion$ and public finance. Da$id: So there are three operative divisions. +illiam :#hat)s right$ and these three operative divisions are bac!ed up b% another three servicing divisions. +e have the 2dministrative 9ivision which covers administrative services as well as personnel$ premises and economic anal%sis. #he >inancial and Information S%stems 9ivision includes the Comptroller)s 9epartment$ the Corporate #a- 9epartment$ and the S%stems and 9ata (rocessing 9epartment. 2nd then finall%$ the Corporate (lanning 9ivision includes strategic planning$ and credit polic% and administration. 3ere %ou have the annual report in case %ou need it for reference. 9avid: #han! %ou ver% much. It was e-tremell% interesting but i thin! %our wor! is not at all eas%$is it4 So$ I wish %ou good luc!. Voca%ulary: 5nnual: for one %ear. 5nnual report: a report presented each %ear giving details of the compan%)s activities and financial performance during the previous financial %ear. 3ortfolio: range$ collection. 3ortfolio management: bu%ing Bselling a range of shares for a client. *omestic: in %our countr%$ not abroad. <ullion: bars of gold or silver. Municipal %onds: documents issued b% a local government authorit% promising to repa% loans at a certain time. 3remises: buildings and surrounding land. To %ack up: to support Backing: financial support. Credit: time given to a customer to pa%. To credit: to put mone% into someone)s account. Credit control chec!ing that customers pa% on time. Credit limit a ma-imum amount that a customer can owe. Creditorperson who is owed mone%. Credit ratingamount which a credit agenc% thin!s a compan%Bperson should be allowed to borrow. =Match the following words with the correct deffinition: &premises$annual report$credit polic%$ domestic$comptroller]s department$ investment portfolio management$ bullion$line division$ personnel$ reorgani5ed$ consumers$ strategic planning$ commercial paper$ municipal bonds' 1.>ormed or structured in a new wa%. , 2 report presented each %ear$giving details of the compan%]s activities and financial performance during the previous financial %ear. ..0 . Sections of a compan% which deal with different products or services from each other. /.(eople who bu% goods or services. 0.In %our own countr%$ not abroad. 1.;anagement of a client]s collected investments. =.Shortterm documents usuall% sold b% big 8.S corporations$ promising to pa% a specified sum of mone% on a particular date7 the% ma% be sold again b% the bu%er. ?.9ocuments issued b% a local government authorit%$ promising to repa% loans at a certain time. G.<ars of gold or silver. 1H.Emplo%ees$staff. 11.<uildings and surrounding land. 1,.2 department which controls the internal finances of a compan%. 1..9eciding the main aims of an organi5ation. 1/ (lans for the lending of mone%. TEKT 5 2dam Cegan is interviewed about his ban!)s organi5ation. Inter$ieer: I would li!e %ou to tell me how %ou)re organi5ed could %ou4 Adam: :es$ certainl%. @ust to give %ou the bac!ground$ it was in 1?1G when we were established as a merchant ban! . +e operated independentl% as one of the ma*or merchant ban!s in the Cit% until 1G==$ when ;etropolitan and (rovincial ac6uired one third interest in us$ and as of last %ear we are now a wholl%owned subsidiar% of that ban!. +nterviewer' Oh$ reall%4 I didn)t reali5e that. Adam: One of the conse6uences of our ac6uisition was that we sold off our non ban!ing related activities$ though of course we still cover a full range of international ban!ing services. "ow in terms of management structure$ we have an 2dministration 9ivision which loo!s after all administrative matters. #hese include planning$ group financial control$ accounting and audit$ computer services$ legal services$ personnel$ premises and so forth. Inter$ieer: 2h$ %es. #hat)s cost centre services then4 Adam: #hat)s cost centre services$ right. "e-t we have the <an!ing 9ivision and the% deal with loans$ s%ndicated loans$ pro*ect finance$ overdrafts$ documentar% credits and correspondent ban!ing. Inter$ieer: I see. Adam: +e)re ver% active in the mar!ets and so therefore we have a 9ealing 9ivision. #he% cover foreign e-change$ currenc% options$ mone% mar!et transactions$ bonds$ floating rate notes$ Eurodollar C9s$... Inter$ieer: C9s4 Adam: Certificates of 9eposit. Inter$ieer: Oh$ I see. :es. Adam: C9s$ financial futures and bullion. #hen there)s our Corporate >inance 9ivision which has e-panded 6uite rapidl% over the last couple of %ears. #he% provide advice to a large number of 8U and international companies. #he activities of the Corporate >inance 9ivision include mergers$ ta!eovers$ ac6uisitions and divestments$ as well as stoc! mar!et and 8S; flotations in Dondon$ and of course capital raising. ..1 Inter$ieer: I see. Adam: +e also have an Investment ;anagement 9ivision which provides services to companies: pension funds$ investment trusts$ unit trusts and offshore funds. 2nd finall% there)s a Deasing 9ivision which organi5es leasing pac!ages for lessors and lessees. +ell$ that)s who we are$ and what we do. I thin! that sums it up. Voca%ulary Merchant %anka ban! concerned with the financing of international trade. 2nterestpercentage of the capital paid b% a borrower to a lender. 5ccounting and auditthe !eeping of financial records and their periodic e-amination. (yndicated loans a ver% large loan for one borrower$ arranged b% several ban!s. Overdraft mone% overdrawn on a ban! accounts to agreed limits. Correspondent %anking- activities where one ban! acts as an agent for another ban!. To deal to trade$ bu%$ sell. *eal business agreement. Bonds documents promising to pa% sums of mone% at specified times. 8loating rate note note on which interest rates are fi-ed periodicall% and which can be traded on the mar!et. 8inancial futures contracts to bu% or sell currencies$ bonds$ bills at a stated price at some future time. To merge to *oin together. Merger the *oining of two or more companies into one. Takeover the bu%ing of a ma*orit% of the shares of a compan%. *ivestment the sellingoff of interests. >.(.M flotation the starting of a new limited compan% where the shares are not included in the official list on the Stoc! E-change. >nit trust an organi5ation which collects and pools mone% from man% small investors and invests it in securities for them. Offshore fundsmone% placed in countries with ver% low ta-es. .easecontract for renting propert% or e6uipment for a period of time. .esseeperson who pa%s for a lease. .essor person who receives mone% for a lease. L Match the term" M7053N ith the ri#ht definition&2#'. 1. merchant ban! ,. clearing ban! .. wholl%owned subsidiar% /. accounting and audit 0. s%ndicated loan 1. overdraft =. documentar% credit ?. correspondent ban!ing G. currenc% option 1H. bonds 11. floating rate note ..= 1,. Eurodollar C9 1.. financial futures 1/. merger 10. ta!eover 11. divestment 1=. 8S; flotation 1?. investment trust 1G. unit trust offshore funds ,H. offshore funds 2. #he sellingoff of interests. <. 2 ver% large loan for one borrower$ arranged b% several ban!s. C. ;one% overdrawn on ban! accounts to agreed limits. 9. 9ocuments promising to pa% sums of mone% at specified times. E. ;one% placed in countries with ver% low ta-es. >. #he *oining of two or more companies into one. F. 2 ban! which is a member of a central organi5ation through which che6ues are presented for pa%ment. 3. 2ctivities where one ban! acts as an agent for another ban!. I. 2 contract where the bu%er has the right to demand purchase or sale of a specified currenc%$ but no obligation to do so. @. 2 ban! mainl% concerned with the financing of international trade. U. 2n organi5ation which collects and pools mone% from man% small investors and invests it in securities for them. D. 2 compan% entirel% owned b% another compan%. ;. 2 limited compan% formed to invest in securities. ". 2 method of financing international trade where the ban! accepts a bill of e-change from the e-porter for the invoice amount$ in return for receipt of the invoice and certain shipping documents. O. #he bu%ing of a ma*orit% of the shares of companies. (. Contracts to bu% or sell currencies$ bonds and bills$ etc. at a stated price at some future time. E. "ote on which interest rates are fi-ed periodicall%$ and which can be traded on the mar!et. C. 9ocument given for a deposit repa%able on a fi-ed date$ the currenc% being dollars which are deposited outside the 8S2. S. #he !eeping of financial records and their periodic e-amination. #. #he starting of a new limited compan%$ where the shares are not included in the official list on the Stoc! E-change. TEKT 8 Conald Sims describes the organi5ation of a Scandinavian Savings <an!. Ronald: In order to understand how we)re organi5ed$ it)s perhaps first necessar% to understand *ust what we are$ and that means a Savings <an!. #his has some important implications as to wh% we)re organi5ed the wa% we are. +e were the oldest and largest Savings <an! in the countr%. In 1GGH we merged with the two ..? largest regional Savings <an!s and effectivel% this now gives us a nationwide networ! of branches to serve the private customer. 3ead Office of course is here$ that)s in the central region$ and there are two other regional offices. #here)s a <oard of 9irectors$ which is elected b% the <oard of #rustees of the ban!$ and a ;anaging 9irector$ who has two 9eput% ;anaging 9irectors who are responsible to him. #he one 9eput% ;anaging 9irector is responsible for the branch networ! of offices$ and reporting to him are the three Cegional ;anagers$ for the northern$ central and southern regions. #he other 9eput% ;anaging 9irector is responsible for the Corporate <usiness 9ivision$ and the formation of this division$ reall%$ was one of the main ob*ectives of the merger: to pool our resources and to gain access to the lucrative mar!ets dominated b% the commercial ban!s. +e)ve still got a long wa% to go$ of course$ but we)ve turned from a Savings ban! which$ prior to 1G?H$ was not able to accept deposits in e-cess of the e6uivalent of ten thousand dollars$ because of the regulations$ into a commerciall% competitive ban! which last %ear$ for instance$ granted an international debenture loan of fort% five million dollars and which had a loan portfolio fift% per cent of which$ in terms of volume$ related to corporate customers. 2nd we)ve done this virtuall% from scratch$ building up our client list of small and mediumsi5ed companies$ establishing and e-panding worldwide correspondent ban!ing relationships$ and$ of course$ ma!ing ma*or investments in terms of personnel and technolog%. In our case$ the new organi5ation structure was ver% necessar% for us to be able to broaden the scope of our activities. >ocabulary (avings %ank ban! where %our mone% earns interest. Trustees people responsible for administering mone% or propert% for the benefit of others. .ucrative markets mar!ets in which there are good profits. Commercial %anks ban!s which offer a wide range of services to the public$ to companies . *e%enture loan loan of mone% at a fi-ed rate of interest$ involving a certificate of the debt. .oan portfolioan entire collection of loans. To %roadento increase$ to e-tend. Corporatereferring to the whole compan%. Companya registered business To invest to put mone% into a ban!$ building societ%$ shares or other pro*ect in order to earn interest. 2nvestment mone% put into a ban! or pro*ect with the intention that it should increase in value. (afe investment nonris!% investment What can you "ay in"tead of the folloin# ord": ..G Mset up in 1GGH Mban! set up to accept deposits from members of the public. M*oined together. Ms%stem of local offices over the whole countr%. Mpeople responsible for administering mone% or propert% for the benefit of others. Mmar!ets in which there are good profits. Mbefore Mban!s which offer a wide range of services to the public$ to companies and other organi5ations. Mmore than Mloan of mone% at a fi-ed rate of interest$ involving a certificate of the debt. Man entire collection of loans. Marrangements with ban!s who act for each other. Mpeople who wor! here. Mincrease the range or e-tent of our operations. /an! performance <an!s necessaril% use sophisticated accounting s%stems to record as clearl% as possible what the financial situation of the ban! is. "ormall% such a s%stem is based on the principle of the double entr%$ which means that each transaction is entered twice$ as a credit in one account and as a debit in another account. If we deposit Z1HH with a ban!$ for e-ample$ the ban! enters a debit for the receiver and a credit for the giver. #he former represents an asset to the ban!$ since it is a sum of mone% at the ban!)s disposal$ as well as a liabilit%$ since it will one da% have to be repaid. #he balance sheet of a ban! gives us a view of its financial situation at one point in time$ usuall% .1 9ecember of a particular %ear. <ut we do not !now what has happened between two balance sheets. #his information is provided b% the profit and loss account for the period in 6uestion. "either statement is e-actl% uniform from ban! to ban!$ but both contain certain essential features. #he largest asset of a ban! is normall% its total portfolio of loans. 9eposits usuall% constitute the largest liabilit%. <alance sheets usuall% include the following items listed as assets: L Cash on hand and due from ban!s mone% in vaults$ balances with other ban!s$ che6ues in process of collection. L Investments bonds$ shares$ etc. L Doans to companies$ the general public$ etc. L >i-ed assets buildings$ e6uipment$ etc. Items listed in the balance sheet as liabilities are: L 9eposits all mone% owed to depositors L #a-es pa%able national and local L 9ividends pa%able decided on$ but not %et paid #he profit and loss account records the income of a ban!$ and here$ t%picall%$ the items in order of si5e are: L interest on loans ./H L return on investments L fees$ commissions$ service charges #he granting of credit provides the largest single source of ban! income. #%picall%$ two thirds of an 2merican commercial ban!)s %earl% earnings result from interest on loans. "ine out of ever% ten dollars the% lend come from depositors) funds. #he following items normall% constitute the main e-penses in a ban!)s profit and loss account$ again in t%pical order of si5e: L interest paid L salaries and other benefits L ta-es 2 ban!)s accounting s%stems$ then$ are designed to record and present the man% transactions that ta!e place ever% da%. Substantial reserves over and above statutor% re6uirements are an indication to customers of the ban!)s strength$ that it has run its business well and has retained profits in the business for future operations. (rofitabilit% indicates the effectiveness of a ban!)s performance and how well it has managed the resources under its control. (ublished figures thus provide some essential data on the li6uidit%$ safet% and income of a ban!. TEKT C Pre"enter: <ill Civer gives an informal presentation of his ban! to a prospective client. /ill:I have here a cop% of our last annual report for %our reference which %ou)ll probabl% want to loo! through later. <ut I can give %ou right now a ver% brief overview of our last %ear performance. Client: #hat)s o.!. /ill: 2s of @anuar% .1st 1GG/$ the Dace% <an! Corporation was the fifth largest ban! in the 8nited States$ based on stoc!holders) e6uit%$ and si-th largest based on deposits. #his ban! has over one thousand two hundred offices around the world with some fourteen thousand emplo%ees spread over thirt%five foreign countries. 2nd within this worldwide framewor! we are offering a wide range of financial services to a ver% diverse customer base which includes corporate clients$ government agencies and correspondent ban!s. In 1GG/ we achieved record earnings coupled with our tenth consecutive %ear of profit growth in what is$ as %ou !now$ an intensel% competitive environment. Consolidated net income was five hundred and fift% million dollars$ ten per cent up on 1G??$ and this was the second %ear that our net income reached the half billion dollar mar!. 2 part of the ban!)s polic% is to maintain a strong capital base and at the end of 1GG/ our total assets amounted to over si-t%five billion dollars. +e hold deposits of around thirt%seven point eight billion dollars and net interest income alone in fiscal GH was one point nine billion dollars. In addition$ we hold two point two billion dollars) worth of investment securities. "et income$ the net income per share for the period was five dollars si-t%five. +e thin! it was a good %ear and we are proud of it. >ocabulary ./1 Overviewdescription (tock6uantit% of goods for sale$ inventories. (tockholdersH e=uitybased on mone% received from the sale of the parts into which the capital of a compan% is divided. *epositsums of mone% left with the ban!. Corporate clients compan% customers. Correspondent %anks ban!s in other countries with whom we have an agenc% relationship. To earnto receive mone% for wor! ,arningssalaries$ profits$ dividends$ interest received. ,arnings per share dividends per share shown as percentage of the mar!et value of a share. 2ncomemone% received through operations or investment ,arned income mone% earned through wor!. Consolidated net incomethe annual income of the group of companies after the pa%ment of costs. 5ssetssomething of value which is owned b% a compan% Current assets assets in dail% use b% a business. 8i'ed assets propert% and machiner% 8ro)en assets assets which cannot be sold. 2ntangi%le assets assets which cannot be seen. .i=uid assets cash or bills which can be easil% converted into cash. Tangi%le assets assets which can be seen. (ecurities investments in stoc!s and shares. (ecurity guarant% that a debt will repaid. The securities market place where shares can be boughtBshould. 2nvestment securities placement of mone% in shares to produce profit. Try to find the meanin# of the folloin# ' Ma very short general description. Isums of money left with the %ank. Imoney received from the sale of the parts into which the capital of a company is divided. Iit includes company customers. I%anks in other countries with whom we have an agency relationship. Ithe highest ever profits after transfers to reserves. Ithe tenth year in a row of profit growth. Ithe annual income of the group of companies after the payment of costs. Ithe value of all the things we own. Ithe financial year. Iplacements of money in shares so as to produce profit. Mthe last report presented each year giving details of the companyHs activities and financial performance during the previous financial year. ./, TEKT D ;a- (rone% gives some information about his ban! to a group of professional visitors from abroad. MaB: +e have a diagram which gives a ver% brief summar% of some of the !e% figures relating to our performance in 1GG/. +e)ll be meeting these figures again later in greater detail$ but it ma% be useful at this stage to present them and to indicate a number of important trends. If we begin with income then$ %ou will see that the total group income amounted to a record level of one hundred and fift%five million pounds$ an increase of nearl% fifteen per cent on the previous %ear$ a rate of increase slightl% above that of recent %ears. Interest received amounted to si- hundred and fifteen million pounds$ and interest paid to five hundred and si-teen million$ leaving us with a net interest income of ninet%nine million pounds. #his is eleven per cent up over the 1G?G figure and represents si-t%four per cent of the total group income for 1GG/. #he net interest income is 6uite satisfactor% in itself$ given the ver% difficult mar!et conditions$ but what is especiall% significant is the increase in noninterest income from fort%si- to fift%si- million pounds$ an increase of some twent%two per cent. 2 ver% important part of the ban!)s polic% lies in limiting dependence on net interest as a source of income and in developing its fee and commission earning activities$ and 1GG/ income in this area accounted for a two per cent higher contribution to total income than was the case in 1G?G. #his is an encouraging trend$ as it reflects the ban!)s response to the changing economic environment in general and to the sensitivit% of interest rates in particular. "oninterest income then of fift%si- million pounds$ ma!ing the total income for the %ear of one hundred and fift%five million pounds$ twent% million pounds higher than the previous %ear. >ocabulary Trendsgeneral development in a mar!et$ business. 2ncomemone% received through operations or investment. ,arned income mone% earned through wor!. >nearned income mone% received from investments. Net interest incomethe amount b% which the total interest received is higher then the total interest paid during the period. -ey figures the most important figures. "ate charge for service or wor! or for loans. 1oing rate mar!et price. ./. To run to manage$ to organise. "unning operating$continuing$consecutivel%. MChoo"e the %e"t an"er* 1 2 brief summar% is: a' a small amount of something7 b' several numbers added together to ma!e a total7c' a short report of the main points7 d' a full report with details. , Ue% figures are: a' figures that are eas% to understand7 b' the most important figures7 c' figures that give an answer to a problem7 d' figures that are well!nown. . #rends are: a' movements or directions7 b' goals that %ou tr% to reach7 c' events that are li!el% to happen7 d' events that happen 6uite often. / 2 record level of income is: a' an amount that will never be reached again7 b' an amount that is written down so that it will not be lost or forgotten7 c' an amount that sta%s the same and does not go up or down7 d' a higher amount than ever before. 0 "et interest income is: a' the amount b% which the total interest received is higher than the total interest paid during the period7 b' the amount b% which the total interest received is lower than the total interest paid during the period7 c' the total interest received b% the lender7 d' the amount earned on an investment after pa%ing for its capital cost. 1 Something which is especiall% significant is: a' the onl% one of its !ind7 b' the ver% best of its !ind7 c' important and worth noting7 d' widel%!nown and accepted. =.>ee and commission earning activities are: a' the bu%ing and selling of currencies for profit7 b' plans to lend mone% profit7 c' services that are sold b% an agent7 d' services for which charges can be made. ?.2 contribution to total income is: a' a fi-ed amount of mone% paid at regular intervals7 b' mone% that is owed or pa%able7 c' an amount of mone% that is ta!en awa% from the total. d' an amount given or supplied. G.#he economic environment is: a' an area of the econom%7 b' the future of the econom%7 c' the economic situation7 d' financial laws and regulations. 1H.#he sensitivit% of interest rates is: a' the wa% in which interest rates affect each other7 b' the wa% in which interest rates are easil% influenced or affected7 c' the changes in interest rates7 d' the wa% in which interest rates are wor!ed out. .// TEKT E #he presentation continues: MaB: +e)ve seen the income7 let)s now loo! at the outgoings. #he largest of these is staff costs which increased b% ten million pounds$ or eighteen per cent$ to si-t%five million pounds in 1GG,. #his increase is larger than in previous %ears and is partl% due to the increase in staff numbers needed to handle the e-pansion of the ban!)s feegenerating activities which I have *ust mentioned. (rovisions for doubtful debts increased to eight million pounds. 9epreciation on leased assets and on premises and e6uipment$ calculated on a straight line basis$ amounted to fifteen million pounds. Other e-penses increased b% a little under seventeen per cent$ from twent% four million to twent%eight million pounds$ the smallest annual increase since 1G??$ which I thin! illustrates our determination to !eep costs under control. #a- not much to sa% there reall% other than to note that we paid five million pounds$ or twent%five per cent more than in 1G?G$ ta!ing us$ in fact$ up to twent% five million pounds. 9ividends remained unchanged over the previous %ear at five million pounds$ as the ma*or part of the %ear)s profit was retained to e-pand our consolidated capital base. Our balance sheet footings have been growing steadil% over recent %ears and this was in fact the first %ear in which the% passed the three billion pounds mar!. 2fter allocation of the dividends$ there remained a net undistributed balance for the %ear of nine million pounds which was transferred to reserves. >ocabulary! Outgoingsamount of mone% spend. (taf costsmone% involved in pa%ing emplo%ees. 8ee generating activitiesservices for which charges can be made. *epreciation on leased assets the decline in value of propert% which is hired. 3remisesbuildings and the land on which the% stand. ,'penses mone% spent on the running of the ban!. *ividents the part of the compan%)s profits which is paid to the shareholders. "etained!ept b% the compan% and not paid to the shareholders. 8ootingstotals. To allocate togive mone% in certain proportions 5llocation setting aside mone% for. >ndistri%uted %alance amount of mone% !ept b% the compan% and not paid to shareholders. "eservesamount of mone% set aside from profits for a special purpose. To grow to become larger. To transfer tom ove from one place to another. Transfer pricing ad*ustment of price son sales made between parts of a multinational compan%. M -ote don hat you thin! it can %e "aid in"tead of the ord" in italic". 1 ... let)s now loo! at the &amount of money spent' , #he largest of these is... &money involved in paying the employees' ./0 . ... to handle the e-pansion of the ban!)s &services for which charges can %e made' /. AAAA. increased to eight million pounds ... &money put aside to cover possi%le credit losses' 0. AAAA.&the decline in value of propert% which is hired' and on..... and e6uipment ... &%uildings and the land on which they stand9 1. Other increased b% ... &money spent on the running of the %ank' =. ... the smallest increase ... &yearly' ?. AAAAAremained unchanged ... &the part of the companyHs profits which is paid to shareholders9 G. Aas the ma*or part of the %ear)s profit wasAA. &kept %y the company and not paid to shareholders9 1H. Our balance sheetAAAA. &totals' 11. 2fterAAA. of the dividends ... &setting aside money for' 1,. Athere remained a netAAAAA &amount of money kept %y the company and not paid to shareholders'. 1.. Anine million pounds$ which wasAAAAA &moved over to funds put aside to cover une'pected events9. ?orei#n eBchan#e >oreign e-change dealing is$ as its name implies$ the e-change of the currenc% of one countr% for the currenc% of another. #he rate of e-change is the value of one unit of the foreign currenc% e-pressed in the other currenc% concerned. +ith the growth of global trade$ man% companies need foreign currencies to pa% producers in other countries. 2 <ritish compan% with a supplier in Ferman%$ for e-ample$ will probabl% use sterling to bu% 9eutschmar!s from its ban! in order to pa% an invoice from the Ferman compan%. #he ban! bu%s the 9eutschmar!s from another ban! at a particular rate and provides them to its customer at a higher rate$ thus ma!ing a profit. Similarl%$ a ban! ma% ma!e gains on bu%ing and selling currencies on the interban! mar!et. ;a!ing a profit on the transaction is the basic idea of foreign e-change dealing. Currencies can be bought or sold in the foreign e-change mar!et either for immediate deliver%$ that is at the spot rate$ or for deliver% later &e.g. two wee!s$ three months$ etc.' at a forward rate. #he forward mar!et is useful for companies$ since if a compan% !nows that it will need a particular foreign currenc% to pa% a bill in four wee!s) time$ for e-ample$ a forward deal enables it to protect itself against future adverse movements in the e-change rate which would have otherwise had the effect of ma!ing the foreign goods more e-pensive. +hen dealing in foreign e-change$ normall% b% telephone$ the ban! 6uotes both the selling and bu%ing rate of a currenc% at which it is prepared to transact business. Settlement for a spot transaction is two wor!ing da%s later. #hus if a contract is made on ;onda%$ the seller delivers the amount sold and receives pa%ment on +ednesda%. Similarl% if the contract is made on #uesda%$ value is #hursda%. Currenc% traded in this wa% is delivered to the bu%er)s account with a ban! in the main centre$ or one of the main centres$ for the currenc% in 6uestion. In the case of sterling$ for e-ample$ this is Dondon$ for 9utch guilders it is 2msterdam and ./1 Cotterdam$ and for <elgian francs it is <russels and 2ntwerp. #he bu%er decides the ban! where his or her account is to be credited. #he foreign e-change dealer fills in a dealing slip containing basic information such as the date and time of the deal$ the contracting part%$ the amount and rate agreed on$ the date of settlement$ and the place of deliver% of the currenc% dealt in. 2s soon as a foreign e-change transaction has been carried out$ both ban!s send a written confirmation containing the basic information mentioned above. 2n% discrepancies ma% thus be detected 6uic!l%. 2 ban! holding debts or claims in a foreign currenc% is itself e-posed to an e-change ris!$ unless the debts and claims neutrali5e each other b% being of e6ual si5e and b% having roughl% the same maturit% dates. 9ealers therefore aim for a balanced total position. If the amount of a ban!)s claims in dollars$ for e-ample$ is larger than the total debts in dollars$ then the ban! has a long position$ but if the debts are larger than the claims$ the ban! is short in dollars. 2s long as the total position balances$ there is no ris! for the ban!. TEKT G Uen +illiams e-plains some of the basic principles of foreign e-change dealing. Aen: +e)re accounted in sterling$ but generall% all dealings are based on the dollar. So$ for instance$ %our spot prices are dollar 9eutschmar!$ OU4 #hat)s the big mar!et reall%$ dollar 9eutschmar!. 2nd it)s the movement in the dollar which is reall% moving the mar!et. I mean$ for instance$ %esterda% the dollar rates firmed up a little. #he% went up about a si-teenth to an eighth of a per cent. So people bu% dollars because the interest differential between dollars and 9eutschmar!s is widening. So I mean$ if %ou bu% dollars$ OU$ %ou$ %ou can lend them out on the ne-t da% at$ sa%$ eleven and a half per cent. :ou)re short of 9eutschmar!s that da%$ and %ou have to purchase$ borrow those for one da%$ and that)s about five and a half per cent. So %ou)re tal!ing about si- per cent difference. #he basic idea of spot dealing is to bu% dollars low and sell high. #hat)s the basis of ma!ing a profit. Inter$ieer: So wh% would %ou need 9eutschmar!s on a particular da%4 :ou said %ou)d be short in 9eutschmar!s so %ou)d have to borrow them. Aen: +ell$ to s6uare the account for that da%. +e)re dealing ahead all the time. #he spot mar!et is dealing two wor!ing da%s forward. So$ for instance$ if I bought dollars against 9eutschmar!s$ I would come in tomorrow and find that on the seventeenth I)m short in 9eutschmar!s and long in dollars. So then I would go into the mar!et and sa% T+hat)s %our tomBne-t dollar mar!4) Inter$ieer: +hat)s %our what4 Aen: #omBne-t dollar mar!. #he%)re dealing terms$ OU4 +e have spot which is normal bu%ing and selling of currencies. #hen we have a tomBne-t. "ow a tomBne-t simpl% means tomorrow to the ne-t da%. #hen we have a spotBne-t which is %our two da%s) forward dealing value date to the ne-t da%. #hen %ou have a spot a wee!$ a spot a fortnight. #hen %ou go one$ two$ three months and so on. +e also have outrights. So someone can as! T+hat is %our spot dollar mar! outright tomorrow4) It)s *ust that %ou)re 6uoting a spot rate but it)s from tomorrow$ ./= and %ou ad*ust the price$ depending what the price is for the tomB ne-t swap. It)s alwa%s$ it)s alwa%s relative to the two da% forward dealing rate. Inter$ieer: So the ... %eah$ %eah$ OU. I don)t$ I don)t see what an outright is. Aen: +ell$ an outright is simpl% ... we also have the term swaps$ in forward dealing which is when %ou lend one currenc% and borrow another for a certain period time. #here are two related contracts$ one sale and one purchase$ and %ou)re ta!ing into consideration different interest rates$ trading on the movement in two currencies. <% using a simple calculation these swaps can calculate into another currenc%)s deposits$ so that the relationship between the two currencies determines the forward pricing. "ow an outright is if someone wants to bu% 9eutschmar! and sell dollars on an% particular da%. It)s not$ it)s not connected to a corresponding spot transaction. Sa%$ for instance$ two month)s time$ a compan% has to cover its 9eutschmar! pa%ments$ so the% cover their foreign e-change e-posure b% bu%ing 9eutschmar!s from tomorrow to that da%. So the% would ring us and sa% T+hat is %our price spot dollar mar! outright to the tenth of October4) 2nd that is an outright. (resenter: So now we !now a little about the principles and terminolog% of foreign e-change dealing. >ocabulary! (pot prices prices for funds which will be e-changed two wor!ing da%s later. To firm upto increase. 2nterest differencialdifference in interest rates. #o purchase to bu%. 3rofita result where the income is higher than the costs. To s=uare to balance. (pot a fortnight a period of two wee!s beginning two wor!ing da%s from now. Outrights deals where someone bu%s one currenc% and sells another on an% particular da%. To =uote to state the price that %ou will charge for a spot rate. (wap an e-change of one currenc% for another$for a certain period of time. *eal a business agreement. To deal to bu% and sell. L Write don the ord" that are u"ed in place of tho"e printed in italic"* 1. +e)re accounted in &British pounds.9 ,. So$ for instance$ %our& prices for funds which will %e e'changed two working days later' are dollar 9eutschmar!. .. I mean$ for instance$ %esterda% the dollar rates &increased slightly'. /. So people bu% dollars because the &difference in interest rates' between dollars and 9eutschmar!s is &increasing'. 0. :ou)re short of 9eutschmar!s that da% and %ou have &to %uy'$ borrow those for one da%... 1. #hat is the basis of ma!ing &a result where the income is higher than the costs'. =. +ell$ &to make totals e=ual& to %alance' the account for that da%. ./? ?. AA.and find that on the 1=th that I am 7in a position where 2 have sold more *eutschmarks than 2 have %ought& and %ought more dollars than 2 have sold.9 G. #hen %ou have spot a wee!$& a period of two weeks %eginning two working days from now.9 1H. +e also have &deals where someone %uys currency and sells another on any particular one day'. 11. It)s *ust that %ou)re &stating the price that %ou will charge for' a spot rate. 1, ... depending what the price is for the tomBne-t &e'change of one currency for another$ for a certain period of time.9 1. ... so that the relationship between the two currencies &fi'es& decides' the forward pricing. 1/ ... so the% cover their foreign e-change &risk or possi%ility of loss' b% bu%ing 9eutschmar!s Meetin#" <an!s provide a wide variet% of services to companies$ and a compan% operating internationall% is li!el% to use several ban!s around the world to meet its various needs. <an!s !eep in touch with these customers b% telephone and perhaps with regular meetings$ to maintain the relationship and to mar!et new services. ;ost companies use ban!s at one time or another to finance their operations. 2s with an% other t%pe of loan$ ban!s charge interest on corporate loans. Interest rates for loans in <ritain$ for e-ample$ can be charged in one of three wa%s: L at a margin above the ban!)s base rate. Each ban! decides its own base rate$ and then charges the compan% a rate of interest which is related to this. 2 big customer with a ver% good reputation ma% be charged the ban!)s base rate plus H.0W$ for e-ample$ while a smaller compan% might be charged the base rate plus .W. L at a margin above DI<OC$ the margin again depending on the ban!)s assessment of the corporate customer. L at a fi-ed rate of interest for the period of the loan. #he first two wa%s are variable and are ad*usted periodicall% to reflect movements in interest rates on the mar!et. #he% ma% also be negotiable. #he third ma% be dangerous for the ban! when mar!et rates are erratic. 2 compan% involved in a business where income and e-penditure are sub*ect to constant changes needs a variable borrowing facilit%. #his is met most simpl% b% an overdraft facilit%. #he compan% opens an account with the ban!$ and an overdraft with a specified limit is granted on the account. ;an% companies ma!e a profit not onl% from the goods or services which the% sell$ but also from the mone% that the% have. Cash managers utili5e funds at their disposal$ bu%ing and selling shares$ treasur% bills and so on$ to generate profit in the form of investment income. Cather than move valuable foreign shares and securities around the world b% post$ a compan% will deposit them for safe !eeping with a ban! in the foreign countr%. 2 compan% in Sweden which bu%s shares on the 2merican mar!et$ for e-ample$ will use the custodian services of a 8S ban!. <an!s naturall% charge fees andBor commissions for custodian services. ./G TEKT 2 Pre"enter: Simon Stillman meets Oliver Cichardson . Simon: Could we ta!e up the 6uestion of the interest rate charged for this overdraft facilit%4 .li$er: :es$ of course. Simon: It seems to be rather high: one per cent over +allers base rate. >irst of all$ what is the base rate4 .li$er: It)s our basic lending rate which at the moment is eleven per cent. Simon: :es$ I see. It)s more or less the overnight rate$ then$ as I understand it$ %our base rate. .li$er: :es. Simon: <ut a mar!up of one per cent seems rather high. 2s %ou !now$ we wor! with a lot of ban!s$ and$ 6uite fran!l%$ one per cent is *ust too e-pensive for us. .li$er: :es$ I see. Simon: I thin! %ou)ll have to thin! about this$ Oliver$ because we)re not interested in having the facilit% if it is going to be so e-pensive for us to use it. +e wor! with Ue% Commercial <an! too$ and *ust for %our information there we pa% 5ero point two per cent above DI<OC$ more or less the same as +allers base rate. .li$er: +hat !ind of reduction did %ou have in mind4 Simon: +ell$ a margin more in line with what we can get from the other ban!s. Sa% 5ero point two five per cent above %our base rate. .li$er: Yero point two five. Simon: :es$ at the ver% highest. +e)d be prepared to pa% that little bit e-tra simpl% to maintain our wor!ing relationship. <ut one per cent is *ust too high for a compan% li!e 9enavian. .li$er: :es$ the... Simon: <% the wa%$ I haven)t told %ou$ but it could be useful for %ou when %ou ta!e this up in the credit committee in the ban!. +e have been rated now b% 2libright and Cich$ and for shortterm debt we have 2 one plus$ and as %ou !now that)s the best %ou can get. .li$er: #hat)s credit rating4 Simon: :es$ credit rating$ and for the longterm we have triple 2. 2nd that)s also the best. #here)s no ris! involved for %ou$ so one per cent for the overdraft facilit% ... we)d reall% li!e %ou to review that. .li$er: >ine$ I)ve made a note of it. I)ll ta!e it up when I get bac! to Dondon$ and I)ll get in touch with %ou. 2ll right4 Simon: :es$ do that. #hen %ou can confirm it. If it)s positive. Otherwise$ there)s not much point in us !eeping this facilit%. >ocabulary: Overdraft amount of mone% which a person or compan% withdraws from a ban! account and which is more than is in the account. Overdraft facility arrangements with a ban! for an overdraft to a certain limit7 Overnight ratethe rate of interest charged for a loan at call from one da% to another. Mark-up the gross profit margin or an increase in price. .0H Margin the relation between profit and selling price. .i%orDondon Inter<an! Offered Cate$ the rate of interest between Dondon ban!s on some deposits. Credit committee a group of ban! staff who control the lending of the ban!. Credit rating a formal and detailed e-amination of the financial strength of a compan%. To confirm to give agreement. *e%t mone% owed. =Match the words with the correct definition! 1' credit rating$ ,' confirm$ .' overnight rate$ /' credit committee$ 0' review$ 1' overdraft facilit%$ =' DI<OC$ ?' mar! up$ G' margin$ 1H' 6uite fran!l% a. the rate of interest charged for a loan at call from one da% to another. b. a ban! service providing for borrowing on current account up to an agreed ma-imum limit. c. the gross profit margin or an increase in price. d. honestl% and directl%$ without wishing to hide an%thing. e. Dondon Inter<an! Offered Cate$ the rate of interest between Dondon ban!s on some deposits. f. the relation between profit and selling price. g. a group of ban! staff who control the lending of the ban!. h. a formal and detailed e-amination of the financial strength of a compan%. i. to loo! at or e-amine again. *. to give agreement. .01 ?inancial ne" ;odern information technolog% has led to news being transmitted worldwide 6uic!er than ever before. #ime differences around the world mean that financial news is being made twent%four hours a da%$ and it is this barrage of readil% accessible information that serves as a basis for man% of the business decisions that are made concerning international ban!ing and financing. #echni6ues of anal%sis are applied to information to determine its implications and to tr% to discern trends in the future. ;an% prices are determined b% a comple- interaction of factors. +ith regard to currencies$ it ma% be said that one factor governing prices is the interaction of suppl% and demand. Interest rates prevailing in different countries affect currenc% e-change rates. If interest rates rise in the 8U for e-ample$ 8S investors ma% move funds to the 8U to earn higher interest income. #he% will then sell dollars for sterling$ and the demand for sterling will rise$ while at the same time the suppl% of dollars will rise too. #he dollar will thersfore fall in value$ while the price of sterling will rise. #rade between countries ma% also affect currenc% rates. If$ sa%$ @apanese e-ports to Ferman% rise$ and Ferman e-ports to @apan remain the same$ there will be an increase in the suppl% of 9eutschmar!s as @apanese e-porters sell them for dollars. #his will normall% increase the value of the :en in relation to 9eutschmar!s. Fovernment intervention ma% also affect e-change rates. If sterling is wea!$ for instance$ the <an! of England ma% enter the mar!et to bu% sterling with some of its reserves of other currencies. #his will reduce the suppl% of sterling$ thereb% increasing its value. Stoc! mar!et prices in a particular countr% are often affected b% stoc! mar!et prices elsewhere in the world$ and mar!ets tend to move together$ as indicated b% the worldwide crash in the autumn of 1G?=. #he share price of an% one compan% will obviousl% tend to be influenced b% the financial performance of the compan%$ details of which are released at various times during the financial %ear. #he factor of suppl% and demand mentioned ealier will also tend to affect commodit% prices. 2 bad coffee harvest in <ra5il will increase the price of coffee because demand will e-ceed suppl%. #he overproduction of oil$ on the other hand$ will lead to a fall in the price of the commodit%$ since there will be a glut of oil available on the mar!et. TEKT H Pre"enter: #he financial news headlines$ and more detailed news of the currenc% mar!ets. -e"reader: 3ere is the >inancial "ews$ read b% ;argret Sinclair. #he dollar recovered after a wea! start. #he pound strengthened. Fold was slightl% stronger$ and silver slightl% wea!er. Dondon share prices were stead%$ but "ew :or! prices drifted down. 2 surve% published in Dondon %esterda% states that over the past five %ears trading on the world)s foreign e-changes has more than doubled in si5e. It estimates that >ore- volume now stands at almost fift%five thousand billion dollars a %ear. Dondon remains the leading centre$ with nearl% fift% billion dollars traded here ever% da%. 9espite increasing competition from the >ar Eastern mar!et$ "ew :or! is in second place and Yurich third. .0, In the European foreign e-changes the dollar closed %esterda% little changed$ after recovering from earl% wea!ness. #rading was thin$ with dealers waiting for 8S economic indicators due on >rida%$ when 8S consumer prices and durable goods orders will be released. In Dondon the dollar closed at two mar!s si-t%three point seven pfennigs$ and later in "ew :or! at two mar!s si-t%three point nine. #hat)s a gain of two and three 6uarters on the previous close there. In #o!%o toda% the dollar slipped bac! a little$ ending at two hundred and fifteen point eight five %en$ against a previous close of two hundred and si-teen point two. Some selling b% the <an! of @apan was noted$ but the dollar was helped b% the covering of short positions. #he pound %esterda% was stronger against most currencies$ aided b% firmer spot oil prices. In the latest currenc% prices in Dondon this morning$ the pound is at one dollar fort%four point five cents$ that)s one and a 6uarter cents up on the closing price %esterda%. #he Ferman mar! is two mar!s si-t%three point eight pfennigs to the dollar. #he Swiss franc is unchanged at two francs si-teen point si-. #he >rench franc is eight francs fort%$ and the 9utch guilder is wea!er at two guilders ninet% seven point five. #he @apanese %en is unchanged at two hundred and fifteen point eight five %en to the dollar. Pre"enter: So now we !now about the currenc% e-change rates for the da% in 6uestion. >ocabulary! To recover to get better after a downturn. (urveya report based on inspection. To drift to fall slightl%. 8ore' volume the volume of foreign e-change. 1ain an increase in volume. To slip %ack fall slightl%. Choose the one best answer 1. 2f prices drifted down they: a' fell heavil%7 b' fell slightl%7 c' fell 6uic!l%7 d' rose then fell. ,. 5 survey is: a' a report based on inspection7 b' a document that describes what is e-pected in the future7 c' a detailed description of goods7 d' an official list of things or events. .. 8ore' volume is: a' a sum of mone% that is borrowed7 b' a sum of mone% that is invested7 c' the volume of mone% in a countr%7 d' the volume of foreign e-change. /. 2f trading was thin: a' bu%ing and selling was not ver% successful7 b' there was a lot of bu%ing and selling7 c' there was not much bu%ing or selling7 d' there was no bu%ing or selling at all. 0. >( economic indicators are: .0. a' the inde- of retail prices produced b% the 8S government7 b' figures that show the difference between the amount of mone% flowing into and out of the 8S27 c' figures dealing with economic activities in the 8S27 d' the total amount of mone% that other countries owe to the 8S2. 1. >( consumer prices are: a' a list of prices to be paid for goods imported into the 8S27 b' the inde- of retail prices produced b% the 8S government7 c' the prices charged for goods e-ported from the 8S27 d' the prices charged for 8S dollars e-pressed in the mone% unit of another countr%. =. *ura%le goods orders are: a' orders for goods which are intended to be used over a period of time7 b' orders for goods which are used up soon after the% are bought7 c' orders for an% t%pe of goods7 d' orders for goods to be e-ported. ?. 2f information is released& it: a' is for sale7 b' is !ept secret from the public7 c' is made !nown to the public7 d' is written down and recorded. G. 5 gain is: a' a change in value7 b' an increase in value7 c' a fall in value7 d' a value that sta%s the same. 1H. 2f the dollar slipped %ack a little& it: a' fell slightl%7 b' fell une-pectedl%7 c' fell 6uic!l%7 d' rose then fell. 11. The covering of short positions is: a' ban!s bu%ing a currenc% because the% had previousl% sold more than the% had bought7 b' ban!s selling a currenc% because the% had previousl% bought more than the% had sold7 c' ban!s bu%ing and selling currencies so as to ma!e a profit7 d' ban!s bu%ing a currenc% and selling it soon. 1,. 2f the pound was aided %y firmer spot oil prices& it was: a' helped b% higher spot oil prices7 b' not helped b% higher spot oil prices7 c' helped b% lower spot oil prices7 d' not helped b% lower spot oil prices. TEKT 73 Pre"enter: "ow we will hear news relating to companies and stoc! mar!ets. -e"reader: #he compan% headlines toda% are that Dewhill is to open a thirt% million pound production centre in <irmingham. It will emplo% around fifteen hundred people. +elb% Engines have landed a twent%five million pound order from 2ir #e-as$ and the latest bid for <asterfields b% the Canadian giant Farvin has been re*ected. On the interim results front$ Du-don)s third 6uarter profit of three hundred thousand pounds came as a setbac!$ after first half profits of two and a half million pounds. 2nother compan% reporting was >isher 3ogg$ who pleased the mar!et$ however$ with a fift% per cent profits rise compared with last 6uarter. On the Dondon stoc! mar!et %esterda%$ shares remained close to last wee!)s record highs. >inancial and discount houses were a firm sector$ with 8nited 2lverson advancing twent% pence to seven pounds si-t%eight. <an!s too made further gains$ and Ue% Commerce rose twelve to si- sevent%si-. .0/ 2mong the other features$ 2inscough and Dee were up nine at four thirt% seven on bid hopes$ and Sheldon *umped thirt% to two fort%five on their ;onda% sale of their Euinton sta!e. 3ale and Owen stuc! at two oh four$ despite reporting treble interim profits which in fact conceal a setbac!$ if one disregards the proceeds from the sale and leasebac! of their <irmingham head6uarters. <err% Sugar were down eight at one sevent% one$ on doubts about the commodit% price. On +all Street on #uesda%$ leading stoc!s were moderatel% firmer$ though the mar!et was mi-ed. >alling stoc!s outnumbered rising ones b% seven hundred and ninet%eight to seven hundred and twent%eight$ on a moderate volume of one hundred and one million shares. <onds were strong. In #o!%o toda% there were heav% falls for man% shares$ especiall% among the mar!et leaders. 3ong Uong shares slipped bac! a little. In 2ustralia$ shares fell sharpl% across the board although trading was subdued. Pre"enter: Some specific news about <ritish companies and share prices there$ followed b% stoc! mar!et news from other parts of the world. (>ocabulary( Market place where products and services can be bought and sold. Capital market place where companies can loo! for investment capital. To land to succeed in obtaining. Bid price offered (et%ack diappointment and difficult%. On the interim results frontin the area of news dealing with the outcome of a compan%)s trading during onl% part of the %ear. (hares the parts into which the ownership of a compan% is divided. 8inancial and discount houses finance companies and finance organi5ations which bu% and sell bills of e-change. 5 firm sector an area of business activit% tending to rise. Bid hopes hopes of an offer to bu%. To conceal to hide. *ou%t uncertaint%. Commodity price price of the raw material. Bonds documents promising to pa% sums of mone% at specified times. To fall across the %oard to move downwards suddenl%. Trading was su%dued there was a lot of bu%ing and selling. Write don the ord" u"ed in"tead of tho"e in italic"' MMthe% have &succeeded in o%taining9 a ver% important order. MMthis is the latest& price offered' for Frandfields. II7in the area of news dealing with the outcome of a company's trading during only part of the year' Du-don]s third profit of N .HH HHH came as a & disappointment and difficulty'. MM&the parts into which the ownership of a company is divided' remained close to last wee!]s record highs. MM&finance companies and finance organi)ations which %uy and sell %ills of e'change' were an &area of %usiness activity tending to rise '. .00 MMon +all Street &maBor shares were slighty higher in price'. MM&documents promising to pay sums of money at specified times' were strong. MMin 2ustralia & all share prices moved downwards suddenly9 although &there was not a lot of %uying and selling'. TEST 070 LCho"e from the ord" in %rac!et" to complete the "entence"* 7Bank of ,ngland& %earer&%ase rate&(tock ,'change&stock& %ear& shares& %ond& %ull&asset9. 1.#he 2merican central ban! is the e6uivalent of ................ in <ritain. ,.#he units of ownership of a compan% allowing the holder to receive a proportion of the compan%)s profits are the ......... ..In the 8. U.a fi-ed amount of a paid up capital held b% a stoc!holder is a ............ /.If the mar!et is thought to be good and prices on the Stoc! E-change are thought to be li!el% to rise the mar!et is called a .........mar!et. 0.If the mar!et is thought to be poor and prices on the Stoc! E-change are li!el% to fall the mar!et is called a ..........mar!et. 1.2 promise to pa% a sum of mone% over an agreed time b% an%one licensed to do so such as a government insurance firm is a ..... =.Certificates of ownership of bond that can be tranferred from seller to bu%er without an% formalities are ...........bonds. ?.Something that is owned b% an individual or a compan% has monetar% value and can be sold to pa% debts is an ......... TEST05 LMatch the folloin# "entence" ith the ord" or phra"e" Ma0!N* 1.#he holder of these has lent the compan% mone% but has no voting rights. , 2 group of si- accountants have decided to form an association to carr% on business in common and ma!e a profit. ..#he investors give these people the power to run the compan% . /.#his compan% holds more than 0HW of the voting shares in another compan%. 0.;embers of the public can onl% invest in this compan% if the% are invited to do so. 1.Investments in man% companies can be made b% bu%ing shares on this mar!et. =.#he public at large can be shareholder in this compan%. ?.#he golf club was set up with the intention of not ma!ing a profit. G.>ift% one per cent of the voting shares of this compan% are held b% another compan%. 1H.#his is the meeting which is held once a %ear for the shareholders. .01 a.subsidiar% b.group c.nonprofitma!ing d.stoc! e-change e.partnership f.directors g.private limited h.debentures i.public limited *.holding compan% !.annual general meeting TEST080 Choo"e the correct an"er in each of the folloin#' 1.>unds coming into a firm are !nown as ................of funds. a.springs %.sources c.origination d.income ,.#he wa%s these funds are used are !nown as the ....................of funds. a.application %.delegation c.disposal d.consumption. ..................funds include mone% in our hands and in the ban!. a.working %.current c.profit d.cash /.+hen %ou ta!e awa% current liabilities from current assets %ou have the amount of .............funds. a.lia%ility %.working capital c.asset d.flow 0.>inancial statements about cash funds are usuall% !nown as.....................statements. a.cash flow %.cash resource .0= c.cash outflow d.cash loss 1.2n item which doesn)t involve flow of funds is ......................... a.sales of fi'ed assets %.drawings c.depreciation d.loan repayment =.2n item which involves flow of funds is............... a.provision for %ad de%ts %.%ook loss on sale of fi'ed assets c.sale of fi'ed asset d.%ook profit on sale of fi'ed asset. ?.2fter ma!ing ad*ustment for items which dont)t involve the flow of funds the net profit or loss is !nown as............... a.gross profit %. outflow of funds c. cash movements d.total generated from operations.. TEST0C0 L?ill in the mi""in# ord" in each of the folloin# "entence"*Cho"e from the alternati$e" %eneath each "entence' 1.#he <oard of .......is responsible for deciding on and controlling the strateg% of a corporation or compan%. a.workers %.directors c.control ,.Small businesses depend on investors providing .........capital. a.venture %.individual c.cooperative ..Investors are influenced b% the pro*ected.........on their capital. a.market %.return c.rate /.#he capital needed to run a business is provided b%............ a.gain %.risk c.investment D.Cent and rates which do not change as turnover volume changes ma!e up the...........costs of a compan%. a.fi'ed %.contri%ution c.varia%le 1.Ever% compan% must watch its...........carefull% if it is to avoid banrupc%. a.market managers %.cash flow c.production lines. =.#he..........account shows whether the compan% is profitable or not. a.profit and loss %.volume .0? c.shareholders J.<an!s re6uire.........to guarantee a loan. a.accounts %.shares c.securities @.Insurance companies ma% use .............to negotiate the amount of insurance to be paid. a.claim forms %.tariff companies c.insurance adBusters. ?G.#he Stoc! E-change deals with the purchase and sale of........... a.stocks and shares %.%ulls and %ears c.statements and invoices. TEST0D0 Choo"e the correct ord" from the folloin#' boo!!eeping$ interest$ creditor$ compan%$ profit$ current$ capital$ net$ shares$ debtor$ divident$ statement$ to complete the definition"* 1."ecording financial transactions is........... A.5 legal organisation&formally registered in one of three ways and having a life independent of its mem%ers is a ............ K.5 person or organisation that owes money is a................ L.5 person or organisation to whom money is owed is a..................... D.The assets&including cash& de%tors and stocks used in a companyHs trading availa%le at the present moment are its...................assets M.The e=ual parts into which the ownership of a company is divided are its.................. N.The money paid to shareholders out of a companyHs profits is the .................. J.5 companyHs turnover& less its cost of sales&is its gross...................... @.5 companyHs turnover after the cost of sales& ta'&rent and other lia%ilities are deducted is its.................profit. ?G.The sum of money paid %y a %orrower to a lender for the use of the lenderHs money is the.............on the loan. ??.The document send to the de%tor %y the creditor& showing how much is owed and for what& is the .............of account. ?A.The shareholdersH investment in a company is the share.............. TEST0E0 1. I have been re6uested to... a deposit a' leave b'let .0G c' put d' do ,. 2n I.O.8... a' is a small loan b' is the same as a che6ue c' is a bill e-change d' is a promise to pa% on the part of the debtor .. :our pa%ment is ... and %our account is now in the red. a' overtime b' overdue c' overta-ed d' overcome /. #he ban! does not want to lend me an% mone%. I shall have to go to the... a' borrower b' hireling c' pawnbro!er)s d' cashregister 0. Counterfoil is a s%non%m for... a' stub b' tic!et c' coupon d'draft 1. 2 bad che6ue ma% be referred to as a ... chec! a' red b' blac! c' dud d' void =. 2 bill of e-change is drawn up b%... a' the pa%er b' the debtor c' the creditor d' the drawee ?. +hen the acceptor stipulates some special condition$ the acceptance of a bill is said to be... a' particular .1H b' 6ualified c' speciali5ed d' peculiar G. 2 hire purchase transaction involves pa%ment b%... a' scattering b' instalments c' settlements d' periods 1H. #he contract provides for the ... to leave 1HW of the loan on deposit. a' lender b' depositor c' borrower d' creditor 11. ;ost foreign bills are pa%able .H$ 1H or GH da%s after... a' record b' sight c' fill in d' signature 1,. 9eeds of propert% ma% be ... as securit% for loans. a' hedged b' dredged c' pledged d' fledged 1.. :ou are supposed to give a few da%s)... before withdrawing the balance of %our deposit account. a' period b' dela% c' warning d' notice 1/. #he bill will ... due on @anuar% .Hth. a' fall b' come c' get d' reach 10. #he acceptor of a bill of e-change is the... .11 a' drawer b' lender c' pa%ee d' drawee 11. +hen ma!ing a deposit %ou have to fill in the... a' folder b' pa%inginslip c' application form d' statement of account 1=. <an!s collect ... and lend them out again. a' coins b' boo!ings c' savings d' ratings 1?. Owing to the credit ... it is increasingl% hard to obtain cash. a' s6uee5e b' loan c' bac! d' stop 1G. +e grant loans to our clients and arrange for ... facilities. a' overdrive b' overdraft c' overdone d' overpaid ,H. #he ... s%stem is the <ritish e6uivalent to the >rench Che6ues (ostau-. a' <iro b' Firo c' #iro d' <arrow Tran"late into En#li"h' 1. 2m vrea sa vP rugPm sP deschide^i un cont curent pe numele ;ateescu and Co. ,.Credeti ca putem sa deschidem un cont current pe numele Stanculescu and Co.4 .1, .. (entru a deschide contul$ ane-Pm un cec emis de banca Carpatica _n valoarea de ,HH.HHH HHH lei. /. 2cest cec _n valoare 0HH HHH HHH lei tras asupra btncii Carpatica va constitui depo5itul nostru ini^ial. 0.Vreau sa ane-e5 cecul meu in valoare de ,H HHH HHH lei$ plPtibil la ordinul dumneavoastrt. 1.Credeam ca `ti^i cP trebuie st plPti^i ta-e bancare pentru cecurile interna^ionale. =. (ute^i plPti prin cec$ ordin de platt sau cashier)s chec!. 2ceastP platP trebuie sP fie trasP asupra unei bPnci din S82. ?. (lata se va face prin transfer bancar. G. 2ne-Pm cecurile noastre _n valoare de 1HHHHHHHH lei$ ca platP corespun5Ptoare urmPtoarelor facturi... 1H. Da care bancP sunte^i4 11.Eu `tiu cP nu pute^i achita cecuri ftrt acoperire. 1,. (entru creditarea corectP am dori sP indica^i _ntotdeauna numPrul dumneavoastrP de cont. 1.. 2m aprecia dact a^i plPti imediat. 1/. Va rugum sP plPti^i astP5i$ deoarece procesarea cecului durea5P . 10.Cum dori^i sP plPti^i: _n numerar sau cu carte dc credit4 11 #rebuie sP andosati cecul pe verso inainte de al incasa or depune. 1=. VP cerem permisiunea st deptsim limita contulul nostru cu pant la = HHH N intre martie ,0 si iulie ,0. 1?. "ea^i face un mare serviciu dacP nea^i sus^ine _n acest moment. 1G. Contul dumneavoastrt este descoperit cu 1HHH N. ,H. Suntem de acord st vP aprobPm o depP`ire a contulul _n valoare de 0HH N panP _n martie anul curent. ,1. Suntem gata st vP acordPm un _mprumut$ cu condi^ia sP fie garantat. ,,. Va trebui st asigura^i garan^ii pentru acoperirea avansului. ,.. Suntem dispu`i sP fim garantul dumneavoastrt. ,/. Ca o garan^ie$ vP vom oferi titluri de valoare. ,0. Va rugPm st ne remite^i garantiile. ,1 9in cau5a tran5ac^iilor sale financiare dubioase$ iam blocat contul. ,=. "oi oferim credite clientilor nostri si le acordPm conditii avanta*oase de rambursare. ,?. Cata de ba5t &de referin^P' este rata pe care bPncile o aplicP celor mai solvabili clien^i. ,G. Ei nu au _ntocmit documente care sP preci5e5e condi^iile _mprumutului. .1. .H. Fraficul de rambursare este pre5entat in contractul de _mprumut. .1. Care este cursul de schimb al 5ilei pentru vuro _n raport cu dolarul S824 .,. Va oferim dolari la cel mai bun curs posibil . ... 2cestea sunt varia^ii ale cursului de schimb$ rata de ba5P$ cursul de schimb actual &curent'. ./ <ancnotele `i cecurile de cPlPtorie _n dolari S82 pot fi convertite _n lire dacP pre5enta^i pa`aportul la ghi`eul din col^. .0. (Pstra^i borderoul$ care vP va fi de folos pentru a schimba %enii _n moneda ^Prii dumneavoastrP la sfar`itul e-cursiei. .1 2gentul de schimb este cel care vP va spune cursul la care ve^i putea schimba valuta dumneavoastrP. .=. Cota^iile monedelor echivalente dolarilor S82 sunt doar apro-imative. (entru cursurile e-acte ar fi bine sP vP adresa^i bPncii dumneavoastrP. .?. (entru remiteri de fonduri _n alte valute decat dolari ve^i fi credita^i cu echivalentul valorii primite pentru remiterea dumneavoastrP. .G. 2lPturat vP trimitem cecul _n valoare de ?HHHN repre5entand plata corespun5Ptoare facturii ane-ate. 2m convenit suma datoratP$considerand cP la data plP^ii cursul de schimb pentru vuro era destul de ridicatP. /H.Vrem sP vP in`tiin^Pm cP cererea dumneavoastrw de cumpPrare a fost refu5atP deoarece a^i depP`it limita creditulul acordat. /1. 9ocumentele care trebuie pre5entate sunt urmPtoarele: o tratP la vedere pentru valoarea creditulul un certificat de origine un certificat &o poli^P ' de asigurare. /,. 9upP cum am convenit$ documentele de e-pedi^ie vP vor fi _nmanate de agen^ii &repre5entan^ii' <Pncii Carpatica la plata tratei$ la scaden^P. /. 2m tras asupra dumneavoastrP valoarea facturii de /HH N$ la 1o de 5ile de la pre5entare$ prin banca de care am vorbit$ cPreia iam remis documentele de e-pedi^ie. //.(ute^i sP vinde^i crean^ele dumneavoastra unei societa^i de factoring. /0.2r fi bine sP oferi^i garan^ie sub forma de obliga^iune. /1.VP vom pregPti comanda atunci cand vom primi confirmarea creditului de la <anca <ucuresti. /=.Contul meu este de*a descoperit a`a cP evit emiterea de cecuri in clipa de fa^P. /?.Cecurile descoperite _i fac pe ma*oritatea van5Ptorilor cu amPnuntul sP refu5e acest instrument de platP `i sP solicite plP^i in numerar pentru valori mici. /?.<anca Centrala `ia diminuat rata de ba5a pentru a evita o cri5P severP. /G.#rebuie sP aflu care este rata dobPn5ii la banca despre care miai vorbit. .1/ 0H.2i un cont la o bancP de stat4 01.Ce garan^ie oferi^i pentru acest _mprumut4 0,.Vreau sP aflu mai mult despre creditul _ncruci`at . 0.."u `tiu prea multe despre metoda numitP compensare. 0/.9acP pre^urile nu vor fi sus^inute ele se vor prPbu`i vertiginos deoarece pia^a este saturatP. 00.2m vrea sP cumpPrPm 1HH de ac^iuni ale societP^ii amintite cu condi^ia ca detaliile tran5ac^iei sP ne parvinP prin avocatul firmei noastre. 7*Tran"late into Romanian' ;odern ban!ing appeared in England and Scotland at the end of the OVIIIth centur%11G/ and 11G0.+e certainl% !now that the <an! of England held a dominant position for about two centuries and en*o%ed a monopol% on overseas operations and acting as the government)s ban!er)s7in 1G/1 it was nationali5ed and we can consider it toda% as a t%pical central ban!. It was in 1=1H when Scotland was the first countr% to have set up a modern ban!ing s%stem with seven ban!s which carried out transactions through a clearing house In 1?,1 the first *oint stoc! ban!s were set up in England and in the OVIIIth centur% there were 1HH clearing ban!s. #he English ban!ing s%stem became a highl% concentrated s%stem with the great ban!s :Dlo%d)s$ <arcla%s$ ;idland$ +esminster and "ational (rovincial. #oda% there are four ma*or ban!s:Dlo%d)s$ ;idland$ "atwest$ <arcla%s which are involved in wholesale ban!ing activities through diferrent subsidiaries. #he 8.S <an!ing s%stem is 6uite peculiar toda% having more than 1H HHHban!s .8nfortunatel% none of them among the top ten in the world. 50Tran"late into Romanian' 9eferred shares do not ta!e part in profits until the preferred share and ordinar% share dividents have alread% been paid. >ounder)s shares are issued to the promoters of the compan%.Can!ing after other shares the% ma% %ield nothing during the earl% %ears.#he% ma% bring huge dividends later.Industrials are the shares of industrial companies. <lue chips are the shares of particularl% well !nown and sound companies. 2n investor who bu%s stoc!s gets tangible shares of a corporation$ which can be held for a long term.#he person who bu%s or sells stoc! inde- futures is ma!ing a short term bet on which direction the mar!et is going towards the near future usuall% a month or less.#he investor bu%ing into futures bu%ing shares on credit has to put up onl% a fraction or percentage of the amount of the investment.2nd this is called the .10 margin .Stoc! inde- futures contracts represent an obligation to bu% or sell an inde- at a stated price before a stated date. 8*Tran"late into Romanian' 2ttempts to introduce other costs and benefits of development$ which would move F"( toward a broader welfare measure$ lac! a logical basis and tend instead to result in a confusion of concepts. Cesearch on Tsocial) indicators has failed to produce an alternative which is as readil% accepted and com prehended as F"( per head ... S%stems of social accounts which could integrate social indicators through some unif%ing concept have not been able to overcome successfull% all the difficult problems encountered. #he search for a composite inde- of social welfare$ analogous to F"( as an inde- of production$ has been a fruitless one so far$ since it has proved virtuall% impossible to translate ever% aspect of social progress into mone% values or some other readil% accepted common denominator. #he great deal of wor! devoted to composite indices$ however$ suggests the need for a single number which$ li!e F"( per head$ can be 6uic!l% grasped and gives a rough indication of IsocialJ development. C*Tran"late into Romanian' ;an% firms la% down definite terms of pa%ment and e-pect their customers to abide b% these terms$ but special arrangements ma% be made in certain cases. #he purchaser should$ however$ pa% his accounts at due date whatever is arranged$ as it is unwise to gain a reputation for slow pa%ment. (romptitude in pa%ment in normal circumstances ma!es it easier to obtain consideration when actual need to dela% pa%ment for a time arises. In general$ terms of pa%ment ma% be classified into cash on or before deliver% of the goods and credit. <% far the greater number if transactions are on credit$ and generall% longer periods of credit are given b% wholesalers to retail customers than b% manufacturers to wholesalers. D*Tran"late into Romanian' #he primar% need when starting a business$ whether a retail firm$ a wholesale warehouse$ or manufacturing concern$ is mone%. Foods have to be bought for stoc!$ premises leased or bought and fitted out to suit the re6uirements of the business$ and some mone% retained for current e-penditure such as wages. 2 small retail business ma% he set up b% a person with ver% small financial resources7 more ambitious concerns will entail great e-pense before the% are able to commence operations. .11 #he mone% which must be got together to start the enterprise is called the capital of the firm. 3ow the original capital is provided depends upon the form the business unit ta!es. E*Tran"late into Romanian' Classes of Shares. #he shares into which a compan%)s capital is divided ma% be of different classes according to the rights given to their holders in respect of them. #he% ma% also be of different amounts$ for e-ample Z1$ Z0$ Z1H$ or Z,0 shares$ but the Z1 share is most general. Shares in a public compan% are freel% transferable and$ unless a further issue of shares is made$ the onl% wa% in which a person ma% become a shareholder in a going concern is to purchase the shares of a present holder. (reference Shares are those which have a prior claim to the profits of the compan%. Ordinar% Shares are generall% entitled to the remainder of the profits after the preference share dividends have been paid. If 9eferred Shares e-ist$ then the ordinar% shares have a limited dividend and the deferred shareholders are entitled to the remainder of the profits. +hen *ointstoc! companies raise loans$ the% usuall% give to the lenders a form of securit%$ named a debenture$ which gives to the holder a right to a fi-ed interest. 2 compan% ma% ma!e application for its full%paid shares to be converted into stoc!$ which ma% be transferred in fractions of a pound$ whereas shares cannot be subdivided. Shares must each bear a distinctive number7 stoc! is unnumbered. G*Tran"late into Romanian' <ills of E-change put debts into tangible form. 2 creditor receiving one has a legal ac!nowledgement of the debt$ and if the amount is not paid when due he can sue on a bill without proving that he has delivered goods. 3e ma% sell or discount the bill at the ban!$ which ma!es a profit called discount for the accommodation7 or he ma%$ in pa%ment of one of his own debts$ endorse the bill to one of his creditors. #he debtor gets longer time in which to pa% and so he ma% ta!e advantage of special opportunities for bu%ing. #hus it will be seen that <ills of E-change are ver% useful commercial documents. .1= >ocabulary agreement- contract as agreed- dupP cum neam _n^eles %ank run- panicP bancarP %earer- %ond- titlu la purtPtor %ill of e'change-trata$cambie clearing %ank-banca de compensa^ie clearing-compensare closing- _ncheiere collateral- garan^ie counterfoil talon$matcP$cotor de%tor-debitor deferred sharesac^iune cu plata ulterioarP draft trata e'change rate- cursul de schimb face value-valoare nominalP fall due to a a*unge la scaden^P fee-comision financial dealings tran5ac^ii financiare. floatations- emisiuni de titluri founderHs share-ac^iune de fondator fundingfinan^are futures contracte la termen glutted(saturat gilt-edged securities titluri de valoare hedging- acoperire financiarP 1iro- serviciu de cecuri postale instalment platP par^ialP$ratP invoice facturP lender-creditor$ loan agreement-contract de _mprumut loan on mortgage-_mprumut ipotecar loan repaya%le_mprumut rambursabil marginmar*P$coeficient de siguran^P. no effectsFuncovered-fPrP acoperire ordercomandP outstanding -restant overdraft- suma cu care sa depP`it contul overdrawn account- cont descoperit overdrawn descoperit overdue- restant$neachitat pawn%roker- propietarul unei case de amanet payee- beneficiar premises sediu prime rate-rata de ba5P rate shift- varia^ii ale cursului de schimb .1? remittanceremitere repayment-rambursare securities-garan^ii security-garan^ie settlementreglementare$decontare share certificates- titluri de ac^iuni shipping documents- documente de e-pedi^ie standing order ordin de platP statement of account-e-tras de cont stu%-matcP$cotor swap agreementacord de swap$ acord de credit _ncruci`at swap- credit _ncruci`at swift sistemul de transfer electronic al fondurilor ta' shelter- paradis fiscal teller casier term deposit- depo5it la termen terms -condi^ii to acknowledge a confirma to %e over a depP`i to comply with- a fi _n concordan^P cu to deem- a considera$a estima to default- a nusi plati datoriile to deny- a refu5a to enclose a ane-a to grant-a acorda to incur a atrage asupra sa to pawn a amaneta to providea - asigura to recocile- a face sP concorde to set out Oa preci5a to settle- a achita to stand surety -a fi garantul to underwrite securities- a subscrie titluri de valoare unsecured credit- credit negarantat to a%ide- a rPmane$a sta$a suporta$a respecta$a se conforma due- datorat$cuvenit$ scadent to retail- a vinde cu amPnuntul instalment- platP par^ialP$ ratP to entitle- a da dreptul la e'penditure- cheltuialP$consum Boint- comun$asociat$ mi-t$ colectiv Boint stock company- societate anonimP pe ac^iuni de%enture- obliga^iune$ _mprumut pe termen lung tangi%le- concret$ palpabil to acknowledge- a recunoa`te$ a confirma acknowledgement- constatare$ confirmare$ certificare$ recipisP$chitan^P %ill- titlu de valoare$ poli^P$ facturP to discount- a reduce$ a diminua to endorse a andosa$ a gira$ a subscrie wholesaler- angrosist .1G warehouse- depo5it de mPrfuri$ maga5ie premises- local lease- contract de _nchiriere to set up a %usiness- a porni o afacere lender- _mprumutPtor lessor- propietar care dP cu chirie lessee chiria` to claim- a pretinde$ a revendica issue- emisiune$ punere _n circula^ie to issue- a emite$ a pune _n circula^ie
#ourism #he +orlds <iggest Industr% #he <usiness of 3otels #he Importance of 3otels #ravel and 3otels #wo Centuries of 3otel!eeping 3otel Docation #%pes of 3otel 3otel (roducts and ;ar!ets #he 3otel as a #otal ;ar!et Concept 3otel >acilities and Services as (roducts 3otel 2ccommodation ;ar!ets 3otel Catering ;ar!ets 3otel 9emand Fenerating Sources 3otel ;ar!et 2reas 3otel ;ar!et Segmentation <u%ing and (a%ing for 3otel Services 3otel ;ar!eting Orientation Special >eatures of 3otel ;ar!eting (ropert% Ownership (ropert% Operation and ;aintenance 3otel Organi5ation Cooms >ood and <everage ;iscellaneous Fuest Services 3otel Support Services #he ;anagement Structure 3otel Services Cooms and <eds Coom Sales ;ail and Other Fuest Services 8niformed Services .=H 3otel 3ouse!eeping >ood and 9rin! Cestaurants ;iscelaneous Fuest Services #ourist 2ttractions #ourism #oda% Docal #ours (aris >oreign #ours #he <ahamas .=1 Touri"m 0 The World" /i##e"t Indu"try 2gainst the bac!ground. of unparalleled growth in the latter half of the twentieth centur%$ tourism now finds itself at a crossroads in its development. On the one hand$ it is heralded as Tthe world)s biggest industr%) b% a number of global organisations including the +orld #ravel and #ourism Council &+##C' and the +orld #ourism Organisation &+#O'$ which highlights the fact that tourism overtoo! both crude petroleum and motor vehicles to become the world)s number one e-port earner in 1GG/. Its economic significance is also illustrated b% the fact that tourism receipts were greater than the world)s e-ports of other selected product groups$ including electronic e6uipment$ clothing$ te-tiles and raw materials. In addition$ receipts from international tourism have achieved growth rates in e-cess of e-ports of commercial services and merchandise e-ports during the period 1G?/ to 1GG/. >or the period 1G?0 to 1GG0 the trend is similar$ with the following average annual percentage growth rates: #ourism l,per cent Commercial services 1, per cent ;erchandise e-ports 1H per cent +#O data also indicate rapid and sustained growth in international tourist arrivals and receipts from tourism over the last .H %ears. #oda%$ tourism is seen as a ma*or contributor to global economic development$ creating emplo%ment and generating wealth on a trul% international scale. 2n increasing number of countries rel% heavil% on receipts from tourism for their economic and social wellbeing. In direct contrast to this ver% positive outloo! for the industr%$ man% national governments are reluctant to invest public funds in tourism development and promotion$ with tourism spending often being cut when more pressing social and economic needs arise. #he decisions$ in 1GG=$ b% the governments of Canada$ the 8nited States of 2merica and <elgium to transfer responsibilit%$ for tourism to private sector enterprises or regional authorities serve to illustrate this point well. In <ritain$ the funding of the English #ourist <oard has been cut drasticall% since the earl% 1GGHs$ the decision of a government that considered the industr% to he sufficientl% mature and able to fund its own e-pansion with diminishing public financial support. 2t a time of increasing corrcern for the environment and the retention of cultural identities$ tourism is also viewed b% governments and consumers ali!e as a potentiall% destructive force$ causing harmful environmental and sociocultural impacts in destination areas and on host communities. (arado-icall%$ it is not difficult to argue that the withdrawal of public funding and control from tourism development ma% well accelerate the industr%)s harmful environmental and sociocultural effects. .=, It is against this bac!ground of a comple- and rapidl% e-panding industr% see!ing to maintain its credibilit% and promote its economic benefits$ often in the face of declining governmental and host communit% support. ,he Business of *otels I The Importance of ,otel" 3otels pla% an important role in most countries in providing facilities for the transaction of business$ for meetings and conferences$ for recreation and entertainment. In that sense hotels are as essential to economies and societies as are .=. ade6uate transport$ communication and retail distribution s%stems for various goods and services. #hrough their facilities hotels contribute to the total output of goods and services$ which ma!es up the material wellbeing of nations and communities. In man% areas hotels are important attractions for visitors who bring to them spending power and who tend to spend at a higher rate than the% do when the% are at home. #hrough visitor spending hotels thus often contribute significantl% to local economies both directl%$ and indirectl% through the subse6uent diffusion of the visitor e-penditure to other recipients in the communit%. In areas receiving foreign visitors$ hotels are often important foreign currenc% earners and in this wa% ma% contribute significantl% to their countries) balance of pa%ments. (articularl% in countries with limited e-port possibilities$ hotels ma% be one of the few sources of foreign currenc% earnings. 3otels are important emplo%ers of labour. #housands of *obs are provided b% hotels in the man% occupations that ma!e up the hotel industries in most countries7 man% others in the industr% are selfeemplo%ed and proprietors of smaller hotels. #he role of hotels as emplo%ers is particularl% important in areas with few alternative sources of emplo%ment$ where the% contribute to regional development. 3otels are also important outlets .for the products of other industries. In the building and moderni5ation of hotels business is provided for the construction industr% and related trades. E6uipment$ furniture and furnishings are supplied to hotels b% a wide range of manufacturers. >ood$ drin! and other consumables are among the most significant dail% hotel purchases from farmers$ fishermen$ food and drin! suppliers$ and from gas$ electricit% and water underta!ings. In addition to those engaged directl% in hotels$ much indirect emplo%ment is$ therefore$ generated b% hotels for those emplo%ed in industries suppl%ing them. Dast but not least$ hotels are an important source of amenities .for local residents. #heir restaurants$ bars and other facilities often attract much local custom and man% hotels have become social centres of their communities. Tra$el and ,otel" Sta%ing awa% from home is a function of travel and three main phases ma% be distinguished in the development of travel in the northern hemisphere. 8ntil about the middle of the nineteenth cenrui% the bul! of *ourne%s were underta!en for business and vocational reasons$ b% road$ b% people travelling mainl% in their own countries. #he volume of travel was relativel% small$ confined to a small fraction of the population in an% countr%$ and most of those who did travel$ did so b% coach. Inns and similar hostelries along the highwa%s and in the principal towns provided the means of accommodation well into the nineteenth centur%. <etween about 1?0H and about 1G0H a growing proportion of travellers went awa% from home for other than business reasons and holida%s came to represent graduall% an important reason for a *ourne%. >or a hundred %ears or so$ the railwa% and the steamship dominated passenger transportation$ and the new means of transport gave an impetus to travel between countries and between continents. .=/ 2lthough the first hotels date from the eighteenth centur%$ their growth on an% scale occurred onl% in the nineteenth centur%$ when first the railwa% and later the steamship created sufficientl% large mar!ets to ma!e the larger hotel possible. 3otels together with guest houses and boarding houses dominated the accommodation mar!et in this period. <% about the middle of the twentieth centur% in most developed countries of the world &a little earlier in "orth 2merica and a little later in Europe' a whole c%cle was completed and most traffic returned to the road$ with the motor car increasingl% providing the main means of passenger transportation. 2lmost concurrentl% the aircraft too! over unmista!abl% both from the railwa%s and from shipping as the principal means of longdistance passenger transport. On man% routes holida% traffic came to match and often greatl% e-ceed other traffic. 2 growing volume of travel awa% from home became international. 3otels entered into competition with new forms of accommodation e holida% centres and holida% villages in Europe$ motels in "orth 2merica$ and various selfecatering facilities for those on holida%. To Centurie" of ,otel!eepin# 3otels are some two hundred %ears old. #he word Thotel) itself came into use in England with the introduction in Dondon$ after 1=1H $ of the !ind of establishment then common in (aris$ called Thotel garni)$ or a large house$ in which apartments were let b% the da%$ wee! or trench. Its appearance signified a departure from the customar% method of accommodating guests in inns and similar hostelries$ into something more lu-urious and even ostentatious. 3otels with managers$ receptionists and uniformed staff arrived generall% onl% at the beginning of the nineteenth centur% and until the middle of that centur% their development was relativel% slow. #he absence of good inns in Scotland to somee-tent accelerated the arrival of the hotel there7 b% the end of the eighteenth centur% Edinburgh$ for e-ample$ had several hotels where the traveller could get elegant and comfortable rooms. 3otels are also !nown to have made much progress in other parts of Europe in the closing %ears of the eighteenth and earl% %ears of the nineteenth centur%$ where at the time originated the idea of a resort hotel. In "orth 2merica earl% accommodation for travellers followed a similar pattern as in England$ with most inns originating in converted houses$ but b% the turn of the eighteenth centur% several cities on the eastern seaboard had purposeebuilt hotels and in the first half of the nineteenth centur% hotel building spread across 2merica to the (acific Coast. #he evolution from inn!eeping to hotel!eeping$ therefore$ proceeded almost in parallel in the Old and in the "ew +orlds and the rise of the hotel industries on both sides of the 2tlantic had probabl% more in common than is generall% recogni5ed. +hat 2merica might have lac!ed in histor% and tradition$ it more than made up in pioneering spirit$ in intense rivalr% between cities and entrepreneurs$ and in the sheer si5e and growth of the travel mar!et. In the last centur% hotels became firml% established not onl% as centres commercial hospitalit% for travellers$ but often also as important social centres of their communities. #heir building$ management and operation became speciali5ed activities$ with their own st%les and methods. #he present centur% brought about growing speciali5ation and increased sophistication in the hotel industries of most countries$ as well as their growth and e-pansion. <ut the growth and the diversit% of .=0 hotel operations has been also matched b% the growth and diversit% of competition in the total accommodation mar!et. Information about accommodation facilities in individual countries essentiall% reflects the designations used for them b% the countries concerned and the coverage of various t%pes in the available statistics. Onl% ver% broad intercountr% comparisons are possible. One source is the annual report of the #ourism Committee of the Organisation for Economic Cooperation and 9evelopment &OEC9'$ which distinguishes between beds available in hotels and similar establishments$ and in what is described as supplementar% accommodation. #he ratio of beds in hotels and similar establishments to beds in supplementar% accommodation gives an indication of the relative importance of the hotel sector in the total accommodation mar!et of individual countries. In most countries the accommodation profile tends to reflect the relative importance of foreign and domestic users$ of leisure and business travel$ and of other influences. In man% countries hotels and similar establishments appear to be minorit% providers of accommodation. ,otel )ocation 3otel services are supplied to their bu%ers direct in person7 the% are consumed at the point of sale$ and the% are also produced there. 3otel services must be$ therefore$ provided where the demand e-ists and the mar!et is the dominant influence on hotel location. In fact$ location is part of the hotel product. In turn$ location is the !e% influence on the viabilit% of the business$ so much so that a prominent entrepreneur could have said with conviction and with much *ustification that there are onl% three rules for success in the hotel business: location$ location$ location. +e have seen earlier that from the earl% da%s all accommodation units followed transport modes$ Inns and other hostelries were situated along the roads and at destinations$ serving transit and terminal traffic. #he rapid spread of railwa%s mar!ed the emergence of railwa% hotels in the nineteenth centur%. In the twentieth centur% motor transport created a new demand for accommodation along the highwa%s and the modern motel and motor hotel have been distinctive responses to the new impetus of the motor car. 2 similar but les pronounced influence was passenger shipping$ which stimulated hotel development in ports$ and more recentl% air transport$ which brought about a ma*or growth of hotels in the vicinit% of airports and air terminals. Secondl%$ although this is closel% related to transport$ man% hotels are located to serve first and foremost holida% mar!ets. In their areas of highest concentration$ holida% visitors are accommodated in hotels in localities whcre the resident population ma% represent onl% a small proportion of those present at the time$ as is the case in man% resorts. #he third ma*or influence on hotel location is the location of economic activit% and of industr% and commerce in particular. +hilst again not separable from transport .=1 development$ industrial and commercial activities create demand for transit and termInal accommodation in industrial and commercial centres$ in locations not fre6uented b% holida% visitors. 9ifferent segments of the travel mar!et give rise to distinctive patterns of demand for hotel accommodation and often distinctive t%pes of hotels. In business and industrial centres hotels normall% achieve their highest occupancies on wee!da%s and in resorts in the main holida% seasons7 their facilities and services reflect the re6uirements of businessmen and of holida% visitors respectivel%. <etween these clearl% defined segments come other towns and areas$ such as bus% commercial centres with historical or other attractions for visitors$ which ma% achieve a more even wee!l% and annual pattern of business. Type" of ,otel" #he rich variet% of hotels can be seen from the man% terms in use to denote particular t%pes. 3otels are referred to as lu-ur%$ resort$ commercial$ residential$ transit$ and in man% other wa%s. Each of these terms ma% give an indication of standard or location$ or particular t%pe of guest who ma!es up most of the mar!et of a particular hotel$ but it does not describe ade6uatel% its main characteristics. #hese can be onl% seen when a combination of terms is applied to an hotel$ each of which describes a particular hotel according to certain criteria. It is helpful to appreciate at this stage what the main t%pes of hotels are$ b% adopting particular criteria for classif%ing them$ without necessaril% attaching precise meanings to them. L #hus according to location hotels are in cities and in large and small towns$ in inland$ coastal and mountain resorts$ and in the countr%. L 2ccording to the actual position of the hotel in its location it ma% be in the cit% or town centre or in the suburbs$ along the beach of a coastal resort$ along the highwa%. L <% reference to its relationship with particular means of transportxthere are motels and motor hotels$ railwa% hotels$ airport hotels &the terms also indicating location'. L 2ccording to the purpose of visit and the main reason for their guests) sta%$ hotels ma% become !nown as business hotels$ holida% hotels$ convention hotels$ tourist hotels. L +here there is a pronounced tendenc% to a short or long duration of guests) sta% it ma% be an important hotel characteristic$ so that the hotel becomes a transit or a residential hotel. L 2ccording to the range of its facilities and services a hotel ma% be open to residents and nonresidents$ or it ma% restrict itself to providing overnight accommodation and at most offering brea!fast to its guests$ and be a hotel garni or apartment hotel. .== L +hether a hotel holds a licence for the sale of alcoholic li6uor or not$ is an important dimension in the range of available hotel services$ and the distinction between licensed and unlicensed hotels is$ therefore$ of relevance in describing a hotel in most countries. L #here is no universal agreement on how hotels should he described according to si5e$ but b% reference to their room or bed capacities we normall% appl% the term small hotel to one with a small amount of sleeping accommodation$ the term large hotel to one with several hundred beds or bedrooms$ and the term medium si5e hotel to one somewhere between the two$ according to the si5e structure of the hotel industr% in a particular countr%. L +hatever the criteria used in hotel guides and in classification and grading s%stems in e-istence in man% countries$ normall% at least four or five classes or grades have been found necessar% to distinguish ade6uatel% in the standards of hotels and these have found some currenc% among hotel users. #he e-tremes of lu-ur% and basic standards$ sometimes denoted b% five stars and one star respectivel% are not difficult concepts7 the mid point on an% such scale denotes the average without an% particular claims to merit. #he intervening points are then standards above average but falling short of lu-ur% &6ualit% hotels' and standards above basic &econom%'. Dast but not least comes the ownership and management. Individuall% owned independent hotels$ which ma% he managed b% the proprietor or b% a salaried manager$ have to he distinguished from chain or group hotels$ invariabl% owned b% a compan%. Independent hotels ma% belong to a hotel consortium or cooperative. 2 compan% ma% operate its hotels under direct management or under a franchise agreement. #he above distinctions then enable us to describe a particular hotel in broad terms$ concisel%$ comprehensivel% and meaningfull%$ e.g.: L #erminus 3otel is a mediumsi5ed econom% town centre unlicensed hotel$ owned and managed b% a small compan%$ catering mainl% for tourists visiting the historic town and the surrounding countr%side. L 3otel E-celsior is a large independent lu-ur% hotel on the main promenade of the coastal resort$ with holida% visitors as its main mar!et. L #he Crossroads 3otel is a small licensed 6ualit% transit motor hotel$ operated as a franchise$ on the outs!irts of the cit%$ which serves mainl% traveling ,otel Product" and Mar!et" #he aim of this sub*ect is to outline the facilities and services provided b% hotels$ who are the people who use hotels$ wh% the% use hotels$ and what influences their choice of particular hotels. In providing answers to these 6uestions$ we can formulate a conceptual model of a hotel$ which attempts to e-plain in simple terms how particular hotel products meet the needs of particular hotel mar!ets$ and establish a basis for a more detailed e-amination of the hotel business. The ,otel a" a Total Mar!et Concept .=? >rom the point of view of its users$ a hotel is an institution of commercial hospitalit%$ which offers its facilities and services for sale$ individuall% or in various combinations$ and this concept is made up of several elements. Its location places the hotel geographicall% in or near a particular cit%$ town or village7 within a given area location denotes accessibilit% and the convenience this represents$ attractiveness of surroundings and the appeal this represents$ freedom from noise and other nuisances$ or otherwise. Its facilities which include bedrooms$ restaurants$ bars$ function rooms$ meeting rooms and recreation facilities such as tennis courts and swimming pools represent a repertoire of facilities for the use of its customers$ and these ma% be differentiated in t%pe$ si5e$ and in other wa%s. I ts service comprises the availabilit% and e-tent of particular hotel services provided through its facilities$ the st%le and 6ualit% of all these in such terms as formalit% and informalit%$ degree of personal attention$ and speed and efficienc%. Its image ma% he defined as the wa% in which the hotel portra%s itself to people and the wa% in which it is perceived as portra%ing itself b% them. It is a b%product of its location$ facilities and service$ but it is enhanced b% such factors as its name$ appearance7 its associations b% who sta%s there and who eats there7 b% what it sa%s about itself and what other people sa% about it. Its price e-presses the value given b% the hotel through its location$ facilities$ service and image$ and the satisfaction derived b% its users from these elements of the hotel concept. #he individual elements assume greater or lesser importance for different people. One person ma% put location as paramount and be prepared to accept basic facilities and service for an overnight da%$ ignoring the image$ as long as the price is within a limit$ to which he is willing to go. 2nother ma% be more concerned with the image of the hotel$ its facilities and service. 3owever$ all the five elements are related to each other$ and in a situation of choice most hotel users tend either to accept or re*ect as a whole$ that is the total concept. #here are var%ing degrees of adaptabilit% and fle-ibilit% in the hotel concept$ ranging from the complete fi-it% of its location to the relative fle-ibilit% of price$ with facilities$ service and image lending themselves to some adaptation in particular circumstances with time. ,otel ?acilitie" and Ser$ice" a" Product" In the earl% da%s of inn!eeping the traveller often had to bring his own food to places where he sta%ed the nightbed for the night was the onl% product offered <ut soon most establishments e-tended their hospitalit% to providing at least some food and refreshments. #oda% man% apartment hotels$ hotels gami$ and motels confine their facilities to sleeping accommodation$ with little or no catering provision. <ut the t%pical hotel as we !now it toda%$ normall% provides not onl% accommodation$ but also food and drin!$ and sometimes other facilities and services$ and ma!es them available not onl% to its residents but also to nonresidents. 2lthough the range of hotel facilities and services ma% e-tend as far as to cater for all or most needs of their customers$ however long their sta%$ and for a hotel to become a selfcontained communit% with its own shops$ entertainments and recreation .=G facilities$ it is helpful at this stage to describe the hotel concept in a simpler form$ b% including onl% the main customer needs t%picall% met b% most hotels. #he main customer demand in most hotels is for sleeping accommodation$ food and drin!$ and for food and drin! for organi5ed groups. #hese four re6uirements then relate to accommodation$ restaurants$ bars and functions$ as the principal hotel products. Sleeping accommodation is provided for hotel residents alone. Cestaurants and bars meet the re6uirements of hotel residents and nonresidents ali!e$ even though separate facilities ma% be sometimes provided for them. >unctions are best seen as a separate hotel product bought b% organi5ed groups7 these groups ma% be resident in the hotel as$ for e-ample$ participants in a residential conference$ or be nonresidents$ such as a local club or societ%$ or the group ma% combine the two. #he total hotel concept e of location$ facilities$ service$ image and price can he$ therefore$ sub divided according to the needs of the customer and the particular facilities brought into pla% to meet them. #he cluster of elements of the total hotel concept is then related to each particular hotel product. Each hotel product contains the elements of the location$ facilities$ services$ image and price$ to meet a particular customer need or set of needs. #he first approach to the segmentation of the hotel mar!et is$ therefore$ ta!en b% dividing hotel users according to the products bought. Corresponding to each hotel product there are the bu%ers of that product who constitute a mar!et for it. ,otel Accommodation Mar!et" 3otel users who are bu%ers of overnight accommodation ma% be classified according to the main purpose of their visit to a particular location into three main categories as holida%$ business and other users. 3olida% users include a variet% of leisure travel as the main reason for their sta% in hotels$ ranging from short sta%s in a particular location on the wa% to somewhere else to wee!end and longer sta%s when the location represents the end of a *ourne%. #heir demand for hotel accommodation tends to be resort oriented$ seasonal and sensitive to price. <usiness users are emplo%ees and others travelling in the course of their wor!$ people visiting e-hibitions$ trade fairs$ or coming together as members of professional and commercial organi5ations for meetings and conferences. #heir demand for hotel accommodation tends to be town and cit% oriented$ nonseasonal and less pricesensitive$ e-cept in the case of some event attractions such as conferences and e-hibitions$ which ma% he usefull% regarded as a separate categor%. Other hotel users comprise visitors to a particular location for a variet% of reasons other than holida% or business$ e.g. those attending such famil% occasions as weddings$ parents visiting educational institutions$ visitors to special events$ and common interest groups meeting for other than business and vocational reasons$ re locating families and individuals see!ing permanent accommodation in an area and sta%ing temporaril% in an hotel$ people living in an hotel permanentl%. #he characteristics of this t%pe of demand are more varied than those of the first and second group$ and it is$ therefore$ often desirable to subdivide it further for practical purposes. .?H +ithin and between the three main groups$ which comprise the total mar!et for hotel accommodation$ there are several distinctions important to individual hotels. +e have noted alread% that some hotel users give rise to demand for transit and short esta% accommodation7 others are terminal visitors with a longer average sta%. 2lso$ for e-ample$ much business demand is generated b% a relativel% small number of travellers who are fre6uent hotel users7 most holida% and other demand comes from a ver% large number of people who use hotels onl% occasionall%. ;oreover$ business users often boo! accommodation at short notice$ whilst holida% and other users tend to do so longcr in advance. 2nd in allthree groups some people are individual hotel users$ and others sta% in hotels in groups. ,otel Caterin# Mar!et" 3otel restaurants$ bars and function rooms ma% be convenientl% grouped together as its food and beverage or catering facilities$ and the meals and refreshments the% provide as the hotel food and beverage or catering products. Corresponding to them there are again bu%ers of these products who constitute the hotel catering mar!ets and who ma% be classified in various wa%s. >or our purposes there is a basic distinction between the demand e-ercised b% hotel residents$ b% nonresidents$ and b% organi5ed groups. #he first categor% of users of hotel restaurants and bars is related to the basic function of the hotel in providing overnight sleeping accommodation$ and consists of hotel residents$ whom we have classified earlier as holida%$ business and other users #heir use of hotel catering facilities tends to be influenced b% the reason for their hotel sta% and b% the terms on which the% sta%. <rea!fast is their common hotel purchase$ but otherwise a hotel resident ma% have his meals in his hotel or elsewhere$ and he is more li!el% to be a hotel restaurant or bar customer in the evenings than at midda%. #he second categor% is nonresidents$ individuall% or in small groups$ when eating out. #he% ma%$ in fact$ be sta%ing at other hotels or accommodation establishments or with friends or relative or be da% visitors to the area$ for holida%$ business or other reasons 2lternativel% the% are local residents$ for whom the hotel restaurants and bars represent outlets for meals and refreshments$ as a leisure activit% or as part of their business activities. #his categor% tends to represent important hotel users at midda% as well as in the evenings$ particularl% at wee!ends. #he third categor% of users of hotel catering facilities is organi5ed groups who ma!e advance arrangements for functions at the hotel$ which ma% call for separate facilities and organi5ational arrangements. #he% include local clubs$ societies$ business and professional groups$ as well as participants in meetings and conferences originating from outside the area. 3otel catering products represent a greater diversit% than its accommodation products and it is often correspondingl% more difficult to classif% them and the mar!ets for them in practice. ;oreover$ hotels are not alone in suppl%ing them. In the mar!et for meals and refreshments for individuals and groups a hotel competes not onl% with other hotels$ but also with restaurants outside hotels$ pubs and clubs$ to name but a few other t%pes of outlet. #herefore$ catering in hotels is a separate hotel function$ with its own ob*ectives$ policies and strategies$ and with its own organi5ation. .?1 ,otel Demand :eneratin# Source" >or most people the use of hotels represents what is !nown as derived demand because few sta% or eat in hotels for its own sa!e7 their primar% reasons for doing so lie in their reasons for visiting an area or for spending their time there in particular wa%s. +hen describing hotel accommodation and catering mar!ets we have seen that hotel users have different degrees of freedom and choice as to whether the% bu% hotel services or not. Some have few or no alternatives7 for them onl% hotels provide the facilities and services which the% re6uire in a particular area in pursuit of their business$ vocational and other interests7 the incidence of their hotel usage arises to a great e-tent from their wor!ing circumstances. >or man% others the use of hotels is a matter of choice7 the% do so in their pursuit of leisure and recreation7 for them hotel usage involves a discretionar% use of their time and mone%. #his distinction helps us identif% the demand generating sources for hotels in a given area$ which are of three main t%pes institutional$ recreational and transit. Institutional sources include industrial and commercial enterprises$ educational institutions$ government establishments and other organi5ations in the private and public sector$ whose activities are involved in the economic life of the communit% and in its administration. #hese institutions generate demand for hotels through their own visitors and their other re6uirements for hotel facilities and services. Cecreational sources include historical$ scenic and other site attractions and event attractions$ which generate demand for hotels from tourists7 local events and activities in the social and cultural life of the communit%$ which generate demand from clubs$ societies and other organi5ations7 happenings of significance to individuals and families. #he third source of demand stems from individuals and groups with no intrinsic reason for spending time in a particular localit%$ other than being on the wa% somewhere else and the need to brea! a *ourne%. #his source of demand is closel% related to particular forms of transport7 it e-presses itself on highwa%s$ at ports and at airports$ and ma% be described as transit. It will be readil% apparent that this view of demand generating sources for hotels is closel% related to several aspects of the hotel business considered earlier e for e-ample$ to the threefold classification of the hotel accommodation mar!et into holida%$ business and other users7 to the three main influences on hotel location e travel$ holida%s and economic activit%7 and to the t%pes of hotel. <% adopting in each case a somewhat different viewpoint$ it is possible to highlight the interdependence between the location$ mar!ets and products of hotels. ,otel Mar!et Area" .?, +e can define a hotel mar!et in several wa%s b% reference to the people who bu% hotel services$ as a networ! of dealings between the hotel and its users$ or as an area which a hotel serves. In the first two approaches hotel users ma% come from within the area$ from various parts of the countr%$ and from abroad7 we then refer to the local$ domestic and foreign mar!ets$ and subdivide them in appropriate wa%s. In the third approach described below we view the hotel mar!et area as a ph%sical area served b% the hotel. >or hotel accommodation it is necessar% to identif% all the institutional and recreational sources of demand$ which ma% be served b% a particular hotel. #he area drawn in this wa% round the hotel ma% e-tend from its immediate vicinit% to a radius of several miles or more. 3ow far it does e-tend depends on the geographical distribution of the demand generating sources$ the mode of transport used b% the hotel users of each source$ and the availabilit% of other facilities in the area. #he head office of a large firm$ a universit%$ a historic castle$ and a town which is a festival centre$ ma% be all within a mar!et area of a hotel$ if the hotel is reasonabl% accessible from these points$ and if its location at least matches the location of other hotels. #he mar!et area ma% coincide for a number of hotels within close pro-imit% of each other$ which offer a similar concept in terms of facilities$ service$ image and price. On the peripher% the mar!et area for a hotel ma% overlap with the mar!et areas of other hotels some distance awa%. 2t periods of pea! demand it ma% e-tend further than at times of low demand. >or transit the accommodation mar!et area is related to the *ourne%s underta!en through the area e their origin and destination$ the method of transportation$ the time of da%$ the time of %ear and other circumstances of the *ourne%s. >or hotel catering services the mar!et area depends on mar!et densit% e the availabilit% of spending power within an area$ as well as on the accessibilit% of the hotel to the different sources of demand$ and on the availabilit% of other catering services in the area. In this there is a close analog% with the concept of a catchment area for other retail outlets$ as far as the resident population is concerned. 3ow far do people go from where the% live to do their shopping4 #he distance ma% var% according to the purchase the% are to ma!e. Similarl% there ma% be a smaller mar!et area for hotel lunches than for hotel dinners and functions$ because close pro-imit% to the hotel ma% he a more important consideration for a midda% meal than for an evening out. ,otel Mar!et Se#mentation #he mar!et for hotel products ma% be divided into several components or segments and this enables individual hotels to identif% their actual and potential users according to various criteria. Segmentation then provides a basis for the mar!eting of hotel products$ for pa%ing close attention to the re6uirements of different users$ and for monitoring the performance in the mar!ets chosen b% a hotel. +e divided hotel users$ according to the product bought b% them$ into bu%ers of accommodation$ food$ drin! and functions. +e divided the accommodation mar!et$ according to the reasons for the users) sta%$ into holida%$ business and other users$ and the hotel catering mar!et into hotel residents$ nonresidents and functions. 2ccording to the origin of demand we also identified institutional$ recreational and transit sources of demand. .?. 2nother basis for segmentation is the needs of hotel users and the meansxthe% have to pa% for their satisfaction$ b% dividing them according to their socio economic characteristics. Socioeconomic classifications see! to group people according to their occupation and emplo%ment status. >or e-ample$ the <ritish @oint Industr% Committee for "ational Ceadership Surve%s &@IC"2CS' defines social grades as shown in the following table: Social :rade Definition" Social grade Social status Occupation 2 8pper middle class 3igher managerial$ administrative or professional < ;iddle class Intermediate managerial$ adminisniative or professional C 1 Dower middle class Supervisor% or clerical$ and *uniormanagerial$ administrative or professional C, S!illed wor!ing class S!illed manual wor!ers 9 +or!ing class Semi and uns!illed manual E #hose at the lowest level of subsistence State pensioners or widows &no other earner'$ casual or lowest grade wor!ers Social grade 2 might be e-pected to sta% in lu-ur% and 6ualit% hotels$ < in medium hotels$ C in econom% hotels. 3owever$ this is an oversimplification$ because the same people ma% interchange between segments according to the circumstances in which the% find themselves. 2 businessman on an e-pense account ma% sta% in a 6ualit% hotel$ but travelling for pleasure with his famil% he ma% sta% in a lower grade hotel. ;oreover$ the incidence of hotel usage among 9E groups is minimal. "evertheless$ segmentation b% socioeconomic criteria is an important approach to mar!et segmentation. >or some purposes age$ famil% composition$ life c%cle stage$ or other criteria ma% be more appropriate. 2 concomitant of mar!et segmentation is product branding$ with a view to differentiating an hotel from others in the minds of bu%ers$ long established in other consumer industries. Some hotel groups have focused on branded segments distinguished b% levels of service7 e-amples include 3olida% Inn upmar!et Crowne (la5a$ core brand 3olida% Inn and limited service Farden Court. Other brands have been created b% grouping li!e operations$ such as >orte (osthouses and +hitbread Danshur% 3otels$ or b% ac6uisition$ such as (orte Crest and ;ount Charlotte #histle. .?/ +e anticipate that product segmentation will assume even greater significance in the future development of hotel companies. It is an effective method for hotel companies to maintain or e-pand mar!et share and in some instances create new mar!ets. (roduct branding will become more focussed and will reflect increasing levels of segmentation. In the light of this$ the future of the Tall purpose hotel) is doubtful in terms of its competitiveness in the mar!et place. <u%ing and (a%ing for 3otel Services It is important to understand how a bu%ing decision is made$ who ma!es it$ and who pa%s for the hotel services bought. #he bu%ing decision itself ma% be basicall% of two !inds edeliberate or impulsive. <efore embar!ing on *ourne%s$ business people ma% as! secretaries to reserve hotel rooms in the towns the% are to visit for specified nights. 2 famil% ma% arrive at their choice of holida% hotel after a scrutin% of hotel guides. 2 societ% ma% ma!e several in6uiries before choosing the venue for their annual dinner dance. #hese are deliberate bu%ing decisions made with some xadvance planning and with advance reservations. 2 tourist loo!ing for somewhere to sta% when travelling b% car$ or on arrival at the railwa% station or airport$ is li!el% to ma!e an impulse decision$ in much the same wa% as a couple wal!ing through the streets of a town and Tdiscovering) a restaurant which appears to be to their li!ing. (urchases of hotel products are both deliberate and impulse purchases and most hotels respond to both$ although different operational policies and procedures normall% appl% to each. ;an% people ma!e their own arrangements for travelling and for sta%ing in hotels. 3owever$ man% hotel boo!ings are made b% people who do it for others: the secretar% for the boss$ the travel agent for the client$ the business travel department of a large compan% for its emplo%ees. In these circumstances it is important to !now who the bu%ing agent is and where that person is located$ if the !nowledge derived from the anal%sis of the hotel demand generating sources is to be applied to bringing about sales. ;ost hotels can no longer hope to fill their beds$ restaurants and bars b% simpl% waiting for the guest. 2ccording to the source of pa%ment for hotel services$ hotel users are also of two basic !inds e those who pa% themselves and those whose hotel bills are covered or reimbursed for them. ;ost leisure use of hotels represents personal e-penditure out of disposable incomes$ the bul! of business use of hotels in the wide sense is paid for directl% or indirectl% b% third parties e emplo%ers and other agencies on behalf of the guest. 2lthough man% business users have no fi-ed limits as to the charges the% incur in hotels$ man% tend to observe what the% and their organi5ations regard as acceptable. #he understanding of these practices is important to hotels too. #he decision on the mar!et segments to be catered for is closel% related to decisions on pricing and we have seen that price is an integral element of each hotel)s total concept. ,otel Mar!etin# .rientation 3otels serve people and their success depends on how well the% serve them in places where the% wish to be served. #his is onl% a wa% of stating in the simplest of .?0 tenns the application to hotel operations of the mar!eting concept$ which is concerned with the consumer as a starting point in the conduct of business. #he mar!eting concept is beginning to be understood b% hoteliers. 2lthough some continue to regard sales andmar!eting as s%non%mous$ most hotels no longer operate in the seller)s mar!et and even massive sales effort is not li!el% to generate a sustained high volume of business$ if consumer needs are not genuinel% met in the planning$ design and subse6uent operation of an hotel. #he basic hotel concept stresses the view of the hotel$ as it is seen b% the hotel user rather than the hotel operator$ as a business to meet the needs of hotel users. Some of these needs are basic and ph%sical$ such as sleeping in clean beds or eating wholesome meals7 others such as those met b% the image of the hotel are ac6uired needs$ which reflect what a person aims to be as an individual. 2 successful hotel must see! to meet both sets of needs. So that an hotel can meet the needs of hotel users$ individual hotel services have to be seen as hotel products sold to particular mar!ets. 2 hotel cannot be all things to all people. Each hotel has to achieve a match between its particular products and particular mar!et segments$ i.e. groups of people with more or less similar characteristics and re6uirements for hotel services. In this there is a difference between the hotel accommodation and catering products$ in that each ma% to some e-tent cater for different mar!ets. <ut this difference onl% reinforces the need for harmon% in the total hotel concept. In order to achieve the match between hotel products and mar!ets$ there is a need for a careful anal%sis of the sources of demand for hotel services in the mar!et area served b% the hotel and an understanding of how hotel services are bought and paid for. >rom this model of a hotel a translation can be made to particular operations. #his ta!es the form of hotel policies$ philosophies and strategies. Special ?eature" of ,otel Mar!etin# ;ar!eting is first and foremost about matching products and mar!ets and in this sense the mar!eting of hotel services is in principle no different from the mar!eting of other consumer products. <ut there are special features of hotel products and mar!ets and hence of hotel mar!eting. >or most users hotel rooms are a means to an end and not an end in itself and the demand for them is what is !nown as derived demand the reason for their use ma% be a business visit or a holida% or something else but rarel% the room itself$ and the same applies to some e-tent to other hotel services. #he availabilit% of the most important hotel product$ the hotel room$ is fi-ed in time and place. In the short term the number of rooms or beds on offer cannot be significantl% changed and location is part of the highl% perishable product$ which cannot be stored for future sale or follow the customer. #he demand for hotel accommodation and other services fluctuates from da% to da%$ from wee! to wee! and from one part of the %ear to another. 2 waste occurs when demand falls and there is a definite upper limit to the volume of business in a period of pea! demand. 3otel investment is primaril% an investment in land and buildings and interior assets. #he bul! of the capital invested in the fi-ed assets of the hotel$ combined with the continuit% of hotel activit%$ gives risc to high fi-ed costs$ which have to be covered irrespective of the volume of business. #hree !e% factors are$ therefore$ critical to a successful hotel operation e the right location$ correct capacit%$ and a .?1 high level of utili5ation$ all of them impl% mar!eting decisions e first in the conception of the hotel and in its operation subse6uentl%. In the conception of the hotel$ mar!eting can contribute first through a mar!et feasibilit% stud% to assess the demand. 2 stud% ma% identif% the best mar!et opportunit% for a hotel$ a gap in the mar!et$ a location or choice between alternative locations$ for a particular hotel concept7 or$ given a particular location$ a stud% can determine the most appropriate hotel concept. #he translation of the concept into an operational facilit% then ta!es place through product formulation and development. In the operation of the hotel$ mar!eting can contribute through a continuous process of mar!et research$ product development$ promotion$ selling$ monitoring and review e the stages of a mar!eting c%cle. In the planning of a new hotel$ there is full scope for the adherence to the mar!eting concept from the outset. In an e-isting hotel$ there is often an important distinction between the shortand longterm mar!eting tas!s. In the short term the mar!eting tas! ma% be to ad*ust customers) wants to available facilities and services$ but the longterm tas! is to modif% the facilities and services to the customers) wants. In the short run our e-isting facilities and services are given within narrow limits. +e ma% research the mar!et to see which mar!et segments are or could be attracted to them$ ma!e such ad*ustments to our products as are possible$ but the main effort is li!el% to focus on promotion and selling. +ith low occupancies and low utili5ation of restaurants$ bars and function rooms$ in the short run the sales effort becomes dominant. <ut it is no e-cuse for doing *ust that7 it is both necessar% and possible to proceed with changing the products: toestablish who our customers could be and what their needs are &mar!et research'$ and to formulate and develop products meeting their needs &product formulation and development'. #his approach ultimatel% calls for less sales effort$ which is then designed to demonstrate to people that their needs can be met7 it is of particular importance in hotels. ;ar!eted commodities and articles are concrete$ ph%sical and capable of measurement7 most of them can be inspected and man% of them even tried out before purchase. Services are less tangible and hotel services particularl% so. 3otel services cannot be easil% defined and described in terms of clearl% measurable products and their 6ualities. #he% are often bought individuall% or as part of a pac!age$ and the% ma% be bought directl% b% the user or through an intermediar%$ for e-ample$ a travel agent. In hotels$ as in other wal!s of life$ it is necessar% to ma!e it eas% to bu% onl% more so. Property .ner"hip 2n investment in hotels is first and foremost an investment in land and buildings$ which represent the dominant assets of hotels. Other fi-ed assets are: L plant and e6uipment$ including such ma*or items as air conditioning$ boilers$ lifts$ and heav% !itchen e6uipment7 L furniture$ furnishings$ and small e6uipment7 L china$ glass$ linen and cutler%. 2ccordingl% there is a dual nature of investment in hotels e as an investment in land and buildings and an investment in interior assets. #his distinction has been recogni5ed in three principal wa%s in recent %ears. .?= >irst$ the building shell ma% be owned b% a developer$ sometimes as part of some larger pro*ect$ and leascd to anhotel operator on a rental basis. #his is also implied b% some hotel groups$ which appl% internal rentals to hotels owned b% them7 in this wa% the hotel profits are assessed after ta!ing into account the notional rental of the land and building. Secondl%$ hotel companies ma!e use of saleandlease bac! arrangements as a means of financing the investment$ which reduces the capital re6uirement for the hotel operator. #hirdl%$ interior assets ma% be also leased b% the hotel operator rather than bought$ thereb% also reducing the capital re6uirement. #here are$ therefore$ various arrangements as to who is involved in propert% ownership and in hotel management. 2 hotel operator ma% invest in the propert% represented b% land and buildings or enter into a leasing arrangement and invest onl% in the interior assets$ or an operator ma% enter into a management contract without an% direct capital investment. Property .peration and Maintenance In large hotels and in hotel groups normall% a senior person is ultimatel% responsible for technical services who ma% be variousl% described as the technical services$ buildings and services$ or wor!s director$ officer$ or superintendent$ or simpl% as chief engineer$ or b% some such title. In large organi5ations the technical services ma% be subdivided between those responsible for buildings$ for engineering$ and for other services. 2lthough technical considerations ma% be the direct concern of hotel management in smaller hotels$ the% arespecialist activities normall% entrusted to specialist staff and sometimes Tcontracted out). (ropert% operation$ maintenance and energ% costs are costs of hotel operation$ as distinct from the capital investment outla% on the assets. #he% are$ therefore$ appropriatel% included in hotel profit and loss statements. In the >niform (ystem of 5ccounts for !otels propert% operation and maintenance includes costs of repairs and maintenance of buildings$ plant and e6uipment$ furniture and furnishings$ as well as the maintenance of grounds$ related wages and salaries$ and wor! let out on contract. #he costs incurred b% hotels contributing to 3orwath International reports in the earl% 1GGH. .?? III*,otel .r#aniIation Organi5ation is the framewor! in which various activities operate. It is concerned with such matters as the division of tas!s within firms and establishments$ positions of responsibilit% and authorit%$ and relationships between them. It introduces such concepts as the span of control &the number of subordinates supervised directl% b% an individual'$ levels of management &the number of tiers through which management operates'$ delegation &the allocation of responsibilit% and authorit% to designated individuals in the line of Tcommand)'. 8ntil not so long ago e about the middle of this centur% and even later than that the t%pical hotel of almost an% si5e was characteri5ed b% a large number of individuals and departments directl% responsible to the hotel manager who was closel% concerned with his guests and with all or most aspects of the hotel operation. #heremight have been one or more assistant managers who had little or no authorit% over such !e% individuals as the chef$ the head waiter or the house!eeper. #he hotel manager usuall% combined the Tmine host) concept of hotel !eeping with a close involvement in the operation. 3e normall% had all or most of the technical s!ills that enter into the business of accommodating and catering for guests. 2lthough he might have given more attention to departments in which he felt confident about his e-pertise$ and less to those in which his !nowledge and s!ills might have been lac!ing$ his approach was essentiall% that of a technician rather than the manager of a business. 3otels served those who chose to use them. #he financial control was e-ercised b% the owners or b% accountants on their behalf. (ersonnel management rarel% e-tended be%ond the Thiring and firing) of staff. 3otel buildings and interiors were not often viewed as business assets re6uired to produce a return comparable to other commercial investments7 maintenance and energ% were cheap. Several influences have tended to change this profile generall% and the approach to hotel organi5ation in particular in the second half of the twentieth centur%. #he mar!et for hotels$ the number of hotels$ and the si5e of individual operations have grown$ against the bac!ground of economic and social conditions in most parts of the world. <usiness and management thought and practice have found their wa% into hotels$ with the entr% into the hotel business of firms engaged in other industries$ development of hotel education and training$ and higher 6ualit% of management. Innovation in hotel organi5ation$ at first largel% confined to a few firms in "orth 2merica$ has spread to others in other countries. #hese and other influences have brought about changesin the wa%s in which hotels organi5e their activities toda%. #hree particular developments illustrate the changes in hotel organi5ation in postwar <ritain. One relates to the grouping of functions. In the earl% I G0Hs hotel reception$ uniformed services and house!eeping were invariabl% regarded as separate .?G departments$ each reporting directl% to the hotel manager7 twent% %ears later man% large hotels had front hall managers$ rooms managers$ or assistant managers with specific responsibilities in this area. Similarl%$ over the same period in most large hotels food and beverage managers came to be appointed$ responsible for all the hotel activities previousl% organi5ed in restaurants$ bars and !itchens under the direct control of the hotel manager. Secondl%$ there has been a growth in specialists. In the earl% 1G0Hs onl% a few large hotels had a staff manager$ a public relations officer or a bu%er7 b% the earl% 1G=Hs personnel$ sales and mar!eting$ and purchasing departments were common features of the large hotels and of hotel groups. #hirdl%$ where each hotel used to be more or less selfsufficient in the provision of its various guest services and supporting re6uirements$ man% of these are now provided through internal rentals and concessions and through specialist suppliers and operators such as outside ba!eries$ butcheries and laundries. #he accommodation function ma% be described in terms of reception$ uniformed services and house!eeping. Several t%pical organi5ational approaches ma% be identified in respect of these activities in practice: all three activities operate as separate departments with their own heads of department7 reception and uniformed services are grouped together as the front hail or front house of the hotel under an assistant manager for whom this is the sole or main responsibilit%7 reception and uniformed services are grouped together as a front hail or front house department with its own head of department. all three activities are grouped together as the rooms department under an assistant manager for whom this is the sole or main responsibilit%7 all three activities are grouped together as the rooms department with its own head of department. #he first approach provides for a direct line of responsibilit% and authorit% between each separate head .GH Room" #he accommodation function ma% be described in terms of reception$uniformed services and house!eeping. Several t%pical organi5ational approaches ma% be identified in respect of these activities in practice: all three activities operate as separate departments with their own heads of department7 reception and uniformed services are grouped together as the front hail or front house of the hotel under an assistant manager for whom this is the sole or main responsibilit%7 reception and uniformed services are grouped together as a front hail or front house department with its own head of department. all three activities are grouped together as the rooms department under an assistant manager for whom this is the sole or main responsibilit%7 all three activities are grouped together as the rooms department with its own head of department. #he first approach provides for a direct line of responsibilit% and authorit% between each separate head of department and the hotel manager and hence for a close contact between the two levels of management7 however$ it e-tends the hotel manager)s span of control and he is re6uired to coordinate the separate departments. #he other four approaches are designed to reduce the hotel manager)s span of control and provide for a coordination of related activities at an intermediate level but increase the number of levels through which management has to operate$ and reduce the amount of direct contact between the hotel manager and the departments concerned. Several activities were described in connection with rooms$ which ma% be arranged differentl% in large hotels: In most hotels advance reservations form an integral part of hotel reception and the same emplo%ees deal with them and with other reception tas!s. <ut advance reservations ma% be dealt with in a separate section of the reception office or in a separate department$ to enable emplo%ees to concentrate on the respective tas!s without conflicting demands on their time and attention. Sometimes all advance .G1 reservations are concentrated in the sales department$ which has a responsibilit% for ma-imi5ing hotel occupanc%. In smaller hotels guest accounts are normall% handled b% boo! !eeperBreceptionists$ but strictl% spea!ing guest accounts represent an e-tension of the accounting function of the hotel. #herefore$ where guest accounting is handled b% bill office cler!s and cashiers$ the% normall% form a part of the accounts department. L In some hotels room service is provided b% house!eeping staff$ but room service is clearl% part of the food and beverage function of the hotel. ?ood and /e$era#e Several t%pical organi5ational approaches identified in respect of this function in practice: y ma% be each sales outlet and supporting service operates as a separate department with its own head of department7 L several departments are grouped together under an assistant manager for whom the% represent the sole or main responsibilit%$ e.g. purchasing and storage$ bars and cellars$ the Tbac!ofthehouse) activities including the !itchen$ and so on7 L several of these departments are grouped together as one department under its own head of department7 L all food and beverage activities are grouped together under an assistant manager for whom the% represent the sole or main responsibilit%7 L all food and beverage activities are grouped together as a food and beverage department with its own head of department. #he same observations appl% to these approaches as are made above in relation to rooms$ regarding lines of responsibilit% and authorit%$ span of control and levels of management7 the si5e of the span of control and the number of management levels are conflicting considerations. Several aspects of the food and beverage function are closel% related to each other but also to other parts of the hotel operation: L ;ost hotels have facilities serving both food and beverages$ although in some of them food or beverages ma% predominate. +hilst it is usuall% relativel% eas% to separate the revenue from each$ it is often impractical to separate accuratel% all the costs of operation other than the cost of sales$ because the same emplo%ees ma% handle both products$ and because other goods and services provided in the same .G, outlet ma% not be readil% identifiable as either food or beverages. In these circumstances food and beverages are treated together$ anal%sed b% sales outlet$ and the related responsibilities are reflected in the organi5ation structure. L >ood and beverage control based on the food and beverage c%cles ma% be appropriatel% seen as part of the total accounting function of the hotel. In these circumstances such emplo%ees as restaurant cashiers and cost control cler!s are included on the staff of the hotel accountant. L T+here there is a separate sales department$ food and beverage sales are usuall% closel% monitored b% that department$ and such arrangements as reservations for functions ma% form part of the responsibilities of the sales department. Mi"cellaneou" :ue"t Ser$ice" ;iscellaneous guest services are illustrated in terms of such activities as telephones and laundr% and the t%pical organi5ational approaches for most of term are shown to be of two main !inds: L the services are operated under direct management of the hotel as minor operated departments7 L the services are operated under rental and concession arrangements with the hotel b% another firm. #he alternative arrangements ma% appl% in the provision of the following main services to guests: beaut% shop and hairdressing secretarial services florist s6uash courts and tennis courts garage gifts and souvenirs laundr% and dr% cleaning swimming pool newspapers and maga5ines tobacconist 9irect management of these services normall% provides for a closer direct control and supervision b% the hotel and for greater fle-ibilit% in operation. In man% hotels the services are merel% grouped as residuar% hotel activities for accounting and control purposes and are in practice provided as part of the services of other hotel departments$ e.g. reception$ uniformed services$ house!eeping or general administration$ and are not separate departments in the organi5ational sense. Onl% when the volume of a particular service is sufficientl% large$ it ma% be organi5ed as a separate department. 