FW: INCOME INEQUALITY RE: MAJOR PROBLEM

 

“I believe this [income inequality] is the defining challenge of our time.”
Barack Obama (2013)

 

“One of the leading economic stories of our time is rising income inequality, and the dark shadow it casts across the global economy.”
Christine Lagarde (2015)

 

There is a clear recognition of the risks, dangers and the pain which income inequality imposes on society. Despite the recognition, it is a problem which seems to constantly be forwarded on to successive generations to resolve rather than finding a decisive set of solutions.

We will all do well to pay heed to the US Senator John Sherman who in 1890 when he introduced his landmark Sherman Antitrust Act said that he sought to “put an end to great aggregations of capital because of the helplessness of the individual before them” and also because he fundamentally believed that amongst all of the nation’s problems, “none is more threatening that the inequality of condition, of wealth and opportunity.”

So why does inequality matter? Why is it important that we all strive towards resolving it? Societies that are hugely imbalanced and unequal ultimately become fractured which in turn lead to painful social and economic consequences that affect everyone. Neither the rich nor the poor will be able to avoid the huge social costs of a fractured society.

The stark facts

  • 62 of the richest people in the world own what the bottom 50% of the world’s population own.

  • 1915: The richest 1% of Americans earned 18% of the national income.
    1930s to 1970s: The share plummeted and remained below 10%
    From the 1970s: The share has increased to almost 30%

  • 1980: The top 0.1% wealthiest Americans controlled about 9% of all household wealth
    2015: The top 0.1% own 22% of all household wealth.

  • USA: The top 1% of America control 40% of America’s wealth

  • Germany: Poverty has risen by half since 2000.

  • 1965: CEO pay at the largest 350 U.S companies was 20 times as high as the pay of the average workers
    1989: The figure is 58 times as high
    2012: The figure is now an astounding 273 times as high.
    (It is worth bearing in mind that Peter Drucker argued that the pay ratio between the top executive and the humblest worker should be no greater than 20 to 1.)

  • OECD: The gap between the rich and poor is now at its highest level in OECD economies in 30 years according to a report produced in 2014. The overall increase in income inequality has been driven by the richest 1%.
  • 2008: The United Nations University (UNU) and the World Institute for Development Economic Research (WIDER) estimate that the global Gini coefficient (a measurement of inequality between 0 – representing complete equality and 1 – representing complete inequality) was 89.

    An alternative way to interpret this is that in a population of 10 people, if one person had $1000, the other nine have only $1 each.

  • 2014: The Credit Suisse Global Wealth report estimates that that the richest 0.7% (who hold over US$1 million in wealth) held 44% of the global net worth.

Some context

The economic success stories of many countries hides a dangerous truth – that a significant majority of economic gains are going to those at the very top of the income distribution whereas those lower down have seen real incomes stagnate or diminish.

This has in turn perpetuated further inequality as those in a position of privilege often use their wealth and influence to shape policies that further increase their concentration of power. These policies have not necessarily been in the interests of those lower down the income ladder.

A research conducted by Martin Gilens, a political scientist at Princeton, lends credence to the notion that the US government responds more positive to the most affluent ten percent of Americans whilst “the preferences of a vast majority of Americans appear to have essentially no impact on which policies the government does or doesn’t adopt.” (A video of Gilen’s lecture can also be viewed here.)

The erosion of the social compact

This wasn’t always the case though. Whilst there has always been inequality, it has never been to this extent or been as pervasive. There was also more concerted effort to reduce the level of inequality and dampen its deleterious impact on society.

The experience of the First World War revolutionised American attitudes towards taxation and redistribution of income. When the War Revenue Act of 1917 was passed, there was talk of “conscription of income” and “conscription of wealth” at a time when young men were enlisting en masse. “Let their dollars die for their country too,” one congressman said. The call for fiscal patriotism helped legitimate the progressive income tax in the United States, and by 1944 the top marginal rate had risen as high as 94 percent.

Across Europe, a fear that the lack of reform could lead to social and political turmoil and the horrors of two World Wars meant that policies such as social insurance, minimum wage, a strong welfare state and progressive income tax were implemented leading to more egalitarian societies and economies.

inequality 2The experiences of global ears produced visions of a social bond holding countries together and nurtured the notion that every single person owed a debt to the welfare of the broader community and society.

However since the 70s, the disappearance of these conditions has meant that the support for egalitarian public policies has also diminished.

We now live in a world where even high skilled jobs are being commoditised so that even highly educated workers are not making sufficient progress as gains in economic growth are limited to a very elite group of financiers, entrepreneurs and managers. In the past only unskilled workers lost jobs to automation, now even highly skilled occupations are at risk with the advancement of artificial intelligence, robotics and automation.

The social structure of Silicon Valley provides us with an instructive view of the future: One where expert systems have replaced the majority of people and a tiny but well-remunerated minority direct the economy whilst the majority exist to serve them alone.