2nd it is onl% then that the option arises for the service to be provided for the guests b% another operator$ because it warrants his involvement$ under a rental or concession arrangement. Such arrangement then relieves the hotel from operating what is often to the hotel operator an unfamiliar service and allows it to concentrate on its primar% activities. #herefore$ ma*or deciding factors are the si5e of the operation$ the availabilit% of suitable operators of particular services$ and the operational philosophies of the hotel or hotel group$ as well as the 6ualit% of service and the financial return to the hotel$ which ma% result from one or the other approach. .G. ,otel Support Ser$ice" In practice the nonrevenue service activities are organi5ed in one of three main wa%s: L retained among the hotel manager)s own responsibilities7 L assigned to an assistant manager as one of his or her responsibilities7 L assigned to a separate department with its own head of department. #o a greater or lesser e-tent each of these activities ma% also draw for its performance on e-ternal specialist advice and assistance. #he main specialist activities$ which ma% be organi5ed in one of these wa%s$ and e-amples of the e-ternal sources of advice and assistance available to the hotel in respect of each$ can be summari5ed as follows: 2ccounting and finance 3otel accountants and consultants (ublic accountants and auditors (rofessional stoc!ta!ers (ersonnel services (ersonnel recruitment and selection specialists +or! stud%$ personnel and industrial relations advisers #raining boards and other agencies (urchasing 3otel accountants and consultants >urniture and e6uipment specialists Various suppliers Sales and mar!eting ;ar!et research agencies 2dvertising agencies (ublic relations consultants (ropert% operation$ maintenance$ energ% 2rchitects$ builders$ designers Consulting engineers 8tilit% underta!ings 2dvisor% services are also sometimes provided b% professional bodies$ trade associations for their members$ the technical press and other agencies. .G/ 2part from an% operational philosophies$ the adoption of the organi5ational approaches$ in respect of a particular activit%$ is largel% determined b% the si5e of operation: the first is normall% associated with a small hotel7 the second with medium si5e7 and the third with large operations$ but no hard and fast rules appl%. Each of these activities comprises specialist !nowledge and s!ills$ as distinct from normal operational !nowhow inherent in the primar% operating activities. The Mana#ement Structure >ollowing the discussion of the division and grouping of operated and service activities into departments$ it is ne-t necessar% to consider the total management structure of the hotel7 this comprises all positions of responsibilit% and authorit% below top management$ which is represented in a hotel compan% b% the board of directors. #he management team consists of the hotel manager$ one or more deput% or assistant managers$ and the heads of departments. 2 discussion of the management structure is concerned with these posts and with the relationships between them. 2ccording to the si5e of the hotel and the particular arrangement in operation$ the hotel chief e-ecutive ma% be variousl% designated as managing director$ general manager or simpl% hotel manager. 3e or she ma% to agreater or lesser e-tent participate in the formulation of the hotel policies and strategies$ and will invariabl% be responsible for their implementation and for the hotel performance. In larger hotels this level ma% be subdivided betweena managing director or general manager and the hotel manager or a resident manager. #he former then reports to the board and normall% coordinates the wor! of the specialist departments and of the hotel or resident manager$ who is in turn responsible for the da%toda% management of the hotel activities. #he comple-it% and continuit% of the hotel activities normall% give rise to the need for one or more deput% or assistant managers. 2 deput% hotel manager normall% has authorit% over the heads of departments. <ut there is much variation in the role$ authorit% and responsibilities of hotel assistant managers. In some instances the% are the hotel manager)s deputies in all but name$ in respect of the whole operation or some parts of it$ e.g. food and beverages$ front hall$ Tbac! of the house)$ and so on7 in other cases the% have these specific responsibilities in addition to their general role as the manager)s deputies. <ut man% socalled assistant managers perform roles$ which are more appropriatel% described as those of general assistants &assisting where re6uired throughout the hotel' or of personal assistants to the manager &acting on his behalf as he directs them to do'. :et in other cases their main role is guest contact. 2ll the roles described above ma% be appropriate in particular circumstances$ but effective hotel management calls for a clear definition of responsibilit% and authorit%. #he relationships with heads of departments are especiall% important in this conte-t. #itles$ which describe the particular roles$ can be helpful in this direction. In order to provide clearcut lines of responsibilit% and authorit% and an effective coordination of related activities$ some hotels function without assistant managers as such: those who would normall% be in such positions are allocated specific responsibilities and appropriate titles to describe them. #hose in positions of heads of departments fall into two distinct categories. 3eads of operated departments are !nown as line managers$ with direct lines of .G0 responsibilit% and authorit% to their superiors and to their subordinates in respect of each operated department. 3eads of service departments are specialists who provide advice and service to line management$ and relieve them of such specialist tas!s as are considered to be more effectivel% discharged through the appointment of specialists7 the% have no direct authorit% over emplo%ees other than those of their own departments. Dine management includes$ for e-ample$ head receptionists$ head house!eepers$ head chefs and restaurant managers. Specialists include accountants$ bu%ers$ personnel and purchasing officers and similar posts. In order to draw a distinction between the two$ it is helpful to confine the designation Tmanager) to operated departments. It is also relevant to refer in this conte-t to a confusion$ which often arises with various trainee positions. It is difficult to *ustilt such titles as Ttrainee manager) unless its holder has been designated to fill a specific post$ for which he is training. 2 person who is undergoing training with a view to an ultimate unspecified position of responsibilit% is more appropriatel% described as a management trainee. +>*otel ervices Room" and /ed" #he primar% function of a hotel is to accommodate those awa% from home and sleeping accommodation is the most distinctive hotel product. In most hotels room sales are the largest single source of hotel revenue and in man%$ more sales are generated b% rooms than b% all the other services combined. Coom sales are invariabl% also the most profitable source of hotel revenue$ which %ield the highest profit margins and contribute the main share of the hotel operating profit. 3otels contributing to annual reports of 3orwath International earned on average the proportions of their total revenue shown in the following from room sales in the earl% 1GGHs. Coom Sales as a Catio of 3otel Cevenue in ;ain Cegions 1GGH 1GG1 1GG, &W' &W' &W' .G1 2frica and the ;iddle East /1.H /..1 /0., 2sia mid 2ustralia 0/.1 01.H 0=.G Europe /G., /G.1 /=.H "orth 2merica 1..G 1,.G =1.1 Datin 2rnericalCaribbean 0..? 0?.0 01. #hree main hotel activities are earning the room revenue: hotel reception$ uniformed services and Coom Sales 2 large proportion of hotel guests reserve their rooms from a few hours to several wee!s or months before the% actuall% arrive at the hotel. #he% do so in person$ b% telephone$ telegram$ #ele- or >a-$ b% mail$ through travel agents$ and in a growing number of cases through central reservations s%stems. 3otel reservations create a multitude of contractual relationships between the hotel and its guests$ which begin at the time each reservation is made and continue until the departure of the guests or until their accounts are settled after their sta%. 2dvance reservations are an important responsibilit% on the part of the hotel$ both in the legal and in the business sense$ and call for a s%stem which enables room reservations to be converted into room revenue. +hen guests arrive in hotels$ the% are as!ed to register b% providing the receptionist with certain particulars about themselves. #he hotel register$ in which the particulars are entered$ has two main functions7 one is to satisf% the law$ which ma!es hotel registration of guests a legal re6uirement in most countries. #he second function is to provide an internal record of guests$ from which data are obtained for other hotel records. In most hotels room allocations of accommodation reserved in advance are made before the guests) arrival and onl% guests registering without a previous reservation are allocated rooms on arrival$ but in some hotels all room allocations are made onl% when guests arrive. #he registration and room allocation are then the starting point for guests) sta% and a signal for the opening of their accounts$ as well as for notif%ing uniformed staff$ the house!eeping department$ telephonists$ and others$ of arrivals. Several main records document the room sale in the reception office: L reservation form or card standardi5es the details of each boo!ing$ forms the top sheet of an% documents relating to it$ and enables a speed% reference to an% individual case7 L reservation diam% or dail% arrival list records all boo!ings b% date of arrival and shows all arrivals for a particular da% at a glance7 L reservation chart provides a visual record of all reservations for a period and shows at a glance rooms reserved and those remaining to he sold7 L hotel register records all arrivals as the% occur and gives details of all current and past guests7 L reception or room status board shows all rooms b% room number and floor and gives the current and pro*ected status of all rooms on a particular da%$ with details of occupation7 L guest inde- lists all current guests in alphabetical order with their room numbers and provides an additional 6uic! point of reference in larger hotels. .G= Mall and .ther :ue"t Ser$ice" 2 combined !e% and mail rac! is a standard feature of most hotel reception offices and reflects two t%pical responsibilities of the office room !e%s and guest mail$ 2rranged b% room number and floor$ it corresponds in la%out to the reception or room status board and is complementar% to it. In the course of a da%)s business room !e%s arc issued from the rac! to arriving guests and to residents who call for them7 !e%s are returned to the rac! b% guests going out of the hotel or departing at the end of their sta%. #he rac! is a point of reference regarding the occupation of rooms and the whereabouts of guests. ;ail ma% arrive for guests before$ during and after their sta% at the hotel$ and ma% consist z.f ordinar% or registered mail$ pac!ets and parcels$ cables and) telegrams$ #ele- messages$ >a- transmissions$ e-press mail and personal messages left for guests. ;ail awaiting guests) arrival should be handed to them when the% are registering7 mail arriving after a guest has left the hotel$ should be forwarded. 9uring the guest)s sta% speed is the essence of >a- transmissions$ securit% is the essence of registered mail$ bul!iness is the essence of parcels7 each calls for standard procedures of their own. <ut the !e% and mail rac! is the focus7 it accommodates much of the mail the guest collects when collecting the room !e%7 it can serve to alert the receptionist to items such as parcels or registered mail$ stored elsewhere. #hree basic aids are$ therefore$ related and complementar% in the provision of !e%$ mail and other guest services: L guest inde- shows whether a particular person is resident and that person)s room number7 L reception or room status board shows who is occup%ing a particular room7 L !e% and mail rac! indicates whether the guest is in the hotel and whether there is an% mail for that person. In man% hotels the reception office or a separate section of it also acts as a source of information to guests e about hotel facilities and services$ about the localit%$ about transport and other matters. In other hotels the !e%s$ mail and information to guests are provided b% uniformed staff$ and there are usuall% good reasons for one or the other arrangement. <ut who does what and to whom the guest can turn$ should be made clear to the guest in terms of individual needs and re6uirements rather than in terms of the hotel organi5ation structure$ particularl% in larger hotels. Such notices as TCeception) and T3all (orter)have different connotations in different hotels and are not necessaril% selfe-planator% even for e-perienced hotel users. Counters and sections of the front hall of the hotel clearl% labelled TCegistration)$ TUe%s)$ T;ail)$ Tinformation)$ TFuest 2ccounts)$ and so on$ are more meaningful to guests. .G? 1niformed Ser$ice" #he second component of the accommodation function is uniformed services$ which form an integral part of the front hail ftmnctions of the hotel and provide a variet% of personal services to guests. Servicing arrivals and departures are the most common uniformed services. #he meeting and greeting of arriving guests$ their luggage and the par!ing of their ears$ are the first responsibilities$ which e-tend from the hotel entrance and car par! to the hotel bedrooms. On departure$ guests$ luggage and transportation are again their primar% responsibilities. In an hotel with a hundred departing guests in the morning$ followed b% a similar volume of arrivals in the afternoon and evening$ uniformed staff attend in a da%)s business to some two hundred people$ handle several hundred pieces of luggage$ par! several do(5en cars$ and arrange several do5en ta-is. #he guests$ their luggage$ and their vehicles$ therefore$ pla% a ma*or part in the provision of uniformed services. 9uring the guest)s sta% uniformed staff are often the main source of informatinn about the hotel and the localit%$ and the guest)s main source of such arrangements as theatre tic!ets$ tours$ car hire and other services. #he hail porter)s des! or an en6uir% counter in the front hail are then the information centres of hotels$ which contribute much to the range of guest services and to their integration. In some hotels other guest services ma% be provided b% uniformed staff. "ewspapers$ as well as other small articles$ ma% be supplied to guests b% uniformed staff who ma% also act as messengers$ lift operators and men)s cloa!room attendants. In man% hotels uniformed staff are the onl% people on dut% during the night and particularl% in smaller hotels maintain a whole range of hotel services provided b% other departments in da% time: to receive and register late arrivals$ to serve light refreshments$ to operate the hotel switchboard$ to arrange earl% morning calls$ as well as to clean public rooms and to ensure the securit% of the hotel. #he provision of uniformed services varies greatl% between hotels of different si5es$ t%pes and standards$ and their organi5ation tends to be influenced b% all these factors$ as well as b% established practices$ 2s mentioned earlier$ information to guests ma% he provided b% the reception office or as part of uniformed services or b% both. #he cleanliness of public rooms ma% be the responsibilit% of uniformed staff$ the house!eeping department$ or outside contractors. +hat hotel services are available during the night and b% whom the% are provided$ is another source of variation. #hese differences are legitimate$ as long as the% reflect the particular re6uirements of guests and the particular circumstances of each hotel$ and as long as the respective functions are defined and understood b% staff and made clear to guests where the% affect them. ,otel ,ou"e!eepin# .GG #he basic house!eeping function of the hotel is the servicing of guest rooms. In its scope$ guest bedrooms ma% be the sole or main responsibilit% of the hotel house!eeping department$ but it ma% e-tend to other areas of the hotel. "ormall% hotel guests spend at least onethird of their sta% in their room. #he design$ la%out$ decor$ furniture and furnishings of the hotel bedroom are fundamental to meeting their needs and in creating customer satisfaction$ and these ma% be significantl% influenced b% the house!eeping department. #he cleanliness and good order$ the linen and other room supplies$ and the smooth functioning of the room are the focus of the department. #his ma% include other guest services$ such as earl% morning teas$ guest laundr%$ bab% sitting and other personal services. #he main house!eeping records are made up of arrival and departure lists and notifications received from the reception office and the house!eeping own room status report$ together with separate records in respect of additional services provided b% the department. #he e-tension of the house!eeping function outside the hotel bedroom normall% includes the cleaning of bedroom floors and ma% include staircases$ public cloa!rooms and other public areas of the hotel. 3owever$ it is 6uite common for such public rooms as hotel lounges to be cleaned b% uniformed staff$ for the responsibilit% for the men)s and women)s cloa!rooms to be divided between uniformed staff and the house!eeping department$ and for restaurants and bars to be cleaned b% the staff of those departments. ;ore recentl%$ hotels have been engaging outside contract firms for the cleaning of public rooms. Other house!eeping services often include the provision of first aid to guests and staff$ dealing with lost propert%$ and floral arrangements throughout the hotel. +hen staff accommodation is provided b% the hotel$ it ma% be included as part of the head house!eeper)s responsibilities. 2lthough in man% countries hotels increasingl% use outside laundries and dr% cleaning firms for their re6uirements$ man% hotels operate their own dr% cleaning and laundr% facilities. #hese Tinhouse) facilities ma% be then organi5ed as separate departments of the hotel or as sections of the house!eeping department. #his outline of the hotel house!eeping function illustrates three organi5ational approaches. One see!s to integrate a number of related functions within a ma*or house!eeping department. #he second assigns certain functions to the house!eeping department and others to other departments of the hotel$ largel% on the basis of ph%sical areas. #he third consists of Tbu%ing in) certain services from outside suppliers rather than operating them directl% as hotel facilities. >ood and 9rin! #he food and drin! service is the second ma*or activit% of most hotels and in man% of them it accounts for a larger proportion of emplo%ees than the provision of sleeping accommodation and related services. #his is due to two main factors: L in contrast to hotel rooms$ meals and refreshments in hotels ma% be supplied to nonresidents as well as to resident guests and include substantial functions sales7 L the provision of meals and refreshments is relativel% labour intensive. #he provision of sleeping accommodation is a service activit%$ in which there is a negligible use of materials$ and there is no cost of sales. #he provision of meals and refreshments results in composite products made up of commodities and of service$ and the use of materials represent the cost of sales. >ood and drin! enter into meals and refreshments served in hotels in several stages from their purchase b% the hotel to their sale in the same or altered form to the hotel customer. 2ccording to the /HH si5e and diversit% of the hotel mar!ets there ma% be more than one restaurant and bar and also food and drin! service in rooms and through functions. Re"taurant" Cestaurants establishment where refreshments or meals ma% be procured b% the public. #he public dining room that came ultimatel% to be !nown as the restaurant originated in >rance$ and the >rench have continued to ma!e ma*or contributions to the restaurant)s development. #he first restaurant proprietor is believed to have been one 2. <oulanger$ a soup vendor$ who opened his business in (aris in 1=10. #he sign above his door advertised restoratives$ or restaurants$ referring to the soups and broths available within. #he institution too! its name from that sign$ and IrestaurantJ now denotes a public eating place in English$ >rench$ 9utch$ 9anish$ "orwegian$ Comanian$ and man% other languages$ with some variations. >or e-ample$ in Spanish and (ortuguese the word becomes restaurante$ in Italian it is ristorante7 in Swedish$ restaurang7 in Cussian$ restoran7 and in (olish$ restauracia. 2lthough inns and hostelries often served pa%ing guests meals from the host)s table$ or table d)hkte$ and beverages were sold in cafjs$ <oulanger)s restaurant was probabl% the first public place where an% diner might order a meal from a menu offering a choice of dishes. /H1 <oulanger operated a modest establishment7 it was not until 1=?, that Da Frande #averne de Dondres$ the first lu-ur% restaurant$ was founded in (aris. #he owner$ 2ntoine <eauvilliers$ a leading culinar% writer and gastronomic authorit%$ later wrote D T2rt du cuisinier &1?1/'$ a coo!boo! that became a standard wor! on >rench culinar% art. #he most illustrious of all 1Gthcentur% (aris restaurants was the Cafj 2nglais$ on the <oulevard des Italiens at the corner of the rue ;arivau-$ where the chef$ 2doiphe 9ugljrj$ created classic dishes such as sole 9ugljrj &filets poached with tomatoes and served with a cream sauce having a fish stoc! base' and the famous sorrel soup potage Fermin%. On @une =$ 1?1=$ the Cafj 2nglais served the now famous I#hree Emperors 9innerJ for three ro%al guests visiting (aris to attend the 8niversal E-position. #he diners included #sar 2le-ander 11 of Cussia7 his son the tsarevich &later the tsar 2le-ander III'7 and Uing +illiam I of (russia$ later the first emperor of Ferman%. #he meal included souffles with creamed chic!en &a Ia reine'$ fillets of sole$ escalloped turbot$ chic!en a la portugaise &coo!ed with tomatoes$ onions$ and garlic'$ lobster a la parisienne &round$ flat medallions gla5ed with a gelatinma%onnaise mi-ture and elaboratel% decorated'$ duc!lings a Ia rouennaise &the carcasses stuffed with liver and pressed$ presented on a platter with boned slices of the breast and the grilled legs$ and served with a red wine sauce containing pureed liver'$ ortolans &small game birds' ontoast$ and eight different wines. #oward the end of the 1Gth centur%$ in the gaud% and e-travagant era !nown as ia belie jpo6ue$ the lu-urious ;a-im)s$ on the rue Co%ale$ became the social and culinar% centre of (aris. #he restaurant temporaril% declined after +orld +ar I but recovered under new management$ to become an outstanding gastronomic shrine. >rance produced man% of the world)s finest chefs$ including Feorges2uguste Escoffier$ who organi5ed the !itchens for the lu-ur% hotels owned b% Cjsar Cit5$ developing the socalled brigade de cuisine$ or !itchen team$ consisting of highl% trained e-perts each with clearl% defined duties. #hese teams included a chef$ or gros bonnet$ in charge of the !itchen7 a sauce chef$ or deput%7 an entremettier$ in charge of preparation of soups$ vegetables$ and sweet courses7 a r{tisseur to prepare roasts and fried or grilled meats7 and the garde manger$ in charge of all supplies and cold dishes. In Escoffier)s time$ the duties and responsibilities of each functionar% were sharpl% defined$ but in modern times$ rising labour costs and the need for faster service have bro!en down such rigidl% defined duties. In the !itchens of even the leading modern restaurants$ duties at the pea! of the dinnerhour preparations are li!el% to overlap widel%$ with efficienc% maintained amid seeming chaos and confusion. I n the ,Hth centur%$ with the development of the automobile$ countr% dining became popular in >rance$ and a number of fine provincial restaurants were established. #he Cestaurant de la (%ramide$ in Vienne$ regarded b% man% as the world)s finest restaurant$ wasfounded b% >ernand (oint and after his death$ in 1G00$ retained its high standing under the direction of his widow$ ;adame I;adoJ (oint. Other leading >rench provincial restaurants have included the #roisgros in Coanne7 the (aul <ocuse Cestaurant near D%on7 the 2uberge de 1)Ill in Illhaeusern$ 2lsace7 and the hotel Ckte d)Or$ at Saulieu. >rench restaurants toda% are usuall% in one of three categories: the bistro$ or brasserie$ a simple$ informal$ and ine-pensive establishment7 the mediumpriced restaurant7 and the more elegant grand restaurant$ where the most intricate dishes are e-ecuted and served in lu-urious surroundings. Other nations have also made man% significant contributions to the development of the restaurant. /H, In Ital% the botteghe &coffee shop' of Venice originated in the 11th centur%$ at first serving coffee onl%$ later adding snac!s. #he modern trattorie$ or taverns$ feature local specialities. #he osterie$ or hostelries$ are informal restaurants offering home st%le coo!ing. In >lorence small restaurants below street level$ !nown as the buca$ serve whatever foods the host ma% choose to coo! on a particular da%. 2ustrian coffeehouses offer leisurel%$ complete meals$ and the diner ma% linger to sip coffee$ read a newspaper$ or even to write an article. ;an% 2ustrians fre6uent their own Istead% restaurants$J !nown as Stain$nbe In 3ungar% the cswrda$ a countr% highwa% restaurant$ offers menus usuall% limited to meat courses and fish stews. #he beer halls of the C5ech Cepublic$ especiall% in (rague$ are similar to coffeehouses elsewhere. >ood is served$ with beer replacing coffee. #he Ferman +einstube is an informal restaurant featuring a large wine selection$ and the +einhaus$ a food and wine shop where customers ma% also dine$ offers a selection of foods ranging from delicatessen fare to full restaurant menus. #he Schen!e is an estatetavern or cottage pub serving wine and food. In the cities a similar establishment is called the Stadischen!e. In Spain the bars and cafjs of ;adrid offer widel% varied appeti5ers$ called tapas$ including such items as shrimp coo!ed in olive oil with garlic$ meatballs with grav% and peas$ salt cod$ eels$ s6uid$ mushrooms$ and tuna fish. #he tapas are ta!en with sherr%$ and it is a popular custom to go on a chateo$ or tour of bars$ consuming large 6uantities of tapas and shen% at each bar. Spain also features the marisco bar$ or marEs 6uerIa$ a seafood bar7 the asadoro$ a Catalan rotisserie7 and the tasca$ or pub wineshop. In (ortugal$ cerve*arias are popular beer parlours also offering shellfish. >ado taverns serve grilled sausages and wine$ accompanied b% the plaintive (ortuguese songs called fados &meaning IfateJ'. In Scandinavia sandwich shops offer openfaced$ artfull% garnished sandwiches called smorrebrod. Swedish restaurants feature the smorgasbord$ which literall% means Ibread and butter tableJ but actuall% is a lavish$ beautifull% arranged feast of herring$ shrimp$ pic!les$ meatballs$ fish$ salads$ cold cuts$ and hot dishes$ served with a6uavit or beer. #he "etherlands has brood*eswin!els$ serving sandwich openfaced shops$ called sandwiches$ seafoods$ hot and cold dishes$ and cheeses from a huge table. English cit% and countr% pubs have three !inds of bars: the public bar$ the saloon$ and the private bar. Ever%one is welcome in the public bar or saloon$ but the private bar is restricted to habitu|s of the pub. (ub food varies widel% through England$ ranging from sandwiches and soups to por! pies$ veal and ham pies$ stea! and !idne% pies$ bangers &sausages' and a pint &beer'$ bangers and mash &potatoes'$ toad in the hole &sausage in a :or!shire pudding crust'$ and Cornish pasties$ or pies filled with meat and vegetables. In the tavjrnas of Freece$ customers are served such beverages as retsina$ a resinated wine$ and ou5o$ an aniseflavoured aperitif$ while the% listen to the music of the bou:ou!i. Di!e other ;editerranean countries$ Freece has the grocei%tavjrna where one can bu% food or eat. #he #ur!ish is!embeci is a restaurant featuring tripe soup and other tripe dishes7 muhalleb icE shops serve boiled chic!en and rice in a soup and mil! pudding. Characteristic of @apan are sushi bars that serve sashimi &raw fish slices' and sushi &fish or other ingredients with vinegared rice' at a counter. Other food bars serve such dishes as noodles and tempura &deep fried shrimp and vegetables'. :udofu /H. restaurants build their meals around varieties of tofu &bean curd'$ and the elegant tea houses serve formal Uaise!i table d)hkte meals. In China$ restaurants serving the local cuisine are found$ and noodle shops offer a wide variet% of noodles and soups. #he dimsum shops provide a neverending suppl% of assorted steamed$ stuffed dumplings and othersteamed or fried delicacies. 2 common sight in most parts of 2sia is a !ind of portable restaurant$ operated b% a single person or famil% from a wagon or litter set up at a particular street location$ where specialties are coo!ed on the spot. >ood and coo!ing utensils var% widel% in 2sia. #he cafeteria$ an 2merican contribution to the restauranfs development$ originated in San >rancisco during the 1?/G gold rush. >eaturing selfservice$ it offers a wide variet% of foods displa%ed on counters. #he customer ma!es his selections$ pa%ing for each item as he chooses it or pa%ing for the entire meal at the end of the line. Other t%pes of 6uic!eating places originating in the 8nited States are the drugstore counter$ serving sandwiches or other snac!s7 the lunch counter$ where the diner is served a limited 6uic!order menu at the counter7 and the drivein$ Idrive thru$J or driveup restaurant$ where patrons are served in their automobiles. Socalled fastfood restaurants$ usuall% operated in chains or as franchises and heavil% advertised$ offer limited menus t%picall% comprising hamburgers$ hot dogs$ fried chic!en$ or pi55a and their complementsand also offer speed$ convenience$ and familiarit% to diners who ma% eat in the restaurant or ta!e their food home. 2mong fastfood names that have become widel% !nown are +hite Castle &one of the first$ originating in +ichita$ Uan.$ in 1G,1'$ ;c9onald)s &which grew from one establishment in 9es >lames$ Ill.$ in 1G00 to more than 10$HHH internationall% within /H %ears'$ Uentuc!% >ried Chic!en &founded in 1G01'$ and (i55a 3ut &1G0?'. ;an% school$ wor!$ and institutional facilities provide space for coinoperated vending machines that offer snac!s and beverages. #he specialt% restaurant$ serving one or two special !inds of food$ such as seafood or stea!$ is another distinctive 2merican establishment. #he (ullman car diner$ serving fullcourse meals to long distance railroad passengers$ and the riverboat steamers$ renowned as floating gourmet palaces$ were original 2merican conceptions. #he% belong to an earlier age$ when dining out was a principal social diversion$ and restaurants tended to become increasingl% lavish in food preparation$ decor$ and service. In man% modern restaurants$ customers now prefer informal but pleasant atmosphere and fast service. #he number of dishes available$ and the elaborateness of their preparation$ has been increasingl% curtailed as labour costs have risen and the availabilit% of s!illed labour decreased. #he trend is toward such efficient operations as fastfood restaurants$ snac! bars$ and coffee shops. #he trend in elegant and e-pensive restaurants is toward smaller rooms and intimate atmosphere$ with authentic$ highl% speciali5ed and limited menus. Mi"celaneou" :ue"t Ser$ice" 2ccommodation$ food and drin! services are the ma*or activities of hotels$ which generate all or most hotel revenue$ account for all or most of their emplo%ees$ and represent the principal products provided b% the ma*or hotel departments. <ut the presentda% hotel guest normall% also e-pects other facilities and services. In addition to a comfortable room$ and meals and refreshments in a /H/ restaurant or bar or in the room$ a guest ma% want to use the telephone or have clothes laundered or dr% cleaned. In a large modern hotel a guest ma% anticipate to be able to bu%newspapers$ maga5ines and souvenirs$ have a haircut$ obtain theatre tic!ets$ and boo! an airline tic!et for the ne-t stage of a trip. #he hotel services other than accommodation$ food and drin! ma% be provided to the guest b% the hotel or b% other operators on the hotel premises. #he revenue earning activities provided directl% b% the hotel are variousl% described as ancillar% or subsidiar% revenue earning$ and are grouped for accounting and control purposes in what are !nown as minor operated departments$ to distinguish them from ma*or operated departments concerned with rooms$ food and beverages. <oth are distinguished from rental and concession arrangements$ under which some of these and other services ma% be provided to guests b% outside firms operating in the hotel. #he three basic components of the accommodation function are present in most hotels and are normall% organi5ed in separate departments. <ut their organi5ation and staffmg often differ in hotels of different si5es$ t%pes and standards. In smaller hotels onl% a few people ma% be engaged in each and cover a wide range of duties7 as the hotel increases in si5e$ each activit% ma% be subdivided into separate departments or sections$ in which those engaged in them perform more speciali5ed tas!s. 2 transit cit% hotel with a short average length of sta% calls for a somewhat different approach from that of a resort hotel$ which accommodates guests for longer and often such regular periods as one or two wee!s. #here is also a relationship between prices$ the range and 6ualit% of facilities and services provided$ and the wa% the% are organi5ed. >or all these and other reasons it is possible to describe the hotel activities related to the accommodation of guests onl% in broad and general terms. >. ,ourist 4ttractions #ourist attractions have an important role to pla% in world tourism since the% often provide the motivating force for travel$ thereb% energising the man% components of the tourist industr%. #he scope of the attractions sector is immense7 logicall% an%thing that has the power to draw visitors to it can be considered an attraction. ;oreover an attraction ma% not be a readil% identifiable place or feature$ but a visitor)s overall perception of a destination as an attractive place to visit$ distilled from a variet% of surces and images. Dondon)s current popularit% as a tourist destination with %oung visitors from around the world is a good case7 the% are not attracted primaril% b% the traditional <ig <en$ <uc!ingham (alace$ 3ouses of (arliament but rather b% the image of the capital as a IcoolJ place to hear good music and have an en*o%able time. #ouristic attractions occur at a variet% of scales. ;an% internationall% famous attractions such as: San >rancisco)s Folden Fate <ridge Ced S6uare in ;oscow #he (onipidou Centre in (aris are household names on man% tourists) Imust seeJ lists. /H0 9omestic tourists travel within their own countries to a variet% of attractions$ some of which are provided free of charge while others charge admission. #hese ma% be da% visits or a part of a long holida% or short brea!. #ourist attraction are provided b% both commercial and noncommercial organi5ations. ;an% historic buildings$ areas of landscape or wildlife interest$ museums and ancient monuments are in the care of public bodies and voluntar% groups which aim to preserve or conserve vital parts of a countr%)s heritage while at the same time ma!ing facilities available to tourists. Type" of touri"t attraction" #ourist attractions are generall% classified into one of two categories: "atural attractions ;an made attractions such as: 3eritage attractions &e.g. +illiamsburg' ;useums and ancient monuments &Te.g Douvre in (aris' #heme par!s &e.g. +alt 9isne% +orld in >lorida' Entertainments &e.g #he S%dne% Opera 3ouse' Sport facilities &e.g +inter Olimpic Faines' Deisure shopping venues &Te.g#he ;etro Center in Englanc +ildlife areas &e.g <usch Farden in >lorida' Touri"m today #he mass tourism that e-ists in the world toda% is a phenomenon of the post industrial societ% of the latter half of the twentieth centur%. #ourism has become an integral part of the move awa% from economies based on heav% engineering and manufacturing to a rapidl% e-panding service sector. #he growth in international and domestic tourism since the 1G0Hs has been nothing short of dramatic$ with international tourist arrivals climbingfrom ,0 million in 1G0H to a record 0G, million in 1GG1 &+orld #ourism Organisation$ 1GG='. +hen we add to this the fact that the volume of domestic tourism worldwide is estimated b% the +orld #ourism Organisation to be appro-imatel% ten times greater than that of international tourism &+orld #ourism Organisation. 1G?.'$ the scale of the tourism phenomenon can begin to be appreciated. Freater wealth$ higher educational standards$ increased mobilit% and more leisure time have all contributed to unparalleled demand for holida%s and e-cursions at home and abroad. Overseas travel is no longer the preserve of the privileged few$ but is available to the ma*orit%$ as developments in transportation$ increased competition and global communications technolog% have reduced the real cost of holida%s. (rivate and public sector organisations have responded to the increased demand b% providing a wide range of facilities and products to meet the needs of an increasingl% discerning travelling public. It must be remembered$ however$ that tourism is a ver% recent phenotnenon that has hitherto been allowed to /H1 grow in a business environment relativel% free of regulation and trade restrictions. Such an unrestricted environment is unli!el% to continue in %ears to come. #he current scale and scope of the international tourism industr% is illustrated in recent data from the +orld #ravel and #ourism Council &1GG1'$ which indicate that in 1GG1 the world travel and tourism industr% is estimated to have: Fmplo%ed ,00 million people Fenerated an output of 8S N..1 trillion Contributed 1H.= per cent of global gross domestic product &.F9(' o invested 8S N=11 billion in capital pro*ects Fenerated& 8S N=11 billion in world e-ports (aid 8S N10. billion in ta-es worldwide Such figures demonstrate the economic significance of the tourism industr% on a global scale and confirm that the age of mass tourism has trul% arrived in spectacular fashion. 'ocal ,ours Pari" (aris is the capital of >rance and one of Europe)s largest conurbations. #he cit% was founded more than ,$HHH %ears ago on an island in the Seine Civer$ some ,.. miles &.=0 !ilometres' upstream from the river)s mouth on the English Channel. #he modern cit% has spread from the island &the lie de la Cite' and far be%ond both ban!s of the Seine. #he Cit% of (aris itself covers an area of /1 s6uare miles &1H0 s6uare !ilometres'7 the Freater (aris conurbation$ formed of suburbs and other builtup areas$ e-tends around it in all directions to cover appro-imatel% ?GH s6uare miles. (aris occupies a central position in the rich agricultural region !nown as the (aris <asin$ and it constitutes one of eight djpartements of theIlede>rance administrative region. It is b% far the nation)s most important centre of commerce and culture. "EIF3<O8C >lOO9S 2"9 SIF3#S (aris) man% old buildings$ monuments$ gardens$ pla5as$ boulevards$ and bridges compose one of the world)s grandest cit%scapes. 2n impressive spot from which to view the cit% is the Chaillot (alace$ which stands on a rise on the Cight <an! of the Seine to the west$ where the river begins its southwestward curve. The Chaillot Palace* #he Chaillot (alace dates from the International E-position of 1G.=. It replaced the #rocadjro (alace$ a structure left over from the 1?=? International E-position. #he Chaillot (alace is made up of two separate pavilions$ from each of which e-tends a curved wing. #he ;usje de I)3omme$ the "aval ;useum$ the ;useum of >rench ;onuments$ and the Cinema ;useum are located there. 8nder the terrace that separates the two sections are two theatres$ the "ational #heatre of /H= Chaillot and a small hall that serves as one of the two motion picture houses of the national film librar%. #he terrace$ which is lined b% statues$ gives a splendid view across (aris. #he slope descending to the river has been made into a terraced par!$ the centre of which is alive with fountains$ cascades$ and pools. #he #rocadjro 26uarium is in a grotto a few steps awa% in the par!. >rom the bottom of the slope the fivearched @ena <ridge &(ont d)Ijna' leads across the river. It was built for "apoleon in 1?1. to commemorate his victor% at the<affle of @ena in 1?H1. On the Deft <an! rises the Eiffel #ower$ an unclad metal truss tower designed b% Fustave Eiffel. #he tower was built for the International E-position of 1??G$ against the strident opposition of national figures who thought it unsafe or ugl% or both. +hen the e-position concession e-pired in 1GHG$ the G?/foot &.HHmetre' tower was to have been demolished$ but its value as an antenna for radio transmission saved it. 2dditions made for television transmission have added 01 feet to the height. >rom the topmost of the three platforms the view e-tends for more than /H miles. >rom the twoacre base of the tower the Champde ;ars &I>ield of ;arsJ'$ an immense field$ stretches to the ;ilitar% 2cadem% &Ecole ;ilitaire'$ which was built from 1=1G to 1==, and is still used b% the +ar College &Ecole Supjrieure de Fuerre'. #he Champde;ars$ which originall% served as the school)s parade ground$ was the scene of two vast rallies during the >rench Cevolution: that of the >ederation &1=GH' and that of the Supreme <eing &1=G/'. >rom 1=G? there were annual national e-positions of crafts and manufactures$ which were followed b% world)s fairs between 1?00 and 1GHH. <ehind the ;ilitar% 2cadem% stands the head6uarters of the 8nited "ations Educational$ Scientific and Cultural Organi5ation &8"ESCO'. #he building$ erected in 1G0?$ was designed b% an international trio of architects and decorated b% artists of member nations. The In$alide"* One street to the northeast is the 3otel des Invalides$ founded b% Douis OIV to shelter =$HHH aged or invalid veterans. #he enormous range of buildings was completed in five %ears &11=1=1'. #he goldplated dome &11=01=H1' that rises /H? above the hospital buildings belongs to the church of SaintDouis. #he dome was designed b% @ules Ilardouin;ansart$ who emplo%ed a st%le !nown in >rance as I@esuitJ because it derives from the @esuits) first church in Come$ built in 101?. #he churches of the >rench 2cadem% &2cadjmie >rancaise'$ the ValdeFrace 3ospital$ and the Sorbonne$ as well as three others in (aris$ all of the 1=th centur%$ followed this st%le. <% using the classical elements more freel% than had been done in Come$ the >rench made it something recogni5abl% (arisian. In the chapels of SaintDouis are the tombs of "apoleon)s brothers @oseph and @jrkme$ of his son &whose bod% was returned from Vienna in 1G/H b% 2dolf 3itler'$ and of the marshals of >rance. Immediatel% beneath the cupola is a red porph%r% sarcophagus that covers the si- coffins$ one inside the other$ enclosing the remains of "apoleon$ which were returned from St. 3elena in 1?/H through the efforts of Uing Douis (hilippe. "apoleon)s uniforms$ personal arms$ and deathbed are displa%ed in the 2rm% ;useum at the front of the Invalides. 2 portion of the Invalides still serves as a militar% hospital7 facilities have been moderni5ed since +orld +ar II. #he vast$ treelined Invalides Esplanade slopes gentl% to the Euai d and the 2le-andre III <ridge. #he first stone for the bridge$ which commemorates the Cussian tsar 2le-ander III$ was laid in 1?G= b% 2le-ander)s son$ #sar "icholas II. #he bridge was finished in time for the International E-position of 1GHH$ and it leads to two other souvenirs of that %ear)s fair$ the Frand (alais and the (etit (alais. #he buildings are still used for annual shows and for ma*or visiting art e-hibits. The )ou$re* Vi!ings camped on the Cight <an! across from the western tip of the lie de la Cite in their unsuccessful siege of (aris in ??0$ and in about 1,HH Uing (hilip II had a s6uare crusader)s castle built on the same site$ *ust outside the new cit% wall$ to buttress the western defenses. Over the following centuries man% additions and renovations were made$ and from the castle grew one of the world)s largest palaces$ completed onl% in 1?0,. >rom the original s6uare$ !nown as the Cour Carr|e &IS6uare CourtJ'$ two galleries e-tend westward for 1$1/H feet$ one along the river$ the other along the rue de Civoli. In 1?=1$ onl% 1G %ears after the huge oblong was completed$ its western face$ the #uileries (alace &begun 101.'$ was destro%ed b% the insurrectionists of the Commune. #wo of the facades of the Cour Carrje had strong influence on >rench architecture. (ierre Descot began his inner court%ard facade in 10/1$ adapting the Cenaissance rh%thms and orders he had observed in Ital% and adding purel% >rench decoration to the classical motifs. #he ph%sician and architect Claude (errault collaborated with Douis De Vau$ architect to the !ing$ to design the outer east face of the palace in 11=.. It$ too$ emplo%s classic elements$ ma!ing especiall% graceful use of coupled columns and a pediment. #he Douvre ;useum occupies the four sides of the palace around the Cour Carrje as well as the south galler%$ which stretches along the river. 2mong the treasures of the museum are the Victor% of Samothrace$ the Venus de ;ilo$ and the ;ona Disa. #he enormous collections contain wor!s from the =th centur% <C to the midlGth centur%$ with a huge cultural and geographic spread. #he north galler%$ along the rue de Civoli$ houses a separate museum$ the ;useum of 9ecorative 2rts$ as well as the ;inistr% of >inance. /HG E-tensive remodeling has been underta!en throughout the Douvre to increase space for art wor!s. Construction began in the earl% 1G?Hs to create a new main entrance and underground reception hail in the vast "apoleon Court%ard$ between the two galleries7 the =Hfoothigh glass p%ramid designed b% I.;. (ei to cover the entrance aroused both strong support and spirited criticism. #he 2rts <ridge &(ont des 2rts'$ which crosses the Seine from the Douvre to the Deft <an!$ is one of the most charming of all the (arisian bridges. It was the first &1?H.' to be made of iron$ and it has alwa%s been reserved for pedestrians: it provides an intimate view of riverside (aris and of the Seine itself. Ile de la Cite* 9ownstream and *ust below the bridge is the tip of the Ile de la Cite$ fashioned into a triangular gravelpathed par! bordered b% flowering bushes$ with rustic benches under the ancient trees. It is surrounded b% a wide cobbled 6ua% that is especiall% popular with sunbathers and lovers. +here the steps come onto the bridge from the par! there is a bron5e e6uestrian statue of Uing 3enr% +$ who insisted on completion of the (ont"euf #he statue is an 1?1? reproduction of the 111/ original$ which was the first statue to stand on a public wa% in (aris. Opposite is the narrow entrance to the (lace 9auphine &11H='$ named for 3enr%)s heir$ the future Douis OIII. #he place was formerl% a triangle of uniform redbric! houses pointed in white stone$ but the row of houses along its base was ripped out in 1?=1 to ma!e room for construction of part of the (alace of @ustice. #he shipshaped lie de la Cite is 1H streets long and five wide. Eight bridges lin! itto the riverban!s and a ninth leads to the scowshaped lie SaintDouis$ which lies to the southeast. #he palace of the earl% Coman governor &now the (alace of @ustice' was rebuilt on the same site b% Douis IO &St. Douis' in the 1.th centur% and enlarged 1HH %ears later b% (hilip IV the >air$ who added the grim$ gra% turreted Conciergerie$ with its impressive Fothic chambers. #he Freat 3ail$ which$ under the !ings$ was the meeting place of the (ariement &the high court of *ustice'$ was !nown throughout Europe for its Fothic beaut%. >ires in 111? and 1?=1 destro%ed much of the original room$ however$ and most of the rest of the palace was devastated b% flames in 1==1. #he Freat 3all now serves as a waiting room for the courts$ in one of which$ the ad*oining first Civil Chamber$ the Cevolutionar% #ribunal sat from 1=G.$ condemning ,$1HH persons to the guillotine. 2fter sentencing$ the victims were ta!en bac! down the stone stairs to the dungeons of the Conciergerie to await the tumbrils. #he Conciergerie still stands and is open to visitors. /1H In the palace court%ards is found one of the great monuments of >rance$ the 1.thcentur% SainteChapelle &TChapelJ'. <uilt at Douis IOs direction between 1,/. and 1,/?$ it is a masterpiece of Fothic Ca%onnant st%le. +ith great daring$ the architect &possibl% (ierre de ;ontreuil' poised his vaulted ceilings on a trellis of slender columns$ the walls between being made of stained glass. #he e-6uisite chapel was designed to hold the Crown of #horns$ thought to be the ver% one worn b% @esus at his crucifi-ion. Douis IO had purchased the relic from the Venetians$ who held it in pawn from <aldwin$ the Datin !ing of <%5antium. Other hol% relics$ such as nails and pieces of wood from the #rue Cross$ were added to the chapel)s collection$ the remnants of which are now in the treasur% of "otre9ame. 8nder Uing Douis(hilippe &1?.H/?'$ the Isaniti5ationJ of the island was begun$ and it was continued for his successor$ "apoleon III$ b% <aron Feorges 3aussmann. #he pro*ect involved a mass clearing of anti6uated structures$ widening of streets and s6uares$ and the erection of massive new government offices$ including parts of the (alace of @ustice. #he portion of the palace that borders the Euai des Orf}vres formerl% the goldsmiths) and silversmiths) 6ua%ebecame the head6uarters of the (aris municipal detective force$ the (olice @udiciaire &I@udicial (oliceJ'$ which !eeps a small museum on the fourth floor. 2cross the boulevard du (alais is the (olice (refecture$ another 1Gthcentur% structure. On the far side of the prefecture is the (lace du (arvis"otre9ame$ an open space enlarged si- times b% 3aussmann$ who also moved the 3ktel9ieu$ the first hospital in (aris$ from the riverside to the inland side of the s6uare. Its present buildings date from 1?1?. -otre0Dame de Pari"* /11 2t the east end of the s6uare is the cathedral of "otre 9ame de (aris$ which is situated on a spot that (arisians have alwa%s reserved to the practice of religious rites. #he FalloComan boatmen of the cite erected their altar to @upiter there &it is now in the Clun% ;useum'$ and$ when Christianit% was established$ a church was built on the temple site. #he first bishop of (aris$ St. 9enis$ became its patron saint. #he red in the colours of (aris represents the blood of this mart%r who$ in popular legend$ after decapitation$ pic!ed up his head and wal!ed. +hen ;aurice de Sull% became bishop in 110G he decided to replace the decrepit cathedral of SaintEtienne and the 1thcentur% "otre9ame with a church in the new Fothic st%le. #he st%le was conceived in >rance$ and a new structural development$ the fl%ing buttress$ which added to the beaut% of the e-terior and permitted interior columns to soar to new heights$ was introduced in the building of "oire9ame. Construction began in 111. and continued until 1./0. 2fter being damaged during the >rench Cevolution$ the church was sold at auction to a buildingmaterials merchant. "apoleon came to power in time to annul the sale$ and he ordered that the edifice be redecorated for his coronation as emperor in 1?H/. Douis(hilippe later initiated restoration of the neglected church. #he architect Eugene Violletle9uc wor!ed from 1?/0 to 1?1/ to restore the monument. Di!e all cathedrals in >rance$ "otre9ame is the propert% of the state$ although its operation as a religious institution is left entirel% to the Coman Catholic Church. 2 few 11th and 1=thcentur% buildings survive north of the cathedral. #he% are what remain of the Cloister of the Cathedral Chapter$ whose school was famous long before the new cathedral was built. Earl% in the 1,th centur%$ one of its theologians$ (eter 2belard$ left the cloister with his disciples$ crossed to the Deft <an!$ and set up an independent school in the open air in the Convent of the (araclete near the present (lace ;aubert. 2fter a prolonged struggle with the mon!s of Saint 9enis the followers of 2belard in 1,HH won the right$ from both the !ing and the pope$ to form and govern their own communit%. #his was the beginning of the 8niversit% of (aris. Rue de Ri$oli* #he Douvre and the #uileries Fardens ta!e up the south side of this street$ and on the other side runs an arcade more than a mile long. Opposite the middle of the Douvre$ the (lace du (alaisCo%al leads to the palace of Cardinal de Cichelieu$ which he willed to the ro%al famil%. Douis OIV lived there as a child$ and during the minorit% of Douis OV the !ingdom was ruled from there b% the debauched but gifted regent (hilippe II$ duc d)Orljans from 1=10 to 1=,.. Date in the 1?th centur% Douis (hilippe d)Orljans$ who was popularl% renamed (hilippeEgalitj during the Cevolution for his radical opinions$ undertoo! e-tensive building around the palace garden. It was a commercial operation$ and the (rince hoped to pa% his debts from the propert% rents. 2round the garden he built a beautiful oblong of colonnaded galleries and at each end of the galler% farthest from his residence a theatre. #he larger pla%house has been the home of the Comjdie>ranzaise$ the state theatre compan%$ since "apoleon)s reign. #he princel% apartments now shelter high state bodies such as the Council of State. @ust behind the court%ard is the <iblioth}6ue "ationale &"ational Dibrar%'$ the national librar% of deposit$ with an enormous collection of boo!s and prints. 3aussrnann greatl% enlarged the (lace du (alaisCo%al in 1?0,$ and he was careful to /1, preserve the palace when he laid out the avenue de l)Opjra. 2t the top of the avenue$ where the Frands <oulevards crossed an enormous new place$ the new opera house was built from 1?,0 to 1?G?. #he (aris Opera 3ouse$ a splendid monument to the Second Empire$ was designed in the neo<aro6ue st%le b% Charles Famier. It is !nown especiall% for its decorative embellishments$ chief among them the Frand Staircase. @ust behind the Opera 3ouse are various large department stores. #he ne-t place along the rue de Civoli is the (lace des (%ramides. #he gilded e6uestrian statue of @oan of 2rc stands not far from where she was wounded at the Saint 3onorj Fate &(orte Saint3onorj' in her unsuccessful attac! on (aris &at that time held b% the English'$ on Sept. ?$ 1/,G. >arther along toward the (lace de la Concorde the rue de Castiglione leads to the (lace Vendkme$ an elegant octagonal place$ little changed from the 11G? designs of @ules 3ardouin;ansart. In the centre$ the Vendkme Column bears a statue of "apoleon. It was pulled down during the Commune and put bac! up under the #hird Cepublic &1?= 11G/H'. #he place and the rue de la (ai- have lost none of their discreet distinction$ nor have their shops. The 9Triumphal Way*= >rom the 2rc de #riomphe du Carrousel$ in the court%ard between the open arms of the Douvre$ e-tends one of the most remar!able perspectives to be seen in an% modern cit%. It is sometimes called la Voie #riomphale & #riumphal +a%KK'. >rom the middle of the Carrousel arch the line of sight runs the length of the #uileries Fardens$ lines up on the obelis! in the (lace de Ia Concorde$ and goes up the ChampsEl%sees to the centre of the 2rc de #riomphe and be%ond to the s!%scrapers of Da 9efense$ in the western suburbs. #he DouvrVs modest triumphal arch stands in the open space where costumed nobles performed in an e6uestrian displa% carrouselto celebrate the 9auphin)s birth in 111,. #he design of the arch$ an imitation of that of the 2rch of Septimius Severus in Come$ was conceived in 1?H? b% Charles (ercier and (ierre >ontaine. #he flan!s of the Carrousel arch are incised with a record of "apoleon)s victories. /1. #he #uileries Fardens$ which fronted the #uileries (alace &looted and burned in 1?=1 during the Commune'$ have not altered much since 2ndrj De "ktre redesigned them in 111/. De "ktre was born and died in the gardener)s cottage in the #uileries7 he succeeded his father there as master gardener. 3is design carried the line of the central allje be%ond the gardens and out into the countr%side b% tracing a path straight along the wooded hill west of the palace. On this hilltop$ 1=H %ears later$ the 2rc de #riomphe was erected. #he (lace de la Concorde was designed as a moated octagon in 1=00 b% @ac6ues2nge Fabriel. #he river end was left open$ and on the inland side two matching buildings were planned. Viewed cloc!wise starting from the "av% ;inistr% &;inistsre de la ;arine'$ the statues are Dille$ Strasbourg$ D%on$ ;arseille$ <ordeau-$ "antes$ <rest$ and Couen. Douis(hilippe also had the Du-or Obelis!$ a gift from Eg%pt$ installed in the centre and flan!ed b% two fountains <etween the twin buildings on the northeastern side of the place$ the broad rue Co%ale mounts to the Church of Sainte;arie;adeleine$ consecrated in 1?/,. #he church is a stern oblong$ fenced with columns 1H feet high. Its design$ supposedl% that of a Free! temple$ is actuall% closer to the Coman notion of Free!. #he (lace de la ;adeleine is the western terminus of the Frands <oulevards$ which imitate the arch of the river from there north and east to the (lace de la Cepubli6ue and the <astille. #o the west off the rue Co%ale runs the rue du >aubourg Saint3onorj$ which$ in addition to the <ritish Embass% and the El%see (alace &residence of the >rench president'$ has on its shop windows some of the most prestigious names in the (aris fashion trade. 2long the first ,$0HH feet of the ChampsEl%sjes$ between Concorde and the Cond(oint des Champs El%sjes &a roundabout$ or traffic circle'$ little has changed for a centur%: the avenue is bordered with chestnut trees$ behind which on both sides are gardens$ usuall% full of children at pla%. #he pavilions in the gardens are used as tearooms$ restaurants$ and theatres. >rom the Cond(oint up to the 2rc de #riomphe$ however$ the avenue has changed with the times. 8nder the Second Empire this was a street of lu-urious town houses. #he% were supplanted b% cafjs$ nightclubs$ lu-ur% shops$ and cinemas$ but the Street retained its feeling of lu-ur%$ and the treeshaded sidewal!s &wide as a normal Street' offered promenades that were the pride of (aris. Since the 1G0Hs$ however$ ban!s$ automobile showrooms$ airline offices$ and fast food eateries have ta!en over much of the space. 2t the top of the ChampsEl%s|es is a circular place from which 1, imposing avenues radiate to form a star &jtoile'. It was called (lace de l)Etoile from 1=0. until 1G=H$ when it was renamed (lace Charles de Faulle. In the centre of the place is the /1/ 2rc de #riomphe$ commissioned b% "apoleon in 1?H1. It is twice as high and as wide as the 2rch of Constantine$ in Come$ which inspired it. @ean Chaigrin was the architect and >ranzois Cude sculpted the frie5e and the spirited group$ T#he 9eparture of the Volunteers of 1=G,J &called IDa ;arseillaiseJ'. On 2rmistice 9a% in 1G,H$ the 8n!nown Soldier was buried under the centre of the arch$ and each evening the flame of remembrance is re!indled b% a different patriotic group. The )atin &uarter M&uartier )atinN* 2t the Concorde <ridge the boulevard SaintFermain begins$ curving eastward to *oin the river again at the Sull% <ridge. 2 little less than halfwa% along the boulevard is the preFothic church of SaintFermain des(rjs. #he old church$ which belonged to a <enedictine abbe% founded in the ?th centur%$ was sac!ed four times b% Vi!ings and was rebuilt between GGH and 1,H1. (arts of the present church date from that time. <e%ond the boulevard Saint;ichel is the universit% precinct$ selfgoverning under the !ings$ where$ in class and out$ students and teachers spo!e Datin until 1=?G. 2t the *unction of the boulevards SaintFermain and Saint ;ichel are the remains of one of the three baths of the Coman cit%. #hese are in the grounds of the Clun% ;useum$ a Fothic mansion built 1/?010HH$ which now houses a collection of medieval wor!s of art$ including the renowned si-panel unicorn tapestr% IDa 9ame a Ia licorne.J #he wide$ straight boulevard Saint;ichel is the main street of the student 6uarter. It is lined with boo!shops$ cafjs$ cafeterias$ and movie houses. #he buildings of the universit% are found on smaller streets. #he universit% was built up of colleges$ each founded and supported b% a donor$ often a prelate or a religious order. In about 1,0= Cobert de Sorbon$ chaplain to Douis DO$ established a college$ !nown as the Sorbonne$ that eventuall% became the centre of theological stud% in >rance. #he oldest part of the Sorbonne is the chapel &11.0/,'$ the gift of Cichelieu$ who is buried there. 9esigned b% Demercier$ it was one of a number of new domed @esuitst%le churches of the period. #he Sorbonne served for centuries as the administrative seat of the 8niversit% of (aris. In 1G1?=1 the universit% was divided into a number of entirel% separate universities$ and the Sorbonne building proper continues to serve as premises for some of these. 2t the top of the hill rising from the river the boulevard s!irts the Du-embourg Fardens$ the remains of the par! of ;arie de ;jdicis) Du-embourg (alace &1111 ,1'$ which now houses the >rench Senate. #he gardens are planted with chestnuts and are enhanced with a pond for to% sailboats$ a marionette theatre$ and statuar%. 2cross the boulevard at the end of the rue Soufflot stands the (antheon &1=00 G,'$ designed b% @ac6ues Fermain Soufflot. It was commissioned b% Douis OV$ after his recover% from an illness$ as a votive offering to St. Fenevieve and was to replace the mouldering 0th centur% abbe% in her name. #hough intended as the principal church in (aris$ it was renamed the (antheon b% the Cevolutionar% authorities$ who made it the last resting place for heroes of the Cevolution. #he walling up of a number of its windows and removal of much interior decoration replaced the intended effect of light interior space with a gloom% dignit%. 2mong those buried under the inscription I2u- grands bommes$ la (atrie reconnaissanteJ &I#o great men$ f their /10 grateful landJ' are the authors Victor 3ugo$ Voltaire$ Cousseau$ and Yola and @ean ;oulin$ chief of the Cesistance in +orld +ar II. The /utte"* #he river valle% of (aris is almost entirel% circled b% high ground. 8pon the heights of (ass%$ on the Cight <an! between the western cit% limits and the 2rc de #riomphe$ perch the wealth% neighbourhoods of the 11 th arrondissement. #he <utte;ontmartre &1? th arrondissement' and the <uttes Chaumont& 1Gth arrondissement'$ which rise along the northern rim of the cit%$ are still wor!ingclass. #he 1?th arrondissement has broad avenues$ but it also has winding lanes$ some of which become stairwa%s on the steeper hills$ >rom the earl% 1Gth centur% until the migration in the 1G,Hs to ;ontparnasse$ ;ontmartre was the ma*or art colon% of (aris. Some sections are highl% commerciali5ed for the tourist trade7 others$ however$ are unselfconsciousl% pictures6ue. ;ontmartre is !nown for its nightclubs and entertainment. #he most noted landmar! of ;ontmartre was built onl% in 1G1G: the Sacred 3eart <asilica &<asili6ue du SacrdCoeur'$ paid for b% national subscription after the >rench defeat b% the (russians in 1?=H. #he wor! began in 1?=1 but was dela%ed b% the death of the architect$ (aul 2badie$ who too! inspiration from the 1,thcentur% fivedomed Comanes6ue church of Saint>ront in (jrigueu-$ itself inspired b% either Venetian or <%5antine churches. <asili6ue du SacrjCoeur 6oreign ,ours The /ahama" /11 Officiall% CO;;O"+E2D#3 O> #3E <232;2S$ archipelago and state on the northwestern edge of the +est Indies$ consisting of about =HH islands and ca%s and more than ,$HHH low$ barren roc! formations$ located off the southeastern coast of >lorida$ 8.S. #he archipelago is spread across the #ropic of Cancer and about GH$HHH s6uare miles &,..$HHH s6uare !m' of ocean in the western 2tlantic. 2ndros &1H/ miles long and /H miles wide p11= !m long and 1/ !m wideg is the largest of the islands. #he capital is "assau on "ew (rovidencethe most important island. 2rea 0$.?, s6uare miles &1.$G.G s6uare !m'. (op. &1GG. est.' ,11$HHH. The land* "ew (rovidence has the ma*orit% of the archipelago)s population. #he rest of the islands$ chief among which are 2baco$ 2ndros$ and Eleuthera$ are called the >amil%$ or Out$ Islands. 2ll the islands of the archipelago are composed of coraline limestone$ lie mostl% onl% a few feet above sea level$ and are generall% flat. #he highest point$ ;ount 2lvemia &formerl% Como 3ill'$ rises ,H1 feet &1. m' on Cat Island. ;ost of the islands are long and narrow$ each rising from its eastern shore to a /1= low ridge$ be%ond which lie lagoons and mangrove swamps7 coral reefs mar! the shorelines. #here are no rivers in #he <ahamas. #he mild subtropical climate of #he <ahamas$ with two seasons &winter and summer is greatl% influenced b% the Fulf Stream and 2tlantic Ocean bree5es. #he average temperature varies from =H~> &,1~C' during the winter to ?1~ > &,=~ C' during the summer7 average annual rainfall is about // inches &1$1,H mm'$ though there is some variation between the islands. #he hurricane season lasts from mid@ul% to mid"ovember. #he islands abound in tropical flora$ including bougainvillea$ *asmine$ orchid$ and oleander. Caribbean pine forests occur on some islands$ such as 2ndros$ Freat 2baco$ and Frand <ahama. "ative trees include the blac! olive$ cor! tree$ and several species of palm7 mahogan%$ casuarina$ and cedar trees have been planted on some islands. 2nimal life is dominated b% frogs$ li5ards$ and sna!es7 mos6uitoes$ sandflies$ and termites are widespread. #here are numerous species of birds$ including the flamingo$ the national bird. #he Inagua "ational (ar! on Freat Inagua Island is the home of more than 0H$HHH +est Indian flamingos$ the largest such floc! in the world. Salt$ aragonite$ and limestone are the onl% commerciall% important minerals. Salt is produced largel% b% solar evaporation from salt beds on Freat Inagua. The people* #he people of #he <ahamas are a blend of European and 2frican ancestr%$ the latter a legac% of the slave trade. English is the official language$ and almost all of the population is Christian. <aptists account for about onethird of the population$ and 2nglicans and Coman Catholics each constitute appro-imatel% onefifth of the total. Onl% about .H of the islands and ca%s are inhabited. 9uring the 1G=Hs there was significant ruraltourban interisland migration$ mostl% directed to the alread% densel% populated islands of "ew (rovidence &where twothirds of the populace lives'$ Frand <ahama$ and Freat 2baco. Dong Ca%$ on the other hand$ had onl% a few do5en inhabitants. 2verage population densit% for the countr% is relativel% low. #he population growth rate of #he <ahamas was relativel% high during the late 1G=Hs &a trend that continued intermittentl% through the 1G?Hs'$ mostl% because of a substantial birth rate7 conse6uentl%$ almost twofifths of the populace is %ounger than 10 %ears of age. #he death rate is relativel% low. The Economy* #he <ahamas has a predominantl% mar!et econom% that is heavil% dependent on tourism and international financial services. #he gross national product &F"(' is growing much more rapidl% than the population. #he F"( per capita is similar to those of other developed countries. 2griculture accounts for about onetwentieth of the F"( and emplo%s a comparable fraction of the wor!force. Onl% about 1 percent of the land is arable$ and soils are shallow. #he government has had onl% limited success in increasing /1? agricultural output$ and nearl% all of the countr%)s foodstuffs are imported$ largel% from the 8nited States. #he sunn% climate favours the cultivation of tomato$ pineapple$ banana$ mango$ guava$ sapodilla$ soursop$ grapefruit$ and sea grape. Some pigs$ sheep$ and cattle are raised. #he small fishing industr%)s catch is dominated b% cra%fish$ groupers$ and conchs. ;ineral industries are limited to the production of salt and cement. Frand <ahama has several petroleum transshipment terminals. ;anufacturing industries centre on the production of rum and other li6uors$ cement$ pharmaceuticals &including hormones'$ canned tomatoes and pineapples$ and fro5en cra%fish. #he Industries Encouragement 2ct offers manufacturers relief from tariffs and various ta-es. Electricit% is generated entirel% from imported fuels. #ourism accounts for as much as twothirds of the F"( and emplo%s about twofifths of the wor!force. It centres on "ew (rovidence and Frand <ahama7 most tourists come from the 8nited States. Several hundred ban!s and trust companies have been attracted to #he <ahamas because there are no income or corporation ta-es and because the secrec% of financial transactions is guaranteed. (ublic e-penditures are constrained b% the government)s dependence on indirect ta-es$ which are levied primaril% on tourism and e-ternal trade. #he 8nited States is #he <ahamas) principal trading partner and e-empts certain <ahamian products from duties under the generali5ed s%stem of preferences. "assau and >reeport$ the latter on Frand <ahama Island$ are the countr%)s two main ports and also have international airports. Cultural life* Outstanding among traditional group activities is the I@un!anooJ parade on <o-ing 9a% and "ew :ear)s 9a%. #he main thoroughfare is given over to hundreds of gail% bedec!ed celebrants who$ with clanging cowbells and beating drums$ march and dance to a rh%thm of 2frican origin. In "assau$ amateur choral$ dramatic$ and dancing groups provide entertainment with much local flavour. ,i"tory* #he <ahamas were originall% inhabited b% a group of 2rawa! Indians !nown as Duca%an. Originall% from the South 2merican continent$ some of the 2rawa! had been driven north into the Caribbean b% the Carib Indians. 8nli!e their Carib neighbours$ the Duca%an were generall% peaceful$ more involved in fishing than agriculture$ and noncannibalistic. +hen Columbus reached the "ew +orld in 1/G,$ he is thought to have landed on San Salvador &also called +atling Island' or possibl% Sarnana Ca%$ both in the <ahamas. #he Spaniards made no attempt to settle but operated slave raids on the peaceful 2rawa! that depopulated the islands$ and b% the time the English arrived the <ahamas were uninhabited. In 11,G Charles I of England granted the islands to one of his ministers$ but no attempt at settlement was made. In 11/? +illiam Sa%le led a group of English (uritans from <ermuda to$ it is thought$ Eleuthera Island. #his settlement met with /1G e-treme adversit% and did not prosper$ but other <ermudian migrants continued to arrive. "ew (rovidence was settled in 1101. <% 11=H the <ahamas were given to the 9u!e of 2lbemarle and five others as a proprietar% colon%. #he proprietors were mostl% uninterested in the islands$ and few of the settlements prospered. (irac% became a wa% of life for man%. #he colon% reverted to the crown in 1=1=$ and serious efforts were made to end the pirac%. #he first ro%al governor$ +oodes Cogers$ succeeded in controlling the pirates but mostl% at his own e-pense. Dittle monetar% and militar% support came from England. Conse6uentl%$ the islands remained poor and susceptible to Spanish attac!. 3eld for a few da%s b% the 8.S. "av% in 1==1$ and for almost a %ear b% Spain in 1=?,?.$ the islands reverted to England in 1=?. and received a boost in population from lo%alists and their slaves who fled the 8nited States after the 2merican Cevolution. >or a time$ cotton plantations brought some prosperit% to the islands$ but when the soil gave out and slaver% was abolished in 1?./$ the <ahamas) endemic povert% returned. #wo other periods of prosperit% followed: the %ears 1?1110$ when the <ahamas became a centre for bloc!ade runners during the 2merican Civil +ar$ and in 1G,H..$ when bootlegging became big business during the %ears of 2merican (rohibition. <ut these were economic accidents7 not until the tourist industr% was developed after +orld +ar II did an% form of permanent prosperit% come to the islands. Some ca"e" a" Po""i%le Entertainment -e Yor!' /roaday #he term <roadwa% is applied to about .? theatres in ;anhattan$ "ew :or!$ which are either on the street <roadwa% itself or in the surrounding streets. <roadwa% refers more to commercial orientation and to the si5e of theatre than to location. <roadwa% theatres usuall% have over 11HH seats and operate for profit. ;ost <roadwa% theatres are not on the street but in the #imes S6uare area. #he <roadwa% area including #imes S6uare has had a reputation in the past as being rather seed% though ;a%or] Fiuliani)s cleanup campaigns have changed. <roadwa% is commercial. forprofit. theatre whereas the notforprofit theatre is old<roadwa%. #here is commercial theatre old<roadwa% but it is small compared with either <roadwa% itself or the nonprofit sector. #here is a particular concentration of off<roadwa% theatres in the Freenwich Village area. Off <roadwa% theatres are associated with neweravantgarde productions and new 2merican productions are more li!el% lo be found here than on <roadwa%. Some productions do though move from off <roadwa%to <roadwa%. /,H "ew :or!]s dominance of theatre in the 8S2 has reduced as regional theatre$ especiall% in Chicago and Dos 2ngeles$ has become more important in the development of new productions. ;an% of these then go on to <roadwa%. 2ttendances at <roadwa% theatres were nearl% 1, million in 1GG? GG compared with = million in 1G?/ ?0 but this has not been an uninterrupted growth. #here was for instance$ a decline in numbers for most of the 1G?Hs. (la%ing wee!s have risen from 1H=? in 1G?/ ?0 lo 1//1 in 1GG?GG with a low of GH0 in 1GG1 G,. #he composition of <roadwa% audiences is similar to that in man% oilier places. #wothirds are aged .0 or older$ three6uarters are Caucasian and over half &compared with 1/ per cent of the 8S population' have an annual income of N=.0HHH or more. ]#here has$ however$ been a doubling$ between 1GG1 and 1GG= of the number of <roadwa% theatregoers under the age of 1? partl% due to the number of c%outh friendl%] productions. +hilst personal recommendation is the single most important reason for choosing to see a show$ one in l i v e of audiences indicated that newspaper reviews were important. 2s in Dondon]s +est End$ new openings and e-isting pla%ing wee!s on <roadwa% have been dominated b% musicals. <roadwa% is associated with large musical and drama productions. #he name <roadwa% has become closel% associated wi t h a part icular t %pe of production such as the older musicals ]2 Chorus Dine] and c/,nd Street] $ which ran for man% %ears. 2s wi t h main theatrical districts$ there is a vi e w that the nature of productions has changed compared wi t h the earl% part of the t we nt i e t h cent ur%. +hereas "ew :or! was regarded as a place where man% new productions occurred each %ear. <roadwa% theatres now concentrateon longrunning pl a%s and musicals in particular. Other productionsdo not get the opportunit%to be seen7 t hi s cri t i ci smis l evel l ed at Dondon]s +est End also. <% producing classic pla%s and musicals$ ris! is reduced especiall %as it is believed that man% people desire t he technological spectacle and di versi on of musicals in particular. <roadwa% has become increasingl% a place for ]a special event ] complete with merchandising. Often productions rel% on famous name film or television stars to increase t i c!et sales. #he name <roadwa% has been used as a term of abuse b% crit ics. 2 review. in the <ritish (unday Times &2pril ,HHH'. of the Dondon +est End production of ]#he Fraduatec included the comment ] the show is li!e the worst of <roadwa%$ shallow and celebrit%driven$ wi t h ghastl % merchandise being sold in the fo%er ] . "ew :or! is a ma*or tourist destination including some of the most famous landmar!s in the worl d such as the Empire State <uilding and the St at ue of Dibert%. In 1GGG. there were over ./ million vi si t ors to "ew :or! ci t % and of these$ nearl% 1 million were international$ mostl% from Canada &H.G million' and the 8U &H.? million'. <roadwa% is regarded as a tourist att ract ion of the ci t % and the name has become universall% recogni5ed as being ] theatre in "ew :or!]. #o facilitate boo!ing$ there is a charge free information and boo!ing ] hotline] and the <roadwa% (ic!et Center located in the bus% vi s i t or area of #imes S6uare. 9espite this the proportion of audiences who are visit ors from the rest of the 8S2 continues to fall though there has been a slight increase in the proportion of international vi si t ors &to one in ten of audiences'. 2n increasing proportion of audiences are resident in "ew :or! ci t % or the surrounding suburbs. ]#he suburban element has shown the great est growt h. 2bout 1= W of ]locals] go to a <roadwa% show at least once a %ear and there is a core of regular theatre goers 1 W$ who account for o ve r .H W of all t ic!etssold. #here are shows such as cCatsc &running since 1G0, ma!ing it the longest running musical in <roadwa% histor%'. cDes ;iserablesc. ]Chicago]. ](hantom of the Opera] and ]>osse] which are being performed in "ew /,1 :or! and Dondon &and other ci t i es ' at the same time. In recent %ear s there has been a large number of ]imports] of productions from abroad especiall% from <ritain. #hese have included a new production of cCabaretc & 1GG?' b% Sam ;endes$later t he Oscarwinningdirector of the film ] 2mer i can <eaut %] as we l l as in 1GGG$ pla%s such as Eugene O]"eill]s ]#he Iceman Cometh and 9avid 3are]s Via 9olorosa]. ]#his is partl% a matter of economics$ being cheaper to bring in an established pla% or musical instead of starting the production processfrom the beginning. Some originated in the more heavil% subsidi5ed theatre of Europe and$ in a sense$ the 8S2 is capitali5ing on that i nvest ment of public funds. #he ris! of new and ] straightc pla%s is reduced b% bu%ing in from elsewhere. ]#here is an argument too that 2merican ] classics] are limited in number compared wi t h those from Europe. #here is however$ also a reverse transfer with productions such as cChicago and ]Uentc originating in the 8 S2 and then being produced in Dondon. #he economic impact of <roadwa% on "ew :or! cit% was estimated at N ,=,/ million in 1GG1G= and as seen in Chapter ?$ N 1=1G million of t hi s wa s due to vi s i t or spending. #he total impact wa s calculated b% adding the initial vi si tor spending other than on tic!ets to the setup and operating costs of <roadwa% companies and the spending on capital improvement s to theatres. #his was sub*ect to a multiplier effect. Compared wi t h 1GG1 G,. there was a .= per cent increase in impact &aft er allowing for i nf l at i on' . #he spending of locals was not included as such. In the case of vi si t or s from outside the ci t %$ the onl% spending that was included was that of people who indicated dial <roadwa% was the main reason for the visit. In addition$ a part of the spending of v i s i t o r swho e-tendedthei r vi si t in order lo go lo <roadwa%t heat r ewa s included. #he proportions of visitors for whom <roadwa% was the main reason$ or was a reason for e-tending the visit$ were not estimated at the same lime as the audience surve%s were underta!en & 1GG1G= ' but from the earlier (ort 2uthorit% surve%s in 1GG,. #hese (ort 2uthorit% surve%s also estimated economic impact and included commercial off<roadwa% theatre and also ]Coad productions]. #hese are <roadwa% shows that are performed elsewhere but which have an economic impact in "ew :or! in the form$ for instance$ of ro%alt% pa%ments. #his impact has been declining partl% because of local financing$ because of touring productions originating elsewhere including the rest of the 8S2 and the influ- of productions from the 8U. )ondon' We"t End Dondon$ apart from being the centre of government in the 8U and a ma*or international commercial and financial centre$ is also the most important tourist destination in the countr%. #otal tourist visits to Dondon are over ,H million and over half of these are international. #he attractions of Dondon are mostl% ]heritage] though ]pop] culture$ clubs$ fashion$ restaurants and lifest%le are claimed to be of increasing /,, importance. Dondon also has a large number of theatres which act as a tourist attraction. Over a 6uarter of all professional theatres in the 8U are in Dondon and there is a particular concentration within Dondon]s +est End. ;an% of the more significant theatres in Dondon are members of the Societ% of Dondon #heatre &SOD#' !nown$ until 1GG/$ as the Societ% of +est End #heatre &S+E#'. SOD# is a trade association with a membership of about 0H of Dondon]s theatres most of which are ]+est End] theatres. #he% are located in central Dondon with several distinct$ but close$ theatre clusters contributing to the leisure 5one of the cit%. #he concentration is itself considered to have a positive influence on attracting visitors to the cit%. SOD# theatres range in si5e from the relativel% small at ,0H capacit% through to a few larger theatres at over ,HHH seats. ;ost are operated as commercial concerns and few are subsidi5ed. 2ttendances at SOD# theatres during 1GG= were about 11.0 million compared with 1H.0 million on <roadwa% the previous %ear though <roadwa% does include fewer theatres. It was seen in Chapter 1 how important the +est End is in attracting tourists to Dondon and how the proportion of tourists in audiences has fluctuated. #he share of international tourists in audiences is currentl% much less than it has been during the 1G?Hs. One of the most noticeable recent features of the +est End is the increased importance of musicals and the reduced importance of pla%s and this has been lin!ed wit h the tourist mar!et &domestic and international'. "earl% twothirds of all attendances in +est End theatres in 1GG= were at ]modern musicals]. #his is mar!edl% different from the situation outside Dondon. #ourists are a higher proportion of musical audiences than the% are for other productions. >or main observers$ the tourist audiences are believednot to be particularl%'discerning and want l i t t l e more than a ] gli t5% night out c. One theatre cri t i c was disappointed$ in 1GG=$ that the stage version of 9isne%)s ] <eaut% and the <east] at the 9ominion theatre was welcomed as favourable for +est End *obs and tourism$ and not seen as a threat to national heritage. 2nother critic condemned as undesirable and a sellout to ]+est End] values$ the programming &in 1GG?' of the musical ]O!lahomaK] at the "ational #heatre. #his had been created as ]a radical al t er nat i ve to a complacent commercial theat re . "ot onl% are musicals denigrated but also then impact on the rest of theatre is considered undesirable. ;usicals and other ] tourist] productions have longruns & ] t he ;ousetrap] since 1G0,. ] Cats] since 1G?1 and cDes ;iserableM] since 1G?0' and socalled serious pla%s are s6uee5ed out and the t ur nover of new pl a%s is restricted. It is not *ust musicals t hat are seen as the problem but also r e vi va l s of popular pla%s$ and associated long runs of man% of these. 2ccess to theatres and to finance and art ist i c talent is restricted for the nonmusical and the new pla%. #here are several reported instances of productions$ such as the awardwinning cthe >ate ;iddle Classesc$ being unable to find a +est End venue because of the desire to produce musicals$ in that case a musical about a bo% band which closed after a few wee!s &IGGG'. #he actor and pla%wright Steven <er!off complained$ al t er his controversial new pla% ] ;essiah] was turned down b% the "ational #heatre in ,HHH$ t hat theatres were too sale and were unwi l l i ng to la!e ris!s. It is obviousl% less ris!% for large commercial theatres to produce bloc!buster musicals or pla%s than it is to put on e-perimental$i nnovati veor controversial productionst hat ma% not sell on a large scale. #he touri st mar!et is one that is large and cont i nual l %turning o ve r and renewingi t sel f e ve r % few da%s or wee!s$ an ideal scenario for investment in largescale spectaculars. Corporat ions are able to absorb earl% losses and to subsidi5e the earl% da%s of one production from the revenue of another until the brea!even point is reached. /,. #here are however$ some +est End theatres$ usuall% subsidi5ed. which are some of the most advent urousand prestigioustheatres in the countr%: the 9onmar +arehouse$ the Co%al Court$ the Co%al "ational #heatre and the <arbican until recentl% a Dondon base for the Co%al Sha!espeare Compan%. #here have been a number of successful transfers$ such as cDes ;iserables] and ]the 3erbal <ed]$ from the subsidi5ed sector to the commercial sector. In addition to these theatres man% of the more innovative and limited interest productions ta!e place off+est End in smaller theatres or in regional theatre. It is claimed that a ]significant proportion] of +est End productions have originated in regional or nonSOD# theatre before transfer. +est End productions also transfer to regional theatres often as a national tour and also to other countries. In 1GG=$ ](hantom of the Opera] was performed in 2ustralia$ "ew Yealand and 1= cities in the 8S2 and ]<udd%] in @apan$ Ferman%$ Canada$ South 2frica and 8S2. Earnings from international performances such as these were estimated at between Z/H to Z1H million in 1GG=. #he concentration of theatre ownership and of influence over productions is li!el% to have had a direct impact on the pattern of programming. Ownership of the commercial theatres is diverse but certain organi5ations and individuals appear dominant. <% earl% ,HHH$ there were two large corporations dominating ownership of Dondon theatres. #he 2mbassador #heatre Froup$ which is part owned b% the 8S corporation S>O$ owned eleven after purchasing nine smaller theatres in >ebruar% and the Ceall% 8seful Froup owned thirteen having purchased ten from Stoll ;oss the previous month. 2s seen in Chapter ,$ S>O had alread% purchased the large national 2pollo group in 1GGG$ four of whose theatres are in Dondon. #he Ceall% 8seful Froup is owned b% the composer 2ndrew Dlo%d +ebber &Cats$ Starlight E-press$ (hantom of the Opera and man% others'. #he producer Cameron ;ac!intosh bought two theatres in 1GGG to *oin the three that his compan% currentl% coowned. #he impresario <ill Uenwright has also been responsible for a large number of +est End productions in recent %ears. #heatre ownership is therefore being combined in the same organi5a tion with composition$ production$ pla% and concert promotion. #here is$ in addition$ a concentration of influence into fewer hands including$ for instance$ through *oint ;ac!intosh+ebber productions. 2ll of this could lead to significant control and influence over the programming of theatres in the +est End. >or the firms concerned$ such integration %ields economies and spreads ris!s. ) a " V e # a " Das Vegas &"evada. 8S2' is perhaps the best!nown instance of a tourist centre wit h an ]entertainment core]. #he main attraction of Das Vegas is gaming and until recentl% "evada was the onl% stale to legali5e casino gaming in the 8S2 &legali5ed in 1G.1'. Das Vegas receives over .H million visitors a %ear & 1GG?' of whom =H percent were there for vacation$ pleasure or traveling. It is also a ma*or centre for conventions. It claims to have more hotel and motel rooms &at 1HG.HHH' than an% oilier resort destination in the world and 1G of the ,H largest hotels in the world. #he ;F; Frand$ for instance$ has over 0HHH rooms. 2t 2t l ant i c Ci t % most gamblers are da% tri ppers bill Das Vegas is more a destination for the sta%ing tourists. ;ost vi si t ors do not have children with them and the average age is late forties. 2 high proportion &three6uarters' are repeat visitors and nearl% all gamble during t heir sta%. #he average st a% is short or * ust over three ni ght s but nearl% a third of visitors are from neighboring California$ half from the +estern /,/ states and one in ten is international. #he ci t% has i t s own international airport wi t h direct flights from countries such as the 8U and @apan. #he !e% at tracti on of Vegas has been gambling but it has a l wa % s been associated wi t h live entertainment. Casinos are usuall% based in hotels that also provide a variet% of live entertainment in order to att ract and retain gaming customers. ;ost Das Vegas entertainment is associated with hotels rather than wi th separate theatres or concert halls. #he musical cStarlight E-press] was$ for instance$ staged al the Das Vegas 3ilton. #he entertainment ranges from musicians in bar and lounge settings through circus and illusionists to national and international stars in large purposebuilt theatres and concert arenas. Some of these operations are so huge t hat effectivel% the% operate as separate enterprises. Caesar]s (alace &10HH rooms' has a /0HH seat indoor theatre and a 10..HH seat outdoor events stadium and ;F; Frand has a similar si5e events centre as well as its own .. acre theme par!. 2t Circus Circus there is live circus in addition to a 0 acre indoor theme par!. #here is a st%le of show$ the glit5% spectacular floorshow with dancers and singers$ that is referred to universall% as a ]Das Vegast%pe showc. #he ]Official Visitors Fuide] to Das Vegas refers to ]other parts of the casinos &where' entertainers adorned in glittering costumes *oin forces in l avi sh stage spectaculars . . . E-travagan5as costing millions to produce surround visitors in a fantas% of shapel% dancers$ intricate choreographs and special effects] . Das Vegas is also a centre for man% associatedspectacularevents including bo-ingh. @ust under half of Das Vegas visitors attend a show during their visit though spending on shows onl% accounts for about ?W of e-penditure per visitor compared$ for instance$ with .?W on food and drin! and ,,W on shopping. Entertainment has been regarded as an incidental attraction and has been *ustified b% its abilit% to attract people to gamble. It was initiall% regarded as a lossleader in order to attract highspending gamblers. #here is now$ however$ more emphasis on entertainment as a profit centre. #his$ in con*unction with rising costs$ has resulted in a shift from the starcentred shows towards smallerscale variet% &or revue' shows and musicals. #he cit% has long had a reputation for being an adult destination with gaming associated not onl% with adult entertainment but also organi5ed crime and prostitution. It has in recent %ears sought to reposition itself as a tourist destination. Casino gaming is now legal in more places in the 8S2$ including 2tlantic Cit% and man% "ative 2merican reservations$ and Das Vegas can no longer rel% on its virtual monopol% to attract visitors. It is therefore developing as a famil% holida% destination. In order to do this$ more famil%oriented entertainment has been offered in the form of virtual realit% e-periences$ theme par!s and free openair events such as an erupting volcano outside the ;irage hotel and a pirate battle performed outside the #reasure Island hotel. #he emphasis on Das Vegas as a gaming centre has been reduced but it is still the hotels that maintain a connection with entertainment$ albeit in a different form. #hese developments have had mi-ed fortunes and$ whilst such enter tainment has undoubtedl% broadened the appeal of Das Vegas$ some gaming operators have found that certain forms of entertainment compete with$ rather than complement$ gaming. #here are several other concerns associated with this repositioning$ such as the increased number of ]nongamblers] and ]lowroller] gamblers in the cit% and the loss of its distinctive character. In addition some casino e-ecutives are not s!illed in providing these t%pes of e-perience and there have been some noticeable failures. #here has been a concern that the cit% has gone too far along the route of a famil%friendl% destination and some business people have been an-ious to maintain the reputation as an adult /,0 destination. #his is partl% due to the lower gaming spend of tourists with children. "onetheless some of the more recent developments$ such as the "ew :or!$ "ew :or! with its own rollercoaster and the Venetian Casino Cesort complete with upscale shopping mall and Frand Canal$ have continued the wider appeal. Das Vegas is ver% much a oneindustr% cit% with *ust over half of the labour force in southern "evada being emplo%ed in the cit%]s tourist and gaming sector. It has been pointed out that this means lows!ill$ lowwage and un unioni5ed emplo%ment for man% and also an e-cessive influence of the ];ining and hold corporations on the political and development process. Since the lG0Hs there arc now fewer individuals and more corporations owning and operating casinos in the cit%. #he needs of the industr% ma% have been prioriti5ed over the social communit% and welfare needs of the local population and the sustainabilit% of the local natural environment. #here woul d appear lo he a coalition of interests between local hotelcasino operators$ other business people$ development agencies$ the vi si t or bureau$ airlines and local government that e-erts a powerful influence in encouraging free enterpriseand growth. / r i t i "h "e a "i d e r e "o r t "' e a r ly d e$ e l o p m en t" #here are features of the seaside resort in <ritain in the past that have been uni6ue features of the entertainment industr%. #he significance of this lies in the fact that their influence lingers on to the presentda%. 2s seaside resorts became more popular during the !ilter part of the nineteenth centur% there was considerable investment in theatres$ pavilions$ concert halls and ]pleasure palaces] . Some of these$ such as the +inter Fardens in <lac!pool &1?=?'$ initiall% represented a more serious purpose b% including gardens and librar%. #he +inter Fardens in C h%l &"orth +ales' built in 1?=1 included a 5oo$ theatre$ seal pond and s!ating rin!. 2t thi s time music hall was flourishing and halls were built in resorts$ firml% establishingthe tradition of the variet% show al the seaside. 2s the seaside began lo a t t r a c t t he wor!i ngcl asses there wa s a need to change what was on offer and from the end of the nineteenth centur% investment in entertainmentrose dramaticall%.#heatres and halls e-isted in man% resorts offering variet%$ melodrama and farce and more cseriousc pla%s$ drama and musicals during the season lo a predominantl% middle class audience alongside a more informal$ often outdoor and beach entertainment. #hese included circuses$ fairgrounds$ cblac!face] minstrels. (ierrots and (unch and @ud% shows geared to a more wor!ing class audience. #he (unch and @ud% Show has been s%non%mous with the seaside though it had originated al inland fairs. #he cblac!lace] minstrels were a prominent feature of English seaside resorts$ dominating popular entertainment until the cmore refined] (ierrots$ originating in >rance$ appeared. Entertainment became increasingl% commercial. Some of the attractions became more bi5arre and included wa-wor!s and frea! shows as well as an assortment of fortune tellers and healers and tal!s$ lectures and lantern slides b% dubious ]e-perts]. 2 ma*or attraction in several resorts during the lG.Hs was the cCector of Stiff!e%] who had been dismissal from the church for se-ual misconduct. 3e earned a living in a sideshow in <lac!pool which included him living in a barrel and also being cdevoured in the flames of /,1 hellc$ lie later appeared in a show in S!egness onl% to he !illed b% one of the lions in lG.?. (iers were also particularl% associated with entertainment. 2lthough most were originall% intended for the arrival and departure of ships$ the% soon became geared towards entertainment. 3olida%ma!ers were able to e-tend their wal!ing and displa% from the promenade itself to a promenade over the sea. (iers often included mone%generating facilities such as pavilions and concert halls$ refreshment rooms$ machines and mechanical devices$ booths and !ios!s. #here was often an ]endofthepier show] performed b% concert parties of small groups of artists all of whom sang$ danced$ told *o!es and performed short s!etches. #he% were particularl% popular from the lG,Hs through to the late lG.Hs. ;ilitar% and brass bands also pla%ed in openair bandstands and in pier pavilions. ;ost resorts also had an orchestra$ however small$ which invariabl% pla%ed in pavilions on piers. ;ost resorts had an orchestra at some time during the late nineteenth and earl% twentieth centuries and the continuing e-istence of orchestras owes a great deal to the holida%ma!er. #he conductors$ musicians and singers were among the most able and famous of the da%. #he% included & Si r ' ;alcolm Sargent at the seaside town of Dlandudno &+al es' who was later conductor of man% famous orchestras and chief conductor of the annual <<C (roms festi val 1G/?11 and Franville <antoc! & at "ew <righton$ a resort near Diverpool' who was later (rofessor of ;usic at <irmingham 8niversit%. 2s emplo%ment in such orchestras was usuall% seasonal$ musicians from nontourist area orchestras were able to find %earround emplo%ment. In the earl% part of the twentieth centur% the (ier Orchestra at Dlandudno was made up largel% of members of the 3alle Orchestra &;anchester'$ which is <ritain]s longest established professional s%mphon% orchestra &founded 1?0?'. #he seaside resort of <ournemouth$ on the south coast of England$ had the distinction of having the first %earround permanent orchestra in England &1?G.' and it has since become an important touring s%mphon% orchestra. ;usical programmes were usuall% short and light for bac!ground or promenading$ but most orchestras endeavoured to provide s%mphon% concerts in addition and to wor! the ]more serious] wor!s into t heir programmes. #he holida% camp is also of particular si gni fi cance in the hi st or% of holida%s and entertainment. 2llinclusive centres for a holida% had e-isted for some lime. Some originated in the earl% twentieth centur% as a form of sell help$ sellimprovement movement where a sense of communit% in a health% environment could he fostered. #hese holida%s$ often in tents$ included organi5ed games and entertainments that were often selfentertainment. Commercial camps emerged during the 1G.Hs and of particular significance were the holida% camps established b% <ill <utlin &i ni t i al l % in S!egness in 1G.= for 1HHH campers and in Clacton in 1G.G'. 3olida%ma!ers did not need to leave the holida% camps during their sla% as apart from the chalett%pe accommodation$ there were catering halls$ swimming pools$ games and sports areas $ theatres and dance halls. 2ccess to all of these was without further charge. In the seaside tradition$ entertainment followed the variet% revue pattern and also dance bands and children]s entertainers. #here was also an emphasis on holida%ma!ers ma!ing their own entertainment. Organi5ers variousl% !nown as Ced Coats &<utlins' or <lue Coats &(ontius' organi5ed games and competitions for campers and entertainment b% campers as wel l pulling on shows themselves. #he holida% camp was particularl% popular during the lG0Hs. #he% were ma*or providers of seaside entertainment and were a significant ]breedingground] for new performing talent. E-:)IS, C.1RSE ?.R ECTS A-D MA-A:EME-T /,= Mar"eting and merchandising Mar!etin# is a process whose principal function is to promote and facilitate e-change. #hrough mar!eting$ individuals and groups obtain what the% need and want b% e-changing products and services with other parties. Such a process can occur onl% when there are at least two parties$ each of whom has something to offer. In addition$ e-change cannot occur unless the parties are able to communicate about and to deliver what the% offer. ;ar!eting is not a coercive process: all parties must be free to accept or re*ect what others are offering. So defined$ mar!eting is distinguished from other modes of obtaining desired goods$ such as through selfproduction$ begging$ theft$ or force. ;ar!eting is not confined to an% particular t%pe of econom%$ because goods must be e-changed and therefore mar!eted in all economies and societies e-cept perhaps in the most primitive. >urthermore$ mar!eting is not a function that is limited to profitoriented business7 even such institutions as hospitals$ schools$ and museums engage in some forms of mar!eting. +ithin the broad scope of mar!eting$ merchandising is concerned more specificall% with promoting the sale of goods and services to consumers &i.e.& retailing' and hence is more characteristic of freemar!et economies. <ased on these criteria$ mar!eting can ta!e a variet% of forms: it can be a set of functions$ a department within an organi5ation$ a managerial process$ a managerial philosoph%$ and a social process. T,E EV.)VI-: DISCIP)I-E .? MARAETI-: #he mar!eting discipline had its origins in the earl% ,Hth centur% as an offspring of economics. Economic science had neglected the role of middlemen and the role of functions other than price in the determination of demand levels and characteristics. Earl% mar!eting economists e-amined agricultural and industrial mar!ets and described them in greater detail than the classical economists. #his e-amination resulted in the development of three approaches to the anal%sis of mar!eting activit%: the commodit%$ the institution$ and the function. Commodit% anal%sis studies the wa%s in which a product or product group is brought to mar!et. 2 commodit% anal%sis of mil!$ for e-ample$ traces the wa%s in which mil! is collected at individual dair% farms$ transported to and processed at local dair% cooperatives$ and shipped to grocers and supermar!ets for consumer purchase. Institutional anal%sis describes the t%pes of businesses that pla% a prevalent role in mar!eting$ such as wholesale or retail institutions. >or instance$ an institutional anal%sis of clothing wholesalers e-amines the ongoing concerns that wholesalers face in order to ensure both the correct suppl% for their customers and the appropriate inventor% and shipping capabilities. >inall%$ a functional anal%sis e-amines the general tas!s that mar!eting performs. >or e-ample$ an% mar!eting effort must ensure that the product is transported from the supplier to the customer. In some industries$ this transportation function ma% be handled b% a truc!$ while in others it ma% be done b% mail$ facsimile$ television signal$ or airline. 2ll these institutions perform the same function. 2s the stud% of mar!eting became more prevalent throughout the ,Hth centur%$ large companie"particularl% mass consumer manufacturersbegan to recogni5e the importance of mar!et research$ better product design$ effective distribution$ and sustained communication with consumers in the success of their brands. ;ar!eting concepts and techni6ues later moved into the industrialgoods sector and subse6uentl% into the services sector. It soon became apparent that organi5ations and individuals /,? mar!et not onl% goods and services but also ideas &social mar!eting'$ places &location mar!eting'$ personalities &celebrit% mar!eting'$ events &event mar!eting'$ and even the organi5ations themselves &public relations'. R.)ES .? MARAETI-: 2s mar!eting developed$ it too! a variet% of forms. It was noted above that mar!eting can be viewed as a set of functions in the sense that certain activities are traditionall% associated with the e-change process. 2 common but incorrect view is that selling and advertising are the onl% mar!eting activities. :et$ in addition to promotion$ mar!eting includes a much broader set of functions$ including product development$ pac!aging$ pricing$ distribution$ and customer service. ;an% organi5ations and businesses assign responsibilit% for these mar!eting functions to a specific group of individuals within the organi5ation. In this respect$ mar!eting is a uni6ue and separate entit%. #hose who ma!e up the mar!eting department ma% include brand and product managers$ mar!eting researchers$ sales representatives$ advertising and promotion managers$ pricing specialists$ and customer service personnel. 2s a managerial process$ mar!eting is the wa% in which an organi5ation determines its best opportunities in the mar!etplace$ given its ob*ectives and resources. #he mar!eting process is divided into a strategic and a tactical phase. #he strategic phase has three componentssegmentation$ targeting$ and positioning &S#('. #he organi5ation must distinguish among different groups of customers in the mar!et &segmentation'$ choose which group&s' it can serve effectivel% &targeting'$ and communicate the central benefit it offers to that group &positioning'. #he mar!eting process includes designing and implementing various tactics$ commonl% referred to as the cmar!eting mi-$c or the c/ (sc: product$ price$ place &or distribution'$ and promotion. #he mar!eting mi- is followed b% evaluating$ controlling$ and revising the mar!eting process to achieve the organi5ation]s ob*ectives #he managerial philosoph% of mar!eting puts central emphasis on customer satisfaction as the means for gaining and !eeping lo%al customers. ;ar!eters urge their organi5ations to carefull% and continuall% gauge target customers] e-pectations and to consistentl% meet or e-ceed these e-pectations. In order to accomplish this$ ever%one in all areas of the organi5ation must focus on understanding and serving customers7 it will not succeed if all mar!eting occurs onl% in the mar!eting department. ;ar!eting$ conse6uentl%$ is far too important to be done solel% b% the mar!eting department. ;ar!eters also want their organi5ations to move from practicing transactionoriented mar!eting$ which focuses on individual e-changes$ to relationshipdriven mar!eting$ which emphasi5es serving the customer over the long term. Simpl% getting new customers and losing old ones will not help the organi5ation achieve its ob*ectives. >inall%$ mar!eting is a social process that occurs in all economies$ regardless of their political structure and orientation. It is the process b% which a societ% organi5es and distributes its resources to meet the material needs of its citi5ens. 3owever$ mar!eting activit% is more pronounced under conditions of goods surpluses than goods shortages. +hen goods are in short suppl%$ consumers are usuall% so desirous of goods that the e-change process does not re6uire significant promotion or facilitation. In contrast$ when there are more goods and services than consumers need or want$ companies must wor! harder to convince customers to e-change with them. T,E MARAETI-: PR.CESS #he mar!eting process consists of four elements: strategic mar!eting anal%sis$ mar!etingmi- planning$ mar!eting implementation$ and mar!eting control. /,G trategic mar"eting analysis M4.8-, -:M-5, #he aim of mar!eting in profitoriented organi5ations is to meet needs profitabl%. Companies must therefore first define which needsand whose needs the% can satisf%. >or e-ample$ the personal transportation mar!et consists of people who put different values on an automobile]s cost$ speed$ safet%$ status$ and st%ling. "o single automobile can satisf% all these needs in a superior fashion7 compromises have to be made. >urthermore$ some individuals ma% wish to meet their personal transportation needs with something other than an automobile$ such as a motorc%cle$ a bic%cle$ or a bus or other form of public transportation. <ecause of such variables$ an automobile compan% must identif% the different preference groups$ or segments$ of customers and decide which group&s' the% can target profitabl%. MARAET -IC,ES Segments can be divided into even smaller groups$ called subsegments or niches. 2 niche is defined as a small target group that has special re6uirements. >or e-ample$ a ban! ma% speciali5e in serving the investment needs of not onl% senior citi5ens but also senior citi5ens with high incomes and perhaps even those with particular investment preferences. It is more li!el% that larger organi5ations will serve the larger mar!et segments &mass mar!eting' and ignore niches. 2s a result$ smaller companies t%picall% emerge that are intimatel% familiar with a particular niche and speciali5e in serving its needs. MARAETI-: T. I-DIVID1A)S 2 growing number of companies are now tr%ing to serve csegments of one.c #he% attempt to adapt their offer and communication to each individual customer. #his is understandable$ for instance$ with large industrial companies that have onl% a few ma*or customers. >or e-ample$ #he <oeing Compan% &8nited States' designs its =/= planes differentl% for each ma*or customer$ such as 8nited 2irlines$ Inc.$ or 2merican 2irlines$ Inc. Serving individual customers is increasingl% possible with the advent of data%a"e mar!eting$ through which individual customer characteristics and purchase histories are retained in compan% information s%stems. Even mass mar!eting companies$ particularl% large retailers and catalog houses$ compile comprehensive data on individual customers and are able to customi5e their offerings and communications. P.SITI.-I-: 2 !e% step in mar!eting strateg%$ !nown as positioning$ involves creating and communicating a message that clearl% establishes the compan% or brand in relation to competitors. #hus$ Volvo 2!tiebolaget &Sweden' has positioned its automobile as the csafest$c and 9aimler<en5 2F &Ferman%'$ manufacturer of ;ercedes<en5 vehicles$ has positioned its car as the best cengineered.c Some products ma% be positioned as /.H coutstandingc in two or more wa%s. 3owever$ claiming superiorit% along several dimensions ma% hurt a compan%]s credibilit% because consumers will not believe that an% one offering can e-cel in all dimensions. >urthermore$ although the compan% ma% communicate a particular position$ customers ma% perceive a different image of the compan% as a result of their actual e-periences with the compan%]s product or through word of mouth. Mar"eting(mix planning 3aving developed a strateg%$ a compan% must then decide which tactics will be most effective in achieving strateg% goals. #actical mar!eting involves creating a mar!eting mi- of four componentsproduct$ price$ place$ promotionthat fulfills the strateg% for the targeted set of customer needs. PR.D1CT /roduct development. #he first mar!etingmi- element is the product$ which refers to the offering or group of offerings that will be made available to customers. In the case of a ph%sical product$ such as a car$ a compan% will gather information about the features and benefits desired b% a target mar!et. <efore assembling a product$ the mar!eter]s role is to communicate customer desires to the engineers who design the product or service. #his is in contrast to past practice$ when engineers designed a product based on their own preferences$ interests$ or e-pertise and then e-pected mar!eters to find as man% customers as possible to bu% this product. Contemporar% thin!ing calls for products to be designed based on customer input and not solel% on engineers] ideas. In traditional economies$ the goods produced and consumed often remain the same from one generation to the ne-tincluding food$ clothing$ and housing. 2s economies develop$ the range of products available tends to e-pand$ and the products themselves change. In contemporar% industriali5ed societies$ products$ li!e people$ go through life c%cles: birth$ growth$ maturit%$ and decline. #his constant replacement of e-isting products with new or altered products has significant conse6uences for professional mar!eters. #he development of new products involves all aspects of a businessproduction$ finance$ research and development$ and even personnel administration and public relations. /ac"aging and branding. Pac!a#in# and branding are also substantial components in the mar!eting of a product. (ac!aging in some instances ma% be as simple as customers in >rance carr%ing long loaves of unwrapped bread or small produce dealers in Ital% wrapping vegetables in newspapers or placing them in customers] string bags. In most industriali5ed countries$ however$ the pac!aging of merchandise has become a ma*or part of the selling effort$ as mar!eters now specif% e-actl% the t%pes of pac!aging that will be most appealing to prospective customers. #he importance of pac!aging in the distribution of the product has increased with the spread of selfservice purchasesin wholesaling as well as in retailing. (ac!aging is sometimes designed to facilitate the use of the product$ as with aerosol containers for room deodorants. In Europe such condiments as mustard$ ma%onnaise$ and !etchup are often pac!aged in tubes. Some pac!ages are reusable$ ma!ing them attractive to customers in poorer countries where metal containers$ for instance$ are often highl% pri5ed. /.1 Mar"eting a service product. #he same general mar!eting approach about the product applies to the development of service offerings as well. >or e-ample$ a health maintenance or#aniIation &3;O' must design a contract for its members that describes which medical procedures will be covered$ how much ph%sician choice will be available$ how outoftown medical costs will be handled$ and so forth. In creating a successful service mi-$ the 3;O must choose features that are preferred and e-pected b% target customers$ or the service will not be valued in the mar!etplace. PRICE #he second mar!etingmi- element is price. Ordinaril% companies determine a price b% gauging the 6ualit% or performance level of the offer and then selecting a price that reflects how the mar!et values its level of 6ualit%. 3owever$ mar!eters also are aware that price can send a message to a customer about the product]s presumed 6ualit% level. 2 ;ercedes<en5 vehicle is generall% considered to be a high6ualit% automobile$ and it therefore can command a high price in the mar!etplace. <ut$ even if the manufacturer could price its cars competitivel% with econom% cars$ it might not do so$ !nowing that the lower price might communicate lower 6ualit%. On the other hand$ in order to gain mar!et share$ some companies have moved to cmore for the samec or cthe same for lessc pricing$ which means offering prices that are consistentl% lower than those of their competitors. #his !ind of discount pricing has caused firms in such industries as airlines and pharmaceuticals &which used to charge a price premium based on their past brand strength and reputation' to significantl% reevaluate their mar!eting strategies. P)ACE Place$ or where the product is made available$ is the third element of the mar!eting mi- and is most commonl% referred to as distribution. +hen a product moves along its path from producer to consumer$ it is said to be following a channel of di"tri%ution. >or e-ample$ the channel of distribution for man% food products includes foodprocessing plants$ warehouses$ wholesalers$ and supermar!ets. <% using this channel$ a food manufacturer ma!es its products easil% accessible b% ensuring that the% are in stores that are fre6uented b% those in the target mar!et. In another e-ample$ a mutual funds organi5ation ma!es its investment products available b% enlisting the assistance of bro!erage houses and ban!s$ which in turn establish relationships with particular customers. 3owever$ each channel participant can handle onl% a certain number of products: space at supermar!ets is limited$ and investment bro!ers can !eep abreast of onl% a limited number of mutual funds. <ecause of this$ some mar!eters ma% decide to s!ip steps in the channel and instead mar!et directl% to bu%ers through direct mail$ telemar!eting$ doortodoor selling$ shopping via television &a growing trend in the late ,Hth centur%'$ or factor% outlets. PR.M.TI.- (romotion$ the fourth mar!etingmi- element$ consists of several methods of communicating with and influencing customers. #he ma*or tools are sales force$ advertising$ sales promotion$ and public relations. /., ales force. Sale" repre"entati$e" are the most e-pensive means of promotion$ because the% re6uire income$ e-penses$ and supplementar% benefits. #heir abilit% to personali5e the promotion process ma!es salespeople most effective at selling comple- goods$ bigtic!et items$ and highl% personal goodsfor e-ample$ those related to religion or insurance. Salespeople are trained to ma!e presentations$ answer ob*ections$ gain commitments to purchase$ and manage account growth. Some companies have successfull% reduced their salesforce costs b% replacing certain functions &for e-ample$ finding new customers' with less e-pensive methods &such as direct mail and telemar!eting'. 4dvertising. Ad$erti"in# includes all forms of paid$ nonpersonal communication and promotion of products$ services$ or ideas b% a specified sponsor. 2dvertising appears in such media as print &newspapers$ maga5ines$ billboards$ fl%ers' or broadcast &radio$ television'. (rint advertisements t%picall% consist of a picture$ a headline$ information about the product$ and occasionall% a response coupon. <roadcast advertisements consist of an audio or video narrative that can range from short 10second spots to longer segments !nown as infomercials$ which generall% last .H or 1H minutes. ales promotion. +hile advertising presents a reason to bu% a product$ sales promotion offers a shortterm incentive to purchase. Sales promotions often attract brand switchers &those who are not lo%al to a specific brand' who are loo!ing primaril% for low price and good value. #hus$ especiall% in mar!ets where brands are highl% similar$ sales promotions can cause a shortterm increase in sales but little permanent gain in mar!et share. 2lternativel%$ in mar!ets where brands are 6uite dissimilar$ sales promotions can alter mar!et shares more permanentl%. #he use of promotions has risen considerabl% during the late ,Hth centur%. #his is due to a number of factors within companies$ including an increased sophistication in sales promotion techni6ues and greater pressure to increase sales. Several mar!et factors also have fostered this increase$ including a rise in the number of brands &especiall% similar ones' and a decrease in the efficienc% of traditional advertising due to increasingl% fractionated consumer mar!ets. /ublic relations. Pu%lic relation"$ in contrast to advertising and sales promotion$ generall% involves less commerciali5ed modes of communication. Its primar% purpose is to disseminate information and opinion to groups and individuals who have an actual or potential impact on a compan%]s abilit% to achieve its ob*ectives. In addition$ public relations specialists are responsible for monitoring these individuals and groups and for maintaining good relationships with them. One of their !e% activities is to wor! with news and information media to ensure appropriate coverage of the compan%]s activities and products. (ublic relations specialists create publicit% b% arranging press conferences$ contests$ meetings$ and other events that will draw attention to a compan%]s products or services. 2nother public relations responsibilit% is crisis managementthat is$ handling situations in which public awareness of a particular issue ma% dramaticall% and negativel% impact the compan%]s abilit% to achieve its goals. >or e-ample$ when it was discovered that some bottles of (errier spar!ling water might have been tainted b% a harmful chemical$ Source (errier$ S2]s public relations team had to ensure that the general consuming public did not thereafter automaticall% associate (errier with tainted water. /.. Other public relations activities include lobb%ing$ advising management about public issues$ and planning communit% events. <ecause public relations does not alwa%s see! to impact sales or profitabilit% directl%$ it is sometimes seen as serving a function that is separate from mar!eting. 3owever$ some companies recogni5e that public relations can wor! in con*unction with other mar!eting activities to facilitate the e-change process directl% and indirectl%. #hese organi5ations have established mar!eting public relations departments to directl% support corporate and product promotion and image management. Mar"eting implementation. Companies have t%picall% hired different agencies to help in the development of advertising$ sales promotion$ and publicit% ideas. 3owever$ this often results in a lac! of coordination between elements of the promotion mi-. +hen components of the mi- are not all in harmon%$ a confusing message ma% be sent to consumers. >or e-ample$ a print advertisement for an automobile ma% emphasi5e the car]s e-clusivit% and lu-ur%$ while a television advertisement ma% stress rebates and sales$ clashing with this image of e-clusivit%. 2lternativel%$ b% integrating the mar!eting elements$ a compan% can more efficientl% utili5e its resources. Instead of individuall% managing four or five different promotion processes$ the compan% manages onl% one. In addition$ promotion e-penditures are li!el% to be better allocated$ because differences among promotion tools become more e-plicit. #his reasoning has led to integrated mar!eting communications$ in which all promotional tools are considered to be part of the same effort$ and each tool receives full consideration in terms of its cost and effectiveness. Mar"eting evaluation and control "o mar!eting process$ even the most carefull% developed$ is guaranteed to result in ma-imum benefit for a compan%. In addition$ because ever% mar!et is changing constantl%$ a strateg% that is effective toda% ma% not be effective in the future. It is important to evaluate a mar!eting program periodicall% to be sure that it is achieving its ob*ectives. MARAETI-: C.-TR.) #here are four t%pes of mar!eting control$ each of which has a different purpose: annualplan control$ profitabilit% control$ efficienc% control$ and strategic control. 4nnual(plan control. #he basis of annualplan control is managerial ob*ectivesthat is to sa%$ specific goals$ such as "ale" and profitabilit%$ that are established on a monthl% or 6uarterl% basis. Organi5ations use five tools to monitor plan performance. #he first is sales anal%sis$ in which sales goals are compared with actual sales and discrepancies are e-plained or accounted for. 2 second tool is mar!etshare anal%sis$ which compares a compan%]s sales with those of its competitors. Companies can e-press their mar!et share in a number of wa%s$ b% comparing their own sales to total mar!et sales$ sales within the mar!et segment$ or sales of the segment]s top competitors. #hird$ mar!eting e-pensetosales anal%sis gauges how much a compan% spends to achieve its sales goals. #he ratio of mar!eting e-penses to sales is e-pected to fluctuate$ and companies usuall% establish an acceptable range for this ratio. In contrast$ financial anal%sis estimates such e-penses &along with others' from a corporate perspective. #his includes a comparison of profits to sales &profit margin'$ sales to assets &asset turnover'$ profits to assets &return on assets'$ assets to worth /./ &financial leverage'$ and$ finall%$ profits to worth &return on net worth'. >inall%$ companies measure cu"tomer "ati"faction as a means of trac!ing goal achievement. 2nal%ses of this !ind are generall% less 6uantitative than those described above and ma% include complaint and suggestion s%stems$ customer satisfaction surve%s$ and careful anal%sis of reasons wh% customers switch to a competitor]s product. /rofitability control. (rofitabilit% control and efficienc% control allow a compan% to closel% monitor its sales$ profits$ and e-penditures. (rofitabilit% control demonstrates the relative profitearning capacit% of a compan%]s different products and consumer groups. Companies are fre6uentl% surprised to find that a small percentage of their products and customers contribute to a large percentage of their profits. #his !nowledge helps a compan% allocate its resources and effort. -fficiency control. Efficienc% control involves microlevel anal%sis of the various elements of the mar!eting mi-$ including sales force$ advertising$ sales promotion$ and distribution. >or e-ample$ to understand its salesforce efficienc%$ a compan% ma% !eep trac! of how man% sales calls a representative ma!es each da%$ how long each call lasts$ and how much each call costs and generates in revenue. #his t%pe of anal%sis highlights areas in which companies can manage their mar!eting efforts in a more productive and costeffective manner. trategic control. Strategic control processes allow managers to evaluate a compan%]s mar!eting program from a critical longterm perspective. #his involves a detailed and ob*ective anal%sis of a compan%]s organi5ation and its abilit% to ma-imi5e its strengths and mar!et opportunities. Companies can use two t%pes of strategic control tools. #he first$ which a compan% uses to evaluate itself$ is called a mar!etingeffectiveness rating review. In order to rate its own mar!eting effectiveness$ a compan% e-amines its customer philosoph%$ the ade6uac% of its mar!eting information$ and the efficienc% of its mar!eting operations. It will also closel% evaluate the strength of its mar!eting strateg% and the integration of its mar!eting tactics. MARAETI-: A1DIT #he second evaluation tool is !nown as a mar!eting audit. #his is a comprehensive$ s%stematic$ independent$ and periodic anal%sis that a compan% uses to e-amine its strengths in relation to its current and potential mar!et&s'. Such an anal%sis is comprehensive because it covers all aspects of the mar!eting climate &unli!e a functional audit$ which anal%5es one mar!eting activit%'$ loo!ing at both macroenvironment factors &demographic$ economic$ ecological$ technological$ political$ and cultural' and micro or tas!environment factors &mar!ets$ customers$ competitors$ distributors$ dealers$ suppliers$ facilitators$ and publics'. #he audit includes anal%ses of the compan%]s mar!eting strateg%$ mar!eting organi5ation$ /.0 mar!eting s%stems$ and mar!eting productivit%. It must be s%stematic in order to provide concrete conclusions based on these anal%ses. #o ensure ob*ectivit%$ a mar!eting audit is best done b% a person$ department$ or organi5ation that is independent of the compan% or mar!eting program. ;ar!eting audits should be done not onl% when the value of a compan%]s current mar!eting plan is in 6uestion7 the% must be done periodicall% in order to isolate and solve problems before the% arise. T,E MARAETI-: ACT.RS #he elements that pla% a role in the mar!eting process can be divided into three groups: customers$ distributors$ and facilitators. In addition to interacting with one another$ these groups must interact within a business environment that is affected b% a variet% of forces$ including governmental$ economic$ and social influences. Customers In order to understand target customers$ certain 6uestions must be answered: +ho constitutes the mar!et segment4 +hat do the% bu% and wh%4 2nd how$ when$ and where do the% bu%4 Unowing who constitutes the mar!et segment is not simpl% a matter of !nowing who uses a product. Often$ individuals other than the user ma% participate in or influence a purchasing decision. Several individuals ma% pla% various roles in the decisionma!ing process. >or instance$ in the decision to purchase an automobile for a small famil% business$ the son ma% be the initiator$ the daughter ma% be an influencer$ the wife ma% be the decider$ the purchasing manager ma% be the bu%er$ and the husband ma% be the user. In other words$ the son ma% read in a maga5ine that businesses can save mone% and decrease ta- liabilit% b% owning or leasing compan% transportation. 3e ma% therefore initiate the product search process b% raising this issue at a wee!l% business meeting. 3owever$ the son ma% not be the best6ualified to gather and process information about automobiles$ because the daughter wor!ed for several %ears in the auto industr% before *oining the famil% business. 2lthough the daughter]s e-pertise and research efforts ma% influence the process$ she ma% not be the !e% decision ma!er. #he mother$ b% virtue of her position in the business and in the famil%$ ma% ma!e the final decision about which car to purchase. 3owever$ the famil% uncle ma% have good negotiation s!ills$ and he ma% be the purchasing agent. #hus$ he will go to different car dealerships in order to bu% the chosen car at the best possible price. >inall%$ despite the involvement of all these individuals in the purchase process$ none of them ma% actuall% drive the car. It ma% be purchased so that the father ma% use it for his fre6uent sales calls. In other instances$ an individual ma% handle more than one of these purchasing functions and ma% even be responsible for all of them. #he !e% is that a mar!eter must recogni5e that different people have different influences on the purchase decision$ and these factors must be ta!en into account in crafting a mar!eting strateg%. In addition to !nowing to whom the mar!eting efforts are targeted$ it is important to !now which products target customers tend to purchase and wh% the% do so. Customers do not purchase cthingsc as much as the% purchase services or benefits to satisf% needs. >or instance$ a conventional oven allows users to coo! and heat food. ;icrowave oven manufacturers recogni5ed that this need could be fulfilledand done so more 6uic!l%with a technolog% other than conventional heating. <% focusing on needs rather than on products$ these companies were able to gain a significant share in the food coo!ing and heating mar!et. Unowledge of when$ where$ and how purchases are made is also useful. 2 furniture store whose target customers tend to ma!e ma*or purchases in the spring ma% send its mailings at the beginning of this season. 2 food vendor ma% set up a stand near the door of a bus% office comple- so that emplo%ees must pass the stand on their wa% to lunch. 2nd a *eweler who !nows that customers prefer to pa% with credit cards ma% ensure that all ma*or credit /.1 cards are accepted at the store. In other cases$ mar!eters who understand specifics about bu%ing habits and preferences also ma% tr% to alter them. #hus$ a remotel% situated wholesale store ma% use deepl% discounted prices to lure customers awa% from the more convenientl% located shopping malls. Customers can be divided into two categories: consumer customers$ who purchase goods and services for use b% themselves and b% those with whom the% live7 and business customers$ who purchase goods and services for use b% the organi5ation for which the% wor!. 2lthough there are a number of similarities between the purchasing approaches of each t%pe of customer$ there are important differences as well. C.-S1MER C1ST.MERS 6actors influencing consumers. >our ma*or t%pes of factors influence consumer bu%ing behaviour: cultural$ social$ personal$ and ps%chological.