The conflict is no longer just between the working class and the middle and upper classes – it is now between a tiny elite and the great majority of citizens. As the majority develop a sense of common interest, or what Marx may have termed ‘class consciousness’, the need to resolve inequality will become more acute as the resentment of it intensifies.

 

What happens when income inequality starts to become entrenched?

  • Health: Societies that are more unequal tend to have lower life expectancies, higher infant mortality, higher levels of infant mortality and high levels of diseases and conditions such as HIV/AIDS.
  • Human capital development: As inequality rises, scores on the UNICEF index of child well-being become significantly worse. Literacy rates are also lower and youth unemployment also becomes a major issue. A higher level of equality also leads to a greater level of innovation as a result of greater access to opportunity.
  • Social mobility: Inequality restricts social mobility – equality of opportunity is enhanced by greater income equality. Reduced social mobility further exacerbates income inequality and this becomes a vicious spiral from which an effective functioning economy becomes more and more difficult.

    inequality1 2
    (C) Walt Handelsman
  • Economic progress and stability: An IMF report highlights that by reducing inequality and bolstering longer term economic growth are “two sides of the same coin.” In both rich and poor countries, inequality is strongly correlated with shorter spells of economic expansion and growth over time. Unequal economies are also more susceptible to severe boom-and-bust cycles leading to greater volatility and crisis. Extreme levels of income inequality depress economic growth. An OECD report estimates that inequality has had a cumulated loss of GDP across OECD economies of 8.5% over twenty-five years.
  • Social challenges and issues: Inequality breeds corruption. Unequal societies also lead to greater economic instability. If one considers the root causes of the Arab Spring, the lack of economic opportunity or equality is one of the main drivers leading to revolt.

A blueprint for change and resolution

The solution and change required for income inequality is not a zero-sum game. There will be those who are impacted more than others, but it is essential in calibrating the world in a more equal way.

It is very easy to be dangerously complacent and ignore equality, but chronic economic inequality hurts everyone, both the rich and the poor.

Resolution of a problem like inequality requires a revolutionary approach. We need to accept a fiscal revolution or risk a social one.

I’ve highlighted below briefly some key practical steps that need to be considered as we seek an urgent resolution to the problem of income inequality.

  1. Tax reforms – Income taxes need to be more progressive (the way they were previously in times of greater equality). There needs to be a reform in the way the transfer of wealth is also taxed. The OECD has suggested that attempts to reduce inequality tax and transfer policies will not harm growth as long as the chosen policies are well designed and implemented. The OECD further argues that redistribution efforts should focus on families with children, on the youth and the improvement in human capital investment through the promotion of skills learning and development.
  1. Continued focus on economic growth and employment – Policies targeting economic growth need to continue as growth ensures jobs are created and ensures employment. Employment will support social mobility which is essential to the reduction of inequality.
  1. Ensure emphasis on social mobility – Social mobility is a key driver towards the reduction on inequality. Emphasis on education, skills learning and development is vital to support social mobility.
  1. Support small savers and small businesses – Policies should not be tilted towards just merely taxing the rich but also be aimed at increasing the wealth of small savers and businesses. For instance we should consider the introduction of accounts for small savers and businesses that guarantees positive returns in excess of inflation. It is also a widely observed phenomenon that lower income families borrow more to support their consumption and this in turn creates a systemic risk.
  1. Enhanced social policies – Governments and policy makers should also consider more directed interventions to enhance the social conditions of lower income families. For instance, in the UK, the Child Benefit offers a weekly allowance to parents for every child they raise. The transfer could be better targeted by making the income taxable as personal income, which will reduce the size of the benefit for those in higher tax brackets or who do not have face any other mitigating circumstances. In the UK, child poverty has dropped sharply whilst in the USA; it has risen by a third between 1969 and 2013. A child-benefit programme will help make a major dent in child poverty and also represent a powerful investment in the future. Introducing a child-benefit program in the US will make a major dent in child poverty and represent a powerful investment into the future.
  1. Minimum wage – Governments should also take an active review of the minimum wage policies in their countries and recalibrate them to local conditions. There is always a temptation to keep minimum wage lower because neighbouring countries are keeping theirs lower, but this beggar thy neighbour policy will not benefit anyone in the long run. Countries that make the effort to ensure greater equality will be healthier in the long term.
  1. Automation and technological change – Governments should take an active interest in the direction of technological change. It is mostly governmental grants and labs that are responsible for the underlying research that has led to the progress in automation and technology and they therefore have the right to ensure a clear review is undertaken to mitigate the social impacts of technological change through appropriate fiscal and taxation policies.

It is crucial that we as a collective rise up to face the challenges of income inequality and work closely to create a more equal society. The corrosive impacts of inequality will affect us all and the sooner we can find solutions to achieve an equal society, the better, for all.

Make hay while the sun shines: Lessons for businesses in emerging markets from the world of farmers.

“The great cities rest upon our broad and fertile prairies. Burn down your cities and leave our farms, and your cities will spring up again as if by magic; but destroy our farms, and grass will grow in the streets of every city in the country.”