Cultural factors. Cultural factors have the broadest influence$ because the% constitute a stable set of values$ perceptions$ preferences$ and behaviours that have been learned b% the consumer throughout life. >or e-ample$ in +estern culture" consumption is often driven b% a consumer]s need to e-press individualit%$ while in Eastern cultures consumers are more interested in conforming to group norms. In addition to the influence of a dominant culture$ consumers ma% also be influenced b% several subcultures. In Euebec the dominant culture is >renchspea!ing$ but one influential subculture is Englishspea!ing. Social class is also a subcultural factor: members of an% given social class tend to share similar values$ interests$ and behaviours. ocial factors. 2 consumer ma% interact with several individuals on a dail% basis$ and the influence of these people constitutes the social factors that impact the bu%ing process. Social factors include reference groupsthat is$ the formal or informal social groups against which consumers compare themselves. Consumers ma% be influenced not onl% b% their own membership groups but also b% reference groups of which the% wish to be a part. #hus$ a consumer who wishes to be considered a successful white collar professional ma% bu% a particular !ind of clothing because the people in this reference group tend to wear that st%le. #%picall%$ the most influential reference group is the family. In this case$ famil% includes the people who raised the consumer &the cfamil% of orientationc' as well as the consumer]s spouse and children &the cfamil% of procreationc'. +ithin each group$ a consumer will be e-pected to pla% a specific role or set of roles dictated b% the norms of the group. Coles in each group generall% are tied closel% to status. /ersonal factors. (ersonal factors include individual characteristics that$ when ta!en in aggregate$ distinguish the individual from others of the same social group and culture. /.= #hese include age$ lifec%cle stage$ occupation$ economic circumstances$ and lifest%le. 2 consumer]s personalit% and selfconception will also influence his or her bu%ing behaviour. /sychological factors. >inall%$ p"ycholo#ical factors are the wa%s in which human thin!ing and thought patterns influence bu%ing decisions. Consumers are influenced$ for e-ample$ b% their motivation to fulfill a need. In addition$ the wa%s in which an individual ac6uires and retains information will affect the bu%ing process significantl%. Consumers also ma!e their decisions based on past e-periencesboth positive and negative. Consumer buying tas"s. 2 consumer]s bu%ing tas! is affected significantl% b% the level of purchase involvement. #he level of involvement describes how important the decision is to the consumer7 high involvement is usuall% associated with purchases that are e-pensive$ infre6uent$ or ris!%. <u%ing also is affected b% the degree of difference between brands in the product categor%. #he bu%ing tas! can be grouped into four categories based on whether involvement is high or low and whether brand differences are great or small. *igh(involvement purchases. Comple- bu%ing behaviour occurs when the consumer is highl% involved with the purchase and when there are significant differences between brands. #his behaviour can be associated with the purchase of a new home or of an advanced computer. Such tas!s are comple- because the ris! is high &significant financial commitment'$ and the large differences among brands or products re6uire gathering a substantial amount of information prior to purchase. ;ar!eters who wish to influence this bu%ing tas! must help the consumer process the information as readil% as possible. #his ma% include informing the consumer about the product categor% and its important attributes$ providing detailed information about product benefits$ and motivating sales personnel to influence final brand choice. >or instance$ realtors ma% offer consumers a boo! or a video featuring photographs and descriptions of each available home. 2nd a computer salesperson is li!el% to spend time in the retail store providing information to customers who have 6uestions. 9issonancereducing bu%ing behaviour occurs when the consumer is highl% involved but sees little difference between brands. #his is li!el% to be the case with the purchase of a lawn mower or a diamond ring. 2fter ma!ing a purchase under such circumstances$ a consumer is li!el% to e-perience the dissonance that comes from noticing that other brands would have been *ust as good$ if not slightl% better$ in some dimensions. 2 consumer in such a bu%ing situation will see! information or ideas that *ustif% the original purchase. 'ow(involvement purchases. #here are two t%pes of lowinvolvement purchases. 3abitual bu%ing behaviour occurs when involvement is low and differences between brands are small. Consumers in this case usuall% do not form a strong attitude toward a brand but select /.? it because it is familiar. In these mar!ets$ promotions tend to be simple and repetitive so that the consumer can$ without much effort$ learn the association between a brand and a product class. ;ar!eters ma% also tr% to ma!e their product more involving. >or instance$ toothpaste was at one time purchased primaril% out of habit$ but (roctor and Famble Co. introduced a brand$ Crest toothpaste$ that increased consumer involvement b% raising awareness about the importance of good dental h%giene. Brand differences. Variet%see!ing bu%ing behaviour occurs when the consumer is not involved with the purchase$ %et there are significant brand differences. In this case$ the cost of switching products is low$ and so the consumer ma%$ perhaps simpl% out of boredom$ move from one brand to another. Such is often the case with fro5en desserts$ brea!fast cereals$ and soft drin!s. 9ominant firms in such a mar!et situation will attempt to encourage habitual bu%ing and will tr% to !eep other brands from being considered b% the consumer. #hese strategies reduce customer switching behaviour. Challenger firms$ on the other hand$ want consumers to switch from the mar!et leader$ so the% will offer promotions$ free samples$ and advertising that encourage consumers to tr% something new. ,he consumer buying process. #he purchase process is initiated when a con"umer becomes aware of a need. #his awareness ma% come from an internal source such as hunger or an e-ternal source such as mar!eting communications. 2wareness of such a need motivates the consumer to search for information about options with which to fulfill the need. #his information can come from personal sources$ commercial sources$ public or government sources$ or the consumer]s own e-perience. Once alternatives have been identified through these sources$ consumers evaluate the options$ pa%ing particular attention to those attributes the consumer considers most important. Evaluation culminates with a purchase decision$ but the bu%ing process does not end here. In fact$ mar!eters point out that a purchase represents the beginning$ not the end$ of a consumer]s relationship with a compan%. 2fter a purchase has been made$ a satisfied consumer is more li!el% to purchase another compan% product and to sa% positive things about the compan% or its product to other potential purchasers. #he opposite is true for dissatisfied consumers. <ecause of this fact$ man% companies continue to communicate with their customers after a purchase in an effort to influence post purchase satisfaction and behaviour. >or e-ample$ a plumber ma% be motivated to consider bu%ing a new set of tools because his old set of tools is getting rust%. #o gather information about what !ind of new tool set to bu%$ this plumber ma% e-amine the tools of a colleague who *ust bought a new set$ read advertisements in plumbing trade maga5ines$ and visit different stores to e-amine the sets available. #he plumber then processes all the information collected$ focusing perhaps on durabilit% as one of the most important attributes. In ma!ing a particular purchase$ the plumber initiates a relationship with a particular tool compan%. #his compan% ma% tr% to enhance postpurchase lo%alt% and satisfaction b% sending the plumber promotions about new tools. /1SI-ESS C1ST.MERS <usiness customers$ also !nown as industrial customers$ purchase products or services to use in the production of other products. Such industries include /.G agriculture$ manufacturing$ construction$ transportation$ and communication$ among others. #he% differ from consumer mar!ets in several respects. <ecause the customers are organi5ations$ the mar!et tends to have fewer and larger bu%ers than consumer mar!ets. #his often results in closer bu%erseller relationships$ because those who operate in a mar!et must depend more significantl% on one another for suppl% and revenue. <usiness customers also are more concentrated7 for instance$ in the 8nited States more than half of the countr%]s business bu%ers are concentrated in onl% seven states. 9emand for business goods is derived demand$ which means it is driven b% a demand for consumer goods. #herefore$ demand for business goods is more volatile$ because variations in consumer demand can have a significant impact on business goods demand. <usiness mar!ets are also distinctive in that bu%ers are professional purchasers who are highl% s!illed in negotiating contracts and ma-imi5ing efficienc%. In addition$ several individuals within the business usuall% have direct or indirect influence on the purchasing process. 6actors influencing business customers. 2lthough business customers are affected b% the same cultural$ social$ personal$ and ps%chological factors that influence consumer customers$ the business arena imposes other factors that can be even more influential. >irst$ there is the economic environment$ which is characteri5ed b% such factors as primar% demand$ economic forecast$ political and regulator% developments$ and the t%pe of competition in the mar!et. In a highl% competitive mar!et such as airline travel$ firms ma% be concerned about price and therefore ma!e purchases with a focus on saving mone%. In mar!ets where there is more differentiation among competitorse.g.& in the hotel industr%man% firms ma% ma!e purchases with a focus on 6ualit% rather than on price. Second$ there are organi5ational factors$ which include the ob*ectives$ policies$ procedures$ structures$ and s%stems that characteri5e an% particular compan%. Some companies are structured in such a wa% that purchases must pass through a comple- s%stem of chec!s and balances$ while other companies allow purchasing managers to ma!e more individual decisions. Interpersonal factors are more salient among business customers$ because the participants in the bu%ing processperhaps representing several departments within a compan%often have different interests$ authorit%$ and persuasiveness. >urthermore$ the factors that affect an individual in the business bu%ing process are related to the participant]s role in the organi5ation. #hese factors include *ob position$ ris! attitudes$ and income. ,he business buying process. #he business bu%ing process mirrors the consumer bu%ing process$ with a few notable e-ceptions. <usiness bu%ing is not generall% needdriven and is instead problemdriven. 2 business bu%ing process is usuall% initiated when someone in the compan% sees a problem that needs to be solved or recogni5es a wa% in which the compan% can increase profitabilit% or efficienc%. #he ensuing process follows the same pattern as that of consumers$ including information search$ evaluation of alternatives$ purchase decision$ and postpurchase evaluation. 3owever$ in part because business purchase decisions re6uire accountabilit% and are often closel% anal%5ed according to cost and efficienc%$ the process is more s%stematic than consumer bu%ing and often involves significant documentation. #%picall%$ a purchasing agent for a business bu%er will generate documentation regarding product specifications$ preferred supplier lists$ re6uests for bids from suppliers$ and performance reviews. //H Mar"eting intermediaries!the distribution channel ;an% producers do not sell products or services directl% to consumers and instead use mar!eting intermediaries to e-ecute an assortment of necessar% functions to get the product to the final user. #hese intermediaries$ such as middlemen &wholesalers$ retailers$ agents$ and bro!ers'$ distributors$ or financial intermediaries$ t%picall% enter into longerterm commitments with the producer and ma!e up what is !nown as the mar!etin# channel$ or the channel of distribution. ;anufacturers use ra material" to produce finished products$ which in turn ma% be sent directl% to the retailer$ or$ less often$ to the consumer. 3owever$ as a general rule$ finished goods flow from the manufacturer to one or more wholesalers before the% reach the retailer and$ finall%$ the consumer. Each part% in the distribution channel usuall% ac6uires legal possession of goods during their ph%sical transfer$ but this is not alwa%s the case. >or instance$ in consignment selling$ the producer retains full legal ownership even though the goods ma% be in the hands of the wholesaler or retailerthat is$ until the merchandise reaches the final user or consumer. Channels of distribution tend to be more directthat is$ shorter and simplerin the less industriali5ed nations. #here are notable e-ceptions$ however. >or instance$ the :hana Cocoa ;ar!eting <oard collects cacao beans in Fhana and licenses trading firms to process the commodit%. Similar mar!eting processes are used in other +est 2frican nations. <ecause of the vast number of smallscale producers$ these agents operate through middlemen who$ in turn$ enlist subbu%ers to find runners to transport the products from remote areas. (apan@" mar!eting organi5ation was$ until the late ,Hth centur%$ characteri5ed b% long and comple- channels of distribution and a variet% of wholesalers. It was possible for a product to pass through a minimum of five separate wholesalers before it reached a retailer. Companies have a wide range of distribution channels available to them$ and structuring the right channel ma% be one of the compan%]s most critical mar!eting decisions. <usinesses ma% sell products directl% to the final customer$ as Dand]s End$ Inc.$ does with its mailorder goods and as is the case with most industrial capital goods. Or the% ma% use one or more intermediaries to move their goods to the final user. #he design and structure of consumer mar!eting channels and industrial mar!eting channels can be 6uite similar or var% widel%. #he channel design is based on the level of service desired b% the target consumer. #here are five primar% service components that facilitate the mar!eter]s understanding of what$ where$ wh%$ when$ and how target customers bu% certain products. #he service variables are 6uantit% or lot si5e &the number of units a customer purchases on an% given purchase occasion'$ waiting time &the amount of time customers are willing to wait for receipt of goods'$ pro-imit% or spatial convenience &accessibilit% of the product'$ product variet% &the breadth of assortment of the product offering'$ and service bac!up &addon services such as deliver% or installation provided b% the channel'. It is essential for the designer of the mar!eting channelt%picall% the manufacturerto recogni5e the level of each service point that the target customer desires. 2 single manufacturer ma% service several target customer groups through separate channels$ and therefore each set of service outputs for these groups could var%. One group of target customers ma% want elevated levels of service &that is$ fast deliver%$ high product availabilit%$ large product assortment$ and installation'. #heir demand for such increased service translates into higher costs for the channel and higher prices for customers. 3owever$ the prosperit% of discount and warehouse stores demonstrates that customers are willing to accept lower service outputs if this leads to lower prices. //1 Channel function" and flo"* In order to deliver the optimal level of service outputs to their target consumers$ manufacturers are willing to allocate some of their tas!s$ or mar!eting flows$ to intermediaries. 2s an% mar!eting channel moves goods from producers to consumers$ the mar!eting intermediaries perform$ or participate in$ a number of mar!eting flows$ or activities. #he t%pical mar!eting flows$ listed in the usual se6uence in which the% arise$ are collection and distribution of mar!etin# re"earch information &information'$ development and dissemination of persuasive communications &promotion'$ agreement on terms for transfer of ownership or possession &ne#otiation'$ intentions to bu% &ordering'$ ac6uisition and allocation of funds &financing'$ a""umption of ri"!" &ris! ta!ing'$ storage and movement of product &ph%sical possession'$ bu%ers pa%ing sellers &pa%ment'$ and transfer of ownership &title'. Each of these flows must be performed b% a mar!eting intermediar% for an% channel to deliver the goods to the final consumer. #hus$ each producer must decide who will perform which of these functions in order to deliver the service output levels that the target consumers desire. (roducers delegate these flows for a variet% of reasons. >irst$ the% ma% lac! the financial resources to carr% out the intermediar% activities themselves. Second$ man% producers can earn a superior return on their capital b% investing profits bac! into their core business rather than into the distribution of their products. >inall%$ intermediaries$ or middlemen$ offer superior efficienc% in ma!ing goods and services widel% available and accessible to final users. >or instance$ in overseas mar!ets it ma% be difficult for an e-porter to establish contact with end users$ and various !inds of agents must therefore be emplo%ed. <ecause an intermediar% t%picall% focuses on onl% a small handful of speciali5ed tas!s within the mar!eting channel$ each intermediar%$ through speciali5ation$ e-perience$ or scale of operation$ can offer a producer greater distribution benefits. Mana#ement of channel "y"tem"* 2lthough middlemen can offer greater distribution econom% to producers$ gaining cooperation from these middlemen can be problematic. ;iddlemen must continuousl% be motivated and stimulated to perform at the highest level. In order to gain such a high level of performance$ manufacturers need some sort of leverage. Cesearchers have distinguished five bases of power: coercive &threats if the middlemen do not compl%'$ reward &e-tra benefits for compliance'$ legitimate &power b% positionran! or contract'$ e-pert &special !nowledge'$ and referent &manufacturer is highl% respected b% the middlemen'. 2s new institutions emerge or products enter different lifec%cle phases$ distribution channels change and evolve. +ith these t%pes of changes$ no matter how well the channel is designed and managed$ conflict is inevitable. Often this conflict develops because the interests of the independent businesses do not coincide. >or e-ample$ franchisers$ because the% receive a percentage of sales$ t%picall% want their franchisees to ma-imi5e sales$ while //, the franchisees want to ma-imi5e their profits$ not sales. #he conflict that arises ma% be vertical$ hori5ontal$ or multichannel in nature. +hen Feneral ;otors Corporation comes into conflict with its dealers$ this is a vertical channel conflict. 3ori5ontal channel conflict arises when a franchisee in a neighbouring town feels a fellow franchisee has infringed on its territor%. >inall%$ multichannel conflict occurs when a manufacturer has established two or more channels that compete against each other in selling to the same mar!et. >or e-ample$ a ma*or tire manufacturer ma% begin selling its tires through mass merchandisers$ much to the disma% of its independent tire dealers. W,.)ESA)ERS +holesaling includes all activities re6uired to sell goods or services to other firms$ either for resale or for business use$ usuall% in bul! 6uantities and at lower thanretail prices. +holesalers$ also called distributors$ are independent merchants operating an% number of wholesale establishments. +holesalers are t%picall% classified into one of three groups: merchant wholesalers$ bro!ers and agents$ and manufacturers] and retailers] branches and offices. Merchant wholesalers. Merchant hole"aler"$ also !nown as *obbers$ distributors$ or suppl% houses$ are independentl% owned and operated organi5ations that ac6uire title ownership of the goods that the% handle. #here are two t%pes of merchant wholesalers: fullservice and limitedservice. 6ull(service wholesalers. >ullservice wholesalers usuall% handle larger sales volumes7 the% ma% perform a broad range of services for their customers$ such as stoc!ing inventories$ operating warehouses$ suppl%ing credit$ emplo%ing salespeople to assist customers$ and delivering goods to customers. Feneralline wholesalers carr% a wide variet% of merchandise$ such as groceries7 specialt% wholesalers$ on the other hand$ deal with a narrow line of goods$ such as coffee and tea$ cigarettes$ or seafood. 'imited(service wholesalers. Dimitedservice wholesalers$ who offer fewer services to their customers and suppliers$ emerged in order to reduce the costs of service. #here are several t%pes of limitedservice wholesalers. Cashandcarr% wholesalers usuall% handle a limited line of fastmoving merchandise$ selling to smaller retailers on a cashonl% basis and not delivering goods. #ruc! wholesalers or *obbers sell and deliver directl% from their vehicles$ often for cash. #he% carr% a limited line of semiperishables such as mil!$ bread$ and snac! foods. 9rop shippers do not carr% inventor% or handle the merchandise. Operating primaril% in bul! industries such as lumber$ coal$ and heav% e6uipment$ the% ta!e orders but have manufacturers ship merchandise directl% to final consumers. Cac! *obbers$ who handle nonfood lines such as housewares or personal goods$ primaril% serve drug and grocer% retailers. Cac! *obbers t%picall% perform such functions as deliver%$ shelving$ inventor% stac!ing$ and financing. (roducers] cooperativesowned b% their members$ who are farmersassemble farm produce to be sold in local mar!ets and share profits at the end of the %ear. In le""0de$eloped countrie"$ wholesalers are often the sole or primar% means of trade7 the% are the main elements in the distribution s%stems of man% //. countries in Datin 2merica$ East 2sia$ and 2frica. In such countries the business activities of wholesalers ma% e-pand to include manufacturing and retailing$ or the% ma% branch out into nondistributive ventures such as real estate$ finance$ or transportation. 8ntil the late 1G0Hs$ (apan was dominated b% wholesaling. Even relativel% large manufacturers and retailers relied principall% on wholesalers as their intermediaries. 3owever$ in the late ,Hth centur%$ @apanese wholesalers have declined in importance. Even in the most highl% industriali5ed nations$ however$ wholesalers remain essential to the operations of significant numbers of small retailers. Bro"ers and agents. ;anufacturers ma% use bro!ers and agents$ who do not ta!e title possession of the goods$ in mar!eting their products. <ro!ers and agents t%picall% perform onl% a few of the mar!eting flows$ and their main function is to ease bu%ing and sellingthat is$ to bring bu%ers and sellers together and negotiate between them. <ro!ers$ most commonl% found in the food$ real estate$ and insurance industries$ ma% represent either a bu%er or a seller and are paid b% the part% who hires them. <ro!ers often can represent several manufacturers of noncompeting products on a commission basis. #he% do not carr% inventor% or assume ris!. 8nli!e merchant wholesalers$ agent middlemen do not ta!e legal ownership of the goods the% sell7 nor do the% generall% ta!e ph%sical possession of them. #he three principal t%pes of agent middlemen are manufacturers] agents$ selling agents$ and purchasing agents. ;anufacturers] agents$ who represent two or more manufacturers] complementar% lines on a continuous basis$ are usuall% compensated b% commission. 2s a rule$ the% carr% onl% part of a manufacturer]s output$ perhaps in areas where the manufacturer cannot maintain fulltime salespeople. ;an% manufacturers] agents are businesses of onl% a few emplo%ees and are most commonl% found in the furniture$ electric$ and apparel industries. Sale" a#ent" are given contractual authorit% to sell all of a manufacturer]s output and generall% have considerable autonom% to set prices$ terms$ and conditions of sale. Sometimes the% perform the duties of a manufacturer]s mar!eting department$ although the% wor! on a commission basis. Sales agents often provide mar!et feedbac! and product information to the manufacturers and pla% an important role in product development. #he% are found in such product areas as chemicals$ metals$ and industrial machiner% and e6uipment. (urchasing agents$ who routinel% have longterm relationships with bu%ers$ t%picall% receive$ inspect$ store$ and ship goods to their bu%ers. Manufacturers) and retailers) branches and offices. +holesaling operations conducted b% the sellers or bu%ers themselves rather than b% independent wholesalers comprise the third ma*or t%pe of wholesaling. ;anufacturers ma% engage in wholesaling through their sales branches and offices. #his allows manufacturers to improve the inventor% control$ selling$ and promotion flows. "umerous retailers also establish purchasing offices in ma*or mar!et centres such as Chicago and "ew :or! Cit% that pla% a role similar to that of bro!ers and agents. #he ma*or difference is that the% are part of the bu%er]s own organi5ation. RETAI)ERS Cetailing$ the merchandising aspect of mar!eting$ includes all activities re6uired to sell directl% to consumers for their personal$ nonbusiness use. #he firm that performs this consumer sellingwhether it is a manufacturer$ wholesaler$ or retaileris engaged in retailing. Cetailing can ta!e man% forms: goods or services ma% /// be sold in person$ b% mail$ telephone$ television$ or computer$ or even through vending machines. #hese products can be sold on the street$ in a store$ or in the consumer]s home. 3owever$ businesses that are classified as retailers secure the vast ma*orit% of their sales volume from storebased retailing. ,he history of retailing. >or centuries most merchandise was sold in mar!etplaces or b% peddlers. In man% countries$ haw!ers still sell their wares while traveling from one village to the ne-t. ;ar!etplaces are still the primar% form of retail selling in these villages. #his was also true in Europe until the Cenaissance$ when mar!et stalls in certain localities became permanent and eventuall% grew into stores and business districts. Cetail chains are !nown to have e-isted in China several centuries before the Christian era and in some European cities in the 11th and 1=th centuries. 3owever$ the birth of the modern chain store can be traced to 1?0G$ with the inauguration of what is now the :reat Atlantic O Pacific Tea Company6 Inc. &2V('$ in "ew :or! Cit%. 9uring the 10th and 11th centuries the >ugger famil% of Ferman% was the first to carr% out mercantile operations of a chainstore variet%. In 11=H the 3udson]s <a% Compan% chartered its chain of outposts in Canada. 9epartment stores also were seen in Europe and 2sia as earl% as the 1=th centur%. #he famous <on ;archj in (aris grew from a large specialt% store into a full fledged department store in the mid1?HHs. <% the middle of the ,Hth centur%$ department stores e-isted in ma*or 8.S. cities$ although small independent merchants still constitute the ma*orit% of retailers. Shoppin# mall"$ a late ,Hthcentur% development in retail practices$ were created to provide for a consumer]s ever% need in a single$ selfcontained shopping area. 2lthough the% were first created for the convenience of suburban populations$ the% can now also be found on main cit% thoroughfares. 2 large branch of a well!nown retail chain usuall% serves as a mall]s retail flagship$ which is the primar% attraction for customers. In fact$ few malls can be financed and built without a flagship establishment alread% in place. Other mall proprietors have used recreation and entertainment to attract customers. ;ovie theatres$ holida% displa%s$ and live musical performances are often found in shopping malls. In 2sian countries$ malls also have been !nown to house swimming pools$ arcades$ and amusement par!s. 3ong Uong]s Cit% (la5a shopping mall includes one of the territor%]s two ice rin!s. Some malls$ such as the ;all of 2merica in <loomington$ ;inn.$ 8.S.$ ma% offer e-hibitions$ sideshows$ and other diversions. 2lthough there is a great variet% of retail enterprises$ with new t%pes constantl% emerging$ the% can be classified into three main t%pes: store retailers$ nonstore retailers$ and retail organi5ations. tore retailers. Several different t%pes of stores participate in retail merchandising. #he following is a brief description of the most important store retailers. pecialty stores. 2 specialt% store carries a deep assortment within a narrow line of goods. >urniture stores$ florists$ sportinggoods stores$ and boo!stores are all specialt% stores. Stores such as 2thlete]s >oot &sports shoes onl%' and #all ;en &clothing for tall men' are considered superspecialt% stores because the% carr% a ver% narrow product line. Department stores. //0 Department "tore" carr% a wider variet% of merchandise than most stores but offer these items in separate departments within the store. #hese departments usuall% include home furnishings and household goods$ as well as clothing$ which ma% be divided into departments according to gender and age. 9epartment stores in western Europe and 2sia also have large food departments$ such as the renowned food court at 3arrods in the 8nited Uingdom. 9epartments within each store are usuall% operated as separate entities$ each with its own bu%ers$ promotions$ and service personnel. Some departments$ such as restaurants and beaut% parlours$ are leased to e-ternal providers. 9epartment stores generall% account for less than 1H percent of a countr%]s total retail sales$ but the% draw large numbers of customers in urban areas. #he most influential of the department stores ma% even be trendsetters in various fields$ such as fashion. 9epartment stores such as Sears$ Coebuc! and Compan% have also spawned chain organi5ations. Others ma% do this through mergers or b% opening branch units within a region or b% e-panding to other countries. upermar"ets. Supermar!et" are characteri5ed b% large facilities &10$HHH to ,0$HHH s6uare feet f1$.G/ to ,$.,. s6uare metresg with more than 1,$HHH items'$ low profit margins &earning about 1 percent operating profit on sales'$ high volume$ and operations that serve the consumer]s total needs for items such as food &groceries$ meats$ produce$ dair% products$ ba!ed goods' and household sundries. #he% are organi5ed according to product departments and operate primaril% on a selfservice basis. Supermar!ets also ma% sell wines and other alcoholic beverages &depending on local licensing laws' and clothing. #he first true supermar!et was opened in the 8nited States b% ;ichael Cullin in 1G.H. 3is Uing Uullen chain of largevolume food stores was so successful that it encouraged the ma*or foodstore chains to convert their specialt% stores into supermar!ets. +hen compared with the conventional independent grocer$ supermar!ets generall% offered greater variet% and convenience and often better prices as well. Conse6uentl%$ in the two decades after +orld +ar II$ the supermar!et drove man% small food retailers out of business$ not onl% in the 8nited States but throughout the world. In >rance$ for e-ample$ the number of larger food stores grew from about 0H in 1G1H to /$=HH in 1G?,$ while the number of small food retailers fell from 1.H$HHH to 1H$HHH. Convenience stores. Docated primaril% near residential areas$ convenience stores are relativel% small outlets that are open long hours and carr% a limited line of highturnover convenience products at high prices. 2lthough man% have added food services$ consumers use them mainl% for cfillinc purchases$ such as bread$ mil!$ or miscellaneous goods. uperstores. //1 Superstores$ h%permar!ets$ and combination stores are uni6ue retail merchandisers. +ith facilities averaging .0$HHH s6uare feet$ superstores meet man% of the consumer]s needs for food and nonfood items b% housing a fullservice grocer% store as well as such services as dr% cleaning$ laundr%$ shoe repair$ and cafeterias. Combination stores t%picall% combine a grocer% store and a drug store in one facilit%$ utili5ing appro-imatel% 00$HHH s6uare feet of selling space. 3%permar!ets combine supermar!et$ discount$ and warehousing retailing principles b% going be%ond routinel% purchased goods to include furniture$ clothing$ appliances$ and other items. Canging in si5e from ?H$HHH to ,,H$HHH s6uare feet$ h%permar!ets displa% products in bul! 6uantities that re6uire minimum handling b% store personnel. Discount stores. Selling merchandise below the manufacturer]s list price is !nown as di"countin#. #he discount store has become an increasingl% popular means of retailing. >ollowing +orld +ar II$ a number of retail establishments in the 8nited States began to pursue a highvolume$ lowprofit strateg% designed to attract price conscious consumers. 2 !e% strateg% for !eeping operating costs &and therefore prices' low was to locate in lowrent shopping districts and to offer minimal service assistance. #his nofrills approach was used at first onl% with hard goods$ or consumer durables$ such as electrical household appliances$ but it has since been shown to be successful with soft goods$ such as clothing. #his practice has been adopted for a wide variet% of products$ so that discount stores have essentiall% become department stores with reduced prices and fewer services. In the late ,Hth centur%$ discount stores began to operate outlet malls. #hese groups of discount stores are usuall% located some distance awa% from ma*or metropolitan areas and have facilities that ma!e them indistinguishable from standard shopping malls. 2s the% gained popularit%$ man% discount stores improved their facilities and appearances$ added new lines and services$ and opened suburban branches. Coupled with attempts b% traditional department stores to reduce prices in order to compete with discounters$ the distinction between man% department and discount stores has become blurred. Specialt% discount operations have grown significantl% in electronics$ sporting goods$ and boo!s. #ff(price retailers. Offprice retailers offer a different approach to discount retailing. 2s discount houses tried to increase services and offerings in order to upgrade$ offprice retailers invaded this lowprice$ highvolume sector. Offprice retailers purchase at below wholesale prices and charge less than retail prices. #his practice is 6uite different from that of ordinar% discounters$ who bu% at the mar!et wholesale price and simpl% accept lower margins b% pricing their products below retail costs. Offprice retailers carr% a constantl% changing collection of overruns$ irregulars$ and leftover goods and have made their biggest fora%s in the clothing$ footwear$ and accessories industries. #he three primar% e-amples of offprice retailers are factor% outlets$ independent //= carriers$ and warehouse clubs. Stoc!ing manufacturers] surplus$ discontinued$ or irregular products$ factor% outlets are owned and operated b% the manufacturer. Independent offprice retailers carr% a rapidl% changing collection of higher6ualit% merchandise and are t%picall% owned and operated b% entrepreneurs or divisions of larger retail companies. +arehouse &or wholesale' clubs operate out of enormous$ lowcost facilities and charge patrons an annual membership fee. #he% sell a limited selection of brandname grocer% items$ appliances$ clothing$ and miscellaneous items at a deep discount. #hese warehouse stores$ such as +al;artowned Sam]s$ (rice Club$ and Costco &in the 8nited States'$ maintain low costs because the% bu% products at huge 6uantit% discounts$ use less labour in stoc!ing$ and t%picall% do not ma!e home deliveries or accept credit cards. 5onstore retailers. Some retailers do not operate stores$ and these nonstore businesses have grown much faster than store retailers. +ith some mar!et observers predicting that b% the %ear ,HHH nonstore retailing will handle .H percent of all general merchandise sold$ nonstore channels ma% become a powerful force in the retailing industr%. #he ma*or t%pes of nonstore retailing are direct selling$ direct mar!eting$ and automatic vending. Direct selling. #his form of retailing originated several centuries ago and has mushroomed into a NG billion industr% consisting of about 1HH companies selling door0to0door$ officetooffice$ or at privatehome sales meetings. #he forerunners in the direct selling industr% include #he >uller <rush Compan% &brushes$ brooms$ etc.'$ Electrolu- &vacuum cleaners'$ and 2von &cosmetics'. In addition$ #upperware pioneered the homesales approach$ in which friends and neighbours gather in a home where #upperware products are demonstrated and sold. "etwor! mar!eting$ a direct selling approach similar to home sales$ is also gaining prevalence in mar!ets worldwide. "etwor! mar!eting companies such as 2mwa% and Sha!lee reward their distributors not onl% for selling products but also for recruiting others to become distributors. Direct mar"eting. 9irect mar!eting is direct contact between a seller &manufacturer or retailer' and a consumer. Fenerall% spea!ing$ a seller can measure response to an offer because of its direct addressabilit%. 2lthough direct mar!eting gained wide popularit% as a mar!eting strateg% onl% in the late ,Hth centur%$ it has been successfull% utili5ed for more than a hundred %ears. #he world]s largest catalog housesSears$ Coebuc! and Compan% and ;ontgomer% +ard V Co.began as direct mar!eters in the late 1??Hs$ selling their products solel% b% mail order. 2 centur% later$ however$ both companies were conducting most of their business in retail stores. Some department stores and specialt% stores ma% supplement their store operations with direct mar!eting transactions b% mail or telephone. ;ailorder firms grew rapidl% in the 1G0Hs and ]1Hs in continental Europe$ Freat <ritain$ and certain other highl% industriali5ed nations. ;odern direct mar!eting is generall% supported b% advanced database technologies that trac! each customer]s purchase behaviour. #hese //? technologies are used b% established retail firms$ such as Euelle and "ec!ermann in Ferman%$ and are the foundation of mail0order %u"ine""e" such as @. Crew$ #he Sharper Image$ and D.D. <ean &all in the 8nited States'. 9irect mar!eting is not a worldwide business phenomenon$ however$ because mailorder operations re6uire infrastructure elements that are still lac!ing in man% countries$ such as efficient transportation networ!s and secure methods for transmitting pa%ments. 9irect mar!eting has e-panded from its earl% forms$ among them direct mail and catalog mailings$ to include such vehicles as telemar!eting$ directresponse radio and television$ and electronic shopping. 8nli!e man% other forms of promotion$ a direct mar!eting campaign is 6uantitativel% measurable. 4utomatic vending. Automatic $endin# is a uni6ue area in nonstore merchandising because the variet% of merchandise offered through automatic vending machines continues to grow. Initiall%$ impulse goods with high convenience value such as cigarettes$ soft drin!s$ cand%$ newspapers$ and hot beverages were offered. 3owever$ a wide arra% of products such as hosier%$ cosmetics$ food snac!s$ postage stamps$ paperbac! boo!s$ record albums$ camera film$ and even fishing worms are becoming available through machines. Vendingmachine operations are usuall% offered in sites owned b% other businesses$ institutions$ and transportation agencies. #he% can be found in offices$ gasoline stations$ large retail stores$ hotels$ restaurants$ and man% other locales. In @apan$ vending machines now dispense fro5en beef$ fresh flowers$ whis!e%$ *ewelr%$ and even names of prospective dating partners. In Sweden$ vending machines have developed as a supplementar% channel to retail stores$ where hours of business are restricted b% law. 3igh costs of manufacturing$ installation$ and operation have somewhat limited the e-pansion of vendingmachine retailing. In addition$ consumers t%picall% pa% a high premium for vended merchandise. .etail organi&ations. +hile merchants can sell their wares through a store or nonstore retailing format$ retail organi5ations can also structure themselves in several different wa%s. #he ma*or t%pes of retail organi5ations are corporate chains$ voluntar% chains and retailer cooperatives$ consumer cooperatives$ franchise organi5ations$ and merchandising conglomerates. Corporate chains. #wo or more outlets that have common ownership and control$ centrali5ed bu%ing and merchandising operations$ and similar lines of merchandise are considered corporate chain "tore". Corporate chain stores appear to be strongest in the food$ drug$ shoe$ variet%$ and women]s clothing industries. ;anaged chain stores have a number of advantages over independentl% managed stores. <ecause managed chains bu% large volumes of products$ suppliers are willing to offer cost advantages that are not usuall% available to other stores. #hese savings can be passed on to consumers in the form of lower prices and better sales. In addition$ because managed chains operate on such a large scale$ the% can hire more speciali5ed and e-perienced personnel$ who ma% be better able to ta!e full advantage of purchasing and promotion opportunities. Chain stores also have the opportunit% to ta!e advantage of economies of scale in the //G areas of advertising$ store design$ and inventor% control. 3owever$ a corporate chain ma% have disadvantages as well. Its si5e and bureaucrac% often wea!en staff members] personal interest$ drive$ creativit%$ and customerservice motivation. >oluntary chains and retailer cooperatives. #hese are associations of independent retailers$ unli!e corporate chains. +holesalersponsored voluntar% chains of retailers who engage in bul! bu%ing and collective merchandising are prevalent in man% countries. #rue Value hardware stores represent this t%pe of arrangement in the 8nited States. In western Europe in the 1G?Hs there were several large wholesalersponsored chains of retailers$ each including more than 10$HHH stores. #hese retail stores were located across 1? countries$ each store using the same name and$ as a rule$ offering the same brands of products but remaining an independent enterprise. +holesalersponsored chains offer the same t%pes of services for their clients as do the financiall% integrated retail chains. Cetailer cooperatives$ such as 2CE hardware stores$ are grouped as independent retailers who establish a central bu%ing organi5ation and conduct *oint promotion efforts. Consumer cooperatives. Con"umer cooperati$e"$ or coops$ are retail outlets that are owned and operated b% consumers for their mutual benefit. #he first consumer cooperative store was established in Cochdale$ Eng.$ in 1?//$ and most coops are modeled after the same$ original principles. #he% are based on open consumer membership$ e6ual voting among members$ limited customer services$ and shared profits among members in the form of rebates generall% related to the amounts of their purchases. Consumer cooperatives have gained widespread popularit% throughout western and northern Europe$ particularl% in 9enmar!$ >inland$ Iceland$ "orwa%$ Sweden$ and Freat <ritain. Coops t%picall% emerge because communit% residents believe that local retailers] prices are too high or service is substandard. 6ranchise organi&ations. ?ranchi"e arrangements are characteri5ed b% a contractual relationship between a franchiser &a manufacturer$ wholesaler$ or service organi5ation' and franchisees &independent entrepreneurs who purchase the right to own and operate an% number of units in the franchise s%stems'. #%pified b% a uni6ue product$ service$ business method$ trade name$ or patent$ franchises have been prominent in man% industries$ including fast foods$ video stores$ health and fitness centres$ hair salons$ auto rentals$ motels$ and travel agencies. ;c9onald]s Corporation is a prominent e-ample of a franchise retail organi5ation$ with franchises all over the world. Merchandising conglomerates. ;erchandising conglomerates combine several diversified retailing lines and forms under central ownership$ as well as integrate distribution and management of functions. ;erchandising conglomerates are relativel% freeform corporations. In the 8nited States$ +oolworth Corporation is considered a merchandising conglomerate /0H because it operates Uinne% shoe stores$ 3erald S6uare Stationers$ >rame Scene$ and Uids ;art. Mar"eting facilitators <ecause mar!eting functions re6uire significant e-pertise$ it is often both efficient and effective for an organi5ation to use the assistance of independent mar!eting facilitators. #hese are organi5ations and consultants whose sole or primar% responsibilit% is to handle mar!eting functions. In man% larger companies$ all or some of these functions are performed internall%. 3owever$ this is not necessar% or *ustifiable in most companies$ which usuall% re6uire onl% parttime or periodic assistance from mar!eting facilitators. 2lso$ most companies cannot afford to support the salaries and operating e-penses re6uired to maintain mar!eting facilitators as a permanent part of their staff. >urthermore$ independent mar!eting contractors can be more effective than an internal department because nonemplo%ee facilitators can have broader e-pertise and more ob*ective perspectives. In addition$ independent contractors often are more motivated to perform at high standards$ because competition in the facilitator mar!et is usuall% aggressive$ and poor performance could mean lost business. #here are four ma*or t%pes of mar!eting facilitators: advertising agencies$ mar!et research firms$ transportation firms$ and warehousing firms. ADVERTISI-: A:E-CIES Ad$erti"in# a#encie" are responsible for initiating$ managing$ and implementing paid mar!eting communications. In addition$ some agencies have diversified into other t%pes of mar!eting communications$ including public relations$ sales promotion$ interactive media$ and direct mar!eting. 2gencies t%picall% consist of four departments: account management$ a creative division$ a research group$ and a media planning department. #hose in account management act as liaisons between the client and the agenc%$ ensuring that client needs are communicated to the agenc% and that agenc% recommendations are clearl% understood b% the client. 2ccount managers also manage the flow of wor! within the agenc%$ ma!ing sure that pro*ects proceed according to schedule. #he creative department is where advertisements are conceived$ developed$ and produced. 2rtists$ writers$ and producers wor! together to craft a message that meets agenc% and client ob*ectives. In this department$ slogans$ *ingles$ and logos are developed. #he research department gathers and processes data about the target mar!et and consumers. #his information provides a foundation for the wor! of the creative department and account management. ;edia planning personnel speciali5e in selecting and placing advertisements in print and broadcast media. /01 MARAET RESEARC, ?IRMS Mar!et re"earch firms gather and anal%5e data about customers$ competitors$ distributors$ and other actors and forces in the mar!etplace. 2 large portion of the wor! performed b% most mar!et research firms is commissioned b% specific companies for particular purposes. 3owever$ some firms also routinel% collect a wide spectrum of data and then attempt to sell some or all of it to companies that ma% benefit from such information. >or e-ample$ the 2.C. "ielsen Co. in the 8nited States speciali5es in suppl%ing mar!eting data about consumer television viewing habits$ and Information Cesources$ Inc. &ICI'$ has an e-tensive database regarding consumer supermar!et purchases. ;ar!eting research ma% be 6uantitative$ 6ualitative$ or a combination of both. Euantitative research is numericall% oriented$ re6uires significant attention to the measurement of mar!et phenomena$ and often involves statistical anal%sis. >or e-ample$ when a restaurant as!s its customers to rate different aspects of its service on a scale from 1 &good' to 1H &poor'$ this provides 6uantitative information that ma% be anal%5ed statisticall%. Eualitative research focuses on descriptive words and s%mbols and usuall% involves observing consumers in a mar!eting setting or 6uestioning them about their product or service consumption e-periences. >or e-ample$ a mar!eting researcher ma% stop a consumer who has purchased a particular t%pe of detergent and as! him wh% that detergent was chosen. Eualitative and 6uantitative research each provides different insights into consumer behaviour$ and research results are ordinaril% more useful when the two methods are combined. ;ar!et research can be thought of as the application of scientific method to the solution of mar!eting problems. It involves stud%ing people as bu%ers$ sellers$ and consumers$ e-amining their attitudes$ preferences$ habits$ and purchasing power. ;ar!et research is also concerned with the channels of distribution$ with promotion and pricing$ and with the design of the products and services to be mar!eted. TRA-SP.RTATI.- ?IRMS 2s a product moves from producer to consumer$ it must often travel long distances. ;an% products consumed in the 8nited States have been manufactured in another area of the world$ such as 2sia or ;e-ico. In addition$ if the channel of distribution includes several firms$ the product must be moved a number of times before it becomes accessible to consumers. 2 basic home appliance begins as a raw material &iron ore at a steel mill$ for e-ample' that is transported from a processing plant to a manufacturing facilit%. #ransportation firms assist mar!eters in moving products from one point in a channel to the ne-t. 2n important matter of negotiation between companies wor!ing together in a channel is whether the sender or receiver of goods is responsible for transportation. ;ovement of products usuall% involves significant cost$ ris!$ and time management. #hus$ when firms consider a transportation option$ the% carefull% weigh its dependabilit% and price$ fre6uenc% of operation$ and accessibilit%. 2 firm that has its own transportation capabilities is !nown as a pri$ate carrier. #here are also contract carrier"$ which are independent transportation firms that can be hired b% companies on a long or shortterm basis. 2 common carrier provides services to an% and all companies between predetermined points on a scheduled basis. #he 8.S. (ostal Service is a common carrier$ as are >ederal E-press and the 2mtra! railwa% s%stem. /0, WARE,.1SI-: ?IRMS <ecause products are not usuall% sold or shipped as soon as the% are produced or delivered$ firms re6uire storage facilities. #wo t%pes of arehou"e" meet this need: storage warehouses hold goods for longer periods of time$ and distribution warehouses serve as wa% stations for goods as the% pass from one location to the ne-t. Di!e the other mar!eting functions$ warehouses can be wholl% owned b% firms$ or space can be rented as needed. 2lthough companies have more control over wholl% owned facilities$ warehouses of this sort can tie up capital and firm resources. Operations within warehouses usuall% re6uire inspecting goods$ trac!ing inventories$ repac!aging goods$ shipping$ and invoicing. MARAETI-: I- DI??ERE-T SECT.RS 2lthough the basic principles of mar!eting appl% to all industries$ the wa%s in which these principles are best applied can differ considerabl% based on the !ind of product or service sold$ the !ind of bu%ing behaviour associated with the purchase$ and the sector &government$ consumer goods$ services$ etc.'. ,he government mar"et #his mar!et consists of federal$ state$ and local #o$ernmental units that purchase or rent goods to fulfill their functions and responsibilities for the public. Fovernment agencies purchase a wide range of products and services$ including helicopters$ paintings$ office furniture$ clothing$ alcohol$ and fuel. ;ost of the agencies manage a significant portion of their own purchasing. T,E CIVI)IA- ESTA/)IS,ME-T One prominent sector of the government mar!et is the federal civilian bu%ing establishment. In the 1nited State" this establishment consists of si- categories: departments &e.g.& the 9epartment of Commerce'$ administration &e.g.& the Feneral Services 2dministration'$ agencies &e.g.& the >ederal 2viation 2dministration'$ boards &e.g.& the Cailroad Cetirement <oard'$ commissions &e.g.& the >ederal Communications Commission'$ and the e-ecutive office &e.g.& the Office of ;anagement and <udget'. In addition there are several miscellaneous civilian bu%ing establishments$ such as$ for e-ample$ the #ennessee Valle% 2uthorit%. T,E MI)ITARY ESTA/)IS,ME-T 2nother governmental purchasing sector is the federal militar% bu%ing establishment$ represented in the 8nited States b% the Department of Defen"e$ which purchases primaril% through the 9efense Suppl% 2genc% and the arm%$ nav%$ and air force. #he 9efense Suppl% 2genc% operates si- suppl% centres$ which speciali5e in construction$ electronics$ fuel$ personnel support$ and industrial and general supplies. P1RC,ASI-: PR.CED1RES Fovernment purchasing procedures fall into two categories: the open bid and the negotiated contract. 8nder openbid bu%ing$ the government disseminates ver% specific information about the products and services re6uired and re6uests bids from suppliers. Contracts generall% are awarded to the lowest bidder. In negotiatedcontract bu%ing$ a government agenc% negotiates directl% with one or more companies /0. regarding a specific pro*ect or suppl% need. In most cases$ contracts are negotiated for comple- pro*ects that involve ma*or researchanddevelopment costs and in matters where there is little effective competition. Consumer(goods mar"eting Con"umer #ood" can be classified according to consumer shopping habits. C.-VE-IE-CE :..DS Convenience goods are those that the customer purchases fre6uentl%$ immediatel%$ and with minimum effort. #obacco products$ soaps$ and newspapers are all considered convenience goods$ as are common staples li!e !etchup or pasta. Conveniencegoods purchasing is usuall% based on habitual behaviour$ where the consumer will routinel% purchase a particular product. Some convenience goods$ however$ ma% be purchased impulsivel%$ involving no habit$ planning$ or search effort. #hese goods$ usuall% displa%ed near the cash register in a store in order to encourage 6uic! choice and purchase$ include cand%$ ra5ors$ and batteries. 2 slightl% different t%pe of convenience product is the emergenc% good$ which is purchased when there is an urgent need. Such goods include umbrellas and snow shovels$ and these are usuall% distributed at a wide variet% of outlets so that the% will be readil% available when necessar%. S,.PPI-: :..DS 2 second t%pe of product is the shopping good$ which usuall% re6uires a more involved selection process than convenience goods. 2 consumer usuall% compares a variet% of attributes$ including suitabilit%$ 6ualit%$ price$ and st%le. 3omogeneous shopping goods are those that are similar in 6ualit% but different enough in other attributes &such as price$ brand image$ or st%le' to *ustif% a search process. #hese products might include automobile tires or a stereo or television s%stem. 3omogeneous shopping goods are often sold strongl% on price. +ith heterogeneous shopping goods$ product features become more important to the consumer than price. Such is often the case with the purchase of ma*or appliances$ clothing$ furniture$ and hightech e6uipment. In this situation$ the item purchased must be a certain si5e or colour and must perform ver% specific functions that cannot be fulfilled b% all items offered b% ever% supplier. +ith goods of this sort$ the seller has to carr% a wide assortment to satisf% individual tastes and must have welltrained salespeople to provide both information and advice to consumers. SPECIA)TY :..DS Specialt% goods have particularl% uni6ue characteristics and brand identifications for which a significant group of bu%ers is willing to ma!e a special purchasing effort. E-amples include specific brands of fanc% products$ lu-ur% cars$ professional photographic e6uipment$ and high fashion clothing. >or instance$ consumers who favour merchandise produced b% a certain shoe manufacturer or furniture ma!er will$ if necessar%$ travel considerable distances in order to purchase that particular brand. In specialt%goods mar!ets$ sellers do not encourage comparisons between options7 bu%ers invest time to reach dealers carr%ing the product /0/ desired$ and these dealers therefore do not necessaril% need to be convenientl% located. 1-S.1:,T :..DS >inall%$ an unsought good is one that a consumer does not !now aboutor !nows about but does not normall% thin! of bu%ing. "ew products$ such as new fro5enfood concepts or new communications e6uipment$ are unsought until consumers learn about them through wordofmouth influence or advertising. In addition$ the need for unsought goods ma% not seem urgent to the consumer$ and purchase is often deferred. #his is fre6uentl% the case with life insurance$ preventive car maintenance$ and cemeter% plots. <ecause of this$ unsought goods re6uire significant mar!eting efforts$ and some of the more sophisticated selling techni6ues have been developed from the challenge to sell unsought goods. ervices mar"eting 2 service is an act of labour or a performance that does not produce a tangible commodit% and does not result in the customer]s ownership of an%thing. Its production ma% or ma% not be tied to a ph%sical product. #hus$ there are pure services that involve no tangible product &as with ps%chotherap%'$ tangible goods with accompan%ing services &such as a computer software pac!age with free software support'$ and h%brid productservices that consist of parts of each &for instance$ restaurants are usuall% patroni5ed for both their food and their service'. Services can be distinguished from products because the% are intangible$ inseparable from the production proce""$ variable$ and perishable. Services are intangible because the% can often not be seen$ tasted$ felt$ heard$ or smelled before the% are purchased. 2 person purchasing plastic surger% cannot see the results before the purchase$ and a law%er]s client cannot anticipate the outcome of a case before the law%er]s wor! is presented in court. #o reduce the uncertaint% that results from this intangibilit%$ mar!eters ma% strive to ma!e their service tangible b% emphasi5ing the place$ people$ e6uipment$ communications$ s%mbols$ or price of the service. >or e-ample$ consider the insurance slogans c:ou]re in good hands with 2llstatec or (rudential]s cFet a piece of the Coc!.c Services are inseparable from their production because the% are t%picall% produced and consumed simultaneousl%. #his is not true of ph%sical products$ which are often consumed long after the product has been manufactured$ inventoried$ distributed$ and placed in a retail store. Inseparabilit% is especiall% evident in entertainment services or professional services. In man% cases$ inseparabilit% limits the production of services because the% are so directl% tied to the individuals who perform them. #his problem can be alleviated if a service provider learns to wor! faster or if the service e-pertise can be standardi5ed and performed b% a number of individuals &as 3VC <loc!$ Inc.$ has done with its networ! of trained ta- consultants throughout the 8nited States'. #he variabilit% of services comes from their significant human component. "ot onl% do humans differ from one another$ but their performance at an% given time ma% differ from their performance at another time. #he mechanics at a particular auto service garage$ for e-ample$ ma% differ in terms of their !nowledge and e-pertise$ and each mechanic will have cgoodc da%s and cbadc da%s. Variabilit% can be reduced b% +uality0control measures. #hese measures can include good selection and training of personnel and allowing customers to communicate dissatisfaction &e.g.& through customer suggestion and complaint s%stems' so that poor service can be detected and. /00 corrected >inall%$ services are perishable because the% cannot be stored. <ecause of this$ it is difficult for service providers to manage an%thing other than stead% demand. +hen demand increases dramaticall%$ service organi5ations face the problem of producing enough output to meet customer needs. +hen a large tour bus une-pectedl% arrives at a restaurant$ its staff must rush to meet the demand$ because the food services &ta!ing orders$ ma!ing food$ ta!ing mone%$ etc.' cannot be cwarehousedc for such an occasion. #o manage such instances$ companies ma% hire parttime emplo%ees$ develop efficienc% routines for pea! demand occasions$ or as! consumers to participate in the servicedeliver% process. On the other hand$ when demand drops off precipitousl%$ service organi5ations are often burdened with a staff of service providers who are not performing. Organi5ations can maintain stead% demand b% offering differential pricing during offpea! times$ anticipating offpea! hours b% re6uiring reservations$ and giving emplo%ees more fle-ible wor! shifts. Business mar"eting <usiness mar!eting$ sometimes called businesstobusiness mar!eting or industrial mar!eting$ involves those mar!eting activities and functions that are targeted toward organi5ational customers. #his t%pe of mar!eting involves selling goods &and services' to organi5ations &public and private' to be used directl% or indirectl% in their own production or servicedeliver% operations. Some of the ma*or industries that comprise the business mar!et are construction$ manufacturing$ mining$ transportation$ public utilities$ communications$ and distribution. One of the !e% points that differentiates business from consumer mar!eting is the magnitude of the transactions. >or e-ample$ in the mid1GGHs$ a <oeing =/= airliner$ selling for about N100 million$ could ta!e up to four %ears to manufacture and deliver once the order was placed. Often$ a ma*or airline compan% will order several aircraft at one time$ ma!ing the purchase price as high as a billion dollars. Customers for industrial goods can be divided into three groups: user customers$ originale6uipment manufacturers$ and resellers. 8ser customers ma!e use of the goods the% purchase in their own businesses. 2n automobile manufacturer$ for e-ample$ might purchase a metalstamping press to produce parts for its vehicles. Originale6uipment manufacturers incorporate the purchased goods into their final products$ which are then sold to final consumers &e.g.& the manufacturer of television receivers bu%s tubes and transistors'. Industrial resellers are middlemenessentiall% wholesalers but in some cases retailerswho distribute goods to user customers$ to originale6uipment manufacturers$ and to other middlemen. Industrialgoods wholesalers include mill suppl% houses$ steel warehouses$ machinetool dealers$ paper *obbers$ and chemical distributors. 5onprofit mar"eting ;ar!eting scholars began e-ploring the application of mar!eting to nonprofit organi5ations in 1G1G. Since then$ nonprofit organi5ations have increasingl% turned to mar!eting for growth$ funding$ and prosperit%. 2lthough it is difficult to define cnonprofitc organi5ations because of the e-istence of a number of 6uasigovernmental organi5ations$ a stud% in the mid1GGHs found more than one million private$ nonprofit organi5ations in the 8nited States. Some e-perts believe that the wa% to distinguish between organi5ations is according to their sources of funding. #he three ma*or sources are profits$ government revenues &such as grants or ta-es'$ and voluntar% donations. In addition$ a legall% defined nonprofit organi5ation is one that has been granted ta-e-empt status b% the Internal Cevenue Service. 3owever$ while nonprofit groups can be defined legall%$ it is more helpful to focus on the specific mar!eting activities that need to be performed within the organi5ation]s environment. ;useums$ hospitals$ universities$ and churches are all /01 e-amples of nonprofit organi5ations. 2lthough man% individuals ma% believe that nonprofit organi5ations have onl% a small impact on the econom%$ the operating e-penditures of private nonprofit organi5ations now represent a significant percentage of the 8.S. gross national product. In addition$ man% of these are substantial enterprises. >or e-ample$ Firl Scout coo!ies$ sold b% Firl Scouts of 2merica$ constitute 1H percent of all coo!ies sold in the 8nited States. ocial mar"eting Social mar!eting emplo%s mar!eting principles and techni6ues to advance a social cause$ idea$ or behaviour. It entails the design$ implementation$ and control of programs aimed at increasing the acceptabilit% of a social idea or practice that would benefit the adoptors or societ%. Social ideas can ta!e the form of beliefs$ attitudes$ and values$ such as human rights. +hether social mar!eters are promoting ideas or social practices$ their ultimate goal is to alter behaviour. In order to accomplish this behaviour change$ social mar!eters set measurable ob*ectives$ research their target group]s needs$ target their cproductsc to these particular cconsumers$c and effectivel% communicate their benefits. In addition$ socialmar!eting organi5ations have to be constantl% aware of changes in their environments and must be able to adapt to these changes. /lace mar"eting (lace mar!eting emplo%s mar!eting principles and techni6ues to advance the appeal and viabilit% of a place &town$ cit%$ state$ region$ or nation' to tourists$ businesses$ investors$ and residents. 2mong the cplace sellersc are economic development agencies$ tourist promotion agencies$ and ma%ors] offices. (lace sellers must gain a deep understanding of how place bu%ers ma!e their purchasing decisions. (lacemar!eting activities can be found in both the private and public sectors at the local$ regional$ national$ and international levels. #he% can range from activities involving downtrodden cities tr%ing to attract businesses to vacation spots see!ing to attract tourists. In implementing these mar!eting activities$ each locale must adapt to e-ternal shoc!s and forces be%ond its control &intergovernmental power shifts$ increasing global competition$ and rapid technological change' as well as to internal forces and decline c%cles. EC.-.MIC A-D S.CIA) ASPECTS .? MARAETI-: Sometimes critici5ed for its impact on personal economic and social well being$ mar!eting has been said to affect not onl% individual consumers but also societ% as a whole. #his section briefl% e-amines some of the criticisms raised and how governments$ individuals$ and mar!eters have addressed them. Mar"eting and individual welfare Criticisms have been leveled against mar!eters$ claiming that some of their practices ma% damage individual welfare. +hile this ma% be true in certain circumstances$ it is important to recogni5e that$ if a business damages individual welfare$ it cannot hope to continue in the mar!etplace for long. 2s a conse6uence$ most unfavourable views of mar!eting are criticisms of poor mar!eting$ not of strategicall% sound mar!eting practices. Others have raised concerns about mar!eting b% sa%ing that it increases prices b% encouraging e-cessive mar!ups. ;ar!eters recogni5e that consumers ma% be willing to pa% more for a productsuch as a nec!lace from #iffan% and Co. /0= simpl% because of the associated prestige. #his not onl% results in greater costs for promotion and distribution$ but it allows mar!eters to earn profit margins that ma% be significantl% higher than industr% norms. ;ar!eters counter these concerns b% pointing out that products provide not onl% functional benefits but s%mbolic ones as well. <% creating a s%mbol of prestige and lu-ur%$ #iffan%]s offers a s%mbolic benefit that$ according to some consumers$ *ustifies the price. In addition$ brands ma% s%mboli5e not onl% prestige but also 6ualit% and functionalit%$ which gives consumers greater confidence when the% purchase a branded product. >inall%$ advertising and promotions are often ver% costeffective methods of informing the general public about items and services that are available in the mar!etplace. 2 few mar!eters have been accused of using deceptive practices$ such as misleading promotional activities or highpressure selling. #hese deceptive practices have given rise to legislative and administrative remedies$ including guidelines offered b% the ?ederal Trade Commi""ion &>#C' regarding advertising practices$ automatic .Hda% guarantee policies b% some manufacturers$ and ccooling offc periods during which a consumer ma% cancel an% contract signed. In addition$ professional mar!eting associations$ such as the 9irect ;ar!eting 2ssociation$ have promulgated a set of professional standards for their industr%. Mar"eting and societal welfare Concern also has been raised that some mar!eting practices ma% encourage e-cessive interest in material possessions$ create cfalse wants$c or promote the purchase of nonessential goods. >or e-ample$ in the 8nited States$ children]s Saturda% morning television programming came under fire for promoting materialistic values. #he >ederal Communications Commission &>CC' responded in the earl% 1GGHs b% regulating the amount of commercial time per hour. In man% of these cases$ however$ the criticisms overstate the power of mar!eting communications to influence individuals and portra% members of the public as individuals unable to distinguish between a good decision and a bad one. In addition$ such charges cast mar!eting as a cause of social problems when often the problems have much deeper societal roots. ;ar!eting activit% also has been sometimes critici5ed because of its control b% strong private interests and its neglect of social and public concern. +hile companies in the cigarette$ oil$ and alcohol industries ma% have significant influence on legislation$ media$ and individual behaviour$ organi5ations that focus on environmental$ health$ or education concerns are not able to wield such influence and often fail to receive appropriate recognition for their efforts. +hile there is clearl% an imbalance of power between private interests and public ones$ in the late ,Hth centur%$ private companies have received more praise for their mar!eting efforts for social causes. Mar"eting)s contribution to individuals and society 2lthough some have 6uestioned the appropriateness of the mar!eting philosoph% in an age of environmental deterioration$ resource shortages$ world hunger and povert%$ and neglected social services$ numerous firms are commendabl% satisf%ing individual consumer demands as well as acting in the longterm interests of the consumer and societ%. #hese dual ob*ectives of man% of toda%]s companies have led to a broadening of the cmar!eting conceptc to become the csocietal mar!eting concept.c Fenerating customer satisfaction while at the same time attending to consumer and societal wellbeing in the long run are the core concepts of societal mar!eting. In practicing societal mar!eting$ mar!eters tr% to balance compan% profits$ consumer satisfaction$ and public interest in their mar!eting policies. ;an% companies have achieved success in adopting societal mar!eting. #wo prominent /0? e-amples are #he <od% Shop International (DC$ based in England$ and <en V @err%]s 3omemade Inc.$ which produces ice cream and is based in Vermont. <od% Shop]s cosmetics and personal h%giene products$ based on natural ingredients$ are sold in rec%cled pac!aging. #he products are formulated without animal testing$ and a percentage of profits each %ear is donated to animal rights groups$ homeless shelters$ 2mnest% International$ rainforest preservation groups$ and other social causes. <en V @err%]s donates a percentage of its profits to help alleviate social and environmental problems. #he compan%]s corporate concept focuses on ccaring capitalism$c which involves the product as well as social and economic missions. ;ar!eting has had man% other positive benefits for individuals and societ%. It has helped accelerate economic development and create new *obs. It has also contributed to technological progress and enhanced consumers] /0G T.1RISM Touri"m 0 The World" /i##e"t Indu"try 2gainst the bac!ground. of unparalleled growth in the latter half of the twentieth centur%$ tourism now finds itself at a crossroads in its development. On the one hand$ it is heralded as Tthe world)s biggest industr%) b% a number of global organisations including the +orld #ravel and #ourism Council &+##C' and the +orld #ourism Organisation &+#O'$ which highlights the fact that tourism overtoo! both crude petroleum and motor vehicles to become the world)s number one e-port earner in 1GG/. Its economic significance is also illustrated b% the fact that tourism receipts were greater than the world)s e-ports of other selected product groups$ including electronic e6uipment$ clothing$ te-tiles and raw materials. In addition$ receipts from international tourism have achieved growth rates in e-cess of e-ports of commercial services and merchandise e-ports during the period 1G?/ to 1GG/. >or the period 1G?0 to 1GG0 the trend is similar$ with the following average annual percentage growth rates: #ourism l,per cent Commercial services 1, per cent ;erchandise e-ports 1H per cent +#O data also indicate rapid and sustained growth in international tourist arrivals and receipts from tourism over the last .H %ears. #oda%$ tourism is seen as a ma*or contributor to global economic development$ creating emplo%ment and generating wealth on a trul% international scale. 2n increasing number of countries rel% heavil% on receipts from tourism for their economic and social wellbeing. In direct contrast to this ver% positive outloo! for the industr%$ man% national governments are reluctant to invest public funds in tourism development and promotion$ with tourism spending often being cut when more pressing social and economic needs arise. #he decisions$ in 1GG=$ b% the governments of Canada$ the 8nited States of 2merica and <elgium to transfer responsibilit%$ for tourism to private sector enterprises or regional authorities serve to illustrate this point well. In <ritain$ the funding of the English #ourist <oard has been cut drasticall% since the earl% 1GGHs$ the decision of a government that considered the industr% to he sufficientl% mature and able to fund its own e-pansion with diminishing public financial support. 2t a time of increasing corrcern for the environment and the retention of cultural identities$ tourism is also viewed b% governments and consumers ali!e as a potentiall% destructive force$ causing harmful environmental and sociocultural impacts in destination areas and on host communities. (arado-icall%$ it is not difficult to argue that the withdrawal of public funding and control from tourism development ma% well accelerate the industr%)s harmful environmental and sociocultural effects. It is against this bac!ground of a comple- and rapidl% e-panding industr% see!ing to maintain its credibilit% and promote its economic benefits$ often in the face of declining governmental and host communit% support. ,he Business of *otels /1H I The Importance of ,otel" 3otels pla% an important role in most countries in providing facilities for the transaction of business$ for meetings and conferences$ for recreation and entertainment. In that sense hotels are as essential to economies and societies as are ade6uate transport$ communication and retail distribution s%stems for various goods and services. #hrough their facilities hotels contribute to the total output of goods and services$ which ma!es up the material wellbeing of nations and communities. In man% areas hotels are important attractions for visitors who bring to them spending power and who tend to spend at a higher rate than the% do when the% are at home. #hrough visitor spending hotels thus often contribute significantl% to local economies both directl%$ and indirectl% through the subse6uent diffusion of the visitor e-penditure to other recipients in the communit%. In areas receiving foreign visitors$ hotels are often important foreign currenc% earners and in this wa% ma% contribute significantl% to their countries) balance of pa%ments. (articularl% in countries with limited e-port possibilities$ hotels ma% be one of the few sources of foreign currenc% earnings. 3otels are important emplo%ers of labour. #housands of *obs are provided b% hotels in the man% occupations that ma!e up the hotel industries in most countries7 man% others in the industr% are selfeemplo%ed and proprietors of smaller hotels. #he role of hotels as emplo%ers is particularl% important in areas with few alternative sources of emplo%ment$ where the% contribute to regional development. 3otels are also important outlets .for the products of other industries. In the building and moderni5ation of hotels business is provided for the construction industr% and related trades. E6uipment$ furniture and furnishings are supplied to hotels b% a wide range of manufacturers. >ood$ drin! and other consumables are among the most significant dail% hotel purchases from farmers$ fishermen$ food and drin! suppliers$ and from gas$ electricit% and water underta!ings. In addition to those engaged directl% in hotels$ much indirect emplo%ment is$ therefore$ generated b% hotels for those emplo%ed in industries suppl%ing them. Dast but not least$ hotels are an important source of amenities .for local residents. #heir restaurants$ bars and other facilities often attract much local custom and man% hotels have become social centres of their communities. Tra$el and ,otel" Sta%ing awa% from home is a function of travel and three main phases ma% be distinguished in the development of travel in the northern hemisphere. /11 8ntil about the middle of the nineteenth cenrui% the bul! of *ourne%s were underta!en for business and vocational reasons$ b% road$ b% people travelling mainl% in their own countries. #he volume of travel was relativel% small$ confined to a small fraction of the population in an% countr%$ and most of those who did travel$ did so b% coach. Inns and similar hostelries along the highwa%s and in the principal towns provided the means of accommodation well into the nineteenth centur%. <etween about 1?0H and about 1G0H a growing proportion of travellers went awa% from home for other than business reasons and holida%s came to represent graduall% an important reason for a *ourne%. >or a hundred %ears or so$ the railwa% and the steamship dominated passenger transportation$ and the new means of transport gave an impetus to travel between countries and between continents. 2lthough the first hotels date from the eighteenth centur%$ their growth on an% scale occurred onl% in the nineteenth centur%$ when first the railwa% and later the steamship created sufficientl% large mar!ets to ma!e the larger hotel possible. 3otels together with guest houses and boarding houses dominated the accommodation mar!et in this period. <% about the middle of the twentieth centur% in most developed countries of the world &a little earlier in "orth 2merica and a little later in Europe' a whole c%cle was completed and most traffic returned to the road$ with the motor car increasingl% providing the main means of passenger transportation. 2lmost concurrentl% the aircraft too! over unmista!abl% both from the railwa%s and from shipping as the principal means of longdistance passenger transport. On man% routes holida% traffic came to match and often greatl% e-ceed other traffic. 2 growing volume of travel awa% from home became international. 3otels entered into competition with new forms of accommodation e holida% centres and holida% villages in Europe$ motels in "orth 2merica$ and various selfecatering facilities for those on holida%. To Centurie" of ,otel!eepin# 3otels are some two hundred %ears old. #he word Thotel) itself came into use in England with the introduction in Dondon$ after 1=1H $ of the !ind of establishment then common in (aris$ called Thotel garni)$ or a large house$ in which apartments were let b% the da%$ wee! or trench. Its appearance signified a departure from the customar% method of accommodating guests in inns and similar hostelries$ into something more lu-urious and even ostentatious. 3otels with managers$ receptionists and uniformed staff arrived generall% onl% at the beginning of the nineteenth centur% and until the middle of that centur% their development was relativel% slow. #he absence of good inns in Scotland to somee-tent accelerated the arrival of the hotel there7 b% the end of the eighteenth centur% Edinburgh$ for e-ample$ had several hotels where the traveller could get elegant and comfortable rooms. 3otels are also !nown to have made much progress in other parts of Europe in the closing %ears of the eighteenth and earl% %ears of the nineteenth centur%$ where at the time originated the idea of a resort hotel. In "orth 2merica earl% accommodation for travellers followed a similar pattern as in England$ with most inns originating in converted houses$ but b% the turn of the eighteenth centur% several cities on the eastern seaboard had purposeebuilt hotels and in the first half of the nineteenth centur% hotel building spread across 2merica to the (acific Coast. #he evolution from inn!eeping to hotel!eeping$ therefore$ proceeded almost in parallel in the Old and in the "ew +orlds and the rise of the hotel industries on both sides of the 2tlantic had probabl% more in common /1, than is generall% recogni5ed. +hat 2merica might have lac!ed in histor% and tradition$ it more than made up in pioneering spirit$ in intense rivalr% between cities and entrepreneurs$ and in the sheer si5e and growth of the travel mar!et. In the last centur% hotels became firml% established not onl% as centres commercial hospitalit% for travellers$ but often also as important social centres of their communities. #heir building$ management and operation became speciali5ed activities$ with their own st%les and methods. #he present centur% brought about growing speciali5ation and increased sophistication in the hotel industries of most countries$ as well as their growth and e-pansion. <ut the growth and the diversit% of hotel operations has been also matched b% the growth and diversit% of competition in the total accommodation mar!et. Information about accommodation facilities in individual countries essentiall% reflects the designations used for them b% the countries concerned and the coverage of various t%pes in the available statistics. Onl% ver% broad intercountr% comparisons are possible. One source is the annual report of the #ourism Committee of the Organisation for Economic Cooperation and 9evelopment &OEC9'$ which distinguishes between beds available in hotels and similar establishments$ and in what is described as supplementar% accommodation. #he ratio of beds in hotels and similar establishments to beds in supplementar% accommodation gives an indication of the relative importance of the hotel sector in the total accommodation mar!et of individual countries. In most countries the accommodation profile tends to reflect the relative importance of foreign and domestic users$ of leisure and business travel$ and of other influences. In man% countries hotels and similar establishments appear to be minorit% providers of accommodation. ,otel )ocation 3otel services are supplied to their bu%ers direct in person7 the% are consumed at the point of sale$ and the% are also produced there. 3otel services must be$ therefore$ provided where the demand e-ists and the mar!et is the dominant influence on hotel location. In fact$ location is part of the hotel product. In turn$ location is the !e% influence on the viabilit% of the business$ so much so that a prominent entrepreneur could have said with conviction and with much *ustification that there are onl% three rules for success in the hotel business: location$ location$ location. +e have seen earlier that from the earl% da%s all accommodation units followed transport modes$ Inns and other hostelries were situated along the roads and at destinations$ serving transit and terminal traffic. #he rapid spread of railwa%s mar!ed the emergence of railwa% hotels in the nineteenth centur%. In the twentieth centur% motor transport created a new demand for accommodation along the highwa%s and the modern motel and motor hotel have been distinctive responses to the new impetus of the motor car. 2 similar but les pronounced influence was passenger shipping$ which stimulated hotel development in ports$ and more recentl% air transport$ which brought about a ma*or growth of hotels in the vicinit% of airports and air terminals. Secondl%$ although this is closel% related to transport$ man% hotels are located to serve first and foremost holida% mar!ets. In their areas of highest concentration$ holida% visitors are accommodated in hotels in localities whcre the resident /1. population ma% represent onl% a small proportion of those present at the time$ as is the case in man% resorts. #he third ma*or influence on hotel location is the location of economic activit% and of industr% and commerce in particular. +hilst again not separable from transport development$ industrial and commercial activities create demand for transit and termInal accommodation in industrial and commercial centres$ in locations not fre6uented b% holida% visitors. 9ifferent segments of the travel mar!et give rise to distinctive patterns of demand for hotel accommodation and often distinctive t%pes of hotels. In business and industrial centres hotels normall% achieve their highest occupancies on wee!da%s and in resorts in the main holida% seasons7 their facilities and services reflect the re6uirements of businessmen and of holida% visitors respectivel%. <etween these clearl% defined segments come other towns and areas$ such as bus% commercial centres with historical or other attractions for visitors$ which ma% achieve a more even wee!l% and annual pattern of business. Type" of ,otel" #he rich variet% of hotels can be seen from the man% terms in use to denote particular t%pes. 3otels are referred to as lu-ur%$ resort$ commercial$ residential$ transit$ and in man% other wa%s. Each of these terms ma% give an indication of standard or location$ or particular t%pe of guest who ma!es up most of the mar!et of a particular hotel$ but it does not describe ade6uatel% its main characteristics. #hese can be onl% seen when a combination of terms is applied to an hotel$ each of which describes a particular hotel according to certain criteria. It is helpful to appreciate at this stage what the main t%pes of hotels are$ b% adopting particular criteria for classif%ing them$ without necessaril% attaching precise meanings to them. L #hus according to location hotels are in cities and in large and small towns$ in inland$ coastal and mountain resorts$ and in the countr%. L 2ccording to the actual position of the hotel in its location it ma% be in the cit% or town centre or in the suburbs$ along the beach of a coastal resort$ along the highwa%. L <% reference to its relationship with particular means of transportxthere are motels and motor hotels$ railwa% hotels$ airport hotels &the terms also indicating location'. L 2ccording to the purpose of visit and the main reason for their guests) sta%$ hotels ma% become !nown as business hotels$ holida% hotels$ convention hotels$ tourist hotels. L +here there is a pronounced tendenc% to a short or long duration of guests) sta% it ma% be an important hotel characteristic$ so that the hotel becomes a transit or a residential hotel. L 2ccording to the range of its facilities and services a hotel ma% be open to residents and nonresidents$ or it ma% restrict itself to providing overnight accommodation and at most offering brea!fast to its guests$ and be a hotel garni or apartment hotel. L +hether a hotel holds a licence for the sale of alcoholic li6uor or not$ is an important dimension in the range of available hotel services$ and the distinction between licensed and unlicensed hotels is$ therefore$ of relevance in describing a hotel in most countries. /1/ L #here is no universal agreement on how hotels should he described according to si5e$ but b% reference to their room or bed capacities we normall% appl% the term small hotel to one with a small amount of sleeping accommodation$ the term large hotel to one with several hundred beds or bedrooms$ and the term medium si5e hotel to one somewhere between the two$ according to the si5e structure of the hotel industr% in a particular countr%. L +hatever the criteria used in hotel guides and in classification and grading s%stems in e-istence in man% countries$ normall% at least four or five classes or grades have been found necessar% to distinguish ade6uatel% in the standards of hotels and these have found some currenc% among hotel users. #he e-tremes of lu-ur% and basic standards$ sometimes denoted b% five stars and one star respectivel% are not difficult concepts7 the mid point on an% such scale denotes the average without an% particular claims to merit. #he intervening points are then standards above average but falling short of lu-ur% &6ualit% hotels' and standards above basic &econom%'. Dast but not least comes the ownership and management. Individuall% owned independent hotels$ which ma% he managed b% the proprietor or b% a salaried manager$ have to he distinguished from chain or group hotels$ invariabl% owned b% a compan%. Independent hotels ma% belong to a hotel consortium or cooperative. 2 compan% ma% operate its hotels under direct management or under a franchise agreement. #he above distinctions then enable us to describe a particular hotel in broad terms$ concisel%$ comprehensivel% and meaningfull%$ e.g.: L #erminus 3otel is a mediumsi5ed econom% town centre unlicensed hotel$ owned and managed b% a small compan%$ catering mainl% for tourists visiting the historic town and the surrounding countr%side. L 3otel E-celsior is a large independent lu-ur% hotel on the main promenade of the coastal resort$ with holida% visitors as its main mar!et. L #he Crossroads 3otel is a small licensed 6ualit% transit motor hotel$ operated as a franchise$ on the outs!irts of the cit%$ which serves mainl% traveling ? ,otel Product" and Mar!et" #he aim of this sub*ect is to outline the facilities and services provided b% hotels$ who are the people who use hotels$ wh% the% use hotels$ and what influences their choice of particular hotels. In providing answers to these 6uestions$ we can formulate a conceptual model of a hotel$ which attempts to e-plain in simple terms how particular hotel products meet the needs of particular hotel mar!ets$ and establish a basis for a more detailed e-amination of the hotel business. The ,otel a" a Total Mar!et Concept >rom the point of view of its users$ a hotel is an institution of commercial hospitalit%$ which offers its facilities and services for sale$ individuall% or in various combinations$ and this concept is made up of several elements. Its location places the hotel geographicall% in or near a particular cit%$ town or village7 within a given area location denotes accessibilit% and the convenience this represents$ attractiveness of surroundings and the appeal this represents$ freedom from noise and other nuisances$ or otherwise. Its facilities which include bedrooms$ restaurants$ bars$ function rooms$ meeting rooms and recreation facilities such as tennis courts and swimming pools /10 represent a repertoire of facilities for the use of its customers$ and these ma% be differentiated in t%pe$ si5e$ and in other wa%s. I ts service comprises the availabilit% and e-tent of particular hotel services provided through its facilities$ the st%le and 6ualit% of all these in such terms as formalit% and informalit%$ degree of personal attention$ and speed and efficienc%. Its image ma% he defined as the wa% in which the hotel portra%s itself to people and the wa% in which it is perceived as portra%ing itself b% them. It is a b%product of its location$ facilities and service$ but it is enhanced b% such factors as its name$ appearance7 its associations b% who sta%s there and who eats there7 b% what it sa%s about itself and what other people sa% about it. Its price e-presses the value given b% the hotel through its location$ facilities$ service and image$ and the satisfaction derived b% its users from these elements of the hotel concept. #he individual elements assume greater or lesser importance for different people. One person ma% put location as paramount and be prepared to accept basic facilities and service for an overnight da%$ ignoring the image$ as long as the price is within a limit$ to which he is willing to go. 2nother ma% be more concerned with the image of the hotel$ its facilities and service. 3owever$ all the five elements are related to each other$ and in a situation of choice most hotel users tend either to accept or re*ect as a whole$ that is the total concept. #here are var%ing degrees of adaptabilit% and fle-ibilit% in the hotel concept$ ranging from the complete fi-it% of its location to the relative fle-ibilit% of price$ with facilities$ service and image lending themselves to some adaptation in particular circumstances with time. ,otel ?acilitie" and Ser$ice" a" Product" In the earl% da%s of inn!eeping the traveller often had to bring his own food to places where he sta%ed the nightbed for the night was the onl% product offered <ut soon most establishments e-tended their hospitalit% to providing at least some food and refreshments. #oda% man% apartment hotels$ hotels gami$ and motels confine their facilities to sleeping accommodation$ with little or no catering provision. <ut the t%pical hotel as we !now it toda%$ normall% provides not onl% accommodation$ but also food and drin!$ and sometimes other facilities and services$ and ma!es them available not onl% to its residents but also to nonresidents. 2lthough the range of hotel facilities and services ma% e-tend as far as to cater for all or most needs of their customers$ however long their sta%$ and for a hotel to become a selfcontained communit% with its own shops$ entertainments and recreation facilities$ it is helpful at this stage to describe the hotel concept in a simpler form$ b% including onl% the main customer needs t%picall% met b% most hotels. #he main customer demand in most hotels is for sleeping accommodation$ food and drin!$ and for food and drin! for organi5ed groups. #hese four re6uirements then relate to accommodation$ restaurants$ bars and functions$ as the principal hotel products. Sleeping accommodation is provided for hotel residents alone. Cestaurants and bars meet the re6uirements of hotel residents and nonresidents ali!e$ even though separate facilities ma% be sometimes provided for them. >unctions are best seen as a separate hotel product bought b% organi5ed groups7 these groups ma% be resident in the hotel as$ for e-ample$ participants in a residential conference$ or be nonresidents$ such as a local club or societ%$ or the group ma% combine the two. #he total hotel concept e of location$ facilities$ service$ image and price can he$ therefore$ sub /11 divided according to the needs of the customer and the particular facilities brought into pla% to meet them. #he cluster of elements of the total hotel concept is then related to each particular hotel product. Each hotel product contains the elements of the location$ facilities$ services$ image and price$ to meet a particular customer need or set of needs. #he first approach to the segmentation of the hotel mar!et is$ therefore$ ta!en b% dividing hotel users according to the products bought. Corresponding to each hotel product there are the bu%ers of that product who constitute a mar!et for it. ,otel Accommodation Mar!et" 3otel users who are bu%ers of overnight accommodation ma% be classified according to the main purpose of their visit to a particular location into three main categories as holida%$ business and other users. 3olida% users include a variet% of leisure travel as the main reason for their sta% in hotels$ ranging from short sta%s in a particular location on the wa% to somewhere else to wee!end and longer sta%s when the location represents the end of a *ourne%. #heir demand for hotel accommodation tends to be resort oriented$ seasonal and sensitive to price. <usiness users are emplo%ees and others travelling in the course of their wor!$ people visiting e-hibitions$ trade fairs$ or coming together as members of professional and commercial organi5ations for meetings and conferences. #heir demand for hotel accommodation tends to be town and cit% oriented$ nonseasonal and less pricesensitive$ e-cept in the case of some event attractions such as conferences and e-hibitions$ which ma% he usefull% regarded as a separate categor%. Other hotel users comprise visitors to a particular location for a variet% of reasons other than holida% or business$ e.g. those attending such famil% occasions as weddings$ parents visiting educational institutions$ visitors to special events$ and common interest groups meeting for other than business and vocational reasons$ re locating families and individuals see!ing permanent accommodation in an area and sta%ing temporaril% in an hotel$ people living in an hotel permanentl%. #he characteristics of this t%pe of demand are more varied than those of the first and second group$ and it is$ therefore$ often desirable to subdivide it further for practical purposes. +ithin and between the three main groups$ which comprise the total mar!et for hotel accommodation$ there are several distinctions important to individual hotels. +e have noted alread% that some hotel users give rise to demand for transit and short esta% accommodation7 others are terminal visitors with a longer average sta%. 2lso$ for e-ample$ much business demand is generated b% a relativel% small number of travellers who are fre6uent hotel users7 most holida% and other demand comes from a ver% large number of people who use hotels onl% occasionall%. ;oreover$ business users often boo! accommodation at short notice$ whilst holida% and other users tend to do so longcr in advance. 2nd in allthree groups some people are individual hotel users$ and others sta% in hotels in groups. ,otel Caterin# Mar!et" 3otel restaurants$ bars and function rooms ma% be convenientl% grouped together as its food and beverage or catering facilities$ and the meals and refreshments /1= the% provide as the hotel food and beverage or catering products. Corresponding to them there are again bu%ers of these products who constitute the hotel catering mar!ets and who ma% be classified in various wa%s. >or our purposes there is a basic distinction between the demand e-ercised b% hotel residents$ b% nonresidents$ and b% organi5ed groups. #he first categor% of users of hotel restaurants and bars is related to the basic function of the hotel in providing overnight sleeping accommodation$ and consists of hotel residents$ whom we have classified earlier as holida%$ business and other users #heir use of hotel catering facilities tends to be influenced b% the reason for their hotel sta% and b% the terms on which the% sta%. <rea!fast is their common hotel purchase$ but otherwise a hotel resident ma% have his meals in his hotel or elsewhere$ and he is more li!el% to be a hotel restaurant or bar customer in the evenings than at midda%. #he second categor% is nonresidents$ individuall% or in small groups$ when eating out. #he% ma%$ in fact$ be sta%ing at other hotels or accommodation establishments or with friends or relative or be da% visitors to the area$ for holida%$ business or other reasons 2lternativel% the% are local residents$ for whom the hotel restaurants and bars represent outlets for meals and refreshments$ as a leisure activit% or as part of their business activities. #his categor% tends to represent important hotel users at midda% as well as in the evenings$ particularl% at wee!ends. #he third categor% of users of hotel catering facilities is organi5ed groups who ma!e advance arrangements for functions at the hotel$ which ma% call for separate facilities and organi5ational arrangements. #he% include local clubs$ societies$ business and professional groups$ as well as participants in meetings and conferences originating from outside the area. 3otel catering products represent a greater diversit% than its accommodation products and it is often correspondingl% more difficult to classif% them and the mar!ets for them in practice. ;oreover$ hotels are not alone in suppl%ing them. In the mar!et for meals and refreshments for individuals and groups a hotel competes not onl% with other hotels$ but also with restaurants outside hotels$ pubs and clubs$ to name but a few other t%pes of outlet. #herefore$ catering in hotels is a separate hotel function$ with its own ob*ectives$ policies and strategies$ and with its own organi5ation. ,otel Demand :eneratin# Source" >or most people the use of hotels represents what is !nown as derived demand because few sta% or eat in hotels for its own sa!e7 their primar% reasons for doing so lie in their reasons for visiting an area or for spending their time there in particular wa%s. +hen describing hotel accommodation and catering mar!ets we have seen that hotel users have different degrees of freedom and choice as to whether the% bu% hotel services or not. Some have few or no alternatives7 for them onl% hotels provide the facilities and services which the% re6uire in a particular area in pursuit of their business$ vocational and other interests7 the incidence of their hotel usage arises to a great e-tent from their wor!ing circumstances. >or man% others the use of hotels is a matter of choice7 the% do so in their pursuit of leisure and recreation7 for them hotel usage involves a discretionar% use of their time and mone%. #his distinction helps us identif% the demand generating sources for hotels in a given area$ which are of three main t%pes institutional$ recreational and transit. /1? Institutional sources include industrial and commercial enterprises$ educational institutions$ government establishments and other organi5ations in the private and public sector$ whose activities are involved in the economic life of the communit% and in its administration. #hese institutions generate demand for hotels through their own visitors and their other re6uirements for hotel facilities and services. Cecreational sources include historical$ scenic and other site attractions and event attractions$ which generate demand for hotels from tourists7 local events and activities in the social and cultural life of the communit%$ which generate demand from clubs$ societies and other organi5ations7 happenings of significance to individuals and families. #he third source of demand stems from individuals and groups with no intrinsic reason for spending time in a particular localit%$ other than being on the wa% somewhere else and the need to brea! a *ourne%. #his source of demand is closel% related to particular forms of transport7 it e-presses itself on highwa%s$ at ports and at airports$ and ma% be described as transit. It will be readil% apparent that this view of demand generating sources for hotels is closel% related to several aspects of the hotel business considered earlier e for e-ample$ to the threefold classification of the hotel accommodation mar!et into holida%$ business and other users7 to the three main influences on hotel location e travel$ holida%s and economic activit%7 and to the t%pes of hotel. <% adopting in each case a somewhat different viewpoint$ it is possible to highlight the interdependence between the location$ mar!ets and products of hotels. ,otel Mar!et Area" +e can define a hotel mar!et in several wa%s b% reference to the people who bu% hotel services$ as a networ! of dealings between the hotel and its users$ or as an area which a hotel serves. In the first two approaches hotel users ma% come from within the area$ from various parts of the countr%$ and from abroad7 we then refer to the local$ domestic and foreign mar!ets$ and subdivide them in appropriate wa%s. In the third approach described below we view the hotel mar!et area as a ph%sical area served b% the hotel. >or hotel accommodation it is necessar% to identif% all the institutional and recreational sources of demand$ which ma% be served b% a particular hotel. #he area drawn in this wa% round the hotel ma% e-tend from its immediate vicinit% to a radius of several miles or more. 3ow far it does e-tend depends on the geographical distribution of the demand generating sources$ the mode of transport used b% the hotel users of each source$ and the availabilit% of other facilities in the area. #he head office of a large firm$ a universit%$ a historic castle$ and a town which is a festival centre$ ma% be all within a mar!et area of a hotel$ if the hotel is reasonabl% accessible from these points$ and if its location at least matches the location of other hotels. #he mar!et area ma% coincide for a number of hotels within close pro-imit% of each other$ which offer a similar concept in terms of facilities$ service$ image and price. On the peripher% the mar!et area for a hotel ma% overlap with the mar!et areas of other hotels some distance awa%. 2t periods of pea! demand it ma% e-tend further than at times of low demand. >or transit the accommodation mar!et area is related to the *ourne%s underta!en through the area e their origin and destination$ the method of transportation$ the time of da%$ the time of %ear and other circumstances of the *ourne%s. /1G >or hotel catering services the mar!et area depends on mar!et densit% e the availabilit% of spending power within an area$ as well as on the accessibilit% of the hotel to the different sources of demand$ and on the availabilit% of other catering services in the area. In this there is a close analog% with the concept of a catchment area for other retail outlets$ as far as the resident population is concerned. 3ow far do people go from where the% live to do their shopping4 #he distance ma% var% according to the purchase the% are to ma!e. Similarl% there ma% be a smaller mar!et area for hotel lunches than for hotel dinners and functions$ because close pro-imit% to the hotel ma% he a more important consideration for a midda% meal than for an evening out. ,otel Mar!et Se#mentation #he mar!et for hotel products ma% be divided into several components or segments and this enables individual hotels to identif% their actual and potential users according to various criteria. Segmentation then provides a basis for the mar!eting of hotel products$ for pa%ing close attention to the re6uirements of different users$ and for monitoring the performance in the mar!ets chosen b% a hotel. +e divided hotel users$ according to the product bought b% them$ into bu%ers of accommodation$ food$ drin! and functions. +e divided the accommodation mar!et$ according to the reasons for the users) sta%$ into holida%$ business and other users$ and the hotel catering mar!et into hotel residents$ nonresidents and functions. 2ccording to the origin of demand we also identified institutional$ recreational and transit sources of demand. 2nother basis for segmentation is the needs of hotel users and the meansxthe% have to pa% for their satisfaction$ b% dividing them according to their socio economic characteristics. Socioeconomic classifications see! to group people according to their occupation and emplo%ment status. >or e-ample$ the <ritish @oint Industr% Committee for "ational Ceadership Surve%s &@IC"2CS' defines social grades as shown in the following table: Social Frade 9efinitions Social grade Social status Occupation 2 8pper middle class 3igher managerial$ administrative or professional < ;iddle class Intermediate managerial$ adminisniative or professional C 1 Dower middle class Supervisor% or clerical$ and *uniormanagerial$ administrative or professional C, S!illed wor!ing class S!illed manual wor!ers 9 +or!ing class Semi and uns!illed manual E #hose at the State pensioners /=H lowest level of subsistence or widows &no other earner'$ casual or lowest grade wor!ers Social grade 2 might be e-pected to sta% in lu-ur% and 6ualit% hotels$ < in medium hotels$ C in econom% hotels. 3owever$ this is an oversimplification$ because the same people ma% interchange between segments according to the circumstances in which the% find themselves. 2 businessman on an e-pense account ma% sta% in a 6ualit% hotel$ but travelling for pleasure with his famil% he ma% sta% in a lower grade hotel. ;oreover$ the incidence of hotel usage among 9E groups is minimal. "evertheless$ segmentation b% socioeconomic criteria is an important approach to mar!et segmentation. >or some purposes age$ famil% composition$ life c%cle stage$ or other criteria ma% be more appropriate. 2 concomitant of mar!et segmentation is product branding$ with a view to differentiating an hotel from others in the minds of bu%ers$ long established in other consumer industries. Some hotel groups have focused on branded segments distinguished b% levels of service7 e-amples include 3olida% Inn upmar!et Crowne (la5a$ core brand 3olida% Inn and limited service Farden Court. Other brands have been created b% grouping li!e operations$ such as >orte (osthouses and +hitbread Danshur% 3otels$ or b% ac6uisition$ such as (orte Crest and ;ount Charlotte #histle. +e anticipate that product segmentation will assume even greater significance in the future development of hotel companies. It is an effective method for hotel companies to maintain or e-pand mar!et share and in some instances create new mar!ets. (roduct branding will become more focussed and will reflect increasing levels of segmentation. In the light of this$ the future of the Tall purpose hotel) is doubtful in terms of its competitiveness in the mar!et place. <u%ing and (a%ing for 3otel Services It is important to understand how a bu%ing decision is made$ who ma!es it$ and who pa%s for the hotel services bought. #he bu%ing decision itself ma% be basicall% of two !inds edeliberate or impulsive. <efore embar!ing on *ourne%s$ business people ma% as! secretaries to reserve hotel rooms in the towns the% are to visit for specified nights. 2 famil% ma% arrive at their choice of holida% hotel after a scrutin% of hotel guides. 2 societ% ma% ma!e several in6uiries before choosing the venue for their annual dinner dance. #hese are deliberate bu%ing decisions made with some xadvance planning and with advance reservations. 2 tourist loo!ing for somewhere to sta% when travelling b% car$ or on arrival at the railwa% station or airport$ is li!el% to ma!e an impulse decision$ in much the same wa% as a couple wal!ing through the streets of a town and Tdiscovering) a restaurant which appears to be to their li!ing. (urchases of hotel products are both deliberate and impulse purchases and most hotels respond to both$ although different operational policies and procedures normall% appl% to each. ;an% people ma!e their own arrangements for travelling and for sta%ing in hotels. 3owever$ man% hotel boo!ings are made b% people who do it for others: the secretar% for the boss$ the travel agent for the client$ the business travel department of a large compan% for its emplo%ees. In these circumstances it is important to !now who the bu%ing agent is and where that person is located$ if the !nowledge derived /=1 from the anal%sis of the hotel demand generating sources is to be applied to bringing about sales. ;ost hotels can no longer hope to fill their beds$ restaurants and bars b% simpl% waiting for the guest. 2ccording to the source of pa%ment for hotel services$ hotel users are also of two basic !inds e those who pa% themselves and those whose hotel bills are covered or reimbursed for them. ;ost leisure use of hotels represents personal e-penditure out of disposable incomes$ the bul! of business use of hotels in the wide sense is paid for directl% or indirectl% b% third parties e emplo%ers and other agencies on behalf of the guest. 2lthough man% business users have no fi-ed limits as to the charges the% incur in hotels$ man% tend to observe what the% and their organi5ations regard as acceptable. #he understanding of these practices is important to hotels too. #he decision on the mar!et segments to be catered for is closel% related to decisions on pricing and we have seen that price is an integral element of each hotel)s total concept. ,otel Mar!etin# .rientation 3otels serve people and their success depends on how well the% serve them in places where the% wish to be served. #his is onl% a wa% of stating in the simplest of tenns the application to hotel operations of the mar!eting concept$ which is concerned with the consumer as a starting point in the conduct of business. #he mar!eting concept is beginning to be understood b% hoteliers. 2lthough some continue to regard sales andmar!eting as s%non%mous$ most hotels no longer operate in the seller)s mar!et and even massive sales effort is not li!el% to generate a sustained high volume of business$ if consumer needs are not genuinel% met in the planning$ design and subse6uent operation of an hotel. #he basic hotel concept stresses the view of the hotel$ as it is seen b% the hotel user rather than the hotel operator$ as a business to meet the needs of hotel users. Some of these needs are basic and ph%sical$ such as sleeping in clean beds or eating wholesome meals7 others such as those met b% the image of the hotel are ac6uired needs$ which reflect what a person aims to be as an individual. 2 successful hotel must see! to meet both sets of needs. So that an hotel can meet the needs of hotel users$ individual hotel services have to be seen as hotel products sold to particular mar!ets. 2 hotel cannot be all things to all people. Each hotel has to achieve a match between its particular products and particular mar!et segments$ i.e. groups of people with more or less similar characteristics and re6uirements for hotel services. In this there is a difference between the hotel accommodation and catering products$ in that each ma% to some e-tent cater for different mar!ets. <ut this difference onl% reinforces the need for harmon% in the total hotel concept. In order to achieve the match between hotel products and mar!ets$ there is a need for a careful anal%sis of the sources of demand for hotel services in the mar!et area served b% the hotel and an understanding of how hotel services are bought and paid for. >rom this model of a hotel a translation can be made to particular operations. #his ta!es the form of hotel policies$ philosophies and strategies. Special ?eature" of ,otel Mar!etin# ;ar!eting is first and foremost about matching products and mar!ets and in this sense the mar!eting of hotel services is in principle no different from the mar!eting of other consumer products. <ut there are special features of hotel products and mar!ets and hence of hotel mar!eting. /=, >or most users hotel rooms are a means to an end and not an end in itself and the demand for them is what is !nown as derived demand the reason for their use ma% be a business visit or a holida% or something else but rarel% the room itself$ and the same applies to some e-tent to other hotel services. #he availabilit% of the most important hotel product$ the hotel room$ is fi-ed in time and place. In the short term the number of rooms or beds on offer cannot be significantl% changed and location is part of the highl% perishable product$ which cannot be stored for future sale or follow the customer. #he demand for hotel accommodation and other services fluctuates from da% to da%$ from wee! to wee! and from one part of the %ear to another. 2 waste occurs when demand falls and there is a definite upper limit to the volume of business in a period of pea! demand. 3otel investment is primaril% an investment in land and buildings and interior assets. #he bul! of the capital invested in the fi-ed assets of the hotel$ combined with the continuit% of hotel activit%$ gives risc to high fi-ed costs$ which have to be covered irrespective of the volume of business. #hree !e% factors are$ therefore$ critical to a successful hotel operation e the right location$ correct capacit%$ and a high level of utili5ation$ all of them impl% mar!eting decisions e first in the conception of the hotel and in its operation subse6uentl%. In the conception of the hotel$ mar!eting can contribute first through a mar!et feasibilit% stud% to assess the demand. 2 stud% ma% identif% the best mar!et opportunit% for a hotel$ a gap in the mar!et$ a location or choice between alternative locations$ for a particular hotel concept7 or$ given a particular location$ a stud% can determine the most appropriate hotel concept. #he translation of the concept into an operational facilit% then ta!es place through product formulation and development. In the operation of the hotel$ mar!eting can contribute through a continuous process of mar!et research$ product development$ promotion$ selling$ monitoring and review e the stages of a mar!eting c%cle. In the planning of a new hotel$ there is full scope for the adherence to the mar!eting concept from the outset. In an e-isting hotel$ there is often an important distinction between the shortand longterm mar!eting tas!s. In the short term the mar!eting tas! ma% be to ad*ust customers) wants to available facilities and services$ but the longterm tas! is to modif% the facilities and services to the customers) wants. In the short run our e-isting facilities and services are given within narrow limits. +e ma% research the mar!et to see which mar!et segments are or could be attracted to them$ ma!e such ad*ustments to our products as are possible$ but the main effort is li!el% to focus on promotion and selling. +ith low occupancies and low utili5ation of restaurants$ bars and function rooms$ in the short run the sales effort becomes dominant. <ut it is no e-cuse for doing *ust that7 it is both necessar% and possible to proceed with changing the products: toestablish who our customers could be and what their needs are &mar!et research'$ and to formulate and develop products meeting their needs &product formulation and development'. #his approach ultimatel% calls for less sales effort$ which is then designed to demonstrate to people that their needs can be met7 it is of particular importance in hotels. ;ar!eted commodities and articles are concrete$ ph%sical and capable of measurement7 most of them can be inspected and man% of them even tried out before purchase. Services are less tangible and hotel services particularl% so. 3otel services cannot be easil% defined and described in terms of clearl% measurable products and their 6ualities. #he% are often bought individuall% or as part of a pac!age$ and the% ma% be bought directl% b% the user or through an intermediar%$ for e-ample$ a travel /=. agent. In hotels$ as in other wal!s of life$ it is necessar% to ma!e it eas% to bu% onl% more so. Property .ner"hip 2n investment in hotels is first and foremost an investment in land and buildings$ which represent the dominant assets of hotels. Other fi-ed assets are: L plant and e6uipment$ including such ma*or items as air conditioning$ boilers$ lifts$ and heav% !itchen e6uipment7 L furniture$ furnishings$ and small e6uipment7 L china$ glass$ linen and cutler%. 2ccordingl% there is a dual nature of investment in hotels e as an investment in land and buildings and an investment in interior assets. #his distinction has been recogni5ed in three principal wa%s in recent %ears. >irst$ the building shell ma% be owned b% a developer$ sometimes as part of some larger pro*ect$ and leascd to anhotel operator on a rental basis. #his is also implied b% some hotel groups$ which appl% internal rentals to hotels owned b% them7 in this wa% the hotel profits are assessed after ta!ing into account the notional rental of the land and building. Secondl%$ hotel companies ma!e use of saleandlease bac! arrangements as a means of financing the investment$ which reduces the capital re6uirement for the hotel operator. #hirdl%$ interior assets ma% be also leased b% the hotel operator rather than bought$ thereb% also reducing the capital re6uirement. #here are$ therefore$ various arrangements as to who is involved in propert% ownership and in hotel management. 2 hotel operator ma% invest in the propert% represented b% land and buildings or enter into a leasing arrangement and invest onl% in the interior assets$ or an operator ma% enter into a management contract without an% direct capital investment. Property .peration and Maintenance In large hotels and in hotel groups normall% a senior person is ultimatel% responsible for technical services who ma% be variousl% described as the technical services$ buildings and services$ or wor!s director$ officer$ or superintendent$ or simpl% as chief engineer$ or b% some such title. In large organi5ations the technical services ma% be subdivided between those responsible for buildings$ for engineering$ and for other services. 2lthough technical considerations ma% be the direct concern of hotel management in smaller hotels$ the% arespecialist activities normall% entrusted to specialist staff and sometimes Tcontracted out). (ropert% operation$ maintenance and energ% costs are costs of hotel operation$ as distinct from the capital investment outla% on the assets. #he% are$ therefore$ appropriatel% included in hotel profit and loss statements. In the >niform (ystem of 5ccounts for !otels propert% operation and maintenance includes costs of repairs and maintenance of buildings$ plant and e6uipment$ furniture and furnishings$ as well as the maintenance of grounds$ related wages and salaries$ and wor! let out on contract. #he costs incurred b% hotels contributing to 3orwath International reports in the earl% 1GGH. /=/ III*,otel .r#aniIation Organi5ation is the framewor! in which various activities operate. It is concerned with such matters as the division of tas!s within firms and establishments$ positions of responsibilit% and authorit%$ and relationships between them. It introduces such concepts as the span of control &the number of subordinates supervised directl% b% an individual'$ levels of management &the number of tiers through which management operates'$ delegation &the allocation of responsibilit% and authorit% to designated individuals in the line of Tcommand)'. 8ntil not so long ago e about the middle of this centur% and even later than that the t%pical hotel of almost an% si5e was characteri5ed b% a large number of individuals and departments directl% responsible to the hotel manager who was closel% concerned with his guests and with all or most aspects of the hotel operation. #heremight have been one or more assistant managers who had little or no authorit% over such !e% individuals as the chef$ the head waiter or the house!eeper. #he hotel manager usuall% combined the Tmine host) concept of hotel !eeping with a close involvement in the operation. 3e normall% had all or most of the technical s!ills that enter into the business of accommodating and catering for guests. 2lthough he might have given more attention to departments in which he felt confident about his e-pertise$ and less to those in which his !nowledge and s!ills might have been lac!ing$ his approach was essentiall% that of a technician rather than the manager of a business. 3otels served those who chose to use them. #he financial control was e-ercised b% the owners or b% accountants on their behalf. (ersonnel management rarel% e-tended be%ond the Thiring and firing) of staff. 3otel buildings and interiors were not often viewed as business assets re6uired to produce a return comparable to other commercial investments7 maintenance and energ% were cheap. Several influences have tended to change this profile generall% and the approach to hotel organi5ation in particular in the second half of the twentieth centur%. #he mar!et for hotels$ the number of hotels$ and the si5e of individual operations have grown$ against the bac!ground of economic and social conditions in most parts of the world. <usiness and management thought and practice have found their wa% into hotels$ with the entr% into the hotel business of firms engaged in other industries$ development of hotel education and training$ and higher 6ualit% of management. Innovation in hotel organi5ation$ at first largel% confined to a few firms in "orth 2merica$ has spread to others in other countries. #hese and other influences have brought about changesin the wa%s in which hotels organi5e their activities toda%. #hree particular developments illustrate the changes in hotel organi5ation in postwar <ritain. One relates to the grouping of functions. In the earl% I G0Hs hotel reception$ uniformed services and house!eeping were invariabl% regarded as separate departments$ each reporting directl% to the hotel manager7 twent% %ears later man% large hotels had front hall managers$ rooms managers$ or assistant managers with specific responsibilities in this area. Similarl%$ over the same period in most large hotels food and beverage managers came to be appointed$ responsible for all the hotel activities previousl% organi5ed in restaurants$ bars and !itchens under the direct control of the hotel manager. Secondl%$ there has been a growth in specialists. In the earl% 1G0Hs onl% a few large hotels had a staff manager$ a public relations officer or a bu%er7 b% the earl% 1G=Hs personnel$ sales and mar!eting$ and purchasing departments were common features of the large hotels and of hotel groups. #hirdl%$ where each hotel used to be more or less selfsufficient in the provision of its various guest services and supporting re6uirements$ man% of these are now provided through /=0 internal rentals and concessions and through specialist suppliers and operators such as outside ba!eries$ butcheries and laundries. #he accommodation function ma% be described in terms of reception$ uniformed services and house!eeping. Several t%pical organi5ational approaches ma% be identified in respect of these activities in practice: all three activities operate as separate departments with their own heads of department7 reception and uniformed services are grouped together as the front hail or front house of the hotel under an assistant manager for whom this is the sole or main responsibilit%7 reception and uniformed services are grouped together as a front hail or front house department with its own head of department. all three activities are grouped together as the rooms department under an assistant manager for whom this is the sole or main responsibilit%7 all three activities are grouped together as the rooms department with its own head of department. #he first approach provides for a direct line of responsibilit% and authorit% between each separate head Room" #he accommodation function ma% be described in terms of reception$uniformed services and house!eeping. Several t%pical organi5ational approaches ma% be identified in respect of these activities in practice: all three activities operate as separate departments with their own heads of department7 reception and uniformed services are grouped together as the front hail or front house of the hotel under an assistant manager for whom this is the sole or main responsibilit%7 reception and uniformed services are grouped together as a front hail or front house department with its own head of department. all three activities are grouped together as the rooms department under an assistant manager for whom this is the sole or main responsibilit%7 /=1 all three activities are grouped together as the rooms department with its own head of department. #he first approach provides for a direct line of responsibilit% and authorit% between each separate head of department and the hotel manager and hence for a close contact between the two levels of management7 however$ it e-tends the hotel manager)s span of control and he is re6uired to coordinate the separate departments. #he other four approaches are designed to reduce the hotel manager)s span of control and provide for a coordination of related activities at an intermediate level but increase the number of levels through which management has to operate$ and reduce the amount of direct contact between the hotel manager and the departments concerned. Several activities were described in connection with rooms$ which ma% be arranged differentl% in large hotels: In most hotels advance reservations form an integral part of hotel reception and the same emplo%ees deal with them and with other reception tas!s. <ut advance reservations ma% be dealt with in a separate section of the reception office or in a separate department$ to enable emplo%ees to concentrate on the respective tas!s without conflicting demands on their time and attention. Sometimes all advance reservations are concentrated in the sales department$ which has a responsibilit% for ma-imi5ing hotel occupanc%. In smaller hotels guest accounts are normall% handled b% boo! !eeperBreceptionists$ but strictl% spea!ing guest accounts represent an e-tension of the accounting function of the hotel. #herefore$ where guest accounting is handled b% bill office cler!s and cashiers$ the% normall% form a part of the accounts department. L In some hotels room service is provided b% house!eeping staff$ but room service is clearl% part of the food and beverage function of the hotel. ?ood and /e$era#e Several t%pical organi5ational approaches identified in respect of this function in practice: y ma% be each sales outlet and supporting service operates as a separate department with its own head of department7 L several departments are grouped together under an assistant manager for whom the% represent the sole or main responsibilit%$ e.g. purchasing and storage$ bars and cellars$ the Tbac!ofthehouse) activities including the !itchen$ and so on7 L several of these departments are grouped together as one department under its own head of department7 /== L all food and beverage activities are grouped together under an assistant manager for whom the% represent the sole or main responsibilit%7 L all food and beverage activities are grouped together as a food and beverage department with its own head of department. #he same observations appl% to these approaches as are made above in relation to rooms$ regarding lines of responsibilit% and authorit%$ span of control and levels of management7 the si5e of the span of control and the number of management levels are conflicting considerations. Several aspects of the food and beverage function are closel% related to each other but also to other parts of the hotel operation: L ;ost hotels have facilities serving both food and beverages$ although in some of them food or beverages ma% predominate. +hilst it is usuall% relativel% eas% to separate the revenue from each$ it is often impractical to separate accuratel% all the costs of operation other than the cost of sales$ because the same emplo%ees ma% handle both products$ and because other goods and services provided in the same outlet ma% not be readil% identifiable as either food or beverages. In these circumstances food and beverages are treated together$ anal%sed b% sales outlet$ and the related responsibilities are reflected in the organi5ation structure. L >ood and beverage control based on the food and beverage c%cles ma% be appropriatel% seen as part of the total accounting function of the hotel. In these circumstances such emplo%ees as restaurant cashiers and cost control cler!s are included on the staff of the hotel accountant. L T+here there is a separate sales department$ food and beverage sales are usuall% closel% monitored b% that department$ and such arrangements as reservations for functions ma% form part of the responsibilities of the sales department. Mi"cellaneou" :ue"t Ser$ice" ;iscellaneous guest services are illustrated in terms of such activities as telephones and laundr% and the t%pical organi5ational approaches for most of term are shown to be of two main !inds: L the services are operated under direct management of the hotel as minor operated departments7 L the services are operated under rental and concession arrangements with the hotel b% another firm. #he alternative arrangements ma% appl% in the provision of the following main services to guests: beaut% shop and hairdressing secretarial services florist s6uash courts and tennis courts garage gifts and souvenirs laundr% and dr% cleaning swimming pool newspapers and maga5ines tobacconist 9irect management of these services normall% provides for a closer direct control and supervision b% the hotel and for greater fle-ibilit% in operation. In man% hotels the services are merel% grouped as residuar% hotel activities for accounting and control purposes and are in practice provided as part of the services of other hotel /=? departments$ e.g. reception$ uniformed services$ house!eeping or general administration$ and are not separate departments in the organi5ational sense. Onl% when the volume of a particular service is sufficientl% large$ it ma% be organi5ed as a separate department. 2nd it is onl% then that the option arises for the service to be provided for the guests b% another operator$ because it warrants his involvement$ under a rental or concession arrangement. Such arrangement then relieves the hotel from operating what is often to the hotel operator an unfamiliar service and allows it to concentrate on its primar% activities. #herefore$ ma*or deciding factors are the si5e of the operation$ the availabilit% of suitable operators of particular services$ and the operational philosophies of the hotel or hotel group$ as well as the 6ualit% of service and the financial return to the hotel$ which ma% result from one or the other approach. ,otel Support Ser$ice" In practice the nonrevenue service activities are organi5ed in one of three main wa%s: L retained among the hotel manager)s own responsibilities7 L assigned to an assistant manager as one of his or her responsibilities7 L assigned to a separate department with its own head of department. #o a greater or lesser e-tent each of these activities ma% also draw for its performance on e-ternal specialist advice and assistance. #he main specialist activities$ which ma% be organi5ed in one of these wa%s$ and e-amples of the e-ternal sources of advice and assistance available to the hotel in respect of each$ can be summari5ed as follows: 2ccounting and finance 3otel accountants and consultants (ublic accountants and auditors (rofessional stoc!ta!ers (ersonnel services (ersonnel recruitment and selection specialists +or! stud%$ personnel and industrial relations advisers #raining boards and other agencies (urchasing 3otel accountants and consultants >urniture and e6uipment specialists Various suppliers Sales and mar!eting ;ar!et research agencies 2dvertising agencies (ublic relations consultants (ropert% operation$ maintenance$ energ% 2rchitects$ builders$ designers Consulting engineers 8tilit% underta!ings /=G 2dvisor% services are also sometimes provided b% professional bodies$ trade associations for their members$ the technical press and other agencies. 2part from an% operational philosophies$ the adoption of the organi5ational approaches$ in respect of a particular activit%$ is largel% determined b% the si5e of operation: the first is normall% associated with a small hotel7 the second with medium si5e7 and the third with large operations$ but no hard and fast rules appl%. Each of these activities comprises specialist !nowledge and s!ills$ as distinct from normal operational !nowhow inherent in the primar% operating activities. The Mana#ement Structure >ollowing the discussion of the division and grouping of operated and service activities into departments$ it is ne-t necessar% to consider the total management structure of the hotel7 this comprises all positions of responsibilit% and authorit% below top management$ which is represented in a hotel compan% b% the board of directors. #he management team consists of the hotel manager$ one or more deput% or assistant managers$ and the heads of departments. 2 discussion of the management structure is concerned with these posts and with the relationships between them. 2ccording to the si5e of the hotel and the particular arrangement in operation$ the hotel chief e-ecutive ma% be variousl% designated as managing director$ general manager or simpl% hotel manager. 3e or she ma% to agreater or lesser e-tent participate in the formulation of the hotel policies and strategies$ and will invariabl% be responsible for their implementation and for the hotel performance. In larger hotels this level ma% be subdivided betweena managing director or general manager and the hotel manager or a resident manager. #he former then reports to the board and normall% coordinates the wor! of the specialist departments and of the hotel or resident manager$ who is in turn responsible for the da%toda% management of the hotel activities. #he comple-it% and continuit% of the hotel activities normall% give rise to the need for one or more deput% or assistant managers. 2 deput% hotel manager normall% has authorit% over the heads of departments. <ut there is much variation in the role$ authorit% and responsibilities of hotel assistant managers. In some instances the% are the hotel manager)s deputies in all but name$ in respect of the whole operation or some parts of it$ e.g. food and beverages$ front hall$ Tbac! of the house)$ and so on7 in other cases the% have these specific responsibilities in addition to their general role as the manager)s deputies. <ut man% socalled assistant managers perform roles$ which are more appropriatel% described as those of general assistants &assisting where re6uired throughout the hotel' or of personal assistants to the manager &acting on his behalf as he directs them to do'. :et in other cases their main role is guest contact. 