                                                                – William Jenning Bryan, Nebraska Congressman, 1896

 

Introduction

Very often, business leaders responsible for the growth and development of emerging markets units turn to the words and deeds of management gurus, industry leaders, governments, business titans and sometimes even politicians (!) to seek a way to best capitalise on the potential and to frame their actions in order to achieve success in their markets.

However, there is a segment of society that offers businesses an enormous amount of wisdom, knowledge and insight that leaders can benefit from – farmers. Now farmers are, for the most part, an unseen and unheard segment of society. We don’t hear much about them, we don’t see much of them and we don’t know much of how they go about conducting their business. The implications and impacts though which farmers have on society are profound. The food we eat, the clothes we wear and the security we seek for our sustenance come from farmers. Without them, society, as we know it, would not function.

Agriculture is a sector that contributes to roughly 3.8 percent of the world’s total GDP which equates to an industry that is worth over US$2.9 trillion at current prices. If farmers of the world united, they would represent the fifth largest country in the world in terms of total GDP!

Business leaders have an opportunity to use farming as the basis and blueprint for success. Over the last half decade of austerity and uncertainty, the one certain thing for most major organisations is that emerging markets represent more than just a passing phenomenon or a rising force – they are the main elements and pillars of sustained economic growth.

However it is important to note that these emerging markets (even amongst themselves) differ fundamentally from more mature markets. This means that the skill sets and capabilities that help emerging markets business leaders in not only establishing operations but to also flourish are unique. We may need to consider the lessons and experiences from farmers, given that the challenges and opportunities are similar. This is the context upon which the rest of this article is based on.

 

The wisdom of farmers

A book published in 1726 titled, ‘The Country Gentleman’s and Farmer’s Monthly Director,’ by Professor Bradley of Cambridge introduces the role of a farmer as follows: “I consider a Farmer as a Person whose Business depends more upon the Labour of the Brain than of the Hands.”

Almost a century later, Sir John Sinclair, founder of the Board of Agriculture highlighted that, “Agriculture, though in general capable of being reduce to simple principles, yet requires on the whole a greater variety of knowledge than any other art.”

The sentiments above remain true two centuries later. Farming and agriculture has been an outstanding, if not neglected, successful endeavour of human society. In the last century, it has succeeded in feeding an ever-increasing global population, a diverse range of produce and goods more efficiently and at lower prices. It can be argued that farmers have been an integral pillar supporting modern economic growth.

Agriculture is not an industry on the periphery of modern civilisation and the world of business. It is a fundamental element of human society from which businesses can gain significant insight and, if applied appropriately, will lead to success in emerging markets and beyond.

 

A common approach to investment

Established businesses looking to develop and sell their product and service offerings must fundamentally treat the way they consider investment in an emerging market or sector differently to their business as usual sectors. A number of organisations make the error of setting performance objectives and deliverables for an emerging market in the same way they would for an established business resulting in unwanted consequences of de-motivated managers on their emerging front lines.

My argument is that businesses looking to establish an emerging markets operation should consider their investment the same way a farmer approaches his investment in his agricultural practice.

To illustrate this further, let us consider an example of a multinational organisation that supplies professional consultancy services across a range of markets. In an instance such as this, we can expect the organisation to have very clear monthly or even weekly targets for their sales performance as they have an established business model, a recognised brand name and the people on the ground who have the experience and the networks to deliver performance to targets. They key factors of production are within control and output therefore is also more easily controlled. Therefore, makes sense to have monthly (or even weekly) targets, forecasts and delivery and indeed performance should be measured with the same frequency.

If the organisation decides to subsequently enter an emerging market where it has no established presence, a brand name that is not recognised and a team that is relatively new, they will need to alter the way they view performance and the way targets are set. Adopting a monthly or weekly target approach will prove to be unfeasible particularly as conditions in emerging markets are not always entirely stable. This is where businesses in emerging markets can consider the way of the farmers.

Farmers have a different system for targets and performance. Farmers do have seasonal targets and objectives but given that the nature of farming is such that it is impossible to predict all the various factors of production. Factors such as the weather and climate, the nature of seeds used, the crop yield, the animal production, amongst other things, can only be managed and not controlled.

A farmer has to deal with many uncertainties, for instance a cold weather snap will destroy ground crops, affect lambing, cause ewes to abort, which all affect the yield for the farmer.

A farmer also needs to deal with farming regulations, subsidies, and changes in government practices or policies (e.g. the structural changes that happened in the farming community upon the adoption of the Common Agricultural by the EU Commission). As Gary Libecap, Professor at the University of California explains, “Agriculture is the most regulated sectors of the American economy. The production and sale of almost all of its commodities are affected by some government policy through a complex mix of programmes.”

It is this enormous ability of farmers to navigate through uncertainties and their overall resilience to rapidly changing underlying conditions and factors that prove most instructive to leaders of emerging markets businesses.

An emerging markets business leader has to remain nimble and agile to the dynamic and sometimes unstable political and regulatory conditions in emerging markets. Even seemingly straight-forward tasks of setting up a legal entity in an emerging market may become a highly tenuous affair and an emerging market business leader has to retain the patience and the will to deliver through the bureaucratic obstacles. It is this patience and perseverance which successful farmers have  in abundance which allows for their ongoing success and growth.

A successful farmer and a successful leader of a business in emerging markets have more in common than we have assumed before.

 

Of growth and harvesting – the shared goals of farming and emerging markets

The objectives of both the farmer and an emerging market business leader are congruent in many respects. The average farmer is a skilled diplomat, a human resource leader, an effective delegator, a scientist, a chemist, a negotiator, a commercial leader, an innovative marketeer and sometimes even auctioneer. He has to possess exceptional skill and energy to carry out the above roles and tasks and ensure that his agricultural endeavour is a successful one.

An emerging market business leader is similar and has to be able to navigate through sometimes sensitive commercial negotiations in the face of vastly evolving regulatory changes and has to be able to engage both his teams as well as key stakeholders such as regulators, government leaders and suppliers in a diplomatic manner that allows him to achieve his business objectives.

Farmers have always been very adept in ensuring that they adopt relevant approaches to farming based on their location and underlying conditions. This is not a modern phenomenon but one that is as old as agriculture itself. For example, the indigenous Ifgugaos in the Philippines realised two thousand years ago that their mountainous and hilly terrain meant that crop cultivation was going to be challenging and sought to change the underlying condition and created what is now known as the Banaue Rice Terraces. These terraces were built with little tools and water was sourced from the forests which were above the terraces through a unique and ancient irrigation system.

To further illustrate this point, in the northern hemisphere, wheat must ripen in late spring or early summer to get as much sunshine as possible. To grow it, one has first to plough the ground, then sow, harrow (to get rid of the weeds), and eventually harvest. Any anticipation or delay of any of these operations entails losses, which can become serious. For example, ripe wheat, if not cut, would fall on the ground and soon become worthless. In Burkino Faso, land has to be ploughed within days of rain or the land becomes too hard to plough.

Similarly, an emerging markets business leader will need to be swift and decisive in their strategic and market implementation. There needs to be ample planning and analysis in advance of delivery and once a common approach has been agreed, timing becomes critical and execution must take place within defined times to attain the defined aims and ambitions. Delaying or vacillating over decisions will lead to missed opportunities and potentially allow for rivals to take the lead in a potentially lucrative segment.

Farmers also need to be able to think strategically for the future in anticipation of global and local circumstances. Strategic management and optimal operational delivery is a way of life for modern farmers. They have to be able to factor all information, both historic and projected, which allows them to make appropriate and relevant decisions that allow them a sustainable farming business. The farming sector, supported by high commodity prices, has demonstrated enduring resilience during the last economic crisis in 2008. World Bank data shows that in 2009, agricultural value added at world level rose by 4 percent which can be contrasted to a 5 percent fall in global sector-wide GDP. This resilience was more pronounced in emerging economies, where agricultural GDP rose by 8 percent.

Likewise, an emerging markets business leader needs to be able to clearly define and articulate their propositions to their markets and customer segments. They will need to prepare adequately for their specific targets and estimate accurately the required resourced needed to achieve their outputs. In this regard, they can learn from farmers whose entire seasonal output and sometimes even survival depends on their ability to estimate accurately the required resources to achieve a given output.

Emerging markets leaders also need to be assess and understand their market terrain and environment. They need to ‘work the ground’ and understand the local feedback, context and factors that will have significant impacts on their output. The most successful farmers continuously identify their strengths and weaknesses relative to their local as well as international competitors who may be able to offer the same output at a lower cost. An example of how this has been done includes potato farmers in Tasmania who undertook extensive research to understand how lower-cost potato imports from the Netherlands and Belgium are undercutting their business and took steps to address these challenges. Similarly, emerging markets business leaders will need to conduct sufficient levels of quantitative and qualitative market research to ensure that their businesses remain resilient against competition, both local and international, and also achieve their growth targets.

 

Resilience and leadership

Farmers face a range of challenges and issues. The challenges range from external environmental factors outside their control such as climate change. Global economic pressures, livestock disease and climatic changes are the types of issues which farmers have to navigate through.  For instance, there is a loss of arable land due to climate change amounting to as much as a fifth of all agricultural land in South America and Africa.

Events and challenges such as this affects crop yield which in turn affects farmers’ incomes and cause them to become highly volatile. These mean that farmers need to be careful in how they manage their finances and funds in order to ensure that they are able to meet expenses and also correctly anticipate demand. Farmers fundamentally need to navigate through uncertainty and steer their operations and farms through competing pressures and noise to keep producing in a way that meets challenges.