2ll the roles described above ma% be appropriate in particular circumstances$ but effective hotel management calls for a clear definition of responsibilit% and authorit%. #he relationships with heads of departments are especiall% important in this conte-t. #itles$ which describe the particular roles$ can be helpful in this direction. In order to provide clearcut lines of responsibilit% and authorit% and an effective coordination of related activities$ some hotels function without assistant managers as such: those who would normall% be in such positions are allocated specific responsibilities and appropriate titles to describe them. #hose in positions of heads of departments fall into two distinct categories. 3eads of operated departments are !nown as line managers$ with direct lines of /?H responsibilit% and authorit% to their superiors and to their subordinates in respect of each operated department. 3eads of service departments are specialists who provide advice and service to line management$ and relieve them of such specialist tas!s as are considered to be more effectivel% discharged through the appointment of specialists7 the% have no direct authorit% over emplo%ees other than those of their own departments. Dine management includes$ for e-ample$ head receptionists$ head house!eepers$ head chefs and restaurant managers. Specialists include accountants$ bu%ers$ personnel and purchasing officers and similar posts. In order to draw a distinction between the two$ it is helpful to confine the designation Tmanager) to operated departments. It is also relevant to refer in this conte-t to a confusion$ which often arises with various trainee positions. It is difficult to *ustilt such titles as Ttrainee manager) unless its holder has been designated to fill a specific post$ for which he is training. 2 person who is undergoing training with a view to an ultimate unspecified position of responsibilit% is more appropriatel% described as a management trainee. +>*otel ervices Room" and /ed" #he primar% function of a hotel is to accommodate those awa% from home and sleeping accommodation is the most distinctive hotel product. In most hotels room sales are the largest single source of hotel revenue and in man%$ more sales are generated b% rooms than b% all the other services combined. Coom sales are invariabl% also the most profitable source of hotel revenue$ which %ield the highest profit margins and contribute the main share of the hotel operating profit. 3otels contributing to annual reports of 3orwath International earned on average the proportions of their total revenue shown in the following from room sales in the earl% 1GGHs. Coom Sales as a Catio of 3otel Cevenue in ;ain Cegions 1GGH 1GG1 1GG, &W' &W' &W' 2frica and the ;iddle East /1.H /..1 /0., 2sia mid 2ustralia 0/.1 01.H 0=.G Europe /G., /G.1 /=.H "orth 2merica 1..G 1,.G =1.1 Datin 2rnericalCaribbean 0..? 0?.0 01. #hree main hotel activities are earning the room revenue: hotel reception$ uniformed services and Coom Sales 2 large proportion of hotel guests reserve their rooms from a few hours to several wee!s or months before the% actuall% arrive at the hotel. #he% do so in person$ b% telephone$ telegram$ #ele- or >a-$ b% mail$ through travel agents$ and in a growing number of cases through central reservations s%stems. 3otel reservations create a /?1 multitude of contractual relationships between the hotel and its guests$ which begin at the time each reservation is made and continue until the departure of the guests or until their accounts are settled after their sta%. 2dvance reservations are an important responsibilit% on the part of the hotel$ both in the legal and in the business sense$ and call for a s%stem which enables room reservations to be converted into room revenue. +hen guests arrive in hotels$ the% are as!ed to register b% providing the receptionist with certain particulars about themselves. #he hotel register$ in which the particulars are entered$ has two main functions7 one is to satisf% the law$ which ma!es hotel registration of guests a legal re6uirement in most countries. #he second function is to provide an internal record of guests$ from which data are obtained for other hotel records. In most hotels room allocations of accommodation reserved in advance are made before the guests) arrival and onl% guests registering without a previous reservation are allocated rooms on arrival$ but in some hotels all room allocations are made onl% when guests arrive. #he registration and room allocation are then the starting point for guests) sta% and a signal for the opening of their accounts$ as well as for notif%ing uniformed staff$ the house!eeping department$ telephonists$ and others$ of arrivals. Several main records document the room sale in the reception office: L reservation form or card standardi5es the details of each boo!ing$ forms the top sheet of an% documents relating to it$ and enables a speed% reference to an% individual case7 L reservation diam% or dail% arrival list records all boo!ings b% date of arrival and shows all arrivals for a particular da% at a glance7 L reservation chart provides a visual record of all reservations for a period and shows at a glance rooms reserved and those remaining to he sold7 L hotel register records all arrivals as the% occur and gives details of all current and past guests7 L reception or room status board shows all rooms b% room number and floor and gives the current and pro*ected status of all rooms on a particular da%$ with details of occupation7 L guest inde- lists all current guests in alphabetical order with their room numbers and provides an additional 6uic! point of reference in larger hotels. Mall and .ther :ue"t Ser$ice" 2 combined !e% and mail rac! is a standard feature of most hotel reception offices and reflects two t%pical responsibilities of the office room !e%s and guest mail$ 2rranged b% room number and floor$ it corresponds in la%out to the reception or room status board and is complementar% to it. In the course of a da%)s business room !e%s arc issued from the rac! to arriving guests and to residents who call for them7 !e%s are returned to the rac! b% guests going out of the hotel or departing at the end of their sta%. #he rac! is a point of reference regarding the occupation of rooms and the whereabouts of guests. ;ail ma% arrive for guests before$ during and after their sta% at the hotel$ and ma% consist z.f ordinar% or registered mail$ pac!ets and parcels$ cables and) telegrams$ #ele- messages$ >a- transmissions$ e-press mail and personal messages left for guests. ;ail awaiting guests) arrival should be handed to them when the% are registering7 mail arriving after a guest has left the hotel$ should be forwarded. 9uring the guest)s sta% speed is the essence of >a- transmissions$ securit% is the essence of /?, registered mail$ bul!iness is the essence of parcels7 each calls for standard procedures of their own. <ut the !e% and mail rac! is the focus7 it accommodates much of the mail the guest collects when collecting the room !e%7 it can serve to alert the receptionist to items such as parcels or registered mail$ stored elsewhere. #hree basic aids are$ therefore$ related and complementar% in the provision of !e%$ mail and other guest services: L guest inde- shows whether a particular person is resident and that person)s room number7 L reception or room status board shows who is occup%ing a particular room7 L !e% and mail rac! indicates whether the guest is in the hotel and whether there is an% mail for that person. In man% hotels the reception office or a separate section of it also acts as a source of information to guests e about hotel facilities and services$ about the localit%$ about transport and other matters. In other hotels the !e%s$ mail and information to guests are provided b% uniformed staff$ and there are usuall% good reasons for one or the other arrangement. <ut who does what and to whom the guest can turn$ should be made clear to the guest in terms of individual needs and re6uirements rather than in terms of the hotel organi5ation structure$ particularl% in larger hotels. Such notices as TCeception) and T3all (orter)have different connotations in different hotels and are not necessaril% selfe-planator% even for e-perienced hotel users. Counters and sections of the front hall of the hotel clearl% labelled TCegistration)$ TUe%s)$ T;ail)$ Tinformation)$ TFuest 2ccounts)$ and so on$ are more meaningful to guests. 1niformed Ser$ice" #he second component of the accommodation function is uniformed services$ which form an integral part of the front hail ftmnctions of the hotel and provide a variet% of personal services to guests. Servicing arrivals and departures are the most common uniformed services. #he meeting and greeting of arriving guests$ their luggage and the par!ing of their ears$ are the first responsibilities$ which e-tend from the hotel entrance and car par! to the hotel bedrooms. On departure$ guests$ luggage and transportation are again their primar% responsibilities. In an hotel with a hundred departing guests in the morning$ followed b% a similar volume of arrivals in the afternoon and evening$ uniformed staff attend in a da%)s business to some two hundred people$ handle several hundred pieces of luggage$ par! several do(5en cars$ and arrange several do5en ta-is. #he guests$ their luggage$ and their vehicles$ therefore$ pla% a ma*or part in the provision of uniformed services. 9uring the guest)s sta% uniformed staff are often the main source of informatinn about the hotel and the localit%$ and the guest)s main source of such arrangements as theatre tic!ets$ tours$ car hire and other services. #he hail porter)s des! or an en6uir% counter in the front hail are then the information centres of hotels$ which contribute much to the range of guest services and to their integration. In some hotels other guest services ma% be provided b% uniformed staff. "ewspapers$ as well as other small articles$ ma% be supplied to guests b% uniformed staff who ma% also act as messengers$ lift operators and men)s cloa!room attendants. In man% hotels uniformed staff are the onl% people on dut% during the night and particularl% in smaller hotels maintain a whole range of hotel services provided b% other departments in da% time: to receive and register late arrivals$ to serve light /?. refreshments$ to operate the hotel switchboard$ to arrange earl% morning calls$ as well as to clean public rooms and to ensure the securit% of the hotel. #he provision of uniformed services varies greatl% between hotels of different si5es$ t%pes and standards$ and their organi5ation tends to be influenced b% all these factors$ as well as b% established practices$ 2s mentioned earlier$ information to guests ma% he provided b% the reception office or as part of uniformed services or b% both. #he cleanliness of public rooms ma% be the responsibilit% of uniformed staff$ the house!eeping department$ or outside contractors. +hat hotel services are available during the night and b% whom the% are provided$ is another source of variation. #hese differences are legitimate$ as long as the% reflect the particular re6uirements of guests and the particular circumstances of each hotel$ and as long as the respective functions are defined and understood b% staff and made clear to guests where the% affect them. ,otel ,ou"e!eepin# #he basic house!eeping function of the hotel is the servicing of guest rooms. In its scope$ guest bedrooms ma% be the sole or main responsibilit% of the hotel house!eeping department$ but it ma% e-tend to other areas of the hotel. "ormall% hotel guests spend at least onethird of their sta% in their room. #he design$ la%out$ decor$ furniture and furnishings of the hotel bedroom are fundamental to meeting their needs and in creating customer satisfaction$ and these ma% be significantl% influenced b% the house!eeping department. #he cleanliness and good order$ the linen and other room supplies$ and the smooth functioning of the room are the focus of the department. #his ma% include other guest services$ such as earl% morning teas$ guest laundr%$ bab% sitting and other personal services. #he main house!eeping records are made up of arrival and departure lists and notifications received from the reception office and the house!eeping own room status report$ together with separate records in respect of additional services provided b% the department. #he e-tension of the house!eeping function outside the hotel bedroom normall% includes the cleaning of bedroom floors and ma% include staircases$ public cloa!rooms and other public areas of the hotel. 3owever$ it is 6uite common for such public rooms as hotel lounges to be cleaned b% uniformed staff$ for the responsibilit% for the men)s and women)s cloa!rooms to be divided between uniformed staff and the house!eeping department$ and for restaurants and bars to be cleaned b% the staff of those departments. ;ore recentl%$ hotels have been engaging outside contract firms for the cleaning of public rooms. Other house!eeping services often include the provision of first aid to guests and staff$ dealing with lost propert%$ and floral arrangements throughout the hotel. +hen staff accommodation is provided b% the hotel$ it ma% be included as part of the head house!eeper)s responsibilities. 2lthough in man% countries hotels increasingl% use outside laundries and dr% cleaning firms for their re6uirements$ man% hotels operate their own dr% cleaning and laundr% facilities. #hese Tinhouse) facilities ma% be then organi5ed as separate departments of the hotel or as sections of the house!eeping department. #his outline of the hotel house!eeping function illustrates three organi5ational approaches. One see!s to integrate a number of related functions within a ma*or house!eeping department. #he second assigns certain functions to the house!eeping department and others to other departments of the hotel$ largel% on the basis of /?/ ph%sical areas. #he third consists of Tbu%ing in) certain services from outside suppliers rather than operating them directl% as hotel facilities. >ood and 9rin! #he food and drin! service is the second ma*or activit% of most hotels and in man% of them it accounts for a larger proportion of emplo%ees than the provision of sleeping accommodation and related services. #his is due to two main factors: L in contrast to hotel rooms$ meals and refreshments in hotels ma% be supplied to nonresidents as well as to resident guests and include substantial functions sales7 L the provision of meals and refreshments is relativel% labour intensive. #he provision of sleeping accommodation is a service activit%$ in which there is a negligible use of materials$ and there is no cost of sales. #he provision of meals and refreshments results in composite products made up of commodities and of service$ and the use of materials represent the cost of sales. >ood and drin! enter into meals and refreshments served in hotels in several stages from their purchase b% the hotel to their sale in the same or altered form to the hotel customer. 2ccording to the si5e and diversit% of the hotel mar!ets there ma% be more than one restaurant and bar and also food and drin! service in rooms and through functions. Re"taurant" Cestaurants establishment where refreshments or meals ma% be procured b% the public. #he public dining room that came ultimatel% to be !nown as the restaurant originated in >rance$ and the >rench have continued to ma!e ma*or contributions to the restaurant)s development. #he first restaurant proprietor is believed to have been one 2. <oulanger$ a soup vendor$ who opened his business in (aris in 1=10. #he sign above his door advertised restoratives$ or restaurants$ referring to the soups and broths available within. #he institution too! its name from that sign$ and IrestaurantJ now denotes a public eating place in English$ >rench$ 9utch$ 9anish$ "orwegian$ Comanian$ and man% other languages$ with some variations. >or e-ample$ in Spanish and (ortuguese the word becomes restaurante$ in Italian it is ristorante7 in Swedish$ restaurang7 in Cussian$ restoran7 and in (olish$ restauracia. 2lthough inns and hostelries often served pa%ing guests meals from the host)s table$ or table d)hkte$ and beverages were sold in cafjs$ <oulanger)s restaurant was probabl% the first public place where an% diner might order a meal from a menu offering a choice of dishes. <oulanger operated a modest establishment7 it was not until 1=?, that Da Frande #averne de Dondres$ the first lu-ur% restaurant$ was founded in (aris. #he /?0 owner$ 2ntoine <eauvilliers$ a leading culinar% writer and gastronomic authorit%$ later wrote D T2rt du cuisinier &1?1/'$ a coo!boo! that became a standard wor! on >rench culinar% art. #he most illustrious of all 1Gthcentur% (aris restaurants was the Cafj 2nglais$ on the <oulevard des Italiens at the corner of the rue ;arivau-$ where the chef$ 2doiphe 9ugljrj$ created classic dishes such as sole 9ugljrj &filets poached with tomatoes and served with a cream sauce having a fish stoc! base' and the famous sorrel soup potage Fermin%. On @une =$ 1?1=$ the Cafj 2nglais served the now famous I#hree Emperors 9innerJ for three ro%al guests visiting (aris to attend the 8niversal E-position. #he diners included #sar 2le-ander 11 of Cussia7 his son the tsarevich &later the tsar 2le-ander III'7 and Uing +illiam I of (russia$ later the first emperor of Ferman%. #he meal included souffles with creamed chic!en &a Ia reine'$ fillets of sole$ escalloped turbot$ chic!en a la portugaise &coo!ed with tomatoes$ onions$ and garlic'$ lobster a la parisienne &round$ flat medallions gla5ed with a gelatinma%onnaise mi-ture and elaboratel% decorated'$ duc!lings a Ia rouennaise &the carcasses stuffed with liver and pressed$ presented on a platter with boned slices of the breast and the grilled legs$ and served with a red wine sauce containing pureed liver'$ ortolans &small game birds' ontoast$ and eight different wines. #oward the end of the 1Gth centur%$ in the gaud% and e-travagant era !nown as ia belie jpo6ue$ the lu-urious ;a-im)s$ on the rue Co%ale$ became the social and culinar% centre of (aris. #he restaurant temporaril% declined after +orld +ar I but recovered under new management$ to become an outstanding gastronomic shrine. >rance produced man% of the world)s finest chefs$ including Feorges2uguste Escoffier$ who organi5ed the !itchens for the lu-ur% hotels owned b% Cjsar Cit5$ developing the socalled brigade de cuisine$ or !itchen team$ consisting of highl% trained e-perts each with clearl% defined duties. #hese teams included a chef$ or gros bonnet$ in charge of the !itchen7 a sauce chef$ or deput%7 an entremettier$ in charge of preparation of soups$ vegetables$ and sweet courses7 a r{tisseur to prepare roasts and fried or grilled meats7 and the garde manger$ in charge of all supplies and cold dishes. In Escoffier)s time$ the duties and responsibilities of each functionar% were sharpl% defined$ but in modern times$ rising labour costs and the need for faster service have bro!en down such rigidl% defined duties. In the !itchens of even the leading modern restaurants$ duties at the pea! of the dinnerhour preparations are li!el% to overlap widel%$ with efficienc% maintained amid seeming chaos and confusion. I n the ,Hth centur%$ with the development of the automobile$ countr% dining became popular in >rance$ and a number of fine provincial restaurants were established. #he Cestaurant de la (%ramide$ in Vienne$ regarded b% man% as the world)s finest restaurant$ wasfounded b% >ernand (oint and after his death$ in 1G00$ retained its high standing under the direction of his widow$ ;adame I;adoJ (oint. Other leading >rench provincial restaurants have included the #roisgros in Coanne7 the (aul <ocuse Cestaurant near D%on7 the 2uberge de 1)Ill in Illhaeusern$ 2lsace7 and the hotel Ckte d)Or$ at Saulieu. >rench restaurants toda% are usuall% in one of three categories: the bistro$ or brasserie$ a simple$ informal$ and ine-pensive establishment7 the mediumpriced restaurant7 and the more elegant grand restaurant$ where the most intricate dishes are e-ecuted and served in lu-urious surroundings. Other nations have also made man% significant contributions to the development of the restaurant. In Ital% the botteghe &coffee shop' of Venice originated in the 11th centur%$ at first serving coffee onl%$ later adding snac!s. #he modern trattorie$ or taverns$ feature /?1 local specialities. #he osterie$ or hostelries$ are informal restaurants offering home st%le coo!ing. In >lorence small restaurants below street level$ !nown as the buca$ serve whatever foods the host ma% choose to coo! on a particular da%. 2ustrian coffeehouses offer leisurel%$ complete meals$ and the diner ma% linger to sip coffee$ read a newspaper$ or even to write an article. ;an% 2ustrians fre6uent their own Istead% restaurants$J !nown as Stain$nbe In 3ungar% the cswrda$ a countr% highwa% restaurant$ offers menus usuall% limited to meat courses and fish stews. #he beer halls of the C5ech Cepublic$ especiall% in (rague$ are similar to coffeehouses elsewhere. >ood is served$ with beer replacing coffee. #he Ferman +einstube is an informal restaurant featuring a large wine selection$ and the +einhaus$ a food and wine shop where customers ma% also dine$ offers a selection of foods ranging from delicatessen fare to full restaurant menus. #he Schen!e is an estatetavern or cottage pub serving wine and food. In the cities a similar establishment is called the Stadischen!e. In Spain the bars and cafjs of ;adrid offer widel% varied appeti5ers$ called tapas$ including such items as shrimp coo!ed in olive oil with garlic$ meatballs with grav% and peas$ salt cod$ eels$ s6uid$ mushrooms$ and tuna fish. #he tapas are ta!en with sherr%$ and it is a popular custom to go on a chateo$ or tour of bars$ consuming large 6uantities of tapas and shen% at each bar. Spain also features the marisco bar$ or marEs 6uerIa$ a seafood bar7 the asadoro$ a Catalan rotisserie7 and the tasca$ or pub wineshop. In (ortugal$ cerve*arias are popular beer parlours also offering shellfish. >ado taverns serve grilled sausages and wine$ accompanied b% the plaintive (ortuguese songs called fados &meaning IfateJ'. In Scandinavia sandwich shops offer openfaced$ artfull% garnished sandwiches called smorrebrod. Swedish restaurants feature the smorgasbord$ which literall% means Ibread and butter tableJ but actuall% is a lavish$ beautifull% arranged feast of herring$ shrimp$ pic!les$ meatballs$ fish$ salads$ cold cuts$ and hot dishes$ served with a6uavit or beer. #he "etherlands has brood*eswin!els$ serving sandwich openfaced shops$ called sandwiches$ seafoods$ hot and cold dishes$ and cheeses from a huge table. English cit% and countr% pubs have three !inds of bars: the public bar$ the saloon$ and the private bar. Ever%one is welcome in the public bar or saloon$ but the private bar is restricted to habitu|s of the pub. (ub food varies widel% through England$ ranging from sandwiches and soups to por! pies$ veal and ham pies$ stea! and !idne% pies$ bangers &sausages' and a pint &beer'$ bangers and mash &potatoes'$ toad in the hole &sausage in a :or!shire pudding crust'$ and Cornish pasties$ or pies filled with meat and vegetables. In the tavjrnas of Freece$ customers are served such beverages as retsina$ a resinated wine$ and ou5o$ an aniseflavoured aperitif$ while the% listen to the music of the bou:ou!i. Di!e other ;editerranean countries$ Freece has the grocei%tavjrna where one can bu% food or eat. #he #ur!ish is!embeci is a restaurant featuring tripe soup and other tripe dishes7 muhalleb icE shops serve boiled chic!en and rice in a soup and mil! pudding. Characteristic of @apan are sushi bars that serve sashimi &raw fish slices' and sushi &fish or other ingredients with vinegared rice' at a counter. Other food bars serve such dishes as noodles and tempura &deep fried shrimp and vegetables'. :udofu restaurants build their meals around varieties of tofu &bean curd'$ and the elegant tea houses serve formal Uaise!i table d)hkte meals. /?= In China$ restaurants serving the local cuisine are found$ and noodle shops offer a wide variet% of noodles and soups. #he dimsum shops provide a neverending suppl% of assorted steamed$ stuffed dumplings and othersteamed or fried delicacies. 2 common sight in most parts of 2sia is a !ind of portable restaurant$ operated b% a single person or famil% from a wagon or litter set up at a particular street location$ where specialties are coo!ed on the spot. >ood and coo!ing utensils var% widel% in 2sia. #he cafeteria$ an 2merican contribution to the restauranfs development$ originated in San >rancisco during the 1?/G gold rush. >eaturing selfservice$ it offers a wide variet% of foods displa%ed on counters. #he customer ma!es his selections$ pa%ing for each item as he chooses it or pa%ing for the entire meal at the end of the line. Other t%pes of 6uic!eating places originating in the 8nited States are the drugstore counter$ serving sandwiches or other snac!s7 the lunch counter$ where the diner is served a limited 6uic!order menu at the counter7 and the drivein$ Idrive thru$J or driveup restaurant$ where patrons are served in their automobiles. Socalled fastfood restaurants$ usuall% operated in chains or as franchises and heavil% advertised$ offer limited menus t%picall% comprising hamburgers$ hot dogs$ fried chic!en$ or pi55a and their complementsand also offer speed$ convenience$ and familiarit% to diners who ma% eat in the restaurant or ta!e their food home. 2mong fastfood names that have become widel% !nown are +hite Castle &one of the first$ originating in +ichita$ Uan.$ in 1G,1'$ ;c9onald)s &which grew from one establishment in 9es >lames$ Ill.$ in 1G00 to more than 10$HHH internationall% within /H %ears'$ Uentuc!% >ried Chic!en &founded in 1G01'$ and (i55a 3ut &1G0?'. ;an% school$ wor!$ and institutional facilities provide space for coinoperated vending machines that offer snac!s and beverages. #he specialt% restaurant$ serving one or two special !inds of food$ such as seafood or stea!$ is another distinctive 2merican establishment. #he (ullman car diner$ serving fullcourse meals to long distance railroad passengers$ and the riverboat steamers$ renowned as floating gourmet palaces$ were original 2merican conceptions. #he% belong to an earlier age$ when dining out was a principal social diversion$ and restaurants tended to become increasingl% lavish in food preparation$ decor$ and service. In man% modern restaurants$ customers now prefer informal but pleasant atmosphere and fast service. #he number of dishes available$ and the elaborateness of their preparation$ has been increasingl% curtailed as labour costs have risen and the availabilit% of s!illed labour decreased. #he trend is toward such efficient operations as fastfood restaurants$ snac! bars$ and coffee shops. #he trend in elegant and e-pensive restaurants is toward smaller rooms and intimate atmosphere$ with authentic$ highl% speciali5ed and limited menus. Mi"celaneou" :ue"t Ser$ice" 2ccommodation$ food and drin! services are the ma*or activities of hotels$ which generate all or most hotel revenue$ account for all or most of their emplo%ees$ and represent the principal products provided b% the ma*or hotel departments. <ut the presentda% hotel guest normall% also e-pects other facilities and services. In addition to a comfortable room$ and meals and refreshments in a restaurant or bar or in the room$ a guest ma% want to use the telephone or have clothes laundered or dr% cleaned. In a large modern hotel a guest ma% anticipate to be able to bu%newspapers$ maga5ines and souvenirs$ have a haircut$ obtain theatre tic!ets$ and boo! an airline tic!et for the ne-t stage of a trip. /?? #he hotel services other than accommodation$ food and drin! ma% be provided to the guest b% the hotel or b% other operators on the hotel premises. #he revenue earning activities provided directl% b% the hotel are variousl% described as ancillar% or subsidiar% revenue earning$ and are grouped for accounting and control purposes in what are !nown as minor operated departments$ to distinguish them from ma*or operated departments concerned with rooms$ food and beverages. <oth are distinguished from rental and concession arrangements$ under which some of these and other services ma% be provided to guests b% outside firms operating in the hotel. #he three basic components of the accommodation function are present in most hotels and are normall% organi5ed in separate departments. <ut their organi5ation and staffmg often differ in hotels of different si5es$ t%pes and standards. In smaller hotels onl% a few people ma% be engaged in each and cover a wide range of duties7 as the hotel increases in si5e$ each activit% ma% be subdivided into separate departments or sections$ in which those engaged in them perform more speciali5ed tas!s. 2 transit cit% hotel with a short average length of sta% calls for a somewhat different approach from that of a resort hotel$ which accommodates guests for longer and often such regular periods as one or two wee!s. #here is also a relationship between prices$ the range and 6ualit% of facilities and services provided$ and the wa% the% are organi5ed. >or all these and other reasons it is possible to describe the hotel activities related to the accommodation of guests onl% in broad and general terms. >. ,ourist 4ttractions #ourist attractions have an important role to pla% in world tourism since the% often provide the motivating force for travel$ thereb% energising the man% components of the tourist industr%. #he scope of the attractions sector is immense7 logicall% an%thing that has the power to draw visitors to it can be considered an attraction. ;oreover an attraction ma% not be a readil% identifiable place or feature$ but a visitor)s overall perception of a destination as an attractive place to visit$ distilled from a variet% of surces and images. Dondon)s current popularit% as a tourist destination with %oung visitors from around the world is a good case7 the% are not attracted primaril% b% the traditional <ig <en$ <uc!ingham (alace$ 3ouses of (arliament but rather b% the image of the capital as a IcoolJ place to hear good music and have an en*o%able time. #ouristic attractions occur at a variet% of scales. ;an% internationall% famous attractions such as: San >rancisco)s Folden Fate <ridge Ced S6uare in ;oscow #he (onipidou Centre in (aris are household names on man% tourists) Imust seeJ lists. 9omestic tourists travel within their own countries to a variet% of attractions$ some of which are provided free of charge while others charge admission. #hese ma% be da% visits or a part of a long holida% or short brea!. #ourist attraction are provided b% both commercial and noncommercial organi5ations. ;an% historic buildings$ areas of landscape or wildlife interest$ museums and ancient monuments are in the care of public bodies and voluntar% groups which aim to preserve or conserve vital parts of a countr%)s heritage while at the same time ma!ing facilities available to tourists. /?G Type" of touri"t attraction" #ourist attractions are generall% classified into one of two categories: "atural attractions ;an made attractions such as: 3eritage attractions &e.g. +illiamsburg' ;useums and ancient monuments &Te.g Douvre in (aris' #heme par!s &e.g. +alt 9isne% +orld in >lorida' Entertainments &e.g #he S%dne% Opera 3ouse' Sport facilities &e.g +inter Olimpic Faines' Deisure shopping venues &Te.g#he ;etro Center in Englanc +ildlife areas &e.g <usch Farden in >lorida' Touri"m today #he mass tourism that e-ists in the world toda% is a phenomenon of the post industrial societ% of the latter half of the twentieth centur%. #ourism has become an integral part of the move awa% from economies based on heav% engineering and manufacturing to a rapidl% e-panding service sector. #he growth in international and domestic tourism since the 1G0Hs has been nothing short of dramatic$ with international tourist arrivals climbingfrom ,0 million in 1G0H to a record 0G, million in 1GG1 &+orld #ourism Organisation$ 1GG='. +hen we add to this the fact that the volume of domestic tourism worldwide is estimated b% the +orld #ourism Organisation to be appro-imatel% ten times greater than that of international tourism &+orld #ourism Organisation. 1G?.'$ the scale of the tourism phenomenon can begin to be appreciated. Freater wealth$ higher educational standards$ increased mobilit% and more leisure time have all contributed to unparalleled demand for holida%s and e-cursions at home and abroad. Overseas travel is no longer the preserve of the privileged few$ but is available to the ma*orit%$ as developments in transportation$ increased competition and global communications technolog% have reduced the real cost of holida%s. (rivate and public sector organisations have responded to the increased demand b% providing a wide range of facilities and products to meet the needs of an increasingl% discerning travelling public. It must be remembered$ however$ that tourism is a ver% recent phenotnenon that has hitherto been allowed to grow in a business environment relativel% free of regulation and trade restrictions. Such an unrestricted environment is unli!el% to continue in %ears to come. #he current scale and scope of the international tourism industr% is illustrated in recent data from the +orld #ravel and #ourism Council &1GG1'$ which indicate that in 1GG1 the world travel and tourism industr% is estimated to have: Fmplo%ed ,00 million people Fenerated an output of 8S N..1 trillion Contributed 1H.= per cent of global gross domestic product &.F9(' o invested 8S N=11 billion in capital pro*ects Fenerated& 8S N=11 billion in world e-ports (aid 8S N10. billion in ta-es worldwide /GH Such figures demonstrate the economic significance of the tourism industr% on a global scale and confirm that the age of mass tourism has trul% arrived in spectacular fashion. 'ocal ,ours Pari" (aris is the capital of >rance and one of Europe)s largest conurbations. #he cit% was founded more than ,$HHH %ears ago on an island in the Seine Civer$ some ,.. miles &.=0 !ilometres' upstream from the river)s mouth on the English Channel. #he modern cit% has spread from the island &the lie de la Cite' and far be%ond both ban!s of the Seine. #he Cit% of (aris itself covers an area of /1 s6uare miles &1H0 s6uare !ilometres'7 the Freater (aris conurbation$ formed of suburbs and other builtup areas$ e-tends around it in all directions to cover appro-imatel% ?GH s6uare miles. (aris occupies a central position in the rich agricultural region !nown as the (aris <asin$ and it constitutes one of eight djpartements of theIlede>rance administrative region. It is b% far the nation)s most important centre of commerce and culture. "EIF3<O8C >lOO9S 2"9 SIF3#S (aris) man% old buildings$ monuments$ gardens$ pla5as$ boulevards$ and bridges compose one of the world)s grandest cit%scapes. 2n impressive spot from which to view the cit% is the Chaillot (alace$ which stands on a rise on the Cight <an! of the Seine to the west$ where the river begins its southwestward curve. The Chaillot Palace* #he Chaillot (alace dates from the International E-position of 1G.=. It replaced the #rocadjro (alace$ a structure left over from the 1?=? International E-position. #he Chaillot (alace is made up of two separate pavilions$ from each of which e-tends a curved wing. #he ;usje de I)3omme$ the "aval ;useum$ the ;useum of >rench ;onuments$ and the Cinema ;useum are located there. 8nder the terrace that separates the two sections are two theatres$ the "ational #heatre of Chaillot and a small hall that serves as one of the two motion picture houses of the national film librar%. #he terrace$ which is lined b% statues$ gives a splendid view across (aris. #he slope descending to the river has been made into a terraced par!$ the centre of which is alive with fountains$ cascades$ and pools. #he #rocadjro 26uarium is in a grotto a few steps awa% in the par!. >rom the bottom of the slope the fivearched @ena <ridge &(ont d)Ijna' leads across the river. It was built for "apoleon in 1?1. to commemorate his victor% at the<affle of @ena in 1?H1. On the Deft <an! rises the Eiffel #ower$ an unclad metal truss tower designed b% Fustave Eiffel. #he tower was built for the International E-position of 1??G$ against the strident opposition of national figures who thought it unsafe or ugl% or both. +hen the e-position concession e-pired in 1GHG$ the G?/foot &.HHmetre' tower was to have been demolished$ but its value as an antenna for radio transmission saved it. 2dditions made for television transmission have added 01 feet /G1 to the height. >rom the topmost of the three platforms the view e-tends for more than /H miles. >rom the twoacre base of the tower the Champde ;ars &I>ield of ;arsJ'$ an immense field$ stretches to the ;ilitar% 2cadem% &Ecole ;ilitaire'$ which was built from 1=1G to 1==, and is still used b% the +ar College &Ecole Supjrieure de Fuerre'. #he Champde;ars$ which originall% served as the school)s parade ground$ was the scene of two vast rallies during the >rench Cevolution: that of the >ederation &1=GH' and that of the Supreme <eing &1=G/'. >rom 1=G? there were annual national e-positions of crafts and manufactures$ which were followed b% world)s fairs between 1?00 and 1GHH. <ehind the ;ilitar% 2cadem% stands the head6uarters of the 8nited "ations Educational$ Scientific and Cultural Organi5ation &8"ESCO'. #he building$ erected in 1G0?$ was designed b% an international trio of architects and decorated b% artists of member nations. The In$alide"* One street to the northeast is the 3otel des Invalides$ founded b% Douis OIV to shelter =$HHH aged or invalid veterans. #he enormous range of buildings was completed in five %ears &11=1=1'. #he goldplated dome &11=01=H1' that rises above the hospital buildings belongs to the church of SaintDouis. #he dome was designed b% @ules Ilardouin;ansart$ who emplo%ed a st%le !nown in >rance as I@esuitJ because it derives from the @esuits) first church in Come$ built in 101?. #he churches of the >rench 2cadem% &2cadjmie >rancaise'$ the ValdeFrace 3ospital$ and the Sorbonne$ as well as three others in (aris$ all of the 1=th centur%$ followed this st%le. <% using the classical elements more freel% than had been done in Come$ the >rench made it something recogni5abl% (arisian. In the chapels of SaintDouis are the tombs of "apoleon)s brothers @oseph and @jrkme$ of his son &whose bod% was returned from Vienna in 1G/H b% 2dolf 3itler'$ and of the marshals of >rance. Immediatel% beneath the cupola is a red porph%r% sarcophagus that covers the si- coffins$ one inside the other$ enclosing the remains of "apoleon$ which were returned from St. 3elena in 1?/H through the efforts of Uing Douis (hilippe. "apoleon)s uniforms$ personal arms$ and deathbed are displa%ed in the 2rm% ;useum at the front of the Invalides. 2 portion of the Invalides still serves as a militar% hospital7 facilities have been moderni5ed since +orld +ar II. /G, #he vast$ treelined Invalides Esplanade slopes gentl% to the Euai d and the 2le-andre III <ridge. #he first stone for the bridge$ which commemorates the Cussian tsar 2le-ander III$ was laid in 1?G= b% 2le-ander)s son$ #sar "icholas II. #he bridge was finished in time for the International E-position of 1GHH$ and it leads to two other souvenirs of that %ear)s fair$ the Frand (alais and the (etit (alais. #he buildings are still used for annual shows and for ma*or visiting art e-hibits. The )ou$re* Vi!ings camped on the Cight <an! across from the western tip of the lie de la Cite in their unsuccessful siege of (aris in ??0$ and in about 1,HH Uing (hilip II had a s6uare crusader)s castle built on the same site$ *ust outside the new cit% wall$ to buttress the western defenses. Over the following centuries man% additions and renovations were made$ and from the castle grew one of the world)s largest palaces$ completed onl% in 1?0,. >rom the original s6uare$ !nown as the Cour Carr|e &IS6uare CourtJ'$ two galleries e-tend westward for 1$1/H feet$ one along the river$ the other along the rue de Civoli. In 1?=1$ onl% 1G %ears after the huge oblong was completed$ its western face$ the #uileries (alace &begun 101.'$ was destro%ed b% the insurrectionists of the Commune. #wo of the facades of the Cour Carrje had strong influence on >rench architecture. (ierre Descot began his inner court%ard facade in 10/1$ adapting the Cenaissance rh%thms and orders he had observed in Ital% and adding purel% >rench decoration to the classical motifs. #he ph%sician and architect Claude (errault collaborated with Douis De Vau$ architect to the !ing$ to design the outer east face of the palace in 11=.. It$ too$ emplo%s classic elements$ ma!ing especiall% graceful use of coupled columns and a pediment. #he Douvre ;useum occupies the four sides of the palace around the Cour Carrje as well as the south galler%$ which stretches along the river. 2mong the treasures of the museum are the Victor% of Samothrace$ the Venus de ;ilo$ and the ;ona Disa. #he enormous collections contain wor!s from the =th centur% <C to the midlGth centur%$ with a huge cultural and geographic spread. #he north galler%$ along the rue de Civoli$ houses a separate museum$ the ;useum of 9ecorative 2rts$ as well as the ;inistr% of >inance. E-tensive remodeling has been underta!en throughout the Douvre to increase space for art wor!s. Construction began in the earl% 1G?Hs to create a new main entrance and underground reception hail in the vast "apoleon Court%ard$ between the two galleries7 the =Hfoothigh glass p%ramid designed b% I.;. (ei to cover the entrance aroused both strong support and spirited criticism. #he 2rts <ridge &(ont des 2rts'$ which crosses the Seine from the Douvre to the Deft <an!$ is one of the most charming of all the (arisian bridges. It was the first &1?H.' to be made of iron$ and it has alwa%s been reserved for pedestrians: it provides an intimate view of riverside (aris and of the Seine itself. Ile de la Cite* /G. 9ownstream and *ust below the bridge is the tip of the Ile de la Cite$ fashioned into a triangular gravelpathed par! bordered b% flowering bushes$ with rustic benches under the ancient trees. It is surrounded b% a wide cobbled 6ua% that is especiall% popular with sunbathers and lovers. +here the steps come onto the bridge from the par! there is a bron5e e6uestrian statue of Uing 3enr% +$ who insisted on completion of the (ont"euf #he statue is an 1?1? reproduction of the 111/ original$ which was the first statue to stand on a public wa% in (aris. Opposite is the narrow entrance to the (lace 9auphine &11H='$ named for 3enr%)s heir$ the future Douis OIII. #he place was formerl% a triangle of uniform redbric! houses pointed in white stone$ but the row of houses along its base was ripped out in 1?=1 to ma!e room for construction of part of the (alace of @ustice. #he shipshaped lie de la Cite is 1H streets long and five wide. Eight bridges lin! itto the riverban!s and a ninth leads to the scowshaped lie SaintDouis$ which lies to the southeast. #he palace of the earl% Coman governor &now the (alace of @ustice' was rebuilt on the same site b% Douis IO &St. Douis' in the 1.th centur% and enlarged 1HH %ears later b% (hilip IV the >air$ who added the grim$ gra% turreted Conciergerie$ with its impressive Fothic chambers. #he Freat 3ail$ which$ under the !ings$ was the meeting place of the (ariement &the high court of *ustice'$ was !nown throughout Europe for its Fothic beaut%. >ires in 111? and 1?=1 destro%ed much of the original room$ however$ and most of the rest of the palace was devastated b% flames in 1==1. #he Freat 3all now serves as a waiting room for the courts$ in one of which$ the ad*oining first Civil Chamber$ the Cevolutionar% #ribunal sat from 1=G.$ condemning ,$1HH persons to the guillotine. 2fter sentencing$ the victims were ta!en bac! down the stone stairs to the dungeons of the Conciergerie to await the tumbrils. #he Conciergerie still stands and is open to visitors. In the palace court%ards is found one of the great monuments of >rance$ the 1.thcentur% SainteChapelle &TChapelJ'. <uilt at Douis IOs direction between 1,/. and 1,/?$ it is a masterpiece of Fothic Ca%onnant st%le. +ith great daring$ the architect &possibl% (ierre de ;ontreuil' poised his vaulted ceilings on a trellis of slender columns$ the walls between being made of stained glass. #he e-6uisite chapel was designed to hold the Crown of #horns$ thought to be the ver% one worn b% @esus at his crucifi-ion. Douis IO had purchased the relic from the Venetians$ who held it in pawn from <aldwin$ the Datin !ing of <%5antium. Other hol% relics$ such as nails and pieces of wood from the #rue Cross$ were added to the chapel)s collection$ the remnants of which are now in the treasur% of "otre9ame. 8nder Uing Douis(hilippe &1?.H/?'$ the Isaniti5ationJ of the island was begun$ and it was continued for his successor$ "apoleon III$ b% <aron Feorges /G/ 3aussmann. #he pro*ect involved a mass clearing of anti6uated structures$ widening of streets and s6uares$ and the erection of massive new government offices$ including parts of the (alace of @ustice. #he portion of the palace that borders the Euai des Orf}vres formerl% the goldsmiths) and silversmiths) 6ua%ebecame the head6uarters of the (aris municipal detective force$ the (olice @udiciaire &I@udicial (oliceJ'$ which !eeps a small museum on the fourth floor. 2cross the boulevard du (alais is the (olice (refecture$ another 1Gthcentur% structure. On the far side of the prefecture is the (lace du (arvis"otre9ame$ an open space enlarged si- times b% 3aussmann$ who also moved the 3ktel9ieu$ the first hospital in (aris$ from the riverside to the inland side of the s6uare. Its present buildings date from 1?1?. -otre0Dame de Pari"* 2t the east end of the s6uare is the cathedral of "otre 9ame de (aris$ which is situated on a spot that (arisians have alwa%s reserved to the practice of religious rites. #he FalloComan boatmen of the cite erected their altar to @upiter there &it is now in the Clun% ;useum'$ and$ when Christianit% was established$ a church was built on the temple site. #he first bishop of (aris$ St. 9enis$ became its patron saint. #he red in the colours of (aris represents the blood of this mart%r who$ in popular legend$ after decapitation$ pic!ed up his head and wal!ed. +hen ;aurice de Sull% became bishop in 110G he decided to replace the decrepit cathedral of SaintEtienne and the 1thcentur% "otre9ame with a church in the new Fothic st%le. #he st%le was conceived in >rance$ and a new structural development$ the fl%ing buttress$ which added to the beaut% of the e-terior and permitted interior columns to soar to new heights$ was introduced in the building of "oire9ame. Construction began in 111. and continued until 1./0. 2fter being damaged during the >rench Cevolution$ the church was sold at auction to a buildingmaterials merchant. "apoleon came to power in time to annul the sale$ and he ordered that the edifice be redecorated for his coronation as emperor in 1?H/. Douis(hilippe later initiated restoration of the neglected church. #he architect Eugene Violletle9uc wor!ed from 1?/0 to 1?1/ to restore the monument. Di!e all cathedrals in >rance$ "otre9ame is the propert% of the state$ although its operation as a religious institution is left entirel% to the Coman Catholic Church. /G0 2 few 11th and 1=thcentur% buildings survive north of the cathedral. #he% are what remain of the Cloister of the Cathedral Chapter$ whose school was famous long before the new cathedral was built. Earl% in the 1,th centur%$ one of its theologians$ (eter 2belard$ left the cloister with his disciples$ crossed to the Deft <an!$ and set up an independent school in the open air in the Convent of the (araclete near the present (lace ;aubert. 2fter a prolonged struggle with the mon!s of Saint 9enis the followers of 2belard in 1,HH won the right$ from both the !ing and the pope$ to form and govern their own communit%. #his was the beginning of the 8niversit% of (aris. Rue de Ri$oli* #he Douvre and the #uileries Fardens ta!e up the south side of this street$ and on the other side runs an arcade more than a mile long. Opposite the middle of the Douvre$ the (lace du (alaisCo%al leads to the palace of Cardinal de Cichelieu$ which he willed to the ro%al famil%. Douis OIV lived there as a child$ and during the minorit% of Douis OV the !ingdom was ruled from there b% the debauched but gifted regent (hilippe II$ duc d)Orljans from 1=10 to 1=,.. Date in the 1?th centur% Douis (hilippe d)Orljans$ who was popularl% renamed (hilippeEgalitj during the Cevolution for his radical opinions$ undertoo! e-tensive building around the palace garden. It was a commercial operation$ and the (rince hoped to pa% his debts from the propert% rents. 2round the garden he built a beautiful oblong of colonnaded galleries and at each end of the galler% farthest from his residence a theatre. #he larger pla%house has been the home of the Comjdie>ranzaise$ the state theatre compan%$ since "apoleon)s reign. #he princel% apartments now shelter high state bodies such as the Council of State. @ust behind the court%ard is the <iblioth}6ue "ationale &"ational Dibrar%'$ the national librar% of deposit$ with an enormous collection of boo!s and prints. 3aussrnann greatl% enlarged the (lace du (alaisCo%al in 1?0,$ and he was careful to preserve the palace when he laid out the avenue de l)Opjra. 2t the top of the avenue$ where the Frands <oulevards crossed an enormous new place$ the new opera house was built from 1?,0 to 1?G?. #he (aris Opera 3ouse$ a splendid monument to the Second Empire$ was designed in the neo<aro6ue st%le b% Charles Famier. It is !nown especiall% for its decorative embellishments$ chief among them the Frand Staircase. @ust behind the Opera 3ouse are various large department stores. #he ne-t place along the rue de Civoli is the (lace des (%ramides. #he gilded e6uestrian statue of @oan of 2rc stands not far from where she was wounded at the /G1 Saint 3onorj Fate &(orte Saint3onorj' in her unsuccessful attac! on (aris &at that time held b% the English'$ on Sept. ?$ 1/,G. >arther along toward the (lace de la Concorde the rue de Castiglione leads to the (lace Vendkme$ an elegant octagonal place$ little changed from the 11G? designs of @ules 3ardouin;ansart. In the centre$ the Vendkme Column bears a statue of "apoleon. It was pulled down during the Commune and put bac! up under the #hird Cepublic &1?= 11G/H'. #he place and the rue de la (ai- have lost none of their discreet distinction$ nor have their shops. The 9Triumphal Way*= >rom the 2rc de #riomphe du Carrousel$ in the court%ard between the open arms of the Douvre$ e-tends one of the most remar!able perspectives to be seen in an% modern cit%. It is sometimes called la Voie #riomphale & #riumphal +a%KK'. >rom the middle of the Carrousel arch the line of sight runs the length of the #uileries Fardens$ lines up on the obelis! in the (lace de Ia Concorde$ and goes up the ChampsEl%sees to the centre of the 2rc de #riomphe and be%ond to the s!%scrapers of Da 9efense$ in the western suburbs. #he DouvrVs modest triumphal arch stands in the open space where costumed nobles performed in an e6uestrian displa% carrouselto celebrate the 9auphin)s birth in 111,. #he design of the arch$ an imitation of that of the 2rch of Septimius Severus in Come$ was conceived in 1?H? b% Charles (ercier and (ierre >ontaine. #he flan!s of the Carrousel arch are incised with a record of "apoleon)s victories. #he #uileries Fardens$ which fronted the #uileries (alace &looted and burned in 1?=1 during the Commune'$ have not altered much since 2ndrj De "ktre redesigned them in 111/. De "ktre was born and died in the gardener)s cottage in the #uileries7 he succeeded his father there as master gardener. 3is design carried the line of the central allje be%ond the gardens and out into the countr%side b% tracing a path straight along the wooded hill west of the palace. On this hilltop$ 1=H %ears later$ the 2rc de #riomphe was erected. #he (lace de la Concorde was designed as a moated octagon in 1=00 b% @ac6ues2nge Fabriel. #he river end was left open$ and on the inland side two matching buildings were planned. Viewed cloc!wise starting from the "av% ;inistr% &;inistsre de la ;arine'$ the statues are Dille$ Strasbourg$ D%on$ ;arseille$ <ordeau-$ "antes$ <rest$ and Couen. Douis(hilippe also had the Du-or Obelis!$ a gift from Eg%pt$ installed in the centre and flan!ed b% two fountains /G= <etween the twin buildings on the northeastern side of the place$ the broad rue Co%ale mounts to the Church of Sainte;arie;adeleine$ consecrated in 1?/,. #he church is a stern oblong$ fenced with columns 1H feet high. Its design$ supposedl% that of a Free! temple$ is actuall% closer to the Coman notion of Free!. #he (lace de la ;adeleine is the western terminus of the Frands <oulevards$ which imitate the arch of the river from there north and east to the (lace de la Cepubli6ue and the <astille. #o the west off the rue Co%ale runs the rue du >aubourg Saint3onorj$ which$ in addition to the <ritish Embass% and the El%see (alace &residence of the >rench president'$ has on its shop windows some of the most prestigious names in the (aris fashion trade. 2long the first ,$0HH feet of the ChampsEl%sjes$ between Concorde and the Cond(oint des Champs El%sjes &a roundabout$ or traffic circle'$ little has changed for a centur%: the avenue is bordered with chestnut trees$ behind which on both sides are gardens$ usuall% full of children at pla%. #he pavilions in the gardens are used as tearooms$ restaurants$ and theatres. >rom the Cond(oint up to the 2rc de #riomphe$ however$ the avenue has changed with the times. 8nder the Second Empire this was a street of lu-urious town houses. #he% were supplanted b% cafjs$ nightclubs$ lu-ur% shops$ and cinemas$ but the Street retained its feeling of lu-ur%$ and the treeshaded sidewal!s &wide as a normal Street' offered promenades that were the pride of (aris. Since the 1G0Hs$ however$ ban!s$ automobile showrooms$ airline offices$ and fast food eateries have ta!en over much of the space. 2t the top of the ChampsEl%s|es is a circular place from which 1, imposing avenues radiate to form a star &jtoile'. It was called (lace de l)Etoile from 1=0. until 1G=H$ when it was renamed (lace Charles de Faulle. In the centre of the place is the 2rc de #riomphe$ commissioned b% "apoleon in 1?H1. It is twice as high and as wide as the 2rch of Constantine$ in Come$ which inspired it. @ean Chaigrin was the architect and >ranzois Cude sculpted the frie5e and the spirited group$ T#he 9eparture of the Volunteers of 1=G,J &called IDa ;arseillaiseJ'. On 2rmistice 9a% in 1G,H$ the 8n!nown Soldier was buried under the centre of the arch$ and each evening the flame of remembrance is re!indled b% a different patriotic group. The )atin &uarter M&uartier )atinN* 2t the Concorde <ridge the boulevard SaintFermain begins$ curving eastward to *oin the river again at the Sull% <ridge. 2 little less than halfwa% along the boulevard is the preFothic church of SaintFermain des(rjs. #he old church$ which belonged to a <enedictine abbe% founded in the ?th centur%$ was sac!ed four times b% Vi!ings and was rebuilt between GGH and 1,H1. (arts of the present church date from that time. <e%ond the boulevard Saint;ichel is the universit% precinct$ selfgoverning under the !ings$ where$ in class and out$ students and teachers spo!e Datin until 1=?G. 2t the *unction of the boulevards SaintFermain and Saint ;ichel are the remains of one of the three baths of the Coman cit%. #hese are in the grounds of the Clun% ;useum$ a Fothic mansion built 1/?010HH$ which now houses a collection of medieval wor!s of art$ including the renowned si-panel unicorn tapestr% IDa 9ame a Ia licorne.J #he wide$ straight boulevard Saint;ichel is the main street of the student 6uarter. It is lined with boo!shops$ cafjs$ cafeterias$ and movie houses. #he buildings of the universit% are found on smaller streets. #he universit% was built up of colleges$ /G? each founded and supported b% a donor$ often a prelate or a religious order. In about 1,0= Cobert de Sorbon$ chaplain to Douis DO$ established a college$ !nown as the Sorbonne$ that eventuall% became the centre of theological stud% in >rance. #he oldest part of the Sorbonne is the chapel &11.0/,'$ the gift of Cichelieu$ who is buried there. 9esigned b% Demercier$ it was one of a number of new domed @esuitst%le churches of the period. #he Sorbonne served for centuries as the administrative seat of the 8niversit% of (aris. In 1G1?=1 the universit% was divided into a number of entirel% separate universities$ and the Sorbonne building proper continues to serve as premises for some of these. 2t the top of the hill rising from the river the boulevard s!irts the Du-embourg Fardens$ the remains of the par! of ;arie de ;jdicis) Du-embourg (alace &1111 ,1'$ which now houses the >rench Senate. #he gardens are planted with chestnuts and are enhanced with a pond for to% sailboats$ a marionette theatre$ and statuar%. 2cross the boulevard at the end of the rue Soufflot stands the (antheon &1=00 G,'$ designed b% @ac6ues Fermain Soufflot. It was commissioned b% Douis OV$ after his recover% from an illness$ as a votive offering to St. Fenevieve and was to replace the mouldering 0th centur% abbe% in her name. #hough intended as the principal church in (aris$ it was renamed the (antheon b% the Cevolutionar% authorities$ who made it the last resting place for heroes of the Cevolution. #he walling up of a number of its windows and removal of much interior decoration replaced the intended effect of light interior space with a gloom% dignit%. 2mong those buried under the inscription I2u- grands bommes$ la (atrie reconnaissanteJ &I#o great men$ f their grateful landJ' are the authors Victor 3ugo$ Voltaire$ Cousseau$ and Yola and @ean ;oulin$ chief of the Cesistance in +orld +ar II. The /utte"* #he river valle% of (aris is almost entirel% circled b% high ground. 8pon the heights of (ass%$ on the Cight <an! between the western cit% limits and the 2rc de #riomphe$ perch the wealth% neighbourhoods of the 11 th arrondissement. #he <utte;ontmartre &1? th arrondissement' and the <uttes Chaumont& 1Gth arrondissement'$ which rise along the northern rim of the cit%$ are still wor!ingclass. #he 1?th arrondissement has broad avenues$ but it also has winding lanes$ some of which become stairwa%s on the steeper hills$ >rom the earl% 1Gth centur% until the migration in the 1G,Hs to ;ontparnasse$ ;ontmartre was the ma*or art colon% of (aris. Some sections are highl% commerciali5ed for the tourist trade7 others$ however$ are unselfconsciousl% pictures6ue. ;ontmartre is !nown for its nightclubs and entertainment. #he most noted landmar! of ;ontmartre was built onl% in 1G1G: the Sacred 3eart <asilica &<asili6ue du SacrdCoeur'$ paid for b% national subscription after the >rench defeat b% the (russians in 1?=H. #he wor! began in 1?=1 but was dela%ed b% the death of the architect$ (aul 2badie$ who too! inspiration from the 1,thcentur% fivedomed Comanes6ue church of Saint>ront in (jrigueu-$ itself inspired b% either Venetian or <%5antine churches. /GG <asili6ue du SacrjCoeur 6oreign ,ours The /ahama" Officiall% CO;;O"+E2D#3 O> #3E <232;2S$ archipelago and state on the northwestern edge of the +est Indies$ consisting of about =HH islands and ca%s and more than ,$HHH low$ barren roc! formations$ located off the southeastern coast of >lorida$ 8.S. #he archipelago is spread across the #ropic of Cancer and about GH$HHH s6uare miles &,..$HHH s6uare !m' of ocean in the western 2tlantic. 2ndros &1H/ miles long and /H miles wide p11= !m long and 1/ !m wideg is the largest of the islands. #he capital is "assau on "ew 0HH (rovidencethe most important island. 2rea 0$.?, s6uare miles &1.$G.G s6uare !m'. (op. &1GG. est.' ,11$HHH. The land* "ew (rovidence has the ma*orit% of the archipelago)s population. #he rest of the islands$ chief among which are 2baco$ 2ndros$ and Eleuthera$ are called the >amil%$ or Out$ Islands. 2ll the islands of the archipelago are composed of coraline limestone$ lie mostl% onl% a few feet above sea level$ and are generall% flat. #he highest point$ ;ount 2lvemia &formerl% Como 3ill'$ rises ,H1 feet &1. m' on Cat Island. ;ost of the islands are long and narrow$ each rising from its eastern shore to a low ridge$ be%ond which lie lagoons and mangrove swamps7 coral reefs mar! the shorelines. #here are no rivers in #he <ahamas. #he mild subtropical climate of #he <ahamas$ with two seasons &winter and summer is greatl% influenced b% the Fulf Stream and 2tlantic Ocean bree5es. #he average temperature varies from =H~> &,1~C' during the winter to ?1~ > &,=~ C' during the summer7 average annual rainfall is about // inches &1$1,H mm'$ though there is some variation between the islands. #he hurricane season lasts from mid@ul% to mid"ovember. #he islands abound in tropical flora$ including bougainvillea$ *asmine$ orchid$ and oleander. Caribbean pine forests occur on some islands$ such as 2ndros$ Freat 2baco$ and Frand <ahama. "ative trees include the blac! olive$ cor! tree$ and several species of palm7 mahogan%$ casuarina$ and cedar trees have been planted on some islands. 2nimal life is dominated b% frogs$ li5ards$ and sna!es7 mos6uitoes$ sandflies$ and termites are widespread. #here are numerous species of birds$ including the flamingo$ the national bird. #he Inagua "ational (ar! on Freat Inagua Island is the home of more than 0H$HHH +est Indian flamingos$ the largest such floc! in the world. Salt$ aragonite$ and limestone are the onl% commerciall% important minerals. Salt is produced largel% b% solar evaporation from salt beds on Freat Inagua. The people* #he people of #he <ahamas are a blend of European and 2frican ancestr%$ the latter a legac% of the slave trade. English is the official language$ and almost all of the 0H1 population is Christian. <aptists account for about onethird of the population$ and 2nglicans and Coman Catholics each constitute appro-imatel% onefifth of the total. Onl% about .H of the islands and ca%s are inhabited. 9uring the 1G=Hs there was significant ruraltourban interisland migration$ mostl% directed to the alread% densel% populated islands of "ew (rovidence &where twothirds of the populace lives'$ Frand <ahama$ and Freat 2baco. Dong Ca%$ on the other hand$ had onl% a few do5en inhabitants. 2verage population densit% for the countr% is relativel% low. #he population growth rate of #he <ahamas was relativel% high during the late 1G=Hs &a trend that continued intermittentl% through the 1G?Hs'$ mostl% because of a substantial birth rate7 conse6uentl%$ almost twofifths of the populace is %ounger than 10 %ears of age. #he death rate is relativel% low. The Economy* #he <ahamas has a predominantl% mar!et econom% that is heavil% dependent on tourism and international financial services. #he gross national product &F"(' is growing much more rapidl% than the population. #he F"( per capita is similar to those of other developed countries. 2griculture accounts for about onetwentieth of the F"( and emplo%s a comparable fraction of the wor!force. Onl% about 1 percent of the land is arable$ and soils are shallow. #he government has had onl% limited success in increasing agricultural output$ and nearl% all of the countr%)s foodstuffs are imported$ largel% from the 8nited States. #he sunn% climate favours the cultivation of tomato$ pineapple$ banana$ mango$ guava$ sapodilla$ soursop$ grapefruit$ and sea grape. Some pigs$ sheep$ and cattle are raised. #he small fishing industr%)s catch is dominated b% cra%fish$ groupers$ and conchs. ;ineral industries are limited to the production of salt and cement. Frand <ahama has several petroleum transshipment terminals. ;anufacturing industries centre on the production of rum and other li6uors$ cement$ pharmaceuticals &including hormones'$ canned tomatoes and pineapples$ and fro5en cra%fish. #he Industries Encouragement 2ct offers manufacturers relief from tariffs and various ta-es. Electricit% is generated entirel% from imported fuels. #ourism accounts for as much as twothirds of the F"( and emplo%s about twofifths of the wor!force. It centres on "ew (rovidence and Frand <ahama7 most tourists come from the 8nited States. Several hundred ban!s and trust companies have been attracted to #he <ahamas because there are no income or corporation ta-es and because the secrec% of financial transactions is guaranteed. (ublic e-penditures are constrained b% the government)s dependence on indirect ta-es$ which are levied primaril% on tourism and e-ternal trade. #he 8nited States is #he <ahamas) principal trading partner and e-empts certain <ahamian products from duties under the generali5ed s%stem of preferences. "assau and >reeport$ the latter on Frand <ahama Island$ are the countr%)s two main ports and also have international airports. Cultural life* Outstanding among traditional group activities is the I@un!anooJ parade on <o-ing 9a% and "ew :ear)s 9a%. #he main thoroughfare is given over to hundreds of gail% bedec!ed celebrants who$ with clanging cowbells and beating drums$ march and dance to a rh%thm of 2frican origin. In "assau$ amateur choral$ dramatic$ and dancing groups provide entertainment with much local flavour. 0H, ,i"tory* #he <ahamas were originall% inhabited b% a group of 2rawa! Indians !nown as Duca%an. Originall% from the South 2merican continent$ some of the 2rawa! had been driven north into the Caribbean b% the Carib Indians. 8nli!e their Carib neighbours$ the Duca%an were generall% peaceful$ more involved in fishing than agriculture$ and noncannibalistic. +hen Columbus reached the "ew +orld in 1/G,$ he is thought to have landed on San Salvador &also called +atling Island' or possibl% Sarnana Ca%$ both in the <ahamas. #he Spaniards made no attempt to settle but operated slave raids on the peaceful 2rawa! that depopulated the islands$ and b% the time the English arrived the <ahamas were uninhabited. In 11,G Charles I of England granted the islands to one of his ministers$ but no attempt at settlement was made. In 11/? +illiam Sa%le led a group of English (uritans from <ermuda to$ it is thought$ Eleuthera Island. #his settlement met with e-treme adversit% and did not prosper$ but other <ermudian migrants continued to arrive. "ew (rovidence was settled in 1101. <% 11=H the <ahamas were given to the 9u!e of 2lbemarle and five others as a proprietar% colon%. #he proprietors were mostl% uninterested in the islands$ and few of the settlements prospered. (irac% became a wa% of life for man%. #he colon% reverted to the crown in 1=1=$ and serious efforts were made to end the pirac%. #he first ro%al governor$ +oodes Cogers$ succeeded in controlling the pirates but mostl% at his own e-pense. Dittle monetar% and militar% support came from England. Conse6uentl%$ the islands remained poor and susceptible to Spanish attac!. 3eld for a few da%s b% the 8.S. "av% in 1==1$ and for almost a %ear b% Spain in 1=?,?.$ the islands reverted to England in 1=?. and received a boost in population from lo%alists and their slaves who fled the 8nited States after the 2merican Cevolution. >or a time$ cotton plantations brought some prosperit% to the islands$ but when the soil gave out and slaver% was abolished in 1?./$ the <ahamas) endemic povert% returned. #wo other periods of prosperit% followed: the %ears 1?1110$ when the <ahamas became a centre for bloc!ade runners during the 2merican Civil +ar$ and in 1G,H..$ when bootlegging became big business during the %ears of 2merican (rohibition. <ut these were economic accidents7 not until the tourist industr% was developed after +orld +ar II did an% form of pennanent prosperit% come to the islands 0H. International Trade International trade includes all economic transactions that are made between countries. 2mong the items commonl% traded are consumer goods$ such as television sets and clothing7 capital goods$ such as machiner%7 and raw materials and food. Other transactions involve services$ such as travel services and pa%ments for foreign patents. International trade transactions are facilitated b% international financial pa%ments$ in which the private ban!ing s%stem and the central ban!s of the trading nations pla% important roles. International trade and the accompan%ing financial transactions are conducted generall% toward the purpose of providing a nation with commodities it lac!s in e-change for those that it produces in abundance7 such transactions$ functioning with other economic policies$ generall% improve the standard of living of a nation. #his article provides a historical and contemporar% overview of the structure of international trade$ of the classic controvers% over free versus controlled trade$ and of the problems that arise in transactions between nations. The theory of international trade *+,#.Y 2ccounts of barter of goods or of services among different peoples can be traced bac! almost as far as the record of human histor%. International trade$ however$ is specificall% an e-change between members of different nations$ and accounts and e-planations of such trade begin &despite fragmentar% earlier discussion' onl% with the rise of the modern nation0"tate at the close of the European ;iddle 2ges. 2s political thin!ers and philosophers began to e-amine the nature and function of the nation$ trade with other nations became a particular topic of their in6uir%. It is$ accordingl%$ no surprise to find one of the earliest attempts to describe the function of international trade within that highl% nationalistic bod% of thought now !nown as Fmercantili"m*F ;ercantilist anal%sis$ which reached the pea! of its influence upon European thought in the 11th and 1=th centuries$ focused directl% upon the welfare of the nation. It insisted that the ac6uisition of wealth$ particularl% wealth in the form of #old$ was of paramount importance for national polic%. ;ercantilists too! the virtues of gold almost as an article of faith7 conse6uentl%$ the% never undertoo! to e-plain ade6uatel% wh% the pursuit of gold deserved such a high priorit% in their economic plans. #he trade polic% dictated b% mercantilist philosoph% was accordingl% simple: encourage e-ports$ discourage imports$ and ta!e the proceeds of the resulting e-port surplus in gold. <ecause of their nationalistic bent$ mercantilist theorists either brushed aside or else did not reali5e that$ from an international viewpoint$ this polic% would necessaril% prove selfdefeating. #he nation that successfull% gains an e-port surplus must ordinaril% do so at the e-pense of one or more other nations that record a matching import surplus. ;ercantilists] ideas often were intellectuall% shallow$ and indeed their trade polic% ma% have been little more than a rationali5ation of the interests of a rising merchant class that wanted wider mar!etshence the emphasis on e-panding e-portscoupled with protection against competition in the form of imported goods. :et mercantilist policies$ as will be noted later$ are b% no means completel% dead toda%. 0H/ C.MPARATIVE0ADVA-TA:E A-A)YSIS #he <ritish school of Fcla""ical economic"F began in no small measure as a reaction against the inconsistencies of mercantilist thought. Adam Smith was the 1?thcentur% founder of this school7 his famous wor!$ The ;ealth of 5ations &1==1'$ is in part an antimercantilist tract. In The $ealth of Nations& Smith emphasi5ed the importance of speciali5ation as a source of increased output$ and he treated international trade as a particular instance of "pecialiIation: in a world where productive resources are scarce and human wants cannot be completel% satisfied$ each nation should speciali5e in the production of goods it is particularl% well e6uipped to produce7 it should e-port part of this production$ ta!ing in e-change other goods that it cannot so readil% turn out. Smith did not e-pand these ideas at much length7 but Da$id Ricardo$ the second great classical economist$ developed them into the cprinciple of comparative advantage$c a principle still to be found$ much as Cicardo spelled it out$ in ever% te-tboo! on international trade. Simplified theory of comparati$e ad$anta#e* >or clarit% of e-position$ the theor% of comparati$e ad$anta#e is usuall% first outlined as though onl% two countries and onl% two commodities were involved$ although the principles are b% no means limited to such cases. 2gain for clarit%$ the cost of production is usuall% measured onl% in terms of labour time and effort7 the cost of a unit of cloth$ for e-ample$ might be given as two hours of wor!. #he two countries will here be 2 and <7 and the two commodities produced$ wine and cloth. #he labour time re6uired to produce a unit of either commodit% in either countr% is as follows: cost of production &labour time' country 5 country B wine 7? unit9 ? hour A hours cloth 7? unit9 A hours M hours 2s compared with countr% 2$ countr% < is productivel% inefficient. Its wor!ers need more time to turn out a unit of wine or a unit of cloth. #his relative inefficienc% ma% result from differences in climate$ in wor!er training or s!ill$ or in the amount of available tools and e6uipment$ or from numerous other possible reasons. Cicardo too! it for granted that such differences do e-ist$ and he was not concerned with their origins. Countr% 2 is said to have an absolute advantage in the production of both wine and cloth because it is more efficient in the production of both goods. 2ccordingl%$ 2]s absolute advantage seemingl% invites the conclusion that countr% < could not possibl% compete with countr% 2$ and indeed that if trade were to be opened up between them$ countr% < would be competitivel% overwhelmed. Cicardo insisted that this conclusion is false. #he critical factor is that countr% <]s disadvantage is less pronounced in wine production$ in which its wor!ers re6uire onl% twice as much time for a single unit as do the wor!ers in 2$ than it is in cloth production$ in which the re6uired time is three times as great. #his means$ Cicardo pointed out$ that countr% < will have a comparative advantage in wine production. <oth countries will profit$ in terms of the real income the% en*o%$ if countr% < speciali5es in wine production$ e-porting part of its output to countr% 2$ and if countr% 2 speciali5es in cloth production$ e-porting part of its output to countr% <. (arado-ical though it ma% seem$ it is preferable for countr% 2 to leave wine production to countr% <$ despite the fact that 2]s wor!ers can produce wine of e6ual 6ualit% in half the time that <]s wor!ers can do so. #o illustrate this conclusion$ it can be considered that countr% 0H0 2]s total labour force consists of .HH wor!ers. 9isregarding the possibilit% of trade with <$ 2 then has a choice of various outputs of cloth and of wine$ depending on the number of wor!ers engaged in each of the two occupations. #his range of choices is illustrated b% the line 9E> in the accompan%ing diagram. If all .HH labourers wor! on cloth production$ total hourl% cloth output will be 10H units &point 9 in the diagram'$ since each such unit re6uires two hours] labour. 2t the other e-treme$ if all labour wor!s on wine production$ wine output will be .HH units per hour &point >'. 2n% intermediate point on the line 9E> is possible. (oint E$ for e-ample$ indicates ?H units of cloth produced each hour &11H wor!ers so emplo%ed' and 1/H units of wine &emplo%ing the other 1/H wor!ers'. 9E> is countr% 2]s cproduction possibilit%c line. If it does not trade with countr% < and so can consume onl% what it produces itself$ 9E> will also be countr% 2]s cconsumption possibilit%c line7 it will choose some point thereon$ depending on the preferences of its citi5ens for wine and cloth. 9E> represents the limit of production and consumption possibilities7 points above and to the right of 9E> are unattainable. In the righthand diagram$ the line F3@ has e-actl% the same production and consumption significance for countr% <assuming its total force to be 1HH wor!ers &so as to ma!e it roughl% e6ual to 2 in total output capacit%'. #he position of the line F3@ reflects the fact that labour in countr% < re6uires two hours to produce a unit of wine$ and si- hours for a unit of cloth. One ma% consider that 2 and < are initiall% isolated from one another. Countr% 2 has chosen point E &?H cloth$ 1/H wine' as its production consumption point. Countr% < has chosen point 3 &00 cloth$ 1.0 wine'. #he opportunit% of free trade between the two countries is now opened up. If both countries want to attain the higher levels of production and consumption available to them through speciali5ing on and trading of the product for which the% have a comparative advantage$ Countr% 2 will shift its entire labour force to cloth production$ and Countr% < will shift its entire labour force to wine production. 2 possible barter rate &setting aside the detail of how this would be wor!ed out' might be one cloth for two and onehalf wine. Countr% 2 might then choose to e-port 1H units of its hourl% cloth output of 10H$ !eeping the other GH for domestic consumption. In e-change for this 1H cloth &at the 1for, 1B, e-change rate' it would receive 10H wine. 2]s real income position is thus improved in comparison with pretrade point E: cloth for domestic consumption has risen from ?H to GH$ and wine consumption has risen from 1/H to 10H. Countr% < en*o%s a similar gain. In comparison with pretrade point 3$ its cloth consumption has risen from 00 to 1H$ and wine consumption has risen from 1.0 to 10H. #he incentive to e-port and to import can be e-plained in price terms. In countr% 2 &before international trade'$ the price of cloth ought to be twice that of wine$ since a unit of cloth re6uires twice as much labour effort. If this price ratio is not satisfied$ one of the two commodities will be overpriced and the other underpriced. Dabour will then move out of the underpriced occupation and into the other$ until the resulting shortage of the underpriced commodit% drives up its price. In countr% < &again$ before trade'$ a cloth unit should cost three times as much as a wine unit$ since a unit of cloth re6uires three times as much labour effort. 3ence$ a t%pical beforetrade price relationship$ matching the underl%ing real cost ratio in each countr%$ might be as follows: countr% 2 countr% < (rice of wine per unit N 0 1 (rice of cloth per unit N1H . 0H1 #he absolute levels of price do not matter. 2ll that is necessar% is that in each countr% the ratio of the two prices should match the labourcost ratio. 2s soon as the opportunit% of e-change between the two countries is opened up$ the difference between the winecloth price ratio in countr% 2 &namel%$ 0:1H$ or 1:,' and that in countr% < &which is 1:.' provides the opportunit% of a trading profit. Cloth will begin to move from 2 to <$ and wine from < to 2. 2 trader in 2$ starting with a capital of N1H for e-ample$ would bu% a unit of cloth$ sell it in < for Z.$ bu% . units of <]s wine with the proceeds$ and sell this in 2 for N10. &#his e-ample assumes$ for simplicit%$ that costs of transporting goods are negligible or 5ero. #he introduction of transport costs complicates the anal%sis somewhat$ but it does not change the conclusions$ unless these costs are so high as to ma!e trade impossible.' So long as the ratio of prices in countr% 2 differs from that in countr% <$ the flow of goods between the two countries will steadil% increase as traders become increasingl% aware of the profit to be obtained b% moving goods between the two countries. (rices$ however$ will be affected b% these changing flows of goods. #he wine price in countr% 2$ for e-ample$ can be e-pected to fall as larger and larger supplies of imported wine become available. #hus 2]s winecloth price ratio of 1:, will fall. >or comparable reasons$ <]s price ratio of 1:. will rise. +hen the two ratios meet$ at some intermediate level &in the e-ample earlier$ at 1:, 1B,'$ the flow of goods will stabili5e. Amplification of the theory* 2t a later stage in the histor% of comparativeadvantage theor%$ the English philosopher and political economist (ohn Stuart Mill showed that the determination of the e-act aftertrade price ratio was a "upply0and0demand problem. 2t each possible intermediate ratio &within the range of 1:, and 1:.'$ countr% 2 would want to import a particular 6uantit% of wine and e-port a particular 6uantit% of cloth. 2t that same possible ratio$ countr% < would wish to import and e-port particular amounts of cloth and of wine. >or an% intermediate ratio ta!en at random$ however$ 2]s e-port import 6uantities probabl% will not match those of <. Ordinaril%$ there will be *ust one intermediate ratio at which the 6uantities correspond7 that is the final trading ratio at which 6uantities e-changed will stabili5e. &Once the% have stabili5ed$ there is no longer an% profit in e-changing goods. Even with such profits eliminated$ however$ there is no reason wh% 2 producers should want to stop selling part of their cloth in <$ since the return there is as good as that obtained from domestic sales. 2n% falloff in the amounts e-ported and imported would reintroduce profit opportunities.' In the elementar% labourcost e-ample used above$ there will be complete speciali5ation: countr% 2]s entire labour force will move to cloth production and countr% <]s to wine production. ;ore elaborate comparativeadvantage models recogni5e production costs other than labour &that is$ the costs of land and of capital'. In such models$ part of countr% 2]s wine industr% ma% survive and compete effectivel% against imports$ as ma% also part of <]s cloth industr%. #he models can be e-panded in other wa%s: to ta!e account of more than two countries$ or more than two commodities$ and of transport costs. #he essential conclusions$ however$ come from the elementar% model used above$ so that this model$ despite its simplicit%$ still provides a wor!able outline of the theor%. &It should be noted that even the most elaborate comparativeadvantage models continue to rel% on certain simplif%ing assumptions without which the basic conclusions do not necessaril% hold. #hese assumptions are discussed below.' 2s noted earlier$ the effect of this anal%sis is to correct an% false first impression that 0H= lowproductivit% countries are at a hopeless disadvantage in trading with high productivit% ones. #he impression is false$ that is$ if one assumes$ as comparative advantage theor% does$ that international trade is an e-change of goods between countries. It is pointless for countr% 2 to sell goods to countr% <$ whatever its labour cost advantages$ if there is nothing that it can profitabl% ta!e bac! in e-change for its sales. +ith one e-ception$ there will alwa%s be at least one commodit% that a low productivit% countr% such as < can successfull% e-port. Countr% < must of course pa% a price for its low productivit%$ as compared with 27 but that price is a lower per capita domestic income and not a disadvantage in international trading. >or trading purposes$ absolute productivit% levels are unimportant7 countr% < will alwa%s find one or more commodities in which it en*o%s a comparative advantage7 that is$ a commodit% in the production of which its absolute disadvantage is least. #he one e-ception is that case in which productivit% ratios$ and conse6uentl% pretrade price ratios$ happen to match one another in two countries. Such would have been the case had countr% < re6uired four labour hours &instead of si-' to produce a unit of cloth. In this particular circumstance$ there would be no incentive for either countr% to engage in trade$ and no gain from trading. In a twocommodit% e-ample such as that emplo%ed$ it might not be unusual to find matching productivit% and price ratios. <ut as soon as one moves on to cases of three and more commodities$ the statistical probabilit% of encountering precisel% e6ual ratios becomes ver% small indeed. #he ma*or purpose of the theor% of comparative advantage is to illustrate the gains from international trade. Each countr% can gain b% speciali5ing in those occupations in which it is relativel% efficient7 it should e-port part of that production and ta!e in e-change those goods in whose production it is$ for whatever reason$ at a comparative disadvantage. #he theor% of comparative advantage thus provides a strong argument for free tradeand indeed for a laisse5faire attitude with respect to trade. #he supporting argument is simple: speciali5ation and free e-change among nations %ield higher real income for the participants. #he fact that a countr% will en*o% higher real income as a conse6uence of the opening up of trade does not mean$ of course$ that ever% famil% or individual within the countr% must share in that benefit. (roducer groups affected b% import competition obviousl% will suffer$ to at least some degree. Comparativeadvantage theorists concede that free trade would affect the relative income position of such groups$ and perhaps even their absolute income level. <ut the% insist that the special interest of these groups clashes with the total national interest$ and the most that the% are usuall% willing to concede is the possible need for temporar% protection against import competition$ in order that the persons affected ma% have sufficient time to move to another occupation. "ations do$ of course$ maintain tariffs and other barriers to imports. #7.C- #6 C#M/4.4,+>- 4D>45,4:- 2s alread% noted$ <ritish classical economists simpl% accepted the fact that productivit% differences e-ist between countries7 the% made no concerted attempt to e-plain which commodities a countr% would e-port or import. 9uring the ,Hth centur%$ international economists have offered a number of theories in an effort to e-plain wh% countries have differences in producti$ity$ the factor that determines comparative advantage and the pattern of international trade. -atural re"ource"* 0H? >irst$ countries can have an advantage because the% are richl% endowed with a particular natural resource. >or e-ample$ countries with plentiful oil resources can generall% produce oil ine-pensivel%. #hus$ Saudi 2rabia produces oil ver% cheapl%$ giving it a comparative advantage in oil$ and it e-ports oil in order to finance its purchases of imports. Similarl%$ countries with large forests generall% are the ma*or e-porters of wood$ paper$ and paper products. #he suppl% available for e-port also depends on domestic demand. Canada$ for e-ample$ has large 6uantities of lumber available for e-port to the 8nited States$ not onl% because of its large areas of forest but also because its small population consumes little of the suppl%$ leaving much of the lumber available for e-port. Climate is another natural resource that provides an e-port advantage. #hus$ for e-ample$ bananas are e-ported b% Central 2merican countries$ not Iceland or >inland. ?actor endoment"' the ,ec!"cher0.hlin theory* #he proposition that countries with plentiful natural resources generall% have a comparative advantage in products using those resources is obvious and straightforward. 2 related$ but much more subtle$ e-planation was put forward b% two Swedish economists$ Eli 3ec!scher and <ertil Ohlin. Ohlin]s wor! was built upon that of 3ec!scher. In recognition of his ideas as described in his pathbrea!ing boo!$ 2nterregional and 2nternational Trade &1G..'$ Ohlin shared the "obel (ri5e for Economics in 1G==. #he 3ec!scher Ohlin theor% focuses on the two most important factors of production$ la%our and capital. Some countries are relativel% wellendowed with capital7 the t%pical wor!er has plent% of machiner% and e6uipment at his disposal. In such countries$ wage rates generall% are high. (roducts re6uiring much laboursuch as te-tiles$ sporting goods$ and simple consumer electronicstend as a result to be more e-pensive than in countries with plentiful labour and low wage rates. On the other hand$ goods re6uiring much capital and onl% a little labour &automobiles and chemicals$ for e-ample' tend to be relativel% ine-pensive in countries with plentiful and cheap capital. #hus$ countries with abundant capital should generall% be able to produce capitalintensive goods relativel% ine-pensivel%$ e-porting them in order to pa% for imports of labour intensive goods. In the 3ec!scherOhlin theor% it is not the absolute amount of capital that is important7 rather$ it is the amount of capital per wor!er. 2 small countr% li!e Du-embourg has much less capital in total than India$ but Du-embourg has more capital per wor!er. 2ccordingl%$ the 3ec!scherOhlin theor% predicts that Du-embourg will e-port capitalintensive products to India and import labourintensive products in return. 9espite its plausibilit% the 3ec!scherOhlin theor% is fre6uentl% at variance with the actual patterns of international trade. 2s an e-planation of what countries actuall% e-port and import$ it is much less accurate than the more obvious and straightforward natural resource theor%. One earl% stud% of the 3ec!scherOhlin theor% was carried out b% Wa""ily )eontief$ a Cussianborn 8.S. economist. Deontief observed that the 8nited States was relativel% wellendowed with capital. 2ccording to the theor%$ therefore$ the 8nited States should e-port capital intensive goods and import labourintensive ones. 3e found that the opposite was in fact the case: 8.S. e-ports are generall% more labour intensive than the t%pe of products that the 8nited States imports. <ecause his findings were the opposite of those predicted b% the theor%$ the% are !nown as the )eontief ParadoB. 0HG Economie" of lar#e0"cale production* Even if countries have 6uite similar climates and factor endowments$ the% ma% still find it advantageous to trade. Indeed$ economicall% similar countries often carr% on a large and thriving trade. #he prosperous industriali5ed countries have become one another]s best customers. 2 main reason for this situation lies in what is called the economies of largescale production. >or man% products$ there are advantages in producing on a large scale7 costs become lower as more is produced. #hus$ for e-ample$ automobiles can be made more cheapl% in a factor% producing 1HH$HHH units than in a small factor% producing onl% 1$HHH units. #his means that countries have an incentive to speciali5e in order to reduce costs. #o sell a large volume of output$ the% ma% have to loo! to e-port mar!ets. #he smaller the countr%$ and the more limited its domestic mar!et$ the more incentive it has to loo! to international trade as a wa% of gaining the advantages of largescale production. #hus$ Du-embourg or <elgium has much more to gain relativel% than does the 8nited States. Indeed$ the advantages of largescale production have been one of the ma*or sources of gain from the establishment of the European Economic Communit% &EEC'$ which was formed for the purpose of providing free trade between most western European countries. Even a large countr% such as the 8nited States$ however$ can gain in some cases b% e-porting in order to lengthen production lines. >or e-ample$ the /oein# Company has been able to produce airplanes more cheapl% because it is able to sell large numbers of aircraft to other countries. #he importing countries also gain because the% can bu% aircraft abroad more cheapl% than the% could produce them at home. Technolo#y* #echnological development can also provide a distinctive trade advantage. #he relativel% advanced countriesparticularl% the 8nited States$ @apan$ and those of western Europeare the principal e-porters of hightechnolog% products such as computers and precision machiner%. One important aspect of technolog% is that it can change rapidl%. Such rapid changes present several challenges. >or the countries that are not in the front ran!$ it raises the 6uestion of whether the% should import hightechnolog% products or attempt to enter the circle of the most advanced nations. >or the countries that have held the technological lead in the past$ there is alwa%s the possibilit% that the% will be successfull% overta!en b% newcomers. #his occurred in the second half of the ,Hth centur% when @apan advanced technologicall% in its automobile production to the point where it could challenge the automobile leadership of "orth 2merica and Europe. @apan 6uic!l% became the world]s foremost producer of automobiles. The product cycle* #he spread of technolog% across national boundaries means that comparative advantage can change. #he most technologicall% advanced countries generall% have the advantage in ma!ing new products$ but as time passes other countries ma% gain the advantage. >or e-ample$ man% television sets were produced in the 8nited States during the 1G0Hs. 2s time passed$ however$ and technological change in the television industr% became less rapid$ there was less advantage in producing sets in the 8nited States. (roducers of television sets had an incentive to loo! to other locations$ with lower wage rates. In time$ the manufacturers established overseas operations in 01H #aiwan$ 3ong Uong$ and elsewhere. Concurrentl%$ the 8nited States turned to new activities$ such as the manufacture of large mainframe computers and the development of computer software. State interference in international trade M-,*#D #6 +5,-.6-.-5C- Cegardless of what comparativeadvantage theor% ma% sa% about the virtues of unrestricted trade$ all nations interfere with international transactions to at least some degree. #ariffs ma% be imposed on importsin some instances ma!ing them so costl% as to bar completel% the entr% of the good involved. Euotas ma% limit the permissible volume of imports. State subsidies ma% be offered to encourage e-ports. ;one% capital e-ports ma% be restricted or prohibited. Investment b% foreigners in domestic plant and e6uipment ma% be similarl% restrained. #hese interferences ma% be simpl% the result of specialinterest pleading$ because particular groups suffer as a conse6uence of import competition. Or a government ma% impose restrictions because it feels impelled to ta!e account of factors that comparative advantage sets aside. It is of interest to note that insofar as goods and services are concerned$ the general pattern of interference follows the old mercantilist dictum of discouraging imports and encouraging e-ports. 2 compan% that finds itself barred from an attractive foreign mar!et b% tariffs or 6uotas ma% be able to leapfrog the barrier simpl% b% establishing a manufacturing plant within that foreign countr%. #his polic% of foreign plant in$e"tment has e-panded enormousl% since the end of +orld +ar II. 8.S. companies have ta!en the lead$ investing particularl% in western Europe$ Canada$ and South 2merica. Industr% in other developed countries has followed a similar patternsome foreign companies establishing plants within the 8nited States as well as in other areas of the world. #he governments of countries sub*ect to this new investment find themselves in an ambivalent position. #he establishment of new foreignowned plants ma% mean more than simpl% the creation of new emplo%ment opportunities and new productive capacit%7 it ma% also mean the introduction of new technologies and superior businesscontrol methods. <ut the government that welcomes such benefits must also e-pect complaints of cforeign control$c an argument that will inevitabl% be pressed b% domestic owners of older plants who fear a new competition that cannot be bloc!ed b% tariffs. #his has been a pressing problem for man% governments$ particularl% insofar as investment b% 8.S. firms is involved. Countries such as the 8nited Uingdom and Canada have been liberal in their admissions polic%7 others$ notabl% @apan$ impose tight restrictions on foreignowned plants. Tariff"* 2 tariff$ or dut%$ is a ta- levied on a commodit% when it crosses the boundar% of a customs area. #he boundar% ma% be that of a nation or a group of nations that have agreed to impose a common ta- on goods entering their territor%. #ariffs are often classified as either protective or revenue. Protecti$e tariff" are designed to shield domestic production from foreign competition b% raising the price of the imported commodit%. Cevenue tariffs are designed to obtain revenue rather than to restrict imports. #he two sets of ob*ectives are$ of course$ not mutuall% e-clusive. (rotective tariffs$ unless the% are so high as to !eep out imports$ %ield revenue. 011 Cevenue tariffs give some protection to an% domestic producer of the dut%bearing goods. 2 transit dut%$ or tran"it taB$ is a ta- levied on commodities passing through a customs area en route to another countr%. Similarl%$ an e-port dut%$ or e-port ta-$ is a ta- imposed on commodities leaving a customs area. >inall%$ some countries provide e-port subsidies7 import subsidies are rarel% used. ,o tariff" or!* #ariffs on imports ma% be applied in several wa%s. If the% are imposed according to the ph%sical 6uantit% of an import &so much per ton$ per %ard$ per item$ etc.'$ the% are called specific tariffs. If the% are levied according to the value of the import$ the% are !nown as ad valorem tariffs. #ariffs ma% differentiate among the countries from which the imports are obtained. #he% ma%$ for instance$ be lower between countries that have previousl% entered into special arrangements$ such as the trade preferences accorded to each other b% members of the Commonwealth. #ariffs ma% affect the econom% of the countr% imposing them in a number of wa%s. <% raising the prices of imported goods$ tariffs ma% encourage domestic production. 2s e-penditures on domestic products rise$ domestic emplo%ment tends to do li!ewise. #his is wh% tariffs are favoured b% industries that find themselves pressed b% foreign competitors. #he tariff ma% also encourage tendencies toward a monopolistic mar!et structure to the e-tent that it lessens foreign competition$ with a resulting decrease in the incentive to moderni5e or innovate. <% increasing the price of an imported commodit% a tariff ma% also reduce its consumption. #he decrease in demand could be large enough in relation to the world mar!et to force the price of the import down. Mea"urin# the effect" of tariff"* It is difficult to gauge the effect of tariff barriers among countries. >irst of all$ how import demand responds to changes in tariffs depends on a variet% of factorsthe reaction of producers and consumers to price changes$ the share of imports in domestic production and consumption$ the substitutabilit% of imports for domestic products$ and so on. 2nd the responsiveness to tariff levels will differ from countr% to countr% as well as from commodit% to commodit%. #hus$ the amount of a tariff does not necessaril% determine its restrictive effect. >or another thing$ such comparisons also must be restricted to commodities for which tariffs are the ma*or protective device. #his is generall% true for nonagricultural commodities in developed countries$ but other devices are often emplo%ed to protect agricultural production. In the third place$ a tariff levied upon imports of raw materials will protect domestic raw material producers but will increase the costs of manufacturers using those raw materials. It is necessar%$ therefore$ to distinguish between nominal and effective rates of protection. #he nominal rate of protection is the percentage tariff imposed on a product as it enters the countr%. >or e-ample$ if a tariff of ,H percent of value is collected on clothing as it enters the countr%$ then the nominal rate of protection is that same ,H percent. #he effective rate of protection is a more comple- concept: consider that the same productclothingcosts N1HH on international mar!ets. #he material that is imported to ma!e the clothing &material inputs' sells for N1H. In a free trade situation$ a firm can charge no more than N1HH for a similar piece of clothing &ignoring transportation costs'. Importing the fabric for N1H$ the clothing manufacturer can add a ma-imum of N/H for labour$ profit mar!up$ rents$ and the li!e. #his N/H difference between the N1H cost of material inputs and the price of the product is called the value added. #he same situation ma% be considered with tariffssa%$ ,H percent on clothing and 1H percent on fabric. #he ,H percent tariff on clothing would raise the domestic price b% N,H to N1,H$ while a 1H percent tariff on fabrics would increase material costs to the domestic producer b% N1 to N11. (rotection would thus enable the firm to operate with a valueadded margin of N0/the difference between the domestic price of N1,H and 01, the material cost of N11. #he difference between the value added of N/H without tariff protection and that of N0/ with it provides a margin of N1/. #his means that the effective rate of protection of the domestic processing activit%the ratio of N1/ to N/Hwould be .0 percent. #he effective rate of protection derived.0 percentis greater than the nominal rate of onl% ,H percent. #his will be the case whenever the tariff rate on the final product is greater than the tariff on inputs. <ecause countries generall% do lev% higher tariffs on final products than on inputs$ effective rates of protection are generall% higher than nominal ratesoften much higher. #he effective rate of protection also depends on the share of value added in the product price. Effective rates can be ver% high if value added to the imported commodit% is a small percentage or ver% low if value added is a large percentage of the total price. #hus$ effective protection in one countr% ma% be much higher than that in another even though its nominal tariffs are lower$ if it tends to import commodities of a high level of fabrication with correspondingl% low ratios of value added to product price. -ontariff %arrier"* Other government regulations and practices ma% also act as barriers to trade. &uota" or 6uantitative restrictions ma% prohibit the importation of certain commodities or limit the amounts imported. Such 6uotas are usuall% administered b% re6uiring importers to have licenses to bring in particular commodities. Euotas raise prices *ust as tariffs do$ but$ being set in ph%sical terms$ their impact on imports is direct$ with an absolute ceiling set on suppl%. Increased prices will not bring more goods in. #here is also a difference between tariffs and 6uotas in their effect on revenues. +ith tariffs$ the government receives the revenue: under 6uotas$ the import license holders obtain a windfall in the form of the difference between the high domestic price and the low international price of the import. 2nother barrier$ which has become increasingl% common during the past several decades$ is the cvoluntar%c e-port restraint &VEC'. >or e-ample$ in the 1G?Hs the @apanese &under pressure from the 8nited States' cvoluntaril%c limited their e-ports of automobiles to the 8.S. mar!et. Di!e 6uotas$ VECs limit the 6uantit% of trade and therefore tend to raise the prices of imported goods. In this case the VEC made @apanese automobiles less available in the 8nited States and raised the prices that 8.S. consumers had to pa% for such automobiles. VECs are usuall% not voluntar% in an% meaningful sense. In this e-ample$ the @apanese agreement to a VEC on automobiles was an attempt to avoid a 8.S. import 6uota. >or the @apanese$ a VEC was preferable to a 8.S. import 6uota because @apanese e-porters could charge higher prices. #he @apanese e-porters$ rather than 8.S. importers$ reaped much of the windfall from the VEC. 2 VEC is also easier to get rid of. In addition$ a VEC has a less damaging effect on the political relations between countries. Still other barriers include state trading organi5ations and government procurement practices that ma% be used preferentiall%. In the 8nited States$ cbu% 2mericanc legislation re6uires government procurement agencies to favour domestic goods. Customs classification and valuation procedures$ health regulations$ and mar!ing re6uirements ma% also have a restrictive effect on trade. >inall%$ eBci"e taBe" ma% act as a barrier to trade if the% are levied at higher rates on imports than on domestic goods. Protectioni"m in the le""0de$eloped countrie"* 01. #he industriali5ation that has ta!en place in the late decades of the ,Hth centur% in some de$elopin# countrie" has been characteri5ed b% the e-pansion of importcompeting industries behind high tariff walls. In man% of those countries tariffs and various 6uantitative restrictions on manufactured goods are great. #he effective rates of protection ma% be even greater$ because the goods tend to be highl% fabricated and the proportion of value added in production after importation is low. +hile some places such as #aiwan and "orth Uorea have oriented their manufacturing industries mainl% toward e-port trade$ those are e-ceptional cases in the developing world. ;ore commonl% the new industries see! to compete with foreignmade goods for the domestic mar!et. 3igh protection in these countries has often contributed to a slowdown in the production and e-port of primar% commodities and has discouraged e-pansion of e-ports of manufactured goods. >urthermore$ while domestic production of nondurable consumer goods has permitted rapid economic growth at an earl% stage$ developing countries have encountered considerable difficulties in producing more sophisticated commodities. #he% suffer all of the disadvantages of small domestic mar!ets$ in addition to a lac! of incentives for technological improvement. 4.:7M-5, 6#. 45D 4:4+5, +5,-.6-.-5C- Re$enue* 9eveloping nations in particular often lac! the institutional machiner% needed for effective imposition of income or corporation ta-es. #he governments of such nations ma% then finance their activit% b% resort to tariffs on imported goods$ since such levies are relativel% eas% to administer. #he amount of ta- revenue obtainable through tariffs$ however$ is alwa%s limited. If the government tries to increase its tariff income b% imposing higher dut% rates$ this ma% cho!e off the flow of imports and so reduce tariff revenue instead of increasing it. Economic de$elopment* Protection of dome"tic indu"try* (robabl% the most common argument for tariff imposition is that particular domestic industries need tariff protection for survival. Comparativeadvantage theorists will of course argue that the industr% in need of such protection ought not to survive and that the resources so emplo%ed ought to be transferred to occupations having greater comparative efficienc%. #he welfare gain of citi5ens ta!en as a whole would more than offset the welfare loss of those groups affected b% import competition7 that is$ total real national income would increase. 2n opposing argument would be$ however$ that this welfare gain would be widel% diffused$ so that the individual beneficiaries might not be conscious of an% great improvement. #he welfare loss$ in contrast$ would be narrowl% and acutel% felt. 2lthough resources can be transferred to other occupations$ *ust as comparativeadvantage theor% sa%s$ the transfer process is sometimes slow and painful for those being transferred. >or such reasons$ comparativeadvantage theorists rarel% advocate the immediate removal of all e-isting tariffs. #he% argue instead against further tariff increasessince increases$ if effective$ attract still more resources into the wrong occupationand the% press for gradual reduction of import barriers. 01/ The infant0indu"try ar#ument* 2dvocates of protection often argue that new and growing industries$ particularl% in lessdeveloped countries$ need to be shielded from foreign competition. #he% contend that costs decline with growth and that some industries must reach a minimum si5e before the% are able to compete with wellestablished industries abroad. #ariffs can protect the domestic mar!et until the industr% becomes internationall% competitive and$ it is often argued$ the costs of protection can be recouped after the industr% has reached maturit%. In short$ the infantindustr% argument is based principall% on the idea that there are economies of largescale production in man% industries and that developing countries have difficult% in establishing such industries. 2dvocates of such protection$ however$ can have their arguments turned against them. +hile an individual countr% can$ in some circumstances$ gain from protecting its infant industries$ this protection is particularl% costl% for the international communit% as a whole. +here there are ma*or advantages in largescale production$ there are also large advantages in relativel% free international trade. <% closing off mar!ets$ protection reduces the abilit% of firms to gain economies of largescale b% e-porting. If a group of countries imposes infantindustr% protection$ it will split up the mar!et7 each countr% ma% end up with smallscale$ locali5ed$ inefficient production$ thus reducing the prosperit% of all of the countries. One wa% in which developing nations have tried to deal with this problem has been through the establishment of customs unions or other regional groupings Infantindustr% tariffs have been disappointing in other wa%s7 the infantindustr% argument is often abused in practice. In man% developing countries$ industries have failed to attain international competitiveness even after 10 or ,H %ears of operation and might not survive if protective tariffs were removed. #he infant industr% is probabl% better aided b% production "u%"idie" than b% tariffs. (roduction subsidies do not raise prices and therefore do not curtail domestic demand7 and the cost of the protection is not concealed in higher prices to consumers. (roduction subsidies$ however$ have the disadvantage of drawing upon government revenue rather than adding to it$ which ma% be a serious consideration in countries at lower levels of development. 1nemployment* #ariffs or 6uotas are also sometimes proposed as a wa% to maintain domestic emplo%mentparticularl% in times of recession. #here is$ however$ nearunanimit% among modernda% economists that proposals to remed% unemplo%ment b% means of tariff increases are misguided. Insofar as a higher tariff is effective for this purpose$ it simpl% ce-ports unemplo%mentc7 the rise in domestic emplo%ment is matched b% a drop in production in some foreign countr%. #hat other countr%$ moreover$ is li!el% to impose a retaliator% tariff increase. >inall%$ the tariff remed% for unemplo%ment is a poor one because it is usuall% ineffective and because more suitable remedies are now available. It has come to be generall% recogni5ed that unemplo%ment is far more efficientl% dealt with b% the implementation of proper fiscal and monetar% policies. -ational defen"e* 2 common appeal made b% an industr% see!ing tariff or 6uota protection is that its survival is essential in the national interest: its product would be needed in 010 wartime$ when the suppl% of imports might well be cut off. #he verdict of economists on this argument is fairl% clear: the nationaldefense argument is fre6uentl% a red herring$ an attempt to cwrap oneself in the flag$c and insofar as an industr% is essential$ the tariff is a dubious means of ensuring its survival. Essential industries ought instead to be given a direct subsid% to enable them to meet foreign competition$ with e-plicit recognition of the fact that the subsid% is a price paid b% the nation in order to maintain the industr% for defense purposes. Autar!y6 or "elf0"ufficiency* ;an% demands for protection$ whatever their surface argument ma% be$ are reall% appeals to the autar!ic feelings that prompted mercantilist reasoning. &2utar!% is defined as the state of being selfsufficient at the level of the nation.' 2 proposal for the restriction of free international trade can be described as autar!ic if it appeals to those halfsubmerged feelings that the citi5ens of the nation share a common welfare and common interests$ whereas foreigners have no regard for such welfare and interests and might even be activel% opposed to them. 2nd it is 6uite true that a countr% that has become heavil% involved in international trade has given hostages to fortune: a part of its industr% has become dependent upon e-port mar!ets for income and for emplo%ment. 2n% cutoff of these foreign mar!ets &brought about b% recession abroad$ b% the imposition of new tariffs b% some foreign countr%$ or b% numerous other possible changes' would be acutel% serious7 and %et it would be a situation largel% be%ond the power of the domestic government involved to alter. Similarl%$ another part of domestic industr% ma% rel% on an inflow of imported raw materials$ such as oil for fuel and power. 2n% restriction of these imports could have the most serious conse6uences. #he vague threat implicit in such possibilities often results in a %earning for autar!%$ for national selfsufficienc%$ for a life free of dependence on the ha5ards of the outside world. #here is general agreement that no modern nation$ regardless of how rich and varied its resources$ could reall% practice selfsufficienc%$ and attempts in that direction could produce sharp drops in real income. "evertheless$ protectionist argumentsparticularl% those made cin the interests of national defensecoften draw heavil% on the strength of such autar!ic sentiments. The term"0of0trade ar#ument* +hen a countr% imposes a tariff$ foreign e-porters have greater difficult% in selling their products. 2s their e-ports decline$ the% ma% cut prices in order to !eep their sales from falling drasticall%. #hus$ for e-ample$ when a tariff of N1H.HH is imposed$ foreign e-porters ma% cut their price b%$ sa%$ N1.HH. #he foreign e-porter is being cta-edc when the tariff is imposed7 the other N/.HH is reflected in a higher price to the consumer. #he use of tariffs to ta- foreign e-porters in this wa% is !nown as the termsoftrade argument for protection. #he terms of trade represent the relative price of what a nation is e-porting$ compared with the price paid to foreigners for imported goods. +hen the price of what is being e-ported rises$ or when the price paid to foreigners for imported goods falls &as it ma% when a nation imposes a tariff'$ terms of trade improve. /alance0of0payment" difficultie"* 011 Fovernments ma% interfere with the processes of foreign trade for a reason 6uite different from those thus far discussed: shortage of forei#n eBchan#e. 8nder the international monetar% s%stem established after +orld +ar II and in effect until the 1G=Hs$ most governments tried to maintain fi-ed e-change rates between their own currencies and those of other countries. Even if not absolutel% fi-ed$ the e-change rate was ordinaril% allowed to fluctuate onl% within a narrow range of values. If balanceofpa%ments difficulties arise and persist$ a nation]s foreign e-change reserve runs low. In a crisis$ the government ma% be forced to devalue the nation]s currenc%. <ut before being driven to this$ it ma% tr% to redress the balance b% restricting imports or encouraging e-ports$ in much the old mercantilist fashion. #he problem of reserve shortages became acute for man% countries during the 1G1Hs. 2lthough the total volume of international transactions had risen steadil%$ there was not a corresponding increase in the suppl% of international reserves. <% 1G=. pa%ment imbalances led to an end of the s%stem of fi-ed$ or pegged$ e-change rates and to a cfloatingc of most currencies. International trade arran#ement" ;an% efforts have been made in modern times to promote trade among nations. #he wa%s in which this ma% be attempted range from agreements among governments to reduce or eliminate trade barriers to more ambitious attempts to harmoni5e economic policies$ as in the European Economic Communit% &EEC' established b% the nations of western Europe. *+,#.Y #6 M#D-.5 ,.4D- /#'+C+- Mercantili"m* ;uch of the modern histor% of international relations concerns efforts to promote freer trade among nations. #he 1=th centur% saw the growth of restrictive policies that later came to be !nown as mercantili"m. #he mercantilists held that economic polic% should be nationalistic and aim to secure the wealth and power of the state. #he concept was based on the conviction that national interests are inevitabl% in conflictthat one nation can increase its trade onl% at the e-pense of other nations. #hus$ governments were led to impose price and wage controls$ foster national industries$ promote e-ports of finished goods and imports of raw materials$ and prohibit the e-ports of raw materials and the import of finished goods. #he state endeavoured to provide its citi5ens with a monopol% of the resources and trade outlets of its colonies. 2 t%pical illustration of the mercantilist spirit is the famous English -a$i#ation Act of 1101$ which reserved for the home countr% the right to trade with the colonies and prohibited the import of goods of non European origin unless transported in ships fl%ing the English flag. #his law lingered on until 1?/G. 2 similar polic% was followed in >rance. )i%erali"m* 2 strong reaction against mercantilist attitudes began to ta!e shape toward the middle of the 1?th centur%. In >rance$ the economists !nown as Phy"iocrat" demanded libert% of production and trade. In England$ as discussed above$ 2dam Smith demonstrated in his The $ealth of Nations &1==1' the advantages of removing trade restrictions. Economists and businessmen voiced their opposition to e-cessivel% high and often prohibitive customs duties and urged the negotiation of trade 01= agreements with foreign powers. #his change in attitudes led to the signing of a number of agreements embod%ing the new liberal ideas$ among them the 2nglo >rench #reat% of 1=?1$ which ended what had been an economic war between the two countries. 2fter 2dam Smith$ the basic tenets of mercantilism were no longer considered defensible. #his did not$ however$ mean that nations abandoned all mercantilist policies. Cestrictive economic policies were now *ustified b% the claim that$ up to a certain point$ the government should !eep foreign merchandise off the domestic mar!et in order to shelter national production from outside competition. #o this end$ customs levies were introduced in increasing number$ replacing outright bans on imports$ which became less and less fre6uent. In the middle of the 1Gth centur%$ customs walls effectivel% sheltered man% national economies from outside competition. #he >rench tariff of 1?1H$ for e-ample$ charged e-tremel% high rates on <ritish products: 1H percent on pig iron7 /H to 0H percent on machiner%7 and 1HH to ?HH percent on woolen blan!ets. #ransport costs between the two countries provided further protection. 2 triumph for liberal ideas was the An#lo0?rench trade agreement of 1?1H$ which provided that >rench protective duties were to be reduced to a ma-imum of ,0 percent within five %ears$ with free entr% of all >rench products e-cept wines into <ritain. #his agreement was followed b% other European trade pacts. Re"ur#ence of protectioni"m* 2 reaction in favour of protection spread throughout the +estern world in the latter part of the 1Gth centur%. Ferman% adopted a s%stematicall% protectionist polic% and was soon followed b% most other nations. Shortl% after 1?1H$ during the Civil +ar$ the 8nited States raised its duties sharpl%7 the ;cUinle% #ariff 2ct of 1?GH was ultraprotectionist. England was the onl% countr% to remain faithful to the principles of free trade. <ut the protectioni"m of the last 6uarter of the 1Gth centur% was mild b% comparison with the mercantilist policies that had been common in the 1=th centur% and were to be revived between the two world wars. E-tensive economic libert% prevailed b% 1G1.. Euantitative restrictions were unheard of$ and customs duties were low and stable. Currencies were freel% convertible into gold$ which in effect was a common international mone%. <alanceofpa%ments problems were few. (eople who wished to settle and wor! in a countr% could go where the% wished with few restrictions7 the% could open businesses$ enter trade$ or e-port capital freel%. E6ual opportunit% to compete was the general rule$ the sole e-ception being the e-istence of limited customs preferences between certain countries$ most usuall% between a home countr% and its colonies. #rade was freer throughout the +estern world in 1G1. than it was in Europe in 1G=H. The FneF mercantili"m* World War I wrought havoc with these orderl% trading conditions. <% the end of hostilities$ world trade was in a strait*ac!et that made recover% ver% difficult. #he first five %ears of the postwar period were mar!ed b% the dismantling of wartime controls proper. #he 1G,H crisis and the commercial advantages accruing to countries whose currencies had depreciated$ as had Ferman%]s$ rapidl% led to fresh measures in restraint of trade. #he protectionist tide engulfed the world econom%$ not because 01? polic%ma!ers consciousl% adhered to an% specific theor% but because of nationalist ideologies and the pressure of economic conditions. In an attempt to end the continual raising of customs barriers$ the Deague of "ations organi5ed the first World Economic Conference in ;a% 1G,=. #went%nine states$ including the main industrial countries$ subscribed to an international convention that was the most minutel% detailed and balanced multilateral trade agreement ever approved until that time. It was a precursor of the arrangements made under the Feneral 2greement on #ariffs and #rade of 1G/=. #he 1G,= agreement remained practicall% without effect. 9uring the :reat Depre""ion of the 1G.Hs$ unemplo%ment in ma*or countries reached unprecedented levels and engendered an epidemic of protectionist measures. Countries attempted to shore up their balance of pa%ments b% raising their customs duties and introducing a range of import 6uotas or even import prohibitions$ accompanied b% e-change controls. >rom 1G.. onward$ the recommendations of all the postwar economic conferences based on the fundamental postulates of economic liberalism were ignored. #he planning of foreign trade came to be considered a normal function of the state. ;ercantilist policies dominated the world scene until after +orld +ar II. ,.4D- 4:.--M-5, #he term trade agreement or commercial agreement can be used to describe an% contractual arrangement between states concerning their trade relationships. #rade agreements ma% be bilateral or multilateralthat is$ between two states or between more than two states. /ilateral trade a#reement"* 2 bilateral trade agreement usuall% includes a broad range of provisions regulating the conditions of trade between the contracting parties. #hese include stipulations governing cu"tom" dutie" and other levies on imports and e-ports$ commercial and fiscal regulations$ transit arrangements for merchandise$ customs valuation bases$ administrative formalities$ 6uotas$ and various legal provisions. ;ost bilateral trade agreements$ either e-plicitl% or implicitl%$ provide for &1' reciprocit%$ &,' mostfavourednation treatment$ and &.' cnational treatmentc of nontariff restrictions on trade. Reciprocity* In a trade agreement$ the parties ma!e reciprocal concessions to put their trade relationships on a basis deemed e6uitable b% each. #he principle of reciprocit% is e-tremel% old$ and in one form or another it is to be found$ implicitl% at least$ in all trade agreements. #he concessions ma%$ however$ be in different areas. In the 2nglo >rench 2greement of 1?1H$ for e-ample$ ?rance pledged itself to reduce its duties to ,H percent b% 1?1/. In return$ /ritain granted dut%free imports of all >rench products e-cept wines and spirits. #he principle of reciprocit% implies onl% that the gains arising out of foreign trade are distributed fairl%. The mo"t0fa$oured0nation clau"e* #he mo"t0fa$oured0nation clause binds a countr% to appl% to its partner countr% an% lower rate of import duties that it ma% later grant to imports from some other countr%. #he clause ma% cover a list of specified products onl%$ or specific concessions %ielded to certain foreign countries. 2lternativel%$ it ma% cover all advantages$ privileges$ immunities$ or other favourable treatment granted to an% third countr% whatever. #he clause is intended to provide each signator% with the assurance that the advantages obtained will not be attenuated or wiped out b% a subse6uent 01G agreement concluded between one of the partners and a third countr%. It guarantees the parties against discriminator% treatment in favour of a competitor. #he effect of the mostfavourednation clause on customs duties is to amalgamate the successive trade agreements concluded b% a state. If the rates in different agreements are fi-ed at var%ing levels$ the clause reduces them to the lowest rate specified in an% agreement. #hus$ goods imported from a countr% benefiting from mostfavourednation treatment are charged the rate of dut% applicable to imports from another countr% which$ in a subse6uent trade agreement$ has negotiated a lower rate of dut%. #he coverage of the most favourednation clause can be considerabl% reduced b% a minute definition of a particular item so that a concession$ while general in form$ applies in practice to onl% one countr%. #he best!nown illustration of this techni6ue is to be found in the Ferman #ariff of 1GH,$ which admitted at a special rate large dappled mountain cattle& reared at a spot at least KGG metres a%ove sea level& and which have at least one month's gra)ing each year at a spot at least JGG metres a%ove sea level. #he advantages granted under the mostfavourednation clause ma% be conditional or unconditional. If unconditional$ the clause operates automaticall% whenever appropriate circumstances arise. #he countr% drawing benefit from it is not called on to ma!e an% fresh concession. <% contrast$ the partner invo!ing a conditional mostfavourednation clause must ma!e concessions e6uivalent to those e-tended b% the third countr%. 2 t%pical wording was that of the 1G11 treat% between the 8nited States and @apan$ which stated that in all that concerns commerce and navigation& any privilege& favour or immunity . . . to the citi)ens or su%Bects of any other (tate shall %e e'tended to the citi)ens or su%Bects of the other Contracting 3arty gratuitously& if the concession in favour of that other (tate shall have %een gratuitous& and on the same or e=uivalent conditions& if the concession shall have %een conditional. #he conditional form of the clause ma% at first sight seem more e6uitable. <ut it has the ma*or drawbac! of being liable to raise dispute each time it is invo!ed$ for it is b% no means eas% for a countr% to evaluate the compensation it is being offered as in fact being e6uivalent to the concession made b% the third countr%. #he effect of the unconditional form of the mostfavourednation clause is$ finall%$ to wipe out an% relevance that the principle of reciprocit% ma% have had to the purel% bilateral preoccupations of the negotiating parties$ since the results of the bargaining process$ instead of being limited to the participants$ influence their relationships with other states. In practice$ therefore$ a countr% negotiating a trade agreement must measure the advantages it is willing to concede in terms of the benefits these concessions will provide collaterall% to that third countr% which is the most competitive. In other words$ the concessions that ma% be granted are determined b% the minimum protection that the negotiating state deems indispensable to protect its home producers. #his sets a ma*or limitation on the scope of bilateral negotiations. (rotagonists of free trade consider that the unconditional mostfavourednation clause is the onl% practical wa% b% which to obtain the progressive reduction of customs duties. 2pologists for protectionism are resolutel% against it$ preferring the conditional form of the clause or some e6uivalent 0,H mechanism. #he conditional mostfavourednation clause was generall% in use in Europe until 1?1H$ when the socalled CobdenChevalier #reat% between Freat <ritain and >rance established the unconditional form as the pattern for most European treaties. #he 1nited State" used the conditional mostfavourednation clause from its first trade agreement$ signed with >rance in 1==?$ until the passage of the #ariff 2ct of 1G,,$ which terminated the practice. &#he #rade Ceform <ill of 1G=/$ however$ in effect restored to the 8.S. president the authorit% to designate preferential tariff treatment$ sub*ect to approval b% Congress.' #he :enoa conference in ;a% 1G,, and the +orld Economic Conference in ;a% 1G,= both recommended that trade agreements should include the mostfavourednation clause whenever possible. <ut the Freat 9epression of the 1G.Hs led instead to a rise of restrictions in world trade. Imperial or regional s%stems of preference came into being: the .ttaa A#reement of 1G., for the <ritish Commonwealth$ similar arrangements for the >rench empire$ and a series of tariff and preference agreements negotiated in eastern and central Europe from 1G.1 on. The ?national treatment? clau"e* #he cnational treatmentc clause in trade agreements is designed to ensure that internal fiscal or administrative regulations are not used to introduce discrimination of a nontariff nature. It forbids discriminator% use of the following: ta-es or other internal levies7 laws$ regulations$ and decrees affecting the sale$ offer for sale$ purchase$ transport$ distribution$ or use of products on the domestic mar!et7 valuation of products for purposes of assessment of dut%7 legislation on prices of imported goods7 warehousing and transit regulations7 and the organi5ation and operation of state trading corporations. Multilateral a#reement" "ince World War II* +hen World War II ended$ the lessons learned from the growth of protectionism since 1?=1$ and most of all from the resurgence of trade restrictions in the interwar %ears$ spurred the development of multilateral trade agreements and other forms of international economic cooperation. #hese developments culminated in the Feneral 2greement on #ariffs and #rade &F2##'. The :eneral A#reement on Tariff" and Trade* #he :eneral A#reement on Tariff" and Trade was signed at Feneva on Oct. .H$ 1G/=$ b% ,. countries$ which among them accounted for fourfifths of world trade. On the same da% 1H of them$ including the 8nited States$ the 8nited Uingdom$ >rance$ <elgium$ and #he "etherlands$ signed a protocol bringing the agreement into force on @an. 1$ 1G/?. F2## ta!es the form of a multilateral trade agreement setting forth the principles under which the signatories$ on a basis of creciprocit% and mutual advantage$c shall negotiate ca substantial reduction in customs tariffs and other impediments to trade$ and the elimination of discriminator% practices in international trade.c +ith the adherence of additional countries$ F2## has become a charter governing almost all world trade e-cept for that of the Communist countries. #he main principles underl%ing F2## are as follows: &1' #here shall be no trade discrimination. #he unconditional mostfavourednation clause is regarded as fundamental. &,' 2s a rule$ there is to be no protection other than that provided b% the customs tariff &the cnational treatmentc principle'. &.' Customs unions and free trade groupings are considered legitimate 0,1 means of trade liberali5ation$ provided that$ ta!en as a whole$ such arrangements do not discriminate against third countries. &/' ;embers of F2## are entitled to lev% the following charges on imports: &a' an import ta- e6ual in amount to internal ta-es on the product concerned$ sub*ect onl% to the general principle embodied in &,' above$ &%' cantidumpingc duties in the case of imported products that are being sold at less than the price in the home mar!et$ or at less than cost$ &c' countervailing duties to offset the effects of e-port subsidies$ and &d' fees and other proper charges for services rendered. #hese$ however$ are onl% the basic principles. #he agreement also contains a variet% of clauses providing e-ceptions from the rules in special situations. #hese include balanceofpa%ments dise6uilibrium7 serious and une-pected damage to domestic production7 the re6uirements of economic development or$ sub*ect to ver% broad reservations$ of agricultural polic%7 the need to protect domestic raw material production7 and the interests of national securit%. In addition the F2## rules permit countries entering a customs union to depart from the mostfavoured nation principle. >or e-ample$ within the European Economic Communit%$ >rance can permit dut%free entr% of goods from its fellow memberssuch as Ferman% and Ital%without e-tending such dut%free treatment to the products of outside nations. (eriodicall%$ ma*or multilateral trade conferences$ called rounds$ are held b% F2## countries to wor! out trade problems. ;ost of these have been held at Feneva$ site of F2## head6uarters. #he formula for multilateral tariff bargaining applied in negotiations held under F2## auspices is a ma*or innovation in intergovernmental cooperation. In appraising the concessions that the% could afford to ma!e$ governments have been able to ta!e account of the indirect advantages that the% could e-pect to accrue to them from the full set of bilateral negotiations. Over the %ears since F2##]s inception$ it has been successful far be%ond its creators] e-pectations7 its contribution to the growth of world trade has been ma*or. #wo F2## sessions of particular historic importance were the Uenned% Cound and the #o!%o Cound. 2s the economic integration of western Europe progressed$ opinion in the 8nited States became concerned at the prospect of remaining outside. (res. (ohn ?* Aennedy pursued the goal of an 2tlantic partnership and secured special negotiating powers under the #rade E-pansion 2ct of 1G1,. #he act authori5ed tariff reductions of up to 0H percent$ sub*ect to reciprocal concessions from the European partners. #his mar!ed a fundamental shift awa% from the traditional protectionist posture of the 8nited States and led to the socalled Uenned% Cound negotiations in the F2##$ held in Feneva from ;a% 1G1/ to @une 1G1=. #he Uenned% Cound negotiations concerned four t%pes of problems: &1' progressive reduction$ to amount finall% to 0H percent$ in the duties on all but a few products$ in place of the itemb%item bargaining that had prevailed in earlier F2## conferences7 &,' inclusion of agricultural as well as industrial products in the scope of the negotiations7 &.' discussion of nontariff obstacles as well as of customs duties7 and &/' nonreciprocit% for economicall% lessdeveloped countries. >ift%four countries participated in the negotiations$ which covered /HH$HHH tariff headings. #he final result was an average reduction of .0 percent in the duties levied on industrial products$ to be implemented over a five%ear period. #his was less than the 0H percent originall% envisaged. >urther$ the reductions were not geographicall% uniform: 8.S.$ European$ and @apanese duties were to fall b% an average of .0 percent$ <ritish duties b% .? percent$ and Canadian b% ,/ percent. Dittle change was made in steel and te-tile tariffs$ since the participants felt that reductions in those industries would create intolerable political and social tensions in most of the industrial countries. (roblems arose with regard to chemicals because of a 0,, socalled 2merican Selling (rice that was used for appraising the dutiable value of some products$ based on prices ruling in the 8.S. mar!et7 in return for a reduction of 0H percent in the rates of dut% charged b% the 8nited States$ Freat <ritain and the European countries agreed to lower their duties b% ,, percent$ with a further ,/ percent reduction to become effective upon abrogation of the 2merican Selling (rice. Cather less spectacular results were achieved for agricultural commodities. #hese included the setting of a minimum price for wheat and a weighted reduction of between 10 and 1? percent in the duties charged on other agricultural and food products. In the area of nontariff barriers to trade the most significant result was the adoption of a uniform antidumping code. #he Uenned% Cound continued the process of tariff reduction begun two decades earlier b% the industrial countries. +hile developing countries drew little immediate advantage from the Uenned% Cound negotiations$ the% were able to obtain the addition of a new part titled c#rade and 9evelopmentc to the F2## charter$ calling for stabili5ation$ as far as possible$ of raw material prices7 reduction or abolition of customs duties or other restrictions that differentiate unreasonabl% between products in their primar% state and the same products in finished form7 and renunciation b% the advanced countries of the principle of reciprocit% in their relations with lessdeveloped countries. #he ne-t ministerial meeting of F2## opened in #o!%o on Sept. 1,$ 1G=.$ and was attended b% representatives of ministerial or comparable level from 1H, countries. On September 1/ the meeting closed with the adoption of what came to be called the #o!%o 9eclaration. #he declaration differed mar!edl% from previous F2## documents in the inordinatel% large portion of its language devoted to strengthening the negotiating position of the lessdeveloped countries. One of the general aims of the negotiations was said to be the securing of additional trade benefits for lessdeveloped countries. Specificall%$ the trade negotiations would aim at improving the conditions of access for products of interest to such countries and ensuring stable$ e6uitable$ and remunerative prices for primar% products. #ropical products would be given special and priorit% treatment. #he principle of nonreciprocit% in negotiations between developed and lessdeveloped countries$ an established principle in F2##$ was reaffirmed: the importance of maintaining and improving the Fenerali5ed S%stem of (references granted b% developed countries to lessdeveloped countries$ as well as the need for special measures and the importance of providing special$ differential$ and more favourable treatment for lessdeveloped countries$ were recogni5ed. Special attention was to be given to the trade interests of the leastdeveloped countries. #he #o!%o 9eclaration was followed b% several %ears of multinational trade negotiations that came to be called the #o!