Risk management is a central pillar in terms of how farmers manage their business. They are now being required to produce more food and other agricultural products on less land, with less pesticide and fertilisers, with less water and also manage a lower carbon footprint. Part of the risk management process of farmers has been to understand what their underlying risks and challenges are and to subsequently develop and implement the technologies and practices that counter environmental and land degradation and climate change to maintain sustainable and viable farms.

Examples of this include mixed cropping that have led to better usage of nutrients in soils and more effective pest management systems. In Zambia, for instance, crop rotations have reduced water requirements by up to 30 percent. They also use a new strain of maize which produces a yield which is 500 percent higher than the average yield for the rest of Africa.

The underlying risks have also been managed through a series of other initiatives such as skills development training across a wide range of relevant topics and generation of non-farm income (such as agri-tourism). They also deal with it through diversification into renewable energy technologies and by developing markets for novel and alternative cropping.

Businesses investing in emerging markets also need to ensure there is a sufficient level of risk management and due diligence conducted prior to entry into new markets. They will need to ensure that they have diversified their risks through investment across a wide portfolio of markets. They also need to be able to react appropriately to emerging regulation and underlying economic conditions by reviewing their business operations and investment accordingly.

Farmers globally seek to create viable and resource-efficient farms and agribusinesses that are able to meet demand and yet remain resilient to fluctuations in the business cycle or other natural causes without recourse to significant public intervention.

Initiatives such as the establishment of grain stores in Africa and the creation of dairy hubs in India, Bangladesh and Pakistan are helping farmers to cut costs, create greater income and reduce price volatility.

A successful farmer is a leader who does not micro-manage staff or instruct them to do something they cannot or will not do. The most effective farmers are inspiring (particularly when they are undergoing moments of extreme uncertainty); strategic (by having a good view of the changing conditions and consumer patterns which impact their sales); energetic (to rouse their teams into action towards peak performance); and possess a clarity of vision which can effect great change.

Likewise, a successful emerging markets business leader should have the ability to delegate effectively and provide enough support to their people and inspire confidence. They should also cultivate and nurture their teams towards peak performance and give them a sense of ownership and achievement. It is also vital that emerging markets business leaders ensure their teams have sufficient levels of training and development so that they are constantly building on their capabilities and can support business and corporate objectives even better.

Farmers also remain a source of emotional vitality in their communities and countries. Their critical importance to the well-being of their nations and their role in a profoundly rebalanced world mean that they provide the vigorous inspiration required for growth and development. Their leadership and resilience has led to the innovation, creativity and has the potential to inspire the social cohesion required in a world marked increasingly by differences.

 

Innovation as a key essence to success

Thomas Malthus predicted in the 18th century that there would come a time in the late 20th century where the world population would exceed food supply leading to widespread impoverishment and famine. This has not come to pass and indeed over the last fifty years, agricultural production has tripled and farmers have ensured that the world, for the most part, remains fed and clothed. This has happened due to the constant innovation in farming. Smallholder farmers (who account for almost half of the emerging world’s labour force) have overseen a rise in agricultural productivity.

Farming innovation can be broadly grouped into four categories: biological innovations (new strains of plants and animals); practices of cultivation; technical and technological innovation (including machinery, fertilisers and the increasing use of technology).

The ‘Green Revolution’ which saw India experiment with new varieties of rice and wheat in the 1960s helped to ensure that India averted the pains of starvation. Increasingly, new strains of rice and wheat that can withstand flooding and salinity are being developed that will ensure that the poor agricultural lands are converted to fertile plains.

Increasingly, innovative agricultural practices are also improving farmers’ yields and performance.  An example of this is the way fertilisers are spread to crops. Traditionally, rural farmers applied fertilisers by spreading them by hand.

However more rural farmers are now applying a practice widely known as ‘Fertiliser Deep Placement’ (FDP) which works by using a specialised fertiliser called a briquette about four inches underground which releases nitrogen gradually.

This prevents less nitrogen to be lost through run off. FDP is now being used widely by farmers across Burkino Faso and Nigeria and has helped increase their yields by almost a fifth of total production.

Modern technological innovation is also being adopted by farmers and extended globally. VetAfrica is a mobile app which now allows for farmers to diagnose livestock illness and to apply appropriate remedies and drugs to treat diseases. In India, farmers now have access to various instructional support by the government’s agricultural agencies that provide both online and offline information to rural farmers and their communities.

This spirit of innovation will also place emerging markets leaders in good stead. Businesses that invest significantly in research and development and ensure their people are empowered to experiment and deliver innovative solutions will be better placed to create scalable and transferrable innovations that can support the wider business.

Farmers have remained at the forefront of innovation and have also been very enthusiastic adopters of new technology and solutions. This is despite the fact that agricultural innovation generally entails a high level of risk and many of them yield little or no financial reward to the inventor.

In an era of rising energy costs and greenhouse gas emissions, some researchers are questioning whether conventional agriculture’s reliance on chemical fertilisers is sustainable, and point to its negative effects: pesticide residues, soil erosion and reduced biodiversity. Switching to organic and resource-conserving methods of farming can improve smallholder crop yields, food security and income, a review study by the International Journal of Agricultural Sustainability has found.

Likewise businesses that enter emerging markets should also consider their overall business practices and consider how the implementation of socially responsible practices can help reduce their overall costs and improve their bottom line in the markets they are operating in.

Farmers have also identified increasing demand from a more affluent customer base and have responded to it by shifting towards organic production and cultivation. The amount of land in organic production across Europe has grown by about five million hectares over the past decade, according to the European Union, and has grown by 13 percent annually over the last decade. A similar phenomenon is also observed in the United States of America according to a survey conducted by the US Department of Agriculture (USDA). The number of USDA certified organic farms has quadrupled since 1990 and the area dedicated to organic farming has increased from 1 million acres of land in 1990 to over 4.1 million acres currently. Organic farming is also becoming increasingly popular across South Asia (particularly India) as farmers tap into the increased demand and are evolving their farming practices accordingly.

Similarly, there is significant scope for emerging markets business leaders to learn from the habits of the farmers. The approach to farmers in testing and innovating to arrive at the optimal farming solution (the way they test to see which crop rotations work best given the soil and land conditions for instance) will also help business leaders in emerging markets to test out product launches and to test it in a given market prior to a full-scale rollout. This allows them to obtain a clearer insight into consumer behaviours and the general market sentiment for their product which will allow them to make the necessary improvements or changes required before they invest in a full rollout. This experimentative approach to new markets will become increasingly important particularly as organisations become more risk averse and seek a higher level of returns on investment but within a defined risk framework.

 

Building a force for good and planting the seeds of hope

Farmers and agriculture are vital to the overall betterment of society as well. The Consultative Group on International Agricultural (CGIAR) certainly believe so and feel that agriculture will help nations meet the emerging UN Sustainable Development Goals (SDGs) – the successor to the UN Millennium Development Goals.

Despite the well publicised challenges and adversity faced by farmers and the struggle they undergo on a daily basis, their resilience and their hopeful outlook provides food for further though and reflection for emerging markets business leaders. This is a spiritual dimension that must be noted.

Likewise, an emerging market business leader has to remain cognisant of their responsibilities within the societies they operate. If they are representatives of larger multinational organisations, the general public will expect them to implement world class practices and behaviour. They will also be required to adapt to the culture-specific scenarios presented to them and act in an appropriate manner.

It is vital that emerging markets business leaders look beyond profitability and financial remuneration. They need to ensure that their organisations are acting in the public interest and whilst creating value for their businesses are also creating positive externalities and value for the communities in which they operate in. It is this that sets the framework for a fruitful and sustainable growth and development of both businesses and societies. This addresses both the social and economic dimensions of sustainability.

The final dimension of sustainability is that of environmental sustainability. It is well known that the natural world that agriculture relies on is exhaustible and the relationship with nature and the environment has been a distinctive and intractable feature of farmers.  This is true from the fertile padi fields of Java to the ranging prairies of the Midwest.

Emerging markets business leaders need to give sufficient consideration to environmental sustainability. This not only ensures that they are contributing in a positive manner to the society but also acts as an important license to operate across a number of countries.

In conclusion, farmers can be a powerful source of inspiration and guidance to business leaders in any market. A farmer needs to tend to his flock with loving care and the successful farmer is one who takes an active interest in the welfare of his farmhands, who cultivates and nurtures his crop and animals with passion and tenderness. A successful farmer also flows with the changes to the external environment and navigates them successfully. A farmer also continues new ideas (be it the type of seeds used, the type of farming, consider the impacts of automation and technology on his farms, the use of data to understand the changing crop yields, risk mitigation, etc) and constantly innovates. A successful farmer also has to negotiate effectively with other farmers, with government, with regulators. He has to manage finances effectively and think of new financing to make it through the lean times. All of these skills and qualities are also what contribute to effective and successful business leadership.

 

 

“The prosperity of other industries is not the basis of prosperity in agriculture, but the prosperity of agriculture is the basis of prosperity in other industries…Immense manufacturing plants and great transportation companies are dependent on agriculture for business and prosperity. Great standing armies and formidable navies may protect the farmer in common with other people of a nation but their support comes from the tillers of the soil.”

                                                    

                                                                     – Nahum J Bacheldar, 1908 (Leader of National Grange)

 

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The catastrophe of bees’ colony collapse globally.

Ad campaign to save bees in the UK - in the London underground
Ad campaign to save bees in the UK – in the London underground

I saw this campaign ad in the London Underground and it raised what I consider to be a very important issue.

Einstein is commonly reported to have predicted that ‘if bees were to disappear from the globe, mankind would only have four years left to live’.

Since the statement above, more than 90% of the world’s bees have disappeared. There is no conclusive evidence to explain why and this is a hugely troubling matter.

One in three mouthfuls of food we eat are crops (fruits, etc) that are dependent entirely on bees.