%o Cound$ concluding in 1G=G with the adoption of a series of tariff reductions to be implemented generall% over an eight %ear period beginning in 1G?H. >urther progress was also made in dealing with nontariff issues. ;ost notabl%$ a Code on Subsidies and Countervailing 9uties was negotiated. #his code had two main features: it listed a number of unacceptable subsid% practices$ and it introduced a re6uirement that formal procedures be followed before the imposition of countervailing duties on imports subsidi5ed b% foreign nations. Specificall%$ before the imposition of a countervailing dut%$ an investigation had to establish that competing domestic firms were being in*ured. #he code was not signed b% all of the members$ however$ and the signing nations agreed onl% to follow the prescribed rules before appl%ing countervailing duties to the e-ports of other signatories. #hus$ while the code represented progress in dealing with a new topic$ it also represented a departure from the mostfavourednation principle: signatories 0,. were not re6uired to e-tend the benefits of the code to F2## members who did not sign the code. 2 new set of negotiations was initiated at a conference in 8rugua% in 1G?1. <ecause traditional tariffs were becoming much less important$ most of the attention was focused on other impediments to international transactions. #he 8nited States was particularl% eager that the new negotiations include international transactions in services and an attac! on the problems of international agricultural trade$ which had been severel% distorted b% domestic price support programs and subsidi5ed e-ports of surplus production. The .r#ani"ation for Economic Co0operation and De$elopment* On 2pril 11$ 1G/?$ 11 European countries responded to a 8.S. offer of economic aid under the European Cecover% (rogram b% setting up the Organisation for European Economic Co0operation &OEEC'. 2lthough the immediate aim was to coordinate the distribution of 8.S. credits$ the .EEC convention was also designed to foster free trade between the members and allow their participation in customs unions or similar institutions. #he members b% 1G00 consisted of <ritain$ >rance$ +est Ferman%$ Ital%$ Spain$ the <enelu- countries$ 2ustria$ 9enmar!$ Sweden$ "orwa%$ Swit5erland$ (ortugal$ Freece$ Ireland$ #ur!e%$ and Iceland. #he Organisation for European Economic Cooperation did much to facilitate the recover% of intraEuropean trade and particularl% to abolish most of the 6uantitative restrictions on imports within the area. On Sept. .H$ 1G11$ the OEEC was converted into a new institution$ the Organisation for Economic Cooperation and 9evelopment &OEC9'$ and its membership was e-panded to include the 8nited States and Canada. @apan became a member in 1G1/$ >inland *oined in 1G1G$ 2ustralia in 1G=1$ and "ew Yealand in 1G=.. #he three fundamental aims of the OEC9 are to promote the economic growth of member countries in conditions of financial stabilit%$ to contribute to the economic growth of lessdeveloped countries$ and to foster the growth of world trade on a multilateral$ nondiscriminator% basis. 3aving little power to enforce its decisions$ the OEC9 has served mostl% as a consultative bod%$ influencing trade through its studies and communications. -C#5#M+C +5,-:.4,+#5 ?orm" of inte#ration* #he economic integration of several countries or states ma% ta!e a variet% of forms. #he term covers preferential tariffs$ freetrade associations$ customs unions$ common mar!ets$ economic unions$ and full economic integration. #he parties to a s%stem of preferential tariffs lev% lower rates of dut% on imports from one another than the% do on imports from third countries. >or e-ample$ Freat <ritain and its Commonwealth countries operated a s%stem of reciprocal tariff preferences after 1G1G. In freetrade associations no dut% is levied on imports from other member states$ but different rates of dut% ma% be charged b% each member on its imports from the rest of the world. #he European >ree #rade 2ssociation is an e-ample. 2 further stage is the cu"tom" union$ in which free trade among the members is sheltered behind a unified schedule of customs duties charged on imports from the rest of the world. #he 1Gthcentur% Ferman Yollverein &see below' was a customs union. 2 common mar!et is an e-tension of the customs union concept$ the additional feature being that it provides for the free movement of labour and capital among the 0,/ members7 an e-ample was the <enelu- common mar!et until it was converted into an economic union in 1G0G. #he term economic union denotes a common mar!et in which the members agree to harmoni5e their economic policies generall%$ as is the case with the European Economic Communit% &often referred to as the Common ;ar!et'. >inall%$ total economic integration implies the pursuit of a common economic polic% b% the political units involved7 e-amples are the states of the 8nited States or the cantons of the Swiss confederation. Economic integration ma% be brought about b% the political will of a state powerful enough to impose it$ as under the Coman Empire or the European colonial s%stems of the 1Gth centur%$ or it ma% result from freel% negotiated agreement between sovereign states$ as has been more common in the ,Hth centur%. #he attempts at economic integration made after +orld +ar II can be appraised onl% b% reviewing them against the bac!ground of the long process through which$ over the centuries$ the nations of the world have progressivel% achieved economic integration. #hus$ for instance$ the world]s greatest power in the 1=th centur%$ ?rance$ was divided into a number of provinces separated from one another b% various customs barriers involving a multitude of duties$ tolls$ and prohibitions. #rade regulations and fiscal charges differed from one region to the ne-t7 there was not even a single s%stem of weights and measures. "ot until after the Cevolution did the economic integration of >rance reall% get under wa%. Inte#ration %eteen the "tate" of federation"* The 1nited State"* #he economic integration of the 8nited States was not achieved all at once$ but as the result of a long process during which the powers of the federal authorities were constantl% reinforced. #he Constitution empowered the federal government to regulate the conditions of trade with other countries and to set up a single s%stem of duties. It also abolished the right of individual states to maintain separate customs legislation and to issue their own currencies. It authori5ed the federal government alone to issue currenc% and established the principle of free movement of persons$ merchandise$ and capital between the federated states. <ut the conflict of interest between "orth and South was settled onl% b% the 2merican Civil +ar. 2lmost ,HH %ears were to elapse before the economies of the states could be considered as integrated for practical purposes$ and even toda% man% economic and fiscal disparities still e-ist among them. #he difficulties faced b% the 1. original states should not be underestimated. 9uring the %ears prior to the adoption of the Constitution there were bitter trade disputes among the states$ which imposed tariffs against each other and refused to accept each other]s currencies. Ever%thing seemed to *ustif% the words of a contemporar% liberal philosopher$ @osiah #uc!er$ 9ean of Floucester &England': 5s to the future grandeur of 5merica& and its %eing a rising empire under one head& whether repu%lican or monarchical& it is one of the idlest and most visionary notions that ever was conceived even %y writers of romance. The mutual antipathies and clashing interests of the 5mericans& their differences of governments& ha%itudes& and manners& indicate that they will have no centre of union and no common interest. They never can %e united into one compact empire under any species of government whatever# a disunited people till the end of time& suspicious and distrustful of each other& 0,0 they will %e divided and su%-divided into little commonwealths or principalities& according to natural %oundaries& %y great %ays of the sea& and %y vast rivers& lakes& and ridges of mountains. SitIerland* #he Swiss e-ample is no less instructive. 2lthough the ,el$etic Confederation emerged as a political entit% in the 1/th centur%$ its economic integration was achieved$ onl% after man% vicissitudes$ with the constitution of 1?/?. #he terms of this document established a common currenc%$ set forth the principle of a common protective s%stem for the cantons$ and provided for free movement of goods and Swiss citi5ens throughout the national territor%. Swiss economic integration is all the more remar!able in that it comprises peoples who spea! four different languages. The economic inte#ration of colonial empire"* +hen the great colonial powers of Europe founded their empires from the 11th centur% onward$ the% attempted to monopoli5e trade with the colonies and to turn it to their own profit. #his polic% involved four main restrictions: &1' #he colonies were to trade e-clusivel% with the mother countr%. &,' #he% were not to underta!e manufacturing7 transformation of raw materials into finished goods remained a monopol% right of the mother countr%. &.' Imports and e-ports of the colonies were to be carried onl% in ships fl%ing the mother countr%]s flag. &/' #he mother countr% e-empted colonial products from dut%$ or imposed lower rates. #his s%stem$ although progressivel% attenuated$ applied in various forms from the 11th to the 1Gth centur%. <ased on force$ it was to the benefit of the home countries and detrimental to the economic growth of their colonies. The Poll$erein* #he best !nown of the earl% customs unions is the Ferman Yollverein &literall%$ ccustoms unionc'. Even though "apoleon had reduced the number of :erman states from .HH to /H at the beginning of the 1Gth centur%$ those that remained were isolated from each other b% their own customs s%stems. In addition$ numerous internal customs barriers hampered trade within each state. 2t the same time there was no single e-ternal tariff$ and the Ferman industries that had sprung up during the "apoleonic +ars were being crushed b% English competition. #hese difficulties were at the root of the creation of the Yollverein. #he starting point was Pru""ia@" abolition of all internal duties and its adoption of an e-ternal tariff in 1?1?. In the ne-t few %ears a number of other Ferman states followed the (russian e-ample. <avaria and +lrttemberg set up a customs union in 1?,?$ and b% 1?.H four separate customs unions were in e-istence. (russia then sought to brea! up the local customs unions and attach them to a general customs union$ the Yollverein. #he coverage of the Yollverein increased until$ b% 1?=1$ it included all the Ferman states. In its first phase$ from 1?./ to 1?1=$ the Yollverein was administered b% a central authorit%$ the Customs Congress$ in which each state had a single vote. 2 common tariff$ the (russian #ariff of 1?1?$ shielded the member states from foreign 0,1 competition$ but free trade was the rule internall%. 9uring a second phase$ from 1?1= to 1?=1 &following (russia]s victor% over 2ustria at Sadowa'$ e-ecutive power was wielded b% a federal council &/unde"rat' composed of governmental delegates$ in which decisions were ta!en b% an absolute ma*orit%. (russia was entitled to 1= of the 0? votes and held the chair of the council. Degislative power la% with a ccustoms parliamentc &Pollparlament' composed of deputies directl% elected b% popular vote$ and$ li!e the council$ ta!ing decisions b% a ma*orit% vote. #his arrangement transformed what had been a confederation into a federal state. 2fter the victor% over >rance and the proclamation of the Ferman empire in 1?=1$ the customs parliament and the federal council were replaced b% the parliament and the e-ecutive council of the empire. #he federal state had become a nation. #he progressive destruction of a tangled ma5e of regulations$ prohibitions$ and controls set the stage for the subse6uent rapid development of the Ferman econom%. 2lthough economic integration occurred before political unification$ it would not have been possible had not man% difficulties been swept awa% b% irresistible pressure from (russia with its militar% victories. The /eneluB Economic 1nion* In 1G,1 )uBem%our#$ a former member of the Yollverein$ signed the Convention of <russels with /el#ium$ creating the <elgiumDu-embourg Economic 8nion. Since 1G,1 <elgium and Du-embourg have$ then$ had the same customs tariff and a single balance of pa%ments. #he union was e-panded after +orld +ar II to include The -etherland". 2t the beginning of 1G/? most import duties within the <enelu- area were abolished$ and a common e-ternal tariff was put into operation. E-ceptions were made$ nevertheless$ for a few agricultural products$ and it was also felt necessar% to introduce a s%stem of 6uotas. It was rapidl% perceived that a simple customs union was inade6uate$ and a treat% on Oct. 10$ 1G/G$ set as its target the progressive and complete liberali5ation of trade between the partners$ s%stematic coordination of their international commercial and monetar% policies$ and the adoption of a *oint bargaining position in negotiations with other countries. #hough the e-periment was optimisticall% viewed ever%where as the precursor of a wider European economic integration$ it faced difficulties arising from the ver% different postwar situations of <elgium and #he "etherlands. #he two economies were competitive rather than complementar%. Other problems arose in connection with the free access of 9utch agricultural products to the <elgian mar!et. ;oreover$ the <elgian economic s%stem was more liberal than the 9utch$ where rigorous price control had long been a standard practice. #he development of <enelu- received strong impetus from the formation of the European Economic Communit% in the 1G0Hs. #he #reat% of Come in 1G0= creating the EEC$ or Common ;ar!et$ spurred the members of <enelu- to confirm and strengthen their own integration in the <enelu- #reat% of Economic 8nion signed at #he 3ague on >eb. .$ 1G0?. #he 3ague treat%$ however$ contained little that was new$ and in outline it was no more than the codification of results alread% achieved. #he <enelu- Economic 8nion ma!es all of its decisions unanimousl%. #he union has e-ecutive organs &the Committee of ;inisters$ the Council of the Economic 8nion$ a number of commissions$ and a Secretariat Feneral'7 consultative organs &the Inter (arliamentar% Council and the Economic and Social 2dvisor% Council'7 and legal organs &the Court of @ustice'. 0,= The European Coal and Steel Community* 2n important step in European integration was ta!en in ;a% 1G0H when the >rench foreign minister$ Ro%ert Schuman$ proposed that a common mar!et for coal and steel be set up b% countries willing to delegate powers over these sectors of their economies to an independent authorit%. #he motive behind the plan was the belief that a new economic and political framewor! was needed if European unit% was to be achieved and if the threat of a future >rancoFerman conflict was to be avoided. In 2pril 1G01 >rance$ +est Ferman%$ Ital%$ and the three <enelu- countries signed a treat% in (aris setting up the European Coal and Steel Communit% &ECSC'. #he signatories bound themselves to abolish all customs barriers and other restrictions on the movement of coal and steel between their countries7 to renounce all discriminator% practices among producers$ purchasers$ or users &with respect to price and deliver% conditions$ transport charges$ selection of suppliers$ etc.'7 to end government subsidies or grantsinaid7 and to eliminate all practices interfering with the operation of mar!ets. The con"titution of the community* +hen first promulgated$ the constitution of the Coal and Steel Communit% allowed that it be governed b% a 3igh 2uthorit%$ assisted b% a Consultative Committee$ a Common 2ssembl%$ a Special Council of ;inisters$ and a Court of @ustice. #he ,i#h Authority was the permanent e-ecutive organ of the communit%. Its decisions$ ta!en b% a ma*orit% vote$ were full% binding on all member countries$ each of which was pledged to respect the csupranational characterc of the 3igh 2uthorit%. #he authorit% was to refer important substantive matters to the Consultative Committee before ta!ing a decision. #he latter was composed of coal and steel industr% representatives$ including producers$ wor!ers$ users$ and traders. #he assembl% was empowered to e-ercise onl% parliamentar% control but could overrule the 3igh 2uthorit% b% a twothirds ma*orit%. Its delegates were composed of deputies of national parliaments. #he function of the Council of ;inisters was to charmonise the actions of the 3igh 2uthorit% and the governments responsible for the economic polic% of respective countries.c It was composed of representatives of member countries$ each of which delegated a member of its government. ;ost decisions of the council were valid if voted b% a ma*orit% of representatives. 8nanimous agreement was re6uired onl% on decisions concerning production 6uestions and shortages. #a!en as a whole$ the treat% was similar to a federal constitution$ embodied in a long and comple- document. #here is$ however$ a basic incompatibilit% between the communit%]s provenance$ limited to the coal and steel industries$ and the sovereignt% of the member countries$ each of which is responsible for its own general economic polic%. 2s a practical matter$ during the first 1= %ears of the communit%]s e-istence$ authorit% on all substantive issues remained vested in the national governments. #he 3igh 2uthorit% was autonomous onl% in matters of secondar% importance. #hus$ the coal crisis of 1G0?when +est Ferman$ <elgian$ and >rench stoc!s of unsold coal rose to unmanageable proportionswas resolved at the national level. 2ll the 3igh 2uthorit% could do was to confirm the measures ta!en$ even when the% were contrar% to the provision of the treat%. Similarl%$ the reduction of the labour force in coal mining from 10H$HHH persons at the end of 1G0= to .HH$HHH 1H %ears later was effected b% individual countries7 there was no communit%wide action. #he treat% reserved for member countries responsibilit% for their own trade 0,? policies toward third countries. #his hindered the establishment of an effective common mar!et since a common mar!et re6uires a unified s%stem of protection from foreign competition. 2t the height of the coal crisis$ for e-ample$ when stoc!s of coal rose in <elgium$ +est Ferman%$ and >rance$ Ital% nonetheless continued to bu% cheap supplies from the 8nited States. )ater de$elopment"* 9espite such difficulties much has been accomplished b% the communit%. #he mar!ets for steel and coal have been liberali5ed to a considerable degree7 the communit% has been a useful forum in which 6uestions of common interest could be e-amined7 and it has fostered the growth of an international spirit$ which did much to facilitate the negotiation of the #reat% of Come$ establishing the European Economic Communit% and the European 2tomic Energ% Communit% &Euratom'. In 1G0= the Coal and Steel Communit%]s assembl% and Court of @ustice were replaced b% parallel institutions established b% the European Economic Communit%. In 1G1= its e-ecutive organs were merged with those of the European Economic Communit% and Euratom in what is now called the European Communities. #he other provisions of the treat% remained unchanged. The European Economic Community* #he European Coal and Steel Communit% was onl% the initial step in the movement for European integration. On ;arch ,0$ 1G0=$ its si- member governments signed the Treaty of Rome$ under which the% agreed to establish the European Economic Communit%$ or Common ;ar!et$ which came into being on @an. 1?$ 1G0?. In 1G=. it was enlarged with the entr% of Freat <ritain$ Ireland$ and 9enmar!. Since that time$ Freece &1G?1'$ Spain &1G?1'$ and (ortugal &1G?1' have become members. #he EEC is the most farreaching attempt at economic integration among sovereign countries. Its founding treat% has been the model$ in whole or part$ for all subse6uent attempts at economic integration. #he #reat% of Come aimed to cestablish a common mar!etc and cprogressivel% bring the economic policies of members into alignmentc so as to promote the harmonious growth of economic activity in the Community as a whole& regular and %alanced e'pansion& augmented sta%ility& a more rapidly rising standard of living& and closer relations %etween the participating states. #he treat% pledged the signatories to a%olish customs duties and =uantitative restrictions on the entry and outflow of merchandise& to a%rogate all other measures having an e=uivalent effect& and to fi' a common customs tariff for imports from non-mem%er states. #he% also agreed to cabolish$ as between members$ all barriers to the free movement of persons$ services and capital.c #his was to be accomplished during a transition period of 1, %ears. #he transition period ended on @an. 1$ 1G=H$ and the communit% then entered into its definitive phase. ?ormation of a cu"tom" union* #he treat% set a timetable for the abolition of customs duties between member states. On balance$ this timetable was met and in some areas e-ceeded so that$ b% the middle of 1G1?$ tariff barriers had been abolished for agricultural as well as industrial 0,G products. <% that date also$ most 6uota restrictions had been lifted. #he customs posts had not disappeared$ however7 the% were still needed for such tas!s as assessing and collecting the compensator% ta-es that e6uali5ed the differences in ta-es between member countries. #ariffs on imports from outside the communit% were graduall% brought closer$ and on @ul% 1$ 1G=H$ a common communit% tariff was put into effect. De$elopment of a common a#ricultural policy* +hen the treat% too! effect at the beginning of 1G0?$ agriculture was subsidi5ed in all si- member countries. #he various pricesupport mechanisms differed substantiall%$ as did foreigntrade policies and tariff levels. #he cumulative impact of governmental intervention of various !inds over the %ears had led to ma*or differences among the members in agricultural price levels. +ith the average price of wheat in the si- countries in 1G0G inde-ed at 1HH$ the relative price levels in individual countries were as follows: Ferman%$ 1H?7 >rance$ =?7 Ital%$ 1H?7 <elgium$ 1H17 Du-embourg$ 11G7 and #he "etherlands$ ?1. #he achievement of common policies in agriculture appeared to be so difficult that the treat% limited itself to setting forth a number of general provisions on which agreement seemed feasible. 9espite this$ a common agricultural polic% was achieved: all tariff and 6uota restrictions on trade in farm products among member countries were abolished7 a common set of tariffs on agricultural imports from nonEEC countries was established7 and a common s%stem of price "upport" too! the place of the former national s%stems. #he price supports re6uired difficult compromises among the member governments because of the differences in their domestic price levels for farm products. #he EEC wheat price$ for e-ample$ was set roughl% halfwa% between the prices of the lowestcost suppliers in the communit%$ >rance and #he "etherlands$ and those of +est Ferman%$ which was the highest. >rance e-erted considerable political pressure to persuade +est Ferman% to accept a substantial lowering of the returns to its wheat producers. #he communit% prices are supported b% purchases from a common fund. #he fund begins bu%ing in an% area where the price of a crop drops to a fi-ed intervention level. #he cost of the price support program is financed b% contributions from the members. Since its inception$ the common agricultural polic% has e-perienced several fundamental problems$ especiall% recurrent surpluses and conflicts of interest between large and smallscale producers. Surpluses have originated as a result of the price support s%stem. +hile this s%stem has helped marginal farmers sta% in business$ it has often encouraged more productive farmers to overproduce$ creating surpluses that must be purchased with EEC funds. Cecurrent surpluses of butter and sugar have become a particular problem. Conflicts of interest have arisen between countries that are net food importers &e.g.$ the 8nited Uingdom'$ which ma!e large contributions to the common polic% but receive little return in e-port subsidies and price supports$ and those countries that are net food e-porting countries &li!e >rance and Ital%'$ which receive greater relative support. Toard a harmoniIation of policie"* 2nother fundamental aim of the #reat% of Come was to achieve a general harmoni5ation of national economic policies. #he treat% envisaged the wor!ing out of common rules covering such matters as competition$ ta-ation$ and other economic legislation. It also called for the development of common policies in such areas as foreign trade and transportation. ;embers were as!ed to concert their economic policies in the fields of fiscal and monetar% polic%$ balanceofpa%ments polic%$ and social welfare. 0.H Relation" ith other countrie"* #he treat% provides that overseas countries and territories having a special relationship with <elgium$ >rance$ #he "etherlands$ and Ital% ma% be granted associate membership. #he purpose of this was to eliminate preferential tariff arrangements b% an% member with outside countries b% e-tending the same preferential terms to all of the members. #he treat% also provides for a European 9evelopment >und to assist the economic development of these countries. -e mem%er"* 2n% European state ma% re6uest membership in the EEC. 2cceptance re6uires a unanimous decision b% the present members after cthe conditions for entr% and the modifications to be made to the #reat% as a resultc have been agreed upon b% the member states and the wouldbe entrant. A""ociate"* #he EEC ma% also conclude an agreement of association with a nonmember countr%$ a union of states$ or an international organi5ation. #he associate is entitled to special terms in its trade with the EEC and can send representatives to its meetings. 2ssociate status providing for a customs union after a 1,%ear transitional period was granted to Freece in 1G1,$ prior to its accession as a full member$ and to #ur!e% in 1G1/. (artial association agreements have been signed with other countries. Con"titution of the EEC* 2s mentioned above$ since 1G1= the governing bodies for the EEC$ the ECSC$ and Euratom have been integrated. #hese bodies include the Council of ;inisters$ the Commission$ the European (arliament$ and the Court of @ustice. #he Council of ;inisters and Commission are assisted b% the Economic and Social Committee with advisor% functions. 3ead6uarters are in <russels$ Du-embourg$ and Strasbourg. #he council has decisionma!ing power in all matters falling within the sphere of competence of the communities. Each member sends one delegate. 9uring the transition period before 1G=H$ all important decisions had to be ta!en unanimousl%7 the% ma% now be ta!en b% either absolute ma*orit% or c6ualifiedc ma*orit% &i.e.& with weighted voting rights' or unanimousl%. Either a 6ualified ma*orit% or unanimit% are re6uired on certain matters b% the treat%. 9ecisions must be ta!en unanimousl% on a ver% large number of issues. #he Commission members are cselected b% reason of their general competence and offering the utmost guarantees of independence.c #he% are appointed b% agreement among the member countries$ not more than two being of the same nationalit%. ;embers serve a four%ear term and ma% be reappointed. #he% are e-pected to act in the general interest of the communities$ without deference to an% government or other organi5ation. #he Commission]s basic function is to watch over the application of the #reat% of Come and other treaties and to assist the council with recommendations or advice. Its powers for the most part are delegated to it b% the council. #he European Parliament is formed of delegates selected from the parliaments of the members. In principle the parliament meets once a %ear. It passes recommendations and resolutions and discusses the Commission]s annual report. It ma% pass a resolution of no confidence in the Commission b% a twothirds ma*orit%$ resulting in immediate dismissal of the Commission members. #he Court of (u"tice is charged with the interpretation and application of the treaties. It is composed of 11 *udges appointed b% mutual agreement of the governments of the member states for si-%ear terms. 2ctions ma% be brought in the court b% an% member state or b% an% ph%sical or legal person. #he court]s powers are considerable since 0.1 communit% law ta!es precedence over the national laws of each member countr%. #he Economic and Social Committee is a consultative bod% composed of representatives of various economic and social strata$ including manufacturing$ agriculture$ transportation$ trade$ handicrafts$ the liberal professions$ wage earners$ and the public. Its members are appointed for a four%ear term b% unanimous decision of the council and ma% be reappointed. The European ?ree Trade A""ociation* +hen the European Economic Communit% was being organi5ed$ Freat <ritain sought to organi5e a freetrade area that would include 1= member countries of the Organi5ation for European Economic Cooperation. #his would have given <ritain access to the benefits of the industrial common mar!et on the Continent while avoiding possible infringements of <ritish sovereignt%. #he effort failed$ mainl% because of >rench opposition. <ritain then undertoo! the formation of a freetrade area in association with 2ustria$ 9enmar!$ "orwa%$ (ortugal$ Sweden$ and Swit5erland. #he convention setting up the European >ree #rade 2ssociation &E>#2' was signed at Stoc!holm on @an. /$ 1G1H. #he preamble stated that one of the main purposes of the organi5ation was to cfacilitate the future establishment of a wider multilateral association for abolition of customs barriers.c ;ore specificall%$ it was intended as a mechanism for freeing trade with the si- Common ;ar!et countries without subscribing to the commitments of political character embodied in the #reat% of Come. In the meantime$ E>#2 gave its seven members a stronger bargaining position visnvis the other si-$ as well as the means of creating a large mar!et of their own. .peration of the E?TA* #he European >ree #rade 2ssociation is governed b% a council composed of one member from each participating state. #he council found it useful to set up a *oint consultative committee composed of representatives of industr%$ business$ and labour7 a set of si- permanent technical committees &on customs$ trade$ economic development$ agriculture$ economics$ and budget'7 and wor!ing parties dealing with special topics. #he E>#2 treat%$ li!e that of the EEC$ provided for a transitional period$ set forth rules governing competition$ and called for the abolition of all indirect protection and trade discrimination. #he E>#2 had one special problem arising from its nature as a freetrade area. Since the duties charged on imports from outside countries might differ from one member to another$ traders could ta!e advantage of the differences b% channeling imports through the countr% lev%ing the lowest rates and delivering them to customers in another member countr%. Cules were established to prevent this b% classif%ing merchandise according to whether it was produced or fabricated in one of the member countries. In the case of goods made from imported raw materials$ the rules re6uired that the import content not e-ceed 0H percent of the e-port price of the finished product. The E?TA@" record* 2lthough a 1H%ear transitional period was originall% envisaged$ internal customs barriers on industrial goods were eliminated on @an. 1$ 1G1=$ three %ears ahead of schedule. <ilateral trade agreements have also been negotiated to increase trade in agricultural products. #he E>#2 passed through two grave crises in the 1G1Hs. #he first was in 1G11 when <ritain$ acting 0., unilaterall%$ informed its partners that it had applied for membership in the EEC. #he upshot was a *oint declaration in which the E>#2 members committed themselves to ccoordinate their action and remain united throughout the negotiations.c #he second crisis occurred in October 1G1/$ when$ to shore up the pound sterling$ <ritain suddenl% introduced a surcharge of 10 percent on all its industrial importsan act that was in violation of the treat%. >inland became an associate member of E>#2 in @ul% 1G11$ and Iceland was admitted to full membership in ;arch 1G=H. In 1G=. <ritain and 9enmar! left the association when the% were accepted as members in the European Economic Communit%<ritain$ after two previous unsuccessful tries. Since that time agreements have been reached between E>#2 and EEC promoting trade between the two groups. Economic inte#ration in )atin America* (rogress toward economic integration in Europe encouraged the )atin0 American republics to ma!e similar attempts. <% the late ,Hth centur% several organi5ations had been established to wor! toward such integration7 the% include the Central 2merican Common ;ar!et7 the Datin 2merican >ree #rade 2ssociation7 the 2ndean Froup7 and the Caribbean Communit% and Common ;ar!et. The Central American Common Mar!et* On @une 1H$ 1G0?$ El Salvador$ Fuatemala$ 3onduras$ "icaragua$ and Costa Cica signed a multilateral treat% aiming at free trade and economic integration. It provided for the establishment of a freetrade area within 1H %ears. #he participating countries also agreed to the industrial integration of the region. #hese arrangements were completed b% the signature on 9ec. 1.$ 1G1H$ of the #reat% of ;anagua. Its aims were similar to those of the EEC in Europe$ namel%$ the establishment of a common mar!et within five %ears and the organi5ation of integrated industrial development. ;ost barriers on the region]s internal trade have since been removed or reduced$ and a single customs tariff has been introduced for most products imported from outside the area. Economic integration in Central America has been hampered b% disagreements and militar% conflicts in the area. >ollowing a dispute with El Salvador in 1G=H$ ,ondura" in effect withdrew from common mar!et membership b% implementing tariffs on imports from other member countries. In 1G?H$ however$ 3onduras signed a treat% with El Salvador$ settling their dispute and restoring 3onduran participation in the common mar!et trade agreements. 9uring the 1G?Hs$ tensions between the revolutionar% government of "icaragua and its neighbours$ as well as other disorders$ have disrupted trade among the nations of Central 2merica. The )atin American Inte#ration A""ociation* On >eb. 1?$ 1G1H$ 2rgentina$ <ra5il$ Chile$ ;e-ico$ (aragua%$ (eru$ and 8rugua% signed a treat% setting up the )atin American >ree #rade 2ssociation &)A?TA'$ predecessor to the Datin 2merican Integration 2ssociation. <% 1G=H the seven signatories had been *oined b% Ecuador$ Colombia$ Vene5uela$ and <olivia. #he treat% provided for a 1,%ear transition period during which all obstacles to trade were to be eliminated. It was based on the principle of reciprocit% and mostfavoured nation treatment. ;ember states also committed themselves to progressive coordination of their industriali5ation policies. Special treatment was provided for agriculture and for the relativel% leastdeveloped member countries. Diberali5ation of trade between the member countries was carried out initiall% through negotiation of productb%product concessions. In 1G1=$ however$ the negotiations failed7 the% were postponed to 1G1?$ when agreement was reached on a s%stem of acrosstheboard automatic tariff reductions similar to 0.. those of the European Economic Communit%. #he eventual aim was that D2>#2 be the first step in a process that would lead to a common Datin2merican mar!et7 but during the 1G=Hs it became apparent that the geographic diversit% and var%ing levels of economic development e-hibited b% the member countries were handicapping the formation of a true common mar!et within the association]s e-isting framewor!. In the late 1G=Hs negotiations were begun to establish a new framewor! for economic integration$ and in 1G?H$ ,H %ears after the creation of D2>#2$ the Datin 2merican Integration 2ssociation &D2I27 2sociaci{n Datino2mericana de Integraci{n' was formed. 8nli!e its predecessor$ D2I2 adopted an alternative to the concept of a free trade area in that it opted for the establishment of bilateral preference agreements that would ta!e into account the var%ing stages of economic development of the member countries. In order to best negotiate bilateral preference agreements the member nations were divided into three categories: most developed countries &2rgentina$ <ra5il$ and ;e-ico'$ intermediate developed countries &Chile$ Colombia$ (eru$ 8rugua%$ and Vene5uela'$ and leastdeveloped countries &<olivia$ Ecuador$ and (aragua%'. Cuba was admitted to D2I2 in 1G?1 with observer status. The Andean :roup* In 1G11 <olivia$ Chile$ Colombia$ Ecuador$ (eru$ and Vene5uela$ all members of the Datin 2merican >ree #rade 2ssociation$ agreed to form a regional subgroup. #he Andean :roup finall% began its official e-istence in @une 1G1G without Vene5uela$ which had withdrawn. <% 1G=. Vene5uela had decided to *oin$ but Chile withdrew in 1G=1. &#he 2ndean @udicial #ribunal was established in 1G?H to monitor$ interpret$ and resolve problems resulting from 2ndean Froup decisions. #he tribunal is composed of one *udge from each countr%$ serving a si-%ear term.' 2mong the group]s aims are the acceleration of economic integration between member countries$ the coordination of regional industrial development$ the regulation of foreign investment in member countries$ and the maintenance of a common e-ternal tariff. The Cari%%ean Community and Common Mar!et* Established in 1G=. b% 1, Caribbean countries$ the Cari%%ean Community and Common Mar!et &Caricom' is the successor to the Caribbean >ree #rade 2ssociation$ which was founded in 1G1? b% five former <ritish colonies &2ntigua$ <arbados$ Fu%ana$ @amaica$ and #rinidad and #obago'$ all of whom *oined the new organi5ation. #he organi5ation attempts to encourage economic integration in the Caribbean region and achieved partial agreement to a common e-ternal tariff and protective polic% for the communit% in 1G=?. Caribbean economic integration was curtailed between 1G=1 and 1G=?$ in part because of import restrictions imposed b% @amaica and Fu%ana$ and in part because of dissatisfaction among the lessdeveloped countries$ who claimed that the% were not receiving their fair share of trading revenues. <% 1G?H @amaica and Fu%ana had removed their import restrictions$ and the Caricom Council had endorsed several measures to improve the status of the lessdeveloped countries within Caricom. #he lessdeveloped countries$ however$ remained dissatisfied$ and in 1G?1 the seven former members of the We"t Indie" 2ssociated States &2ntigua and <arbuda$ 9ominica$ Frenada$ ;ontserrat$ Saint Uitts"evis$ Saint Ducia$ and Saint Vincent' formed a subregional economic integration organi5ation$ the Organi5ation of Eastern Caribbean States. #he% retained their Caricom membership. The Council for Mutual Economic A""i"tance M7HCH0H3N* 0./ 2 Sovietsponsored effort to integrate the economies of eastern Europe began as earl% as @an. ,0$ 1G/G$ in response to the ;arshall (lan. #he founding states were <ulgaria$ 3ungar%$ (oland$ Comania$ C5echoslova!ia$ and the Soviet 8nion. 2lbania *oined in 1G/G$ the Ferman 9emocratic Cepublic in 1G0H$ and the ;ongolian (eople]s Cepublic in 1G1,. 2lbania ceased to participate after 1G11. In its earl% %ears the activities of the Council for Mutual Economic A""i"tance &or Comecon' were limited mainl% to the registration of bilateral trade and credit agreements among the member countries. 2fter Stalin]s death in 1G0. it made efforts to promote industrial speciali5ation and to reduce cparallelismc in the economies of its members. In 1G01 and 1G0=$ when most of its standing commissions began to operate$ attempts were made to harmoni5e the longterm plans of the members. #he establishment of the European Economic Communit% in 1G0?$ together with pressures from the eastern European countries for a greater degree of independence$ induced the Soviet leadership to rethin! the organi5ation. 2 new charter was signed b% the members in Sofia on 9ec. 1/$ 1G0G. #he council]s economic ob*ectives were to coordinate each member countr%]s efforts for development in technolog% and industriali5ation$ growth of labour productivit%$ and speciali5ation in industr%. 3owever$ the democratic revolutions throughout eastern Europe in 1G?GGH left the organi5ation defunct. In 1GG1 the Council for ;utual Economic 2ssistance was renamed the Organi5ation for International Economic Cooperation$ under which each member countr% was free to develop its own foreign trade. 2fter the collapse of the communist governments$ member countries moved toward private enterprise and mar!etbased price s%stems. Comecon]s original ob*ectives had been hindered b% certain political and economic constraints. One of the most serious was the absence of fle-ible and realistic price s%stems in the member countries. #his made it impossible to base trade on relative prices7 instead it was conducted mainl% on a barter basis through bilateral agreements between governments. In negotiating such agreements$ the parties were led to use cworld pricesci.e.& prices prevailing in the trade of countries outside the Council for ;utual Economic 2ssistance. 2nother hindrance to economic integration was the highl% centrali5ed economic planning in the member countries$ which had onl% limited success in coordinating their plans. #here were also serious nationalistic tensions within the council. #he Romanian government$ for e-ample$ announced its intention to pursue allaround industriali5ation$ including the development of its heav% industries$ in opposition to the polic% of speciali5ation in raw materials and agricultural products that was said to have been the Council for ;utual Economic 2ssistance]s polic% for Comania. 2mong the practical achievements of the Council for ;utual Economic 2ssistance$ however$ were the organi5ation of railroad coordination &1G01'7 construction of a highvoltage electricit% grid &1G1,'7 creation of the International <an! for Economic Cooperation &1G1.'7 the pooling of G.$HHH railwa% freight cars &1G1/'7 and construction of the c>riendshipc oil pipeline from Cussia]s Volga region to the eastern European countries. Comecon initiall% was composed of the old Soviet 8nion]s eastern European satellites$ but in 1G=, Cuba became a member and in 1G=? Vietnam *oined. #he highest authorit% of the organi5ation was the councilinsession. It was composed of delegations from all member countries$ the composition of each delegation being fi-ed b% the government concerned. #he conference of representatives of member countries$ composed of one representative of each countr%$ could issue recommendations and decisions. It could also submit proposals for e-amination b% the councilinsession. Various 0.0 permanent commissions were composed of e-perts and officials of member countries. Some were general economic commissions7 others dealt with specific industries. #he head6uarters of the various commissions were located in the capital cities of member countries. #he central secretariat was in ;oscow. #he Council for ;utual Economic 2ssistance was often called the eastern European counterpart of western Europe]s EEC. 2lthough the general aims were indeed the same$ the two organi5ations differed radicall% in their approach to the problems involved. #he EEC aims to achieve integration on a decentrali5ed basis b% means of an economic mar!et in which goods$ services$ capital$ and persons have full freedom of movementa mar!et regulated b% uniform economic legislation. #he Council for ;utual Economic 2ssistance sought to achieve cooperation among national economies each of which was centrall% planned and administered. :ATT rule" re#ardin# re#ional arran#ement"* +hen countries *oin regional trading groups such as the European Economic Communit%$ the% provide preferences to one another. >or e-ample$ Ferman producers can e-port dut%free to >rance$ whereas 8.S. or @apanese e-porters still have to pa% duties on products shipped to >rance. #hus$ Ferman producers are preferred over 8.S. or @apanese suppliers7 a customs union represents a departure from mostfavoured nation treatment. "evertheless$ countries entering a customs union or freetrade association are not in violation of their commitments under the Feneral 2greement on #ariffs and #rade7 customs unions and freetrade associations are permitted under F2##. F2## article OOIV allows countries to grant special treatment to one another b% establishing a customs union or freetrade association$ provided that &1' duties and other trade restrictions are celiminated on substantiall% all the tradec among the participants$ &,' the elimination of internal barriers occurs cwithin a reasonable length of timec &commonl% interpreted as permitting a phasein period of not more than 1H %ears'$ and &.' duties and other barriers to imports from nonmember countries cshall not on the whole be higher or more restrictivec than those preceding the establishment of the customs union or free trade association. #he third condition was e-plicitl% aimed at protecting the rights of outside countries. #he first condition disapproves partial preferential arrangements covering onl% some products$ while accepting broad arrangements covering &substantiall%' all products. It was supported on the ground that large$ unrestricted mar!etsmost notabl%$ that within the 8nited Statesprovide substantial benefits. Such benefits should also be available to others. >or e-ample$ when the F2## articles were being drafted$ consideration was being given to an integration of the nations of western Europe. Shortl% after article OOIV was written$ it received substantial support in the classic stud% of (aco% Viner$ The Customs >nion 2ssue &1G0H'. Viner$ a Canadianborn 8.S. economist$ saw efficienc% as the main gain from international trade$ since trade encourages production in a less costl% location. 3e contended that a customs union wor!s to increase efficienc% in one wa%$ but decreases it in another. #o e-plain$ Viner drew a distinction between two forces at wor! when a customs union is established. 2s two &or more' countries cut tariffs on each other]s products$ new trade is created. Some goods previousl% bought from domestic producers are now bought from lowercost producers in the trading partner$ whose goods now come in dut%free$ improving efficienc%. +hen$ however$ a countr% removes tariffs on its partner]s goods but not on the goods of outside 0.1 countries$ the partner has preferred access. 2s a result$ some purchases are switched goods are bought from the partner nation$ rather than from the outside world. Such trade diversion reduces efficienc%7 purchases are switched from the efficient outside countr% to the less efficient partner nation. 2 customs union &or freetrade area' ma% be predominantl% tradecreating$ which is desirable$ or it ma% be predominantl% trade diverting$ which is not. Viner]s boo! thus introduced a s!eptical note into the discussion of customs unions$ which had previousl% been given broad approval. Viner]s wor! also supported the distinctions made in article OOIV of the Feneral 2greement on #ariffs and #rade. Clearl%$ if barriers on imports from nonmember countries are !ept down$ then trade diversion is less li!el%. >urthermore$ the provision to disapprove partial preferential arrangements covering onl% some products$ while accepting broad arrangements covering virtuall% all products found support within Viner]s framewor!. <ecause of the political d%namics of trade negotiations$ partial preferential arrangements generall% cause more trade diversion than trade creation. #his can be illustrated in a h%pothetical situation in which countries &sa%$ >rance and Ferman%' are permitted to get together to ma!e whatever preferential agreements the% wish. 2 natural wa% for >rance to open negotiations would be to sa% to Ferman%: c+e]ll cut tariffs on %our automobiles and bu% from %ou rather than @apan$ if %ou will cut tariffs on our sugar and bu% from us rather than from the Caribbean nations.c In other words$ negotiators tend to pic! and choose those items previousl% imported from outside countries7 the% tend to cut tariffs where trade diversion is greatest. <% re6uiring a comprehensive approach$ article OOIV ensures that tradecreating tariff cuts will be made$ too. Pattern" of trade D-:.-- #6 54,+#54' /4.,+C+/4,+#5 "ations var% considerabl% in the e-tent of their foreign trade. 2s a ver% rough generali5ation$ it ma% be said that the larger a countr% is in ph%sical si5e and population$ the less its involvement in foreign trade$ mainl% because of the greater diversit% of raw materials available within its borders and the greater si5e of its internal mar!et. #hus$ the participation of the 8nited States is relativel% low$ as measured b% percentage of gross national product$ and that of the former Soviet 8nion was even lower. #he 8.S. gross national product$ however$ is so immense b% world standards that the 8nited States still ran!s as one of the world]s most important trading countries. Some of the smaller countries of western Europe &such as #he "etherlands' have e-port and import totals that appro-imate half of their gross national products. ,.4D- 4M#5: D->-'#/-D C#75,.+- #he greatest volume of trade occurs among the developed$ capitalrich countries$ especiall% among industrial leaders such as 2ustralia$ <elgium$ Canada$ >rance$ Ferman%$ Ital%$ @apan$ #he "etherlands$ Spain$ Sweden$ the 8nited Uingdom$ and the 8nited States. Fenerall%$ as a countr% matures economicall%$ its participation in foreign trade grows more rapidl% than its gross national product. #he European Economic Communit% &EEC' affords an impressive instance of the gains to be derived from freer trade. 2 ma*or part of the increases in real income in EEC countries is almost certainl% attributable to the removal of trade barriers. #he EEC]s formation cannot$ however$ be interpreted as reflecting an un6ualified dedication to the freetrade principle$ since EEC countries maintain tariffs against goods from outside the Communit%. 0.= TRADE /ETWEE- DEVE).PED A-D DEVE).PI-: C.1-TRIES 9ifficult problems fre6uentl% arise out of trade between developed and developing countries. ;an% lessdeveloped countries are tropical$ fre6uentl% rel%ing heavil% for income upon the proceeds from e-port of one or two crops$ such as coffee$ cacao$ or sugar. ;ar!ets for such goods are highl% competitive &in the sense in which economists use the term competitive'that is$ prices are e-tremel% sensitive to ever% change in demand or in suppl%. (rices of manufactured goods$ the t%pical e-ports of developed countries$ are commonl% much more stable. 3ence$ as the price of its e-port commodit% fluctuates$ the tropical countr% e-periences large fluctuations in its cterms of trade$c the ratio of e-port prices to import prices$ often with painful effects on the domestic econom%. +ith respect to almost all important primar% commodities$ efforts have been made at price stabili5ation and output control. #hese efforts have met with varied success. Comparable problems arise when the developing countr% e-ports a mineral resource such as petroleum or copper. #he initiative in developing such a resource has often been ta!en b% a foreign compan% from a developed countr% that owns &in part if not in full' the e-tracting capital facilities. (articularl% since the mineral resource is e-haustible$ charges of e-ploitation are common. #he matter is a continuing source of political strife and ma% on occasion lead to e-propriation of the mineral properties. Several groups of developing countries have *oined in creating organi5ations for the promotion of trade between themselves. "otable e-amples include the Central 2merican Common ;ar!et &1G11'$ the Organisation Commune 2fricaine et ;auricienne &1G10'$ the 2ssociation of Southeast 2sian "ations &1G1='$ the Caribbean Communit% and Common ;ar!et &1G=.'$ and the Datin 2merican Integration 2ssociation &1G?H'. International commodity trade Foods that are traded internationall% fall into two broad categoriesprimar% goods and manufactured products. ;anufactured products$ such as machiner% and clothing$ comprise products whose value reflects largel% the cost of manufacturing processes. Such manufacturing processes contribute relativel% little to the value of primar% goods$ such as crude petroleum and cotton$ which undergo little processing before the% are traded. Commodities and commodity mar!et" are terms used as s%non%ms for primar% goods and the mar!ets in such goods. /.+M4.Y C#MM#D+,Y M4.8-, #rade in primar% goods ma% ta!e the form of a normal e-change of goods for mone% as in an% ever%da% transaction &referred to technicall% as trade in Factual"F'$ or it ma% be conducted b% means of future" contracts. 2 futures contract is an agreement to deliver or receive a certain 6uantit% of a commodit% at an agreed price at some stated time in the future. #rade in actuals has declined considerabl% and in man% cases &such as the Diverpool mar!ets in cotton and grain' has even come to a halt. .peration of the mar!et* #he great bul! of commodit% trading is in contracts for future deliver%. #he purpose of trading in futures is either to insure against the ris! of price changes &hedging' or to ma!e a profit b% "peculatin# on the price trend. If a speculator believes that prices will rise$ he bu%s a futures contract and sells it when he wishes &e.g.& at a more distant deliver% date'. #he speculator either gains &if prices have risen' or loses &if the% have fallen'$ the difference being due to the change in price. F,ed#in#F means the offsetting of commitments in the mar!et in actuals b% futures contracts. 2 producer who bu%s a commodit% at spot ¤t' 0.? prices but does not normall% resell until three months later can insure himself against a decline in prices b% selling futures: if prices fall he loses on his inventories but can purchase at a lower price7 if prices rise he gains on his inventories but loses on his futures sales. Since price movements in the actuals mar!et and the futures mar!et are closel% related$ the loss &or gain' in actual transactions will normall% be offset b% a comparable gain &or loss' in the futures mar!et. #he operation of futures mar!ets re6uires commodities of uniform 6ualit% grades in order that transactions ma% ta!e place without the bu%er having to inspect the commodities themselves. #his e-plains wh% there is no futures mar!et$ for e-ample$ in tobacco$ which varies too much in 6ualit%. 2 stead%$ unfluctuating suppl% also is needed7 this is referred to technicall% as clow elasticit% of suppl%$c meaning that the amount of a commodit% that producers suppl% to the mar!et is not much affected b% the price at which the% are able to sell the commodit%. If suppl% could be ad*usted relativel% 6uic!l% to changes in demand$ speculation would become too difficult and ris!% because e-ceptionall% high or low prices$ from which speculators are able to profit$ are eliminated as soon as suppl% is ad*usted. ;onopolistic control of demand and suppl% is also unfavourable to the operation of a futures mar!et because price is sub*ect to a large e-tent to the control of the monopolist and is thus unli!el% to fluctuate sufficientl% to provide the speculator with an opportunit% for ma!ing profits. #here is$ for e-ample$ no mar!et in diamonds$ because there is onl% one mar!eting cooperative. In 1G11 the Dondon mar!et in shellac ceased to function after the Indian government applied control of e-porters] prices at the source. <efore +orld +ar II )ondon was the centre of international trade in primar% goods$ but -e Yor! City has become at least as important. It is in these two cities that the international prices of man% primar% products are determined. 2lthough "ew :or! often has the bigger mar!et$ man% producers prefer the Dondon mar!et because of the large fluctuations in local demand in the 8nited States that influence "ew :or! mar!et prices. In some cases international commodit% agreements have reduced the significance of certain commodit% mar!ets. #here are mar!ets in both "ew :or! and Dondon for numerous primar% goods$ including cotton$ copper$ cocoa$ sugar$ rubber$ coffee$ wool and wooltops$ tin$ silver$ and wheat. #ea$ wool$ and furs are auctioned in Dondon$ but in the case of man% other commodities$ auctions have been superseded b% private sales. In Dondon the metal mar!et is much more a cspotc or deliver% mar!et than other futures mar!ets. ;an% countries have their own mar!ets: 2ustralia for wool$ Sri Dan!a and India for tea$ and ;ala%sia for rubber and tin. The term" of trade* #he relation between the price of primar% goods and that of manufactures has long intrigued economists. #he relationship is !nown as the Fterm" of tradeF and ma% be defined as the ratio of the average price of a countr%]s or a group of countries] e-ports to the average price of its imports. #he longrange trend of the terms of trade between primar% products and manufactures has been the sub*ect of diametricall% opposed conclusions: some theorists hold that the trend is favourable to the less developed countries$ others that it is unfavourable. >ault% statistical material and methods in various countries are responsible for this lac! of agreement. 2n% comparison of the terms of trade over a long period of time is ver% difficult and ma% be misleading because the structure of trade changes$ as does the 0.G 6ualit% of the groups of goods studied. ;an% economists believe that the terms of trade were adverse for lessdeveloped countries from 1?=H to 1G.?. #he% point to the fact that as developed countries become more technologicall% advanced there is a tendenc% for them to re6uire relativel% less in the wa% of primar% products. 2 downward influence is thus e-ercised on primar% product prices. 2nother factor is that in the industrial countries the benefits of progress find e-pression not in lower prices but in higher wages. #his$ together with inflationar% pressures$ means that prices of manufactured goods produced b% the developed countries tend to rise steadil%. #here is thus a tendenc%$ it is argued$ for the lessdeveloped countries to receive relativel% less for what the% have to sell and to have to pa% more for what the% need to bu%. <ut the statistical problems posed b% an% attempt to verif% this h%pothesis are considerable. #he countries selected$ the relative weight assigned to the various goods$ changes in transport costs$ and the fact that the 6ualit% of manufactured goods has improved much more than that of primar% goods ma!e the statistics unreliable. #here is also the problem that the terms of trade between primar% commodities and manufactures do not necessaril% coincide with the terms of trade between lessdeveloped and industrial areas. Even if it were established that the terms of trade have moved against the lessdeveloped$ largel% primar%producing countries$ this would not necessaril% mean that their balanceof pa%ments situation has been adversel% affected. 2 decline in the terms of trade ma% in fact improve a countr%]s balanceofpa%ments$ because$ although the prices of that countr%]s eBport" have fallen$ it ma%$ as a conse6uence of this fall in price$ be able to sell a far larger 6uantit%. #otal revenue from e-ports ma% thus increase. Similarl%$ although import" ma% become more e-pensive$ the result ma% be that the countr%]s demand for imports drops ver% steepl%$ so that less is spent on them than when the% were cheaper. #hese problems ma!e it e-tremel% difficult to generali5e about the effects of commodit% price changes on the economic situation of one or a group of countries. /.+C- M#>-M-5, (rices usuall% var% widel% in commodit% mar!ets$ not onl% in the short run but also in the long run. In the short run there are fre6uent changes in suppl% because of var%ing climatic conditions &for agricultural products' and because of political and other events on the international scene &such as the closure of the Sue5 Canal' and in individual countries &such as stri!es'. 2s a rule$ price changes do not give rise in the short run to substantial changes in the suppl% of or demand for primar% goods &low elasticit% of suppl% and demand'. <usiness c%cles in the importing countries$ however$ have an influence on demand. ;ar!et conditions differ$ of course$ from product to product. In the case of "u#ar and heat$ demand is fairl% stable$ but suppl% is not7 as regards tin$ and$ indeed$ the ma*orit% of metal"$ the converse is true. In the case of industrial commodities$ such as cotton$ there are fluctuations in both suppl% and demand. In the long run the e-tent of changes in demand and suppl% is usuall% greater. 2 considerable and sustained price increase$ for e-ample$ ma% result in a fall in demand and the appearance of substitute products. 2fter a number of %ears$ suppl% ma% increase in response to a higher level of demand reflected b% higher prices. #he length of time re6uired to ad*ust suppl% to demand varies from commodit% to commodit%. #ree crops$ for e-ample$ need a long growth period$ and mineral reserves are tapped onl% if e-pectations about the price trend are favourable. Effect on economic de$elopment* 0/H #hrough their repercussion on e-port earnings$ price fluctuations are often held responsible for the variations in the growth rate of countries producing primar% goods$ especiall% since e-ports of a single primar% good account for a large part of the total e-ports of man% countries. <ut apart from the fact that$ as described above$ 6uantities e-ported influence e-port earnings as much as prices$ there are man% other factors that determine e-port earnings. Such factors include the t%pe and destination of e-ports and$ above all$ the economic policies of the countries concerned. It is thus difficult to generali5e about the relation of foreign trade to economic growth. ;an% countries with ver% unstable e-ports have relativel% stable national incomes7 others whose e-ports are stable have highl% unstable national incomes. #he stimulus from e-ports will usuall% be stronger$ for e-ample$ if the rate of demand for these e-ports is growing rapidl%. Often$ however$ the transmission of growth to the none-porting sector of the econom% is impeded in lessdeveloped countries b% the economic$ social$ and political organi5ation of the econom%. It is important$ for e-ample$ for some countries to tr% to decrease e-ports of goods that have a slowl% growing demand and at the same time to tr% to increase e-ports of goods$ such as minerals$ for which world demand is growing more rapidl%. Effort" to "ta%iliIe price"* #he uncertaint% both for private producers and for governments resulting from sharp and sudden commodit% price changes has resulted in man% efforts to achieve greater stabilit% on the mar!et in primar% goods. Action in indi$idual countrie"* In theor% a countr% could insulate domestic producers against international price fluctuations through variable charges and subsidies$ but politicall% it is difficult to ta- awa% producers] profits during a period of rising prices and to hold the resulting revenue in order to redistribute it should prices and profits fall. In -i#eria$ :hana$ Sierra )eone$ and The :am%ia$ for instance$ national mar!eting boards that attempted to even out price fluctuations of cocoa$ cotton$ and peanuts &groundnuts' were in operation before those countries became independent. In the former >rench territories in 2frica$ stabili5ation funds fi-ed producer prices and controlled margins and profits. #he main dangers inherent in national stabili5ation schemes are inconsistent government policies and the e-cessive operating costs of the public bodies concerned. #hese factors e-plain the unsatisfactor% results of man% national price agencies. International cooperation* In the 1G,Hs international cartel" were created for rubber$ sugar$ tin$ and tea$ but the% %ielded no lasting results. "or did cooperation between the governments of e-porting and importing countries &such as in the International +heat 2greement of 1G.. and the International Sugar 2greement of 1G.=' serve to attain the desired goals during the Freat 9epression. Of special significance among more recent attempts to raise and stabili5e a commodit% price has been the one made b% the Organi5ation of (etroleum E-porting Countries &O(EC'. &#he special features of the oil mar!et are considered below.' Other attempts to stabili5e commodit% prices since +orld +ar II have mainl% assumed three formsthe multilateral contract agreement$ the 6uota agreement$ and the bufferstoc! agreement. #ransactions are effected at world mar!et prices. +hen a minimum or a ma-imum price is reached or approached$ efforts are made to ensure that prices remain within the two limits. Each of the three s%stems 0/1 achieves this in a different wa%. In the multilateral contract s%stem$ consumers and producers underta!e to bu% or sell a specified 6uantit% of the commodit% at agreed minimum and ma-imum prices$ or at a price within the agreed range. In the +uota method$ the 6uantit% negotiated is determined b% a previousl% fi-ed 6uota when a minimum or ma-imum price is e-ceeded. +hen there is a surplus$ the producers restrict their e-ports or production7 when there is a shortage$ 6uotas are allotted to the consumer countries. +ith the bufferstoc! method$ stabilit% is ensured b% a combination of an e-port control arrangement and a bufferstoc! arrangement. In certain circumstances e-ports are restricted b% the controlling bod%. #he bufferstoc! agenc% bu%s when the mar!et price is in the lower sector or at the floor price set out in the agreement7 the bufferstoc! agenc% sells when the mar!et price is in the upper sector or at the ceiling price. Re"ult"* #he utilit% of commodit% agreements in general can hardl% be *udged on past e-perience. E-perience with wheat$ sugar$ and tin agreements$ which cover a comparativel% long period$ is not conducive to generali5ation. Some degree of stabilit%$ though at a high price level$ was achieved in the case of wheat$ but this was due to the dominant influence of 8.S. and Canadian policies. In the case of tin$ too$ transactions for the 8.S. strategic stoc!pile e-erted an influence. (olitical factors &including the Cuban revolution' underla% the de facto suspension from 1G1, to 1G1G of the sugar agreement$ which had covered$ and still covers$ onl% a limited share of the world mar!et. #he value of world transactions in tin$ wheat$ coffee$ and sugar amounts to onl% a small part of the value of the world]s entire commodit% trade. >urthermore$ the agreements in 6uestion do not cover all transactions. It is$ in a wa%$ understandable that onl% a few such agreements have been concluded7 during a boom the producer countries are not inclined to conclude them$ and during a depression there is little incentive for consumer countries to enter into them. Condition" for "ucce""* 2 prere6uisite for the success of commodit% agreements is that the% should embrace the vast ma*orit% of producers and especiall% the largest of them. "o transactions should be e-cluded$ and substitute commodities should be covered b% the agreements. #he most intractable of the difficulties in concluding commodit% agreements lies in the fi-ing of the price range. "either undul% high nor undul% low price scales are tenable. >uture mar!et conditions are not easil% foreseeable$ so the possibilit% of errors cannot be ruled out7 regular ad*ustment of the price ranges is necessar%. +hen it comes to determining the price range$ the importing and e-porting countries$ respectivel%$ do not s%stematicall% advocate low and high prices. Certain importing countries are not opposed to a relativel% high price because the difference between the international price and the tariffprotected price of domestic producers is thereb% reduced7 e-porting countries in a favourable competitive position are often in favour of lower prices so that the% will be able to increase their share of the mar!et at the e-pense of lesscompetitive countries. In concluding an agreement$ the parties have to bear in mind that complete price stabili5ation is impossible. It would in fact be undesirable$ because in the long run suppl% and demand need to remain in e6uilibrium$ and the necessar% ad*ustments in the economies concerned must not be precluded. (rice fluctuations do not necessaril% impl% failure$ because the fluctuations might well have been larger had the agreement not been concluded. #he method of stabili5ation needs to be chosen carefull%$ with due regard for the characteristics of 0/, the commodities concerned. #he multilateral purchase contract and bufferstoc! s%stems offer the advantage of not re6uiring an% restrictions on production7 new producers with improved technical e6uipment ma% participate. 2 buffer stoc! needs to be sufficientl% large if it is to achieve its purpose. +ider financing facilities are necessar%7 this is something to which the importing countries could contribute. Even then the buffer stoc! is better used together with other methods of stabili5ation. <ecause of the perishable nature of certain commodities or their bul! and high storage costs$ however$ a buffer stoc! is not alwa%s feasible. <uffer stoc!s alone often are not sufficient for the control of prices$ and it is sometimes necessar% for producers to restrict e-ports in order to reduce suppl%$ thus pushing prices up. +5,-.-, #6 ,*- '-(D->-'#/-D C#75,.+- So far as the producer countries are concerned$ stabili5ation of incomes$ rather than of prices$ is the most important factor. 2lthough commodit% agreements ma% contribute to this$ their relativel% limited success has caused other proposals to be advanced. Compen"atory financin# refers to international financial assistance to a countr% whose e-port earnings have suffered as a result of a decline in primar% commodit% prices. Such a s%stem was instituted in 1G1. b% the International Monetary ?und &I;>'. In 1G1G the I;> also began ma!ing loans available to countries having a balanceofpa%ments need in relation to the financing of buffer stoc!s under international commodit% agreements. EEC "ta%iliIation fund* #he European Economic Communit% has established a stabili5ation fund for its associated overseas countries7 prices must fall b% a specified percentage before the mechanism of the fund goes into effect$ and the richer beneficiar% countries must repa% the aid received. Other proposals involve the introduction of simultaneous negotiations for a whole range of commodities. #hese discussions$ however$ and more particularl% the administration of the resulting multicommodit% agreement$ would be highl% comple-. It ma% also be argued that the significance of e-port instabilit% has been e-aggerated and that most of the economies involved have suffered no serious damage. #hus$ the resources devoted to countering price fluctuations and compensator% financing might be better emplo%ed in investments or technical assistance. 2s to the possibilit% of the lessdeveloped countries themselves influencing prices$ circumstances var% from commodit% to commodit%. In the case of primar% goods$ such as coffee$ that are produced onl% in the lessdeveloped countries and for which practicall% no substitutes e-ist$ action to increase prices can easil% be ta!en if demand is not too much affected b% price increases. 2 simple wa% to raise prices would be for the governments of producing countries to lev% a dut% on e-ports. 2ttempts b% some developing countries to raise prices$ however$ can induce other developing countries to increase their output. >or e-ample$ 2frican coffee production was stimulated when Datin2merican countries too! steps to raise the price of their coffee. )imitation" on pricin#* #he fact that there are substitutes for a few primar% goods &such as cotton$ wool$ and rubber' limits the e-tent to which primar%goods producers can raise their prices. 2lso$ most commodities produced b% lessdeveloped countries face competition from the developed countries$ which ma% produce the same commodities 0/. &such as petroleum$ sugar$ rice$ and tobacco' or goods substitutable in var%ing degrees &such as so%bean oil for peanut oil'. ;an% agricultural commodities are protected in the developed countries b% tariffs$ which means that their re6uirements are often met entirel% from domestic production. Some developed countries produce surpluses that are sold abroad at low$ subsidi5ed prices. Such commodities are therefore traded to a relativel% small e-tent on world mar!ets. #he sales of the lessdeveloped countries are thus influenced b% the developed countries] national policies and b% the price at which these countries sell their surpluses on the residual mar!ets. #he lessdeveloped countries that produce minerals and metals seemingl% have the most favourable e-port prospects because demand for such finite commodities is e-panding among the developed countries$ man% of which are concerned over the depletion of their domestic resources. #/-C 45D #+' Of the multinational organi5ations aimed at affecting the price of a commodit%$ one of the most significant is the Organi5ation of Petroleum E-porting Countries &.PEC'. It was founded in 1G1H b% ;iddle Eastern countries and Vene5uela$ although its membership has come to include developing nations in other parts of the world. Some ma*or oile-porting nations have remained outside the organi5ation$ notabl% ;e-ico and Cussia. #he principal ob*ective of O(EC has been to raise the price received b% the oile-porting countries. 9uring its earl% %ears$ it was notabl% unsuccessful: plentiful supplies of oil !ept the price low throughout the 1G1Hs. In the earl% 1G=Hs$ however$ ma*or changes too! place. #he rapid economic e-pansion$ which was simultaneousl% occurring in man% countries$ put upward pressure on the demand for oil. 2t the same time$ the production of oil was leveling out and beginning to decline in the 8nited States$ with the result that 8.S. demand for imported oil was rising rapidl%. In 1G=. O(EC sei5ed the opportunities offered b% the changing mar!et conditionsand b% the political and economic disruptions associated with the war between Israel and its 2rab neighboursto raise prices sharpl%$ from about N. to more than N1, per barrel. <etween 1G=/ and 1G=G the international price of oil remained 6uite stable$ but then O(EC was once again successful in pushing the price up sharpl%to more than N.H per barrel in 1G?H. #hese price increases caused a huge transfer in revenues from the oilimporting nations to the oile-porting countries. #he% also contributed to a ma*or increase in inflation in the importing countries. #he large increase in revenues in the O(EC nations allowed man% of them to embar! on ma*or development programs. On the other side$ the loss of revenues$ combined with the inflationar% impact$ precipitated ma*or recessions in man% of the oilimporting countries in 1G=/=0 and 1G?H?,. #he higher oil price also has been suggested as a cause of a decline in productivit% in man% countries after 1G=.$ although the causes of the decline are not well understood. O(EC has often been called an international cartel$ but it lac!ed the standard enforcement mechanism of a cartel during the two periods &1G=. and 1G=G?H' when prices rose spectacularl%. #hat is$ it did not have a mechanism for sharing the mar!et among the oile-porting nations. Saudi Ara%ia pla%ed a !e% role in enforcing the organi5ation]s price increases. In the 1G=Hs Saudi 2rabia had proven reserves in e-cess of 10H billion barrels$ more than twice as much as an% other nation$ and five or si- times the proven reserves of such ma*or nonO(EC producers as the 8nited States and ;e-ico. <ecause of its huge reserves and productive capacit%$ Saudi 2rabia was able to act as the residual supplier$ cutting bac! on production when demand slac!ened$ thus reducing downward pressures on prices. Saudi 2rabia]s 0// willingness to act as the residual supplier was partl% the result of its limited population7 even when producing at much less than capacit%$ it had a ver% large oil income per capita. 9uring the earl% and middle 1G?Hs$ the oil mar!et softened mar!edl%. Oil consumption grew much more slowl%$ partl% as a result of the ma*or 8.S. recession of 1G?, and sluggish growth in western Europe$ and partl% as a result of increased conservation measures$ a reaction to the upward spiral of fuel prices in the 1G=Hs. 2t the same time$ oil output increased in a number of nonO(EC areas such as the "orth Sea. #he result was downward pressure on prices through the mid1G?Hs. In order to maintain sales and revenues$ O(EC members had an incentive to undercut the posted price. 2s its oil production fell sharpl% and the bills from its ambitious development pro*ects continued to increase$ Saudi 2rabia became less willing to act as the residual supplier. In order to relieve the downward pressure on prices$ O(EC members attempted to transform the organi5ation into a more formal cartel$ with production 6uotas for each member. 3owever$ these efforts faced the classic problem of cartels: each member had an incentive to cheat on the organi5ation b% producing more than its 6uota and b% offering secret price concessions to bu%ers. International payment" and eBchan#e Economic life does not stop at national boundaries but flows bac! and forth across them. #he money of one countr%$ however$ cannot as a rule be used in another countr%7 the flow of pa%ments must be interrupted at national boundaries b% e-change transactions in which one national mone% is converted into another. #hese transactions serve to cover pa%ments so long as there is a balance between them: local mone% can be e-changed against foreign mone% onl% insofar as there is a counterbalancing offer of foreign mone% in e-change. In China and other countries with centrali5ed economic planning$ there are no legal private mar!ets for foreign e-change7 in those countries the state has a monopol% of the business of foreign trade$ which is generall% conducted through formal agreements on a countr% b%countr% basis. +hile the currencies of the Communist countries have official par values$ these bear no particular relationship to their purchasing power or to the prices at which goods are e-changed. #he international economic relationships of those countries therefore fall outside the scope of this discussion. B4'45C-(#6(/4YM-5, 4CC#75,+5: #he balanceofpa%ments accounts provide a record of transactions between the residents of one countr% and the residents of foreign nations. #he two t%pes of accounts used are the current account and the capital account. The current account* +hen using balanceofpa%ments statistics$ it is important to understand their basic concepts. #he balance of pa%ments includes$ among other things$ pa%ments for goods and services7 these are often referred to as the balance of trade$ but the e-pression has been used in a variet% of wa%s. In order to be more specific$ some authorities have ta!en to using the e-pression cmerchandise balance$c which unmista!abl% refers to trade in goods and e-cludes services and other occasions of international pa%ment. >igures for the 0/0 merchandise balance often 6uote eBport" valued on an >O< &free on %oard' basis and import" valued on a CI> basis &including co"t6 in"urance6 and frei#ht to the point of destination'. #his swells the import figures relative to the e-port figures b% the amount of the insurance and freight included. #he reason for this practice has been that in man% countries the trade statistics have been based on customs house data$ which naturall% include insurance and freight costs for imports but not for e-ports. #he authorities have more recentl% made a point of providing estimates of imports valued on an >O< basis. 2nother e-pression$ cbalance of goods and services$c is often used. #he <ritish$ however$ continue to use the term in$i"i%le" for current services entering into international transactions. >or man% %ears the cvisiblec balance was ta!en to be e6uivalent to e-ports 6uoted >O< and imports CI> as e-plained above. #he <ritish authorities have more recentl% instituted another linguistic usage b% which the visible balance is e6uivalent to the true merchandise balance. #he old usage still lingers on in the less e-pert literature. 2nd so the total current account is the balance of goods &merchandise' and services. #he 8nited Uingdom includes unilateral transfers among invisibles and in the current account. #he 8nited States statistics$ more correctl%$ show them under a separate heading. Services include such items as pa%ments for shipping and civil aviation$ travel$ e-penditures &including militar%' b% the home government abroad and e-penditures b% foreign governments at home$ interest and profits and dividends on investments$ pa%ments in respect of insurance$ earnings of ban!ing$ merchanting$ bro!erage$ telecommunications and postal services$ films and television$ ro%alties pa%able b% branches$ subsidiaries and associated companies$ agenc% e-penses in regard to advertising and other commercial services$ e-penditures b% *ournalists and students$ construction wor! abroad for which local pa%ment is made and$ conversel%$ earnings of temporar% wor!ers such as entertainers and domestic wor!ers$ and professional consultants] fees. #his list contains the more important items but is not comprehensive. 2mong unilateral transfers the more important are outright aid b% governments$ subscriptions to international agencies$ grants b% charitable foundations$ and remittances b% immigrants to their former home countries.
The capital account* #here is also the capital account$ which includes both longterm and short term capital movements. )on#0term flo"* Dongterm capital movement divides into direct in$e"tment" &in plant and e6uipment' and portfolio in$e"tment" &in securities'. In the 1Gth centur% direct investment in plant and e6uipment was preponderant. #he 8nited Uingdom was b% far the most important contributor to direct investment overseas. In the earl% part of the centur% it even contributed to the industrial development of the 8nited States7 later its attention shifted to South 2merica$ Cussia$ other European countries$ and India. Investment in what came to be called the cCommonwealthc and cEmpire$c not prominent at that time$ became ver% important in the ,Hth centur%. #he other 0/1 countries of western Europe also made important contributions to direct investment overseas. #he most important items of direct investment were railwa%s and other basic installations. In earl% stages direct investment ma% help developing countries to balance their pa%ments$ but in later stages there will have to be a flow of interest and profit in the opposite direction bac! to the investing countr%. #he 8nited Uingdom is fre6uentl% cited as the countr% whose overseas investments were most helpful for developing countries because its rapidl% growing population and small cultivable land area permitted it to develop large net imports of food and to run corresponding deficits on its merchandise account. #he complementar% surplus this generated in the developing countries from which the imports came enabled them to pa% the interest and profit on <ritish capital without straining their balances of pa%ments. <etween +orld +ar I and +orld +ar II the 8nited States began to ta!e a more active interest in overseas investment$ but this was not alwa%s welladvised. 2fter the great world slump$ which started in 1G,G$ international investment almost ceased for lac! of profit opportunities. 2fter +orld +ar II the 8nited States began to build up a leading position as overseas investor. #he process accelerated in 1G01 and afterward$ both on direct investment and on portfolio investment accounts. #his ma% have been partl% due to the desire of 8.S. firms to have plants inside the European Economic Communit%. Other countries also found more opportunities for capital e-port than there had been in the interwar period. #he 8nited Uingdom gave special attention to the Commonwealth. 9uring the 1G=Hs and 1G?Hs @apan became a ma*or overseas investor$ financing its foreign investments with the funds accumulated with its large current account surpluses. #he 8.S. international position changed sharpl% in the 1G?Hs. 2s a result of its large current account deficits$ the 8nited States accumulated large overseas debts. Its position changed from that of ma*or net creditor &it had larger investments abroad than foreign nations had in the 8nited States' to that of the largest debtor nation. Its liabilities to foreign nations came to e-ceed its foreign assets b% hundreds of billions of dollars. Short0term flo"* 2 ver% important distinction must be drawn between the shortterm capital that flows in the normal course of industrial and commercial development and that which flows because of e-changerate movements. #he first class of shortterm capital ma% be thought of as going in the train of direct longterm investment. 2 parent compan% ma% desire from time to time to suppl% its branch or affiliate with wor!ing capital. #here ma% also be repa%ments from time to time. #he second t%pe of shortterm capital flow occurs because of e-pectations of changes in e-change rates. >or e-ample$ if people e-pect that the price of the dollar will fall in terms of the @apanese %en$ the% have an incentive to sell dollars and bu% %en. 2n international capital mar!et developed in the 1G1Hs dealing in what are !nown as Eurocurrencie"$ of which much the most important was the Eurodollar. #he prefi- Euro is used because initiall% the mar!et largel% centred on the countries of Europe$ but it has b% no means been confined to them. @apan and the ;iddle Eastern oil states have been important dealers. +hile these shortterm lendings normall% move across national frontiers$ the% do not directl% involve foreign e-change transactions. #he% ma%$ however$ indirectl% cause such transactions to ta!e place. #he nature of the mar!et is as follows: In the ordinar% course of affairs$ an Italian$ for e-ample$ ac6uiring dollarssa% from e-ports or from a legac%would sell these dollars for his own currenc%. <ut he ma% decide to deposit the dollars at his 0/= ban! instead$ with an instruction not to sell them for cash but to repa% him in dollars at a later date. #hus the ban! has dollars in hand and a commitment to pa% them out in$ sa%$ three months. It ma% then proceed to lend these dollars to another ban!$ an%where in the world. Since the lending and borrowing is done in dollars$ no foreign e-change transaction is directl% involved. #he sum total of all operations of this sort is the Eurodollar mar!et. It is not centred on an% particular place and has no formal rules of procedure or constitution. It consists of a networ! of deals conducted b% telephone and tele- around the world. 8.S. residents themselves lend to and borrow from this mar!et. One ma% as! wh% lenders and borrowers use this mar!et in preference to more conventional methods of lending and borrowing. Ordinaril% the answer is because the% can get more favourable terms$ since the mar!et wor!s on ver% narrow margins between lending and borrowing rates. #his involves e-pertise7 Dondon has pla%ed the most important part in the creation of the mar!et. #he lender hopes to get a better rate of interest than he would on a time deposit in the 8nited States &restrictions limiting interest pa%able on 8.S. time deposits are said to have been a contributing cause of the growth of the mar!et during the 1G1Hs'. 2t the same time$ normall%$ the borrower will find that he has to pa% a lower rate than he would on a loan from a commercial ban! in the 8nited States. #his has not alwa%s been the case. In 1G1G Eurodollar interest rates went to ver% high levels. One reason for this was the set of restrictions imposed b% the 8nited States on its commercial ban!s lending abroad. #he second was that although the prime lending rates of the principal 8.S. ban!s might be below Eurodollar rates$ man% individuals$ including 8.S. citi5ens$ found that the% could not get loans from their ban!s because of the ccredit s6uee5e.c <ecause this form of international lending does not involve the sale of one currenc% for another$ it does not enter into balanceofpa%ments accounts. "onetheless it ma% have a causal effect on the course of the e-changes. >or instance$ the Italian cited above might have chosen to sell his dollars had he not been tempted b% the more attractive Eurodollar rate of interest. In this case$ the mar!et causes dollars not to be sold that otherwise would have been. Others who have li6uid cash at their disposal for a time ma% even bu% dollars in order to invest them in the mar!et at short term. #hat would be helpful to the dollar. #here are countercases. 2n individual who has to ma!e a pa%ment in dollars but lac!s cash ma% borrow the dollars in the Eurodollar mar!et$ when otherwise he would have got credit in his own countr% and used that to bu% dollars7 in this case the mar!et is damaging to the dollar because its e-istence prevents someone from bu%ing dollars in the regular wa%. A""e""in# the %alance* #o summari5e$ the overall balance of pa%ments comprises the current account &merchandise and services'$ unilateral transfers &gifts$ grants$ remittances$ and so on'$ and the capital account &longterm and shortterm capital movements'. If pa%ments due in e-ceed those due out$ a countr% is said to be in overall surplus7 and when pa%ments due out e-ceed pa%ments due in$ it is in overall deficit. #he surplus or deficit must be balanced b% a monetar% movement in the opposite direction$ and conse6uentl% the overall balance including monetar% movements must alwa%s be e6ual. In practice$ great difficulties have been found in assessing whether a countr% is in deficit or in surplus. It is often important to establish this with a view to possible corrective measures. #he 8nited Uingdom stresses the combined balance of current and longterm capital accounti.e.& e-cluding shortterm 0/? capital. Such a balance$ however$ omits shortterm movements that occur in the ordinar% course of business$ which ma% be called cnormalc and which ought in principle to be included. On the other hand it is not desirable to include e6uilibrating or dise6uilibrating capital movements. #hese occur in conse6uence of a deficit &or surplus'$ actual or anticipated. <ut there ma% be great statistical difficult% in distinguishing between the normal shortterm capital flows and those that are conse6uential on a surplus or deficit. It has been noted that the overall balance$ including monetar% movements$ must be e6ual$ but it usuall% happens that the figures do not in fact balance. 8.S. statisticians call the residual figure that has to be inserted to s6uare the account cerrors and omissions.c If the average value of this figure over a substantial period$ such as 1H %earsan even longer period ma% have to be ta!en if a countr% is in persistent surplus or deficithas a positive or negative value of substantial amount$ then it ma% be ta!en to constitute genuine items that have escaped the statistical net. #hese ma% legitimatel% be included in assessing whether a countr% is in genuine surplus or deficit and whether corrective measures are needed. #he cerrors and omissionsc item is e-tremel% volatile from %ear to %ear and often ver% large. Such movements up and down are probabl% caused b% precautionar% shortterm capital movements. #here have been periods when a minus item in the 8.S. account was rather stri!ingl% associated with a plus item in the 8.U. account$ and conversel%. 2ccordingl%$ in the short term$ the cerrors and omissionsc item should not be included in assessing whether a countr% is in surplus or deficit. It has been noted that the 8nited Uingdom stresses the balance of current and longterm capital accounts &which include unilateral transfers'. #he 8.S. position is less clear. It traditionall% published two overall balanceofpa%ments measures: the cDi6uidit% <alancec and the cOfficial Settlements <alance.c In distinguishing between monetar% and nonmonetar% items$ the Di6uidit% <alance included an% increase in the holding of shortterm dollar securities abroad as part of the 8.S. deficit during the period7 but it did not include as counterweight an% increase in shortterm foreign claims held b% 8.S. resident ban!s or others &apart from official holdings'. #hus$ in this respect the treatment was as%mmetrical. #he rationale for this was precautionar%. #he argument was that shortterm dollar assets held abroad outside the central ban!s might at an% time be sold in the mar!et or turned in to the central ban!s of the respective countries and thus constitute a drain$ or the threat of a drain$ on 8.S. reserves. On the other hand the corresponding foreign shortterm assets held b% 8.S. resident ban!s or others were not readil% mobili5able b% 8.S. authorities for ma!ing pa%ments. #hus b% this rec!oning$ if during a period noncentralban! foreign holdings of shortterm dollar securities and resident noncentralban! 8.S. holdings of shortterm foreign securities went up b% an e6ual amount$ the situation would be shown as having deteriorated$ since the former class &liabilities' were a threat to 8.S. reserves$ while the latter class &assets' could not be mobili5ed b% 8.S. authorities to meet such a threat. #hus$ though the motive for this as%mmetrical treatment ma% have been understandable$ it was statisticall% unsatisfactor% and also unsatisfactor% as a guide to corrective action. #his balance is thus mainl% of historical interest$ and it has not been commonl% used since 1G=1. #he 8.S. Official Settlements <alance rec!oned an increase in noncentralban! foreign holdings of shortterm dollar assets as an inflow of shortterm capital into the 8nited States7 similarl% an increase in 8.S. resident holdings of shortterm foreign assets was an outflow of shortterm capital. #his was a logical treatment. <ut the balance thus defined proved in the 1G1Hs to be e-tremel% volatile. #his was due to large movements of funds between foreign central ban!s and 0/G noncentralban! foreign holders$ associated with the rise of the Eurodollar mar!et. Oscillations of this !ind do not represent changes in the fundamental balance that are needed in order to determine whether corrective measures are re6uired. It ma% well be that the <ritish method of omitting shortterm capital movements altogether in the assessment of surplus or deficit is$ although imperfect$ the most practical available. Since e-change rates began to float in the earl% 1G=Hs$ the ma*or industrial countries have paid much less attention to overall %alance0of0payment" measures. #he current account and the trade account are the two measures that are now most commonl% used in developing countries. 4D<7,+5: 6#. 675D4M-5,4' D+-97+'+B.+7M 2 cfundamental dise6uilibriumc e-ists when outward pa%ments have a continuing tendenc% not to balance inward pa%ments. 2 dise6uilibrium ma% occur for various reasons. Some ma% be grouped under the head of structural change &resulting from changes in tastes$ habits$ institutions$ technolog%$ etc.'. 2 fundamental imbalance ma% occur if wages and other costs rise faster in relation to productivit% in one countr% than the% do in others. Imbalance ma% also result when aggregate demand runs above the suppl% potential of a countr%$ forcing prices up or raising imports. 2 war ma% have a profoundl% disturbing effect on a countr%]s econom%. The cla""ical $ie* In the traditional cclassicalc view no intervention b% the authorities was necessar% to maintain e-ternal e6uilibrium$ e-cept for their readiness to convert currenc% into gold &or silver' upon demand. #he s%stem was supposed to wor! automaticall%. If a countr% had a deficit$ gold would flow out$ and the conse6uent reduction in the domestic mone% suppl% would cause prices to move downward. #his would stimulate e-ports and tend to reduce imports. #he process would continue until the deficit was eliminated. Classical doctrine did not embod% a clearcut theor% about international capital movements. It was usuall% assumed that the trade balance &more strictl%$ balance on goods and services' would be tailored to accommodate an% capital movement that occurred. #hus$ if the countr% was e-porting capital$ gold flows would cause prices to move to such a level that e-ports minus imports would be e6ual to the capital flow7 e6uilibrium in the overall balance was automaticall% secured. In due course the classical scheme of thought came under criticism. Some critics as!ed if an outflow or inflow of specie would necessaril% have a sufficient effect on the price level to ensure an e6ual balance of pa%ments. ;ore important$ a reduction in the mone% suppl%$ it was pointed out$ might have a side effect on the level of economic activit%. Some critics went further and argued that this side effect would be stronger than the effect on prices to such a degree as to cause unemplo%ment to rise to an undesirable level. Contemporary $ie"* Monetary and fi"cal mea"ure"* #he belief grew that positive action b% governments might be re6uired as well. #he doctrine was first related to monetary policy in particular. #he idea was that interestrate ad*ustments should be combined with openmar!et operations b% a central ban! to ensure that the domestic mone% suppl% and borrowing facilities were conducive to e-ternal longperiod e6uilibrium. 2fter +orld +ar II the idea came to 00H be widel% held that government budget polic% &usuall% called fi"cal policy' should be brought in to assist monetar% polic%. >or instance$ if aggregate domestic demand was running so high as to cause rising prices$ this should be reduced both b% having a tight monetar% polic% and b% increasing ta-ation more than e-penditure or reducing e-penditure without reducing ta-ation. #he correct apportionment of this tas! between the monetar% and fiscal arms is still a sub*ect of discussion. "or is there %et agreement about the scope of these policies or their abilit% to secure fundamental e6uilibrium in all cases. #here is probabl% agreement that when overall demand is running in e-cess of the suppl% potential of the econom%$ it should be reduced b% monetar% and fiscal policies. #here is difference of opinion$ however$ as to whether the reduction of aggregate demand will bring e-ternal pa%ments into balance in all cases. >or instance$ a countr% ma% have a deficit owing to some underl%ing economic change &such as a shift in the pattern of world trade'$ even if domestic demand is not above the suppl% potential and prices are not rising. In this case$ policies designed to reduce domestic demand &commonl% called deflationar% policies' would cause unemplo%ment. Some hold that$ if there is an e-ternal deficit$ deflationar% policies should be pursued to whatever e-tent ma% be needed to eliminate the deficit. Others hold that such a polic% is sociall% unacceptable. Opinions differ also about how deflationar% measures wor! to improve the e-ternal balance. Some hold that the% wor! mainl% b% reducing domestic activit% and thereb% the amount of imported materials that a countr% needs and the amount of income that people can afford to spend on imported goods. If this were the whole effect of a deflationar% polic%$ it would improve the e-ternal balance onl% in proportion to the amount b% which it increases unemplo%ment. #hose who hold that this is the onl% manner in which deflation affects the e-ternal balance are especiall% opposed to rel%ing on deflationar% policies alone to eliminate a deficit in conditions in which aggregate domestic demand is not running above the suppl% potential. Some hold that a reduction of home demand also helps because it ma!es producers loo! around more eagerl% for e-port mar!ets &and increase their selling efforts in the home mar!et'. #his appears to be doubtful$ however. #here is further disagreement on the e-tent to which deflationar% policies influence the course of prices. If aggregate demand is running above the suppl% potential of the econom%$ it is highl% probable that deflationar% policies will slow the increase of prices and thus ma!e a countr% more competitive with foreign suppliers. #here is not the same agreement about the effects when demand is initiall% running below the suppl% potential of the econom%. Some hold that a deflationar% polic%$ if pushed hard enough$ will infallibl% slow up price increases and so help the countr%]s e-ternal balance. Others hold that it will not$ and some even argue that higher interest rates and higher ta-es &weapons of deflation' can cause prices to rise. #hus$ it is not absolutel% clear that monetar% and fiscal policies will in all cases suffice to cure an e-ternal deficit$ at least without sociall% unacceptable results. #here is also the opposite case of countries with a trade surplus. It is clear that these countries will be unwilling to encourage policies that cause domestic prices to rise. (rice inflation is a social evil and politicall% unpopular. In the case of surplus countries$ the same distinction must be made between the situation in which aggregate demand is full% up to or above the suppl% potential of the econom% and that in which it is not. In the former case a further increase in demand would almost certainl% have an inflationar% effect7 accordingl%$ surplus countries in this condition will be unwilling to use monetar% and fiscal policies to eliminate their e-ternal surpluses. On the other hand$ if aggregate demand is running below suppl% potential$ then a surplus countr% might 001 reasonabl% be as!ed to increase aggregate demand b% monetar% and fiscal policies on the view that the increase will not cause inflation but will tend to remove the e-ternal surplus b% inducing more imports and possibl% causing producers to be less active in their selling efforts abroad. Income" policy* (rices ma% rise even when aggregate demand is not in e-cess of the suppl% potential. #his ma% be due to wage increases and other factors. Some hold that this can be dealt with through efforts to discourage e-cessive wage increases b% a direct approach$ which ma% consist of a propaganda campaign on the evil effects of wage price inflation$ together with guidelines governing rates of wage increases. #his direct attempt to deal with the problem is generall% !nown as Fincome" policy*F Chan#e" in eBchan#e rate"* EBchan#e0rate movements wor! b% ma!ing the products of a deficit countr% more price competitive or those of a surplus countr% less price competitive. 2n% program that see!s to rectif% an imbalance b% changing the level of prices will be effective onl% if demand is cprice elastic.c In other words$ if the offer of an article at a lower price does not cause an increase in demand for it more than in proportion to the fall in price$ the proceeds from its e-port will fall rather than increase. Economists believe that price elasticities are sufficientl% great for most goods so that price reductions will increase revenues in the long run. #he outcome is not 6uite so certain in the short run. 2 fast means of changing relative price levels is de$aluation$ which is li!el% to have a 6uic! effect on the prices of imported goods. #his will raise the cost of living and ma% thereb% accelerate demands for higher wages. If granted$ these will probabl% cause rises in the prices of domesticall% produced goods. 2 cwageprice spiralc ma% follow. If this spiral moves too 6uic!l% it ma% frustrate the intended effect of the devaluation$ namel% that of enabling the countr% to offer its goods at lower prices in terms of foreign currenc%. #his means that if the beneficial effects of a devaluation are not gathered in 6uic!l%$ there ma% be no beneficial effect at all. #he authorities of a countr% that has *ust devalued must therefore be especiall% active in preventing or moderating domestic price increases. #he% will need to use the other polic% measures discussed above. 9evaluation &or the downward movement of a fle-ible rate' is thus not a remed% that ma!es other forms of official polic% unnecessar%. Some have argued that$ if e-change rates were allowed to float$ nothing further would have to be done officiall% to bring the e-ternal balance into e6uilibrium$ but this is a minorit% view. One further point must be made regarding e-changerate movements. It has been found in practice that governments resist upward valuation more than the% do devaluation. 8nder the I;> s%stem prior to 1G=.$ devaluations in fact were larger and more fre6uent than upward valuations. #his had an unfortunate conse6uence. It meant that the aggregate amount of price inflation in deficit countries resorting to devaluation as a remed% was not offset b% e6uivalent price decreases in the surplus countries. #herefore this s%stem had a bias toward worldwide inflation. Trade re"triction"* Since +orld +ar II the ma*or industrial countries have attempted to reduce interferences with international trade. #his polic%$ b% e-tending the international division of labour$ should increase world economic welfare. 2n e-ception has had to be allowed in favour of the lessdeveloped countries. In the earl% stages of the development of a countr%$ the effectiveness and feasibilit% of the three t%pes of ad*ustment mechanism discussed above$ particularl% monetar% and fiscal policies$ 00, ma% be much less than in the more advanced countries. #he lessdeveloped countries ma% therefore be driven to protection or the control of imports$ for lac! of an% other weapon$ if the% are to sta% solvent. It has alread% been noted that$ even in the case of a more advanced countr%$ the effectiveness and appropriateness of the abovementioned ad*ustment mechanisms are not alwa%s certain. #hus$ there is no certaint% that some limitation on foreign trade and on the international division of labour ma% not be a lesser evil than the conse6uences that might follow from a vigorous use of the other ad*ustment mechanisms$ such as unemplo%ment. Re"triction" on capital eBport"* Interference with capital movements is generall% considered a lesser evil than interference with the free flow of trade. #he theor% of the optimum international movement of capital has not %et been thoroughl% developed$ but there ma% be a presumption in favour of absolutel% free movement. #he matter is not 6uite certain7 for instance$ it might be desirable from the point of view of the world optimum to channel the outflow of capital from a highsaving countr% into the lessdeveloped countries$ although the level of profit obtainable in other highsaving countries might be greater. Or it might be e-pedient to restrain wealth% individuals in lessdeveloped countries$ where domestic saving was in notabl% short suppl%$ from sending their funds to highsaving countries. +hile there ma% be good reasons for interfering with the free international flow of capital in certain cases$ it is not obvious that the outflow of capital from$ or inflow of capital into$ a countr% should be tailored to surpluses or deficits in current e-ternal accounts. It ma% be that in some cases the sound remed% for a deficit &or surplus' is to adopt ad*ustment measures such as those discussed above$ bearing upon current items$ rather than ta!ing the easier wa% of ad*usting capital movements to the de facto balance on current account. 6#.-+:5 -2C*45:- M4.8-, /uyin# and "ellin# currencie"* 2 forei#n eBchan#e mar!et is one in which those who want to bu% a certain currency in e-change for another currenc% and those who want to move in the opposite direction are able to do business with each other. #he motives of those desiring to ma!e such e-changes are various. Some are concerned with the import or e-port of goods between one countr% and another$ some with the purchase and sale of services. Some wish to move capital from one area to the other$ and some wish to ma!e gifts &the latter including government aid and gifts b% charitable foundations'. In an% organi5ed mar!et there must be intermediaries who are prepared to c6uote a price$c in this case a rate of e-change between two currencies. #hese intermediaries must move the price 6uoted in such a wa% to permit them to ma!e the suppl% of each currenc% e6ual to the demand for it and thus to balance their boo!s. In an important foreign e-change mar!et the price 6uoted is constantl% on the move. 2n e-change rate is the price of one currenc% in terms of another. >or e-ample$ in the mar!et for the <ritish 00. pound sterling & ' in e-change for 8.S. dollars &N'$ the e-change rate might be 1 S N,. #his price ma% also be 6uoted the other wa% around7 that is$ N1 S H.0H. Determination of eBchan#e rate"* In a foreign e-change mar!et$ there ma% be a standard$ government determined price$ or par value. #his par value ma% be 6uoted in terms of another currenc%7 for e-ample$ the par value of the pound was 1 S N,.?H between 1G/G and 1G1=. In 1G=. man% governments abandoned their par values and let their e-change rates be determined b% the forces of demand and suppl%. 2n e-change rate determined in this wa%$ without being tied to an official par$ is called a fle-ible or floating e-change rate7 in contrast$ an e-change rate is said to be pegged if the government ties it to par value. 3istoricall%$ countries often tied their currencies to #old$ setting their official parities in terms of that metal. 8nder this historical #old "tandard$ the gold e6uivalence of currencies determined e-change rates. >or e-ample$ the <ritish pound was worth /.?1 times as much gold as the 8.S. dollar during the period prior to +orld +ar I. #he e-change rate remained at or 6uite close to the mint parit% of 1 S N/.?1. "obod% would pa% much more than N/.?1 for a <ritish pound$ nor ta!e much less. 3istoricall%$ there were also periods of %imetalli"m$ when the gold standard was combined with a "il$er standard$ and currencies were fi-ed in terms of both gold and silver. #he bimetallic standard was given up b% most of its adherents &the 8nited States$ >rance$ Ital%$ Swit5erland$ #he "etherlands$ and <elgium' in the 1?=Hs. ,*- :#'D ,45D4.D The function of #old* If the demand b% those holding a particular currenc%$ sa% "terlin#$ for another currenc%$ sa% the dollar$ e-ceeds the demand of dollar holders for sterling$ the dollar will tend to rise in the foreign e-change mar!et. 8nder the gold standard s%stem there was a limit to the amount b% which it could rise or fall. If a sterling holder wanted to ma!e a pa%ment in dollars$ the most convenient wa% for him to procure the dollars would be in the foreign e-change mar!et. <ut under the gold standard he had another option7 i.e.& he had a legal right to obtain gold from the authorities in e-change for paper currenc% at the established par value of that currenc% and remit the gold to the other countr%$ where he would have a legal right to obtain its currenc% in e-change for bars of gold at the official valuation. #hus$ it would not be advantageous for a sterling holder to obtain dollars in the foreign e-change mar!et if the 6uotation for a dollar there e-ceeded parit% b% more than the cost of remitting gold. #he e-change rate at which it became cheaper to remit gold rather than use the foreign e-change mar!et was !nown as the cgolde-port point.c #here was also a cgoldimport pointc determined on similar lines . ;ost of those see!ing dollars$ however$ did not underta!e to remit gold even if the dollar 6uotation was at the golde-port point. #he remission of gold was handled b% ar%itra#eur". #hese are people who bu% and sell 00/ currencies simultaneousl% on different e-changes in order to profit b% small differences in the 6uoted rates. #heir action would reduce the suppl% of sterling$ since the% would be selling sterling for gold to the <ritish authorities$ and increase the suppl% of dollars$ since the% would ac6uire dollars in e-change for gold from the 8.S. authorities. #he arbitrageurs would carr% out these operations to the e-tent needed to prevent the scarcit% of the dollar from raising its sterling price above the golde-port point for the 8nited Uingdom$ and conversel%. 2t the same time$ the gold reserve of the <ritish authorities would be diminished$ and the gold reserve of the 8.S. authorities increased. #he international gold standard provided an automatic ad*ustment mechanism$ that is$ a mechanism that prevented an% countr% from running large and persistent deficits or surpluses. It wor!ed in the following manner. 2 countr% running a deficit would see its currenc% depreciate to the golde-port point. 2rbitrage would then result in a gold flow from the deficit to the surplus countr%. In other words$ the deficit would be settled in gold. #he gold flow had an effect on the mone% s%stem. +hen gold flowed into the ban!ing s%stem of the surplus countr%$ its mone% stoc! rose as a conse6uence. On the other side$ when a deficit countr% lost gold$ its mone% stoc! fell. #he falling mone% stoc! caused deflation in the deficit countr%7 the rising mone% stoc! caused inflation in the surplus countr%. #hus$ the goods of the deficit countr% became more competitive on world mar!ets. Its e-ports rose$ and its imports declined$ correcting the balanceofpa%ments deficit. Pro%lem" ith the #old "tandard* 2lthough this ad*ustment process wor!ed automaticall%$ it was not problem free. #he ad*ustment process could be ver% painful$ particularl% for the deficit countr%. 2s its mone% stoc! automaticall% fell$ aggregate demand fell. #he result was not *ust deflation &a fall in prices' but also high unemplo%ment. In other words$ the deficit countr% could be pushed into a recession or depression b% the gold standard. 2 related problem was one of instabilit%. 8nder the gold standard$ gold was the ultimate ban! reserve. 2 withdrawal of gold from the ban!ing s%stem could not onl% have severe restrictive effects on the econom% but could also lead to a run on ban!s b% those who wanted their gold before the ban! ran out. #hese twin problems materiali5ed during the :reat Depre""ion of the 1G.Hs7 the gold standard contributed to the instabilit% and unemplo%ment of that decade. <ecause of the strains caused b% the gold standard$ it was graduall% abandoned. In 1G.1$ faced with a run on its gold$ <ritain abandoned the gold standard7 the <ritish authorities were no longer committed to redeem their currenc% with gold. In earl% 1G.. the 8nited States followed suit. 2lthough the tie of the dollar to gold was partiall% restored at a later date$ one ver% important feature of the old gold standard was omitted. #he public was not permitted to e-change dollars for gold7 onl% foreign central ban!s were allowed to do so. In this wa% the 8.S. authorities avoided the ris! of a run on their gold stoc!s b% a panic!% public. 000 ,*- +5,-.54,+#54' M#5-,4.Y 675D #he International Monetary ?und &I;>'$ founded at the /retton Wood" Conference in 1G//$ is the official organi5ation for securing international monetar% cooperation. It has done useful wor! in various fields$ such as research and the publication of statistics and the tendering of monetar% advice to lessdeveloped countries. It has also conducted valuable consultations with the more developed countries. Of particular interest to this discussion is the >und]s s%stem of Drain# Ri#ht"$ which permits countries in temporar% deficit to draw supplies of foreign currenc% according to predetermined 6uotas. #hese e-tra supplies of currenc% give a countr% more time in which to ad*ust its balance of pa%ments and so avoid ta!ing unsound or unneighbourl% measures li!e import restrictions for lac! of enough reserves to tide it over a difficult%. #he mechanism is as follows: members of the >und are re6uired to ma!e initial deposits according to their 6uotas$ which are based on the countr%]s national income$ monetar% reserves$ trade balance$ and other economic factors. Euotas are pa%able partiall% in Special Drain# Ri#ht" and partiall% in a countr%]s own currenc%. 2 countr%]s 6uota closel% appro-imates its voting power$ the amount of foreign e-change it ma% purchase &9rawing Cights'$ and its allotment of Special 9rawing Cights. #he >und ma!es its stoc! of members] currencies available to member countries that wish to draw upon their 6uotas. +hen creditor countries are presented with their own currencies previousl% deposited b% them with the >und$ the% are obliged to ta!e them in final discharge of debts owed b% other member countries. Since the% previousl% deposited these currencies themselves the% are in effect getting nothing from the debtor countries in respect of the debts owed to them$ and their willingness to accept pa%ment in this wa% is their contribution to the overall li6uidit% of the world s%stem. Dater the creditor countries ma% themselves become debtors and parta!e of the benefits. #he debtors have to repa% the >und usuall% in three to five %ears. 2 countr% with more serious financial problems ma% draw as much as 1/H percent of its 6uota during a three%ear period$ and repa%ment must be made between four to 1H %ears afterward. #he e-ercise of 9rawing Cights is sub*ect to discussion and sometimes to conditions$ e-cept for drawings on what are called the reserve tranches &sums e6ual to the member]s original deposits in its own currenc% and Special 9rawing Cights'$ which are given cthe overwhelming benefit of the doubt.c Countries are also free to draw without discussion up to the net amount to which the% have previousl% been drawn upon b% other countries. #he 6uotas paid b% members of the I;> are the primar% source of income for the organi5ation. Euotas for member countries are periodicall% reviewed and reevaluated according to the countr%]s financial situation. Feneral increases in 6uotas normall% occur following the periodic reviews$ although special reviews and increases sometimes occur for specific countries$ such as Saudi Ara%ia in 1G?1. #he I;> also borrows to supplement its 6uota resources. In 1G?1$ for e-ample$ Saudi 2rabia agreed to loan the >und more than N?$HHH$HHH$HHH over a two%ear period$ and an additional N1$.HH$HHH$HHH was loaned b% a group of countries. <etween 1G=1 and 1G?H about onethird of the >und]s gold holdings were sold at public auction to benefit the member developing countries. ;ore than N/$1HH$HHH$HHH was received from the gold sale7 part of the revenue was made available to members according to their 6uotas$ and part of the revenue was placed in a trust fund to dispense lowinterest loans to developing countries. #he International ;onetar% >und as it finall% emerged from the wartime discussions was a much more modest underta!ing than had originall% been conceived b% the <ritish. 2n earl% <ritish proposal would have 001 re6uired creditor countries to receive pa%ment in paper mone% up to the total amount of all the 6uotas of all the debtor countries. #his seemed to man% to be more than it was fair to as! creditors to do. #he 8nited States claimed that for a number of %ears after the war it was li!el% to be in credit against the whole of the rest of the world$ and so it was. 8nder the <ritish plan the% would have had to give an unconscionabl% large amount of credit$ with no certaint% of repa%ment. 2t that time it did not seem at all li!el% that the 8nited States would ever go into deficit$ which$ of course$ it eventuall% did. ,*- +M6 Y,-M #6 /4.+,Y 1/-::-D3 -2C*45:- .4,- +hen the I;> was established toward the end of +orld +ar II$ it was based on a modified form of the #old "tandard. #he s%stem resembled the gold standard in that each countr% established a legal gold valuation for its currenc%. #his valuation was registered with the International ;onetar% >und. #he gold valuations served to determine parities of e-change between the different currencies. 2s stated above$ such fi-ed currencies are said to be pegged to one another. It was also possible$ as under the old gold standard$ for the actual e-change 6uotation to deviate somewhat on either side of the official parity. #here was agreement with the International ;onetar% >und about the range$ on either side of parit%$ within which a currenc% was allowed to fluctuate. <ut there was a difference in the technical mode of operation. #he service of the arbitrageurs in remitting ph%sical gold from countr% to countr% as needed was dispensed with. Instead the authorities were placed under an obligation to ensure that the actual e-change rates 6uoted within their own territories did not go outside the limits agreed upon with the International ;onetar% >und. #his the% did b% intervening in the foreign e-change mar!et. If$ for instance$ the dollar was in short suppl% in Dondon$ the <ritish authorities were bound to suppl% dollars to the mar!et to whatever e-tent was needed to !eep the sterling price of the dollar from rising above the agreedupon limit. #he same was true with the other currencies of the members of the International ;onetar% >und. #hus$ the obligation of the monetar% authorities to suppl% the currenc% of an% >und member at a rate of e-change that was not above the agreedupon limit too! the place of the obligation under the old gold standard to give actual gold in e-change for currenc%. It would be inconvenient for the monetar% authorities of a countr% to be continuall% watching the e-change rates in its mar!et of all the different currencies. ;ost authorities confined themselves to watching the rate of their own currenc% against the dollar and suppl%ing from time to time whatever 6uantit% of dollars might be re6uired. 2t this point the ar%itra#eur" came into service again. #he% could be relied upon to operate in such a wa% that the e-change rates between the various currencies in the various foreign e-change mar!ets could be !ept mutuall% consistent. #his use of the dollar b% man% monetar% authorities caused it to be called a currenc% of cintervention.c #he official fi-ing of e-change rates as limits on either side of parit%$ outside of which e-changerate 6uotations were not allowed to fluctuate$ bears a famil% resemblance to the gold points of the old gold standard s%stem. #he 6uestion naturall% arose wh%$ in devising a somewhat different s%stem$ it was considered desirable to !eep this range of fluctuation. In the old s%stem it arose necessaril% out of the cost of remitting gold. Since there was no corresponding cost in the new s%stem$ wh% did the authorities decide not to have a fi-ed parit% of e-change from which no deviation would be allowed4 #he answer was that there was convenience in having a range within which fluctuation was allowed. Supply and demand between each pair of currencies would not be precisel% e6ual ever% da%. #here would alwa%s be fluctuations$ and if there were one rigidl% fi-ed rate of e-change the authorities would have to suppl% from 00= their reserves various currencies to meet them. In addition to being inconvenient$ this would re6uire each countr% to maintain much larger reserves than would otherwise be necessar%. 8nder a s%stem of pe##ed eBchan#e rate"$ shortterm capital movements are li!el% to be e6uilibrating if people are confident that parities will be maintained. #hat is$ shortterm capital flows are li!el% to reduce the si5e of overall balanceofpa%ments deficits or surpluses. On the other hand$ if people e-pect a parit% to be changed$ shortterm capital flows are li!el% to be dise6uilibrating$ adding to underl%ing balanceofpa%ments deficits or surpluses. E+uili%ratin# "hort0term capital mo$ement"* Commercial %an!" and other corporation" involved in dealings across currency frontiers are usuall% able to see some &but not necessaril% all' of their needs in advance. #heir foreign e-change e-perts will watch the course of the e-changes closel% and$ if a currenc% is wea! &i.e.& below parit%'$ advise their firms to ta!e the opportunit% of bu%ing it$ even if somewhat in advance of need. Conversel%$ if the currenc% is above parit% but not e-pected to remain so indefinitel%$ the% ma% recommend postponing purchases until a more favourable opportunit% arises. #hese ad*ustments under the influence of common sense and selfinterest have an e6uilibrating influence in foreign e-change mar!ets. If a currenc% is temporaril% wea!$ it is presumabl% because of seasonal$ c%clical$ or other temporar% factors. If on such an occasion private enterprise ta!es the opportunit% to bu% the currenc% while it is cheap$ that tends to bring demand up to e6ualit% with suppl% and relieves the authorities from the need to intervene in order to prevent their currenc% from falling below the lower point whenever there is a temporar% deficit in the balance of pa%ments. 2s previousl% noted$ when confidence in the fi-ed parit% e-change rate drops and mar!et participants e-pect a change in parit%$ shortterm capital movements ma% be dise6uilibrating. 2nother e6uilibrating influence arises from the movements of shortterm intere"t rates. +hen the authorities have to suppl% foreign currencies in e-change for the domestic currenc%$ this causes a decline in the mone% suppl% in domestic circulationunless the authorities deliberatel% ta!e offsetting action. #his decline in the mone% suppl%$ which is similar to that occurring under the gold standard$ tends to raise shortterm interest rates in the domestic money mar!et. #his will bring an inflow of mone% from abroad to ta!e advantage of the higher rates or$ what amounts to the same thing$ will discourage foreigners from borrowing in that countr%]s mone% mar!et since borrowing will have become more e-pensive. #hus$ the interestrate differential will cause a net movement of shortterm funds in the direction re6uired to offset the temporar% deficit or$ in the opposite case$ to reduce a temporar% surplus that is embarrassing to others. It must be stressed again that this e6uilibrating interestrate mechanism implies confidence that the parit% will not be altered in the near future. #he helpful movement of interest rates ma% be reinforced b% action of the monetar% authorities$ who b% appropriate openmar!et operations ma% cause shortterm interest rates to rise above the level that the% would have attained under mar!et forces and thus increase the e6uilibrating movement of shortterm funds. #he <an! of England provided the most notable e-ample of the smooth and successful operation of this polic% under the old gold standard during man% decades before +orld +ar I. ?orard eBchan#e* 00? #he transactions in which one currenc% is e-changed directl% for another are !nown as spot transactions. #here can also be forard tran"action"$ consisting of contracts to e-change one currenc% for another at a future date$ perhaps three months ahead$ but at a rate determined now. >or instance$ a Ferman firm ma% have a commitment to pa% a 8.S. firm in dollars in threemonths] time. It ma% not want to ta!e the ris! that the dollar will rise relative to the mar! during the three months$ so that it would have to surrender more mar!s in order to honour its commitment. It could of course bu% the dollars right awa% and thus obviate this ris!$ but it ma% not have an% spare cash and borrowing ma% be inconvenient. #he firm has the alternative of bu%ing dollars at a rate agreed upon now for which it does not have to surrender mar!s until three months have passed. Some firms have a regular routine procedure for covering all future commitments to be paid for in a foreign currenc% as soon as these are entered into. Of course$ even a firm that does this ma% combine its routine procedure with a little *udgment$ for instance$ if there are good reasons for believing that the foreign currenc% will become cheaper during the relevant period. 2nd firms with multinational commitments will var% the distribution of their assets among different currencies in accordance with changing conditions. #he forwarde-change rate will$ li!e the spot rate$ be continuall% var%ing. It is not usuall% identical with the spot rate but in normal times has a regular relation to it. #his relation is determined as follows: 9ealers in forward e-change usuall% balance their commitments7 for instance$ a contract to deliver forward mar!s can be offset against one to deliver forward dollars$ and nothing more has to be done about it. If a particular dealer cannot manage this he will be in communication with another who ma% be in the opposite position. It ma% not$ however$ alwa%s be possible to offset ever% transaction. If this is not done$ the dealer must ma!e a spot purchase of the currenc%sa% mar!sin e-cess demand in the forward mar!et. If he did not do this he would ris! an e-change loss on some of his forward transactions. >or the purpose of evaluating the forwarde-change rate to be as!ed in a particular deal$ it is alwa%s correct to suppose that the deal is one that cannot be offset. If the dealer has to purchase mar!s on the spot$ he can earn the rate of interest prevailing in >ran!furt until the time comes when he has to deliver the mar!s. +hether this is advantageous or not depends on whether the rate of interest in >ran!furt is higher or lower than that in "ew :or! Cit%. If it is higher in >ran!furt$ the dealer will normall% 6uote a rate per forward mar! that is lower than the spot rate7 but if the rate of interest in >ran!furt is lower$ then the forward mar! will normall% stand above the spot mar! to compensate the dealer for having to emplo% his li6uid funds in a less remunerative mar!et. +hen the relation of the forward rate to the spot rate is determined b% a comparison of the shortterm interest rates in the two centres in the manner *ust described$ the forward rate is said to be at cinterest parit%.c #he 6uestion arises as to what particular interest rates are used to calculate the interest parit%. #here is a variet% of practice. In previous times the rate of interest on 8.S. #reasur% bills and the rate of interest on <ritish #reasur% bills were used to determine the interest parit% of the sterling price for forward dollars. ;ore recentl% the interest rates on Eurodollars and Eurosterling have been usedthat is$ the interest on dollar and sterling accounts held b% European ban!s. In normal times arbitrage ma% be e-pected to hold forward rates to their interest parities. #here have been times$ and even rather prolonged periods$ in which the forward rate for a currenc% has fallen below &or risen above' its interest parit%. #his ma% happen when there is a large onewa% movement of funds &such as when there is a lac! of confidence in a particular currenc%'. In some cases$ such as a simultaneous multiple 00G swapping of currencies$ the arbitrager does not have to commit an% funds$ but in forward arbitrage funds have to be committed for a period of three months. It is true that an arbitrageur who had bought threemonths] sterling could resell the sterling before the three months had elapsed$ but if he did so he might have to accept a loss. If the onewa% movement is ver% heav% there ma% be a shortage of funds available for forward arbitrage. "onetheless the demand for forward sterling has to be !ept e6ual to the suppl% of it$ and if there is insufficient arbitrage for this purpose then a positive profit has to appear on the purchase of forward sterling7 in other words$ its price has to fall below the interest parit%. If dealers in a forward currenc% cannot offset contracts for sale with contracts for purchase and find an e-cess of customers wishing to sell$ the e-cess suppl% causes immediate pressure on the spot mar!et$ since arbitrageurs and others who supplement the forward demand for the wea! currenc% must cover their positions b% selling an e6uivalent amount spot. #he onl% wa% in which the authorities can prevent an e-cess offer of their currenc% forward from causing an immediate drain on their reserves is b% offering to bu% it forward themselves$ without simultaneousl% selling it spot. <ritish authorities engaged in such operations during periods when sterling was wea!$ and similar operations have been conducted b% other central ban!s in connection with swap agreements for mutual accommodation. #he foregoing descriptions of the e6uilibrating movements of short term funds have not applied when there has been a serious lac! of confidence that a given parit% will be maintained. Occasions of lac! of confidence occurred much more fre6uentl% under the modified gold standard &International ;onetar% >und' than the% did under the old gold standard. #he reason for this is simple. 8nder the old gold standard it was not e-pected that a countr% of good standing would alter the gold valuation of its currenc% &although in much earlier da%s cdebasementc was common enough'. 2 devaluation of the official gold content was regarded as not far removed from a declaration of ban!ruptc%$ and it was assumed that a countr% would avoid it at all costs and in all times short of a ma*or war or revolution. 8nder the International ;onetar% >und this position was altered 6uite deliberatel% to allow a countr% whose pa%ments were in cfundamental dise6uilibrium$c to propose a change of parit%. #his remed% was proposed at the <retton +oods Conference &1G//'$ which set up the International ;onetar% >und$ because it was thought to be better than alternative remedies$ such as domestic deflation. Di"e+uili%ratin# capital mo$ement"* +hatever its merits from a longterm point of view$ the idea that it is 6uite respectable for a countr% to alter the par value of its currenc% in certain circumstances had disturbing effects on the movements of shortterm fundseffects that ma% not have been clearl% foreseen at the time of <retton +oods. Such movements of funds were sometimes ver% large indeed. #hese movements were not e6uilibrating$ li!e those described in relation to a parit% in which there is confidence7 on the contrar%$ the% were dise6uilibrating. If a currenc% became wea!if the demand for it fell below the suppl%this could give rise to the idea that the authorities having the wea! currenc% might in due course decide to devalue it$ as the% were perfectl% entitled$ under International ;onetar% >und principles$ to do. 01H Co$erin#* >oreign e-change advisers to corporations had to watch for such possibilities and propose a read*ustment of assets entailing a movement out of the wea! currenc%. It was not necessar% that there be$ on an ob*ective assessment$ a probabilit% &more than a 0H percent chance' that the currenc% in 6uestion had to be devalued. #o provo!e a dise6uilibrating movement of funds it was enough that there should be a small chance &much less than 0H percent' that it would be devalued. In strict theor%$ funds should be moved out of a given currenc% whenever the probabilit% that it will be devalued outweighs the cost of moving the funds. If a firm or its affiliate has foreseeable commitments to ma!e pa%ments in a currenc% other than that of the area in which it operates$ it ma% thin! it wise to ccoverc its position b% bu%ing the currenc% at once$ in either the spot or the forward mar!et. Covering ma% ta!e other forms also. If a contract to pa% abroad is in the currenc% of the home$ or pa%ing$ countr%$ then the prospective foreign receiver of these funds will have to consider whether he should not cover his own position b% selling the currenc% of the pa%ing countr% forward. (a%ments in the opposite direction have also to be considered. If these are in the currenc% of the home countr%$ the foreigner due to ma!e the pa%ment will consider whether he should cover his position b% bu%ing the currenc% of the home countr% forward. If the pa%ment is in the foreign currenc%$ then the firm in the home countr% due to receive it will consider whether to cover itself b% selling the foreign currenc% forward. #hus$ there are four main classes of covering. In normal times it is probable that not all positions are covered in these four wa%s$ although it is not impossible that the% should be. If a suspicion arises that a particular currenc%$ sa% that of the home countr%$ ma% be devalued$ then the position is radicall% changed. #he following arguments appl% in reverse to the case when it is believed that a particular currenc% ma% be valued upward. It is necessar% to go through the four classes of cases. ;embers of the home countr% who normall% cover their commitments to ma!e pa%ments in a foreign currenc% would clearl% continue to do so. 2nd those$ if an%$ who do not habituall% do so would be strongl% advised to do so when there is a possibilit% that the home currenc% ma% be devalued. #o ta!e the second casethat of outward pa%ments to be made in the home currenc%the same applies: foreigners who normall% sell it forward should continue to do so$ and those who do not normall% sell it forward would be strongl% advised to do so lest the currenc% be devalued before the pa%ment is made. Coming to the pa%ments due to the home countr%$ in the case of those to be made in the home currenc%$ the foreigners who normall% cover themselves b% bu%ing forward or spot should be advised to cease doing so immediatel%$ since the% ma% get the currenc% cheaper before the pa%ment has to be made. #hus$ in this case the fear of de$aluation causes those concerned to stop covering their positions. #he same applies to inward pa%ments to be made in foreign currencies7 residents of the home countr% would be advised to cease from such covering$ since in the interval their currenc% ma% be devalued$ and therefore it would be foolish to sell the foreign currenc% due to come$ in advance of pa%ment. #hus$ the prospect of devaluation ma% cause both additional covering and uncovering. <oth t%pes of change are adverse to the currenc% under suspicion. It is notable that the total value of the appropriate covering plus that of the uncovering when a currenc% becomes suspect is independent of the proportion of positions that are normall% covered. If all positions are normall% covered then the adverse effect will consist of an uncovering of about half of all positions. If all positions are not normall% covered$ then the adverse effect will be e6ual to the sum of 011 the amount of e-tra covering and the amount of uncovering. #he movement of funds under these heads can be ver% large in relation to a countr%]s normal balance of incoming and outgoing pa%ments. It ma!es no difference whether the changed action b% the firms relates to the spot or to the forward mar!ets. #his is because$ when there is a big onewa% movement in the forward mar!et$ the whole of it is thrown$ through the actions of the dealers$ arbitrageurs$ and the li!e$ onto the spot mar!et.