If the bees are wiped out, our food shortage problems (which are already at crisis levels), will reach catastrophic levels.

Bees’ colony collapse is a problem that will have a huge implication with devastating consequences for people around the world. More urgent effort is needed to better understand the reasons for the decline of bee colonies (this decline will further impact agriculture and crop produce – which in turn will exacerbate the current problem of global food security and supply).

I will strong recommend that we learn more about this very critical issue (which to my mind is almost as important as that of climate change) and act on it.

For further information, please read: http://www.nature.com/scitable/blog/green-science/global_crisis_honeybee_population_on

For those with children, get them to watch Bee Movie!!

Let’s start doing our part, inform and educate and above all act. This is not just for us, but for those who will follow us.

Thank you.

Myanmar: After the elections – where to next? Some suggestions

After peaceful and fair parliamentary by-elections, the people of Myanmar can look forward to even greater optimism.

Myanmar is a country of immense potential and there is plenty of scope for development and enhancement of the quality of life there. A few interesting facts about Myanmar:

  • It is the 40th largest country in the world, the second largest country in Southeast Asia:
  • and 24th most populous country with over 58.8 million people;
  • Under British administration it was the second wealthiest country in South East Asia;
  • The current capital of Myanmar is now Naypyidaw (“City of Kings” in Burmese) which was chosen as the new capital in 2006. The previous capital used to be Yangon, which is still the commercial hub of the country;
  • It is a hugely vibrant country with a significant level of multi-culturalism and tolerance. Indeed it is not uncommon to see mosques, churches and Hindu temples dotted around the main cities in a largely Buddhist nation.

I have proposed below a number of suggestions as to what Myanmar should consider as the country grows. These thoughts should by no means be viewed as expert opinion but rather as those made by a layman with a deep interest and affection for Myanmar and its people.

Infrastructure improvements

There is an urgent need for Myanmar to improve the following:

Telecommunications & IT infrastructure – Internet access remains expensive and patchy. This is a result of very few operators in the telco space and there should be an active process of inviting regional/international telco partners into the fold and help drive down costs of Internet access. There should also be tie-ups with international partners to allow for an upgrading of the current telecommunication infrastructure. The Myanmar Ministry of Communications, Posts and Telegraphs needs to start working with foreign partners to help support the upgrading efforts.

Roads/railway – With greater economic growth, we will see greater rural-urban migration, which will increase the burden on roads/highways and railways in the cities especially Yangon. Yangon’s traffic network as it stands is just sufficient – but with any further increase in the city’s population, there is a real risk that we will find gridlocked roads that’s commonplace in Jakarta and Bangkok. There must be a realization that there is a severe business and economic cost to poorly managed roads – a point not lost on Jakarta/Bangkok’s city planners. Yangon however – if it chooses to be proactive – can mitigate future problems and issues in a more efficient manner.

Natural disaster early warning systems – The government should also seek aid support (both financially and technically) to help develop and establish early warning systems for cyclones and other natural disasters that afflict Myanmar. This will help minimize casualties and mitigate damages. An early warning system, cyclone shelters, coordinated response systems, integrated medical and emergency protocols, etc will all help with recovery efforts subsequently.

Healthcare – There should be an effort to upgrade medical and healthcare facilities. The current facilities are outdated and with the medical teams normally being overworked and underpaid. The health of the people has to be paramount and there has to be good state hospitals. The easy alternative is to simply let private hospitals operate in the country but this normally tends to create a 2-tier healthcare system – one for those who can afford it (normally a minority) and those who cannot (the majority) and this only exacerbates the problems of social inequality.

Banking sector reforms (including currency exchange)

Banking system

Myanmarese banking systems need to be plugged in with regional partner banks. There should be greater facilitation of international banking norms like Automated Teller Machines (ATMs), international banking transfers, trade financing (such as the use of LCs, DPs, DAs, etc), credit cards, etc.

Credit card acceptance in Myanmar is extremely low – and this hurts locals as well as tourists and businessmen. It also affects the hospitality industry. Plenty of tourists go into Myanmar without realizing that the 99% of the economy is a cash economy which prevents tourists from spending what they would have planned in advance.

Lack of international banking transfers also means that profit repatriation is affected for international investors. This has to be managed as well.

Currency exchange regulations

It is good to note that the Myanmar government has allowed for managed floating of the kyat. However it is important to note that there is still significant dollarization within the economy. Myanmar should avoid the path taken by Vietnam which allowed for the US Dollar to be used as a currency of choice within the country – which effectively meant that the Vietnamese lost all control of their monetary policies as they had no control over the USD. The Myanmar government should restrict the use of the USD extensively within the economy and there should be a push to use kyats by all key sectors of the economy. This will help support the use of the kyat as well as ensure greater monetary policy control subsequently. If the Myanmarese do not control this problem early, it will become too big to solve – see Vietnam experiences.