,ed#in#* +hereas the word ccoveringc relates to pa%ments foreseen or possible$ the term hed#in# is used for operations related not to prospective pa%ments but to e-isting assets. #hus$ a non<ritish firm ma% need to have a sterling balance for an indefinite period ahead. It ma% thin! it desirable in this case to protect its position against the possibilit% of sterling being devalued in the near future b% selling sterling forward at the e-isting 6uoted rate. If sterling is devalued before the forward contract matures$ the operator will get a foreign currenc%sa% the francat the old rate and can rebu% sterling at a cheaper rate. #he profit that he ma!es recoups him for the loss in the franc value of his sterling due to the devaluation. If there is no devaluation he can renew his hedge at the date due$ if sterling is still suspect$ or he can terminate it without loss e-cept for the actual cost$ or service charge$ of the hedging transaction. 2n even more important use of hedging is to protect the international value of real assets such as securities$ real estate$ and industrial buildings and plants. If a non<ritish person conducts business and has assets in <ritain$ he ma% thin! it wise to protect the international value of these assets b% selling a certain amount of sterling forward. 2 devaluation$ if it occurs$ will reduce the foreign e-change value of the sterling assets7 but the profit that the owner ma!es from selling sterling forward and bu%ing it bac! at a cheaper rate will be an offset to this loss. Speculation* #he movements so far considered are of a precautionar% nature. It is sometimes suggested$ when there is a big movement of funds out of a currenc%$ that those prompting it are actuated b% some motive hostile to the suspect currenc%. #his is usuall% 6uite wrong. Such large movements of funds are often referred to incorrectl% as F"peculati$e*F #his gives a false impression of what is happening. Speculation can$ and often does$ occur when a currenc% becomes suspect7 but the word speculative should be confined to movements of funds made not to protect positions but purel% in the hope of gain. 2 person ma% believe that the 9eutsche ;ar! is li!el% to be valued upward and decide to bu% 9eutsche ;ar!s$ not because he has an% commitments denominated in 9eutsche ;ar!s but because he wants to resell them afterward at a profit. 3e will probabl% bu% the 9eutsche ;ar!s forward. Such speculation pla%s onl% a minor role in the earl% movements of funds in anticipation of a change of parit%. It ma%$ however$ mount up ver% strongl% in the last stages when an upward or downward revaluation has become almost certain. 2 big outward movement of funds ma% precipitate a change of parit%$ desirable or undesirable in itself$ simpl% because there are not enough reserves to finance the withdrawals. Even if the countr% in trouble is assisted b% international credits$ in certain cases these ma% not be large enough to avert the need for devaluation. 2 great movement of funds from a particular countr% ma% occur because it is thought li!el% 01, that it will have to devalue. #here ma% also be a great movement into a countr% thought li!el% to value upward. #he latter !ind of movement will cause difficulties for other countries$ since the funds must come from somewhere. #his adverse effect ma% be concentrated on one other currenc%$ as in the classic crisis centred on a possible upward valuation of the 9eutsche ;ar! in "ovember 1G1?$ where the drain was mainl% from the >rench franc7 or it ma% be more widel% diffused$ as in the crisis of the mar! in September 1G1G. Stre""e" in the IM? "y"tem* #he International ;onetar% >und s%stem of peggedbutad*ustable e-change rates came under increasing pressures during the 1G1Hs. #he s%stem suffered from three ma*or$ interrelated problems: inade6uate ad*ustment$ confidence$ and li6uidit%. Changes actuall% made in e-change rates were inade6uate to deal with the ma*or disturbances occurring in international pa%ments. <ecause the ad*ustment mechanisms in the s%stem were inade6uate$ a number of countries ran large and persistent imbalances in their international pa%ments. #his led to a lac! of confidence that e-isting par values could be maintained and to periodic speculative rushes into strong currencies and awa% from wea! ones. 9eficit countries were not in a position to meet large speculative attac!s because of their limited 6uantities of li6uid reserves. #raditionall%$ there had been two ma*or methods of international reserve creation: the mining of gold and the ac6uisition of reserves in the form of !e% currencies &mainl% dollars'. Fold mining did not !eep up with the rapid increase in international trade7 gold reserves became less and less ade6uate as a means for covering balanceofpa%ments deficits. #he alternative method for ac6uiring reservesthe accumulation of 8.S. dollars b% central ban!shad one ma*or disadvantage. >or countries such as the 8nited Uingdom$ +est Ferman%$ or <ra5il to accumulate dollars$ the 8nited States had to run a balanceofpa%ments deficit. <ut when the 8nited States ran large deficits$ doubts arose regarding the abilit% of the 8nited States to maintain the convertibilit% of the dollar into gold. In other words$ there was a fundamental inconsistenc% in the design of the I;> s%stem$ which created something of a parado-: if the 8nited States did run large deficits$ the dollar would sooner or later be sub*ect to a crisis of confidence7 if it did not run large deficits$ the rest of the world would be starved for dollar reserves. Special Drain# Ri#ht"* #o deal with the inabilit% of the e-isting s%stem to create an ade6uate 6uantit% of reserves without re6uiring the 8nited States to run large deficits$ a new !ind of reserve called Special 9rawing Cights &S9Cs' was devised b% the International ;onetar% >und. ;embers of the >und were to be allocated S9Cs$ %ear b% %ear$ in prearranged 6uantities to be used for the discharge of international indebtedness. 2t the I;> meeting in 1G1G$ agreement was reached for an issue e-tending over three %ears. #hese Special 9rawing Cights differed from ordinar% Drain# Ri#ht" in three important respects: &1' #he use of Special 9rawing Cights was not to be sub*ect to negotiations or conditions. &,' #here was to be onl% a ver% much modified form of repa%ment obligation. 2 member who used more than =H percent of all the Special 9rawing Cights allotted in a given period had to repa% to the e-tent needed to reduce its average use of the rights during that period to =H percent of the total. #hus$ =H percent of all Special 9rawing Cights issued could be thought of as reserves in the fullest sense$ since a member who limited its use to this amount would have no 01. repa%ment obligation. &.' In the case of 9rawing Cights$ the >und uses currencies as subscribed b% members to provide the medium of pa%ment. <% contrast$ the Special 9rawing Cights were to be accepted in final discharge of debt without being translated into an% particular currenc%. #hough currencies would still have to be subscribed b% members receiving Special 9rawing Cights$ these would be in the bac!ground and would not be used$ e-cept in the case of a member in net credit on Special 9rawing Cights account who wished to withdraw from the scheme. Initiall%$ the total amount of Special 9rawing Cights allocated was e6uivalent to more than 8.S. NG$HHH$HHH$HHH$ but additional allocations to I;> members during the 1G=Hs more than doubled the total. #he value of the Special 9rawing Cights is based on the currencies of the largest e-porting I;> members. #he use of S9Cs was altered and e-panded in 1G=?$ allowing agencies other than the I;> to use S9Cs in monetar% e-change. Subse6uentl% S9Cs have been used b% the 2ndes Ceserve >und$ the 2rab ;onetar% >und$ the <an! for International Settlements$ and others. .ther effort" at financial cooperation* The :roup of Ten* 2s earl% as 1G11 there were signs of a crisis in the I;> s%stem. #he 8nited States had been running a heav% deficit since 1G0?$ and the 8nited Uingdom plunged into one in 1G1H. It loo!ed as if these two countries might need to draw upon continental European currencies in e-cess of the amounts available. (er @acobssen$ then managing director of the I;>$ persuaded a group of countries to provide standb% credits amounting to N1$HHH$HHH$HHH in all$ so that supplementar% supplies of their currencies would be available. #he plan was not confined to the countries that happened to be in credit at that time but was e-tended to other important countries$ the currencies of which might run short at some future time. #his plan was !nown as the F:eneral Arran#ement" to /orro*F #he adhering countries were 1H in number: the 8nited States$ the 8nited Uingdom$ Canada$ >rance$ +est Ferman%$ Ital%$ #he "etherlands$ <elgium$ Sweden$ and @apan. #he% became !nown as the cFroup of #en.c #he arrangement was sub*ect to the agreement that countries actuall% suppl%ing additional currenc% would have the right to ta!e cogni5ance of how the >und used it. #his put them in a power position as against the International ;onetar% >und itself. Since then the Froup of #en has wor!ed together in deliberating on international monetar% problems. #he dominant position gained b% the Froup of #en has been due not onl% to their provision of standb% credit but also to the manner in which the% do their business. #he ultimate authorit% of the Froup resides in the finance ministers of the countries concerned$ who meet from time to time. #heir deputies meet more fre6uentl% for detailed wor! on particular problems. #hese deputies consist of highran!ing persons in their respective treasuries and central ban!s7 the% are resident in their own countries and have da%toda% !nowledge of their problems and of what is politicall% feasible. In this respect the% are in a much more advantageous position than the e-ecutive directors of the International ;onetar% >und$ who live in +ashington$ 9.C.$ and have less contact with their home governments7 the% also tend to be persons of higher standing and authorit%. 01/ The /a"el :roup* In 1G.H a /an! for International Settlement" was established at <asel$ Swit5.7 its main dut% was to supervise and organi5e the transfer of Ferman reparation" to the recipient countries. #his ctransfer problemc had caused much trouble during the 1G,Hs. #here ma% also have been a hope in the minds of some that this institution might one da% develop into something li!e a world central ban!. "ot long after it was set up the Fermans gained a moratorium on their reparations pa%ments. <% then$ however$ the <an! for International Settlements had become a convenient place for the heads of the European central ban!s to meet together and discuss current problems. #his practice was resumed after the war$ and the 8nited States$ although not a member$ was invited to *oin in the deliberations. +hen Mar"hall Plan aid was furnished b% the 8nited States to help European countries in their postwar reconstruction$ a European (a%ments 8nion was established to facilitate multilateral trade and settlements in advance of the time when it might be possible to reestablish full multilateralism on a world scale. #he war had left a *umble of trade restrictions that could not be 6uic!l% abolished. #he European (a%ments 8nion also contained a plan for the provision of credit to European debtors. #he 8nited Uingdom was a member$ and with it was associated the whole sterling area. Cesponsibilit% for wor!ing the machiner% of the European (a%ments 8nion was assigned to the <an! for International Settlements. #he European (a%ments 8nion was ultimatel% wound up after the countries of Europe were able to eliminate the last restrictions and ma!e their currencies full% convertible in 1G0?. In @anuar% and >ebruar% 1G11 there was a serious "terlin# crisis$ due partl% to the <ritish deficit of 1G1H and partl% to a large movement of funds in anticipation of an upward valuation of the +est Ferman mar!$ which happened$ and thereafter in anticipation of a second upward valuation$ which did not happen at that time. #o help the <ritish$ the <asel Froup of central ban!s provided substantial credits. #hese were li6uidated when the 8nited Uingdom transferred its indebtedness to the International ;onetar% >und the following @ul%. #he <asel Froup has provided further credits from time to time. #he problems involved have continued to be discussed at the monthl% meetings. #he arrangement made for the support of the sterling area in 1G1? is noteworth%. 2fter the devaluation of sterling in 1G1= it was feared that the monetar% authorities of the countries composing the sterling area might wish to reduce their holdings of sterling. <ecause there was a continuing problem of world li6uidit% and sterling pla%ed an important part as a reserve currenc%$ the international consensus was that an% substantial reduction in the holding of sterling as a reserve currenc% would be damaging to the international monetar% s%stem. 8nder the arrangement made in 1G1? the 8nited Uingdom on its side agreed to give a dollar guarantee to the value of the greater part of the sterlingarea reserves7 there were slightl% different arrangements with each monetar% authorit%. On its side the <an! for International Settlement agreed to organi5e credits to finance pa%ments deficits for some countries of the sterling area$ should these occur at times when the 1nited Ain#dom might find it difficult to handle them. The .ECD* #he .r#ani"ation for European Economic Co0operation &OEEC' was set up in 1G/? to ma!e arrangements for the distribution of ;arshall 2id among the countries of Europe. +hen its tas!s in this connection were accomplished$ it remained in e-istence$ was broadened to include the 8nited States$ Canada$ and @apan$ and it was renamed the .r#ani"ation for Economic Co0operation and De$elopment 010 &OEC9'. It has a permanent staff and head6uarters in (aris. It underta!es research on a substantial scale and affords a forum for the discussion of international economic problems. #he +or!ing (art% "o. . of the organi5ation]s Economic Committee$ which is concerned with problems of mone% and e-change$ has made significant contributions7 it issued a ver% important report on balanceofpa%ments ad*ustment problems in 1G11. 2t times the personnel of the +or!ing (art% has been much the same as that of the deputies of the Froup of #en. #he Organisation for Economic Co operation and 9evelopment has also set up an organi5ation called the 9evelopment 2ssistance Committee$ concerned with problems of assistance to the developing countries. Sap a#reement"* #he informal s%stem of swap agreements provides a mutual arrangement between central ban!s for standb% credits designed to see countries through difficulties on the occasions of large movements of funds. #hese are intended onl% to offset private international flows of capital on precautionar% or speculative account$ not to finance even temporar% deficits in countries] balance of pa%ments. 2rranged ad hoc and informall%$ the% depend on the mutual goodwill and trust of the central ban!s involved. #he s%stem of credits$ although informal$ must be rec!oned as important$ because the% are of large amount. The end of pe##ed eBchan#e rate"* The cri"i" of the dollar* #he monetar% s%stem established b% the I;> in 1G// underwent profound changes in the 1G=Hs. #his s%stem had assumed that the dollar was the strongest currenc% in the world because the 8nited States was the strongest economic power. Other countries were e-pected to have difficult% from time to time in stabili5ing their e-change rates and would need assistance in the form of credits from the I;>$ but the dollar was e-pected to remain stable enough to function as a substitute for gold in international transactions. In the second half of the 1G1Hs these assumptions came into 6uestion. #he war in Vietnam led to inflation. #he flood of dollars into other countries caused difficult% for the European central ban!s$ which were forced to increase their dollar holdings in order to maintain their currencies at the established e-change rates. 2s the flood continued in 1G=1$ the +est Ferman and 9utch governments decided to let their currencies floatthat is$ to let their e-change rates fluctuate be%ond their assigned parities. 2ustria and Swit5erland revalued their currencies upward in relation to the dollar. #hese measures helped for a time$ but in 2ugust the outflow of dollars resumed. On 2ugust 10 (res. Richard M* -iBon suspended the 8.S. commitment made in 1G./ to convert dollars into gold$ effectivel% ending the postwar monetar% s%stem established b% the I;>. ;ost of the ma*or trading countries decided to abandon fi-ed e-change rates temporaril% and let their currencies find their own values in relation to the dollar. The Smith"onian A#reement and after* On 9ec. 1= and 1?$ 1G=1$ representatives of the Froup of #en met at the Smithsonian Institution in +ashington$ 9.C.$ and agreed on a realignment of currencies and a new set of pegged e-change rates. #he dollar was devalued in terms of gold$ while other currencies were appreciated in terms of the dollar. On the whole$ the dollar was devalued b% nearl% 1H percent in relation to the other Froup of #en currencies &those of the 8nited Uingdom$ Canada$ >rance$ +est Ferman%$ Ital%$ #he "etherlands$ <elgium$ Sweden$ and @apan'. Several months after the Smithsonian 011 2greement$ the si- members of the European Economic Community &EEC' agreed to maintain their e-change rates within a range of ,.,0 percent of parit% with each other. #he Smithsonian 2greement proved to be onl% a temporar% solution to the international currenc% crisis. 2 second devaluation of the dollar &b% 1H percent' was announced in >ebruar% 1G=.$ and not long afterward @apan and the EEC countries decided to let their currencies float. 2t the time$ these were thought of as temporar% measures to cope with speculation and capital shifts7 it was$ however$ the end of the s%stem of established par values. 6'#4,+5: -2C*45:- .4,- #he floating e-changerate s%stem emerged when the old I;> s%stem of pegged e-change rates collapsed. #he case for the pegged e-change rate is based partl% on the deficiencies of alternative s%stems. #he I;> s%stem of ad*ustable pegs proved unwor!able in a world in which there were huge volumes of internationall% mobile financial capital that could be shifted out of countries in balanceofpa%ments difficulties and into the stronger nations. #he earlier gold standard s%stem had li!ewise contained substantial defects. 8nder some circumstances$ it re6uired countries to go through a painful deflation. #he gold standard$ it is widel% held$ made the Freat 9epression of the 1G.Hs even deeper than it might otherwise have been. #hree ma*or$ interrelated hopes were e-pressed when fle-ible e-change rates replaced the collapsing I;> s%stem of pegged e-change rates in the earl% 1G=Hs. >irst$ fle-ible e-change rates would allow currencies to hold at or near their fundamental e6uilibrium values7 national authorities would not feel obliged to defend e-change rates that were severel% out of line. Second$ deficit countries would be able to reestablish their international competitiveness without going through the painful deflationar% process re6uired b% the old gold standard and without facing the political embarrassment of abandoning an established par value. >inall%$ the national monetar% authorities would have a substantial degree of independence to pursue the most appropriate domestic monetar% and fiscal policies$ without being severel% constrained b% balanceofpa%ments pressures. In practice$ e-changerate fle-ibilit% turned out to be more complicated than its proponents had anticipated. EBchan#e0rate fluctuation"* #he pegged e-changerate s%stem collapsed in two speculative flurries against the 8.S. dollar in 1G=1 and 1G=.. In each case$ the dollar depreciated about 1H percent in terms of an average of other currencies. &In calculating an average e-change rate for the dollar$ the currencies of each other nation is weighted according to the volume of trade of that nation with the 8nited States.' 2fter these initial ad*ustments$ e-change rates of the ma*or trading nations were generall% 6uite stable for the ne-t four %ears &late 1G=.=='$ although there were some fluctuations. #he dollar strengthened following the first oil shoc!$ which occurred in 1G=.=/7 because the 8nited States still produced most of the oil it consumed$ it was e-pected to be less severel% sha!en b% high oil prices than would its ma*or trading partners$ especiall% +est Ferman% and @apan. In the 1G=.== period$ the ma*or e-changerate change was a fall in the <ritish pound sterling b% about .H percent when measured in terms of dollars. In late 1G== the dollar entered a period of instabilit%. 2s the 8.S. econom% e-panded and inflation increased$ 8.S. goods became less competitive on world mar!ets. In response$ the dollar began to slide downward. #his raised the price of imported goods in the 8nited States$ adding to inflationar% pressures. #he 8nited States seemed in danger of entering a wagepricee-change rate spiral. 2nticipating worse to come$ speculators began to unload dollars$ moving the e-change value of the dollar even lower. 9uring the 1G== 01= =G period$ the average e-change value of the dollar declined b% about 10 percent. >aced with a rapidl% deteriorating situation$ the 8nited States tightened its domestic policies sharpl%. In particular$ monetar% polic% was tightened in order to combat the rapid inflation. #his e-perience provided one earl%$ important lesson about fle-ible e-change rates. Even though fle-ible e-change rates provide some independence for domestic monetar% policies$ domestic policies cannot be made without concern for international complications. #his is true even for a large$ prosperous econom%$ such as that of the 8nited States. 9uring the late 1G=Hs$ the 8.S. dollar was threatened with a collapse. <% the mid1G?Hs the opposite had occurred: the dollar had soaredrising about ?H percent. 2 number of forces contributed to this rise. One was 8.S. fiscal polic%: ta- rates were cut sharpl%$ and budgetar% deficits ballooned. Dargescale government borrowing added to the demands on financial mar!ets$ leading to high interest rates. #his encouraged foreign asset holders to bu% 8.S. bonds. #o do so$ the% bought dollars$ creating upward pressure on the e-change value of the dollar. In turn$ the high dollar made it difficult for 8.S. producers to compete on world mar!ets. 8.S. imports rose bris!l%7 e-ports were relativel% sluggish$ and the 8.S. trade deficit soared. <ecause of strong competition from imports$ 8.S. producers of automobiles$ te-tiles$ and a number of other products lobbied for protection. 8nder the threat of unilateral 8.S. actions$ the government of @apan was persuaded to impose cvoluntar%c limits on e-ports of cars to the 8nited States. #here were concernsboth in the 8nited States and in its trading partnersthat the 8nited States might adopt a much more protectionist polic% because the high e-change value of the dollar was ma!ing it so difficult for 8.S. producers to compete. >aced with this unwelcome prospect$ senior officials of the cFroup of >ivec &>rance$ +est Ferman%$ @apan$ the 8nited Uingdom$ and the 8nited States' met at the (la5a 3otel in "ew :or! Cit% in 1G?0. In the c(la5a 2greement$c the% declared their intention to bring the dollar down to a more competitive level$ if necessar% b% official sales of dollars on e-change mar!ets. #his episode raised fundamental 6uestions about fle-ible e-change rates$ leading some financial e-perts to suggest an intermediate s%stem between freel% fle-ible e-change rates and the old I;> s%stem of ad*ustable pegs. +ith si5able e-changemar!et interventions b% governments and central ban!s$ e-change rates were not freel% fle-ible. #he% were being managed b% the authorities. &Such a managed floating rate is sometimes called a cdirt%c float.' Some e-perts supported more active e-changerate management in order to prevent currencies from becoming severel% misaligned. Fovernments were advised to declare ctarget 5onesc for e-change rates and to bu% or sell currencies whenever needed to !eep e-change rates within these 5onesmoving the target 5ones as fundamental economic conditions changed. #he concept was to avoid large e-changerate swings. ,*- +5,-.54,+#54' D-B, C.++ 9eveloping nations have traditionall% borrowed from the developed nations to support their economies. In the 1G=Hs such borrowing became 6uite heav% among certain developing countries$ and their e-ternal debt e-panded at a ver% rapid$ unsustainable rate. #he result was an international financial crisis. Countries such as ;e-ico and <ra5il declared that the% could not !eep up with the schedule of interest and principal pa%ments$ causing severe reactions in the financial world. Cooperating with creditor nations and the I;>$ these countries were able to reschedule their debtsthat is$ dela% pa%ments to remove financial pressure. <ut the underl%ing problem remaineddeveloping countries were saddled with staggering debts that totaled more than N?HH$HHH$HHH$HHH b% the mid1G?Hs. >or the lessdeveloped countries as a whole &e-cluding the ma*or oil e-porters'$ debt service pa%ments were 01? claiming more than ,H percent of their total e-port earnings. #he large debts created huge problems for the developing countries and for the ban!s that faced the ris! of substantial losses on their loan portfolios. Such debts increased the difficult% of finding funds to finance development. In addition$ the need to ac6uire foreign currencies to service the debt contributed to a rapid depreciation of the currencies and to rapid inflation in ;e-ico$ <ra5il$ and a number of other de$elopin# nation". #he wide fluctuations in the price of oil were one of the factors contributing to the debt problem. +hen the price of oil rose rapidl% in the 1G=Hs$ most countries felt unable to reduce their oil consumption 6uic!l%. In order to pa% for e-pensive oil imports$ man% went deepl% into debt. #he% borrowed to finance current consumptionsomething that could not go on indefinitel%. 2s a ma*or oil importer$ <ra5il was one of the nations adversel% affected b% rising oil prices. (arado-icall%$ however$ the oilimporting countries were not the onl% ones to borrow more when the price of oil rose rapidl%. Some of the oil e-porterssuch as ;e-icoalso contracted large new debts. #he% thought that the price of oil would move continuall% upward$ at least for the foreseeable future. #he% therefore felt safe in borrowing large amounts$ e-pecting that rapidl% increasing oil revenues would provide the funds to service their debts. #he price of oil drifted downward$ however$ ma!ing pa%ments much more difficult. #he debt reschedulings$ and the accompan%ing policies of demand restraint$ were built on the premise that a few %ears of tough ad*ustment would be sufficient to get out of such crises and to provide the basis for renewed$ vigorous growth. #o the contrar%$ however$ some authorities believed that huge foreign debts would act as a continuing drag on growth and could have catastrophic results. 01G Political Partie" and Intere"t :roup" 2 political party is a group organi5ed to achieve and e-ercise power within a political s%stem. 2n interest group &or specialinterest group' is an aggregate of individuals who$ bound b% one or more concerns or wants$ ma!es claims upon other groups or upon societ% in general in order to maintain or promote its position or ob*ectives. 2n interest group that attempts to influence government becomes a cpressure group.c It is distinguished from a political part% in that$ whereas a part% puts up candidates for election to public office and carries out activities to secure their election$ a pressure group see!s to influence both the government and the parties. #he Coman Catholic interest in Ital%$ for instance$ is served b% the Christian 9emocratic (art% and also b% the Catholic 2ction Societ%. #he first is a part%$ and the second is a pressure group. 2gain the ethnic Swedes in >inland is served b% the Swedish (eople]s (art%7 this is clearl% a specialinterest group$ %et it puts up candidates and is represented in the legislature because it thin!s its members thin! their constituents] interest is best served b% e-erting pressure as part of a governmental coalition. #hus$ what begins as a pressure group ma% eventuall% become a political part%. #he <ritish Dabour (art%$ for e-ample$ had its origins in 1GHH$ when trade unionists formed a Dabour Cepresentation Committee in order to elect wor!ingclass ;(s to (arliament7 later it broadened its membership and program to become the Dabour (art%. In >rance$ (ierre (ou*ade]s pressure group$ the 8nion of Small Shop!eepers$ was involved in the 1G01 elections and won more than /H seats$ thus becoming a political part%$ before reverting to pressuregroup status in 1G0?. #he reverse process can also occur$ as when a political part% engenders pressure groups7 thus$ Communist parties set up interest groups for women$ %outh$ wor!ers$ and the li!e. /olitical parties (olitical parties originated in their modern form in Europe and the 8nited States in the 1Gth centur%$ along with the electoral and parliamentar% s%stems$ whose development reflects the evolution of parties. #he term part% has since come to be applied to all organi5ed groups see!ing political power$ whether b% democratic elections or b% revolution. In earlier$ prerevolutionar%$ aristocratic and monarchical regimes$ the political process unfolded within restricted circles in which cli6ues and factions$ grouped around particular noblemen or influential personalities$ were opposed to one another. #he establishment of parliamentar% regimes and the appearance of parties at first scarcel% changed this situation. #o cli6ues formed around princes$ du!es$ counts$ or mar6uesses there were added cli6ues formed around ban!ers$ merchants$ industrialists$ and businessmen. Cegimes supported b% nobles were succeeded b% regimes supported b% other elites. #hese narrowl% based parties were later transformed to a greater or lesser e-tent$ for in the 1Gth centur% in Europe and 2merica there emerged parties depending on mass support. #he ,Hth centur% saw the spread of political parties throughout the entire world. In 2frica large parties have sometimes been formed in which a modern organi5ation has a more traditional ethnic or tribal basis7 in such cases the part% leadership is fre6uentl% made up of tribal chiefs. In certain areas of 2sia$ membership in modern political parties is often determined largel% b% religious factors or b% affiliation with ritual brotherhoods. ;an% political 0=H parties in the developing countries are partl% political$ partl% militar%. Certain Socialist and Communist parties in Europe earlier e-perienced the same tendencies. #hese lastmentioned European parties have demonstrated an e6ual aptitude for functioning within multipart% democracies and as the sole political part% in a dictatorship. 9eveloping originall% within the framewor! of liberal democrac% in the 1Gth centur%$ political parties have been used in the ,Hth centur% b% dictatorships for entirel% undemocratic purposes. TYPES .? P.)ITICA) PARTY 2 fundamental distinction can be made between cadre parties and mass based parties. #he two forms coe-ist in man% countries$ particularl% in western Europe$ where Communist and Socialist parties have emerged alongside the older conservative and liberal parties. ;an% parties do not fall e-actl% into either categor% but combine some characteristics of both. Cadre partie"* Cadre partie"i.e.& parties dominated b% politicall% elite groups of activistsdeveloped in Europe and 2merica during the 1Gth centur%. E-cept in some of the states of the 8nited States$ >rance from 1?/?$ and the Ferman Empire from 1?=1$ the suffrage was largel% restricted to ta-pa%ers and propert% owners$ and$ even when the right to vote was given to larger numbers of people$ political influence was essentiall% limited to a ver% small segment of the population. #he mass of people were limited to the role of spectators rather than that of active participants. #he cadre parties of the 1Gth centur% reflected a fundamental conflict between two classes: the aristocrac% on the one hand and the bourgeoisie on the other. #he former$ composed of landowners$ depended upon rural estates on which a generall% unlettered peasantr% was held bac! b% a traditionalist clerg%. #he bourgeoisie$ made up of industrialists$ merchants$ tradesmen$ ban!ers$ financiers$ and professional people$ depended upon the lower classes of cler!s and industrial wor!ers in the cities. <oth aristocrac% and bourgeoisie evolved its own ideolog%. <ourgeois liberal ideolog% developed first$ originating at the time of the English revolution of the 1=th centur% in the writings of @ohn Doc!e$ an English philosopher. It was then developed b% >rench philosophers of the 1?th centur%. In its clamouring for formal legal e6ualit% and acceptance of the ine6uities of circumstance$ liberal ideolog% reflected the interests of the bourgeoisie$ who wished to destro% the privileges of the aristocrac% and eliminate the lingering economic restraints of feudalism and mercantilism. <ut$ insofar as it set forth an egalitarian ideal and a demand for libert%$ bourgeois classical liberalism e-pressed aspirations common to all men. Conservative ideolog%$ on the other hand$ never succeeded in defining themes that would prove as attractive$ for it appeared to be more closel% allied to the interests of the aristocrac%. >or a considerable period$ however$ conservative sentiment did maintain a considerable impact among the people$ since it was presented as the e-pression of the will of Fod. In Catholic countries$ in which religion was based upon a hierarchicall% structured and authoritarian clerg%$ the conservative parties were often the clerical parties$ as in >rance$ Ital%$ and <elgium. Conservative and liberal cadre parties dominated European politics in the 1Gth centur%. 9eveloping during a period of great social and economic upheaval$ the% 0=1 e-ercised power largel% through electoral and parliamentar% activit%. Once in power$ their leaders used the power of the arm% or of the police7 the part% itself was not generall% organi5ed for violent activit%. Its local units were charged with assuring moral and financial bac!ing to candidates at election time$ as well as with maintaining continual contact between elected officials and the electorate. #he national organi5ation endeavoured to unif% the part% members who had been elected to the assemblies. In general$ the local committees maintained a basic autonom% and each legislator a large measure of independence. #he part% discipline in voting established b% the <ritish partieswhich were older because of the fact that the <ritish (arliament was long establishedwas imitated on the Continent hardl% at all. #he first 1nited State" political parties of the 1Gth centur% were not particularl% different from European cadre parties$ e-cept that their confrontations were less violent and based less on ideolog%. #he first 8nited States form of the struggle between the aristocrac% and the bourgeoisie$ between conservative and liberal$ was carried out in the form of the Cevolutionar% +ar$ in which Freat <ritain embodied the power of the !ing and the nobilit%$ and the insurgents that of bourgeoisie and liberalism. Such an interpretation is$ of course$ simplified. #here were some aristocrats in the South and$ in particular$ an aristocratic spirit based on the institutions of slaveholding and paternalistic ownership of land. In this sense$ the Civil +ar could be considered as a second phase of violent conflict between the conservatives and the liberals. "evertheless$ the 8nited States was from the beginning an essentiall% bourgeois civili5ation$ based on a deep sense of e6ualit% and of individual freedom. >ederalists and 2nti>ederalists$ Cepublicans and 9emocratsall belonged to the liberal famil% since all shared the same basic ideolog% and the same s%stem of fundamental values and differed onl% in the means b% which the% would reali5e their beliefs. In terms of part% structure$ 8nited States parties in the beginning differed little from their European counterparts. Di!e them$ the 8nited States parties were composed of local notables. #he ties of a local committee to a national organi5ation were even wea!er than in Europe. 2t the state level there was some effective coordination of local part% organi5ations$ but at the national level such coordination did not e-ist. 2 more original structure was developed after the Civil +arin the South to e-ploit the vote of the blac!s and along the East Coast to control the votes of immigrants. #he e-treme decentrali5ation in the 8nited States enabled a part% to establish a local 6uasidictatorship in a cit% or count% b% capturing all of the !e% posts in an election. "ot onl% the position of ma%or but also the police$ finances$ and the courts came under the control of the part% machine$ and the machine was thus a development of the original cadre parties. #he local part% committee came t%picall% to be composed of adventurers or gangsters who wanted to control the distribution of wealth and to ensure the continuation of their control. #hese men were themselves controlled b% the power of the boss$ the political leader who controlled the machine at the cit%$ count%$ or state levels. 2t the direction of the committee$ each constituenc% was carefull% divided$ and ever% precinct was watched closel% b% an agent of the part%$ the captain$ who was responsible for securing votes for the part%. Various rewards were offered to voters in return for the promise of their votes. #he machine could offer such inducements as union *obs$ trader]s licences$ immunit% from the police$ and the li!e. Operating in this manner$ a part% could fre6uentl% guarantee a ma*orit% in an election to the candidates of its choosing$ and$ once it was in control of local government$ of the police$ the courts$ and public finances$ etc.$ the machine and its clients were assured of impunit% in illicit activities such as prostitution and 0=, gambling rings and of the granting of public contracts to favoured businessmen. #he degeneration of the part% mechanism was not without benefits. #he European immigrant who arrived in the 8nited States lost and isolated in a huge and different world might find wor! and lodging in return for his commitment to the part%. In a s%stem of almost pure capitalism and at a time when social services were practicall% none-istent$ machines and bosses too! upon themselves responsibilities that were indispensable to communit% life. <ut the moral and material cost of such a s%stem was ver% high$ and the machine was often purel% e-ploitative$ performing no services to the communit%. <% the end of the 1Gth centur% the e-cesses of the machines and the bosses and the closed character of the parties led to the development of primar% elections$ in which part% nominees for office were selected. #he primar% movement deprived part% leaders of the right to dictate candidates for election. 2 ma*orit% of the states adopted the primar% s%stem in one form or another between 1GHH and 1G,H. #he aim of the s%stem was to ma!e the parties more democratic b% opening them up to the general public in the hope of counterbalancing the influence of the part% committees. In practice$ the aim was not reali5ed$ for the committees retained the upper hand in the selection of candidates for the primaries. In its original form the <ritish )a%our Party constituted a new t%pe of cadre part%$ forming an intermediate lin! with the massbased parties. It was formed with the support of trade unions and leftwing intellectuals. 2t the base$ each local organi5ation sent representatives to a district labour committee$ which was in turn represented at the national congress. #he earl% &pre1G1?' Dabour (art% was thus structured of man% local and regional organi5ations. It was not possible to *oin the part% directl%7 membership came onl% through an affiliated bod%$ such as a trade union. It thus represented a new t%pe of part%$ depending not upon highl% political individuals brought together as a result of their desire to ac6uire and wield power but upon the organi5ed representatives of a broader interestthe wor!ing class. Certain Christian 9emocrat partiesthe <elgian Social Christian (art% between the two world wars and the 2ustrian (opular (art%$ for e-amplehad an analogous structure: a federation of unions$ agricultural organi5ations$ middle class movements$ emplo%ers] associations$ etc. 2fter 1G1?$ the Dabour (art% developed a polic% of direct membership on the model of the continental Socialist parties$ individual members being permitted to *oin localconstituenc% branches. #he ma*orit% of its membership$ however$ continued to be affiliated rather than direct. Ma""0%a"ed partie"* Cadre parties normall% organi5e a relativel% small number of part% adherents. ;assbased parties$ on the other hand$ unite hundreds of thousands of followers$ sometimes millions. <ut the number of members is not the onl% criterion of a massbased part%. #he essential factor is that such a part% attempts to base itself on an appeal to the masses. It attempts to organi5e not onl% those who are influential or well !nown or those who represent special interest groups but rather an% citi5en who is willing to *oin the part%. If such a part% succeeds in gathering onl% a few adherents$ then it is mass based onl% in potential. It remains$ nevertheless$ different from the cadret%pe parties. 2t the end of the 1Gth centur% the Socialist parties of continental Europe organi5ed themselves on a mass basis in order to educate and to organi5e the growing population of labourers and wage earners$ which industriali5ation was ma!ing increasingl% large and which was becoming more 0=. important politicall% because of e-tensions of the suffrage$ and to gather the mone% necessar% for propaganda b% mobili5ing in a regular fashion the resources of those who$ although poor$ were numerous. ;embership campaigns were conducted$ and each member paid part% dues. If its members became sufficientl% numerous$ the part% emerged as a powerful organi5ation$ managing large funds and diffusing its ideas among an important segment of the population. Such was the case with the Ferman Social 9emocratic (art%$ which b% 1G1. had more than 1$HHH$HHH members. Such organi5ations were necessaril% rigidl% structured. #he part% re6uired an e-act registration of membership$ treasurers to collect dues$ secretaries to call and lead local meetings$ and a hierarchical framewor! for the coordination of the thousands of local sections. 2 tradition of collective action and group discipline$ more developed among wor!ers as a result of their participation in stri!es and other union activit%$ favoured the development and centrali5ation of part% organi5ation. 2 comple- part% organi5ation tends to give a great deal of influence to those who have responsibilit% at various levels in the hierarch%$ resulting in certain oligarchical tendencies. #he Socialist parties made an effort to control this tendenc% b% developing democratic procedures in the choice of leaders. 2t ever% level those in responsible positions were elected b% members of the part%. Ever% local part% group would elect delegates to regional and national congresses$ at which part% candidates and part% leaders would be chosen and part% polic% decided. #he t%pe of massbased part% described above was imitated b% man% non Socialist parties. Some cadret%pe parties in Europe$ both conservative and liberal$ attempted to transform themselves along similar lines. #he Christian 9emocrat parties often developed organi5ations copied even more directl% from the massbased model. <ut nonSocialist parties were generall% less successful in establishing rigid and disciplined organi5ations. #he first Communi"t partie" were splinter groups of e-isting Socialist parties and at first adopted the organi5ation of these parties. 2fter 1G,/$ as a result of a decision of the Comintern &the #hird International$ or federation of wor!ing class parties'$ all Communist parties were transformed along the lines of the Soviet model$ becoming mass parties based on the membership of the largest possible number of citi5ens$ although membership was and is limited to those who embraced and espoused the ideolog% of ;ar-ismDeninism. #he Communist parties developed a new structural organi5ation: whereas the local committees of cadre and Socialist parties focussed their organi5ing efforts and drew their support from a particular geographical area$ Communist groups formed their cells in the place of wor!. #he wor!place cell was the first original element in Communist part% organi5ation. It grouped together all part% members who depended upon the same firm$ wor!shop$ or store or the same professional institution &school or universit%$ for e-ample'. (art% members thus tended to be tightl% organi5ed$ their solidarit%$ resulting from a common occupation$ being stronger than that based upon residence. #he wor!placecell s%stem proved to be effective$ and other parties tried to imitate it$ generall% without success. Such an organi5ation leads each cell to concern itself with problems of a corporate and professional nature rather than with those of a more political nature. #hese basic groups$ however$ smaller and$ therefore$ more numerous than the Socialist sections$ tend to go their separate wa%. It is necessar% to have a ver% strong part% structure and for part% leaders to have e-tensive authorit% if the groups are to resist such centrifugal pressure. #his has resulted in a second distinctive characteristic of the Communist parties: a high degree of centrali5ation. 2lthough all massbased parties 0=/ tend to be centrali5ed$ Communist parties are more so than others. #here is$ in principle$ free discussion$ which is supposedl% developed at ever% level before a decision is made$ but afterward all must adhere to the decision that has been made b% the central bod%. #he splintering that has from time to time divided or paral%5ed the Socialist parties is forbidden in Communist parties$ which have generall% succeeded in maintaining their unit%. 2 further distinctive characteristic of Communist parties is the importance given to ideolog%. 2ll parties have a doctrine or at least a platform. #he European Socialist parties$ which were doctrinaire before 1G1/ and between the two wars$ later became more pragmatic$ not to sa% opportunistic. <ut$ in Communist parties$ ideolog% occupies a much more fundamental place$ a primar% concern of the part% being to indoctrinate its members with ;ar-ism. #he 1G,Hs and ].Hs saw the emergence of >ascist parties that attempted$ as do the Communist and Socialist parties$ to organi5e the ma-imum number of members but that did not claim to represent the great masses of people. #heir teaching was authoritarian and elitist. #he% thought that societies should be directed b% the most talented and capable peopleb% an elite. #he part% leadership$ grouped under the absolute authorit% of a supreme head$ constituted such an elite. (art% structure had as its goal the assurance of the obedience of the elite. #his structure resembled that of armies$ which are also organi5ed in such a wa% as to ensure$ b% means of rigorous discipline$ the obedience of a large number of men to an elite leadership. #he part% structure$ therefore$ made use of a militar%t%pe organi5ation$ consisting of a p%ramid made up of units that at the base were ver% tin% but that$ when *oined with other units$ formed groups that got larger and larger. 8niforms$ ran!s$ orders$ salutes$ marches$ and un6uestioning obedience were all aspects of >ascist parties. #his similarit% rests upon another factor7 namel%$ that >ascist doctrine taught that power must be sei5ed b% organi5ed minorities ma!ing use of force. #he part% thus made use of a militia intended to assure victor% in the struggle for control over the unorgani5ed masses. Darge parties built upon the >ascist model developed between the two wars in Ital% and Ferman%$ where the% actuall% came into power. >ascist parties appeared also in most other countries of western Europe during this period but were unable to achieve power. #he lessdeveloped nations of eastern Europe and Datin 2merica were e6uall% infected b% the movement. #he victor% of the 2llies in 1G/0$ as well as the revelation of the horrors of "a5ism$ stopped the growth of the >ascists and provo!ed their decline$ but >ascistt%pe part% organi5ation and doctrine remain a potent means of e-ercising power. PARTIES A-D P.)ITICA) P.WER +hether the% are conservative or revolutionar%$ whether the% are a union of notables or an organi5ation of the masses$ whether the% function in a pluralistic democrac% or in a monolithic dictatorship$ parties have one function in common: the% all participate to some e-tent in the e-ercise of political power$ whether b% forming a government or b% e-ercising the function of opposition$ a function that is often of crucial importance in the determination of national polic%. The "tru##le for poer* It is possible in theor% to distinguish revolutionar% parties$ which attempt to gain power b% violence &conspiracies$ guerrilla warfare$ etc.'$ from those parties wor!ing within the legal framewor! of elections. <ut the distinction is not 0=0 alwa%s eas% to ma!e$ because the same parties ma% sometimes ma!e use of both procedures$ either simultaneousl% or successivel%$ depending upon the circumstances. In the 1G,Hs$ for e-ample$ Communist parties sought power through elections at the same time that the% were developing an underground activit% of a revolutionar% nature. In the 1Gth centur%$ liberal parties were in the same situation$ sometimes emplo%ing the techni6ues of conspirac%$ as in Ital%$ 2ustria$ Ferman%$ (oland$ and Cussia$ and sometimes confining their struggles to the ballot bo-$ as in Freat <ritain and >rance. Cevolutionar% methods var% greatl%. Clandestine plots b% which minorit% groups sei5e the centres of power presuppose monarchies or dictatorships in which the masses of people have little sa% in government. <ut terrorist and disruptive activit% can serve to mobili5e citi5ens and to demonstrate the powerlessness of an% government. 2t the beginning of the ,Hth centur% leftist trade unionists e-tolled the revolutionar% general stri!e$ a total stoppage of all economic activit% that would paral%5e societ% completel% and put the government at the revolutionaries] merc%. Cural guerrilla activit% has often been used in countries with a predominantl% agrarian societ%7 urban guerrilla warfare was effective in the European revolutions of the 1Gth centur%$ but the development of techni6ues of police and militar% control has made such activit% more difficult. Cevolutionar% parties are less numerous than parties that wor! within the law: the contest at election time is the means normall% used in the struggle for power. Such activit% corresponds$ morever$ to the original nature of political parties and involves three factors: the organi5ation of propaganda$ the selection of candidates$ and the financing of campaigns. #he first function is the most visible. #he part% first of all gives the candidate a label that serves to introduce him to the voters and to identif% his position. <ecause of this part% label the voters are better able to distinguish the candidates. #he promises and declarations of individuals are seldom ta!en with too much seriousness$ and it means more to indicate that one candidate is a Communist$ another a Socialist$ a third a >ascist$ and a fourth a liberal. >inall%$ the part% also furnishes the candidate with wor!ers to raise funds$ put up his posters$ distribute his literature$ organi5e his meetings$ and canvass from door to door. #he function of selecting candidates is e-ercised in three wa%s. In cadre parties$ candidates are selected b% committees of the part% activists who ma!e up the part% the caucu" s%stem$ as it is !nown in the 8nited States. In general$ local committees pla% essential roles in this regard. In some countries$ however$ the selection is centrali5ed b% a national caucus$ as$ for e-ample$ b% the Conservative (art% in <ritain and the 8nion of 9emocrats in >rance. In mass based parties$ selection is made b% members of the regional and national congresses according to apparentl% democratic procedures7 in actual practice$ the governing committees pla% an essential role$ the local constituenc% members generall% ratif%ing their choice. #hirdl%$ in the 8nited States the mechanism of primary election" has established a s%stem for selecting candidates b% means of the votes of all part% members or all voters within a particular electoral district. #he various processes of selecting candidates do not$ however$ differ significantl% in their results$ for it is almost alwa%s the part% leaders who pla% the essential role. #his introduces an oligarchical tendenc% into part% politics$ a tendenc% that has not been overcome b% the congresses of the massbased parties or the 8nited States primaries$ which provide onl% a partial limitation on the power of the governing committees. 2n important aspect of the struggle for power between political parties is the financing of campaigns. Cadre parties alwa%s have in their committees some !e% figure having connections with businessmen who is responsible for collecting gifts from them. In 0=1 massbased parties$ rather than loo!ing for large sums of mone% from a few people$ leaders gather smaller sums from a large number of people who usuall% give on a monthl% or annual basis. #his method has been viewed as one of the distinguishing characteristics of massbased parties. Sometimes the law intervenes in the financing of elections and of parties. Daws often limit campaign e-penses and attempt to restrict the resources of the parties$ but the% are generall% inoperative because it is 6uite eas% to circumvent them. In some countries the state contributes public funds to the parties. 2t first$ such financial participation was limited to e-penses for campaigns and was based on the uniform treatment of candidates &as in >rance'$ but in Sweden and >inland the state contributes to the general finances of parties. Participation in poer* Onl% the functions of parties in democratic regimes will be considered at this time. #he role of the single part% in a dictatorship will be anal%5ed separatel%. Once a political part% has achieved electoral victor%$ the 6uestion arises of how much influence the part% is to have on the government. #he influence of the part% on members in elective office is fre6uentl% 6uite wea!. It defines the general lines of their activit%$ but these lines can be 6uite ha5%$ and few decisions are ta!en in the periodic meetings between officeholders and their part%. Each member of the legislature retains personal freedom of action in his participation in debates$ in his participation in government$ and$ especiall%$ in his voting. #he part% ma%$ of course$ attempt to enforce the part% line$ but parliamentar% or congressional members cannot be compelled to vote the wa% the part% wants them to. Such is the situation in the 8nited States$ within most of the liberal and conservative European parties$ and within cadre parties in general. #he 6uestion of how disciplined a part% is$ of the e-tent to which it will alwa%s present a united front$ enables a distinction to be made between what ma% be termed rigid and fle-ible parties7 that is$ between those that attempt alwa%s to be united and disciplined$ following what is most often an ideologicall% based part% line$ and those that$ representing a broader range of interests and points of view$ form legislatures that are assemblies of individuals rather than of parties. +hether the parties operating within a particular s%stem will be rigid or fle-ible depends largel% on the constitutional provisions that determine the circumstances in which a government ma% continue in office. #his is clearl% illustrated b% comparing the situation in the 8nited States with that in Freat <ritain. In the 8nited States the president and his government continue in office for the constitutionall% defined period of four %ears$ regardless of whether a ma*orit% in the legislature supports him or not. Since a united part% is thus not crucial to the immediate survival of the government$ both ma*or parties are able to contain broad coalitions of interests$ and votes on issues of ma*or importance fre6uentl% split each part%. In the 1nited Ain#dom the situation is 6uite different. #here$ government can continue in office onl% so long as it commands a ma*orit% in the legislature. 2 single adverse vote can result in the 0== dissolution of (arliament and a general election. (art% discipline and unit% are thus of crucial importance$ and this fact has farreaching conse6uences for the composition$ organi5ation$ and policies of each part%. #he conse6uences of part% disunit% within such a constitutional framewor! are well illustrated b% the wea!ness and instabilit% of the governments of the #hird and >ourth >rench republics. #he distinction between fle-ible and rigid parties applies e6uall% to parties in power and to those forming the opposition. Votes of censure or of lac! of confidence$ votes on proposed legislation or on the budget$ 6uestions put to ministers or challenges made to themin short$ all the functions of an opposition part%are wor!ed out differentl% in fle-ible and rigid part% s%stems. In fle-ible part% s%stems the absence of strong discipline is often of great conse6uence to the opposition part% because onl% rigid parties can constitute an opposition force sufficientl% strong to counterbalance the strength of the part% in power. 2t the same time$ part% discipline permits the opposition to present the public with an alternative to the ma*orit% part%7 the logical conse6uence of such a situation is <ritain]s cshadow cabinet$c which accustoms the electorate to the idea that a new group is read% to ta!e over the reins of government. (arties provide$ moreover$ a channel of communication between opposition legislators and the public. #he governing part% performs a similar service for the government$ although it is less necessar%$ since the government has at its disposal numerous means of communicating with the public. Opposition parties thus provide a means of e-pressing negative reaction to decisions of government and proposing alternatives. #his role *ustifies the official recognition given to opposition parties$ as is the case in Freat <ritain and Scandinavia. Poer and repre"entation* It is difficult to envisage how representative democrac% could function in a large industriali5ed societ% without political parties. In order for citi5ens to be able to ma!e an intelligent choice of representative or president$ it is necessar% for them to !now the real political orientation of each candidate. (art% membership provides the clearest indication of this. #he programs and promises of each individual candidate are not too significant or informative$ because most candidates$ in their attempt to gain the most votes$ tr% to avoid difficult sub*ects7 the% all tend to spea! the same language7 that is$ to camouflage their real opinions. #he fact that one is a Socialist$ another a conservative$ a third a liberal$ and a fourth a Communist provides a far better clue as to how the candidate will perform when in office. In the legislature the discipline of the part% limits the possibilit% that elected representatives will change their minds and their politics$ and thus the part% label acts as a sort of guarantee that there will be at least some correspondence between promise and performance. (arties ma!e possible the representation of var%ing shades of opinion b% s%nthesi5ing different positions into a stance that each representative adopts to a greater or lesser e-tent. <ut parties$ li!e all organi5ations$ tend to manipulate their members$ to bring them under the control of an inner circle of leaders that often perpetuates itself b% cooptation. In cadre parties$ members are manipulated b% powerful committees containing cli6ues of influential part% leaders. In massbased parties$ leaders are chosen b% the members$ but incumbents are ver% often reelected because the% control the part% apparatus$ using it to ensure their continuation in power. 9emocratic political s%stems$ while performing the function of 0=? representation$ thus rest more or less on the competition of rival oligarchies. <ut these oligarchies consist of political elites that are open to all with political ambition. "o modern democrac% could function without parties$ the oligarchical tendencies of which are best regarded as a necessar% evil. PARTY SYSTEMS (art% s%stems ma% be bro!en down into three broad categories: two part%$ multipart%$ and "in#le0party. Such a classification is based not merel% on the number of parties operating within a particular countr% but on a variet% of distinctive features that the three s%stems e-hibit. #wopart% and multipart% s%stems represent means of organi5ing political conflict within pluralistic societies and are thus part of the apparatus of democrac%. Single parties usuall% operate in situations in which genuine political conflict is not tolerated. #his broad statement is$ however$ sub*ect to 6ualification$ for$ although single parties do not usuall% permit the e-pression of points of view that are fundamentall% opposed to the part% line or ideolog%$ there ma% well be intense conflict within these limits over polic% within the part% itself. 2nd even within a twopart% or a multipart% s%stem$ debate ma% become so st%mied and a particular coalition of interests so entrenched that the democratic process is seriousl% compromised. #he distinction between twopart% and multipart% s%stems is not as easil% made as it might appear. In an% twopart% s%stem there are invariabl% some tin% parties in addition to the two ma*or parties$ and there is alwa%s the possibilit% that such small parties might prevent one of the two main parties from gaining a ma*orit% of seats in the legislature. #his is the case with regard to the Diberal (art% in Freat <ritain$ for e-ample. Other countries do not fall clearl% into either categor%7 thus$ 2ustria and the >ederal Cepublic of Ferman% onl% appro-imate the twopart% s%stem. It is not simpl% a 6uestion of the number of parties that determines the nature of the twopart% s%stem7 man% other elements are of importance$ the e-tent of part% discipline in particular. Multiparty "y"tem"* In 2ngloSa-on countries there is a tendenc% to consider the twopart% s%stem as normal and the multipart% s%stem as the e-ceptional case. <ut$ in fact$ the twopart% s%stem that operates in Freat <ritain$ the 8nited States$ and "ew Yealand is much rarer than the multipart% s%stem$ which is found in almost all of western Europe. In western Europe$ three ma*or categories of parties have developed since the beginning of the 1Gth centur%: conservative$ liberal$ and Socialist. Each reflects the interests of a particular social class and e-pounds a particular political ideolog%. 2fter +orld +ar I other categories of parties developed that were partl% the result of divisions or transformations of older parties. Communist parties began as splinter groups of Socialist parties$ and Christian 9emocrat parties attempted to weld together moderate Socialists and conservatives and some liberals. Other distinctive t%pes of part% emerged in some countries. In Scandinavia$ liberal rural parties developed in the 1Gth centur%$ reflecting a long tradition of separate representation of the rural population. In man% countries ethnic minorities formed the basis of nationalist parties$ which then either *oined e-isting parties or divided them. 0=G #he appearance of Socialism in the 1Gth centur% upset the earlier lines of battle between conservatives and liberals and tended to throw the latter two groups into a common defense of capitalism. Dogicall%$ this situation should have led to the fusion of conservatives and liberals into one bourgeois part% that would have presented a united stand against Socialism. #his is$ in fact$ what happened in Freat <ritain after +orld +ar I. One of the most important factors determining the number of parties operating within a particular countr% is the electoral s%stem. (roportional representation tends to favour the development of multipart% s%stems because it ensures representation in the legislature for even small parties. #he ma*orit%$ single ballot s%stem tends to produce a twopart% s%stem$ because it e-cludes parties that ma% gain substantial numbers of votes but not the ma*orit% of votes necessar% to elect a representative within a constituenc%. #he ma*orit% s%stem with a second ballot favours a multipart% s%stem tempered b% alliances between parties. Such a s%stem is ver% rare$ found onl% in the Ferman Empire &1?=11G1/' and in the >rench #hird &1?=H1G/H' and >ifth &since 1G0?' republics. Voters choose between the parties that did best in a first ballot. #his leaves small parties at a disadvantage but$ nevertheless$ gives them opportunit% to strengthen their role during the second balloting as long as the% are willing to enter into alliances with the leading parties. 2nother factor producing multipart% s%stems is the intensit% of political conflicts. If$ within a given political movement$ e-tremists are numerous$ then it is difficult for the moderates in that part% to *oin with them in a united front. #wo rival parties are li!el% to be formed. #hus$ the power of the @acobins among 1Gthcentur% >rench liberals contributed to the inabilit% of the moderates to form one great liberal part%$ as was successfull% achieved in Freat <ritain. Di!ewise$ the power of the e-tremists among the conservatives was an obstacle to the development of a strong conservative part%. #he distinction between the multipart% s%stem and the twopart% s%stem corresponds largel% to a distinction between two t%pes of +estern political regime. In a twopart% situation the administration has$ in effect$ an assurance of a ma*orit% in the legislature$ deriving from the predominance of one part%7 it has$ therefore$ a guarantee of continuance and effectiveness. Such a s%stem is often referred to as ma*orit% parliamentarianism. In a multipart% situation$ on the other hand$ it is 6uite rare for one part% to have a ma*orit% in the legislature7 governments must$ therefore$ be founded on coalitions$ which are alwa%s more heterogeneous and more fragile than a single part%. #he result is less stabilit% and less political power. Such s%stems ma% be referred to as nonma*orit% parliamentarianism. In practice$ ma*orit% and nonma*orit% parliamentar% s%stems do not coincide e-actl% with twopart% s%stems and multipart% s%stems. >or$ if each of the two parties is fle-ible and does not control the voting patterns of its members &as is the case in the 8nited States'$ the numerical ma*orit% of one of the parties matters little. It can happen$ moreover$ that one part% in a multipart% s%stem will hold an absolute ma*orit% of seats in the legislature so that no coalition is re6uired. Such a situation is unusual but did occur in +est Ferman%$ Ital%$ and <elgium at various times after 1G/0. Ordinaril%$ however$ a coalition will be the onl% means of attaining a parliamentar% ma*orit% within the framewor! of the multipart% s%stem. Coalitions are b% nature more heterogeneous and more unstable than a grouping made up of one part%$ but their effectiveness varies greatl% according to the discipline and organi5ation of the parties involved. In the case of fle-ible parties that are undisciplined and that allow each legislator to vote on his 0?H own$ the coalition will be wea! and probabl% shortlived. #he instabilit% and wea!ness of governments is at its ma-imum in such situations$ of which the #hird >rench Cepublic provides a good e-ample. If$ on the other hand$ the parties involved in a coalition are rigid and disciplined$ it is possible for a s%stem 6uite similar to the twopart% s%stem to develop. #his is often the case when two opposing alliances are formed$ one on the left and one on the right$ and when both are strong enough to endure through the legislative session. #his t%pe of coalition$ referred to as bipolari5ed$ introduces elements of the twopart% s%stem into a multipart% framewor!. 2 situation of this t%pe has developed in Seden$ where conservative$ liberal$ and agrarian parties have been aligned against the Social 9emocrat (art%$ which eventuall% allied itself with the Communist (art% &1G=H'. #he s%stem of bipolar alliances ma% be contrasted with the s%stem of a centrist alliance. Cather than the parties on the right forming a centreright coalition to oppose a centreleft coalition$ there is the possibilit% that the centreleft and the centreright will *oin forces and re*ect the e-tremes at both ends of the political spectrum. Such a situation occurred in Ferman% during the +eimar Cepublic$ when the government rested on a ma*orit% formed of a coalition of Catholic Centrists and Social 9emocrats$ with opposition coming from the Communists and the nationalists on the e-treme left and right. Centrist coalitions all tend to give the average citi5en a sense of political alienation. In re*ecting both e-tremes$ coalitions ma% well be isolating the radical$ unstable elements$ but the governing coalition ma% tend to be unresponsive to new ideas$ uninspiringl% pragmatic$ and too read% to compromise. #his situation gives rise to a more or less permanent breach between practical politics and political ideals. 2n advantage of bipolari5ation or of the twopart% s%stem is that the moderates of both sides must collaborate with those who are more e-treme in their views$ and the e-tremists must be willing to wor! with those who are more moderate7 the pressure from the e-tremists prevents the moderates from getting bogged down$ while collaboration with the moderates lends a touch of realism to the policies of the e-tremists. To0party "y"tem"* 2 fundamental distinction must be made between the twopart% s%stem as it is found in the 1nited State" and as it is found in :reat /ritain. 2lthough two ma*or parties dominate political life in the two countries$ the s%stem operates in 6uite different wa%s. The American to0party "y"tem* #he 8nited States has alwa%s had a twopart% s%stem$ first in the opposition between the >ederalists and the 2nti>ederalists$ then in the competition between the Cepublicans and the 9emocrats. #here have been fre6uent thirdpart% movements in the histor% of the countr%$ but the% have alwa%s failed. (residential elections seem to have pla%ed an important role in the formation of this t%pe of two part% s%stem. #he mechanism of a national election in so large a countr% has necessitated ver% large political organi5ations and$ at the same time$ relativel% simplified choices for the voter. 2merican parties are different from their counterparts in other +estern countries. #he% are not tied in the same wa% to the great social and ideological movements that have so influenced the development of political 0?1 life in Europe during the last two centuries. #here have been Socialist parties at various times in the histor% of the 8nited States$ but the% have never challenged the dominance of the two ma*or parties. It can be argued that the main reason for the failure of Socialist parties in 2merica has been the high degree of upward mobilit% permitted b% a rich and continuall% e-panding econom%. #he conse6uence of this mobilit% has been that class consciousness has never developed in the 8nited States in a manner that would encourage the formation of large Socialist or Communist parties. In comparison with European political movements$ therefore$ 2merican parties have appeared as two varieties of one liberal part%$ and within each part% can be found a wide range of opinion$ going from the right to the left. #he 2merican parties have a fle-ible and decentrali5ed structure$ mar!ed b% the absence of discipline and rigid hierarch%. #his was the structure of most of the cadret%pe parties of the 1Gth centur%$ a structure that most liberal parties have retained. >ederalism and a concern for local autonom% accentuate the lac! of rigid structure and the wea!ness of lines of authorit% in the parties. Organi5ation ma% be relativel% strong and homogeneous at the local level$ but such control is much wea!er on the state level and practicall% none-istent on the national level. #here is some truth to the observation that the 8nited States has not two parties but 1HHthat is$ two in each state. <ut it is also true that each part% develops a certain degree of national unit% for the presidential election and that the leadership of the president within his part% gives the victorious part% some cohesion. In voting$ Cepublicans and 9emocrats are usuall% found on both sides. 2n alliance between liberal Cepublicans and 9emocrats against conservative Cepublicans and 9emocrats tends to develop. <ut neither bloc is stable$ and the alignment varies from one vote to another. 2s a conse6uence$ despite the e-istence of a twopart% s%stem$ no stable legislative ma*orit% is possible. In order to have his budget adopted and his legislation passed$ the president of the 8nited States must carefull% tr% to gather the necessar% votes on ever% 6uestion$ bearing the wearisome tas! of constantl% forming alliances. #he 2merican twopart% s%stem is thus a pseudotwopart% s%stem$ because each part% provides onl% a loose framewor! within which shifting coalitions are formed. The /riti"h to0party "y"tem* 2nother form of the twopart% s%stem is operative in Freat <ritain and in "ew Yealand. #he situation in Au"tralia is affected somewhat b% the presence of a third part%$ the Countr% (art%. 2 tight alliance between the 2ustralian Diberal (art% and the Countr% (art% introduces$ however$ a rather rigid bipolari5ation with the Dabour (art%. #he s%stem thus tends to operate on a twopart% basis. Canada also possesses what is essentiall% a twopart% s%stem$ Diberals or Conservatives usuall% being able to form a wor!ing ma*orit% without the help of the small$ regionall% based parties. Freat <ritain has had two successive twopart% alignments: Conservative and Diberal prior to 1G1/ and Conservative and Dabour since 1G.0. #he period from 1G,H to 1G.0 constituted an intermediate phase between the two. <ritain]s Conservative (art% is actuall% a ConservativeDiberal (art%$ resulting from a fusion of the essential elements of the two great 1Gthcentur% parties. 9espite the name Conservative$ its ideolog% corresponds to political and economic liberalism. 2 similar observation could be made about the other ma*or 0?, European conservative parties$ such as the Ferman Christian 9emocratic (art% and the <elgian Social Christian (art%. #he <ritish two part% s%stem depends on the e-istence of rigid parties7 that is$ parties in which there is effective discipline regarding parliamentar% voting patterns. In ever% important vote$ all part% members are re6uired to vote as a bloc and to follow to the letter the directives that the% agreed upon collectivel% or that were decided for them b% the part% leaders. 2 relative fle-ibilit% ma% at times be tolerated$ but onl% to the e-tent that such a polic% does not compromise the action of the government. It ma% be admissible for some part% members to abstain from voting if their abstention does not alter the results of the vote. #hus$ the leader of the ma*orit% part% &who is at the same time the prime minister' is li!el% to remain in power throughout the session of (arliament$ and the legislation he or she proposes will li!el% be adopted. #here is no longer an% real separation of power between the e-ecutive and legislative branches$ for the government and its parliamentar% ma*orit% form a homogeneous and solid bloc before which the opposition has no power other than to ma!e its criticisms !nown. 9uring the four or five %ears for which a (arliament meets$ the ma*orit% in power is completel% in control$ and onl% internal difficulties within the ma*orit% part% can limit its power. Since each part% is made up of a disciplined group with a recogni5ed leader who becomes prime minister if his or her part% wins the legislative elections$ these elections perform the function of selecting both the legislature and the government. In voting to ma!e one of the part% leaders the head of the government$ the <ritish assure the leader of a disciplined parliamentar% ma*orit%. #he result is a political s%stem that is at once stable$ democratic$ and strong7 and man% would argue that it is more stable$ more democratic$ and stronger than s%stems an%where else. #his situation presupposes that both parties are in agreement with regard to the fundamental rules of a democrac%. If a >ascist part% and a Communist part% were opposed to one another in Freat <ritain$ the twopart% s%stem would not last ver% long. #he winner would 5ealousl% suppress the opponent and rule alone. #he s%stem$ of course$ does have its wea! points$ especiall% insofar as it tends to frustrate the innovative elements within both parties. <ut it is possible that this situation is preferable to what would happen if the more e-treme elements within the parties were permitted to engage in unrealistic policies. #he ris! of immobilit% is in fact a problem for an% part% in a modern industrial societ%$ and not *ust for those in a twopart% situation. #he problem is related to the difficulties involved in creating new organi5ations capable of being ta!en seriousl% b% an important segment of the population and in revitali5ing long standing organi5ations encumbered b% established practices and entrenched interests. Sin#le0party "y"tem"* #here have been three historical forms of the singlepart% s%stem: Communist$ >ascist$ and that found in the developing countries. The Communi"t model* In Communist countries the part% is considered to be the spearhead of the urban wor!ing class and of other wor!ers united with it &peasants$ intellectuals$ etc.'. Its role is to aid in the building of a Socialist regime during the transitor% phase between capitalism and pure Socialism$ called the dictatorship of the proletariat. 2n 0?. understanding of the e-act role of the part% re6uires an appreciation of the ;ar-ist conception of the evolution of the state. In countries based on private ownership of the means of production$ the power of the state$ according to the ;ar-ist point of view$ is used to further the interests of the controlling capitalists. In the first stage of revolution the power of the state is bro!en. (ower$ however$ still has to be wielded to prevent counterrevolution and to facilitate the transition to Communism$ at which stage coercion will no longer be necessar%. #hus$ the part%$ in effect$ assumes the coercive functions of the state during the dictatorship of the proletariat or$ to be more accurate$ during the dictatorship of the part% in the name of the proletariat. In all Communist countries$ the structure of the part% has been determined largel% b% the need for it to govern firml% while at the same time maintaining its contact with the masses of the people. (art% members are a part of the general public$ of which the% are the most active and most politicall% conscious members. #he% remain in contact with the masses b% means of a networ! of part% cells that are present ever%where. (art% leaders are thus alwa%s clistening in on the masses$c and the masses are alwa%s informed of decisions of part% leaders$ as long as the communication networ! is wor!ing in both directions. #he part% is not onl% a permanent means of contact between the people and part% leaders but also a propaganda instrument. (olitical indoctrination is essential to the survival of Communist parties$ and man% resources are devoted to it. Indoctrination is accomplished in training schools$ b% means of ceducationc campaigns$ b% censorship$ and through the untiring efforts of militants$ who pla% a role similar to that of the clerg% in organi5ed religion. #he part% is thus the guardian of orthodo-% and has the power to condemn and to e-communicate. In the traditional Communist model$ the part% hierarch%$ then$ and not the official state hierarch%$ has the real power. #he first secretar% of the part% is the most important figure of the regime$ and$ whether the part% leadership is in the hands of one man or several$ the part% remains the centre of political power. "ear the end of the ,Hth centur%$ however$ the Communist model began to change as the centre of power began shifting toward a popularl% elected state hierarch%. 2 %ounger generation of Communist leaders$ openl% critical of the part%]s inefficient$ unresponsive$ and domineering management of the governmentparticularl% the econom%sought a return to Denin]s original concepts of democratic centralism and socialism. In some countries$ democratic concepts were emphasi5ed$ and constitutional amendments eliminated the part%]s official control$ clearing the wa% for a multipart% s%stem. The ?a"ci"t model* >ascist parties in a singlepart% state have never pla%ed as important a role as Communist parties in an analogous situation. In Italy$ the >ascist part% was never the single most important element in the regime$ and its influence was often secondar%. In Spain the >alange never pla%ed a crucial role$ and in (ortugal the "ational 8nion was a ver% wea! organi5ation even at the height of dictator 2nt{nio Sala5ar]s strength. Onl% in :ermany did the "ational Socialist (art% have a great influence on the state. <ut$ in the end$ 3itler]s dictatorship was dependent on his private arm%$ the SS &Schut5staffel'$ which formed a separate element within the part% and which was closed to outside influences$ and on the Festapo$ which was a state organi5ation and not an organi5ation of the part%. #he >ascist part% in the singlepart% 0?/ state has a policing or militar% function rather than an ideological one. 2fter their rise to power$ the >ascist parties in both Ferman% and Ital% graduall% ceased to perform the function of maintaining contact between the people and the government$ a function that is usuall% performed b% the part% in a singlepart% situation. It was possible to observe a tendenc% for the part% to close in upon itself while suppressing its deviant members. #he renewal of the part% was then assured through recruitment from %outh organi5ations$ from which the most fanatical elements$ the products of a gradual selection process starting at a ver% earl% age$ entered the part%. #he part% tended$ therefore$ to constitute a closed order. The "in#le party in the de$elopin# countrie"* Some of the Communist parties in power in de$elopin# countrie" do not differ significantl% from their counterparts in industriali5ed countries. #his is certainl% true of the Communist (art% of the Socialist Cepublic of Vietnam and the +or!ers] (art% of "orth Uorea. #here have alwa%s been$ however$ countries in which the single part% in power could not be characteri5ed in terms of a traditional European counterpart. #his observation applies to$ for e-ample$ the former 2rab Socialist 8nion in Eg%pt$ the "eo9estour (art% in #unisia &renamed the 9estour 9emocratic Call%'$ and the "ational Diberation >ront in 2lgeria$ as well as man% other parties in blac! 2frica. ;ost of these parties claimed to be more or less Socialist or at least progressive$ while remaining far removed from Communism and$ in some cases$ ardent foes of Communism. (resident "asser attempted to establish a moderate and nationalistic Socialism in Eg%pt. In #unisia the "eo9estour (art% was more republican than Socialist and was inspired more b% the e-ample of the reforms in #ur!e% under Uemal 2tatlr! than b% "asserism. In blac! 2frica$ single parties have often claimed to be Socialist$ but with few e-ceptions the% rarel% are in practice. Single parties in developing countries are rarel% as well organi5ed as Communist parties. In #ur!e% the Cepublican (eople]s (art% was more a cadre part% than a massbased part%. In Eg%pt it has been necessar% to organi5e a core of professional politicians within the framewor! of a pseudopart% of the masses. In subSaharan 2frica the parties are most often genuinel% mass based$ but the membership appears to be motivated primaril% b% personal attachment to the leader or b% tribal lo%alties$ and organi5ation is not usuall% ver% strong. It is this wea!ness in organi5ation that e-plains the secondar% role pla%ed b% such parties in government. Some regimes$ however$ have endeavoured to develop the role of the part% to the fullest e-tent possible. #he politics of 2tatlr! in #ur!e% were an interesting case stud% in this regard. It was also "asser]s goal to increase the influence of the 2rab Socialist 8nion$ thereb% ma!ing it the bac!bone of the regime. #his process is significant in that it represents an attempt to move awa% from the traditional dictatorship$ supported b% the arm% or based on tribal traditions or on charismatic leadership$ toward a modern dictatorship$ supported b% one political part%. Singlepart% s%stems can institutionali5e dictatorships b% ma!ing them survive the life of one dominant figure. ?1T1RE .? P.)ITICA) PARTIES It has often been said in the +est that political parties are in a state of decline. 2ctuall%$ this has been a longstanding opinion in certain conservative 0?0 circles$ arising largel% out of a latent hostilit% to parties$ which are viewed as a divisive force among citi5ens$ a threat to national unit%$ and an enticement to corruption and demagoguer%. In certain European countries>rance$ for e-ample rightwing political organi5ations have even refused to call themselves parties$ using instead such terms as movement$ union$ federation$ and centre. 2nd it cannot be denied that to some e-tent the ma*or European and 2merican parties of the late ,Hth centur% do appear old and rigid in comparison with their condition at the turn of the centur% or immediatel% following +orld +ar I. Even relativel% new parties$ such as the Christian 9emocratic parties of Ferman% and Ital% &founded in 1G/0'$ seem somewhat lifeless. In terms of si5e and number$ however$ political parties are not declining but growing. 2t the turn of the centur% the% were confined mainl% to Europe and "orth 2merica7 elsewhere the% were 6uite wea! or none-istent. In the late ,Hth centur%$ parties are found practicall% ever%where in the world. 2nd in Europe and "orth 2merica there are generall% far more people holding membership in parties than prior to 1G1/. (arties of the late ,Hth centur% are larger$ stronger$ and better organi5ed than those of the late 1Gth centur%. In the industriali5ed nations$ especiall% in western Europe$ parties have become less revolutionar% and innovative$ and this factor ma% e-plain the rigid and wornout image that the% sometimes present. <ut even this phenomenon is found onl% in a limited area and ma%$ perhaps$ pass. #he growth of parties into ver% large organi5ations ma% be responsible for the feelings of powerlessness on the part of man% individuals who are involved in them. #his is a problem e-perienced b% people who find themselves part of an% large organi5ation$ whether it be a political part%$ business enterprise$ corporation$ or union. #he difficulties involved in reforming or changing political parties that have become large and institutionali5ed$ coupled with the ne-ttoimpossible tas! of creating new parties li!el% to reach sufficient strength to be ta!en seriousl% b% the electorate$ have resulted in much frustration and impatience with the part% s%stem. <ut it is difficult to imagine how democrac% could function in a large industriali5ed countr% without political parties. In the modern world$ democrac% and political parties are two facets of the same realit%$ the inside and outside of the same fabric. Intere"t #roup" TYPES .? I-TEREST :R.1P Cate#orie" defined %y purpo"e* +ithin the broad definition of interest groups$ two polar t%pes are recogni5able: first$ interest groups proper$ such as trade union"$ farmers] unions$ and emplo%ers] associations$ which have as their primar% purpose the enhancement of the advantage of their members7 and$ second$ promotional groups$ such as the societies for the prevention of cruelt% to children or various voluntar% relief agencies$ which e-ist primaril% or entirel% to enhance the advantage not of their own members but of the population$ even perhaps to the discomfort or disadvantage of their own members. Some of these$ such as churches or various evangeli5ing groups$ e-ist to promulgate a distinctive set of values to be applied to societ% as a whole. #he distinction between interest groups proper and promotional groups is not sharp for two reasons. In the first place$ most interest groups proper sincerel% believe that in furthering their own material advantage the% are also serving that of societ% as a wholeb% promoting cfree enterprisec or a health% and wealth% bod% of farmers or a wellpaid and enthusiastic corps of schoolteachers. 0?1 <ut the propagation of such beliefs is certainl% not the primar% purpose of such organi5ations$ thus distinguishing them from promotional groups. #he second reason is that some groupsfor instance$ organi5ed churchesfall between the two t%pes7 the% can simultaneousl% pursue advantages for their own sect and see! to inculcate a distinctive set of values in a whole societ%. Cate#orie" defined %y "tructure* In primitive or developing societies$ the most prominent t%pe of interest group is the natural &i.e.& primordial or communal' onethat is$ one based on !inship$ lineage$ neighbourhood$ or religious confession. In +estern$ industriali5ed societies$ though such groups do sometimes retain influence &as do the nationalities in Datvia and <elgium'$ the most prominent interest group is the associational &i.e.& secondar% or factitious' t%pe$ li!e the trade union or Campaign for "uclear 9isarmament$ which is deliberatel% created to serve defined purposes. Often$ associational &or factitious' groups are created for the sa!e of the speciali5ed purposes of the first t%pe7 the Indian +or!ers 8nion$ for instance$ was created from the communit% of Indian persons in <ritain. +ithin the class of associational groups$ further 6ualifications must be made: 1. "ot all associational groups possess formal structure. c+all Streetc in the 8nited States$ or the cCit%c in Dondon$ though consisting of a loose networ! of persons or functions$ ma% nevertheless e-ert powerful collective pressures. ,. Some associational groups are collectivities7 but others are single$ discrete or#aniIation". #hus Feneral ;otors Corporation e-erts its own strong influence vis vis the 8.S. government irrespective of the influence of the more general emplo%ers] organi5ation to which it possibl% belongs$ li!e the "ational 2ssociation of ;anufacturers. .. Some associational groups are temporar% or ad hoc. Such are the socalled anomic groups$ such as enraged >rench farmers who come together briefl% to put logs across roads in order to draw governmental attention to their grievances. /. Some associational groups are clatent.c #here ma% be a common interest among certain members of the public even though these individuals ma% not have combined into a formal or informal organi5ation. #he individuals ma% be unaware that the% have a common interest or$ if aware$ see no reason to defend or promote it. Or$ even if the members consciousl% wish to defend or promote an interest$ the laws ma% restrict or control their abilit% to associate for such a purpose. Cate#orie" defined %y political acti$ity* If or when an% interest group tries to influence the government in the pursuit of its aims$ it becomes a cpressure group.c "ot all interest groups proper tr% to e-ert influence on governments7 man% &such as businesses and trade unions' do so onl% as a part of their more general activities of promoting their own interests. (romotional groups$ on the other hand$ spend much or all their time precisel% in tr%ing to influence the government to favour their aims. Froups such as an anglers] association ma%$ therefore$ turn into pressure groups for a timethe time when the% see! to influence the government for one of their purposesand then revert to simple interestgroup status. 2 pressure group is therefore definable as can% interest group that is not a part of the government and does not itself see! to govern the countr% in 0?= its own name$ but does see! to influence that government for its own purposes.c 9ifficulties of definition arise$ however. Some groups are neither a governmental agenc% nor entirel% a private group. In autocratic states$ Communist or otherwise$ for instance$ trade unions are often controlled b% the government or the governing part%. In the +estern liberal democracies$ again$ agencies li!e the #ennessee Valle% 2uthorit% &in the 8.S.' or the <ritish <roadcasting Corporation$ though sub*ect to the overriding control of the government$ en*o% substantial autonom% in certain broad areas. 2lso$ as noted at the beginning of this article$ some pressure groups eventuall% turn into political parties$ or vice versa. C,ARACTERISTICS .? PRESS1RE :R.1PS Poer element"* Even in the most pluralistic of the +estern liberal democratic states$ it is wrong to picture public polic% as simpl% the result of a parallelogram of group forces. #he groups are themselves restrained b% institutions$ procedures$ and public beliefs. 2mong the institutions& the most important are the public bureaucrac%$ the political parties$ and the independent branches of the government &the e-ecutive$ legislature$ and *udiciar%or some combination of these$ depending on the structure of government'. #o the e-tent that each or all of these institutions have strong traditions$ no interest group supplants them but instead has to deal with them. #he governmental procedures in force also affect groups] performance. #o the e-tent that public issues are traditionall% sub*ect to publicit% and wide discussion$ groups are limited in the !ind of activities that the% can pursue. #he% are constrained b% public %eliefs as to what is in cthe public interest$c b% what is a proper or improper procedure$ or b% what causes are respectable and what are not. If an% of these three entitiesinstitutions$ procedures$ or public beliefsbecome feeble$ interest groups can intrude into them. <% all%ing with or gaining power over the parties$ the legislature$ or the bureaucrac%$ for instance$ groups can tend to substitute themselves for such organs in the decisionma!ing process. Inside ever% countr% the power that pressure groups wield against the government and that each group wields relative to its rivals depends on a combination of the following variables$ some of which are mutuall% dependent: 1. 9ensit% is the ratio of actual membership to potential membership. #he higher the densit%$ the more crepresentativec is the group of all the people whose interests it purports to represent and the greater will be the inclination for governments to recogni5e and consult it. On the other hand$ too wide a membership brings with it internal cleavages$ so that on certain issues the organi5ation ma% not be able to tender clearcut advice or$ indeed$ ma% have to refrain from offering advice altogether. ,. +ealth not onl% helps a group to develop a s!illed management and bureaucrac% but also enables it to propagandi5e and to finance political parties. .. (restige lends a group the abilit% to get a favourable initial hearing from government and public$ even though its numbers ma% be small and its wealth meagre. /. Organi5ation consists notabl% of the abilit% to brief legislators and administrators well and 6uic!l%$ to mobili5e members and the public rapidl%$ and to receive advance intelligence of li!el% trends in polic%. 0?? 0. Socioeconomic leverage is strong among some groups &such as trade unions' that can disrupt social life and low among others &such as consumers associations'. 1. ;ilitanc% consists of ma!ing an effective nuisance of oneself$ so that$ hopefull%$ governments will be willing to cbu%c time or peace. =. Speciali5ed information and s!ills add the weight of authorit%. ?. Electoral strength refers to the power of some groups that$ though poorl% organi5ed or having a low densit%$ nevertheless command wide support in the electorate and so find themselves courted b% rival political parties. Strate#y and tactic"* 2lthough all groups see! out the most influential agencies of government$ the most influential ma% not be accessible7 and resort must be had to the ne-t most influential organ that is accessible. <ecause the Communist trade unions in Ital%$ for instance$ are not welcome at the Coman Catholic controlled ;inistr% of Dabour$ the% tr% to penetrate the legislature through political election. Indeed$ in an% s%stem the influence of the various organs of government varies. In >rance the president and bureaucrac% are more influential than the ma*orit% part% and (arliament7 in the 8nited States$ the president and Congress balance each other$ with control of the bureaucrac% shared between the two. Strateg%$ for an interest group$ consists of determining and going to the most influential organ that is accessible. #he tactics of an interest group range from the constitutional to the unconstitutional &or cdirect actionc'$ the legal to the illegalall sub*ect$ as noted above$ to the restraints of institutions$ public procedures$ and public beliefs. +hen the target of the tactics is the eBecuti$e and the governmental %ureaucracy$ the following are the prime methods: Constitutional operations include &1' advice via advisor% bodies attached to the ministries &as in <ritain and >rance'$ &,' official hearings outside the ministries &as in Co%al Commissions in the 8.U. and presidential commissions in the 8.S.' or inside the ministries &as in Ferman% or Sweden'$ and &.' ad hoc consultations and cooperation. (emiconstitutional operations include &1' recruitment of state civil servants into the private bureaucracies of the interest groups$ or vice versa$ and &,' briber% and favours$ which need not necessaril% mean passing of mone% but can ta!e the form of providing entertainment$ gifts$ or meals. (emidirect operations include such measures as refusing to provide information or to cooperate in administering legislation and thus generall% withdrawing from advisor% functions. *irect action includes such measures as the withdrawal of labour &the <ritish ;edical 2ssociation$ for instance$ advised its members to withdraw from the state medical service in 1G10 unless its demands were met' or even violence such as the roadbloc!ing activities of enraged >rench farmers in the 1G1Hs'. +hen the target is the le#i"lature$ the following are the chief !inds of tactics used b% interest groups: Constitutional operations include &1' testimon% before legislative committee hearings &e-tremel% important in the 8.S. and somewhat important in Sweden$ the Ferman >ederal Cepublic$ @apan$ and Ital%'7 &,' direct representation in the legislature$ which involves having individual businessmen$ financiers$ farmers$ school teachers$ *ournalists$ and other professionals representing the larger interests of their profession or sponsoring group &in Freat <ritain in 1G00 some .H percent of Dabour]s ;(]s were tradeunion sponsored'7 and &.' lo%%yin#$ which refers to the activities of salaried or nonsalaried persons who tr% to promote their interest groups] aims b% see!ing personal contacts with legislators$ b% sending communications or information to legislators or persuading others to do so$ and b% 0?G rendering campaign assistance to favoured legislators. &In the 8.S.$ lobb%ing is conducted not onl% b% private interest groups but also b% certain members of the e-ecutive branch and the bureaucrac%.' (emiconstitutional operations include subvention or pa%ment of retainers as well as providing campaign contributions$ secretarial help$ office accommodations$ and the li!e$ which are restricted but not forbidden b% law. (emidirect action includes mass lobb%ing$ such as promoting mass demonstrations before legislators$ ostensibl% to relate grievances but in fact to impress public opinion. *irect action includes threatening legislators with a withdrawal of financial assistance$ with ph%sical violence$ or with riots &as in @apan$ where sna!e dances and riots become a means of protest'. +hen political parties are powerful$ the% ma% prove a highl% preferred target. #actics in such cases include the following: Constitutional operations& such as$ &1' e-acting election pledges$ which is most important and fruitful in countries &such as the 8.S.' where there is relativel% little nationalpart% discipline$ where representatives owe a certain allegiance to localpart% groups and constituents$ and where$ most important$ representatives do possess legislative power7 &,' financing the part%$ which in all s%stems is perhaps the most effective operation and which in most +estern parliamentsand in +esternst%le parliaments li!e @apan]sis s%stematicall% done b% trade unions$ emplo%ers associations$ and individual firms7 and &.' lobb%ing the part% machiner%$ a method that is virtuall% none-istent in the 8nited States but is significant in such countries as Freat <ritain and Ferman%. 2 final target of interest groups is public opinion. #he general opinion of the public at large can be of importance in issues where 6uestions of cfairnessc or c*usticec arise &on which most people feel the% can pronounce'. #hese 6uestions involve such matters as capital punishment$ the use of nuclear weapons$ or certain wars$ about which large numbers of people feel ver% strongl%. R.)E .? I-TEREST :R.1PS I- VARI.1S P.)ITICA) SYSTEMS The An#lo0American and Sedi"h pattern"* In the 1nited State"$ :reat /ritain$ and Seden$ the general population is not irreparabl% divided on ideological or cultural lines. 2lthough there arise from time to time some small e-tremist groups$ the population at large is not split into irreconcilable bloc!s. Fiven this situation$ the most influential and prominent groups are csecondar%c associations that have highl% speciali5ed ob*ectives$ form freel% without the re6uirement of prior governmental permission$ and carr% out their activities autonomousl%. +ith the e-ception of the affiliation of the tradeunion movement to the Dabour (art% in <ritain and in Sweden$ the groups are politicall% neutral7 and even the alignment of <ritish and Swedish trade unions and cooperatives does not prevent them from cooperating with other parties nor hinder their free access to government departments. Datent groups are few$ since freedom of speech and association and the right to petition the government permit most interests to organi5e$ while good communication media facilitate such organi5ation. (ublic participation in such groups is$ b% world standards$ high. #he pressure groups pla% highl% speciali5ed roles and are sharpl% differentiated from the political parties. 2lthough 2merican and <ritish means of influencing the e-ecutive are similar &b% advisor% committees$ special in6uiries$ and da%toda% consultation and mutual assistance'$ these relations are more institutionali5ed in <ritain than in the 8.S. <ritish groups see! to influence the parties b% affiliation or b% securing their members] nomination as candidates$ 0GH neither mode being emplo%ed in the 8.S.$ and b% financial assistance$ which occurs in both states but in 6uite different wa%s owing to the ver% different legislation on this matter in the two countries. <ritish groups see! to influence the legislature b% securing direct representation through participation in part% caucuses and b% promoting amendments in the committee stage. In the 8.S. the methods emplo%ed consist of lobb%ing influential congressmen and appearing at committee hearings$ which are far more important in Congress than in the 3ouse of Commons. In influencing public opinion$ 2merican groups spend far more than their <ritish counterpartsone reason being that purchase of time on radio and television networ!s is permissible in the 8.S.$ whereas in <ritain it is not. In addition$ access to the presidenc% can prove decisive in the 8.S.7 and some groups such as the "ational 2ssociation for the 2dvancement of Colored (eople have scored notable successes b% see!ing court action. In Sweden the tactics are somewhat different$ owing to three factors: the e-istence of a multipart% s%stem and the e-istence of coalition cabinets$ the structure of the bureaucrac%$ and the much greater institutionali5ation of pressure groups. Sweden$ 9enmar!$ and "orwa% each possess a multipart% s%stem7 but when coalitions are formed$ the% are highl% stable. Consensus is achieved in a threetier operationfirst at interpart% &electoral' level$ then at the interpart%coalition &legislative' level$ and finall% at the bureaucratic level. In Sweden groups see! to influence the parties b% affiliation &the trade unions being affiliated to the Dabour (art%'$ b% financing them &trade unions giving to the Dabour (art%$ emplo%ers groups to the antisocialist parties'$ and b% securing direct representation through the nomination of members as parliamentar% candidates. #he parties respond b% tr%ing to compose a balanced tic!et of the spectrum of interests. 3ence the groups can affect the legislature through their representatives inside each of the parties and ma%$ on occasion$ form a crosspart% legislative pressure group in defense of their common interest7 and the% also see! access to the part% caucus and influence the committee stage of legislation. In the latter case the% are assisted b% the standard Swedish procedure b% which the ccommentsc of outside interests are attached to the government]s bill$ even if the% contradict the bill]s purposes. Froups have read% access to the legislature in the same wa%s that 2nglo2merican groups do$ e-cept that the procedure is highl% institutionali5ed7 the cCo%al Commissionc with representatives of the bureaucrac%$ the parties$ and the interest groups see! to reach initial agreement on a bill to be presented to the legislature7 and when this device is not used$ ccommentsc appended to the bill serve to put the measure in the conte-t of the avowed interests of various groups. "ot unli!e the s%stem in <ritain$ the 8.S.$ and Sweden is the s%stem in (apan$ which$ despite sharp ideological divisions$ has a strong and stable twopart% arrangement. #his has led to the emergence of a pattern of highl% institutionali5ed pressure groups of the csecondar%c t%pe$ the most influential of these being business and organi5ed labour. <usiness$ on the whole$ is aligned with the conservative Diberal9emocratic part%$ supplies the bul! of its funds$ and has a large sa% in polic% formation. Organi5ed labour constitutes a powerful element within the @apanese Socialist (art%. In an earlier da%$ rural farm groups carried considerable political weightfor the conservativesbut the increasing industriali5ation and urbani5ation of the countr% have tended to reduce its importance. The ?rench and Italian pattern"* 0G1 In ?rance and Italy the political pattern is characteri5ed b% deep ideological cleavages. #he Roman Catholic Church$ for e-ample$ operates through both its own political part% and its own interest groups$ such as the Catholic 2ction Societ% and Catholic %outh and women]s group. <% the same to!en$ the highl% ideological and sectarian Communi"t (art% establishes its own pressure groups$ such as trade unions$ farmers associations$ and %outh movements. Several rival groups thus compete for the same clientele aligned or affiliated with rival political parties. 8nder >rance]s ?ifth Repu%lic$ the e-ecutive branch currentl% controls the ma*orit% part% in the legislature$ and the role of the legislature has been reduced7 whereas$ under Ital%]s current s%stem$ feeble and fragile coalition cabinets have wea!ened e-ecutive leadership of the legislature$ and the legislature itself is highl% fragmented among numerous parties. <ecause contacts between interest groups on the one hand and the parties$ civil service departments$ and legislature on the other are poorl% institutionali5ed$ semidirect action or even direct action against the e-ecutive and the legislature are more common$ and lawless activities of crowds and violent organi5ations have proved more widespread. #he means of influencing the chosen targets also var%. In >rance attention has shifted from the legislature &under the >ourth Cepublic' to the president and bureaucrac% &under the >ifth'7 interest groups now act through the numerous advisor% bodies$ private contacts$ and such official institutions as the Economic and Social Council. Interest groups secure contacts b% putting former civil servants on their own pa%rolls. #he fact that man% civil servants and business e-ecutives come from the same schools facilitates private collusion. In Ital% interest groups direct their attention mainl% to three targets. >irst$ the bureaucrac%$ even though it is highl% fragmented and provides few formal advisor% channels of communication$ is open to ad hoc and personal consultations &e-cept to groups deemed ideologicall% distasteful$ such as the Communists'. Second$ the parties are often twinned to interest groups$ as noted earlier7 and thus the groups see! and achieve direct representation in the legislature. #hird$ the legislature$ because it is composed of interest groups$ is heavil% influenced in speciali5ed legislative committees. In general$ therefore$ interest groups have tended to cintrudec into the organs of government$ forming close alliances with certain departments and legislative commissions and inserting themselves into others via their membership in political parties. In short$ interest groups are not ccontainedc as the% are in 2nglo 2merican and Scandinavian countriespolitical institutions are fragmented and wea!$ procedures are irregular or personal and not formal$ and public beliefs are polari5ed into uncompromising ideologies. Pattern" in de$elopin# countrie"* 2lthough there is no one t%pical pattern for all de$elopin# countrie"$ which of course embrace more than twothirds of the world]s sovereign states$ there are a few common characteristics that can be suggested. >irst$ political culture in each of these countries is fragmented$ sometimes because of ideological differences$ sometimes because of the mutual hostilit% of cnaturalc groupings based on !inship$ lineage$ tribe$ or language. Second$ nascent interest groups representing new moderni5ing and industriali5ing forces tend to range against rural natural groupings. #he moderni5ers have defined and speciali5ed ob*ectives$ whereas the traditionalists usuall% represent a spectrum of attitudes$ beliefs$ values$ and interests. <oth$ in an% case$ tend to sponsor or generate 0G, their own political parties. #hird$ during preindependence da%s in some countries$ trade unions and other movements &such as the Somali :outh Deague' carried on activities that would otherwise have been carried on b% political parties7 when independence came$ these groups continued such activities$ thus blurring the functional distinctions between parties and interest groups. >ourth$ associations in these countries tend to have low membership densities7 and in most of these countries the principal cinterestcthat is$ the peasantr%is hardl% organi5ed at all. 2ttempts to develop widel% represented peasant movements have had onl% limited success. >ifth$ although organi5ation and established procedures ma% be poor$ latent interest is usuall% high. In a particularl% divisive and administrativel% feeble countr%$ this interest latenc% ma% reveal itself in lawless and violent group activit%such as stri!es$ riots$ guerrilla movements$ and assassinations. In some countries cpartiesc in elections are not reall% parties but simpl% electoral coalitions of various interest groupsthe most influential groups consisting of cli6ues of landlords7 leaders of religious$ ethnic$ or linguistic groups7 and the li!e. Degislatures tend to reflect these divisions and temporar% arrangements in societ% and so en*o% onl% feeble authorit%. In countries that have had single part% regimes$ such as Uen%a and #an5ania$ the parties tended to lose their mass following and fairl% welldefined organi5ation in the %ears after independence. #o enhance their authorit%$ the part% leaders tried to limit or abolish the autonom% of such interest groups as trade unions$ cooperative movements$ and %outh and women]s movements and tried to turn these groups into ancillaries of the part%. In some countries the militar% has ta!en over$ either alone or with civilian elements$ and imposed an authoritarian rule. In such cases$ the most prominent groups are governmentalthe militar% and the e-ecutive. 8nless interest groups en*o% a long histor% of organi5ation &as does the Coman Catholic hierarch% in Datin 2merica'$ the% are often turned into governmental ancillaries or suppressed. In these countries ruled b% the militar% or single parties$ the political process turns into a highl% informal medle% of pressures and personal contacts between the government$ the militar% forces$ the various cnaturalc groups$ and some of the more strategicall% placed groups &such as the church hierarch% or private industr%'. #he cs%stemc is constantl% threatened with government coercion or violent outbrea!s b% sections of the population. Pattern" in former Communi"t "tate"* >rom +orld +ar II to 1G?G$ most of the Communist nations in eastern Europe were ruled b% a single Communi"t party &as in 2lbania$ 3ungar%$ Comania$ and the Soviet 8nion'$ or b% a Communist part% that dominated one or more satellite parties in a hegemonic multipart% s%stem &as in <ulgaria$ (oland$ C5echoslova!ia$ and East Ferman%'. >alling somewhere between these categories was :ugoslavia$ which was governed b% a Deague of Communists composed of Communist parties based in its several ethnic republics. >ollowing the fall of the <erlin +all in "ovember 1G?G$ these part% s%stems were entirel% transformed. <% 1GGH$ each countr% &2lbania in 1GG1' 6uic!l% held relativel% free elections that shattered the old regime. In most cases$ power was transferred to those with little connection to the old leadership or who were dissident Communists. In most cases$ the former Communist parties soon disbanded or reformed under different names to compete with new parties for votes 0G. and political influence. #he parties and part% s%stems in these countries are not %et institutionali5ed and will need time$ perhaps decades$ to achieve stabilit% and ac6uire popular value. #his slow process is common to countries see!ing democratic government after authoritarian rule. #he first wave of elections &1G?G GH' tended to go heavil% against Communist candidates and toward candidates bac!ed b% mass popular movements. In (oland$ for e-ample$ Dech +alesa]s labourbased Solidarity movement swept nearl% all the offices it contested in 1G?G. In C5echoslova!ia$ Vwclav 3avel]s Ci$ic ?orum &and its Slova! counterpart' decisivel% defeated the Communist candidates in the 1GGH assembl% elections. Oldline Communist rulers were also ousted that %ear in 3ungar% and East Ferman%. 2lthough Communist governments were reelected in 2lbania and <ulgaria$ even these hardline regimes were defeated b% opposition forces in the second round of elections<ulgaria in 1GG1 and 2lbania in 1GG,. In Ru""ia onl% the Communist (art% was allowed to participate as a part% in the 1GGH elections for the 1$H1? seats in the Congress of (eople]s 9eputies. "evertheless$ man% candidates were bac!ed b% popular fronts$ interest groups$ and political clubs that had arisen under glasnost &the Soviet polic% of copennessc that began in the late 1G?Hs'. 9emocratic Cussia$ an organi5ation of progressive forces$ claimed 1GH seats after the election. In Cussia]s historic popular election for president of the republic in 1GG1$ <oris :eltsin won 0= percent of the vote against five other candidates$ some of whom were bac!ed b% the Communist (art% of the Soviet 8nion. Onl% in Comania did voters !eep former Communists in power through 1GG,$ although oldline Communists also won power in most of the former Soviet republics. #his was particularl% true in the 2sian republics$ where elections were less free and mar!ed b% a high turnout of governmentmobili5ed voters$ but old line Communists also won elections in 8!raine$ the largest republic after Cussia. 3owever$ three small <altic republics &Estonia$ Datvia$ and Dithuania' ousted their former Communist leaders$ most convincingl% in Dithuania$ where the mass popular movement Sa*udis won about 10 percent of the parliamentar% seats in earl% elections. 9espite the initial landslides toward massbased democratic movements in some cases$ the most characteristic feature of free elections in these former Communist nations was the proliferation of political parties$ as political entrepreneurs sought to ta!e advantage of an uprooted electorate. >or e-ample$ (oland soon had more than 1HH registered parties$ Comania more than ?H$ and <ulgaria more than 0H. 2 surve% of parties in eastern Europe and the Soviet 8nion published in 1GG1 listed more than 0HH different parties. ;ost of these were !nown as ccouchc parties &the entire membership would fit on a sofa'$ and the% had little structure or staff. #he proliferation of ephemeral parties produced political confusion as voters faced a bewildering arra% of choices in an unfamiliar mar!et. In Comania$ for instance$ citi5ens who were new to free elections could choose among the "ational 9emocrats$ Comanian 9emocrats$ >ree 9emocrats$ Social 9emocrats$ Diberal 9emocrats$ Constitutional 9emocrats$ and Christian 9emocratsto name a few. One conse6uence was disillusionment with the electoral process and low voter turnout. In (oland$ for e-ample$ onl% /. percent of the eligible electorate voted in the parliamentar% elections of 1GG1$ which saw ,G different parties elected to the lower house$ including the (olish (art% of the >riends of <eer &<eer Dovers] (art%'$ which won 11 seats in the lower parliament in 1GG1. In general terms$ the nascent parties that sprouted in the former Communist countries can be classified into seven t%pes. >irst$ there were the parties of mass democratic movementsSolidarit% in (oland$ Civic >orum in C5echoslova!ia$ and Sa*udis in Dithuania$ for instancethat were often instrumental in forcing the Communist 0G/ authorities to schedule free elections. 3owever$ most parties of this t%pe dramaticall% lost support in the second wave of elections. &Civic >orum had split into two wings b% then.' Second were the remnants of the former Communist (art% operating with names li!e the Socialist (art% &2lbania$ <ulgaria$ and 3ungar%' or the "ational Salvation >ront &Comania'. #hese parties ma% change their names as the% develop. >or instance$ the 9emocratic "ational Salvation >ront in Comania became the (art% for Social 9emocrac% in @ul% 1GG.. In Dithuania$ the former Communists reorgani5ed as the 9emocratic Dabour (art%actuall% outpolled the Sa*udis in the "ovember 1GG, parliamentar% election and regained the government. 2 third t%pe consisted of parties that too! up the mantles of pre+orld +ar II parties$ such as various farmers] and liberal parties. 2 fourth !ind represented nationalist parties promoting ethnic interests$ as$ for e-ample$ the 3ungarian 9emocratic 8nion in Comania. >ifth were religious parties$ t%picall% Christian 9emocrats. 2 si-th categor% consisted of parties modeled after +estern political values$ such as environmentalism$ feminism$ and capitalism. >inall%$ there were the frivolous parties$ li!e the <eer Dovers] and Volcano parties in (oland. 2s e-plained above$ the nature of the electoral s%stem affects the number of parties that win representation to parliament. Countries using proportional representation and having few electoral barriers to discourage minor parties sustained severel% fragmented part% s%stems. (oland$ for e-ample$ did not re6uire parties to achieve an% minimum vote &threshold' to gain representation in 1GG1$ and none of its ,G parliamentar% parties had more than 1. percent of the vote. #his fragmentation in the (olish parliament made it difficult to form a governing coalition. 3ungar%$ on the other hand$ re6uired that parties win / percent of the national vote in 1GGH$ and onl% si- out of more than 10 registered parties entered parliament. Countries that did not use proportional representation$ such as Cussia$ usuall% re6uired that candidates win an absolute ma*orit% of the vote or face a runoff election. #his twoballot s%stem$ also used in >rance$ favours part% fragmentation b% encouraging minor parties to form for the purpose of den%ing the leading candidate a ma*orit% on the first ballot and thus costing him the election. ;inor parties can then bargain their support$ in e-change for favours$ on the second ballot$ often held one wee! after the first. #he alternative s%stem$ used in most 2nglo2merican democracies$ re6uires onl% a simple pluralit% of the vote and tends to produce twopart% rather than multipart% s%stems. #he new democracies that have emerged from the former Communist countries are certain to e-periment with different electoral s%stems as the% see! to develop institutionali5ed parties and stable part% s%stems. 5* The ,i"tory of We"tern Political Philo"ophy*
#he central problem of political philo"ophy is how to deplo% or limit public power so as to maintain the survival and enhance the 6ualit% of human life. Di!e all aspects of human e-perience$ it is conditioned b% environment and b% the scope and limitations of mind7 and the answers given b% successive political philosophers to perennial problems reflect the !nowledge and the assumptions of their times. (olitical philosoph%$ as distinct from the stud% of political and administrative organi5ation$ is more theoretical and normative than descriptive. It is inevitabl% related to general 0G0 philosoph% and is itself a sub*ect of social anthropolog%$ sociolog%$ and the sociolog% of !nowledge. 2s a normative discipline it is thus concerned with what ought$ on various assumptions$ to be and how this purpose can be promoted$ rather than with a description of factsalthough an% realistic political theor% is necessaril% related to these facts. #he political philosopher is thus not concerned so much$ for e-ample$ with how pressure groups wor! or how$ b% various s%stems of voting$ decisions are arrived at$ as with what the aims of the whole political process should be in the light of a particular philosoph% of life. #here is thus a distinction between political philosoph%$ which reflects the world outloo! of successive theorists and which demands an appreciation of their historical settings$ and modern political science proper$ which$ insofar as it can be called a science$ is empirical and descriptive. (olitical philosoph%$ however$ is not merel% unpractical speculation$ though it ma% give rise to highl% impractical m%ths: it is a vitall% important aspect of life$ and one that$ for good or evil$ has had decisive results on political action7 for the assumptions on which political life is conducted clearl% must influence what actuall% happens. (olitical philosoph% ma% thus be viewed as one of the most important intellectual disciplines$ for it sets standards of *udgment and defines constructive purposes for the use of public power. Such consideration of the purposes for which power should be used is in a sense more urgent toda% than it has been in earlier periods$ for man!ind has at its disposal the power either to create a world civili5ation in which modern technolog% can benefit the human race or to destro% itself in pursuit of political m%ths. #he scope for political philosoph% is thus great$ the clarification of its purpose and limitations urgentan aspect$ indeed$ of civili5ation]s survival. ,he history of political philosophy in the ;est to the end of the @Ath century A-TI&1ITY 2lthough in anti6uit% great civili5ations arose in Eg%pt and ;esopotamia$ in the Indus Valle%$ and in China$ there was little speculation about the problems of political philosoph% as formulated in the +est and since predominant. #he laws of 3ammurabi of <ab%lon &c. 1=0H <C' are rules propounded b% the monarch as a representative of Fod on Earth and are mainl% concerned with order$ trade$ and irrigation7 the 5dmonitions of the Eg%ptian vi5ier (tahhotep &c. ,.HH <C' are shrewd advice on how to prosper in a bureaucrac%7 and the 5rthashastra of Uautil%a$ grand vi5ier to the Indian Candragupta ;aur%a in the late /th centur% <C$ are ;achiavellian precepts on how to survive under an arbitrar% power. #o be sure$ the <uddhist concept of dharma &social custom and dut%'$ which inspired the Indian emperor 2sho!a in the .rd centur% <C$ implies a morali5ation of public power$ and the teachings of Confucius in the 1th centur% <C are a code of conduct designed to stabili5e societ%7 but there is not$ outside Europe$ much speculation about the basis of political obligation and the purpose of the state$ with both of which +estern political philosoph% is mainl% concerned. 2n authoritarian societ% is ta!en for granted$ bac!ed b% religious sanctions$ and a conservative and arbitrar% power is generall% accepted. In contrast to this overwhelming conservatism$ paralleled b% the rule of custom and tribal elders in most primitive societies$ the political philosophers of ancient :reece 0G1 6uestion the basis and purpose of government7 and$ though the% do not separate political speculation from shrewd observations that toda% would be regarded as empirical political science$ the% created the vocabular% of +estern political thought. Plato #he first elaborate wor! of European political philosoph% is ,he .epublic of Plato &c. .=? <C'$ a masterpiece of insight and feeling$ superbl% e-pressed in dialo#ue form and probabl% meant for recitation. >urther development of (lato]s ideas is underta!en in his (tatesman and .aws& the latter prescribing the ruthless methods whereb% the% might be imposed. (lato grew up during the great war between 2thens and Sparta in which 2thens suffered defeat and$ li!e man% political philosophers$ tried to find remedies for prevalent political in*ustice and decline. Indeed$ The "epu%lic is the first of the utopias$ though not one of the more attractive7 and it is the first classic attempt of a European philosopher to morali5e political life. Cast as a livel% discussion between Socrates$ whose wisdom (lato is recounting$ and various leisured 2thenians$ <oo!s V$ VIIVIII$ and IO of The "epu%lic state the ma*or themes of political philosoph% with poetic power. (lato]s wor! has been critici5ed as static and class bound$ reflecting the moral and aesthetic assumptions of an elite in a slaveowning civili5ation and bound b% the narrow limits of the city0"tate. #he wor! is indeed a classic e-ample of a philosopher]s vivisection of societ%$ imposing b% relativel% humane means the rule of a highminded minorit%. The "epu%lic is a criticism of current 3ellenic politicsoften an indictment. It is based upon a metaphy"ical act of faith$ for (lato believes that a world of permanent >orms e-ists be%ond the limitations of human e-perience and that moralit% and the good life$ which the state should promote$ are reflections of these ideal >orms. #he point is best made in the famous simile of the cave$ in which men are chained with their faces to the wall and their bac!s to the light$ so that the% see onl% the shadows of realit%. So constrained$ the% shrin! from what is trul% crealc and permanent and need to be forced to face it. #his idealistic doctrine$ !nown misleadingl% as Reali"m &in nontechnical language it is hardl% realistic'$ pervades all (lato]s philosoph%: its opposite doctrine$ "ominalism$ declares that onl% particular and observed cnamedc data are accessible to the mind. On his Cealist assumption$ (lato$ who was perhaps influenced b% Indian thought$ regards most ordinar% life as illusion and the current evils of politics as the result of men pursuing brute instinct. It follows that unless philo"opher" bear !ingl% rule in cities or those who are now called !ings and princes become genuine and ade6uate philosophers$ and political power and philosoph% are brought together . . . there will be no respite from evil for cities. Onl% philosopherstatesmen can apprehend permanent and transcendant >orms and turn to cface the brightest bla5e of beingc outside the cave$ and onl% philosophicall% minded men of action can be the saviours and helpers of the people. (lato is thus indirectl% the pioneer of modern beliefs that onl% a part% organi5ation$ inspired b% correct and cscientificc doctrines$ formulated b% the written word and interpreted b% authorit%$ can rightl% guide the state. 3is rulers would form an elite$ not responsible to the mass of the people. #hus$ in spite of his high moral purpose$ he has been called an enem% of the open societ% and the father of totalitarian lies. <ut he is also an anatomist of the evils of unbridled appetite and political corruption and insists on the need to use public power to moral ends. 3aving described his utopia$ 0G= (lato turns to anal%5e the e-isting t%pes of government in human terms with great insight. Uingl% government is the best but impracticable7 in oligarchies the rule of the few and the pursuit of wealth divide societiesthe rich become demorali5ed and the poor envious$ and there is no harmon% in the state. In democrac%$ in which the poor get the upper hand$ demagogues distribute ca peculiar !ind of e6ualit% to e6uals and une6uals impartiall%$c and the old flatter the %oung$ fawning on their *uniors to avoid the appearance of being sour or despotic. #he leaders plunder the propertied classes and divide the spoils among themselves and the people until confusion and corruption lead to t%rann%$ a worse form of government. >or the t%rant becomes a wolf instead of a man and clops offc potential rivals and starts wars to distract the people from their discontent. c#hen$ b% Yeus$c (lato concludes$ cthe public learns what a monster the% have begotten.c In the tatesman (lato admits that$ although there is a correct science of government$ li!e geometr%$ it cannot be reali5ed$ and he stresses the need for the rule of law$ since no man can be trusted with unbridled power. 3e then e-amines which of the current forms of government is the least difficult to live with$ for the ruler$ after all$ is an artist who has to wor! within the limits of his medium. In the 'aws& purporting to be a discussion of how best to found a polis in Crete$ he presents a detailed program in which a state with some 0$HHH citi5ens is ruled b% .= curators of laws and a council of .1H. <ut the !e%stone of the arch is a sinister and secret "octurnal Council to be cthe sheet anchor of the state$c established in its ccentral fortress as guardian.c (oets and musicians will be discouraged and the %oung sub*ected to a rigid$ austere$ and e-acting education. #he star! conse6uence of (lato]s political philosoph% here becomes apparent. 3e had$ nonetheless$ stated$ in the dawn of European political thought$ the normative principle that the state should aim at promoting the good life and social harmon% and that the rule of law$ in the absence of the rule of philosopher !ings$ is essential to this purpose. Ari"totle* 2ristotle$ who was a pupil in the 2cadem% of (lato$ remar!s that call the writings of (lato are original: the% show ingenuit%$ novelt% of view and a spirit of en6uir%. <ut perfection in ever%thing is perhaps a difficult thing.c 2ristotle was a scientist rather than a prophet$ and his /olitics &c. ..0.,, <C'$ written while he was teaching at the D%ceum at 2thens$ is onl% part of an enc%clopaedic account of nature and societ%$ in which he anal%5es societ% as if he were a doctor and prescribes remedies for its ills. (olitical behaviour is here regarded as a branch of biolog%$ as well as of ethic"7 in contrast to (lato$ 2ristotle was an empirical political philosopher. 3e critici5es man% of (lato]s ideas as impracticable$ but$ li!e (lato$ he admires balance and moderation and aims at a harmonious cit% under the rule of law. #he boo! is composed of lecture notes and is arranged in a confusing wa%a 6uarr% of arguments and definitions of great value but hard to master. #he first boo!$ though probabl% the last written$ is a general introduction7 <oo!s II$ III$ and VIIVIII$ probabl% the earliest$ deal with the ideal state7 and <oo!s IVVII anal%5e actual states and politics. #he treatise is thus$ in modern terms$ a mi-ture of political philosoph% and political science Di!e (lato$ 2ristotle naturall% thin!s in terms of the cit%state$ which he regards as the natural form of civili5ed life$ social and political$ and the best medium in which men]s capacities can be reali5ed. 3ence his famous definition of man as a cpolitical animal$c distinguished from the other animals b% his gift of speech and power of moral 0G? *udgment. c;an$ when perfected$c he writes$ is the best of animals$ but when separated from law and *ustice he is the worst of all$ since armed in*ustice is the most dangerous$ and he is e6uipped at birth with the arms of intelligence and wit$ moral 6ualities which he ma% use for the worst ends. Since all nature is pervaded b% purpose and since men caim at the good$c the cit%state$ which is the highest form of human communit%$ aims at the highest good. Di!e sailors with their separate functions$ who %et have a common ob*ect in safet% in navigation$ citi5ens$ too$ have a common aimin modern terms survival$ securit%$ and the enhancement of the 6ualit% of life. In the conte-t of the cit%state$ this high 6ualit% of life can be reali5ed onl% b% a minorit%$ and 2ristotle$ li!e (lato$ e-cludes those who are not full citi5ens or who are slaves7 indeed$ he sa%s that some men are cslaves b% naturec and deserve their status. (lato and 2ristotle aim at an aristocratic and e-acting wa% of life$ reflecting$ in more sophisticated forms$ the ideas of the warrior aristocracies depicted b% 3omer. 3aving stated that the aim of the cit%state is to promote the good life$ 2ristotle insists that it can be achieved onl% under the rule of law. #he rule of law is preferable to that of a single citi5en7 if it be the better course to have individuals ruling$ the% should be made law guardians or ministers of the laws. #he rule of law is better than that even of the best men$ for che who bids law rule ma% be deemed to bid Fod and reason alone rule$ but he who bids men rule adds the element of the beast7 for desire is a wild beast$ and passion perverts the minds of rulers$ even if the% are the best of men.c #his doctrine$ which distinguishes between lawful government and t%rann%$ survived the ;iddle 2ges and$ b% sub*ecting the ruler to law$ became the theoretical sanction of modern con"titutional government. 2ristotle also vindicates the rule of custom and *ustifies the obligations accepted b% members of societ%: the solitar% man$ he writes$ cis either a beast or a Fod.c #his outloo! at once reflects the respect for custom and solidarit% that have promoted survival in primitive tribal societies$ even at the price of sacrificing individuals$ and gives a theoretical *ustification for the acceptance of political obligation. Di!e (lato$ 2ristotle anal%5es the different !inds of cit%states. +hile states are bound$ li!e animals$ to be different$ he considers a balanced cmi-edc constitution the bestit reflects the ideal of <u"tice &dike' and fair dealing$ which gives ever% man his due in a conservative social order in which citi5ens of the middle condition preponderate. 2nd he attac!s oligarch%$ democrac%$ and t%rann%. 8nder democrac%$ he argues$ demagogues attain power b% bribing the electorate and waste accumulated wealth. <ut it is t%rann% that 2ristotle most detests7 the arbitrar% power of an individual above the law who is cresponsible to noone and who governs all ali!e with a view to his own advantage and not of his sub*ects$ and therefore against their will. "o free man can endure such a government.c #he 3olitics contains not onl% a firm statement of these principles but also a penetrating anal%sis of how cit%states are governed$ as well as of the causes of revolutions$ in which cinferiors revolt in order that the% ma% be e6ual$ and e6uals that the% ma% be superior.c #he treatise concludes with an elaborate plan for educating the citi5ens to attain the cmean$c the cpossible$c and the cbecoming.c #he first implies a balanced development of bod% and mind$ abilit% and imagination7 the second$ the recognition of the limits of mind and the range and limitations of talent7 the third$ an outcome of the other two$ is the st%le and selfassurance that come from the resulting selfcontrol 0GG and confidence. +hile$ therefore$ 2ristotle accepts a conservative and hierarchic social order$ he states firml% that public power should aim at promoting the good life and that onl% through the rule of law and *ustice can the good life be attained. #hese principles were novel in the conte-t of his time$ when the great e-traEuropean civili5ations were ruled$ *ustl% or un*ustl%$ b% the arbitrar% power of semidivine rulers and when other peoples$ though respecting tribal custom and the authorit% of tribal elders$ were increasingl% organi5ed under war leaders for depredation. Cicero and the Stoic"* <oth (lato and 2ristotle had thought in terms of the cit%state. <ut 2ristotle]s pupil 2le-ander the Freat swamped the cities of old Freece and brought them into a vast empire that included Eg%pt$ (ersia$ and the Devant. #hough the civili5ation of anti6uit% remained concentrated in cit%states$ the% became part of an imperial power that bro!e up into !ingdoms under 2le-ander]s successors. #his imperial power was reasserted on an even greater scale b% Come$ whose empire at its greatest e-tent reached from central Scotland to the Euphrates and from Spain to eastern 2natolia. Civili5ation itself became identified with empire$ and the development of eastern and western Europe was conditioned b% it. Since the city0"tate was no longer self sufficient$ universal philosophies developed that gave men something to live b% in a wider world. Of these philosophies$ Stoici"m and Epicureani"m were the most influential. #he former inspired a rather grim selfsufficienc% and sense of dut%$ as e-emplified b% the writings of the Coman emperor ;arcus 2urelius7 the latter$ a prudent withdrawal from the world of affairs. #he setting for political philosoph% thus became much wider$ relating individuals to universal empire$ thought of$ as in China$ as coterminous with the civili5ation itself. Its inspiration remained 3ellenic7 but derivative Coman philosophers reinterpreted it$ and Coman legists enclosed the old concepts of political *ustice in a carapace of legal definitions$ capable of surviving their civili5ation]s decline. Cicero lived in a time of political confusion during which the old institutions of the republic were brea!ing down before militar% dictators. 3is De republica and .aws are both dialogues and reflect the classical sense of purpose: cto ma!e human life better b% our thought and effort.c Cicero defined the res pu%lica &commonealth' as an association held together b% law7 he further asserted$ as (lato had maintained with his doctrine of >orms manifest in the *ust cit%$ that government was sanctioned b% a universal natural la that reflected the cosmic order. Cicero e-presses the pre Christian Stoic attempt to morali5e public power$ apparent in the e-acting sense of public responsibilit% shown b% 3adrian and ;arcus 2urelius in the ,nd centur% 29. St* Au#u"tine* +ith the conversion of the emperor Constantine &29 .1,'$ when Chri"tianity$ long influential$ became the predominant creed of the empire$ and$ under #heodosius &.=G.G0'$ the sole official religion$ political philosoph% changed profoundl%. St* Au#u"tine@" City of 1od &/1./,1'$ written when the empire was under attac! b% barbarians within and without$ sums up and defines a new division 1HH between church and "tate and a conflict between cmatterc and cspiritc resulting from the >all of man and original sin. St. 2ugustine$ whose Confessiones are a record of a new sort of introspection$ combined a classical and 3ebraic duali"m. >rom the Stoics and Virgil he inherited an austere sense of dut%$ from (lato and the "eoplatonists a contempt for the illusions of appetite$ and from the (auline and patristic interpretation of Christianit% a sense of the conflict between Dight and 9ar!ness that reflects Yoroastrian and ;anichaean doctrines emanating from Iran. In this conte-t worldl% interests and government itself are dwarfed b% the importance of attaining "al$ation and of escaping from an astrologicall% determined fate and from the demons who embod% the dar!ness. Dife becomes illuminated for the elect minorit% b% the prospect of eternal salvation or$ for those without grace$ shrivels under the glare of eternal fires. St. 2ugustine regarded salvation as predestinate and the cosmic process as designed to cgatherc an elect to fill the places of the fallen angels and so cpreserve and perhaps augment the number of the heavenl% inhabitants.c #he role of government and indeed of societ% itself becomes subordinated into a csecular arm$c part of an earthl% cit%$ as opposed to the cCit% of Fod.c #he function of government is to !eep order in a world intrinsicall% evil. Since Christianit% had long pla%ed the main role in defense of the veneer of a precarious urban civili5ation in anti6uit%$ this claim is not surprising. Constantine came of crude <al!an origins$ a soldier putting to rights a brea!down in government that would continue in the +est with the abdication of the last +estern emperor in /=1$ though in the East the empire would carr% on with great wealth and power$ centred in the new capital of Constantinople &<%5antium'. St. 2ugustine thus no longer assumed$ as did (lato and 2ristotle$ that a harmonious and selfsufficient good life could be achieved within a properl% organi5ed cit%state7 he pro*ected his political philosoph% into a cosmic and lurid drama wor!ing out to a predestinate end. #he normal interests and amenities of life became insignificant or disgusting$ and the Christian Church alone e-ercised a spiritual authorit% that could sanction government. #his outloo!$ reinforced b% other patristic writings$ would long dominate medieval thought$ for with the decline of civili5ation in the +est the church became more completel% the repositor% of learning and of the remnants of the old civili5ed life. T,E MIDD)E A:ES #he decline of ancient civili5ation in the +est was severe7 not$ indeed$ in technolog%$ for the horse collar$ the stirrup$ and the heav% plow now came in7 but political philosoph%$ li!e other intellectual interests$ became elementar%. In the <%5antine Empire$ on the other hand$ @ustinian]s law%ers in 0,G0.. produced the Code- Constitutionum$ the 9igest$ the Institutes$ which defined and condensed Coman law$ and the "ovels. #he <%5antine %asileus& or autocrat$ had moral responsibilit% for guarding and harmoni5ing an elaborate state$ a ccolon%c of heaven in which reason and not mere will ought to rule. 2nd this autocrac% and the orthodo- form of Christianit% were inherited b% the Christiani5ed rulers of the <al!ans$ of Uievan Cussia$ and of ;uscov%. In the +est$ two essential principles of 3ellenic and Christian political philosoph% were transmitted$ if onl% in elementar% definitions$ in rudimentar% enc%clopaedias. I"idore of Se$ille in his =thcentur% ,tymologiae& for e-ample$ asserts that !ings rule onl% on condition of doing right and that the rule reflects a Ciceronic law of nature ccommon to all people and man!ind 1H1 ever%where b% natural instinct.c >urther$ the barbarians respected the civili5ation the% too! over and e-ploited. +hen converted$ the% revered the papac%$ and in ?HH the >ran!ish Charlemagne even revived the +estern Empire as hol% and Coman. #he idea of Christian empire coterminous with civili5ation thus survived in +estern as well as Eastern Christendom. A+uina"* It is a far cr% from this practical 1,thcentur% treatise b% a man of affairs to the elaborate *ustification of Christian !ingship and natural law created b% St* Thoma" A+uina" in the 1.th centur%$ during the clima- of medieval +estern civili5ation. 3is political philosoph% is onl% part of a metaph%sical construction of 2ristotelian range for 2ristotle had now been assimilated from 2rabic sources and given a new Christian content$ with the added universalit% of the Stoic and 2ugustinian world outloo!. 26uinas] umma theologiae purports to answer all the ma*or 6uestions of e-istence$ including those of political philosoph%. Di!e 2ristotle$ 26uinas thin!s in terms of an ethical purpose. "atural law is discussed in the first part of the second boo! as part of the discussion of original sin and what would now be termed ps%cholog%$ while war comes under the second part of the second boo! as an aspect of virtue and vice. Daw is defined as cthat which is regulation and measure.c It is designed to promote the cfelicit% and beatitudec that are the ends of human life. 26uinas agrees with 2ristotle that cthe cit% is the perfection of communit%c and that the purpose of public power should be to promote the common good. #he onl% legitimate power is from the communit%$ which is the sole medium of man]s well being. In his *e regimine he compares societ% to a ship in need of a helmsman and repeats 2ristotle]s definition of man as a social and political animal. 2gain following 2ristotle$ he considers oligarch% un*ust and democrac% evil. Culers should aim to ma!e the clife of the multitude good in accordance with the purpose of life which is heavenl% happiness.c #he% should also create peace$ conserve life$ and preserve the statea threefold responsibilit%. 3ere is a complete program for a hierarchical societ% within a cosmic order. It combines the 3ellenic sense of purpose with Christian aims and asserts that$ under Fod$ power resides in the communit%$ embodied in the ruler but onl% for so long as he does right. 3ence the comment that cSt. #homas 26uinas was the first +higca pioneer of the theor% of constitutional government. #he societ% he envisages$ however$ is medieval$ static$ hierarchical$ conservative$ and based on limited agriculture and even more limited technolog%. "onetheless$ Thomi"m remains the most complete and lasting political doctrine of the Catholic Church$ since modified and adapted but not in principle superseded. Dante* <% the earl% 1/th centur% the great European institutions$ empire and papac%$ were brea!ing down through mutual conflict and the emergence of national realms. <ut this conflict gave rise to the most complete political theor% of universal and secular empire formulated in the medieval +est. 9ante]s De monarchia &c. 1.1.'$ still in principle highl% relevant$ insists that onl% through universal peace can human faculties come to their full compass. <ut onl% ctemporal MonarchyF can achieve this: ca uni6ue princedom e-tending over all persons in time.c #he aim of civili5ation is to actuali5e human potentialities$ and to achieve that cfullness of life which comes from the fulfillment of our being.c 1H, ;onarch%$ 9ante argues$ is necessar% as a means to this end. #he imperial authorit% of the 3ol% Coman emperor$ moreover$ comes direct from Fod and not through the pope. #he empire is the direct heir of the Coman Empire$ a legitimate authorit%$ or Christ would not have chosen to be born under it. In sub*ecting the world to itself$ the Coman Empire had contemplated the public good. #his highflown argument$ part of the political warfare between the partisans of the emperor and pope that was then affecting Ital%$ drives to essentials: that world peace can be secure onl% under a world authorit%. #hat 9ante]s argument was impractical did not concern this medieval genius$ who was writing more the epitaph than the prospectus of the 3ol% Coman Empire7 he was concerned$ li!e St. #homas$ to create a political philosoph% with a clearcut aim and a universal view. Out of the grand but impractical visions of the 3igh ;iddle 2ges in the 1.thcentur% clima- of Christian civili5ation there emerged b% earl% modern times the idea of a wellgoverned realm$ its authorit% derived from the communit% itself$ with a program designed to ensure the solvenc% and administrative efficienc% of a secular state. In spite of the decline of the civili5ation of anti6uit% in the +est$ the FrecoComan sense of purpose$ of the rule of law$ and of the responsibilit% of power survived in Christian form. T,E 7ET, T. T,E 72T, CE-T1RIES Machia$elli* In the thought of the Italian political philosopher -iccolQ Machia$elli ma% be seen a complete seculari5ation of political philosoph%. ;achiavelli was an e-perienced diplomat and administrator$ and$ since he stated flatl% how the power struggle was conducted in Cenaissance Ital%$ he won a shoc!ing reputation. 3e was not$ however$ without idealism about the old Coman republic$ and he admired the independent spirit of the Ferman and Swiss cities. #his idealism made him all the more disgusted with Italian politics$ of which he ma!es a disillusioned and ob*ective anal%sis. +riting in retirement after political disgrace$ ;achiavelli states firml% that$ Since this is to be asserted in general of men$ that the% are ungrateful$ fic!le$ false$ cowards$ covetous$ and as long as %ou succeed the% are %ours entirel%: the% will offer %ou their blood$ propert%$ life$ and children . . . when the need is far distant7 but when it approaches the% turn against %ou. 2nd again$ since the desires of men are insatiable$ nature prompting them to desire all things and fortune permitting them to en*o% but few$ there results a constant discontent in their minds$ and a loathing of what the% possess. #his view of human nature$ alread% e-pressed b% (lato and St. 2ugustine$ is here unredeemed b% (lato]s doctrine of form and illusion or b% St. 2ugustine]s dogma of salvation through grace. ;achiavelli accepts the facts and advises the ruler to act accordingl%. #he prince$ he states$ must combine the strength of the lion with the cunning of the fo-: he must alwa%s be vigilant$ ruthless$ and prompt$ stri!ing down or neutrali5ing his adversaries without warning. 2nd when he does an in*ur% it must be total. >or cmen ought to be either well treated or crushed$ because the% can avenge themselves of lighter in*uries$ of more serious ones the% cannot.c ;oreover$ cirresolute princes who follow a neutral path are generall% ruined.c 3e advises that it is best to come down at the right moment on the winning side and that con6uered cities ought to be either governed directl% b%the t%rant himself residing there or 1H. destro%ed. (rinces$ furthermore$ unli!e private men$ need not !eep faith: since politics reflects the law of the *ungle$ the state is a law unto itself$ and normal moral rules do not appl% to it. ;achiavelli had stated with unblin!ing realism how$ in fact$ t%rants behave7 and$ far from critici5ing their conduct or distinguishing between the *ust prince who rules b% law and the t%rant whose laws are in his own breast$ he considers that the successful ruler has to be be%ond moralit% since the safet% of and e-pansion of the state are the supreme ob*ective. In this m%opic view$ the cosmic visions of 26uinas and 9ante are disregarded$ and politics becomes a fight for survival. +ithin his terms of reference$ ;achiavelli made a convincing case$ although as an e-perienced diplomat he might have reali5ed that dependabilit% in fact pa%s and that s%stematic deceit$ treacher%$ and violence usuall% bring about their own nemesis. ,o%%e"* #he 1=thcentur% English political philosopher #homas 3obbes$ who spent his life as a tutor and companion to great noblemen$ was a writer of genius with a greater power of phrase than an% other English political philosopher. 3e was not$ as he is sometimes misrepresented$ a prophet of cbourgeoisc individualism$ advocating free competition in a capitalistic free mar!et. On the contrar%$ he was writing in a preindustrial$ if increasingl% commercial$ societ% and did not much admire wealth as such but rather chonours.c 3e was sociall% conservative and an-ious to give a new philosophical sanction to a hierarchical$ if businessli!e$ commonwealth in which famil% authorit% was most important. (hilosophicall%$ 3obbes was influenced b% nominalist scholastic philosoph%$ which had discarded #homist metaph%sics and had accepted a strict limitation of mind. 3e therefore based his conclusions on the rudimentar% mathematical ph%sics and ps%cholog% of his da% and aimed at practical ob*ectivesorder and stabilit%. 3e believed that the fundamental ph%sical law of life was motion and that the predominant human impulses were fear and$ among those above the povert% level$ pride and vanit%. ;en$ 3obbes argued$ are strictl% conditioned and limited b% these laws$ and he tried to create a science of politics that would reflect them. c#he s!ill of ma!ing$ and maintaining Commonwealths$c therefore$ cconsisteth in certain Cules$ as doth 2rithmeti6ue and Feometr%7 not &as #ennis pla%' on (ractise onel%: which Cules$ neither poor men have the leisure$ nor men that have had the leisure$ have hitherto had the curiosit%$ or the method to find out.c 3obbes ignores the classical and #homist concepts of a transcendent law of nature$ itself reflecting divine law$ and of a cchain of beingc whereb% the universe is held harmoniousl% together and$ following 9escartes]s practical method of investigation$ states plainl% that power creates law$ not law power. >or law is law onl% if it can be enforced$ and the price of securit% is one supreme sovereign public power. >or$ without it$ such is the competitive nature of men$ that once more than subsistence has been achieved the% are actuated b% vanit% and ambition$ and there is a war of all against all. #he true law of nature is selfpreservation$ he argues$ which can be achieved onl% if the citi5ens ma!e a compact among themselves to transfer their individual power to the cleviathanc &ruler'$ who alone can preserve them in securit%. Such a commonwealth has no intrinsic supernatural or moral sanction: it derives its original authorit% from the people and can command lo%alt% onl% so long as it succeeds in !eeping the peace. 3e thus uses both the old concepts of natural law and 1H/ contract$ often invo!ed to *ustif% resistance to authorit%$ as a sanction for it. 3obbes$ li!e ;achiavelli$ starts from an assumption of basic human foll%$ competitiveness$ and depravit%$ and contradicts 2ristotle]s assumption that man is b% nature a cpolitical animal.c On the contrar%$ he is naturall% antisocial7 and$ even when men meet for business and profit$ onl% ca certain mar!etfellowshipc is engendered. 2ll societ% is onl% for gain or glor%$ and the onl% true e6ualit% among men is their power to !ill each other. 3obbes sees and desires no other e6ualit%. Indeed$ he specificall% discouraged cmen of low degree from a sauc% behaviour towards their betters.c #he 'eviathan horrified most of his contemporaries7 3obbes was accused of atheism and of cmaligning the 3uman "ature.c <ut$ if his remedies were tacticall% impractical$ in political philosoph% he had gone ver% deep b% providing the sovereign nationstate with a pragmatic *ustification and directing it to utilitarian ends. SpinoIa* #he 1=thcentur% 9utch philosopher <enedict de Spino5a also tried to ma!e a scientific political theor%$ but it was more humane and more modern. 3obbes assumes a preindustrial and economicall% conservative societ%$ but Spino5a$ a (ortuguese @ew born in 2msterdam$ assumes a more urban setting. Di!e 3obbes$ he is Cartesian$ aiming at a scientific basis for political philosoph%7 but$ whereas 3obbes was dogmatic and authoritarian$ Spino5a desired toleration and intellectual libert%$ b% which alone human life achieves its highest 6ualit%. Spino5a$ reacting against the ideological wars of religion and s!eptical of both metaph%sics and religious dogma$ was a scientific humanist who *ustified political power solel% b% its usefulness. If state power brea!s down and can no longer protect him or if it turns against him$ frustrates$ or ruins his life$ then an% man is *ustified in resisting it$ since it no longer fulfills its purpose. It has no intrinsic divine or metaph%sical authorit%. In Tractatus Theologico- 3oliticus and the Tractatus 3oliticus Spino5a develops this theme. 3e intends$ he writes$ cnot to laugh at men or weep over them or hate them$ but to understand them.c In contrast to St. 2ugustine$ he glorifies life and holds that governments should not tr% to cchange men from rational beings into beasts or puppets$ but enable them to develop their minds and bodies in securit% and to emplo% their reason unshac!led.c #he more life is en*o%ed$ he declares$ the more the individual participates in the divine nature. Fod is immanent in the entire process of nature$ in which all creatures follow the laws of their own being to the limit of their powers. 2ll are bound b% their own consciousness$ and man creates his own values. It seems that Spino5a thought good government appro-imated to that of the free burgesses of 2msterdam$ a cit% in which religious toleration and relative political libert% had been reali5ed. 3e is thus a pioneer of a scientific humanist view of government and of the neutralit% of the state in matters of belief. Richard ,oo!er@" adapted Thomi"m* +hile out of the brea!up of the medieval social order there emerged the humanist but sceptical outloo! of ;achiavelli$ then the scientific humanist principles of 9escartes$ 3obbes$ and Spino5a$ from which the utilitarian and pragmatic outloo! of modern times derives$ another influential and politicall% important strain of political philosoph% also emerged. 9uring the Reformation and Counter Ceformation$ (rotestant and Catholic dogmatists denounced each other and even 1H0 attac!ed the authorit% of princes who$ from interest or conviction$ supported one side or the other. (olitical assassination became endemic$ for both (rotestant and Catholic divines declared that it was legitimate to !ill an heretical ruler. 2ppeal was made to rival religious authorit% as well as to conscience. ;en would resist authorit% and suffer e-ecution rather than ris! damnation$ and in the resulting welter 3obbes and Spino5a advocated a sovereign state as the remed%. <ut other political philosophers salvaged the old #homist concept of a divine cosmic order and of natural and human laws sanctioning the state. #he% also put forth the classical and medieval idea of the derivation of public power from the commonwealth as a whole and the responsibilit% of princes to the law. +hen 3obbes wrote that might ma!es right$ he outraged such critics$ who continued to assert that public power was responsible to Fod and the laws and that it was right to resist a t%rant who declared that the laws were in his own breast. #his political theor% was most influentiall% developed in England$ where it inspired the constitutionalism that would also predominate in the 8nited States. Cichard 3oo!er$ an 2nglican divine who wrote #f the lawes of ecclesiasticall politie &10G.111,'$ reconciled #homist doctrines of transcendent and natural law$ binding on all men$ with the authorit% of the Eli5abethan 2nglican Church$ which he defended against the (uritan appeal to conscience. Societ%$ he argued$ is itself the fulfillment of natural law$ of which human and positive law are reflections$ adapted to societ%. 2nd public power is not something personal$ for it derives from the communit% under law. #hus$ #he lawful power of ma!ing laws to command whole politic societies of men belongeth so properl% unto the same entire societies$ that for an% prince . . . to e-ercise the same of himself . . . is no better than mere t%rann%. Such power can derive either directl% from Fod or else from the people. #he prince is responsible to Fod and the communit%7 he is not$ li!e 3obbes]s ruler$ a law unto himself. Daw ma!es the !ing$ not the !ing law. 3oo!er$ indeed$ insisted that cthe prince has a delegated power$ from the (arliament of England$ together with the convocation &of clerg%' anne-ed thereto . . . whereupon the ver% essence of all government doth depend.c #his is the power of the crown in parliament in a balanced constitution. 3ence an idea of harmonious government b% consent. #he #homist medieval universal harmon% had been adapted to the nationstate. )oc!e* It was @ohn Doc!e$ politicall% the most influential English philosopher$ who further developed this doctrine. 3is ,wo ,reatises of :overnment &11GH' were written to *ustif% the Florious Cevolution of 11???G$ and his 'etter Concerning ,oleration &11?G' was written with a plain and eas% urbanit%$ in contrast to the baro6ue elo6uence of 3obbes. Doc!e was a scholar$ ph%sician$ and man of affairs$ welle-perienced in politics and business. 2s a philosopher he accepted strict limitations for mind$ and his political philosoph% is moderate and sensible$ aimed at a balance among e-ecutive$ *udicial$ and legislative powers$ although with a bias toward the last. 3is first #reatise was devoted to confuting the Co%alist doctrine of patriarchal divine right b% descent from 2dam$ an argument then ta!en ver% seriousl% and reflecting the idea of government as an aspect of a divinel% ordained chain of being. If this order were bro!en$ chaos would come about. #he argument was part of the contemporar% conflict of the ancients and the moderns. Doc!e tried to provide an answer b% defining a limited purpose for political power$ 1H1 which purpose he considered to be ca right of ma!ing laws with penalties of death$ and conse6uentl% all less penalties$ for the regulating and preserving of propert%$ and of emplo%ing the force of the communit% in e-ecution of such laws$ and in the defense of the commonealth from foreign in*ur%$ and all this onl% for the public good.c #he authorit% of government derives from a contract between the rulers and the people$ and the contract binds both parties. It is thus a limited power$ proceeding according to established laws and cdirected to no other end but the peace$ safet%$ and public good of the people.c +hatever its form$ government$ to be legitimate$ must govern b% cdeclared and reasoned laws$c and$ since ever% man has a cpropert%c in his own person and has cmi-ed his labourc with what he owns$ government has no right to ta!e it from him without his consent. It was the threat of attac! on the laws$ propert%$ and the (rotestant religion that had roused resistance to @ames II. Doc!e is e-pressing the concerns and interests of the landed and mone%ed men b% whose consent @ames]s successor$ +illiam III$ came to the throne$ and his commonwealth is strictl% con"er$ati$e$ limiting the franchise and the preponderant power to the propertied classes. Doc!e was thus no democrat in the modern sense and was much concerned to ma!e the poor wor! harder. Di!e 3oo!er$ he assumes a conservative social hierarch% with a relativel% wea! e-ecutive power and defends the propertied classes both against a ruler b% divine right and against radicals. In advocating toleration in religion he was more li%eral: freedom of conscience$ li!e propert%$ he argued$ is a natural right of all men. +ithin the possibilities of the time$ Doc!e thus advocated a constitutional mi-ed government$ limited b% parliamentar% control of the armed forces and of suppl%. 9esigned mainl% to protect the rights of propert%$ it was deprived of the right of arbitrar% ta-ation or imprisonment without trial and was in theor% responsible to all the people through the politicall% conscious minorit% who were thought to represent them. #hough he was sociall% conservative$ Doc!e]s writings are ver% important in the rise of liberal political philosoph%. 3e vindicates the responsibilit% of government to the governed$ the rule of law through impartial *udges$ and the toleration of religious and speculative opinion. 3e is an enem% of the totalitarian state$ drawing on medieval arguments and deplo%ing them in practical$ modern terms. /ur!e* #he Irishman Edmund <ur!e$ while elaborating +hig constitutional doctrine e-pressed with such common sense b% Doc!e$ wrote with more emotion and too! more account of time and tradition. +hile reiterating that government is responsible to the governed and distinguishing between a political societ% and a mere mob$ he thought that governments were trustees for previous generations and for posterit%. 3e made the predominant political philosoph% of the 1?thcentur% establishment appear more attractive and moral$ but he wrote no great single wor! of political philosoph%$ e-pressing himself instead in numerous pamphlets and speeches. In his earl% ;indication of Natural (ociety <ur!e is critical of the sufferings imposed b% government$ but his c Thou#ht" on the Cau"e of the Pre"ent Di"content"F defines and defends the principles of the +hig establishment. 3e invo!ed a transcendent moralit% to sanction a constitutional commonwealth$ but he detested abstract political theories in whose name men are li!el% to vivisect societ%. 3e set great store b% ordered libert% and denounced the 1H= arbitrar% power of the @acobins who had captured the >rench Cevolution. In his .eflections on the .evolution in 6rance &1=GH' and 4n 4ppeal from the 5ew to the #ld ;higs &1=G1'$ he discerned in the doctrine of sovereignt% of the people$ in whose name the re$olutionarie" were destro%ing the old order$ another and worse form of arbitrar% power. "o one generation has the right to destro% the agreed and inherited fabric of societ%$ and c"either the few nor the man% have the right to govern b% their will.c 2 countr% is not a mere ph%sical localit%$ he argued$ but a communit% in time into which men are born$ and onl% within the e-isting constitution and b% the consent of its representatives can changes legitimatel% be made. Once the frame of societ% is smashed and its law violated$ the people become a cmere multitude told b% the head$c at the merc% of an% dictator who can sei5e power. 3e was realistic in predicting the conse6uences of violent revolution$ which usuall% ends up in some !ind of dictatorship. <ur!e$ in sophisticated accents$ spo!e for the ancient and worldwide rule of custom and conservatism and supplied a needed romanticism to the calculating good sense of Doc!e. Vico*
#he political philosophies hitherto surve%ed contained little idea of progress. In anti6uit% the idea of c%clic recurrence predominated$ and even 1?thcentur% Christians believed that the world had been created in /HH/ <C and would end in the Second Coming of Christ and a *udgment. #he 1/thcentur% 2rab philosopher of histor% Ibn Uhaldun of #unis$ in the Mu=addimah to his -ita% al-'i%ar& had pioneered a vast sociological view of the historical process7 but in western Europe it was a neglected "eapolitan philosopher$ Fiambattista Vico &111?1=//'$ who first interpreted the past in terms of the changing consciousness of man!ind. 3is (cien)a nuova &1=,07 revised edition 1=//' interpreted histor% as an organic process involving language$ literature$ and religion and attempted to reveal the mentalit% or ethos of earlier ages: the age of the gods$ the heroic age$ and the human age$ its clima- and decadence. #hese ages recur$ and each is distinguished b% m%tholog%$ heroic poetr%$ and rational speculation respectivel%. In contrast to the legalistic$ contractual$ and static political philosophies then prevalent$ Vico had discerned new hori5ons. Monte"+uieu* #his sort of vision was developed and elegantl% populari5ed b% the cosmopolitan >rench savant ;ontes6uieu$ whose wor! ,he pirit of 'aws &Eng. trans. 1=0H' won immense influence. It was an ambitious treatise on human institutions and a pioneer wor! of anthropolog% and sociolog%. <elieving in an ordered universefor chow could blind fate have produced intelligent beings4c ;ontes6uieu e-amined the varieties of natural law$ var%ing customs$ laws$ and civili5ations in different environments. 3e made the pedestrian good sense of Doc!e seem provincial$ although he admired him and the <ritish constitution. 8nfortunatel%$ he overemphasi5ed the separation of e-ecutive$ *udicial$ and legislative powers$ considerable in Doc!e]s da% but b% his own time tending to be concentrated in the sovereignt% of (arliament. #his doctrine much influenced the founders of the 8nited States and the earl% >rench Cevolutionaries. Rou""eau* 1H? #he revolutionar% romanticism of the Swiss>rench philosopher @ean@ac6ues Cousseau ma% be interpreted in part as a reaction to the anal%tic rationalism of the Enlightenment. 3e was tr%ing to escape the aridit% of a purel% empirical and utilitarian outloo! and attempting to create a substitute for revealed religion. Cousseau]s Qmile &1=1,' and Du contrat social &1=1,' proved revolutionar% documents$ and his posthumous ConsidErations sur le gouvernement de 3ologne &cConsiderations on the Fovernment of (olandc' contains desultor% but often valuable reflections on specific problems. #here had been radical political slogans coined in medieval peasant revolts and in the 1=th centur%$ as in the (utne% debates &11/=' in the Cromwellian arm%$ when a (uritan officer declared that cthe poorest hee that is in England hath a life to live as the greatest hee$c but the inspiration of these movements had been religion. "ow Cousseau proclaimed a secular egalitarianism and a romantic cult of the common man. 3is famous sentence$ cman is born free$ but he is ever%where in chains$c called into 6uestion the traditional social hierarch%: hitherto$ political philosophers had thought in terms of elites$ but now the mass of the people had found a champion and were becoming politicall% conscious Cousseau was a romantic$ given to weeping under the willows on Da!e Feneva$ and the (ocial Contract and *iscourses are h%pnoticall% readable$ flaming protests b% one who found the hard rationalit% of the 1?th centur% too e-acting. <ut man is not$ as Cousseau claims$ born free. ;an is born into societ%$ which imposes restraints on him. Casting about to reconcile his artificial antithesis between man]s purported natural state of freedom and his condition in societ%$ Cousseau utili5es the old theories of contract and transforms them into the concept of the F#eneral ill*F #his general will$ a moral will that aims at the common good and in which all participate directl%$ reconciles the individual and the communit% b% representing the will of the communit% as deriving from the will of moral individuals$ so that to obe% the laws of such a communit% is in a sense to follow one]s own will$ assuming that one is a moral individual. Similar ideas to that of the general will became accepted as a basis for both the socialdemocratic welfare state and for totalitarian dictatorships. 2nd$ since the idea was misapplied from small village or civic communities to great sovereign nationstates$ Cousseau was also a prophet of a nationalism that he never advocated. Cousseau himself wanted a federal Europe. 3e never wrote the proposed se6uel to the *u contrat social in which he meant to deal with international politics$ but he declared that e-isting governments lived in a state of nature$ that their obsession with con6uest was imbecilic$ and that cif we could reali5e a European republic for one da%$ it would be enough to ma!e it last for everc &3olitical $ritings I$ pp. .10.??'. <ut$ with a flash of realism$ he thin!s the pro*ect impracticable$ owing to the foll% of men. #he incursion of this revolutionar% romantic into political philosoph% changed the climate of political opinion$ for it coincided with the brea!down of the old d%nastic order and the emergence first of the middle classes and then of the masses to political consciousness and power. #hat the concept of general will was vague onl% increased its adaptabilit% and prestige: it would both ma!e constitutionalism more liberal and d%namic and give demagogues and dictators the e-cuse for cforcing people to be freec &that is$ forcing people to follow the general will$ as interpreted b% the ruling forces'. Cousseau could inspire liberals$ such as the 1Gthcentur% English philosopher #.3. Freen$ to a creative view of a state helping people to ma!e the best of their potential through a variet% of free 1HG institutions. It could also pla% into the hands of demagogues claiming to represent the general will and bent on molding societ% according to their own abstractions. T,E 7HT, CE-T1RY 1tilitariani"m* 2 ma*or force in the political and social thought of the 1Gth centur% was 8tilitarianism$ the doctrine that the actions of governments should be *udged simpl% b% the e-tent to which the% promoted the cgreatest happiness of the greatest number.c #he founder of the 8tilitarian school was (eremy /entham$ an eccentric Englishman trained in the law. <entham *udged all laws and institutions b% their utilit% thus defined. c#he >abric of >elicit%$c he wrote$ cmust be reared b% the hands of reason and Daw.c <entham]s 8ragment& on 1overnment &1==1' and +ntroduction to the /rinciples of Morals and 'egislation &1=?G' elaborated a 8tilitarian political philosoph%. <entham was an atheist and an e-ponent of the new laisse5faire economics of 2dam Smith and 9avid Cicardo$ but he inspired the spate of legislation that$ after the Ceform <ill of 1?.,$ had tac!led the worst conse6uences of 1?thcentur% inefficienc% and of the Industrial Cevolution. 3is influence$ moreover$ spread widel% abroad. 2t first a simple reformer of law$ <entham attac!ed notions of contract and natural law as superfluous$ c#he indestructible prerogatives of man!ind$c he wrote$ chave no need to be supported upon the sand% foundation of a fiction.c #he *ustification of government is pragmatic$ its aim improvement and to release the free choice of individuals and the pla% of mar!et forces that will create prosperit%. <entham thought men far more reasonable and calculating than the% are and brushed aside all the Christian and humanist ideas rationali5ing instinctive lo%alt% and awe. 3e thought societ% could advance b% calculation of pleasure and pain$ and his 2ntroduction even tries to wor! out cthe value of a lot of pleasure and pain$ how now to be measured.c 3e compared the relative gratifications of health$ wealth$ power$ friendship$ and benevolence$ as well as those of cirascible appetitec and cantipath%.c 3e also thought of punishment purel% as a deterrent$ not as retribution$ and graded offenses on the harm the% did to happiness$ not on how much the% offended Fod or tradition. If <entham]s ps%cholog% was nave$ that of his disciple (ame" Mill was philistine. ;ill postulated an economic man whose decisions$ if freel% ta!en$ would alwa%s be in his own interest$ and he believed that universal suffrage$ along with 8tilitarian legislation b% a sovereign parliament$ would produce the !ind of happiness and wellbeing that <entham desired. In his ,ssay on 1overnment &1?,?' ;ill thus shows a doctrinaire faith in a literate electorate as the means to good government and in laisse5faire economics as a means to social harmon%. #his 8tilitarian tradition was humani5ed b% @ames ;ill]s son$ (ohn Stuart Mill$ one of the most influential of midVictorian liberals. +hereas @ames ;ill had been entirel% pragmatic$ his son tried to enhance more sophisticated values. 3e thought that civili5ation depended on a tin% minorit% of creative minds and on the free pla% of speculative intelligence. 3e detested conventional public opinion and feared that complete democrac%$ far from emancipating opinion$ would ma!e it more restrictive. 2mid the dogmatic and strident voices of mid1Gthcentur% nationalists$ utopians$ and revolutionaries$ the 6uiet$ if sometimes priggish$ voice of midVictorian li%erali"m proved e-tremel% influential in the ruling circles of Victorian England. 2ccepting democrac% as inevitable$ @.S. ;ill e-pressed the still optimistic and 11H progressive views of an intellectual elite. +ithout complete libert% of opinion$ he insisted$ civili5ations ossif%. #he 6ualit% of progress results not merel% from the blind forces of economic competition but from the free pla% of mind. #he worth of the state in the long run is onl% the worth of the individuals composing it$ and without men of genius societ% would become a cstagnant pool.c #his militant humanist$ unli!e his father$ was aware of the dangers of even benevolent bureaucratic power and declared that a state that cdwarfs its menc is culturall% insignificant. ;ill also advocated the legal and social emancipation of women$ holding that abilit% was wasted b% midVictorian conventions. 3e believed that the masses could be educated into accepting the values of liberal civili5ation$ but he defended private propert% and was as war% of rapid e-tensions of the franchise as of bureaucratic power. Toc+ue$ille* ;ill]s friend 2le-is de #oc6ueville$ whose *e la dEmocratie en 5mEri=ue & Democracy in 4merica' appeared in 1?.0/H$ was a >rench civil servant also concerned with maintaining the standards and creativeness of civili5ation in face of the rising tide of mass democrac%. Since the 8nited States was then the onl% large scale democrac% e-tant$ #oc6ueville decided to go there$ and as a result of his visit wrote a classic account of earl% 1Gthcentur% 2merican civili5ation. c+e cannot$c he wrote$ cprevent the conditions of men from becoming e6ual$ but it depends upon ourselves whether the principle of e6ualit% will lead them to servitude or freedom$ to !nowledge or barbarism$ to prosperit% or wretchedness.c 3e feared the possible abuse of power b% centrali5ed government$ unrestrained b% the power of the old privileged classes$ and thought it essential to ceducate democrac%c so that$ although it would never have the cwild virtuesc of the old regimes$ it would have its own dignit%$ good sense$ and even benevolence. #oc6ueville greatl% admired 2merican representative institutions and made a penetrating anal%sis of the new power of the press. 3e reali5ed$ as few people then did$ that the 8nited States and Cussia would become world powers$ and he contrasted the freedom of the one and the despotism of the other. 3e also foresaw that under democrac% education would be respected more as a ladder to success than for its intrinsic content and might thus become mediocre. 3e was alive to the dangers of uniform mediocrit% but believed$ li!e ;ill$ that democrac% could be permeated b% creative ideas. T*,* :reen* #his !ind of humanism was given a more elaborate philosophical content b% the English philosopher #.3. Freen$ whose .ectures on the 3rinciples of 3olitical O%ligation &1?G07 reprinted from 3hilosophical $orks& vol. ,$ 1??0' greatl% influenced the Diberals in the <ritish governments of the period 1GH110. Freen$ li!e @.S. ;ill and #oc6ueville$ wished to e-tend the minorit% culture to the people and even to use state power to chinder hindrances to the good life.c 3e had absorbed from 2ristotle$ Spino5a$ Cousseau$ and 3egel an organic theor% of the state. #he latter$ b% promoting the free pla% of spontaneous institutions$ ought to help individuals both to csecure the common good of societ% fandg enable them to ma!e the best of themselves.c +hile hostile to the abuse of landed propert%$ Freen was not a Socialist. 3e accepted the idea that propert% should be private and 111 une6uall% distributed and thought the operation of the free mar!et the best wa% to benefit the whole societ%7 for free trade would$ he thought$ diminish the ine6ualities of wealth in a common prosperit%. <ut Freen would have e-tended the power of the state over education$ health$ housing and town planning$ and the relief of unemplo%menta new departure in Diberal thought. #hese recommendations are embedded in the most elaborate and close!nit intellectual construction made b% an% modern <ritish political philosopher$ and the% laid the foundation of the <ritish welfare state. )i%eral nationali"m* +hereas Freen shir!ed the e-tension of liberal and constitutional principles into international affairs$ the Italian patriot and revolutionar% prophet :iu"eppe MaIIini made it his vision and became the most influential prophet of liberal nationalism. In his The *uties of Man and ,ssays he envisaged a harmon% of free peoplesa csisterhood of nations$c in which the rule of militar% empires would be thrown off$ the destruction of clerical and feudal privileges accomplished$ and in which the emancipated peoples would be regenerated b% means of education and universal suffrage. #his vision inspired the more idealistic aspects of the Italian Ri"or#imento &national revival or resurrection' and of nationalistic revolts in Europe and be%ond. #hough$ in fact$ fervid nationalism often proved destructive$ ;a55ini advocated a united Europe of free peoples$ in which national singularities would be transcended in a panEuropean harmon%. #his sort of liberal democratic idealism was catching$ and even if it fre6uentl% inspired ;achiavellian policies$ it also inspired (resident +oodrow +ilson of the 8nited States$ who$ had he not been thwarted b% domestic opposition$ might well have made a ;a55iniant%pe Deague of "ations a success. ;oreover$ the Europe of the Common ;ar!et owes much to the apparentl% impractical liberal idealism of ;a55ini. American con"titutionali"m* #he 1nited State" was founded b% men deepl% influenced b% republicanism$ b% Doc!e$ and b% the optimism of the >rench Enlightenment. Feorge +ashington$ @ohn 2dams$ and #homas @efferson all concurred that laws$ rather than men$ should be the final sanction and that government should be responsible to the governed. <ut the influence of Doc!e and the Enlightenment was not entirel% happ%. @ohn 2dams$ who followed +ashington as president$ prescribed a constitution with a balance of e-ecutive and legislative power chec!ed b% an independent *udiciar%. #he federal constitution$ moreover$ could be amended onl% b% a unanimous vote of the states. 2n-ious to safeguard state liberties and the rights of propert%$ the founding fathers gave the federal government insufficient revenues and coercive powers$ as a result of which the constitution was stigmati5ed as being cno more than a #reat% of 2lliance.c :et the federal union was preserved. #he civil power controlled the militar%$ and there was religious toleration and freedom of the press and of economic enterprise. ;ost significantl%$ the concept of natural rights had found e-pression in the Declaration of Independence and was to influence mar!edl% political and legal developments in the ensuing decades$ as well as inspire the >rench 9eclaration of the Cights of ;an. Anarchi"m and utopiani"m* 11, +hile a liberal political philosoph% within a framewor! of capitali"tic free trade and constitutional selfgovernment dominated the greatest +estern powers$ mounting criticism developed against centrali5ed government itself. Cadical utopian and anarchist views$ previousl% e-pounded mainl% b% religious sects$ became seculari5ed in such wor!s as William :odin@" /olitical <ustice &1=G.'$ Ro%ert .en@" 5ew >iew of ociety &1?1.'$ and Pierre0(o"eph Proudhon@" voluminous and anticlerical writings. #he English philosopher +illiam Fodwin$ an e-treme individualist$ shared <entham]s confidence in the reasonableness of man!ind. 3e denounced the wars accepted b% most political philosophers and all centrali5ed coercive states. #he t%rann% of demagogues and of cmultitudes drun! with powerc he regarded as being as bad as that of !ings and oligarchs. #he remed%$ he thought$ was not violent revolution$ which produces t%rann%$ but education and freedom$ including se-ual freedom. 3is was a program of highminded$ atheistic anarch%. #he English Socialist Cobert Owen$ a cotton spinner who had made a fortune$ also insisted that bad institutions$ not original sin or intrinsic foll%$ caused the evils of societ%$ and he sought to remed% them b% changing the economic and educational s%stem. 3e thus devised a scheme of model cooperative communities that would increase production$ permit humane education$ and release the naturall% benevolent 6ualities of man!ind. #he >rench moralist and advocate of social reform (ierre@oseph (roudhon attac!ed the ctentacularc nationstate and aimed at a classless societ% in which ma*or capitalism would be abolished. Selfgoverning producers$ no longer slaves of bureaucrats and capitalists$ would permit the reali5ation of an intrinsic human dignit%$ and federation would replace the accepted condition of war between sovereign states. (roudhon tried to transform societ% b% rousing the mass of the people to cooperative humanitarian consciousness. Saint0Simon and Comte* 2nother revolt against the prevalent establishment$ national and international$ was made b% the >rench social philosopher ,enri de Saint0Simon. SaintSimon wanted to develop the Indu"trial Re$olution so as to ameliorate the condition of the poorest class. #his would be achieved not through political revolution$ but through a government of ban!ers and administrators who would supersede !ings$ aristocrats$ and politicians. If >rance were suddenl% deprived of three thousand leading scientists$ engineers$ ban!ers$ painters$ poets$ and writers$ he argued$ the result would be catastrophic7 but if all the courtiers and bishops and 1H$HHH landowners vanished$ the loss$ though deplorable$ would be much less severe. SaintSimon also demanded a united Europe$ superseding the warring nationstates$ with a European parliament and a *oint development of industr% and communication. 3e also invented a s%nthetic religion appropriate to a scientific phase of histor%$ with a cult of "ewton and the great men of science. SaintSimon]s disciple Au#u"te Comte went further. 3is Course of 3ositive 3hilosophy &1?.H/,' and (ystem of 3ositive 3olity &1?010/' elaborated a creligion of humanit%$c with ritual$ calendar$ and a priesthood of scientists$ and secular saints$ including @ulius Caesar$ 9ante$ and @oan of 2rc. Societ% would be ruled b% ban!ers and technocrats and Europe united into a +estern republic. #his doctrine$ bac!ed b% pioneering sociolog%$ won much influence among intellectuals. Comte$ li!e SaintSimon$ tac!led the essential 6uestions: how to 11. deplo% the power of modern technolog% for the benefit of all man!ind7 how to avoid wars between sovereign states7 and how to fill the void left b% the waning of Christian beliefs. ,e#el* +hereas the utopian reformers had discarded metaph%sical arguments$ the Ferman philosopher F.+.>. 3egel claimed to apprehend the totalit% of the cosmos b% speculative cognition. Di!e Vico$ he saw the past in terms of changing consciousness$ but he viewed the historical process as one of cbecomingc rather than as one of eternal recurrence. 3egel had no ade6uate historical data for his intuitions$ since the whole of world histor% was even less !nown then than it is toda%$ but his novel sweep and range of theor% proved an into-icating substitute for religion. 3e divided world histor% into four epochs: the patriarchal Eastern empire$ the brilliant Free! bo%hood$ the severe manhood of Come$ and the Fermanic phase after the Ceformation. #he c2bsolute$c li!e a conductor$ summons each people to their finest hour$ and neither individuals nor states have an% rights against them during their historicall% determined period of supremac%. ;an% felt some sense of anticlima-$ however$ when he claimed that the (russian state embodied the hitherto highest selfreali5ation of the c2bsolutec "ot since St. 2ugustine had so compelling a drama been adumbrated. 3egel]s drama$ moreover$ culminates in this world$ for cthe state is the divine idea as it e-ists on earth.c MarB and En#el"*
3egel was a conservative$ but his influence on the revolutionaries Uarl ;ar- and his collaborator ?riedrich En#el" was profound. #he% inherited the 3egelian claim to understand the ctotalit%c of histor% and life as it progressed through a dialectic of thesis$ antithesis$ and s%nthesis. <ut$ whereas 3egel envisaged a conflict of nationstates$ ;ar- and Engels thought that the d%namism of histor% was generated b% inevitable cla"" conflict economicall% determined. #his was an idea even more d%namic than 3egel]s and more relevant to the social upheavals that were a conse6uence of the Industrial Cevolution. ;ar- was a formidable prophet whose writings lead up to an apocal%pse and redemption. 2 deepl% learned humanist$ his ideal was the fullest development of the human personalit%. <ut$ whereas (lato was concerned with an elite$ ;ar- cared passionatel% for the elevation of whole peoples. #he ;ar-ist credo was all the more effective as it e-pressed with elo6uent ferocit% the grievances of the poor$ while prophes%ing retribution and a happ% ending. >or the state$ once captured b% the classconscious vanguard of the proletariat$ would ta!e over the means of production from the capitalists$ and a brief cdictatorship of the proletariatc would establish a trul% communist societ%. #he state would then wither awa% and man at last become cfull% humanc in a cla""le"" "ociety. #he powerful slogans of ;ar- and Engels were a natural result of the unbridled capitalism of laisse5faire$ but politicall% the% were nave. In classical$ medieval$ and humanistic political philosoph% the essential problem is the control of power$ and to imagine that a dictatorship$ once established$ will wither awa% is utopian. 2s even ;ar-]s fellow revolutionar% the Cussian anarchist M*A* /a!unin observed$ #he revolutionar% dictatorship of the doctrinaires who put science before life would differ from the established state onl% in e-ternal trappings. 11/ #he substance of both are a t%rann% of the minorit% over the ma*orit%in the name of the man% and the supreme wisdom of the few. #he revolutionaries would vivisect societ% in the name of dogmas and cdestro% the present order$ onl% to erect their own rigid dictatorship among its ruins.c /olitical philosophy in the BCth century "ineteenthcentur% European civili5ation had been the first to dominate and pervade the whole world and to create a new selfsustaining productivit% in which all eventuall% might share. <ut$ as SaintSimon had pointed out$ this civili5ation had a fatal flaw. #he rule of law$ accepted within the politicall% advanced states$ had never been achieved among them. 3eavil% armed nations and empires remained in a 3obbesian cposture of war$c and classical and medieval ideals of world order had long been discarded. +ithin states$ also$ laisse5faire capitalism had e-acerbated class conflicts$ while the decline of religious belief had undermined traditional solidarit%. 2nd in 1G1/$ when a general European war bro!e out$ the peoples$ contrar% to the hopes of cosmopolitan revolutionaries$ rallied behind their national governments. +hen the victorious powers failed to promote world order through the Deague of "ations$ a second global conflict followed$ during which were developed weapons so destructive as to threaten life ever%where. In the aftermath of these catastrophes and the worldwide revulsion the% occasioned$ not least against the European colonial powers$ three mainstreams of mid,Hthcentur% political philosoph% ma% be discerned. In liberalconstitutional states$ with modified$ managerial capitalism and various degrees of public welfare$ a political pragmatism has emerged$ still maintaining the 2ristotelian distinction between the rule of law and government b% consent$ on the one hand$ and t%rann% on the other. Second$ there has been a reaffirmation of religious or 6uasireligious values appealing to conscience and the inner man$ e-pressed persuasivel% in E-istentialist writings. #hird$ revolutionar% ideas have also developed$ most of them along ;ar-ist lines. Other revolutionar% doctrines appeal to anarchist traditions and are elaborated with neo;ar-ist and neo>reudian insights. +ithin these categories man% shades of opinion are e-pressed$ and onl% a sampling of representative views is presented here. P.)ITICA) PRA:MATISM #he first$ pra#mati"t approach probabl% has been most powerfull% asserted in the 8nited States and Freat <ritain. #he 2merican writer )ei" Mumford$ for e-ample$ has advocated a militant humanism$ defending people against the alienations of megalopolitan life and attac!ing mechani5ation and materialism. Di!e the Free! philosophers and li!e #oc6ueville$ whom he admires$ ;umford declares$ cIn the end$ all our contrivances have but one ob*ect7 the continued growth of human personalities and the cultivation of the best life possible.c #he 2merican philosopher and educationist (ohn Deey$ on the other hand$ sought to counteract the dehumani5ation of industrial mass societ% b% a freer form of education$ liberating the personalit%. <oth these writers critici5e the e-isting structure of societ% and its modified capitalism$ but tr% to wor! within it. 2nother humanist$ the English philosopher /ertrand Ru""ell$ was more radical. Cussell carried into political philosoph% an aristocratic individualism$ campaigning for toleration$ se-ual freedom$ compassion$ and common sense. 3e broadcast elite values to a mass societ% and attac!ed 110 materialism$ crass bureaucrac%$ and war. 3e twice went to prison in pacifist protest and was obsessed with the universal menace of nuclear weapons. 3e denounced warli!e political theories: cCemember %our humanit%$c he said$ cand forget the rest.c On political tactics often inept$ Cussell won wide influence as a man of principle$ concerned to adapt archaic institutions to the changed environment of man!ind. #he 2ustrianborn <ritish philosopher Sir Aarl Popper has demonstrated the pretensions of the 1Gth centur% determinist philosophies such as those of 3egel and ;ar-$ while an English historian and philosopher$ Sir I"aiah /erlin$ has ridiculed the idea of a supposedl% ob*ective march of histo%. <erlin also re*ects the ;ar-ist belief that all values are conditioned b% the place men occup% on the cmoving stair of time.c ;ar-$ he points out$ was as romantic as 3egel in envisaging a cworld which moves from e-plosion to e-plosion in order to fulfil the great cosmic design.c ;oral values$ he insists$ are not *ust a csub*ective gloss unworth% of consideration on the great hard edifice of historical construction.c "o single formula can be found$ <erlin argues$ whereb% the various ob*ectives of men can be harmoniousl% reali5ed. #here are man% human goals$ which ma% well be in conflict with one another. #his empirical$ pluralist$ and liberal political philosoph% has much in common with the approach of the >renchman Rmile Dur!heim and the Englishman :raham Walla"$ both founding fathers of modern sociolog%. Statesmen and political philosophers$ the% contend$ should not pla% the part of prophets but rather confine themselves to investigating social patterns and the ideas that are part of them. +a%s might thus be found of promoting the survival and vitalit% of a given societ% in its particular setting. Fraham +allas was concerned to adapt constitutional societies b% consent. 3e wanted to nationali5e man% essential means of production$ including transport and communications$ and through increased ta-ation strengthen social democrac% b% greater economic and social e6ualit%. 3e was not a revolutionar% but a reformer$ who understood the precariousness of civili5ation and the dangers of nationalism$ which could onl% bring$ he prophesied$ centuries of warfare and regression. 3e advocated a worldwide and constitutionalist scientific humanism$ inspired b% the idea of the solidarit% of the whole species$ for cthe master tas! of civili5ed man!ind is to promote the conditions leading to the good life.c Other political sociologists who accepted the established order did not e-pect to improve it. #he Italian Vilfredo Pareto$ and :aetano Mo"ca$ a Sicilianborn law%er$ set themselves not to state what the% wanted but to record what occurs in societ%. (areto]s Mind and (ociety &1G11' is an elaborate$ 6uasimathematical classification of nonlogical political m%ths. Its form is daunting$ but its insights are penetrating$ especiall% a hilarious dissection of Cousseau]s 1eneral $ill& of which$ (areto concludes$ cthe intrinsic logicoe-perimental value . . . is 5ero.c Canging sardonicall% over histor%$ (areto insists that elites will alwa%s manipulate societ%$ power merel% shifting from one set of rulers to another. ;osca$ in The "uling Class &1G.G'$ anal%5ed how political m%ths are e-ploited. 3e also concluded that elites ever%where are bound to rule and that the least bad government occurs when abuse of power is chec!ed b% legal means7 that is$ b% the rule of law. ;osca admired the liberal constitutionalism of the 1Gth centur%$ although he was aware of its precariousness and limitations. 3e argued that there is no total e-planation of histor%$ which has alwa%s been the unpredictable outcome of competing and interacting interests. One thing is certain$ 111 nevertheless: in various forms there will alwa%s be a struggle for predominance. ;osca]s views$ more clearl% set out than (areto]s$ have a salutar% realism. #he 2merican philosopher and critic (ame" /urnham also anal%5ed shifts of power. In The Managerial "evolution &1G/1' he propounded a theor% of bureaucratic revolution: the rulers of the new societ%$ the class with power and privilege$ will be the bureaucratic managers of csuper states.c In The Machiavellians& *efenders of 8reedom &1G/.'$ he reinterprets ;achiavelli and cites ;osca as a modern ;achiavellian. >ollowing (areto]s idea of the ccirculation of elites$c he asserts that$ when a ruling class becomes inade6uate$ frivolous$ or bored$ loses confidence in itself and its m%ths$ and becomes irresolute in deplo%ing necessar% force$ new elites are bound to ta!e overas in the managerial revolution of the ,Hth centur%. RE)I:I.1S A-D EKISTE-TIA)IST APPR.AC,ES
In the second religious and 6uasireligious group of political philosophies$ the Catholic hierarch% has reiterated its ancient neo#homist doctrine of original sin and redemption. (ope )eo KIII$ in the enc%clicals 2nscruta%ili *ei Consilio &1?=?'$ 2mmortale *ei &1??0'$ and "erum Novarum &1?G1'$ dismissed all anthropocentric political philosophies as new versions of old heresies. #he world$ cthrough an insatiable craving for things perishable$c was crushing wildl% upon the straight road to destruction.c Societ% is intelligible onl% in the light of the Christian revelation and a future life: e-clude the idea of futurit% and forthwith the ver% notion of what is good and right would perish$ na%$ the whole scheme of the universe would become a dar! and unfathomable m%ster%. Such is the human condition that visionar% innovations are fruitless$ and cvenomousc teachings can onl% bring cdeathbearing fruit.c Societ%$ as St. 2ugustine had declared$ if organi5ed without Fod$ can onl% be a present hell. 3ierarch%$ authorit%$ and censorship can alone ccontrol the e-cesses of the unbridled intellect$ which unfailingl% end in the oppression of the untutored multitude.c (ropert% is essential to the famil%$ on which the social order depends$ and ine6ualit% is inherent in all human societies. Onl% a harmonious Christian commonwealth can assuage the conse6uences of sin$ and within that social order the state should therefore encourage Christian trade unions and promote the welfare of the poor. #hus$ with these views the papac%$ maintaining its monopol% of revelation$ tried to come to terms with the demands of industrial civili5ation. 9uring the rise of 1Gthcentur% nationalism and of Communist$ >ascist$ and "a5i dictatorships$ and in face of the increasing dominance of governments and largescale industr% in all mass societies$ the importance of individual responsibilit% with regard to moral issues was emphasi5ed b% a divergent group of thin!ers who have come to be described as EBi"tentiali"t". SSren Aier!e#aard &died 1?00'$ a 9anish philosopher$ declared that ctruth is sub*ectivit%c and that onl% b% means of inward revelation can man !now Fod. (ean0Paul Sartre$ a brilliant >rench E-istentialist$ tried to come to terms with dialectical ;aterialism. 3is ,'istentialism and !umanism &1G/?' comprises an affirmation of human dignit%. cIf$c he writes$ cI have e-cluded Fod the >ather$ there must be someone to invent values.c ;an$ who has abandoned Fod$ cmust liberate himself b% some practical commitment$c for onl% then can he become full% human. Sartre]s elaborate .',tre et le nEant &1G/.7 Eng. trans.$ Being and 5othingness& 1G01' is at once Cartesian and laborious$ complete with a c!e%c to its special and pedantic 11= terms. It investigates the loneliness of the human condition$ attitudes to others$ love$ masochism$ indifference$ desire$ and hate. #his intense introspection is even more vividl% e-pressed in his fiction and drama. #he 2lgerianborn Al%ert Camu" in The Myth of (isyphus &1G/,' and The "e%el &1G01' also agoni5es brilliantl% over the current human condition$ and in Man in "evolt he discards hope of pragmatic improvement. REV.)1TI.-ARY D.CTRI-ES #he third stream of contemporar% political philosoph% is ;ar-istDeninist totalitarian and neo;ar-ist anarchist. ;an% of ;ar-]s original insights into the socioeconomic process and its effect on ideas are now generall% accepted. 3is prophecies$ on the other hand$ have not been fulfilled. #he proletarian revolution$ for e-ample$ came not in an economicall% advanced countr% but in one of the most bac!ward7 and the state$ far from withering awa% or being diminished b% ine-orable economic trends$ has in fact become more powerful both in Communist and in social democratic countries. #hose who have accepted the total ;ar-ist revelation as superseding all else have had thus to adapt and revise it. 3ence$ much tortuous and artificial debate has ensued. 2ll orthodo- ;ar-ists accept the 3egelian position that one can get be%ond empirical !nowledge and perceive the historicall% revealed installments of a total e-planation. #he% also start from ;ar-]s 1Gthcentur% belief that economicall% determined conflicts among feudal$ bourgeois$ and proletarian classes are the d%namic of histor% and that the rule of law is not a safeguard for the whole societ% against arbitrar% power but merel% the e-pression of class interest. )enin* #he first and b% far the most significant interpretation of ;ar-]s doctrine as reali5ed in the Soviet 8nion was made b% )enin and developed b% Stalin and is entirel% authoritarian. 2ccording to ;ar- and Engels$ the revolution could occur onl% after the bourgeois phase of production had ccontradictedc the tsarist order$ but Denin determined to ta!e advantage of the opportunities provided b% +orld +ar I and settle accounts directl% with the caccursed heritage of serfdom$ of 2siatic barbarism . . . an insult to man!ind$c and in 1G1= he engineered a coup that secured the support of the peasantr% and the industrial wor!ers. 3e also adopted the revolutionar% theorist Deon #rots!%]s idea of a cpermanent revolutionc from above b% a small revolutionar% elite. 2lread% in ;hat +s ,o Be DoneD &1GH,'$ Denin had argued that an educated elite must direct the proletarian revolution$ and when he came to power he dissolved the constituent assembl% and ruled through a crevolutionar% and democratic dictatorship supported b% the state power of the armed wor!ers.c In asserting the need for an elite of professional revolutionaries to sei5e power$ Denin reverted to ;ar-]s program in The Communist Manifesto rather than conforming to the fated pattern of economic development wor!ed out in *as -apital. In 1G,1 he further adapted theor% to the times. 3is new economic polic% sanctioned the development of a class of prosperous c!ula!c peasantr% to !eep the econom% viable. >or Denin alwa%s thought in terms of world revolution7 and$ in spite of the failure of the ;ar-ists in central Europe and the defeat of the Ced armies in (oland$ he died in the e-pectation of a global se6uel. #hus$ in 2mperialism& the !ighest (tage of Capitalism &1G1='$ he had e-tended the class war into an inevitable conflict between 11? European imperialism and the colonial peoples involved. 3e had been influenced b% the English historian (*A* ,o%"on@" 2mperialism& a (tudy &1GH,'$ which alleged that decadent capitalism was bound to turn from glutted mar!ets at home to e-ploit the toil of creluctant and unassimilated peoples.c <ut$ as observed b% classical$ medieval$ and modern constitutionalist political philosophers$ authoritarian regimes suffer the tensions of all autocracies. ;ar- himself might have thought that such planned autocracies had made the worst of his revelation. .ther MarBi"t approache"* ;an% ;ar-ist revisionists tend toward anarchism$ stressing the 3egelian and utopian elements of his theor%. #he 3ungarian :yTr#y )u!Uc"$ for e-ample$ and the Ferman ,er%ert Marcu"e$ who fled from the "a5is to the 8nited States$ have won some following among those in revolt against both authoritarian cpeoples] democraciesc and the diffused capitalism and meritocrac% of the managerial welfare state. Du!wcs] 1eschichte und -lassen%ewusstsein &1G,.7 Eng. trans.$ !istory and Class Consciousness$ 1G=1'$ a neo3egelian wor!$ claims that onl% the intuition of the proletariat can properl% apprehend the totalit% of histor%. <ut world revolution is contingent$ not inevitable$ and ;ar-ism is an instrument$ not a prediction. Du!wcs renounced this heres% after residence in the Soviet 8nion under Stalin$ but he maintained influence through literar% and dramatic criticism. 2fter Uhrushchev]s denunciation of Stalin$ Du!wcs advocated peaceful coe-istence and intellectual rather than political subversion. In The Meaning of Contemporary "ealism &trans. 1G1.'$ he again relates ;ar- to 3egel and even to 2ristotle$ against the Stalinist claim that ;ar- made a radicall% new departure. Du!wcs] neo;ar-ist literar% criticism can be tendentious$ but his neo 3egelian insights$ stri!ingl% e-pressed$ have appealed to those an-ious to salvage the more humane aspects of ;ar-ism and to promote revolution$ even against a modified capitalism and social democrac%$ b% intellectual rather than b% political means. ;arcuse also reached bac! to the more utopian ;ar-. "ow that most of the proletariat has been absorbed into a conformist managerial capitalism or has been regimented into bureaucratic peoples] democracies$ freedom$ argues ;arcuse$ is in retreat. In +estern affluent societies most emplo%ers and wor!ers are e6uall% philistine$ dominated b% the commerciali5ed mass media$ or ccogs in a culture machine.c #he former Soviet 8nion had reverted to an even more philistine monolithic repression$ distorting art and literature. #his enslavement of man b% his own industrial productivit% had been clinched b% the colossal power of governments$ which rendered the old brief and bris! class warfare a romantic$ impracticable idea. ;arcuse attac!ed all establishments and transferred the redeeming mission of the proletariat to a fringe of alienated minoritiesradical students and the e-ponents of the chippiec wa% of lifeas well as to Viet Cong guerrillas and <lac! (ower militants. Such groups$ he declared$ could apparentl% form liberating elites and destro% the managerial societ%. #hus reappeared the old ;ar-ist3ebraic pattern of redemption through struggle b% a chosen people. #he Italian Communist Antonio :ram"ci deplo%ed a vivid rhetorical talent in attac!ing e-isting societ%. Di!e ;arcuse$ Framsci was alarmed that the proletariat was being assimilated b% the capitalist order. 3e too! his stand on the alread% obsolescent ;ar-ist doctrine of irreconcilable class war between bourgeois and proletariat. 3e aimed to unmas! the bourgeois idea of libert% and to replace parliaments b% an cimplacable machinec of wor!ers] councils$ which would destro% 11G the current social order through a dictatorship of the proletariat. c9emocrac%$c he wrote$ cis our worst enem%. +e must be read% to fight it because it blurs the clear separation of classes.c "ot onl% would parliamentar% democrac% and established law be unmas!ed$ but culture$ too$ would be transformed. 2 wor!ers] civili5ation$ with its great industr%$ large cities$ and ctumultuous and intense life$c would create a new civili5ation with new poetr%$ art$ drama$ fashions$ and language. Framsci insisted that the old culture should be destro%ed and that education should be wrenched from the grip of the ruling classes and the church. <ut this militant revolutionar% was also a utopian. 3e turned bitterl% hostile to Stalin]s regime$ for he believed$ li!e Engels$ that the dictatorship of the wor!ers] "tate would wither awa%. c+e do not wish$c he wrote$ cto free5e the dictatorship.c >ollowing world revolution$ a classless societ% would emerge$ and man!ind would be free to master nature instead of being involved in a class war. Since +orld +ar II$ Framsci]s notions have en*o%ed a minor revival. #he% appeal to the fringe of revolutionaries who admire ;arcuse and detest the embourgeoisement of an ideali5ed proletariat. <ut$ in a civili5ation in which$ if total war can be avoided$ material prospects are good$ the destruction of the old culture out of rage$ env%$ and nave idealism appears to be a pointless program. Di!e ;arcuse]s doctrine$ it is a cr% of pain$ t%pical of the 1G,Hs in Ital%. Conclusion #he histor% of political philosoph% from (lato until the present da% ma!es plain that modern political philosoph% is still faced with the basic problems defined b% the Free!s. #he need to redeplo% public power in order to maintain the survival and enhance the 6ualit% of human life$ for e-ample$ has never been so essential. 2nd$ if the opportunities for promoting wellbeing are now far greater$ the penalties for the abuse of power are nothing less than the destruction or gross degradation of all life on the planet. In these circumstances it is of no great importance that some anal%tical philosophers have declared themselves neutral7 the% have at least often discredited pretentious metaph%sical m%ths. On the empirical evidence$ constitutionalism and the rule of law$ with the ancient classic$ medieval$ and humanist traditions behind them$ have proved themselves a more successful response to the environment than t%rann% and repression. In the current and more sophisticated view$ there are no shortcuts to the millennium. 2s ;osca points out$ utopian ideas become dangerous when the% succeed in bringing a large mass of intellectual and moral energies to bear upon an end that can never be achieved$ and that in the da% of purported achievement can mean nothing more than the triumph of the worst people and distress and disappointment for the good. #here will perhaps alwa%s be a struggle for preeminence in an% societ%$ and public laws are necessar% to regulate it. #oo much cannot be hoped of government$ and the best societ% is that in which t%rann% and caprice of power are prevented and in which men are free to create diverse and spontaneous institutions within the framewor! of law. Onl% within such a framewor! of a tolerabl% wellorgani5ed constitutionalism$ graduall% e-tended to relations between states$ can the swiftl% mounting opportunities provided b% applied science be ta!en and the pattern of social life ad*usted$ so that the human species$ instead of being thwarted and deformed b% its institutions$ can reali5e its full potentialities. Political Sy"tem" 1,H #he term political "y"tem ma% be used narrowl% or broadl%. "arrowl% defined$ it is the set of formal legal institutions that constitute a cgovernmentc or a F"tate*F #his is the definition adopted b% man% studies of the legal or constitutional arrangements of advanced political orders. ;ore broadl% defined$ it comprehends actual as well as prescribed forms of political behaviour$ not onl% the legal organi5ation of the state but also the realit% of how the state functions. Still more broadl% defined$ the political s%stem is seen as a set of cprocesses of interactionc or as a subs%stem of the social s%stem interacting with other nonpolitical subs%stems$ such as the economic s%stem. #his points to the importance of informal sociopolitical processes and emphasi5es the stud% of political development. #raditional legal or constitutional anal%sis$ using the first definition$ has produced a huge bod% of literature on governmental structures$ man% of the speciali5ed terms that are a part of the traditional vocabular% of political science$ and several instructive classif%ing schemes. Similarl%$ empirical anal%sis of political processes and the effort to identif% the underl%ing realities of governmental forms have %ielded a rich store of data and an important bod% of comparative theor%. #he third definition has inspired much scholarl% wor! that emplo%s new !inds of data$ new terms$ and some new concepts and categories of anal%sis. #he discussion that follows draws on all three approaches to the stud% of political s%stems. ,ypologies of government #he most important t%pe of political s%stem in the modern world is the nation state. #he world toda% is divided territoriall% into more than 1=0 states$ in each of which a national government claims to e-ercise sovereignt%or the power of final authorit%and see!s to compel obedience to its will b% its citi5ens. #his fact of the world]s political organi5ation suggests the distinction emplo%ed in the following section among supranational$ national$ and subnational political s%stems. S1PRA-ATI.-A) P.)ITICA) SYSTEMS #he formation of supranational relationships is a principal result of the division of the world into a number of separate national entities$ or states$ that have contact with one another$ share goals or needs$ and face common threats. In some cases$ as in man% alliances$ these relationships are shortlived and fail to result in significant institutional development. In other cases$ the% lead to interstate organi5ations and supranational s%stems. #he discussion below e-amines several t%pes of supranational political s%stems$ together with historical and contemporar% e-amples of each. Empire"* <ecause the% are composed of peoples of different cultures and ethnic bac!grounds$ all empire" are ultimatel% held together b% coercion and the threat of forcible recon6uest. Imposing their rule on diverse political structures$ the% are characteri5ed b% the centrali5ation of power and the absence of effective representation of their component parts. 2lthough force is thus the primar% instrument of imperial rule$ it is also true that histor% records man% cases of multiethnic empires that were governed peaceabl% for considerable periods and were often 6uite successful in maintaining order within their boundaries. #he histor% of the ancient 1,1 world is the histor% of great empiresEg%pt$ China$ (ersia$ and imperial Come whose autocratic regimes provided relativel% stable government for man% sub*ect peoples in immense territories over man% centuries. <ased on militar% force and religious belief$ the ancient despotisms were legitimi5ed also b% their achievements in building great bureaucratic and legal structures$ in developing vast irrigation and road s%stems$ and in providing the conditions for the support of high civili5ations. Enhancing and transcending all other political structures in their sphere$ the% could claim to function as effective schemes of universal order. In contrast to the empires of the ancient world$ the colonial empires of recent times fell far short of universal status. In part$ these modern European empires were made up of ccoloniesc in the original Free! sense7 peopled b% immigrants from the mother countr%$ the colonies usuall% established political structures similar to those of the metropolitan centre and were often able to e-ercise a substantial measure of self government. In part$ also$ the European empires were composed of territories inhabited b% native populations and administered b% imperial bureaucracies. #he government of these territories was generall% more coercive than in the European colonies and more concerned with protection and supervision of the commercial$ industrial$ and other e-ploitative interests of the imperial power. #he disintegration of these empires occurred with astonishing speed. #he two world wars of the ,Hth centur% sapped the power of the metropolitan centres$ while their own doctrines of democrac%$ e6ualit%$ and selfdetermination undermined the principle of imperial rule. (owers such as <ritain and >rance found it increasingl% difficult to resist claims to independence couched in terms of the representative concepts on which their home governments were based$ and the% lac!ed the militar% and economic strength to continue their rule over restive native populations. In the two decades after 1G/0$ nearl% all the ma*or colonial territories won their independence7 the great colonial empires that had once ruled more than half the world were finall% dismembered. )ea#ue"* One of the commonest forms of supranational organi5ation in histor% is that of leagues$ generall% composed of states see!ing to resist some common militar% or economic threat b% combining their forces. #his was the case with the earl% cit% leagues$ such as the 2chaean and 2etolian leagues in ancient Freece and the 3anseatic and the Swabian leagues in Europe7 and to a great e-tent it was the case with the Deague of "ations. Other common features of leagues include the e-istence of some form of charter or agreement among the member states$ an assembl% of representatives of the constituent members$ an e-ecutive organ for the implementation of the decisions of the assembl% of representatives$ and an arbitral or *udicial bod% for ad*udicating disputes. #he Deague of "ations was one of the great e-periments in supranational organi5ation of the ,Hth centur% and the predecessor in several important respects of the 8nited "ations. #he Covenant of the Deague was drafted b% a special commission of the (eace Conference after +orld +ar I$ with (res. +oodrow +ilson of the 8nited States as its leading advocate$ and approved b% a plenar% conference of the victorious powers in 1G1G. #he initial membership of the Deague consisted of ,H states. #he 8nited States failed to ta!e membership in the Deague$ but b% 1G,? the organi5ation had a total membership of 0/. #he machiner% of the Deague consisted of an 2ssembl% of all the member nations$ acting through agents of their governments7 a council on which the great powers were permanentl% represented and to which the other member powers were elected b% the 2ssembl% for 1,, three%ear terms7 a Secretariat to administer the internal affairs of the Deague7 and a number of speciali5ed agencies$ such as the International Dabour Organisation$ that were responsible for implementing various economic and humanitarian programs on an international basis. #he Covenant re6uired that international disputes be submitted to peaceful settlement with a provision for ad*udication or arbitration b% the (ermanent Court of International @ustice or for intervention b% the Council of the Deague. #he Covenant also provided for the use of financial and economic penalties$ such as embargoes$ to enforce the decisions of the Deague and for *oint militar% action against convicted aggressors. In practice$ however$ the Deague failed its most important tests and was unable to master the crises that led to +orld +ar II and its own collapse. Confederation"* Confederation" are voluntar% associations of independent states that$ to secure some common purpose$ agree to certain limitations on their freedom of action and establish some *oint machiner% of consultation or deliberation. #he limitations on the freedom of action of the member states ma% be as trivial as an ac!nowledgment of their dut% to consult with each other before ta!ing some independent action or as significant as the obligation to be bound b% ma*orit% decisions of the member states. Confederations usuall% fail to provide for an effective e-ecutive authorit% and lac! viable central governments7 their member states t%picall% retain their separate militar% establishments and separate diplomatic representation7 and members are generall% accorded e6ual status with an ac!nowledged right of secession from the confederation. 3istoricall%$ confederations have often proved to be a first or second step toward the establishment of a national state$ usuall% as a federal union. #hus$ the federal union of modern Swit5erland was preceded b% a confederation of the Swiss cantons7 Ferman%]s modern federal arrangements ma% be traced to the Ferman Confederation of the 1Gth centur% &the 9eutsche <und'7 and the federal constitution of the 8nited States is the successor to the government of the 2rticles of Confederation. In some other cases$ confederations have replaced more centrali5ed arrangements$ as$ for e-ample$ when empires disintegrate and are replaced b% voluntar% associations of their former colonies. #he <ritish Commonwealth$ or Commonwealth of "ations$ and the >rench Communit% are cases of this t%pe. 2n e-ample of confederal arrangements that gave birth to a federal union is the Article" of Confederation &1=?1?G' that preceded the Constitution of the 8nited States. #he 2rticles established a Congress of the confederation as a unicameral assembl% of ambassadors from the 1. states$ each possessing a single vote. #he Congress was authori5ed to appoint an e-ecutive committee of states to e-ecute$ in the recess of Congress$ such of the powers of Congress as the 8nited States$ in Congress assembled$ b% the consent of nine States$ shall from time to time thin! e-pedient to vest them with7 in turn$ the committee of states could appoint a presiding officer or president for a term of one %ear. #he Congress could also appoint such other committees and ccivil officers as ma% be necessar% for managing the general affairs of the 8nited Statesc and was given the authorit% to serve as cthe last resort or appeal in all disputes and differences$ now subsisting or that hereafter ma% arise between two or more states.c 2lthough the Congress was given authorit% in important areas such as the regulation of foreign affairs$ the establishment of coinage and weights and measures$ the appointment of officers in the confederation]s land and naval forces$ and the 1,. issuance of bills of credit$ all its powers were in fact dependent for their enforcement upon the states. #he Congress lac!ed both an independent source of revenue and the e-ecutive machiner% to enforce its will directl% upon individuals. 2s the language of the 2rticles summari5ed the situation$ each State retains its sovereignt%$ freedom and independence$ and ever% power$ *urisdiction and right$ which is not b% this Confederation e-pressl% delegated to the 8nited States in Congress assembled. #he Commonealth of -ation" is an e-ample of a confederation born as the result of the decentrali5ation and eventual disintegration of an empire. #he original members were the 8nited Uingdom$ 2ustralia$ Canada$ the Irish >ree State$ "ewfoundland$ "ew Yealand$ and the 8nion of South 2frica. In 1G/G "ewfoundland became a province of Canada$ and the Irish >ree State became an independent republic7 South 2frica became an independent republic in 1G11. "ew commonwealth members in the latter half of the ,Hth centur% were newl% independent former <ritish colonies$ such as ;ala%sia &1G0='$ C%prus &1G11'$ and Uiribati &1G=G'$ and numbered well over /H. #he Statute of +estminster &1G.1' established that all members were e6ual in status$ although all recogni5ed the <ritish monarch as head of the commonwealth. Commonwealth governments were represented in the capitals of other commonwealth countries b% high commissioners e6ual in status to ambassadors. In 1G10 the commonwealth established its Secretariat to organi5e meetings$ !eep the membership informed$ and implement its collective decisions. #he Commonwealth >und for #echnical Cooperation$ which is financed b% all member states$ was implemented to provide technical assistance to lessdeveloped states. #he nations of the commonwealth rarel% acted in concert on the international scene$ and$ despite fairl% regular meetings of the commonwealth prime ministers$ there were at times severe strains in the relations among several of the member states. #he fairl% general use of the English language and of English common law$ together with some common s%mbols and remaining cultural affinities$ appeared to be the ma*or ties binding together this loose association. ?ederation"* #he term federation is used to refer to groupings of states$ often on a regional basis$ that establish central e-ecutive machiner% to implement policies or to supervise *oint activities. In some cases such groupings are motivated primaril% b% political or economic concerns7 in others$ militar% ob*ectives are paramount. E-amples of the former include the European Communities &EC'$ actuall% a combination of three main structures the European Coal and Steel Community$ established in 1G0,7 the European Economic Communit% &Common ;ar!et'$ established in 1G0?7 and the European Atomic Ener#y Community &Euratom'$ established in 1G0?. #he Communities 6uic!l% developed e-ecutive machiner% e-ercising significant regulator% and directive authorit% over the governments and private business firms of the member countries. 2lthough each of the member governments retains a substantial measure of sovereignt%$ and a s%stematic effort b% one or more of the governments to resist the authorit% of the Communities] agencies could endanger the whole fabric of cooperative effort$ the Communities have developed significant supranational features. #hese include the staffing of e-ecutive organs with persons other than governmental representatives$ the ma!ing of binding decisions on important matters b% ma*orit% vote$ and the capabilit% of the Communities] agencies to deal directl% and authoritativel% with individuals and companies within the member 1,/ states. >or e-ample$ the high authorit% of the Coal and Steel Communit% acts b% ma*orit% vote of its members$ without instruction from an% of the governments$ to cassure the achievement of the purposes stated in the #reat%c7 and in pursuing this function it involves itself deepl% in the economies of each of the member nations. #he -orth Atlantic Treaty .r#aniIation &"2#O'$ established in 2pril 1G/G$ is an e-ample of a modern militar% alliance endowed with comple- and permanent e-ecutive machiner%$ emplo%ing multilateral procedures$ and involving the continuous elaboration of plans for the conduct of *oint militar% action b% its member states &<elgium$ Canada$ 9enmar!$ >rance$ Ferman%$ Freece$ Iceland$ Ital%$ Du-embourg$ #he "etherlands$ "orwa%$ (ortugal$ Spain$ #ur!e%$ the 8nited Uingdom$ and the 8nited States'. 2s stated in its treat%$ the purpose of "2#O is to maintain the securit% of the "orth 2tlantic area b% e-ercise of the right of collective securit% recogni5ed in the Charter of the 8nited "ations. 2n impressive arra% of institutional mechanisms was established$ including a secretar%general and a permanent staff$ a council$ a militar% command structure$ and liaison staffs7 and an ongoing s%stem of collaboration in planning and *oint militar% e-ercises was brought into being. +ith the continued development of its organi5ation$ "2#O graduall% added a number of economic and cultural activities to its functions until it came to possess several of the features of a multipurpose supranational organi5ation. The 1nited -ation" or#aniIation* 2 supranational political s%stem that does not fit precisel% an% of the conventional classifications of such s%stems is the 1nited -ation"$ a voluntar% association of most of the world]s nationstates. Its membership had grown from an original 01 states to more than 1=0 b% the late ,Hth centur%. &#he government of the (eople]s Cepublic of China was admitted in place of the government of #aiwan in 1G=1.' #he 8nited "ations was founded in 1G/0 at a conference in San >rancisco that was attended b% representatives of all the nations that had declared war on Ferman% or @apan. #he purposes of the organi5ation are declared in its Charter to be the maintenance of international peace and securit%$ the development of friendl% relations among states$ and international cooperation in solving the political$ economic$ social$ cultural$ and humanitarian problems of the world. Its organi5ational structure consists of a Securit% Council of five permanent members &China$ >rance$ Cussia$ the 8nited Uingdom$ and the 8nited States' and 1H nonpermanent members elected for two%ear terms$ a Feneral 2ssembl%$ a secretar%general and a Secretariat$ an Economic and Social Council$ a #rusteeship Council$ and the International Court of @ustice. 2ttached to the 8nited "ations are a number of speciali5ed agencies$ including the >ood and 2griculture Organi5ation$ the International 2tomic Energ% 2genc%$ the International Civil 2viation Organi5ation$ the International Dabour Organisation$ the International ;onetar% >und$ the International #elecommunications 8nion$ the 8niversal (ostal 8nion$ the 8nited "ations Educational$ Scientific and Cultural Organi5ation$ the +orld 3ealth Organi5ation$ and the International <an! for Ceconstruction and 9evelopment &+orld <an!'. 2side from the rather generall% stated and decidedl% elusive aims of the Charter$ the member states of the 8nited "ations cannot be said to have an% common goal$ and the% have often failed to unif% in the face of common e-ternal threats to securit%. #here also has been difficult% in reaching and implementing decisions. #wo different formulas are emplo%ed for voting in the two principal organs$ the Feneral 2ssembl% and the 1,0 Securit% Council. In the Feneral 2ssembl% a twothirds ma*orit% decides on important matters$ but$ since the 2ssembl%]s decisions are not binding and are merel% recommendations$ this 6ualified ma*orit% principle must be viewed as of little significance. 2lthough$ on the other hand$ the decisions of the Securit% Council ma% be binding$ a unanimous vote of all five of the permanent members *oined b% the votes of at least four of the nonpermanent members is re6uired7 whenever important 6uestions of peace and securit% are at sta!e$ it has rarel% been possible to achieve agreement among the five great powers of the council. 2lthough these difficulties might be fatal to the survival of man% supranational organi5ations$ the% are not in fact totall% debilitating for the 8nited "ations. #he 8nited "ations continues to serve as a ver% important forum for international debate and negotiation$ and its speciali5ed agencies pla% an important role in what is sometimes referred to as cthe functional approach to peace.c -ATI.-A) P.)ITICA) SYSTEMS #he term nation0"tate is used so commonl% and %et defined so variousl% that it will be necessar% to indicate its usage in this article with some precision and to give historical and contemporar% e-amples of nationstates. #o begin with$ there is no single basis upon which such s%stems are established. ;an% states were formed at a point in time when a people sharing a common histor%$ culture$ and language discovered a sense of identit%. #his was true in the cases of England and >rance$ for e-ample$ which were the first nationstates to emerge in the modern period$ and of Ital% and Ferman%$ which were established as nationstates in the 1Gth centur%. In contrast$ however$ other states$ such as India$ the Soviet 8nion$ and Swit5erland$ came into e-istence without a common basis in race$ culture$ or language. It must also be emphasi5ed that contemporar% nationstates are creations of different historical periods and of varied circumstances. <efore the close of the 1Gth centur%$ the effective mobili5ation of governmental powers on a national basis had occurred onl% in Europe$ the 8nited States$ and @apan. It was not until the ,Hth centur% and the collapse of the Ottoman$ 3absburg$ >rench$ and <ritish empires that the world could be full% organi5ed on a national basis. #his transformation was completed in 1GG1 with the dissolution of the 8.S.S.C. In 1G,H the Deague of "ations recogni5ed seven nationstates as cFreat (owersc &<ritain$ >rance$ the 8nited States$ Ferman%$ Ital%$ @apan$ and Cussia' and eventuall% admitted more than /H other states to membership7 the 8nited "ations had more than 1=0 member states in the late ,Hth centur%. States in the postCold +ar world include the 8nited States as the preeminent power7 the established powers of <ritain$ >rance$ China$ @apan$ Ferman%$ and Cussia7 emerging powers such as 8!raine and <ra5il7 and a host of old and new states such as 9enmar!$ "amibia$ Ua5a!stan$ Swit5erland$ Eg%pt$ #ur!e%$ ;ala%sia$ and Chile. #he characteristics that 6ualif% these variousl% composed and historicall% differing entities as nationstates and distinguish them from other forms of social and political organi5ation amount in sum to the independent power to compel obedience from the populations within their territories. #he state is$ in other words$ a territorial association that ma% range in si5e from Cussia to Singapore$ in population from China to Du-embourg$ and that claims supremac% over all other associations within its boundaries. 2s an association$ the state is peculiar in several respects: membership is compulsor% for its citi5ens7 it claims a monopol% of the use of armed force within its borders7 and its officers$ who are the government of the state$ claim the right to act in the name of the land and its people. 1,1 2 definition of the state in terms onl% of its powers over its members is not wholl% satisfactor%$ however. 2lthough all states ma!e a claim to supremac% within their boundaries$ the% differ widel% in their abilit% to ma!e good their claims. States are$ in fact$ often challenged b% competing associations within their boundaries7 their supremac% is often more formal than real7 and the% are sometimes unable to maintain their e-istence. ;oreover$ a definition in terms of power alone ignores the fact that there are great differences among states in the structures the% emplo% for the e-ercise of power$ in the wa%s the% use power$ and in the ends to which the% turn their power. Some of these differences are e-plored in the discussion that follows of two general categories of nationstates: the unitar% state and the federal state. (artl% from administrative necessit% and partl% because of the pressures of territorial interests$ nearl% all modern states provide for some distribution of governmental authorit% on a territorial basis. S%stems in which power is delegated from the central government to subnational units and in which the grant of power ma% be rescinded at the will of the central government are termed unitar% s%stems. S%stems in which a balance is established between two autonomous sets of governments$ one national and the other provincial$ are termed federal. In federal s%stems$ the provincial units are usuall% empowered to grant and ta!e awa% the authorit% of their own subunits in the same manner as national governments in unitar% s%stems. #hus$ although the 8nited States is federall% organi5ed at the national level$ each of the 0H states is in a unitar% relationship to the cities and local governments within its own territor%. 1nitary nation0"tate"* 2 great ma*orit% of all the world]s nationstates are unitary "y"tem"$ including <elgium$ <ulgaria$ >rance$ Freat <ritain$ #he "etherlands$ @apan$ (oland$ Comania$ the Scandinavian countries$ Spain$ and man% of the Datin2merican and 2frican countries. #here are great differences among these unitar% states$ however$ specificall% in the institutions and procedures through which their central governments interact with their territorial subunits. In one t%pe of unitar% s%stem$ decentraliIation of power among subnational governments goes so far that in practice$ although not in constitutional principle$ the% resemble federal arrangements. In Freat <ritain$ for e-ample$ there are important elements of regional autonom% in the relationship between "orthern Ireland$ +ales$ and Scotland and the national government in Dondon7 and the comple- s%stem of elected local governments$ although in constitutional theor% sub*ect to abrogation b% (arliament$ is in practice a fi-ed and fairl% formidable part of the apparatus of <ritish government. In other unitar% s%stems of this t%pe$ decentrali5ation on a territorial basis is actuall% provided for constitutionall%$ and the powers of locall% elected officials are prescribed in detail. #hus$ the @apanese constitution$ for e-ample$ specifies certain autonomous functions to be performed b% local administrative authorities. 2 second t%pe of unitar% s%stem ma!es substantiall% less provision for territorial decentrali5ation of authorit% and emplo%s rather strict procedures for the central supervision of locall% elected governments. #he classic e-ample of this t%pe is ?rance. 8ntil ;arch 1G?,$ when a law on decentrali5ation went into effect$ the >rench administrative s%stem was built around dEpartements& each headed b% a prEfet& and subdivisions of the dEpartements& termed arrondissements& each headed b% a sous-prEfet. #he prEfets and sous-prEfets were appointed b% the government in 1,= (aris to serve as agents of the central government and also as the e-ecutives of the divisional governments$ the conseils gEnErau'& which were composed of elected officials. #he s%stem thus combined central supervision of local affairs through appointed officials with territorial representation through locall% elected governments. &>ollowing the passage of the decentrali5ation law$ the e-ecutive powers of the prEfets were transferred to the conseils gEnErau'.' :et a third t%pe of unitar% s%stem provides for onl% to!en decentrali5ation. In such cases$ the officials responsible for managing the affairs of the territorial subdivisions are appointees of the central government$ and the role of locall% elected officers is either minimal or none-istent. E-amples of this !ind of arrangement include Ferman% under 2dolf 3itler and also several formerl% Communist countries. #he #hird Ceich was divided into /, 1aue& each headed b% a gauleiter chosen for his personal lo%alt% to 3itler. In eastern Europe$ the people]s councils or people]s committees were named b% the centrall% organi5ed Communist parties7 their appointment was confirmed b% elections with one slate of candidates. ?ederal "y"tem"* In federal s%stems$ political authorit% is divided between two autonomous sets of governments$ one national and the other subnational$ both of which operate directl% upon the people. 8suall% a constitutional division of power is established between the national government$ which e-ercises authorit% over the whole national territor%$ and provincial governments that e-ercise independent authorit% within their own territories. Of the eight largest countries in the world$ seven2rgentina$ 2ustralia$ <ra5il$ Canada$ India$ Cussia$ and the 8nited Statesare organi5ed on a federal basis. >ederal states also include 2ustria$ Ferman%$ ;ala%sia$ ;e-ico$ "igeria$ Swit5erland$ and Vene5uela. #he governmental structures and political processes found in these federal s%stems show great variet%. One ma% distinguish$ first$ a number of s%stems in which federal arrangements reflect rather clearcut cultural divisions. 2 classic case of this t%pe is SitIerland$ where the people spea! four different languagesFerman$ >rench$ Italian$ and Comanshand the federal s%stem unites ,1 historicall% and culturall% different entities$ !nown as canton" and demicantons. #he Swiss constitution of 1?/?$ as modified in 1?=/$ converted into the modern federal state a confederation originall% formed in the 1.th centur% b% the three forest cantons of 8ri$ Schw%5$ and 8nterwalden. #he principal agencies of federal government are a bicameral legislature$ composed of a "ational Council representing the people directl% and a Council of States representing the constituent members as entities7 an e-ecutive branch &<undesrat' elected b% both houses of the legislature in *oint session7 and a supreme court that renders decisions on matters affecting cantonal and federal relations. #he Ru""ian ?ederation@" arrangements$ although of a mar!edl% different !ind$ also reflect the cultural and linguistic diversit% of the countr%. 9epending on their si5e and on the territories the% have historicall% occupied$ ethnic minorities ma% have their own autonomous republic$ province$ or district. #hese divisions provide var%ing degrees of autonom% in setting local policies and provide a basis for the preservation of the minorities] cultures. Some of these areas were integrated into the Cussian Empire centuries ago$ after the lands were ta!en from the ;ongols of the Folden 3orde$ and others resisted occupation even late in the 1Gth centur%. It is not uncommon for Cussians to constitute a pluralit% of the population in these areas. #he national government 1,? consists of the e-ecutive branch$ led b% the nationall% elected president7 the parliament7 and a *udicial branch that resolves constitutional matters. In other s%stems$ federal arrangements are found in con*unction with a large measure of cultural homogeneit%. #he Con"titution of the 1nited State" delegates to the federal government certain activities that concern the whole people$ such as the conduct of foreign relations and war and the regulation of interstate commerce and foreign trade7 certain other functions are shared between the federal government and the states7 and the remainder are reserved for the states. 2lthough these arrangements re6uire two separate bodies of political officers$ two *udicial s%stems$ and two s%stems of ta-ation$ the% also allow e-tensive interaction between the federal government and the states. #hus$ the election of Congress and the president$ the process of amending the Constitution$ the lev%ing of ta-es$ and innumerable other functions necessitate cooperation between the two levels of government and bring them into a tightl% interloc!ing relationship. S1/-ATI.-A) P.)ITICA) SYSTEMS 2lthough national government is the dominant form of political organi5ation in the modern world$ an e-traordinar% range of political forms e-ists below the national leveltribal communities$ the intimate political associations of villages and towns$ the governments of regions and provinces$ the comple- arra% of urban and suburban governments$ and the great political and administrative s%stems of the cities and the metropolises. #hese subnational entities are$ in a sense$ the basic political communitiesthe foundation on which all national political s%stems are built. Tri%al communitie"* #he t%pical organi5ation of man!ind in its earl% histor% was the tri%e. #oda%$ in man% parts of the world$ the tribal communit% is still a ma*or form of human political organi5ation. Even in advanced s%stems$ traces can still be found of its influence. Some of the .Rnder of modern Ferman%$ such as <avaria$ Sa-on%$ or +estphalia$ have maintained their identit% since the da%s of the Fermanic tribal settlements. In England$ too$ man% count% boundaries can be e-plained onl% b% reference to the territorial divisions in the period after the end of the Coman occupation. In man% 2frican states$ the tribe is still an effective communit% and a vehicle of political consciousness. ;ost of these states are the successors to the administrative units established b% colonial regimes and owe their present boundaries to the often arbitrar% decisions of imperial bureaucracies or to the territorial accommodations of rival colonial powers. #he result was often the splintering of the tribal communities or their aggregation in largel% artificial entities. #ribal lo%alties continue to hamper nationbuilding efforts in some parts of the world where tribes were once the dominant political structure. #ribes ma% act through formal political parties li!e an% other interest group. In some cases the% simpl% act out their tribal bias through the machiner% of the political s%stem$ and in others the% function largel% outside of formal political structures. In its primar% sense$ the tribe is a communit% organi5ed in terms of !in"hip$ and its subdivisions are the intimate !indred groupings of moieties$ gentes$ and totem groups. Its territorial basis is rarel% defined with an% precision$ and its institutions are t%picall% the undifferentiated and intermittent structures of an omnifunctional social s%stem. #he leadership of the tribe is provided b% the group of adult males$ the lineage elders acting as tribal chiefs$ the village headmen$ or the shamans$ or tribal magicians. #hese 1,G groups and individuals are the guardians of the tribal customs and of an oral tradition of law. Daw is thus not made but rather invo!ed7 its repositor% is the collective memor% of the tribal council or chief men. #his !ind of customar% law$ sanctioned and hallowed b% religious belief$ nevertheless changes and develops$ for each time it is declared something ma% be added or omitted to meet the needs of the occasion. Rural communitie"* #he $illa#e has traditionall% been contrasted with the cit%: the village is the home of rural occupations and tied to the c%cles of agricultural life$ while the inhabitants of the cit% practice man% trades$ and its econom% is founded on commerce and industr%7 the village is an intimate association of families$ while the cit% is the locus of a mass population7 the culture of the village is simple and traditional$ while the cit% is the centre of the arts and sciences and of a comple- cultural development. #he village and the cit% offer even sharper contrasts as political communities. 3istoricall%$ the village has been ruled b% the primitive democrac% of facetoface discussion in the village council or b% a headman whose decisions are supported b% village elders or b% other cooperative modes of government7 urban government has never been such a simple matter$ and monarchical$ t%rannical$ aristocratic$ and oligarchic forms of rule have all flourished in the cit%. In the village$ the boundaries among political$ economic$ religious$ and other forms of action have not been as clearl% drawn as in cities. #he origins and development of the apparatus of government can be seen most clearl% in the simple political societ% of the rural communit%. #he transformation of !inbound societies with their informal$ fol!sustained s%stems of sociopolitical organi5ation into differentiated$ hierarchical societies with comple- political structures began with the enlargement of the rural communit%an increase in its population$ the diversification of its econom%$ or its interaction with other communities. #he rudimentar% organs of communal government were then elaborated$ the communal functions received more speciali5ed direction$ and leadership roles were institutionali5ed. #his was sometimes a process that led b% gradual stages to the growth of cities. Elsewhere$ however$ as in the case of ancient 2ttica$ the cit% was established as the result of a process of synoikismos& or the uniting of a number of tribal or village communities. #his was undoubtedl% the origin of 2thens$ and$ according to its legendar% histor%$ Come also was established as a result of the forcible unification of the tribes that dwelt on the hills surrounding the (alatine 3ill. Even in the nationstates of toda%]s world$ the contrasts between the village or the town and the cit% as centres of human activit% are readil% apparent. In the countr%$ life is more intimate$ human contacts more informal$ the structure of societ% more stable. In the cit%$ the individual becomes anon%mous$ the contacts between people are mainl% formal$ and the standing of the individual or the famil% in societ% is sub*ect to rapid change. In man% contemporar% s%stems$ however$ the differences in the forms of government of rural and urban communities appear to be growing less pronounced. In the 8nited States$ for e-ample$ rural institutions have been seriousl% wea!ened b% the movement of large numbers of people to the cit%. #he township meeting of "ew England and other forms of direct citi5en participation in the affairs of the communit% have declined in importance and have often been displaced b% more formal structures and the growth of local governmental bureaucracies. Citie"* 1.H Citie" first emerged as comple- forms of social and political organi5ation in the valle%s of the Euphrates and the #igris$ the "ile$ the 3uang 3o$ and the :angt5e. #hese earl% cities bro!e dramaticall% with the patterns of primitive life and the rural societies from which the% sprang. Uinship as the basis of societ% was replaced b% status determined b% class and occupation7 the primitive magical leaders of the tribe were displaced b% temple priesthoods presiding over highl% developed religious institutions and functioning as important agencies of "ocial control7 earlier s%stems of rule b% the tribal chieftains and the simple forms of communal leadership gave wa% to !ingships endowed with magical powers and important religious functions7 and speciali5ed functionaries in the ro%al courts became responsible for supervising new !inds of governmental activit%. ;an% other developments contributed to the growing centrali5ation of power in these cit% civili5ations. <arter was replaced b% more effective s%stems of e-change$ and the wealth generated in commerce and the speciali5ed cit% trades became both an ob*ect of ta-ation and an instrument of power. Class distinctions emerged as the result of a division of labour and advances in technical development. 2 militar% order and a professional soldier% were created and trained in new techni6ues of warfare$ and a slave class provided the wor! force for largescale pro*ects of irrigation$ fortification$ and ro%al architecture. 2s these developments proceeded$ the cit% was able to pro*ect its power even further into the surrounding countr%side$ to establish its rule over villages and other cities in its sphere$ and finall% to become the centre of such earl% empires as those of Sumeria$ Eg%pt$ China$ <ab%lonia$ 2ss%ria$ and (ersia. 2 ver% different form of cit% life emerged among the Free!s. #he Free! poli" also bro!e with the fol!wa%s of primitive societ%$ but its political development was in stri!ing contrast to the despotism of the Oriental cit% empires and their massive concentrations of power in the hands of !ing and priest. 2s the polis transcended its origins in village life$ the powers of the tribal chief dwindled and passed into the hands of aristocratic families. #he !ingship of 3omeric tradition vanished$ the c!ingsc who remained became mere dignitaries in the religious and ceremonial life of the cit%$ and new magistracies and other civic offices were founded. #hese office" became the focus of factional struggle among the aristocratic families and later$ with the wea!ening of aristocratic rule$ the chief pri5es in a contest of power between the nobilit% and the common citi5ens. Eventuall%$ these developments issued in the characteristic form of Free! cit% government. 2 citi5en bod%$ alwa%s a much narrower group than the total population but often as numerous as the population of freeborn males$ ac6uired power in the direction of the cit% government through the election of its officers and direct participation in the cit% councils. 2lthough often interrupted b% episodes of oligarchic or t%rannical rule and b% periods of civic dissension and class rivalr%$ the main theme of governmental development in the Free! cit% was the elaboration of structures that permitted the control of political affairs b% its citi5ens. 2utonomous cities also sprang up in Europe in the later Middle A#e". ;edieval cit% life$ although it differed from that of the polis and was coloured b% the forms of feudal societ%$ also emphasi5ed the principle of cooperative association. Indeed$ for the first time in the histor% of cit% civili5ation$ the ma*orit% of the inhabitants of the cit% were free. #he development of trades$ the growth of commerce$ and the mobili5ation of wealth emancipated the cit% from its feudal environment$ and the merchant and craft guilds became the matrices of a new !ind of cit% democrac%. In time$ the guilds were transformed into closed corporations and became a basis for oligarchic control7 and the cit%]s independence was threatened b% 1.1 the rise of the new nationstates. #empting targets for the ambition of !ings$ Venice$ Fenoa$ >lorence$ ;ilan$ Cologne$ 2msterdam$ 3amburg$ and other free cities of Europe eventuall% succumbed to monarchical control. #heirs was an important legac%$ however$ for the political order of the medieval cit% was a powerful influence in the development of the constitutional structures of the modern democratic state. 2lthough cities are no longer independent$ the almost universal increase in urban population has made them more important than ever before as centres of human activit%. #he political organi5ation of modern cities differs from countr% to countr%. Even within the same nationstate$ there are often important contrasts in the structures of city #o$ernment. In the 8nited States$ for e-ample$ three principal t%pes of cit% government are usuall% distinguished: the council manager form$ the ma%orcouncil form$ and the commission form. ;ore than half of all 2merican cities with populations between ,0$HHH and ,0H$HHH operate under council manager governments. In council0mana#er "y"tem" the council is generall% small$ elected at large on a nonpartisan ballot for overlapping four%ear terms7 no other offices are directl% elected$ and the ma%or$ who presides at council meetings and performs mainl% ceremonial functions$ is chosen b% the council from among its members. #he manager$ a professional cit% administrator$ is selected b% the council$ serves at the council]s pleasure$ and is responsible for supervising the cit% departments and municipal programs$ preparing the budget$ and controlling e-penditures. ;a%orcouncil governments are found in two basic forms$ the cwea!c ma%or and the cstrongc ma%or. #he former was t%pical of the 1Gthcentur% municipal organi5ation and is now mainl% confined to cities of less than ,0$HHH population7 the latter is a common arrangement in cities with significantl% larger populations. In wea!ma%orcouncil governments$ a number of officials$ elected or appointed for length% terms$ wield important administrative powers7 the council$ t%picall% elected b% divisions of the cit% called wards$ is responsible for the direction of the ma*or cit% agencies7 and the ma%or]s powers of appointment and removal and his control over the cit% budget are severel% limited. In man% cases$ strongma%orcouncil governments evolved from wea!ma%orcouncil s%stems as an independentl% elected ma%or won the power of veto over council ordinances$ strengthened his control over appointment and removal$ and established himself as the cit%]s chief budgetar% officer7 at the same time$ also$ the elective administrative officers and the semi autonomous appointive boards and commissions were often eliminated and the number of councilmen reduced. #he commission plan$ which is now found in fewer than ,HH cities of more than 1H$HHH population$ concentrates legislative and e-ecutive powers in the hands of a small group of commi""ioner". #he commissioners serve individuall% as the heads of administrative departments and choose one of their number to act as a ceremonial ma%or without e-ecutive authorit%. #he variet% in the governmental structures of 2merican cities is paralleled in man% other countries$ for ever%where in the modern world the government of the cit% continues to challenge man]s political invention. 2lthough no longer sovereign$ cities are the centres of modern civili5ation andboth in terms of the services demanded of them and the range and importance of the functions the% e-ercisethe most important of contemporar% subnational political s%stems. ;oreover$ it is in the cities that most of the problems of modern industrial societ% seem to have their focus. #hese problems are not onl% governmental but also technological$ cultural$ and economic. #he% are 1., found in their most acute form in the great metropolitan centres and in that vast urban agglomeration !nown as the megalopolis. In political terms$ the issue that is posed appears to be whether these huge centres of population can continue as effective communities with democraticall% manageable governments. Re#ion"* In man% contemporar% national political s%stems the forces of histor% and administrative necessit% have *oined to produce regional communities at an intermediate level between the local and the national communit%. In some casesthe Swiss canton$ the English count%$ the Ferman .and& and the 2merican statethese regional communities possess their own political institutions and e-ercise governmental functions. In other cases$ however$ the territorial communit% is a product of ethnic$ cultural$ linguistic$ ph%siographic$ or economic factors and maintains its identit% without the support of political structures. 2s subnational political s%stems$ regional communities are sometimes based in tradition$ even tracing their origin to a period prior to the founding of the nation7 in other cases$ the% are modern administrative units created b% national governments for their own purposes. E-amples of both t%pes ma% be found in the histor% of regionalism in >rance and its comple- pattern of internal territorial divisions. <efore the >rench Cevolution$ >rance was divided into ancient provinces<urgund%$ Fascon%$ <rittan%$ "ormand%$ (rovence$ 2n*ou$ (oitou$ and others. 2fter the Cevolution$ in what seems to have been an effort to discourage regional patriotism and threats of separatism$ the "apoleonic government superimposed a new regional structure of dEpartements on the old provincial map. ;ore than a centur% and a half later$ in the era of rapid communications and national economic planning$ the >rench national government announced a regrouping of the "apoleonic dEpartements into much larger Faullist rEgions. Cecogni5ing$ perhaps$ the continuing strength of the provincial attachments of Fascon$ <reton$ "orman$ and (rovenzal and the survival of old regional fol! cultures with their distinctive patterns of speech$ the new rEgions were given boundaries similar in man% cases to the traditional provincial boundaries of pre republican >rance. #he histor% of the >rench regional communities is not a special case$ for political$ administrative$ economic$ and technical forces have led man% other national governments to replace traditional territorial divisions with new regional units. In England$ for e-ample$ the traditional structure of count% governments &0, in number' was replaced b% a s%stem of administrative counties &11 plus Dondon'7 and$ in 1G1G$ a ro%al commission proposed a further reform that would abolish .G counties. 2ttempts have also been made to use older regional communities as the infrastructure for new s%stems of regional government. #hus$ the Italian constitution provides for semiautonomous government in five special regionsValle d]2osta$ Sardinia$ Sicil%$ #rentino2lto 2dige$ and >riuliVene5ia Fiuliawhich$ in different wa%s$ are historicall% distinct from the rest of Italy. In %et other cases the fear of competition from regional governments or of separatist movements has led national governments to ma!e various efforts to resist the development of regional political structures. 2gain$ Ital% provides a convenient e-ample$ for its constitution re6uires the establishment of 1/ other autonomous regions$ but Italian governments refused to implement this provision of the 1G/= constitution until recentl%. It should be noted that the Italian republic of 1?=H1G,, and its >ascist successor state also made similar efforts to combat regional political development$ the former b% the creation of a large number of administrative provinces and the latter b% establishing 1.. corpora)ione to represent occupations regardless of geographic location. In several modern states the growth of vast conurbations and the rise of the megalopolis have prompted the development of new !inds of regional governmental structures. #he (ort of Dondon 2uthorit%$ the (ort of "ew :or! 2uthorit%$ and the San >rancisco <a% 2rea #ransit 2uthorit% are e-amples of regional s%stems designed to serve the needs of urban communities that have outgrown the boundaries of e-isting cit% governments. "ew regional structures have also resulted from the increased responsibilit% of national governments for the administration of comprehensive social and economic programs. #he #ennessee Valle% 2uthorit%$ for e-ample$ is both a national agenc% and a regional government whose decisions affect the lives of the inhabitants of all the states and cities in its sphere. Other e-amples of new regional administrative structures include the 5onal councils established in India for social and economic planning purposes$ the districts of the Interstate Commerce Commission in the 8nited States$ and the governmental and economic units established in <ritain to deal with the problems of industriall% depressed areas. ISS1ES .? C)ASSI?ICATI.- Type" of cla""ification "cheme"* #he almost infinite range of political s%stems has been barel% suggested in this brief review. Confronted b% the vast arra% of political forms$ political scientists have attempted to classif% and categori5e$ to develop t%pologies and models$ or in some other wa% to bring anal%tic order to the bewildering variet% of data. ;an% different schemes have been developed. #here is$ for e-ample$ the classical distinction between governments in terms of the number of rulersgovernment b% one man &monarch% or t%rann%'$ government b% the few &aristocrac% or oligarch%'$ and government b% the man% &democrac%'. #here are schemes classif%ing governments in terms of their !e% institutions &for e-ample$ parliamentarism$ cabinet government$ presidentialism'. #here are classifications that group s%stems according to basic principles of political authorit% or the forms of legitimac% &charismatic$ traditional$ rationallegal$ and others'. Other schemes distinguish between different !inds of economic organi5ation in the s%stem &the laisse5faire state$ the corporate state$ and Socialist and Communist forms of state economic organi5ation' or between the rule of different economic classes &feudal$ bourgeois$ and capitalist'. 2nd there are modern efforts to compare the functions of political s%stems &capabilities$ conversion functions$ and s%stem maintenance and adaptation functions' and to classif% them in terms of structure$ function$ and political culture. 2lthough none is comprehensive$ each of these principles of anal%sis has some validit%$ and the classif%ing schemes that are based on them$ although in some cases no longer relevant to modern forms of political organi5ation$ have often been a ma*or influence on the course of political development. #he most influential of such classif%ing schemes is undoubtedl% the attempt of Plato and Ari"totle to define the basic forms of government in terms of the number of power holders and their use or abuse of power. (lato held that there was a natural succession of the forms of government: an aristocrac% &the ideal form of government b% the few' that abuses its power develops into a timocrac% &in which the rule of the best men$ who value wisdom as the highest political good$ is succeeded b% the rule of men who are primaril% concerned with honour and martial virtue'$ which through greed develops into an oligarch% &the perverted form of government b% the few'$ which in turn is succeeded b% a democrac% &rule b% the man%'7 through e-cess$ the democrac% becomes an anarch% &a lawless government'$ to which a t%rant is 1./ inevitabl% the successor. 2buse of power in the (latonic t%polog% is defined b% the rulers] neglect or re*ection of the prevailing law or custom & nomos'7 the ideal forms are thus nomos observing &ennomon'$ and the perverted forms are nomos neglecting ¶nomon'. 2lthough disputing the character of this implacable succession of the forms of government$ 2ristotle also based his classification on the number of rulers and distinguished between good and bad forms of government. In his t%polog% it was the rulers] concern for the common good that distinguished the ideal from perverted forms of government. #he ideal forms in the 2ristotelian scheme are monarch%$ aristocrac%$ and polit% &a term conve%ing some of the meaning of the modern concept of cconstitutional democrac%c'7 when perverted b% the selfish abuse of power$ the% are transformed respectivel% into t%rann%$ oligarch%$ and ochlocrac% &or the mob rule of lawless democrac%'. #he concept of the polit%$ a cmi-edc or blended constitutional order$ fascinated political theorists for another millennium. #o achieve its advantages$ innumerable writers from (ol%bius to St. #homas 26uinas e-perimented with the construction of models giving to each social class the control of appropriate institutions of government. 2nother ver% influential classif%ing scheme was the distinction between monarchies and republics. In the writings of ;achiavelli and others$ the tripartism of classical t%pologies was replaced b% the dichotom% of princel% and republican rule. So$erei#nty in the monarch% or the principalit% is in the hands of a single ruler7 in republics$ sovereignt% is vested in a pluralit% or collectivit% of power holders. Ceducing aristocrac% and democrac% to the single categor% of republican rule$ Machia$elli also laid the basis in his anal%sis of the e-ercise of princel% power for a further distinction between despotic and nondespotic forms of government. In the wor! of ;ontes6uieu$ for e-ample$ despotism$ or the lawless e-ercise of power b% the single ruler$ is contrasted with the constitutional forms of government of the monarch% and the republic. 2s a result of the decline of monarchies and the rise of new totalitarian states terming themselves republics$ this traditional classification is now$ of course$ of little more than historical interest. Modern cla""ifyin# "y"tem"* #he usefulness of all the traditional classifications has been undermined b% the momentous changes in the political organi5ation of the modern world. #%pologies based on the number of power holders or the formal structures of the state are rendered almost meaningless b% the standardi5ation of cdemocraticc forms$ the deceptive similarities in the constitutional claims and governmental institutions of regimes that actuall% differ mar!edl% in their political practices$ and the rise of new political orders in the non+estern world. 2 number of modern writers have attempted to overcome this difficult% b% constructing classif%ing schemes that give primar% importance to social$ cultural$ economic$ or ps%chological factors. #he most influential of such schemes is the ;ar-ist t%polog%$ which classifies t%pes of rule on the basis of economic class divisions and defines the ruling class as that which controls the means of production in the state. 2 monistic t%polog% that also emphasi5ed the importance of a ruling class was developed b% an Italian theorist of the earl% ,Hth centur%$ :aetano Mo"ca. In ;osca]s writings all forms of government appear as mere facades for oligarch% or the rule of a political celitec that centres power in its own hands. 2nother classification$ which distinguishes between clegitimatec and crevolutionar%c governments$ was suggested b% ;osca]s contemporar% Fuglielmo >errero. 8sing a sociops%chological approach to the 1.0 relations between rulers and ruled$ >errero held that a legitimate government is one whose citi5ens voluntaril% accept its rule and freel% give it their lo%alt%7 in revolutionar% s%stems$ the government fears the people and is feared b% them. Degitimac% and leadership are also the basis of a t%polog% developed b% the Ferman sociologist MaB We%er. In +eber]s scheme there are three basic t%pes of rule: charismatic$ in which the authorit% or legitimac% of the ruler rests upon some genuine sense of calling and in which the followers submit because of their faith or conviction in the ruler]s e-emplar% character7 traditional$ in which$ as in hereditar% monarch%$ leadership authorit% is historicall% or traditionall% accepted7 and rationallegal$ in which leadership authorit% is the outgrowth of a legal order that has been effectivel% rationali5ed and where there is a prevailing belief in the legalit% of normative rules or commands. #he +eberian t%polog% has been elaborated b% a number of recent writers who have found it particularl% useful for comparing and classif%ing the emergent political orders of the non+estern world. 2 serviceable classification of political s%stems must penetrate beneath formal appearances to underl%ing realities7 these realities$ however$ do not consist onl% of the facts of social and economic organi5ation. Important differences often e-ist between political s%stems having ver% similar socioeconomic structures. #hat is wh% some recent sociological classifications and schemes of anal%sis fail as tools of political in6uir%: the% cannot effectivel% distinguish between certain societies whose political orders are full of contrasts. #he political s%stem itself must be the primar% focus of in6uir% and the phenomena of politics the principal facts of investigation. Such an approach ma% involve man% different !inds of anal%sis$ but it must begin with an e-amination of the wa%s in which power is ac6uired and transferred$ e-ercised$ and controlled. #his is important for comparing advanced political orders and also for drawing important distinctions between regimes in the underdeveloped areas of the world. :.VER-ME-TS C)ASSI?IED /Y M.DE .? S1CCESSI.- 2 !e% problem of all political orders is that of succession. c#he !ing is dead7 long live the !ingc was the answer$ not alwa%s uncontested$ of European hereditar% monarch% to the 6uestion of who should rule after the death of the !ing. 2 second$ closel% related problem is in what manner and b% whom a present ruler ma% be replaced or deprived of power. #o this second 6uestion hereditar% monarch% gave no definite answer$ although the concept of diffidatio& or the severance of the bond of allegiance between !ing and feudal lord$ was invo!ed more than once in the medieval period. (olitical s%stems$ even those of primitive tribal societies$ have approached both problems in a variet% of wa%s. 2nthropological records show that tribal chiefs or !ings were sometimes selected as a result of ritual tests or the displa% of magical signs and proofs of divine origin$ usuall% as determined b% the tribal elders or magical leaders7 in other cases$ a principle of heredit%$ often diluted b% a choice among heirs in terms of ph%si6ue or warrior abilit%$ was applied7 in still other cases$ the chief was elected$ often from among the adult males of a select group of families. #echni6ues for the removal of tribal rulers were e6uall% varied. Sometimes the ruler would be !illed after a specified period or when his magical powers wea!ened or when his ph%sical prowess or health failed7 in other cases the chief was e-posed to periodic tests of his magical powers or re6uired to accept challenges to combat from other 6ualified candidates for rule7 and in some cases the elders could remove him from office. #echni6ues for assuring the succession are also varied in the modern world. Succession procedures range from the comple- hieratic process of identif%ing a 1.1 reincarnated 9alai Dama$ which was practiced until 6uite recentl% in #ibet$ to the subtle$ informal procedures b% which parliamentar% ma*orities choose a successor to the office of prime minister in <ritain. In fact$ however$ the succession practices of modern political s%stems appear to be of four main t%pes: &1' heredit%$ &,' constitutional prescription$ &.' election$ and &/' force. ,ereditary "ucce""ion* 2lthough dictators still occasionall% see! to establish their sons as their heirs$ the% usuall% rel% on force rather than the claims of heredit% to achieve their ob*ect. 2part from a few states$ mostl% in the 2rab world$ where the d%nastic ruler is the effective head of the government$ the hereditar% principle of succession is now almost e-clusivel% confined to the constitutional monarchies of western Europe. #here is some iron% in the fact that the line of succession is more securel% established in these monarchies now than at an% point in their earlier histor%: intrad%nastic struggle$ it appears$ is much less li!el% when !ingship is mainl% ceremonial. 3eredit% ma% be reinforced or modified b% constitutional prescription: this was the case$ for e-ample$ of the famous 2ct of Settlement that secured the 3anoverian succession in <ritain. Succe""ion %y con"titutional pre"cription* 2 leading e-ample of succession b% constitutional prescription is the 8nited States. 2rticle II$ Section 1$ of the Constitution of the 8.S. provides: In case of the removal of the Pre"ident from office$ or of his death$ resignation$ or inabilit% to discharge the powers and duties of the said office$ the same shall devolve on the Vice (resident$ and the Congress ma% b% law provide for the case of removal$ death$ resignation$ or inabilit%$ both of the (resident and Vice (resident$ declaring what officer shall then act as (resident$ and such officer shall act accordingl%$ until the disabilit% be removed$ or a (resident shall be elected. 2 constitutional amendment was ratified in 1G1= elaborating these procedures to include further arrangements for dealing with the problem of presidential disabilit%. #he original language of the Constitution has been the basis for the peaceful succession of Vice (residents @ohn #%ler$ ;illard >illmore$ 2ndrew @ohnson$ Chester 2rthur$ #heodore Coosevelt$ Calvin Coolidge$ 3arr% S. #ruman$ and D%ndon @ohnson. Constitutionall% prescribed arrangements for assuring the succession are not alwa%s so successful$ and man% states whose constitutions contain ver% similar provisions have e-perienced succession crises that were resolved onl% b% violence. Succe""ion %y election* Election is a principle of succession also fre6uentl% combined with force. In cases of closel% contested elections or where there is doubt as to the validit% or proper form of the election$ the result is often a disputed succession. #he Freat Schism in the papac% in the 1/th centur% and the disputed succession to the elective !ingship of 3ungar% in the 11th centur% are e-amples of the failure of elective s%stems to assure an orderl% succession. >orce is the effective basis of succession in several contemporar% states in which pro forma electoral confirmation is given to a ruler who sei5es power. #he problem of succession imposes great 1.= strains on an% political order: the continuit% of rule is bro!en$ established patterns of action are interrupted$ and the future suddenl% becomes uncertain. #his political crisis tests the character of regimes in wa%s that are of some importance for comparative political anal%sis. 2 number of interesting comparisons ma% be drawn from the stud% of succession practices$ but perhaps the most important is the distinction between those s%stems in which the problem is resolved primaril% b% force and those s%stems in which heredit%$ constitutional prescription$ or election assure a peaceful and orderl% succession. (olitical orders are sub*ected to another !ind of strain when the rule of their present power holders is challenged and the 6uestion arises of depriving them of authorit%. #his is the problem of the transfer of power: whether$ in what wa%$ and b% whom a present ruler ma% be displaced. Di!e succession$ it is a recurrent problem in all political s%stems$ and$ as in the case of succession practices$ the wa%s in which political s%stems respond to the strains involved offer important clues to their character. It is$ in a sense$ the fundamental political crisis$ for all s%stems are in some wa% sha!en$ often violentl%$ sometimes to the point of destruction$ b% the struggles between established rulers and their rivals. Succe""ion %y force*
Re$olution"$ which are the result of the crisis in its most e-treme form$ involve the overthrow not merel% of the government but of the political order itself. #%picall%$ a revolution is preceded b% a series of strains within the s%stem: challenges to the authorit% of the government mount$ and its legitimac% is increasingl% 6uestioned7 the e-ercise of power becomes coercive$ and the challenge to rule assumes ever more violent forms7 eventuall%$ the struggle comes to a dramatic clima- in the destruction of the old order. #he coup d@etat is another form of violent response to the crisis of rule$ but it is distinguished from the revolution in that it involves the overthrow onl% of the government: the political order is not immediatel% affected$ for the coup is managed b% an individual or group within the government or within the ruling class. In some cases$ however$ the coup d]etat is merel% a preliminar% stage to revolution. Sometimes this happens when the new ruler leads a governmentall% imposed revolution: this was the role pla%ed b% "apoleon I$ "apoleon III$ ;ussolini$ and 3itler. 2t other times$ coups are actuall% prompted b% fear of revolution but succeed onl% in further wea!ening the claims to legitimac% of the e-isting order: this has recentl% been the case in some countries in the non+estern world where conservativeled coups were 6uic!l% overthrown b% revolutionar% movements. In addition to revolutions and coups d]etat$ the crisis of rule ma% prompt other forms of violent political reaction$ including civil war and secession$ resistance movements and rebellions$ guerrilla warfare and terrorism$ class warfare$ and peasant revolts. #he causes of internal conflict leading to the forcible overthrow of governments are e-tremel% varied. #he% include tensions created b% rapid social and economic development7 the rise of new social classes and the refusal of established elites to share their power7 problems of the distribution of wealth and the grievances of different economic groups and interests7 the rise of corrosive social and political philosophies and the estrangement of intellectuals7 conflict of opinions over the ends of government7 factional struggles among power holders or within the ruling class7 the rise of a charismatic leader7 oppressive rule that alienates powerful groups7 wea! rule that tolerates antigovernmental or revolutionar% movements7 and man% different combinations of these and other social$ economic$ and political factors. 2ll political s%stems e-perience some of these conditions with some fre6uenc%. :et 1.? there are a number of modern states that have avoided internal wars and the forcible overthrow of their governments for considerable periods. It appears that rulers in the contemporar% world are generall% safe from violent challenges if the% possess an effective monopol% of militar%$ economic$ and political power$ lin!ed with certain important social controls7 or$ alternativel%$ if the% are obliged to e-ercise limited powers for specified periods and are re6uired to %ield office to rivals who meet certain 6ualifications. #he first is the definition of a modern totalitarian regime$ full% and efficientl% organi5ed7 the second describes the governments of several contemporar% constitutional democracies. In the first case$ the government secures itself b% force combined with social and ps%chological means of preventing the formation of opposition. In the second case$ alternatives to internal war are provided b% the opportunities for oppositions to influence the e-ercise of power and ultimatel% to replace the government. #he great achievement of constitutional democrac% has been to give reasonable securit% to governments from forcible overthrow b% compelling them to accept limitations on their power$ b% re6uiring them to forgo the use of force against rivals who agree to accept the same limitations$ and b% establishing well!nown legal procedures through which these rivals ma% themselves constitute the government. Autocratic $er"u" nonautocratic rule* #he foregoing discussion has suggested a distinction among political s%stems in terms of the role pla%ed b% force in the ac6uisition and transfer of power. #he role of force is vital$ also$ in distinguishing among political s%stems in terms of the e-ercise and control of power. 3ere the contrast is essentiall% between cautocraticc and cnonautocraticc governments$ for totalitarianism is onl% a recent species of autocrac%$ to which constitutionalism is the principal contemporar% antithesis. Autocracy is characteri5ed b% the concentration of power in a single centre$ be it an individual dictator or a group of power holders such as a committee or a part% leadership. #his centre relies on force to suppress opposition and to limit social developments that might eventuate in opposition. #he power of the centre is not sub*ect to effective controls or limited b% genuine sanctions: it is absolute power. In contrast$ nonautocratic government is characteri5ed b% the e-istence of several centres$ each of which shares in the e-ercise of power. "onautocratic rule allows the development of social forces that generate a variet% of interests and opinions. It also sub*ects the power holders to reciprocal controls and to effective sanctions of law. In appearance$ autocrac% ma% sometimes be difficult to distinguish from nonautocratic rule. Often$ autocracies attempt to borrow legitimac% b% adopting the language of the constitutions of nonautocratic regimes or b% establishing similar institutions. It is a common practice$ for e-ample$ in man% modern totalitarian states to establish institutionsparliaments or assemblies$ elections and parties$ courts and legal codesthat differ little in appearance from the institutional structures of constitutional democracies. Similarl%$ the language of totalitarian constitutions is often couched in terms of the doctrines of popular rule or democrac%. #he difference is that in totalitarian regimes neither the institutions nor the constitutional provisions act as effective chec!s on the power of the single centre: the% are essentiall% facades for the e-ercise of power through hierarchical procedures that sub*ect all the officials of the state to the commands of the ruling individual or group. #he underl%ing realities of autocratic rule are alwa%s the concentration of power in a single centre and the mobili5ation of force to prevent the emergence of 1.G opposition. Totalitariani"m$ as alread% noted$ has been a chief form of autocratic rule7 it is distinguished from previous forms in its use of state power to impose an official ideolog% on its citi5ens. "onconformit% of opinion is treated as the e6uivalent of resistance or opposition to the government$ and a formidable apparatus of compulsion$ including various !inds of state police or secret police$ is !ept in being to enforce the orthodo-% of the proclaimed doctrines of the state. 2 single part%$ centrall% directed and composed e-clusivel% of lo%al supporters of the regime$ is the other t%pical feature of totalitarianism. #he part% is at once an instrument of social control$ a vehicle for ideological indoctrination$ and the bod% from which the ruling group recruits its members. In the modern world$ constitutional democracy is the chief t%pe of nonautocratic government. #he minimal definition in institutional terms of a constitutional democrac% is that it should provide for a regulari5ed s%stem of periodic elections with a free choice of candidates$ the opportunit% to organi5e competing political parties$ adult suffrage$ decisions b% ma*orit% vote with protection of minorit% rights$ an independent *udiciar%$ constitutional safeguards for basic civil liberties$ and the opportunit% to change an% aspect of the governmental s%stem through agreed procedures. #wo features of constitutional democrac% re6uire emphasis in contrasting it with modern totalitarian government: the constitution$ or basic law$ and the political part%. 2 constitution$ as the e-ample of <ritish con"titutional democrac% suggests$ need not be a single written instrument7 indeed$ the essence of a constitution is that it formali5es a set of fundamental norms governing the political communit% and determining the relations between the rulers and the people and the interaction among the centres of power. In most modern constitutional democracies$ however$ there is a constitutional document providing for fi-ed limitations on the e-ercise of power. #hese provisions usuall% include three ma*or elements: an assignment of certain specified state functions to different state organs or offices$ the delimitation of the powers of each organ or office$ and the establishment of arrangements for their cooperative interaction7 a list of individual rights or liberties that are protected against the e-ercise of state power7 and a statement of the methods b% which the constitution ma% be amended. +ith these provisions a concentration of power in the hands of a single ruler is prevented$ certain areas of political and social life are made immune to governmental intervention$ and peaceable change in the political order is made possible. #he political party is the other chief instrument of constitutional democrac%$ for it is the agenc% through which the electorate is involved in both the e-ercise and transfer of power. In contrast with the centrali5ed$ autocratic direction of the totalitarian singlepart% organi5ation$ with its emphasis on ideological conformit% and restricted membership$ the political parties of constitutional democrac% are decentrali5ed$ concerned with the integration of man% interests and beliefs$ and open to public participation. In constitutional democracies there is usuall% some measure of competition among two or more parties$ each of which$ if it cannot hope to form a future government$ has some abilit% to influence the course of state action. #he part% in a constitutional democrac% is at once a means of representing a mass electorate in the e-ercise of power and also a device for allowing the peaceful replacement of one set of power holders with another. #he distinction between autocratic and nonautocratic rule should not conceal the e-istence of intermediate t%pes that combine elements of both. In these cases$ also$ the best procedure for comparative purposes is to investigate the power configurations underl%ing the formal structures and to e-amine the e-tent to which power is concentrated in a single centre or the role that is pla%ed b% force in the 1/H maintenance of the regime. It is a t%pe of anal%sis that$ b% guiding attention to the relative weight of coercive and consensual power and the scope of individual freedom in the political order$ allows comparisons between s%stems in terms of their most important attributes. :.VER-ME-TS C)ASSI?IED /Y STA:E .? DEVE).PME-T AnalyIin# political chan#e*
(olitical life is shaped b% a wide variet% of factors$ including social and cultural conditions$ economic organi5ation$ intellectual and philosophical influences$ geograph% or climate$ and historical circumstance. Cecurrent attempts have been made to reduce this range of variables to anal%ticall% manageable dimensions. #his is partl% the motive$ for e-ample$ of ;ar-ist and other efforts to relate specific t%pes of political s%stems to stages of economic development or particular !inds of socioeconomic organi5ation. 2lthough interesting interrelations between political and economic development have been discovered$ such monistic$ or singlefactor$ approaches are inade6uate to the tas! of e-plaining political change. #he problem is not onl% that there are man% factors that should be e-amined but also that the% are found in different combinations from one societ% to another. 2ll political orders are uni6ue as products of histor% and creations of the peculiar forces and conditions of their environment. 2 second problem that confronts comparative anal%sis is the difficult% of devising measures of political development. #he definition of what is modern or what constitutes an advanced or developed political s%stem has troubled man% recent writers. Clearl%$ the older notions of development toward the goals of constitutionalism or democrac% must now be seriousl% 6uestioned$ and to *udge the maturit% of a political s%stem in terms of the e-tent to which it adopts an% particular set of institutions or techni6ues of rule is an e6uall% doubtful procedure. 2nother difficult% is that political change is not simpl% a reaction to cob*ectivec factors such as economic forces but also the product of conscious manipulation. In e-plaining the growth and development of political s%stems it is impossible to ignore the fact that men$ having considered the advantages and disadvantages of different forms of government$ often decide to adopt one form rather than another. 2 similar problem arises from the fact that the nature of the interaction between political s%stems and their environment is e-tremel% comple-. >or e-ample$ to treat the political s%stem as merel% the outgrowth of particular patterns of social or economic organi5ation is to ignore the fact that changes in social and economic structures are often the product$ sometimes the intended product$ of governmental action. Emer#ence of ad$anced nation0"tate"* #hese difficulties of anal%sis have prevented the emergence of an% satisfactor% theor% to e-plain the processes of political change or growth. In the absence of such a theor%$ however$ several writers have recentl% attempted to identif% certain basic phases in the development of national political s%stems. >or e-ample$ five ma*or steps in the emergence of the advanced nationstates of the modern world are often distinguished: &1' unification and independence or autonom%7 &,' development and differentiation of political institutions and political roles7 &.' transfer 1/1 of power from traditional elites7 &/' further institutional and political role differentiation accompanied b% the development of a number of organi5ed social interests and growth in governmental functions7 and &0' use of state power in attempts to guide or control social and economic activit%$ e-tensive e-ploitation of resources as the result of technological development$ and full participation in the international political s%stem. Other writers distinguish among ctraditional$c ctransitional$c and cmodernc societies in an effort to identif% differences and regularities in social$ economic$ cultural$ and political development. #he social structure of the traditional societ% is described as hierarchical$ class bound$ based on !inship$ and divided into relativel% few effectivel% organi5ed social groupings7 its economic basis is primaril% agricultural$ and industr% and commerce are relativel% undeveloped7 its political institutions are those of sacred monarch%$ rule b% a nobilit%$ and various forms of particularism. #he social s%stem of the transitional societ% is t%pified b% the formation of new classes$ especiall% a middle class and a proletariat$ and conflict among ethnic$ religious$ and cultural groupings7 its economic s%stem e-periences ma*or tensions as the result of technological development$ the growth of industr%$ urbani5ation$ and the use of rapid communications7 its political institutions are t%picall% authoritarian$ although constitutional forms also ma!e their appearance. ;odernit% is seen as the age of high social mobilit%$ e6ualit%$ universal education$ mass communications$ increasing secularism$ and sociocultural integration7 in its economic s%stem$ the modern societ% e-periences a further technological revolution$ massive urbani5ation$ and the development of a full% diversified econom%7 its political institutions are those of democrac% and modified totalitarianism$ and$ in either case$ a speciali5ed bureaucrac% is used to carr% on the e-panding functions of government. #hese efforts to identif% stages of cmoderni5ationc are poor substitutes for a general theor% of political change$ but the% serve to emphasi5e the increasing comple-it% of all the structuressocial$ economic$ and politicalof the modern state. #he elaboration of the institutions and procedures of modern government appears to be partl% a reflection of the social and economic forces at wor! in the contemporar% world and partl% the result of efforts to control these forces through governmental action. #he comple- structures of advanced political orders are treated in the discussion that follows. ,he structure of government #he stud% of governmental structures must be approached with great caution$ for political s%stems having the same !ind of legal arrangements and using the same t%pe of governmental machiner% often function ver% differentl%. 2 parliament$ for e-ample$ ma% be an important and effective part of a political s%stem7 or it ma% be no more than an institutional facade of little practical significance. 2 constitution ma% provide the framewor! within which the political life of a state is conducted7 or it ma% be no more than a piece of paper$ its provisions bearing almost no relationship to the facts of political life. (olitical s%stems must never be classified in terms of their legal structures alone: the fact that two states have similar constitutions with similar institutional provisions and legal re6uirements should never$ b% itself$ lead to the conclusion that the% represent the same t%pe of political s%stem. #o be useful$ the stud% of governmental structures must alwa%s proceed hand in hand with an investigation of the actual facts of the political process: the anal%st must e-ercise the greatest care in 1/, distinguishing between form and realit% and between prescription and practice. 2pproached in this wa%$ an e-amination of the organi5ational arrangements that governments use for ma!ing decisions and e-ercising power can be a valuable tool of political in6uir%. C.-TEMP.RARY ?.RMS .? :.VER-ME-T
>ew states in the modern world have constitutional arrangements that are more than a centur% old. Indeed$ the vast ma*orit% of all the world]s states have constitutions written in the ,Hth centur%. #his is true of states$ such as Ferman%$ Ital%$ and @apan$ that were defeated in +orld +ar II and of other states$ such as the successor states of the Soviet 8nion$ Spain$ and China$ that have e-perienced civil war and revolutions in the course of the centur%. Freat <ritain and the 8nited States are almost alone among ma*or contemporar% nationstates in possessing constitutional arrangements that predate the ,Hth centur%. Even in <ritain and the 8nited States$ the ,Hth centur% has seen much change in the governmental s%stem. In the 8nited States$ for e-ample$ the relationship of legislature and e-ecutive at both the national and the state levels has been significantl% altered b% the growth of bureaucracies and the enlargement of the e-ecutive]s budgetar% powers. In <ritain$ even more farreaching changes have occurred in the relationship between the prime minister and (arliament and in (arliament]s role in supervising the e-ecutive establishment. In both countries$ the appearance of the welfare state$ the impact of modern technolog% on the econom%$ and international crises have resulted in ma*or alterations in the wa%s in which the institutions of government function and interact. #he modern student of constitutional forms and institutional arrangements confronts an endlessl% changing world. In man% parts of the world$ in countries as different as >rance$ (a!istan$ 2rgentina$ and #an5ania$ there have been continuing e-periments with new constitutions. #he adoption of new constitutions is also a ma*or aspect of political change in almost all of the states of eastern Europe and in the successor states of the Soviet 8nion. 2ll s%stems$ moreover$ even without formal constitutional change$ undergo a continual process of ad*ustment and mutation as their institutional arrangements respond to and reflect changes in the social order and the balance of political forces. Monarchy*
#he ancient distinction among monarchie"$ t%rannies$ oligarchies$ and constitutional governments$ li!e other traditional classifications of political s%stems$ is no longer ver% descriptive of political life. 2 !ing ma% be a ceremonial dignitar% in one of the parliamentar% democracies of western Europe$ or he ma% be an absolute ruler in one of the emerging states of "orth 2frica$ the ;iddle East$ or 2sia. In the first case his duties ma% be little different from those of an elected president in man% republican parliamentar% regimes7 in the second his role ma% be much the same as that of countless dictators and strongmen in autocratic regimes throughout the less developed areas of the world. It ma% be said of the reigning d%nasties of modern Europe that the% have survived onl% because the% failed to retain or to ac6uire effective powers of government. Co%al lines have been preserved onl% in 1/. those countries of Europe in which ro%al rule was severel% limited prior to the ,Hth centur% or in which ro%al absolutism had never firml% established itself. ;ore successful d%nasties$ such as the 3ohen5ollerns in Ferman%$ the 3absburgs in 2ustria3ungar%$ and the Comanovs in Cussia$ which continued to rule as well as to reign at the opening of the ,Hth centur%$ have paid with the loss of their thrones. #oda% in countries such as Freat <ritain or #he "etherlands or 9enmar! the monarch is the ceremonial head of state$ an indispensable figure in all great official occasions and a s%mbol of national unit% and of the authorit% of the state$ but is almost entirel% lac!ing in power. ;onarch% in the parliamentar% democracies of modern Europe has been reduced to the status of a dignified institutional facade behind which the functioning mechanisms of governmentcabinet$ parliament$ ministries$ and parties go about the tas!s of ruling. #he ,Hth centur% has also seen the demise of most of the hereditar% monarchies of the non+estern world. #hrones have toppled in #ur!e%$ in China$ in most of the 2rab countries$ in the principates of India$ in the tribal !ingdoms of 2frica$ and in several countries of Southeast 2sia. #he !ings who maintain their position do so less b% the claim of legitimate blood descent than b% their appeal as popular leaders responsible for wellpublici5ed programs of national economic and social reform or as national militar% chieftains. In a sense$ these !ings are less monarchs than monocrats$ and their regimes are little different from several other forms of oneman rule found in the modern world. Dictator"hip* +hile ro%al rule$ as legitimi5ed b% blood descent$ had almost vanished as an effective principle of government in the modern world$ monocrac%a term that comprehends the rule of the remaining non+estern ro%al absolutists$ of the generals and strongmen of Datin 2merica and 2sia$ of the messianic leaders of postcolonial 2frica$ and of the totalitarian heads of Communist statesstill flourished. Indeed$ the ,Hth centur%$ which has witnessed the careers of 2tatlr!$ <enito ;ussolini$ 2dolf 3itler$ @oseph Stalin$ >rancisco >ranco$ ;ao #setung$ @uan (er{n$ #ito$ Famal 2bdel "asser$ Su!arno$ Uwame "!rumah$ and Charles de Faulle$ could appear in histor% as the age of plebiscitar% dictatorship. In man% of the states of 2frica and 2sia$ for e-ample$ dictators 6uic!l% established themselves on the ruins of constitutional arrangements inherited from +estern colonial powers. In some of these countries$ presidents and prime ministers captured personal power b% banning opposition parties and building primitive replicas of the onepart% s%stems of the Communist world. In other new countries$ the armies sei5ed power$ and militar% dictatorships were established. +hether as presidential dictatorships or as militar% dictatorships$ the regimes that came into being appear to have had common roots in the social and economic problems of the new state. #he constitutional s%stems inherited from the colonial powers proved unwor!able in the absence of a strong middle class7 local traditions of autocratic rule retained a powerful influence7 the arm%$ one of the few organi5ed forces in societ%$ was also often the onl% force capable of maintaining order7 and a tin% intellectual class was impatient for economic progress$ frustrated b% the lac! of opportunit%$ and deepl% influenced b% the e-ample of authoritarianism in other countries. #he dictatorships that resulted proved highl% unstable$ and few of the individual dictators were able to satisf% for long the demands of the different groups that supported their bids for power. 2lthough similar in some respects to the dictatorships of the new nations$ the caudillos of 1Gth and ,Hthcentur% Datin 2merica represent a ver% 1// different t%pe of monocratic rule. In its 1Gthcentur% form$ caudillismo was the result of the brea!down of central authorit%. 2fter a brief period of constitutional rule$ each of the former Spanish colonies in the 2mericas e-perienced a collapse of effective national government. 2 selfproclaimed leader$ usuall% an arm% officer$ heading a private arm% t%picall% formed from the peasantr% with the support of provincial landowners$ established his control over one or more provinces$ and then marched upon the national capital. #he famous 1Gthcentur% caudillos2ntonio D{pe5 de Santa 2nna of ;e-ico or @uan ;anuel de Cosas of 2rgentina$ for e-amplewere thus essentiall% provincial leaders who sei5ed control of the national government to maintain the social and economic power of provincial groups. #he ,Hthcentur% dictatorships in Datin2merican countries have had different aims. #he modern caudillo is less a provincial than a national leader. #he (er{n regime$ for e-ample$ was established b% nationalistic arm% officers committed to a program of national reform and ideological goals. Often$ too$ recent dictators in Datin 2merica have allied themselves with a particular social class$ attempting either to maintain the interests of established economic groupings or to press social reforms. 9ictatorship in the technologicall% advanced$ totalitarian regimes of modern Communism is distinctivel% different from the authoritarian regimes of either Datin 2merica or the new states of 2frica and 2sia. "a5i Ferman% under 3itler and the Soviet 8nion under Stalin are the leading e-amples of modern totalitarian dictatorships. #he crucial elements of both were the identification of the state with the single mass part% and of the part% with its charismatic leader$ the use of an official ideolog% to legitimi5e and maintain the regime$ the emplo%ment of a terroristic police force and a controlled press$ and the application of all the means of modern science and technolog% to control the econom% and individual behaviour. #he two s%stems$ however$ ma% be distinguished in several wa%s. ?a"ci"m$ in its "ational Socialist form$ was primaril% a counterrevolutionar% movement that mobili5ed middle and lower middleclass groups to pursue nationalistic and militaristic goals and whose sole principle of organi5ation was obedience to the >lhrer. <% contrast$ Soviet Communi"m grew out of a revolutionar% theor% of societ%$ pursued the goal of revolutionar% overthrow of capitalist s%stems internationall%$ and emplo%ed the comple- bureaucratic structures of the Communist (art% as mechanisms of governmental organi5ation. +estern constitutional democracies have provided e-amples of another t%pe of contemporar% dictatorship. 2t various points in the ,Hth centur%$ during periods of domestic or foreign crisis$ most constitutional regimes have conferred emergenc% powers on the e-ecutive$ suspending constitutional guarantees of individual rights or liberties or declaring some form of martial law. Indeed$ the constitutions of some +estern democracies e-plicitl% provide for the grant of emergenc% powers to the e-ecutive in a time of crisis to protect the constitutional order. In man% cases$ of course$ such provisions have been the instruments with which dictators have overthrown the regime. #hus$ the proclamation of emergenc% rule was the beginning of the dictatorships of ;ussolini in Ital%$ of Uemal 2tatlr! in #ur!e%$ of @{5ef (ilsuds!i in (oland$ of 2nt{nio de Olveira Sala5ar in (ortugal$ of >ran5 von (apen and 3itler in Ferman%$ and of Engelbert 9ollfuss and Uurt von Schuschnigg in 2ustria. In other democracies$ however$ constitutional arrangements have survived 6uite length% periods of crisis government. 2fter +orld +ar II$ for e-ample$ in both the 8nited States and <ritain$ the use of e-traordinar% powers b% the e-ecutive came to a halt with the end of the wartime emergenc%. Similarl%$ although the 1G0? constitution of the >ifth Cepublic of >rance contained farreaching emergenc% powers 1/0 conferred on the presidentcwhen the institutions of the Cepublic$ the independence of the nation$ the integrit% of its territor% or the fulfillment of its international obligations are threatened with immediate and grave danger$ and when the regular functioning of the constitutional authorit% is interruptedctheir implicit threat to the constitutional order has not been reali5ed. ;an% forces at wor! in the ,Hth centur% appear to lend impetus to the rise of monocratic forms of rule. In nearl% all political s%stems$ the powers of chief e-ecutives have increased in response to the demanding social$ economic$ and militar% crises of the age. #he comple- decisions re6uired of governments in a technological era$ the perfectionist impulses of the great bureaucratic structures that have developed in all industriali5ed societies$ and the imperatives of national survival in a nuclear world continue to add to the process of e-ecutive aggrandi5ement. #he 6uestion for man% constitutional regimes is whether the limitation and balance of power that are at the heart of constitutional government can survive the growing enlargement of e-ecutive power. .li#archy* In the 2ristotelian classification of government$ there were two forms of rule b% the few: aristocrac% and its debased form$ oli#archy. 2lthough the term oligarch% is rarel% used to refer to contemporar% political s%stems$ the phenomenon of irresponsible rule b% small groups has not vanished from the world. ;an% of the classical conditions of oligarchic rule were found until recentl% in those parts of 2sia in which governing elites were recruited e-clusivel% from a ruling castea hereditar% social grouping set apart from the rest of societ% b% religion$ !inship$ economic status$ prestige$ and even language. In the contemporar% world$ in some countries that have not e-perienced the full impact of industriali5ation$ governing elites are still often recruited from a ruling classa stratum of societ% that monopoli5es the chief social and economic functions in the s%stem. Such elites have t%picall% e-ercised power to maintain the economic and political status 6uo. #he simple forms of oligarchic rule associated with preindustrial societies are$ of course$ rapidl% disappearing. Indu"trialiIation produces new$ differentiated elites that replace the small leadership groupings that once controlled social$ economic$ and political power in the societ%. #he demands of industriali5ation compel recruitment on the basis of s!ill$ merit$ and achievement rather than on the basis of inherited social position and wealth. "ew forms of oligarchic rule have also made their appearance in man% advanced industrial societies. 2lthough governing elites in these societies are no longer recruited from a single class$ the% are often not sub*ected to effective restraints on the e-ercise of their power. Indeed$ in some circumstances$ the new elites ma% use their power to convert themselves into a governing class whose interests are protected b% ever% agenc% of the state. Oligarchic tendencies of a lesser degree have been detected in all the great bureaucratic structures of advanced political s%stems. #he growing comple-it% of modern societ% and its government thrusts ever greater power into the hands of administrators and committees of e-perts. Even in constitutional regimes$ no full% satisfactor% answer has been found to the 6uestion of how these bureaucratic decision ma!ers can be held accountable and their powers effectivel% restrained without$ at the same time$ *eopardi5ing the efficienc% and rationalit% of the polic%ma!ing process. 1/1 Con"titutional #o$ernment* Constitutional government is defined b% the e-istence of a constitution which ma% be a legal instrument or merel% a set of fi-ed norms or principles generall% accepted as the fundamental law of the polit%that effectivel% controls the e-ercise of political power. #he essence of constitutionalism is the control of power b% its distribution among several state organs or office" in such a wa% that the% are each sub*ected to reciprocal controls and forced to cooperate in formulating the will of the state. 2lthough constitutional government in this sense flourished in England and in some other historical s%stems for a considerable period$ it is onl% recentl% that it has been associated with forms of mass participation in politics. In England$ for e-ample$ constitutional government was not harnessed to political democrac% until after the Ceform 2ct of 1?., and subse6uent 1Gthcentur% e-tensions of the suffrage. In the contemporar% world$ however$ constitutional governments are also generall% democracies$ and in most cases the% are referred to as constitutional democracies or constitutionaldemocratic s%stems. #he contemporar% political s%stems that combine constitutionalism and democrac% share a common basis in the primac% the% accord to the will of the ma*orit% of the people as e-pressed in free elections. In all such s%stems$ political parties are !e% institutions$ for the% are the agencies b% which ma*orit% opinion in a modern mass electorate is mobili5ed and e-pressed. Indeed$ the histor% of the political party in its modern form is coincidental with the development of contemporar% constitutionaldemocratic s%stems. In each case$ the transition from the older forms of constitutionalism to modern constitutional democrac% was accompanied b% the institutionali5ation of parties and the development of techni6ues of part% competition. #he essential functions of political parties in a constitutional democrac% are the integration of a multitude of interests$ beliefs$ and values into one or more programs or proposals for change and the nomination of part% members for elective office in the government. In both functions$ the part% serves as a lin! between the rulers and the ruled: in the first case b% allowing the electorate to register an opinion on polic% and in the second b% giving the people a chance to choose their rulers. Of course$ the centrali5ed$ autocraticall% directed$ and ideologicall% orthodo- onepart% s%stems of totalitarian regimes perform neither of these functions. #he two ma*or t%pes of constitutional democrac% in the modern world are e-emplified b% the 8nited States and Freat <ritain. #he 8nited States is the leading e-ample of the presidential s%stem of constitutional democrac%7 <ritain$ although its s%stem is sometimes referred to as a ca%inet s%stem in recognition of the role of the Cabinet in the government$ is the classic e-ample of the parliamentary s%stem. #he 8.S. presidential s%stem is based on the doctrine of "eparation of poer" and distinguishes sharpl% between the personnel of the legislature and the e-ecutive7 the <ritish parliamentar% s%stem provides for the integration or fusion of legislature and e-ecutive. In the 8.S. s%stem the separation of legislature and e-ecutive is reinforced b% their separate election and b% the doctrine of chec!" and %alance" that provides constitutional support for routine disagreements between the branches7 in the <ritish s%stem the integration of legislature and e-ecutive is reinforced b% the necessit% for their constant agreement$ or for a condition of cconfidencec between the two$ if the normal processes of government are to continue. In the 8.S. s%stem reciprocal controls are provided b% such devices as the presidential veto of legislation &which ma% be overridden b% a twothirds ma*orit% in Congress'$ the Senate]s role in ratif%ing treaties and confirming 1/= e-ecutive nominations$ congressional appropriation of funds and the e-clusive abilit% to declare war$ and *udicial review of legislation7 in the <ritish s%stem the ma*or control device is the vote of cno confidencec or the re*ection of legislation that is considered vital. #he prestige of constitutional democrac% was once so great that man% thought all the countries of the world would eventuall% accede to the e-amples of the 8nited States or <ritain and establish similar arrangements. 3owever$ the collapse of the +eimar Constitution in Ferman% in the 1G.Hs and the recurrent political crises of the >ourth Cepublic in >rance after +orld +ar II suggested that con"titutional democrac% carries no guarantee of stabilit%. #he failure of both presidential and parliamentar% s%stems to wor! as e-pected in lessadvanced countries that modelled their constitutions on those of the 8nited States and <ritain resulted in a further diminution in the prestige of both s%stems. >unctioning e-amples are located throughout the world$ though these are generall% poorl% institutionali5ed outside of those countries with direct historical ties to western Europe. @apan is a notable e-ception to this generali5ation$ as are Costa Cica$ India$ and several other states to a lesser degree. C.-TEMP.RARY )EVE)S .? :.VER-ME-T ;ost national societies have passed through a stage in their social and political development$ usuall% referred to as feudali"m$ in which a wea! and ineffectivel% organi5ed national government competes for territorial *urisdiction with local power holders. In medieval England and >rance$ for e-ample$ the crown was perenniall% threatened b% the power of the feudal nobles$ and a protracted struggle was necessar% before the national domain was sub*ected to full ro%al control. Elsewhere$ innumerable societies continued to e-perience this !ind of feudal conflict between local magnates and the central government well into the modern era. #he warlords of 1Gth and ,Hthcentur% China$ for e-ample$ were *ust as much the products of feudal societ% as the warring barons of 1.thcentur% England and presented the same !ind of challenge to the central government]s claim to e-ercise sovereign *urisdiction over the national territor%. <% the 1G=Hs$ feudalism was almost e-tinct. #he social patterns that had formerl% supported the power of local landowners were rapidl% disappearing$ and central governments had generall% ac6uired a near monopol% of communications and militar% technolog%$ enabling them to pro*ect their power into areas once controlled b% local rulers. In nearl% all national political s%stems$ central governments are better e6uipped than ever before to e-ercise effective *urisdiction over their territories. In much of the developing world$ nationalist political movements and a variet% of modern economic forces have swept awa% the traditional structures of local government$ and the 6uasi autonomous governments of village and tribe and province have been replaced b% centrall% directed s%stems of subnational administration. Even in the heavil% industriali5ed states of the modern world$ there has been an accelerating tendenc% toward greater centrali5ation of power at the national level. In the 8nited States$ for e-ample$ the structure of relationships among the governments at the national$ state$ and local levels has changed in a number of wa%s to add to the power of the federal government in +ashington. Even though the s%stem of national grantsinaid appears to have been designed as a means of decentrali5ing administration$ the effect has been decidedl% centralist$ for the conditional character of the grants has allowed the federal 1/? government to e-ercise influence on state policies in fields that were once invulnerable to national intervention. -ational #o$ernment* #he nationstate is the dominant t%pe of political s%stem in the contemporar% world$ and nationali"m$ or the creed that centres the supreme lo%alt% of the people upon the nationstate$ is the dominating force in international politics. #he national ideal triumphed as a result of the wars of the 1Gth and ,Hth centuries. #he "apoleonic +ars$ which spread the doctrines of the >rench Cevolution$ unleashed nationalism as a force in Europe and led to the Cisorgimento in Ital% and the emergence of <ismarc!]s Ferman%. #he two world wars of the ,Hth centur% carried the principles of national selfdetermination and liberal democrac% around the world and gave birth to the independence movements that resulted in the foundation of new states in eastern Europe in 1G1G and the emergence from colonial status of countries in 2sia and 2frica after 1G/0. #he collapse of the +arsaw (act and the Soviet 8nion itself completed this process of moving from multinational empires to trul% sovereign national states. 2ll the ma*or forces of world politics e.g.& ar$ the development of national economies$ and the demand for social serviceshave reinforced the national state as the primar% focus of people]s lo%alties. +ars have pla%ed the ma*or part in strengthening national governments and wea!ening political regionalism and localism. #he attachments that people have to subnational political communities are loosened when the% must depend for their securit% on the national power. Even in the new age of total war which few nations are capable of waging and even fewer of survivingpeople loo! for their securit% to national governments rather than to international organi5ations. In nearl% all contemporar% states$ the national budget is dominated b% e-penditures for defense$ the militar% emplo%s the largest fraction of the wor! force$ and 6uestions of national securit% pervade the discussion of politics. One of the lessons of the late ,Hth centur% is that national "o$erei#nty continues to be the most important obstacle not onl% to the emergence of new forms of supranational government but to effective international cooperation as well. 2lmost ever%where$ attempts to achieve federation and other forms of multinational communication have foundered on the roc!s of nationalism. #he collapse of the >ederation of Chodesia and "%asaland and the >ederation of ;ala%a$ for e-ample$ were paralleled b% the seeming ineffectiveness of the Organi5ation of 2merican States and the 2rab Deague. On another level is the collapse of the +arsaw (act when the nations of eastern Europe reclaimed their sovereignt% in the late 1G?Hs$ after decades of domination b% the Soviet 8nion. In western Europe$ nations have *oined together to form a confederation !nown as the European 8nion &E8'. #hese countries are united not onl% b% a long histor% and a common cultural inheritance but also b% the e-pectation of mutual economic advantage. Even in this case$ nationalism has proved to be an obstacle to the most ambitious goals of unification$ which would severel% limit national sovereignt% in some spheres. 2t the international level$ anarch% is the principal form of contemporar% rule$ for the nationstate]s freedom of action is limited onl% b% its power. +hile the state]s freedom of action ma% not be directl% threatened$ the effectiveness of the state]s action in the economic realm is increasingl% being called into 6uestion. #he development of national industries in the 1Gth and earl% ,Hth centuries pla%ed a ma*or part in strengthening national as against 1/G regional and local political entities$ but the scale of economic activit% has now outgrown national mar!ets. Industrial combines and commercial groupings have emerged that cross national frontiers and re6uire international mar!ets. #his tight integration of the world econom% has limited the effectiveness of some traditional instruments used to influence national trends in capitalist economies. It is increasingl% clear that some aspects of traditional sovereignt% ma% be affected b% serious efforts to confront some issues that act on the entire international s%stem. "ational frontiers can no longer be ade6uatel% defended in an era of intercontinental ballistic missiles$ especiall% with the rapid diffusion of the technolog% re6uired for deliver% s%stems as well as for nuclear weapons themselves. 2ction in this area is$ b% definition$ an attempt to shape the national securit% polic% of states$ something ver% near the core of a state]s sovereignt%. Concern over environmental matters could lead to more restrictive regimes than an% armscontrol provisions$ ultimatel% shaping the wa% in which nations evolve economicall%. 9estruction of ma*or ecos%stems$ wasteful use of energ%$ and industriali5ation based on the use of fossil fuels are all national policies with international repercussions. 2s technolog% empowers more countries to directl% affect the state of the planet as well as other nations$ there are increasing incentives to limit the domestic polic% choices of all nations. 2lthough the failure of efforts to achieve world government and to develop an effective s%stem of international law ma% be regretted$ it should perhaps be remembered that the nationstate continues to function as an e-tremel% effective s%stem for maintaining order within its boundaries. In some cases$ this is achieved with remar!abl% little coercion and in such a wa% that the progress of civili5ation is encouraged. 8nder presentda% conditions$ world government might well involve much higher levels of coercion and much less civili5ation. Re#ional and "tate #o$ernment* #he 1?thcentur% political philosopher ;ontes6uieu wrote that governments are li!el% to be t%rannical if the% are responsible for administering large territories$ for the% must develop the organi5ational capacit% characteristic of despotic states. It was partl% this fear that led the 2merican founding fathers to provide for a federal s%stem and to divide governmental functions between the government in +ashington and the state governments. ;odern technolog% and mass communication are often said to have deprived ;ontes6uieu]s a-iom of its force. :et the technolog% that ma!es it possible for large areas to be governed democraticall% also holds out the spectre of an even greater t%rann% than ;ontes6uieu foresaw. In all political s%stems the relationships between national and regional or state governments have been affected b% technolo#y and new means of communication. In the 1?th centur% #homas @effersonin arguing that local government$ or the government closest to the people$ was bestcould claim that citi5ens !new most about their local governments$ somewhat less about their state governments$ and least about the national government. In the presentda% 8nited States$ however$ the concentration of the mass media on the issues and personalities of national government has made nonsense of this proposition. 2s several recent studies have demonstrated$ people !now much less about local government than national government and turn out to vote in much larger numbers in national elections. #he necessit% for emplo%ing s%stems for the devolution of political power is reduced when a central government can communicate directl% with citi5ens in all parts of the national territor%$ and the vitalit% of subnational levels 10H of government is sapped when public attention is focussed on national problems. 2nother general development that has lessened the importance of regional or state government is the rise of efficient national %ureaucracie". In nearl% all political s%stems$ there has been some tendenc% toward bureaucratic centrali5ation$ and in some cases national bureaucracies have almost completel% replaced older s%stems of regional and provincial administration. In the 8nited States$ for e-ample$ comple- programs of social securit%$ income ta-es$ agricultural subsidies$ and man% others that bear directl% on individuals are centrall% administered. Even in s%stems in which a division of functions between national and subnational governments is constitutionall% prescribed$ the prevailing trend in intergovernmental relations is toward increasing involvement of the national government in areas once dominated b% regional or state governments. #hus$ the original constitutional arrangements prescribed b% the 2llied powers for the +est Ferman republic in 1G/G won general acclaim at the time because the% provided for greater decentraliIation than had the +eimar Constitution7 but$ as soon as Ferman% was free to amend its own constitution$ several state functions were reassigned to the national government. In the 8nited States$ also$ the collapse of the doctrine of cdual federalism$c according to which the powers of the national government were restricted b% the powers reserved to the states$ signalled the end of an era in which the states could claim e-clusive *urisdiction over a wide range of functions. #oda%$ forms of cooperative federalism involving *oint action b% national and state governments are increasingl% common. Such cooperative relationships in the 8nited States include programs of public assistance$ the interstate highwa% s%stem$ agricultural e-tension programs$ and aid to education. In some areas$ such as school desegregation$ the national government has used broad powers to compel states to conform to national standards. Efforts made to halt the trend toward centrali5ation and to reinvigorate regional or state governments have met with little success. In the 8nited States a Commission on Intergovernmental Celations established b% (resident Eisenhower in 1G0. concluded that it could recommend no ma*or reversion of functions to state governments. Similarl%$ efforts in >rance and Ital% to decentrali5e parts of the national administrations have had few practical results. (olitical regionalism appears to be in steep decline almost ever%where$ whether in China or in the 2merican South. #he attachments that bind people to localities and allow the growth of genuine subnational political communities have wea!ened under the impact of technolog% and the growth of national economies. Onl% where political regionalism has alwa%s been in realit% a cloa! for movements of national independencefor e-ample$ in Scotland$ +ales$ "orthern Ireland$ Euebec$ and <rittan%are there popular attempts to reverse the trend toward national centrali5ation. City and local #o$ernment* (olitical scientists since 2ristotle have recogni5ed that the nature of political communities changes when their populations grow larger. One of the central problems of contemporar% government is the vast increase in urban population and the progression from cpolis to metropolis to megapolis.c #he catalog of ills that have resulted from urban growth includes political and administrative problems of e-traordinar% comple-it%. 2ging infra"tructure has become an issue of pressing national importance in the 8nited States$ with the ma*or cities obviousl% suffering in this area. Frave social problems for e-ample$ violent crime &especiall% that committed b% %ouths in povert%stric!en 101 areas'$ drug traffic!ing$ unemplo%ment$ and homelessnessare concentrated to such a degree that the% directl% shape the environment in man% large urban areas. #he ma*orit% of cities are ill e6uipped to handle these problems without significant assistance from the national government. #he ta- base of 8.S. cities has dwindled with the flight of the middle classes to the "u%ur%" and the relocation of industr%. Dargel% as a result of this$ political power has begun to follow wealth out of the cities and into ad*oining suburbs. #hese outl%ing areas have not onl% increased significantl% in population$ but$ compared with that of man% large cities$ it is a population more li!el% to vote and otherwise lobb% for its interests. #his has served to reduce the national government]s activism in the cities at the ver% time when most cities are suffering from a drasticall% reduced capacit% to act. 2side from such fiscal and political pressures$ however$ the national government is inevitabl% concerned with the threats posed b% racial conflict$ ghetto violence$ and other !inds of social chaos in the cities. #he metropolis suffers from several acute governmental and administrative failures. Cesponsibilit% for the issues that transcend the boundaries of local governments has not been defined$ for representative institutions have failed to develop at the metropolitan level. In most cases$ there are no effective governmental structures for administering areawide services or for dealing comprehensivel% with the common problems of the metropolitan communit%. #he result has been the appearance of a new class of problems created b% government itself$ including uneven levels of service for metropolitan residents$ ine6uities in financing government services and functions$ and variations in the democratic responsiveness of the governments scattered through the metropolitan area. #he tangled pattern of local governments$ each operating in some independent sphere$ does not allow the comprehensive planning necessar% to deal with the escalating problems of urban life. Efforts to create new governing structures for metropolitan communities are among the most interesting developments in contemporar% government. In the 8nited States these efforts include the creation of special districts to handle specific functions$ areawide planning agencies$ interstate compacts$ consolidated school and librar% s%stems$ and various informal intergovernmental arrangements. 2lthough anne-ation of outl%ing areas b% the central cit% and cit% count% consolidations have been attempted in man% cases$ the reluctance of urban areas to surrender their political independence or to pa% for centralcit% services has been an obstacle. #he Dos 2ngeles plan$ b% which the count% has assumed responsibilit% for man% areawide functions$ leaving the local communities with substantial political autonom%$ ma% represent a partial solution to the problem of urbansuburban tensions. In other cases$ cmetropolitan federationc has been attempted. One of the earliest and most influential e-amples of a federated s%stem of metropolitan government is the Freater Dondon 2rea in <ritain$ which encompasses ., Dondon boroughs and places effective governing powers in the hands of an elected cit% council. In Canada the cit% of #oronto and its suburbs adopted a metropolitan cconstitutionc in 1G0. under which mass transit$ highwa%s$ planning$ and several other functions are controlled b% a council composed of elected officials from the central cit% and surrounding governments. In 1G0= ;iami and 9ade Count% in >lorida chose cmetroc government: ;iami and ,= suburban cities retained control of local functions$ while areawide functions such as fire and police protection and transportation were allocated to the new federal structure. In 1G1, "ashville$ #ennessee$ combined with 9avidson Count% to form a single metropolitan government7 and in 1G1? @ac!sonville$ >lorida$ *oined with 9uval Count% in a similar 10, arrangement. Other e-amples of various degrees of areawide consolidation in the 8nited States include <aton Couge$ Douisiana7 Seattle$ +ashington7 (ortland$ Oregon7 and Indianapolis$ Indiana. ;ost of the ma*or problems of contemporar% politics seem to have found their focus in the metropolis$ and there is almost universal agreement that new governing s%stems must be devised for the metropolitan communit% if the problems are ever to be resolved. C.-TEMP.RARY DIVISI.-S .? :.VER-ME-T In his 3olitics& Ari"totle differentiated three categories of state activit% deliberations concerning common affairs$ decisions of e-ecutive magistrates$ and *udicial rulingsand indicated that the most significant differences among constitutions concerned the arrangements made for these activities. #his threefold classification is not precisel% the same as the modern distinction among legislature$ e-ecutive$ and *udiciar%. 2ristotle intended to ma!e onl% a theoretical distinction among certain state functions and stopped short of recommending that the% be assigned as powers to separate organs of government. Indeed$ since 2ristotle held that all power should be wielded b% one man$ preeminent in virtue$ he never considered the concept of separated powers. In the 1=th centur% the English political philosopher (ohn )oc!e also distinguished the legislative from the e-ecutive function but$ li!e 2ristotle$ failed to assign these to separate organs or institutions. Monte"+uieu was the first to ma!e the modern division among legislative$ e-ecutive$ and *udiciar%. 2rguing that the purpose of political association is libert%$ not virtue$ and that the ver% definition of libert%]s great antagonist$ t%rann%$ is the accumulation of all power in the same hands$ he urged the division of the three functions of government among three separate institutions. 2fter ;ontes6uieu$ the concept of separation of powers became one of the principal doctrines of modern constitutionalism. "earl% all modern constitutions$ from the document written at (hiladelphia in 1=?= through the >rench 9eclaration of the Cights of ;an and of the Citi5en of 2ugust 1=?G up to the constitutions of the new states of 2frica and 2sia$ provide for the separate establishment of legislative$ e-ecutive$ and *udiciar%. #he functional division among the branches of government is never precise. In the 2merican s%stem$ for e-ample$ the doctrine of chec!s and balances *ustifies several departures from the strict assignment of functions among the branches. (arliamentar% forms of government depart even further from the concept of separation and integrate both the personnel and the functions of the legislature and the e-ecutive. Indeed$ the principle of shared rather than separated powers is the true essence of constitutionalism. In the constitutional state$ power is controlled because it is shared or distributed among the divisions of government in such a wa% that the% are each sub*ected to reciprocal chec!s and forced to cooperate in the e-ercise of political power. In the nonconstitutional s%stems of totalitarianism or autocrac%$ although there ma% be separate institutions such as legislatures$ e-ecutives$ and *udiciaries$ power is not shared but rather concentrated in a single organ. <ecause this organ is not sub*ected to the chec!s of shared power$ the e-ercise of political power is uncontrolled or absolute. The le#i"lature* 10. #he characteristic function of all legislatures is the ma!ing of law. In most s%stems$ however$ legislatures also have other tas!s$ such as selection and criticism of the government$ supervision of administration$ appropriation of funds$ ratification of treaties$ impeachment of e-ecutive and *udicial officials$ acceptance or refusal of e-ecutive nominations$ determination of election procedures$ and public hearings on petitions. Degislatures$ then$ are not simpl% lawma!ing bodies. "either do the% monopoli5e the function of ma!ing law. In most s%stems the e-ecutive has a power of veto over legislation$ and$ even where this is lac!ing$ the e-ecutive ma% e-ercise original or delegated powers of legislation. @udges$ also$ often share in the lawma!ing process$ through the interpretation and application of statutes or$ as in the 8.S. s%stem$ b% means of *udicial review of legislation. Similarl%$ administrative officials e-ercise 6uasilegislative powers in ma!ing rules and deciding cases that come before administrative tribunals. Degislatures differ stri!ingl% in their si5e$ the procedures the% emplo%$ the role of political parties in legislative action$ and their vitalit% as representative bodies. In si5e$ the <ritish 3ouse of Commons is among the largest7 the Icelandic lower house$ the "ew Yealand 3ouse of Cepresentatives$ and the Senate of "evada are among the smallest. ;ost legislatures are bicameral$ although "ew Yealand$ 9enmar!$ the state of Eueensland$ in 2ustralia$ and "ebras!a$ in the 8nited States$ have all abolished their second chambers. #he procedures of the 8nited States ,ou"e of Repre"entati$e"$ which derive from a manual of procedure written b% #homas @efferson$ are among the most elaborate of parliamentar% rules$ re6uiring stud% and careful observation over a considerable period before members become proficient in their manipulation. Voting procedures range from the formal procession of the division or teller vote in the <ritish ,ou"e of Common" to the electric voting methods emplo%ed in the California legislature and in some other 2merican states. 2nother point of difference among legislatures concerns their presiding officers. #hese are sometimes officials who stand above part% and$ li!e the spea!er of the <ritish 3ouse of Commons$ e-ercise a neutral function as parliamentar% umpires7 sometimes the% are the leaders of the ma*orit% part% and$ li!e the spea!er of the 8nited States 3ouse of Cepresentatives$ ma*or political figures7 and sometimes the% are officials who$ li!e the vice president of the 8nited States in his role as presiding officer of the Senate$ e-ercise a vote to brea! ties and otherwise perform mainl% ceremonial functions. Degislative parties are of various t%pes and pla% a number of roles or functions. In the 8nited States 3ouse of Cepresentatives$ for e-ample$ the part% is responsible for assigning members to all standing committees7 the part% leadership fills the ma*or parliamentar% offices$ and the part% membership on committees reflects the proportion of seats held b% the part% in the 3ouse as a whole. #he congressional part%$ however$ is not disciplined to the degree found in <ritish and some other European legislative parties$ and there are relativel% few cpart% linec votes in which all the members of one part% vote against all the members of the other part%. In the 3ouse of Commons$ part%line voting is general7 indeed$ it is ver% unusual to find members voting against their part% leadership$ and$ when the% do$ the% must rec!on with the possibilit% of penalties such as the cwithdrawal of the whipc or the loss of their official status as part% members. It is often said that the ,Hth centur% has dealt harshl% with legislatures and that this is an age of e-ecutive aggrandi5ement. Certainl%$ e-ecutives in most countries have assumed an increasingl% large role in the ma!ing of law$ through the initiation of the legislation that comes before parliaments$ assemblies$ and congresses$ through the e-ercise of various rulema!ing functions$ 10/ and as a result of the growth of different t%pes of delegated legislation. It is also true that e-ecutives have come to predominate in the sphere of foreign affairs and$ b% such devices as e-ecutive agreements$ which are fre6uentl% used in place of treaties$ have freed themselves from dependence upon legislative approval of important foreign polic% initiatives. ;oreover$ devices such as the e-ecutive budget and the rise of speciali5ed budgetar% agencies in the e-ecutive division have threatened the traditional fiscal controls of legislatures. #his decline in legislative power$ however$ is not universal. #he 8nited States Congress$ for e-ample$ has preserved a substantial measure of its power. Indeed$ congressional oversight of the bureaucrac% is an area in which it has added to its power and has developed new techni6ues for controlling the e-ecutive. #he difficulties of presidents in the late ,Hth centur% with legislative programs of foreign aid and the perennial congressional criticism of e-ecutive policies in foreign affairs also suggest that Congress continues to pla% a vital role in the governing process. The eBecuti$e* (olitical eBecuti$e" are government officials who participate in the determination and direction of government polic%. #he% include heads of state and government leaders pre"ident"$ prime mini"ter"$ premiers$ chancellor"$ and other chief e-ecutivesand man% secondar% figures$ such as cabinet members and ministers$ councillors$ and agenc% heads. <% this definition$ there are several thousand political e-ecutives in the 8.S. national government$ including the president$ do5ens of political appointees in the Cabinet departments$ in the agencies$ in the commissions$ and in the +hite 3ouse staff$ and hundreds of senior civil servants. #he same is true of most advanced political s%stems$ for the ma!ing and implementation of government polic% re6uire ver% large e-ecutive and administrative establishments. #he crucial element in the organi5ation of a national e-ecutive is the role assigned to the chief e-ecutive. In presidential s%stems$ such as in the 8nited States$ the president is both the political head of the government and also the ceremonial head of state. In parliamentar% s%stems$ such as in Freat <ritain$ the prime minister is the national political leader$ but another figure$ a monarch or elected president$ serves as the head of state. In mi-ed presidentialparliamentar% s%stems$ such as that established in >rance under the constitution of 1G0?$ the president serves as head of state but also wields important political powers$ including the appointment of a prime minister and Cabinet to serve as the government. #he manner in which the chief e-ecutive is elected or selected is often decisive in shaping his role in the political s%stem. #hus$ although he receives his seals of office from the monarch$ the effective election of a <ritish prime minister usuall% occurs in a private conclave of the leading members of his part% in (arliament. Elected to (arliament from onl% one of more than 1.H constituencies$ he is tied to the fortunes of the legislative ma*orit% that he leads. <% contrast$ the 2merican president is elected b% a nationwide electorate$ and$ although he leads his part%]s tic!et$ his fortunes are independent of his part%. Even when the opposition part% controls the Congress$ his fi-ed term and his independent base of power allow him considerable freedom of manoeuvre. #hese contrasts e-plain man% of the differences in the roles of the two chief e-ecutives. #he <ritish prime minister invariabl% has served for man% %ears in (arliament and has developed s!ills in debate and in political negotiation. 3is ma*or political tas!s are the designation of the other members of the Cabinet$ the direction of parliamentar% strateg%$ and the retention of 100 the lo%alt% of a substantial ma*orit% of his legislative part%. #he presidential chief e-ecutive$ on the other hand$ often lac!s prior legislative and even national governmental e-perience$ and his main concern is with the cultivation of a ma*orit% in the electorate through the leadership of public opinion. Of course$ since the president must have a legislative program and often cannot depend on the support of a congressional ma*orit%$ he ma% also need the s!ills of a legislative strategist and negotiator. 2nother important area of contrast between different national e-ecutives concerns their role in e-ecuting and administering the law. In the 8.S. presidential s%stem$ the personnel of the e-ecutive branch are constitutionall% separated from the personnel of Congress: no e-ecutive officeholder ma% see! election to either house of Congress$ and no member of Congress ma% hold e-ecutive office. In parliamentar% s%stems the political management of government ministries is placed in the hands of the part% leadership in parliament. In the 8.S. s%stem the president often appoints to Cabinet positions persons who have had little prior e-perience in politics$ and he ma% even appoint members of the opposition part%. In the <ritish s%stem$ Cabinet appointments are made to consolidate the prime minister]s personal ascendanc% within the parliamentar% part% or to placate its different factions. #hese differences e-tend even further into the character of the two s%stems of administration and the role pla%ed b% civil servants. In the 8.S. s%stem a change in administration is accompanied b% the e-odus of a ver% large number of top government e-ecutivesthe political appointees who pla% the vital part in shaping da%toda% polic% in all the departments and agencies of the national government. In <ritain$ when political control of the 3ouse of Commons changes$ onl% the ministers$ their parliamentar% secretaries$ and one or two other top political aids are replaced. >or all practical purposes$ the ministries remain intact and continue under the supervision of permanent civil servants. In nearl% all political s%stems$ even in constitutional democracies where e-ecutive responsibilit% is enforced through free elections$ the ,Hth centur% has seen an alarming increase in the powers of chief e-ecutives. #he office of the presidenc% in the 8nited States$ li!e the office of prime minister in <ritain$ has greatl% enlarged the scope of its authorit%. One of the challenges of representative government is to develop more constitutional restraints on the abuse of e-ecutive powers while retaining their advantages for effective rule. The <udiciary* Di!e legislators and e-ecutives$ *udges are ma*or participants in the polic% ma!ing process7 and courts$ li!e legislatures and administrative agencies$ promulgate rules of behaviour having the nature of law. #he process of *udicial decision ma!ing$ or ad*udication$ is distinctive$ however$ for it is concerned with specific cases in which an individual has come into conflict with societ% b% violating its norms or in which individuals have come into conflict with one another$ and it emplo%s formal procedures that contrast with those of parliamentary or administrative bodies. Established court s%stems are found in all advanced political s%stems. 8suall% there are two *udicial hierarchies$ one dealing with civil and the other with criminal cases$ each with a large number of local courts$ a lesser number at the level of the province or the region$ and one or more courts at the national level. #his is the pattern of *udicial organi5ation in <ritain$ for e-ample. In some countries for e-ample$ in >rancealthough there is a double hierarch%$ the distinction is not between courts dealing with criminal cases and other courts dealing with civil cases but rather between those that handle all civil and criminal cases and those that deal 101 with administrative cases or challenges to the administrative authorit% of the state. Ceflecting the federal organi5ation of its government$ the 8nited States has two court s%stems: one set of national courts and 0H sets of state courts. <% contrast$ Ferman%$ which is federal in governmental organi5ation$ possesses onl% a single integrated court s%stem. Docal courts are found in all s%stems and are usuall% of two t%pes. #he first t%pe deals with pett% offenses and ma% include a traffic court$ a municipal court$ a smallclaims court$ and a court presided over b% a *ustice of the peace or a local magistrate. #he second t%pe$ sometimes called trial courts$ are courts of first instance in which most cases of ma*or importance are begun. #hese are the state superior courts in the 8nited States$ the count% courts and 6uarter sessions in <ritain$ the tri%unal de grande instance in >rance$ and the district courts$ or .andgerichte& in Ferman%. In some s%stems there is a level above the local court$ usuall% referred to as assi5e courts$ in which e-ceptionall% serious crimes$ such as homicide$ are tried. Courts of appeal review the procedures and the law in the lower court and$ in some instances$ return the case for a new trial. In all s%stems there are national supreme courts that hear appeals and e-ercise original *urisdiction in cases of the greatest importance$ such as those involving conflict between a state and a national government. Outside the regular court s%stems$ there are sometimes found speciali5ed *udicial tribunals$ such as administrative courts$ or courts of claims that deal with special categories of cases. ,he functions of government In all modern states$ governmental functions have greatl% e-panded with the emergence of government as an active force in guiding social and economic development. In Socialist countries$ government has a vast range of responsibilities for man% t%pes of economic behaviour. Even in the 8nited States$ where there remains a much greater attachment than in most societies to the idea that government should be onl% an umpire ad*udicating the rules b% which other forces in societ% compete$ such governmental activities as the #ennessee Valle% 2uthorit% or the use of credit controls to prevent economic fluctuations are now accepted with relativel% little 6uestion. Fovernment has thus become the ma*or or even the dominant organi5ing power in all contemporar% societies. #he historical stages b% which governments have come to e-ercise their contemporar% functions ma!e an interesting stud% in themselves. #he scope of government in the ancient polis involved the comprehensive regulation of the ends of human e-istence. 2s 2ristotle e-pressed it$ what was not commanded b% government was forbidden. #he e-tent of the functions of government in the ancient world was challenged b% Christianit% and its insistence on a division of those things that belong separatel% to Caesar and to Fod. +hen the feudal world succeeded the Coman Empire$ however$ the enforcement of the sanctions of religion became one of the first ob*ects of political authorit%. #he tendencies that began in the 1?th centur% separated church from state and state from societ%$ and the modern concept of government came into being. #he 2merican colonies] Declaration of Independence e-presses the classic modern understanding of those ends that governmental functions e-ist to secure. #he first aim of government is to secure the right to life7 this comprehends the safet% of fellow citi5ens as regards one another and the selfpreservation of the nation as regards foreign powers. Dife e-ists for the e-ercise of libert%$ in terms of both natural and civil rights$ and these$ along with other specific functions of government$ provide those conditions upon 10= which men ma% pursue happiness$ an end that is finall% entirel% private and be%ond the competence of government. +ith the advent of the ;ar-ist conception of the state$ the ends of human e-istence once again became the ob*ects of comprehensive government regulation. MarBi"m sees the state as a product of class warfare that will pass out of e-istence in the future age of perfect freedom. 2ristotle believed human perfection to be possible onl% within political societ%7 ;ar- believed that the perfection of man would follow upon the abolition of political societ%. <efore the final disposal of the state$ however$ man% ;ar-ists believe that forceful use of governmental power is *ustified in order to hasten man!ind]s progress toward the last stage of histor%. T,E TASAS Self0pre"er$ation* #he first right of men and nations is selfpreservation. #he tas! of maintaining the nation$ however$ is more comple- than the individual]s dut% of self preservation$ for the nation must see! to command the attachment of a communit% of citi5ens as well as to preserve itself from e-ternal violence. 2s #homas 3obbes insisted$ ci$il ar constitutes the greatest threat to governments$ for it represents the dissolution of the csovereign power.c In modern terms$ civil war signifies that the government has lost one of the basic attributes of political authorit%: its monopol% of force and its control over the use of violence. In a fundamental sense$ political authorit% ma% be preserved from the threat of civil war onl% when there e-ists in the political communit% an agreement on the basic principles of the regime. Such a consensus is the result$ among other things$ of a shared c ideolo#yF that gives fellow citi5ens a sense of communal belonging and recogni5es interloc!ing values$ interests$ and beliefs. Ideolog%$ in this sense$ ma% be the product of man% different forces. Sometimes it is associated with ancient customs$ sometimes with religion$ sometimes with severe dislocations or the sort of common need that has led to the formation of man% nationstates$ and sometimes with the fear of a common enem%. #he ideological commitment that people call patriotism is t%picall% the product of several of these forces. Fovernments neglect at their peril the tas! of strengthening the ideological attachment of their citi5ens to the regime. In this sense$ civic education should be counted among the essential functions of the state$ for it is primaril% through s%stems of education that citi5ens learn their duties. Indeed$ as a number of sociological studies have shown$ the process of political "ocialiIation that transforms people into citi5ens begins in !indergarten and grade school. Even more than this$ education is the instrument b% which governments further the cohesion of their societies and build the fundamental !inds of consensus that support their authorit%. It is not surprising$ therefore$ that national s%stems of education are often lin!ed to central elements of the regimes. In >rance public education was traditionall% mi-ed with the teachings of the Coman Catholic church7 in Freat <ritain a private s%stem of education supported the class divisions of societ%7 and in the 8nited States a primaril% secular form of public education traditionall% used constitutional documents as the starting point of children]s training in patriotism. #he preservation of the authorit% of the state also re6uires a governmental organi5ation capable of imposing its *urisdiction on ever% part of the national territor%. #his involves the maintenance of means of communication$ the use of administrative s%stems$ and the emplo%ment of police forces capable of controlling domestic violence. #he police function$ li!e 10? education$ is often a !e% to the character of a regime. In "a5i Ferman%$ 3itler]s <rownshirts too! over the operation of local and regional police s%stems and often supervised the administration of law in the streets. In the Soviet 8nion the securit% police acted to chec! an% deviation from the polic% of the part% or state. In the 8nited States the police powers are left in the hands of the 0H states and the local agencies of government. +ith the e-ception of certain offenses created b% the ;cCarran 2ct and some parallel statutes$ political crimes as such are un!nown. In addition$ there are state militias that act$ under the control of the governors of the various states$ in moments of local emergenc%$ such as riots or natural catastrophes. #he >ederal <ureau of Investigation &><I'$ the onl% e6uivalent of a national police force$ is an agenc% established to carr% out specific assignments dealing with a limited but important class of crimes. Since there is no comprehensive federal criminal code$ there is not$ strictl% spea!ing$ a federal police. Fovernments must preserve themselves against e-ternal as well as domestic threats. >or this purpose the% maintain armed forces and carr% on intelligence activities. #he% also tr% to prevent the entr% of aliens who ma% be spies or saboteurs$ imprison or e-pel the agents of foreign powers$ and embargo the e-port of materials that ma% aid a potential enem%. #he ultimate means of preserving the state against e-ternal threats$ of course$ is war. In war$ governments usuall% enlarge the scope of their domestic authorit%7 the% ma% raise conscript forces$ imprison conscientious ob*ectors$ sub*ect aliens to internment$ sentence traitors to death$ impose e-traordinar% controls on the econom%$ censor the press$ compel settlement of labour disputes$ impose internaltravel limitations$ withhold passports$ and provide for summar% forms of arrest. ;an% forces generate clashes between nations$ including economic rivalr% and disputes over trade$ the desire to dominate strategic land or sea areas$ religious or ideological conflict$ and imperialistic ambition. 2ll national governments develop organi5ations and policies to meet these and other situations. #he% have foreign ministries for the conduct of diplomatic relations with other states$ for representing them in international or#aniIation"$ and for negotiating treaties. Some governments conduct programs such as foreign aid$ cultural e-change$ and other activities designed to win goodwill abroad. In the ,Hth centur%$ relationships among governments have been affected b% a developing awareness that world peace and prosperit% depend on multinational and international cooperation. #he Deague of "ations and the 8nited "ations$ together with their associated agencies$ have represented ma*or efforts to establish substitutes for traditional forms of diplomac%. Cegional alliances and *oint efforts$ such as the Organi5ation of 2merican States$ the "orth 2tlantic #reat% Organi5ation$ the European Economic Communit%$ and the Organi5ation of 2frican 8nit%$ represent another t%pe of cooperation among nations. Super$i"ion and re"olution of conflict"* #he conflict of private interest is the leading characteristic of the political process in constitutional democracies$ and the supervision$ mediation$ arbitration$ and ad*udication of such conflicts are among the !e% functions of their governments. Cepresentative institutions are themselves a device for the resolution of conflict. Elections in constitutional democracies provide opportunities for mass participation in a process of open debate and public decision7 assemblies$ congresses$ and other parliamentar% institutions provide for public hearings on ma*or issues of polic% and 10G re6uire formal deliberative procedures at different stages of the legislative process7 and political parties integrate a variet% of interests and effect compromises on polic% that win acceptance from man% different groups. If the interests that compete in the political process are too narrow or restricted$ efforts ma% be made to control or change the rules of competition. #hus$ laws have been enacted that see! to prevent discrimination from loc!ing racial and other minorities out of the democratic process7 the franchise has been e-tended to all groups$ including minorities such as women$ blac!s$ and 1? %earolds7 and government bodies such as courts and administrative agencies enforce legislation against groups considered to be too large or monopolistic. @udicial processes offer a means b% which some disputes in societ% are settled according to rule and legal authorit%$ rather than b% political struggle. In all advanced societies$ law is elaborated in comple- codes governing rights and duties and procedural methods$ and court s%stems are emplo%ed that ad*udicate disputes in terms of the law. In constitutional s%stems such as the 8nited States$ the *udiciar% is deepl% involved in the process of public decision ma!ing7 the courts actuall% produce much of the substantive law that bears on private individuals and economic groups in societ%. Re#ulation of the economy* Fovernment regulation of economic life is not a new development. #he national mercantilist s%stems of the 1?th centur% provided for regulation of the production$ distribution$ and e-port of goods b% government ministries7 even during the 1Gth centur%$ governments continued to intervene in the econom%. #he government of the 8nited States$ for e-ample$ from its inception in 1=?G$ allotted funds or subsidies for the support of agriculture$ maintained a s%stem of tariffs for its own revenue and the support of domestic manufacturers$ patroni5ed the arts and sciences$ and engaged in various !inds of public wor!s to advance commerce and promote the general welfare. In >rance even more elaborate governmental schemes of economic regulation were practiced throughout the 1Gth centur%$ including a variet% of Socialist e-periments such as the (ublic +or!shops that Douis <lanc established in (aris in 1?/?. In <ritain the various factor% acts of the 1Gth centur% represented an effort b% government to improve slightl% the wor!ing conditions in industr%. 2fter +orld +ar II the abilit% of a government to regulate or control the econom% became one of the chief tests of its success$ and regulator% agencies multiplied to the point at which the% are now often referred to as cthe fourth branch of government.c #he e-tent of the controls imposed on the econom% is one of the principal distinctions among capitalist$ Sociali"t$ and Communist s%stems. In Communist countries it is a matter of doctrine that the means of production should be owned and therefore controlled b% the state. In <ritain the Dabour governments nationali5ed some ma*or industries$ including coal$ steel$ and the railroads$ prompted partl% b% Socialist doctrine and partl% b% the failure of <ritish industr% to remain competitive in international mar!ets. #his process was then reversed when the Conservative (art% became ascendent. In the 8nited States the government has involved itself in the econom% primaril% through its regulator% powers. In >rance the government has gone further and has engaged in national economic planning in cooperation with private business organi5ations. #he regulation of industrial conditions and of labourmanagement relations has been a ma*or concern of most +estern 11H governments. In the 8nited States the first regulator% efforts in this field were made during the (rogressive era at the turn of the ,Hth centur%$ when the wages$ hours$ and wor!ing conditions of women and children in industr% became a matter of public scandal. 2 little later the conditions$ hours$ food$ and wages of merchant seamen were brought under government regulation7 an eighthour da% was set for railwa% crews7 and wor!men]s compensation laws were instituted. +ith the Freat 9epression in the 1G.Hs$ minimum wages were introduced for wor!ers in man% industries$ hours of wor! were set$ and the right to collective bargaining was given legal sanction. Cegulation of transportation has been another ma*or activit% in most +estern political s%stems$ beginning with the railroads. In the 8nited States their monopolistic practices attracted the criticism of agricultural interests and led eventuall% to the Interstate Commerce 2ct of 1??=$ which regulated railroad rates7 subse6uent legislation covered the hours$ conditions$ and wages of railroad emplo%ees$ among other things. Other modes of land and air transportation have since been brought under regulator% controls implemented b% government agencies. In most European countries$ facilities of communicationthe telegraph$ telephone$ radio$ and televisionare owned and operated b% the government. In the 8nited States$ most of these facilities have remained in private ownership$ although the% are regulated b% the >ederal Communications Commission. #he regulation b% government of important instruments of public opinion such as radio$ television$ and newspapers has important implications for the freedoms of speech and press and other individual rights. In the 8nited States and Freat <ritain$ government censorship of the press and other media has been restricted to matters of national securit%. #his is also generall% true of other +estern constitutional democracies$ although the celebrated *er (piegel affair in Ferman% in 1G1, and some e-traordinar% controls imposed on the media in >rance have been widel% critici5ed. In man% of the lessdeveloped nations with authoritarian governments$ ver% e-tensive controls are imposed on the press$ and government owned newspapers are often the principal sources of political news. Other forms of government regulation of the econom% involve the use of ta-es and tariffs$ the regulation of weights and measures$ and the issuance of mone%. Protection of political and "ocial ri#ht"* #o some e-tent$ all modern governments assume responsibilit% for protecting the political and social rights of their citi5ens. #he protection of individual rights has ta!en two principal forms: first$ the protection of libert% in the face of governmental oppression7 second$ the protection of individual rights against hostile ma*orities and minorities. >rom the 1G1Hs to the mid1G?Hs the sphere of public discussion in the Soviet 8nion was graduall%$ though erraticall%$ widened. +hile this widening never e-tended to the purel% political$ some of the sociological discussion allowed served to set the intellectual stage for the Forbachev period of radical reform. 2lthough the Soviet 8nion suppressed most e-pression of political opinion until the late 1G?Hs$ domination b% a central authorit% protected the basic human ri#ht" of some groups from violent rival minorities. On a larger scale$ this is also what suppressed man% longstanding rivalries in eastern Europe during the Cold +ar. #he degree of repression in the former Communist states varied from countr% to countr% and changed with time after the death of Stalin. 111 In the 8nited States the Supreme Court e-panded the rights of the criminall% accused7 and after 1G0/ the national government acted to bar legal discrimination against ethnic minorities. Indeed$ almost all the freedoms detailed in the first 1H amendments to the Constitution have been e-tended since +orld +ar II. 2nother t%pe of government regulation bearing on the individual concerns the law of immigration and emigration. #he great mass migrations of the 1Gth and earl% ,Hth centuries came to an abrupt halt after 1G1/ with the proliferation of government controls on the freedom of movement across national boundaries. 2fter some later liberali5ation$ immigration to the industriali5ed states again saw increased restrictions near the end of the ,Hth centur%. Pro$i"ion of #ood" and "er$ice"* 2ll modern governments participate directl% in the econom%$ purchasing goods$ operating industries$ providing services$ and promoting various economic activities. One of the indispensable functions of governmentnational defensehas made governments the most important consumers of goods$ and the% have not hesitated to use their resulting pricing$ purchasing$ and contracting powers to achieve various economic aims. In efforts to avoid dependence on private sources of strategic goods and defense materials$ some governments have ta!en a further step and established their own militar% production plants. In wartime$ governments have assumed control over entire industries and have sub*ected the wor! force to militar% direction in addition to rationing goods and regulating prices. In nearl% all political s%stems$ certain functions are recogni5ed as public$ or belonging to the government. In addition to national defense$ these include the maintenance of domestic peace$ public education$ fire protection$ traffic control$ aid to the indigent$ conservation of natural resources$ flood control$ and postal services. <ut governments have assumed responsibilit% for man% other commercial operations$ even in non Socialist countries. #he sale of electric power$ for e-ample$ is one of the established enterpri"in# functions of national$ state$ and local governments in the 8nited States and Canada. ;unicipall% owned power utilities e-ist in about ,$HHH cities in "orth 2merica7 1/ states of the 8.S. have public power districts7 and the 8.S. government mar!ets power through the #ennessee Valle% 2uthorit%$ the <ureau of Ceclamation$ and several other agencies. 2nother range of functions is performed b% other national agencies$ including the Cural Electrification 2dministration$ which loans mone% to rural cooperatives to finance local power pro*ects7 the E-portImport <an! of +ashington$ which ma!es loans to finance e-port and import trade7 the ;aritime 2dministration$ which holds mortgages on ships7 and the Veterans 2dministration$ which ma!es loans for farm or home purchases to militar% veterans. #he 8nited States government$ acting through agencies such as the Social Securit% <oard$ the >ederal 9eposit Insurance Corporation$ and the >ederal 3ousing 2dministration$ is also the largest insurer in the nation. #hrough other agencies$ such as the 3ousing and 3ome >inance 2genc%$ the 8rban Cenewal 2dministration$ and the (ublic +or!s 2dministration$ the national government has also developed a ma*or role in the construction and rental of residential housing for lowincome persons. Other miscellaneous enterprises in which governments are involved include the provision of health care$ the operation of public transport facilities$ the development of public wor!s$ airport and port maintenance$ and watersuppl% s%stems. In Freat <ritain the 11, government operates hospitals and provides medical care under the "ational 3ealth Service. In the 8nited States man% state and local governments operate hospitals on a commercial basis$ although providing some charit% care. 2t the local level in the 8nited States the (ort of "ew :or! 2uthorit% constructs and operates bridges$ terminals$ and airports. #he states in the 9elaware <asin have *oined in a compact to establish an agenc% to control the use of water from the basin$ institute programs to prevent pollution$ provide recreation facilities$ transmit and sell h%droelectric power$ and provide watershed management. Cities in the 8nited States and Canada operate more than =H urban transit s%stems$ 1HH municipal gas utilities$ and more than /$HHH watersuppl% s%stems. Cities are also generall% responsible for garbage disposal and sometimes operate commercial slaughterhouses$ coal %ards$ laundries$ ice plants$ and golf courses. >inall%$ pac!aged li6uor sales$ either wholesale or retail or both$ are often made b% the state governments. P1/)IC ADMI-ISTRATI.- +hile the functional ob*ectives of government administration var% from s%stem to s%stem$ all countries that are technologicall% developed have evolved s%stems of pu%lic admini"tration. 2 number of common features ma% be detected in all such s%stems. #he first is the hierarchical$ or p%ramidal$ character of the organi5ation b% which a single chief e-ecutive oversees a few subordinates$ who in turn oversee their chief subordinates$ who are in turn responsible for overseeing other subordinates$ and so on until a great structure of personnel is integrated and focussed on the components of a particular program. 2 second common feature is the division of labour or speciali5ation within the organi5ation. Each individual in the hierarch% has speciali5ed responsibilities and tas!s. 2 third feature is the maintenance of detailed official records and the e-istence of precise paper procedures through which the personnel of the s%stem communicate with each other and with the public. >inall%$ tenure of office is also characteristic of all public bureaucracies. #he various national ci$il "er$ice"$ despite their similarities$ also show important differences$ particularl% in the wa% in which individuals are recruited and in the status accorded them in the political s%stem. #he <ritish civil service$ for e-ample$ has traditionall% been composed of three classes$ or gradesclerical$ e-ecutive$ and administrative. 2dministrative civil servants$ the highest grade$ are recruited b% e-amination from among recent universit% graduates. #he top managers of the different government ministries are drawn from this elite group. #he% remain in office despite changes in government and are accorded immense prestige. #he 8.S. civil service is organi5ed into 1? grades. 2lthough promotion from the lower grades is the t%pical means b% which positions in the top grades are filled$ there is also a flow of individuals into senior positions from private business and the professions. #he 8.S. e6uivalent of the administrative civil servant in <ritain is usuall% a political appointee recruited b% each new administration from private life or from a position in politics. Development and change in political systems #he student of political s%stems grapples with a sub*ect matter that is toda% in constant flu-. 3e must deal not onl% with the ma*or processes of growth$ deca%$ and brea!down but also with a ceaseless ferment of adaptation and ad*ustment. #he magnitude and variet% of the changes that occurred in the world]s political s%stems 11. between the second and eighth decades of the ,Hth centur% suggest the dimensions of the problem. Freat empires disintegrated7 nationstates emerged$ flourished briefl%$ and then vanished7 world wars twice transformed the international s%stem7 new ideologies swept the world and shoo! established groups from power7 all but a few nations e-perienced at least one revolution and man% nations two or more7 domestic politics in ever% s%stem were contorted b% social strife and economic crisis7 and ever%where the nature of political life was changed b% novel forms of political activit%$ new means of mass communication$ the enlargement of popular participation in politics$ the rise of new political issues$ the e-tension of the scope of governmental activit%$ the threat of nuclear war$ and innumerable other social$ economic$ and technical developments. CA1SES .? STA/I)ITY A-D I-STA/I)ITY 2lthough it is possible to identif% a number of factors that obviousl% have a great deal to do with contemporar% development and change in the world]s political s%stemsindustriali5ation$ population growth$ the crevolution of rising e-pectationsc in the less developed countries$ and international tensionsthere is no agreed theor% to e-plain the causes of political change. Some social scientists have followed 2ristotle]s view that political instabilit% is generall% the result of a situation in which the distribution of wealth fails to correspond with the distribution of political power and have echoed his conclusion that the most stable t%pe of political s%stem is one based on a large middle class. Others have adopted ;ar-ist theories of economic determinism that view all political change as the result of changes in the mode of production. Still others have focussed on governing elites and their composition and have seen in the alienation of the elite from the mass the prime cause of revolutions and other forms of violent political change. In the discussion that follows$ a distinction is drawn between unstable and stable political s%stems$ and an attempt is made to suggest wa%s of understanding the processes of political development and change. 1n"ta%le political "y"tem"* In modern times the great ma*orit% of the world]s political s%stems have e-perienced one form or another of internal warfare leading to violent collapse of the governments in power. Certain crisis situations seem to increase the li!elihood of this !ind of brea!down. +ars and$ more particularl%$ national militar% defeats have been decisive in prompting man% revolutions. #he (aris Commune of 1?=1$ the Cussian revolutions of 1GH0 and 1G1=$ 3itler]s overthrow of the +eimar Constitution in Ferman%$ and the revolutions in China all occurred in the aftermath of national militar% disasters. ;an% factors in such a situation$ including the cheapening of human life$ the dislocation of population$ the read% availabilit% of arms$ the disintegration of authorit%$ the discrediting of the national leadership$ material scarcities$ and a sense of wounded national pride$ contribute to the creation of an atmosphere in which radical political change and violent mass action are acceptable to large numbers of people. Economic crises are another common stimulus to revolutionar% outbrea!s$ for the% produce not onl% the obvious pressures of material scarcit% and deprivation but also a threat to the individual]s social position$ a sense of insecurit% and uncertaint% as to the future$ and an aggravation of the relationships among social classes. 2 severe national economic crisis wor!s$ in much the same wa% 11/ as a militar% disaster$ to discredit the e-istent leadership and the present regime. 2nother triggering factor is the outbrea! of revolutions in other political s%stems. Cevolutions have a tendenc% to spread: the Spanish Cevolution of 1?,H had repercussions in "aples$ (ortugal$ and (iedmont7 the >rench Cevolution of @ul% 1?.H provo!ed similar outbrea!s in (oland and <elgium7 the Cussian Cevolution of 1G1= was followed b% a do5en other revolutions7 and the colonial liberation movements in 2frica$ Southeast 2sia$ and elsewhere after +orld +ar II appear to have involved a similar chain reaction. Crisis situations test the stabilit% of political s%stems in e-tremel% revealing wa%s$ for the% place e-traordinar% demands on the political leadership and the structure and processes of the s%stem. Since the 6ualit% of the political leadership is often decisive$ those s%stems that provide methods of selecting able leaders and replacing them possess important advantages. 2lthough leadership abilit% is not guaranteed b% an% method of selection$ it is more li!el% to be found where there is free competition for leadership positions. #he availabilit% of established methods of replacing leaders is e6uall%$ if not more$ important$ for the result of crises is often to disgrace the leaders in power$ and$ if the% cannot be replaced easil%$ their continued incumbenc% ma% discredit the whole regime. #he stamina and resolve of the ruling elite are also important. It is often said that a united elite$ firml% believing in the *ustice of its own cause and determined to emplo% ever% measure to maintain its power$ will not be overthrown. ;ost revolutions have gotten under wa% not when the oppression was greatest but onl% after the government had lost confidence in its own cause. Other conditions of the survival of political s%stems relate to the effectiveness of the structures and processes of government in meeting the demands placed on them. (olitical s%stems suffer violent brea!down when channels of communication fail to function effectivel%$ when institutional structures and processes fail to resolve conflicts among demands and to implement acceptable policies$ and when the s%stem ceases to be viewed as responsive b% the individual and groups ma!ing demands on it. 8suall%$ a s%stem has failed over a period of some time to satisf% persistent and widespread demands7 then$ e-posed to the additional strains of a crisis situation$ it is unable to maintain itself. Cevolutions and other forms of violent collapse are thus rarel% sudden catastrophes but rather the result of a process of considerable duration that comes to its clima- when the s%stem is most vulnerable. 8nstable political s%stems are those that prove vulnerable to crisis pressures and that brea! down into various forms of internal warfare. #he fundamental causes of such failures appear to be the lac! of a widespread sense of the legitimac% of state authorit% and the absence of some general agreement on appropriate forms of political action. Fovernments suffer their gravest handicap when the% must govern without consent or when the legitimac% of the regime is widel% 6uestioned. #his is often the case in s%stems that have e-perienced prolonged civil war$ that are torn b% tensions among different national or ethnic groups$ or in which there are divisions along sharpl% drawn ideological or class lines. #he problem is often most acute where there is a pretender to the throne$ a government in e-ile$ a neighbouring state s%mpathetic to a rebel cause$ or some other focus for the lo%alt% of dissidents. #o some degree$ also$ the problem of legitimac% confronts all newl% established regimes. ;an% of the new states of 2frica and 2sia$ for e-ample$ have found it a source of great difficult%. Often the% have emulated the form of +estern institutions but failed to achieve their spirit: borrowing eclecticall% from +estern political philosophies and s%stems of law$ the% have created 110 constitutional framewor!s and institutional structures that lac! meaning to their citi5ens and that fail to generate lo%alt% or a sense that government e-ercises rightful powers. Closel% related to the problem of legitimac% as a cause of the brea!down of political s%stems is the absence of a fundamental consensus on what is appropriate political behaviour. 2 regime is fortunate if there are wellestablished$ open channels of political action and settled procedures for resolving grievances. 2lthough the importance of such crules of the gamec is that the% allow change to occur in mainl% peaceful wa%s$ stable political s%stems often show surprising tolerance for potentiall% violent forms of political behaviour$ such as stri!es$ bo%cotts$ and mass demonstrations. Such forms of political behaviour are not permitted in s%stems where there are no agreed limits to the role of violence and where there is a high ris! that violence ma% escalate to the point of actual warfare. If the government cannot count upon widespread support for peaceful political procedures$ it must restrict man% !inds of political action. Such restriction$ of course$ inhibits still more the development of open methods of citi5en participation in politics and adds to tension between the government and the people. Sta%le political "y"tem"* #he simplest definition of a stable political s%stem is one that survives through crises without internal warfare. Several t%pes of political s%stems have done so$ including despotic monarchies$ militarist regimes$ and other authoritarian and totalitarian s%stems. 2fter 1?1?$ in the period of the restoration regime under the ;ei*i emperor$ @apan succeeded$ without ma*or political brea!downs$ in building an industrial state and developing commercial structures that transformed traditional @apanese societ%. #his achievement was based on the development of centrali5ed patterns of political control and the growth of a t%pe of authoritarianism involving the rule of a militar% elite. Similarl%$ some of the totalitarian regimes of the contemporar% world have demonstrated an impressive capabilit% for survival. #he !e% to their success is their abilit% to control social development$ to manage and prevent change$ and to bring under governmental direction all the forces that ma% result in innovations that are threatening to the s%stem. In some s%stems$ survival does not depend on the detailed management of the societ% or close governmental control over social processes but is the result of sensitive political response to the forces of change$ of fle-ible ad*ustment of the structures of the s%stem to meet the pressures of innovation$ and of open political processes that allow gradual and orderl% development. ;uch of the +estern democratic world has achieved peaceful progress in this wa%$ despite new political philosophies$ population increases$ industrial and technological innovations$ and man% other social and economic stresses. Such evolutionar% change is possible when representative institutions provide effective channels for the communication of demands and criticisms to governments that rel% upon ma*orit% support. #he election of legislators and e-ecutive officials$ competition between political parties$ constitutional guarantees of freedom of speech and press$ the right of petition$ and man% other structures and procedures perform this function in contemporar% constitutional democracies. In such s%stems$ social and economic problems are 6uic!l% transformed into issues in the open arenas of politics7 governments are obliged to shape policies that reflect a variet% of pressures and effect compromises among man% conflicting demands. #he representative mechanisms 111 that have produced evolutionar% change in +estern constitutional democracies are themselves sub*ect to a continuous process of ad*ustment and mutation. Indeed$ representative institutions must develop in wa%s that reflect social and economic developments in the societ% or the% will lose their legitimac% in the minds of the people. In political s%stems such as the 8nited States$ for e-ample$ subtle shifts in the function and relative power of different institutions are continuousl% being made and$ over time$ produce entirel% new structures and ver% different patterns of institutional behaviour. It is as a result of this process that the presidenc% has accumulated a range of new powers that have given it primac% among the branches of 2merican government. #his process also e-plains the growth of administrative agencies that perform both legislative and *udicial functions. #his process of d%namic ad*ustment is crucial$ for institutions that remain static in a changing societ% are unable to serve as agencies of evolutionar% change. TYPES .? P.)ITICA) C,A-:E #he stud% of political change is difficult$ for change occurs in man% different wa%s and at man% different points in the political s%stem. One ma% distinguish several ma*or t%pes of change. Radical re$olution* >irst are changes of the most fundamental t%petransformations not onl% of the structure of government but of the whole polit%. Such change is not limited to political life but transforms also the social order$ the moral basis$ and the values of the whole societ%. 9rastic change of this !ind occurred in the four great revolutions of the modern erathe English Cevolution of the 1=th centur%$ the 2merican Cevolution$ the >rench Cevolution$ and the Cussian Cevolution. #hese movements had the most profound effect on social and political life$ permanentl% altering the beliefs b% which men live. #heir conse6uences were felt not onl% in the societies in which the% occurred but also in man% other political s%stems$ in which$ as a result of their e-ample$ revolutions of an e6uall% fundamental character occurred. Each of these ma*or revolutions was something of a world revolution$ for it resulted in a basic change in the wa%s in which men in all political s%stems viewed the nature of politics and the purpose of political life. #he independence movements in the colonial empires after +orld +ar II$ for e-ample$ were fuelled b% those principles of individual libert% and representative government that were once the slogans of 1?thcentur% 2merican and ?rench revolutionaries. ;ar-ist revolutionar% concepts emphasi5ing economic progress and radical social change have shaped the development of man% of the new nations. #he continuing impact of such ideas is an e-ample of another wa% in which fundamental political change occurs. #he nature of a political s%stem ma% be transformed not suddenl% or violentl% in the course of revolution but b% the gradual$ corrosive influence of ideas and b% the accumulating impact of different political philosophies. Structural re$i"ion* 2 second t%pe of change involves alterations to the structure of the political s%stem. Such change is not fundamental$ in the sense of a basic transformation of the 11= nature of the regime$ but it ma% produce great shifts in polic% and other political outcomes. <ecause the structure of a political s%stemthat is$ its formal and informal institutional arrangementsis a ma*or determinant of polic% outcomes$ it is fre6uentl% the target of political action of various !inds. #he political activist$ the reformer$ and the revolutionar% share the recognition that the policies of a government ma% be effectivel% changed b% ad*usting the institutional forms through which the government acts. In some s%stems$ structural change has been accomplished b% legal means. In the 8nited States$ for e-ample$ such ma*or institutional reforms as the direct election of the Senate and the limitation on presidential terms were made b% constitutional amendment7 and in <ritain the various reforms of (arliament were accomplished b% statute. In other s%stems$ structural changes are often achieved b% revolution and other violence. Chan#e of leader"* 2 third t%pe of political change involves the replacement of leaders. 2gain$ the recognition that to change the personnel of a government ma% be an effective wa% of changing government polic% prompts man% !inds of political action$ ranging from election contests to political assassination and various forms of coup d]etat. In some s%stems the e-istence of established means of changing political leaderships wor!s to prevent violent t%pes of political action. In the 8nited States the 6uadrennial contests for the presidenc% afford a constitutional opportunit% to throw the whole e-ecutive leadership out of office. 2t the other e-treme$ the coup d@etat leads to the abrupt$ often violent replacement of national e-ecutives. 2lthough it is a t%pe of revolution$ the coup d]etat usuall% does not involve prolonged struggle or popular participation7 after sei5ing office$ the principal aim of the leaders of the coup is usuall% the restoration of public order. #he coup d]etat occasionall% develops into much more than the replacement of one set of governmental leaders b% another and ma% prove to be the initial stage of a trul% revolutionar% process7 e.g.& the coups d]etat that initiated Communist rule in C5echoslova!ia in 1G/? and ended Uing >arou! I]s regime in Eg%pt in 1G0,. Chan#e of policie"* Fovernment polic% itself ma% be an important agenc% of political change. #he social and economic policies of >ran!lin 9. Coosevelt]s "ew 9eal and the Socialist programs implemented b% the <ritish Dabour (art% after 1G/0 are e-amples. In both cases$ government policies resulted in farreaching modifications to the functioning of the political s%stem: a vast e-pansion in the role of government in the econom%$ the use of ta-es to redistribute wealth$ an increase in the political influence of organi5ed labour$ and the implementation of national programs of social welfare. ;a*or polic% change of this t%pe$ of course$ is often a response to widespread pressures and demands that$ if not satisfied b% the s%stem$ ma% intensif% and lead to various forms of violent political action. 2t other times$ however$ polic% changes are imposed b% a government to achieve the political$ social$ and economic goals of a single class$ of an elite$ or of the political leadership itself. ;an% important 6uestions remain as to the reasons for change$ the wa%s in which change occurs$ and the effects of change. (olitical scientists are still not completel% certain$ for e-ample$ wh% some s%stems have managed to avoid violent political change for considerable periods$ while in other s%stems change is t%picall% accomplished through coups d]etat$ revolutions$ and other forms of internal warfare. 2s suggested above$ the 11? e-planation ma% have much to do with the e-istence in countries such as the 8nited States and Freat <ritain of wellestablished political institutions that permit peaceful change$ the presence in the population of widel% shared attitudes toward the government$ and the e-istence of basic agreement on the legitimac% of state authorit%. Clearl%$ however$ other factors are also involved. (erhaps one of the chief goals of the stud% of political s%stems should be to determine as e-actl% as possible the conditions and prere6uisites of those forms of change that permit the peaceful and evolutionar% development of human societ%. E)ECT.RA) PR.CESSES Election" provide a means of ma!ing political choices b% voting. #he% are used in the selection of leaders and in the determination of issues. #his conception of elections implies that the voters are presented with alternatives$ that the% can choose among a number of proposals designed to settle an issue of public concern. #he presence of alternatives is a necessar% condition$ for$ although electoral forms ma% be emplo%ed to demonstrate popular support for incumbent leaders and their policies$ the absence of alternatives dis6ualifies such devices as genuine elections. #he widespread use of elections in the modern world is due in large part to the gradual emergence of representative government from the 1=th centur% on. >or proper appraisal$ however$ it is important to distinguish between the form and substance of elections. Electoral forms ma% be present but the substance ma% be missing. #he substance is$ of course$ that the voter has a free and genuine choice between at least two alternatives. In a purel% formal sense$ the great ma*orit% of the more than 10H contemporar% nations have what are called celections$c but probabl% onl% about a third of these have more or less competitive elections7 perhaps a fifth have onepart% elections7 and in some others the electoral situation ma% be highl% ambiguous. #he discover% of the individual as the unit to be counted was$ from the 1=th centur% on$ the critical factor in the emergence of modern electoral processes. #he counting of indi$idual"$ in turn$ was a b%product of the change from the holistic conception of representation in the ;iddle 2ges to an individualistic conception. #he <ritish (arliament$ for instance$ was seen no longer as representing estates$ corporations$ and vested interests but rather as standing for actual human beings. #he movement abolishing c rotten %orou#h"Fboroughs of small population controlled b% a single person or famil%that culminated in the Ceform 2ct of 1?., was a direct conse6uence of the individualistic conception of representation. Once governments were not onl% believed to derive their powers from the consent of the governed but were e-pected to see! consent$ the onl% remaining problem was to decide who was to be included among the governed whose consent was to be sought. #he democratic answer was$ of course$ universal adult "uffra#e. 2lthough it is common to e6uate representative government$ elections$ and democrac% and although competitive elections under universal suffrage are in man% respects a defining characteristic of political democracy$ universal suffrage is not a necessar% condition of competitive electoral politics. 2n electorate ma% be limited b% formal legal re6uirementsas was the case before universal adult suffrage or it ma% be limited b% citi5ens] failure to ta!e advantage of the vote$ as is often the case in 2merican municipal and other elections. 2lthough such legal or selfimposed e-clusion affects the democratic 6ualit% of elections and ma% ultimatel% affect the legitimac% of government$ it does not impede decision ma!ing b% election$ provided the voter is presented with alternatives among which to choose. 11G 2ccess to the political arena during the 1?th centur% depended largel% on membership in some aristocrac%$ and participation in elections was regulated mainl% b% local customs and arrangements. +ith the 2merican and >rench revolutions$ ever% citi5en was declared formall% e6ual to ever% other citi5en$ but the vote remained an instrument of political power possessed b% ver% few. Even with the arrival of universal suffrage$ the ideal of cone man$ one votec was not achieved. S%stems of plural voting were maintained in some countries$ giving certain social groups an electoral advantage. In Freat <ritain$ for e-ample$ universit% graduates and owners of businesses in constituencies other than those in which the% lived continued to have an e-tra vote until 1G/?. <efore +orld +ar I both 2ustria and (russia had three classes of weighted votes that effectivel% !ept electoral power in the hands of the upper social strata. +hereas in the +estern nations of the 1Gth and ,Hth centuries the increasing use of competitive mass elections in selecting governments had the purpose and the effect of institutionali5ing the diversit% of modern societies$ in the Eastern$ onepart%$ Communist regimes mass elections came to have 6uite different purposes and conse6uences. #he% differed from competitive elections in that each voter usuall% had onl% the choice of voting for or against the official candidate. Indeed$ the% were in the nature of the 1Gthcentur% "apoleonic plebiscites$ in that the% were intended to demonstrate the unit% rather than the diversit% of the people. 9issent could be registered b% crossing out the name of the candidate on the ballot$ as several million Soviet citi5ens did in each election before 1G?G. 2s voting was not private$ however$ this invited reprisals. It ma% well be that some portion of dissenting votes were cast not so much because of disli!e of Communism but because of grievances involving the conduct of minor officials. #his ma% have served to weed out some of the worst officials at the ver% lowest levels. Even not voting was a form of protest$ especiall% because local Communist (art% activists were under e-treme pressure to get nearl% a 1HH percent turnout. <efore the revolutions of 1G?G$ not all elections in eastern Europe followed the Soviet model e-actl%. In Poland$ for instance$ more names appeared on the ballot than there were offices to fill$ and some degree of electoral choice was possible. ;an% authoritarian regimes throughout the world have attempted to gain some level of legitimac% through the holding of elections. #his ma% be done when it is clear that$ because of repression$ no substantive opposition is remotel% feasible. Often$ however$ the process is more subtle in order to ma-imi5e the regime]s gains. Elections ma% be scheduled when economic factors favour the regime and$ more importantl%$ when election laws have been written to the severe disadvantage of competing parties. #he opposition ma% be given little time to prepare$ while the government alread% has various networ!s of supporters in place. Challengers also ma% be forced to campaign in an atmosphere of intimidation that precludes the effective organi5ation of man% potential supporters. 2 regime ma% cite unrelated reasons for postponing an election if it perceives a significant chance of losing. 2lso$ it is not uncommon for government intervention to occur once balloting has begun$ either in the form of voter intimidation ¬ infre6uentl% actuall% attac!ing voters' or manipulating the count of votes freel% cast. ?unction" of election"* 1=H >undamental to the use of elections is the contribution that the% ma!e to democratic government. +here the members of the bod% politic cannot themselves govern and must entrust government to representatives$ elections serve not onl% to select leaders acceptable to the voters but also to hold the leaders accountable for their performance in office. 2ccountabilit%$ however$ is greatl% *eopardi5ed in electoral situations in which elected leaders$ for want of ambition$ do not care whether or not the% are reelected or in situations in which$ for historical or other reasons$ one part% is so predominant as to preclude effective choice among alternate candidates or policies. "evertheless$ the possibilit% of controlling leaders b% re6uiring them to submit to regular and periodic elections contributes to solving the problem of succession in leadership and$ thereb%$ to the continuation of democrac%. ;oreover$ where the electoral process is competitive and forces candidates or parties to e-pose their record of accomplishment and future intentions to popular scrutin% in election campaigns$ elections serve as forums for the discussion of public issues$ facilitate the e-pression of pu%lic opinion$ and$ more generall%$ permit an e-change of influence between governors and governed. Elections also serve to reinforce the stabilit% and legitimac% of the political communit% in which the% ta!e place. Di!e national holida%s commemorating common e-periences$ elections serve to lin! the members of a bod% politic to each other and thereb% confirm the viabilit% of the political communit%. <% mobili5ing masses of voters in a common act of governance$ elections lend authorit% and legitimac% to the acts of those who wield power in the name of the people. Elections can also confirm the worth and dignit% of the individual citi5en as a human being. +hatever other needs he ma% have$ participation in an election serves to gratif% the voter]s sense of selfesteem and selfrespect. It gives him an opportunit% to have his sa%$ and he can$ through e-pressing partisanship and even through nonvoting$ satisf% his sense of belonging to or alienation from the political communit%. It is for *ust this reason that the agelong battle for the right to vote and the demand for e6ualit% in electoral participation can be seen as the manifestation of a profound human craving for personal fulfillment. In all forms of government$ from the most democratic to the most totalitarian ali!e$ elections have a ritualistic aspect. Elections and the campaigns preceding them are dramatic events which$ depending on cultural or historical circumstances$ ma% e-ude the ga% atmosphere of a circus or the sombre atmosphere of a funeral. Callies$ banners$ posters$ buttons$ headlines$ and television call attention to the importance of participation in the event. Candidates and parties$ from right to left$ in addition to propagating their polic% ob*ectives through rhetoric and slogans$ invo!e the s%mbols of nationalism or patriotism$ reform or revolution$ past glor% or future promise. +hatever the peculiar national$ regional$ or local variations$ elections are events that$ b% arousing emotions and channelling them toward collective s%mbols$ brea! the monoton% of dail% life and focus attention on the common fate. Sy"tem" of countin# $ote"* Individual votes are totalled into collective decisions b% a wide variet% of rules of counting that voters and leaders have accepted as legitimate prior to the election. #hese decision rules ma% call for pluralit% voting$ which re6uires that$ among three or more alternatives$ the winner need have onl% the highest number of votes7 simple ma*orit% voting$ which re6uires that the winner receive more than 0H 1=1 percent of the vote7 e-traordinar% ma*orit% voting$ which re6uires some higher proportion for the winner$ such as a twothirds vote7 or unanimit%. Plurality and ma<ority deci"ion* #he simplest means of deciding an election is the pluralit% rule. #o win$ a candidate need onl% poll more votes than an% other single opponent7 he need not$ as re6uired b% the ma*orit% formula$ poll more votes than the combined opposition. #he more candidates contesting a constituenc% seat$ the greater the probabilit% that the winning candidate will receive less than 0H percent of the vote. #he pluralit% formula is used in the national elections of such countries as Freat <ritain$ Canada$ and "ew Yealand. Onehalf of the former +est Ferman <undestag was elected according to the pluralit% s%stem$ while the other half was elected according to a proportional representation formula &see below'. 8nder the ma*orit% rule$ the part% or candidate winning more than 0H percent of the vote in a constituenc% is awarded the contested seat. #he winning part% or candidate must poll more votes than the combined opposition. #his s%stem thus ensures that the elected representative has the support of the ma*orit% of the voters. #he ma*orit% formula is emplo%ed in 2ustralia and >rance. It is usuall% applied onl% within singlemember electoral constituencies. <oth the pluralit% and the ma*orit%decision rules are emplo%ed in the election of 1*S* presidents. #he composition of the electoral colle#e$ which actuall% elects the president$ is determined b% a pluralit% vote ta!en within each state. Voters choose between the names of the presidential candidates$ but the% are in effect choosing the electors who will elect the president b% means of a ma*orit% vote in the electoral college. 2ll of a state]s electoral votes &which are e6ual in number to its seats in Congress' are given to the presidential candidate who gains a pluralit% of the vote in the state election. It is thus possible for a president to be elected on the basis of a minorit% of the popular vote. 2 critical difficult% with the ma*orit% formula is that$ in a multipart% political s%stem$ the formula ma% produce an electoral deadloc! if no candidate secures 0H percent of the total vote. In order to brea! such deadloc!s a second round of elections & second ballot' is re6uired$ if no candidate obtains a ma*orit% on the first round. In Au"tralia$ voters ran! the candidates on an alternate preference ballot. If a ma*orit% is not achieved on the first round of elections$ the wea!est candidate is eliminated$ and the votes he accrued are distributed to the other candidates according to the second preference on the ballot. #his redistributive process is repeated until one candidate collects a ma*orit% of the votes. If no candidate secures a ma*orit% in the first round of the >rench "ational 2ssembl% elections$ another round of elections is re6uired. In this second round$ the candidate securing a pluralit% of the popular vote is declared winner. "either the ma*orit% nor the pluralit% formulas distribute legislative seats in proportion to the share of the popular vote won b% the competing parties. <oth formulas tend to award the strongest part% disproportionatel% and to handicap the wea!er parties. #he latter is particularl% true if small parties are rooted in ethnic$ religious$ or social minorities7 small parties escape the ine6uities of the electoral s%stem onl% if the% have a regionall% concentrated base. #he pluralit% formula distorts the distribution of seats more than the ma*orit% s%stem. Proportional repre"entation* 1=, Proportional repre"entation re6uires that the distribution of offices be proportional to the distribution of the popular vote among competing political parties or candidates. It see!s to overcome the distribution imbalances that result from ma*orit% and pluralit% formulas and to create a representative bod% that reflects the distribution of opinion within the electorate. <ecause of the use of multimember constituencies in proportional representation$ parties with neither a ma*orit% nor pluralit% of the popular vote can still win legislative representation. (roportional representation is an ideal that is sought after$ but onl% appro-imated: the si5e of electoral districts is the critical factor7 the larger the electoral district in terms of seats$ the more proportional the representation will be. #he number of seats assigned to a constituenc% is in fact a greater determinant of the proportionalit% of the outcome than is the specific t%pe of proportional formula used. #he different formulas of proportional representation are basicall% similar in their effect on the conversion of votes to political representation. 9eveloped in the 1Gth centur% in 9enmar! and in <ritain$ the single transferable vote formulaor ,are "y"tem &after one of its English developers$ #. 3are'emplo%s a ballot that allows the voter to ran! the competing candidates in order of preference. +hen the ballots are counted$ an% candidate receiving the necessar% 6uota of first preference votes is awarded a seat. In the electoral calculations$ votes received b% a winning candidate in e-cess of the 6uota are transferred to other candidates according to the second preference mar!ed on the ballot. 2n% candidate who then has the necessar% 6uota is also awarded a seat. #his process is repeated$ with subse6uent surpluses also being transferred$ until all the remaining seats have been awarded. >ivemember constituencies are considered optimal for the wor!ing of the 3are s%stem. #he single transferable vote formula$ because it involves the aggregation of ran!ed preferences$ necessitates comple- electoral computations. #his factor$ plus the fact that the 3are s%stem limits the influence of political parties$ probabl% accounts for its infre6uent use7 it has been used in "orthern Ireland$ Ireland$ and ;alta in the selection of the 2ustralian and South 2frican senates. #he characteristic of the 3are formula that distinguishes it from other proportional representation formulas is its emphasis on candidates$ not parties. #he part% affiliation of the candidates has no bearing on the computations. #he basic difference between the transferable vote formula and the li"t "y"tem" is that$ in the latter$ voters choose among part%compiled lists of candidates rather than among individual candidates. 2lthough voters ma% have some limited choice among individual candidates$ electoral computations are on the basis of part% affiliation7 seats are awarded in respect to part% rather than candidate totals. #he seats that a part% wins are allocated to its candidates in the order in which the% appear on the part% list. Several t%pes of electoral formulas are used$ although the% fall into two main categories: largest average formulas and greatest remainder formulas. 2ll emplo% some t%pe of electoral 6uota. In the largest average formula$ the number of votes won b% each part% is divided b% the number of seats held b% the part%$ plus one. #he first seat is awarded to the part% with the highest number of votes$ since$ no seats %et having been allocated$ the initial denominator is one. +hen a part% wins a seat$ its formula denominator is increased b% one and hence the part%]s chances of winning the ne-t seat are reduced. #he available seats are awarded one at a time to the part% with the greatest average. (art% totals$ not candidate totals$ are used in the calculations. "o transfer of ballots ta!es place. >re6uentl% named after its <elgian inventor$ Victor 1=. d]3ondt$ the largest average formula is used in 2ustria$ <elgium$ >inland$ and Swit5erland. #he d]3ondt formula has a slight tendenc% to overreward large parties and to reduce the chance of small parties gaining legislative representation. #he socalled Dague variation of the d] 3ondt formulaused in 9enmar!$ "orwa%$ and Swedenreduces the reward to large parties but increases further the handicap to small parties. <% ad*usting the denominator of the d@,ondt formula$ the Dague formula increases both the cost of the initial seat of a part% and that of additional seats. #he Dague formula thus aids middlesi5e political parties and reduces the number of legislativel% represented small parties. #he greatest remainder method establishes a vote 6uota for each seat in an electoral district b% dividing the total vote in the district b% the number of competing parties. #he total popular vote won b% each part% is then divided b% the 6uota$ and a seat is awarded as man% times as the part% total contains the full 6uota. If all the seats are awarded in this manner$ the election is complete. Such an outcome is unli!el%$ however. Seats that were not won b% full 6uotas are subse6uentl% awarded to the parties with the largest remainder of votes after the 6uota has been subtracted from each part%]s total vote for each seat it was awarded. Seats are awarded se6uentiall% to the parties with the largest remainder until all the district]s allocated seats have been awarded. Of all the proportional representation formulas$ the greatest remainder formula$ given large enough constituencies$ %ields results closest to the proportional ideal. Small parties fare better when the greatest remainder formula is used than when the largest average formula is emplo%ed. #he greatest remainder formula is used in Israel$ Italy$ and Du-embourg and in some elections in 9enmar!. Ital%$ however$ uses a special variet% of the formula$ called the Imperiali formula$ whereb% the electoral 6uota is established b% dividing the total popular vote b% the number of parties plus two. #his modification increases the legislative representation of small parties but leads to a greater distortion of the proportional ideal. #he choice of ma*orit% and pluralit% or proportional s%stems is$ of course$ not simpl% a matter of pure theor%. 9ifferent methods of counting$ *ust as different conceptions of representation$ usuall% reflect cultural$ socialstructural$ and political circumstances in a particular *urisdiction. ;a*orit% or plural methods of voting are most li!el% to be acceptable in relativel% stable political cultures. In such cultures$ fluctuations in electoral support$ given to one part% or another from one election to the ne-t$ reduce polari5ation and ma!e for political centrism. #hus the cwinner ta!e allc implications of the ma*orit% or pluralit% formulas are not e-perienced as undul% deprivational or restrictive. (roportional representation$ on the other hand$ is more li!el% to be found in societies with traditional ethnic$ linguistic$ and religious cleavages or in societies e-periencing pervasive class and ideological conflicts. Votin# practice"* #here is a direct relation between the si5e of an electorate and the formali5ation and standardi5ation of its voting practices. In ver% small voting groups$ in which political encounters are facetoface and the members are bound together b% ties of friendship or common e-perience$ voting is mostl% informal and ma% not even re6uire counting$ because the csense of the meetingc emerges from the group]s deliberations. #he consensus of the Eua!er meeting is of this order. 2n issue is discussed until a solution emerges to which all participants can agree or$ at least$ from 1=/ which an% one participant will not dissent. <% wa% of contrast$ in modern mass electorates$ in which millions of individual votes are aggregated into the collective choice$ formali5ation and standardi5ation of voting practices and vote counting are the rule. #his is necessar% in order to guarantee that the outcome can be considered valid$ reliable$ and legitimate. Validit% means that the collective choice in fact e-presses the sense of the electorate. Celiabilit% means that each vote is accuratel% recorded and effectivel% counted into the total. Degitimac% means that the criteria of validit% and reliabilit% have been met$ so that the result of the voting is acceptable and provides authoritative guidelines in subse6uent political conduct. #he development of routini5ed and standardi5ed electoral practices in mass electorates is a surprisingl% recent phenomenon$ not much older than 1HH %ears. It is as much a corollar% of the growth of rapid communication through telephone and telegraph as of the growth of the electorate and rational insistence on ma!ing electoral processes fair and e6uitable. "evertheless$ even toda% electoral practices around the world differ a great deal$ depending not *ust on formal institutional arrangements$ but even more on a countr%]s political culture. Secret $otin#* Once suffrage rights had been e-tended to masses of voters who$ in theor%$ were assumed to be e6ual but who$ in fact$ were une6ual &in order of birth$ in intellectual endowment and educational accomplishment$ in social status and the possession of propert%$ and so on'$ open voting was no longer tolerable precisel% because it could and often did involve undue influence$ ranging from hidden persuasion and briber% to intimidation$ coercion$ and punishment. E6ualit%$ at least in voting$ was not something given but something that had to be engineered7 the secrec% of the vote was a first and necessar% administrative step toward the one man$ one vote principle. E6ualit% in voting was possible onl% if each vote was formall% independent of ever% other vote$ and this suggested the need for strict secrec%. #he slow progress made in introducing secret voting$ from the >rench Cevolution well into the ,Hth centur%$ attests to the fact that social engineering$ no matter how desirable or loft% in purpose$ depends on favourable conditions for success. One need not assume that the obstacles placed in the wa% of secret voting were the result of some conspirac% on the part of those who recogni5ed$ 6uite accuratel%$ that the mobili5ation of large numbers of voters fundamentall% changed the distribution of political power and who$ through opposing the secret vote$ hoped to maintain a stranglehold on the newl% enfranchised electorates. Cather$ the success of secret voting depended on the reduction of illiterac% and$ at the cultural level$ on the spread of the individualistic norms of privac% and anon%mit% to certain classes of the population$ notabl% peasants and wor!ers. #raditionall% these groups too! their cues from those accepted as superior in status$ or from their peers. Secret voting re6uired learning to free oneself as a citi5en from one]s customar% associations and from pressures for conformit%. #he difficult% of introducing and practicing the secret vote in toda%]s politicall% and economicall% less developed nations mirrors the tortuous advance of the secret ballot in the +estern nations during the 1Gth and earl% ,Hth centuries. Secret voting reduces drasticall% the possibilit% of undue influence on the voter. +ithout it$ influence can range from outright purchase of votes to social chastisement or 1=0 economic sanctions. #his is not to sa% that briber% in voting is automaticall% eliminated b% secret voting. Daws prohibiting and punishing the purchase of votes are on the statute boo!s of man% countries and undoubtedl% contribute to discouraging the practice. 2lthough informal social pressures on the voter are probabl% unavoidable and$ in some respects$ useful in reducing political rootlessness and contributing to political stabilit%$ secrec% in voting permits voters to brea! awa% from their social moorings and gives them a considerable degree of independence if the% wish to ta!e advantage of this electoral freedom. 2s a result it becomes ever more difficult for intere"t #roup"$ whether labour unions$ farmers] organi5ations$ commercial or industrial associations$ ethnic leadership groups$ or even criminal s%ndicates$ to cdeliver the vote.c #he e-tent to which cdeviant votingc occurs depends partl% on the degree of rigidit% in the social structure. In countries where caste or class barriers are high or where traditional social$ economic$ religious$ or regional cleavages remain strong$ deviant voting is less li!el% than in countries where social mobilit% is possible and where political conflicts cut across traditional social cleavages. In +estern nations the increasing difficulties of labour$ farm$ religious$ or ethnic leaders in influencing the voter attests to the success that secret voting seems to have had on freeing the individual from electoral bondage to his traditional or economic affiliations. /allotin#* #he ballot ma!es secret voting possible. Its initial use seems to have been a means to reduce irregularities and deception in elections. #his ob*ective$ however$ could be achieved onl% if the ballot was not supplied b% the voter himself$ as was the case in much earl% voting b% secret ballot$ or b% political parties$ as is still the case in some countries. <allot procedures differ widel%$ ranging from mar!ing the names of preferred candidates to crossing out those not preferred or writing in the names of persons who are not formal candidates. <allots also differ according to the t%pe of voting s%stem emplo%ed. +here pluralit% or ma*orit% voting is practiced$ most elections emplo% classified ballots whereb% the voter casts his vote for onl% one candidate or list of candidates. +here proportional methods are used$ election is b% ballots that enable the voter to ran! the candidates according to his preferences. #hough evidence is hard to come b%$ it is commonl% believed that the nature of the ballot influences the voter]s choice. In *urisdictions where electors are called upon to vote not onl% for higher offices but also for a multitude of local positions and where$ in addition$ the election ma% include propositions in the nature of referenda$ the length of the ballot seems to be a factor affecting vote outcomes. Overwhelmed b% the length of the ballot$ voters ma% be discouraged from e-pressing their preferences for candidates of whom the% have not heard$ or from deciding on propositions that the% do not understand. <rea!ing up of the single ballot into separate short ballots helps overcome this problem but does not eliminate it. Election data show a rapid decline from votes cast for higher offices to those cast for lower offices and referendumt%pe propositions. <allot position also seems to have an effect on the votes cast for particular candidates$ especiall% in the absence of cues as to part% affiliation or other identifications. #he first position on the ballot ma% be favoured$ and in the case of a long ballot both first and last names ma% benefit$ with candidates in the middle of the ballot suffering a slight handicap. <allot position is li!el% to have its greatest impact in nonpartisan elections$ primaries$ and elections for minor offices. >inall%$ the 1=1 manner in which candidates are listedb% part% column or office blocis li!el% to affect election outcomes. On part%column ballots it is possible to vote a cstraight tic!etc for all of a part%]s candidates b% entering a single mar!$ although voting for individual candidates is usuall% possible. On the other hand$ on the officebloc ballot$ voting is for individual candidates grouped b% office rather than part%. #his discourages$ though it does not eliminate$ voting e-clusivel% for members of one part%. #his can have important conse6uences for the structure of government$ especiall% in s%stems with separated powers and federal territorial organi5ation. If different offices are controlled b% different parties$ the governmental process ma% be mar!ed b% greater conflict than would otherwise be the case$ and governmental decisionma!ing often will be more difficult. #he introduction of voting machines has not substantiall% changed the balloting process$ although it has made it faster$ more accurate and economical$ and virtuall% tamperproof. #he voting machine is not without some minor problems of its own$ in that it ma% marginall% depress the level of voting. In candidate elections the dampening effect is accounted for b% improper use of the machine$ a problem that is being overcome through improved machines and voter education. Compul"ory $otin#* In some nations$ notabl% 2ustralia and <elgium$ electoral participation is legall% re6uired of all citi5ens$ and nonvoters without legitimate e-cuses face mone% fines. #he concept of compulsor% voting reflects a strain in democratic theor% in which voting is considered not merel% a right but a dut%. Its purpose is to ensure the electoral e6ualit% of all social groups. +hether made compulsor% in law or through social pressure$ it is doubtful that high voter turnout as such is a good indication of an electorate]s capabilit% for intelligent social choice. On the other hand$ high rates of abstention or differential rates of abstention b% different social classes are not necessaril% signs of satisfaction with governmental processes and policies and ma% in fact indicate the contrar%. Electoral a%u"e"* Corruption of electoral practices is$ of course$ not limited to briber% or intimidation of the individual voter. #he possibilities are endless$ ranging from the dissemination of scurrilous rumours about candidates$ and deliberatel% false campaign propaganda$ to tampering with the election machiner% b% stuffing the ballot bo- with fraudulent returns$ dishonest counting or reporting of the vote$ and total disregard of electoral outcomes b% incumbent officeholders. #he e-istence of these practices depends more on a population]s adherence to political civilit% and the democratic ethos than on the prohibitions and sanctions written into the law. #he integrit% of the electoral process is maintained b% a variet% of devices and practices. (ermanent and uptodate registries of voters are maintained to guarantee eas% identification of those eligible to participate in elections$ and procedures are designed to ma!e the registration process as simple as possible. In most *urisdictions$ elections are now held on a single da% rather than staggered. (olling hours in all localities are the same$ and opening and closing hours are fi-ed and announced$ so that voters have an e6ual opportunit% to participate. (olling stations are manned b% presumabl% disinterested government officials or polling 1== cler!s under governmental supervision7 and political part% agents or part% wor!ers are given an opportunit% to observe the polling process$ enabling them to challenge irregularities and prevent abuses. Efforts are made to maintain order in polling stations$ directl% through police protection or indirectl% through such practices as closing bars and li6uor stores. #he act of voting itself ta!es place in voting booths that protect privac%. Votes are counted and often recounted b% tellers$ watched b% part% wor!ers to assure an honest count. #he transmission of voting results from local polling stations to central election head6uarters is safeguarded and chec!ed. Participation in election"* #he rate at which individuals participate in the electoral process depends on man% factors$ including the t%pe of electoral s%stem$ the social groupings to which voters belong$ the voters] personalit% and beliefs$ their place of residence$ and a host of other idios%ncratic factors. #he level and t%pe of election has a great impact on the rate of electoral participation. Electoral turnout is greater in national than in state or provincial elections$ and greater in the latter than in local elections. <ecause of this$ scheduling has an impact on the turnout for local elections. If local elections are held concurrentl% with provincial or national elections$ a higher voter turnout is achieved than for nonconcurrent elections. +hether an election is partisan or nonpartisan also affects voter turnoutlighter participation occurring in the nonpartisan elections. (articipation is also greater in candidate elections than in noncandidate elections such as referenda. #here is some evidence that elections based on proportional representation$ in which in some cases ever% vote counts$ have higher electoral turnouts than ma*orit% or pluralit% elections. "oncompetitive or safe electoral districts tend to depress the level of voter turnout$ whereas marginal elections increase the turnout. #echnicalities in electoral law involuntaril% disenfranchise man% potential voters. 2s a result of moving$ people ma% temporaril% lose their vote because of residence re6uirements for voters in their new electoral district. Complicated voter registration procedures$ combined with a high level of geographical mobilit%$ significantl% reduce the si5e of the active electorate in the 8nited States$ whereas in Canada and Freat <ritain the si5e of the electorate is ma-imi5ed b% governmentinitiated registration immediatel% prior to elections. Voter registration in the 8nited States is left to the initiative of individuals and political parties. Celativel% low levels of electoral participation are associated with rural residence$ and also with low levels of education$ occupational status$ and income. #he groups in societ% that have been most recentl% enfranchised also tend to vote less. 3ence women vote less than men$ 2merican blac!s less than whites$ and wor!ing class people less than those of the middle class. :oung people who have *ust turned of age$ and have therefore *ust been enfranchised$ are less li!el% to vote than people who are middleaged. It is important to note that the nonparticipation of certain groups in elections has important implications7 if ever%one were to vote$ the balance of electoral power would shift toward the recentl% enfranchised and less privileged members of the societ%. Some people are conscientious nonvoters$ although such people are rare. Others$ perceiving the vote more as an instrument of censure than of support$ ma% not vote because the% are satisfied with the present government. #his group of voluntar% nonvoters is also small$ however. In fact$ nonvoters have been shown to be generall% less satisfied with the political status 6uo than are voters. #he vote is a rather blunt and ineffectual instrument for e-pressing dissatisfaction$ and nonvoting is more li!el% to be s%mptomatic of alienation from$ than of satisfaction with$ the political s%stem. 1=? Supporters of political parties vote more often than nonsupporters7 to part% supporters the vote becomes a pledge of part% lo%alt% as well as a political instrument. #hose who feel that government policies have some direct relevance to their lives are more li!el% to vote than those who are disinterested or who sense the government as being more remote. >inall%$ a great number of random factors ma% determine individual participation in specific elections. Election campaigns var% in their intensit%. 2 crisis atmosphere ma% induce an unusuall% large number of people to vote on one occasion$ whereas on another the chance to vote for an e-tremist candidate ma% increase the participation of the normall% disinterested. Even the weather has a substantial impact on election turnout. Influence" on the direction of $otin#* #he electoral choice of voters is largel% influenced b% their membership in social groups or b% the social groups with which the% identif%$ and$ to a much lesser e-tent$ b% campaign issues and part% promises. #he determinants of part% membership or part% identification are the most crucial factors behind the voting decision. ;embership in social and occupational classes$ regional$ religious$ or ethnic groupings$ and so on$ are thus important influences on the direction of the vote. <ecause the electoral choice appears to be largel% determined b% long standing group and part% identifications$ the voting decision ma% appear to be irrational$ in that it is not based on a careful calculation of the immediate benefits e-pected to accrue to the voter from each electoral outcome. Froupdetermined voting does not preclude rationalit%$ however$ for individual selfinterest ma% well be tied to the destin% of the social groups to which the voter belongs. #he independent voter$ contrar% to much common belief$ is li!el% to be poorl% informed politicall% and relativel% uninterested and uninvolved in politics. (arado-icall%$ however$ b% switching their support$ independent voters represent an important factor in democratic politics. In most countries the relativel% permanent part% alignments are based on social and cultural cleavages. <ut if elections are to be competitive$ and if control of the government is to alternate between parties or coalitions of parties$ then some voters must switch part% support from election to election. 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Micro Trend Trading For Daily Income Using Intra Day Trading Tactics To Harness The Power of Todays Volatile Markets by Carr Thomas K 1st Edition 2010 Hardcover by Thomas K Carr B010ik5k2e