Education

There should be an extensive review of current tertiary education institutions. There should be greater quality control and better alignment to international best practices. Myanmar’s key universities should invest in (and seek support for investment) their teaching infrastructure and lecturers. There should also be a regional broad-based support of Myanmar’s universities through partnerships with other leading institutions within ASEAN. Exchange programmes, best-practices sharing and scholarships should be implemented with reputable partners. There should also be a review of curriculum (at all levels), textbooks and teaching material (many of which are obsolete), teachers’ competency frameworks and teachers/lecturers’ remuneration.

There should also be additional focus on the development of competencies of Myanmerese youngsters in these areas:

  • Software programming
  • Accountancy & Finance
  • Medicine
  • Engineering
  • Architecture

The above are all areas which Myanmarese have traditionally excelled in and there is a natural gravitation of the talented youngsters towards these subject areas. The government should support the aspiration of the youngsters by ensuring they develop robust and viable capacities and capabilities in these areas.

Public sector / civil service salary review

As the country grows economically and with increasing incomes and greater investments by multinational firms, there remains a real risk that corruption will rear its ugly head. Rampant corruption has been the bane of many a rapidly emerging economy and it becomes a real business cost for the country subsequently. One way of curbing this is to ensure that the members of the civil service have salaries that are consistent with the private sector. Yes, it will be an extremely costly affair, but rather than as a cost, it should be viewed as investment to protecting the country’s future.

A better benchmarked salary will also mean that the civil service and public sector will attract a better quality of individuals with a real commitment to the country’s cause which will help in the country’s development.

This should be a matter which the government addresses sooner rather than later (when it may be too late – the Indian experience is a sorry tale in this regard).

Reinventing the economy

Free-trade zones / Special Economic Zones / Preferred Trading Nations agreements

Myanmar should establish formal country economic partnerships with India, China, the UK and ASEAN. This could be in the form of preferred trading nations agreements, free trade agreements and also in the form of special economic zones whereby the investing nation will get tax breaks and incentives to set up operations in Myanmar. Therefore, we could have an Indian special economic zone (SEZ), a Chinese SEZ, an ASEAN SEZ (where all interested ASEAN member states can invest freely and enjoy liberal benefits). This means that Myanmar also diversifies its economic dependency across a whole host of countries and not remain entirely under the influence of just one major economic partner. This will result in severe risks further down the road.

Professio-nationalisation of key industries and sectors

The country should also consider professionalizing and nationalizing key industries in areas such as mining, energy, infrastructure and transportation. Currently they are either nationalized (but lack professionalism) or have not yet been nationalized at all. Vital industries should be protected by the government. Perhaps one other model is to allow for joint ventures with foreign companies in areas where the government does not have the skill sets. For instance, in Brunei, Shell has a 50-50 venture with the Brunei government (a JV entity known as Brunei Shell Petroleum or BSP) which ensures that Brunei enjoys the technical and managerial expertise of Shell but also ensuring that the returns are shared with the government and ultimately the people.

Supporting small and medium sized enterprises

The government should also provide incentives and support structures for small and medium sized enterprises (SMEs) as they tend to account for the bulk of employment and GDP of any country. Supporting SMEs will also spur greater entrepreneurship, innovation and growth that is led from the bottom-up and which will ensure better distribution of economic resources amongst people.

Conservation & commitment to sustainable growth

In the midst of all these developments, Myanmar however, should not lose sight of the fact that it is a large country with significant environmental beauty and value which must be preserved. Economic progress must not come at all costs and therefore endangering the environment. There must be an overriding commitment to conversation and sustainability. There is no point if the country grows but finds itself polluted and dying from the inside. To this day, I find it absurd that nations spend significant percentages of their GDP of defence spending and yet neglect to look after their environment and allow it to be robbed, pillaged, polluted and destroyed. Effectively, guns are being bought to secure the country from external forces while the country dies from the inside. Myanmar has a real opportunity to ensure this is not the case from a very early stage.


Corporate responsibility for small businesses in Indonesia – At a tipping point?

First published in BritCham Indonesia magazine Up.Date – February 2012 edition

Corporate responsibility for small businesses in Indonesia – At a tipping point? 

Malcolm Gladwell in his book, “The Tipping Point” describes how sometimes little things can make a significant difference and lead to sparks in trends and monumental shifts in mindsets.

In the same way, the themes of corporate social responsibility (CSR) and sustainability for small and medium sized businesses (SMEs) in Indonesia stand on the verge of a paradigm shift and will likely change the way these businesses operate and function.  CSR and sustainability can be defined as a company’s commitment towards the integration of economic growth, environmental management and social equity in a way that meets the needs of its stakeholders, now and for the future.
SMEs are an important part of Indonesia’s economy. They comprise 99% of all establishments and employ almost 90% of the workforce. Indonesia is home to many dynamic and vibrant SMEs contributing to more than half of Indonesia’s gross domestic product (GDP).Accordingly, the success in promoting SMEs is widely recognized as critical to long-term sustainable economic growth. As a result of this aggregate influence, SMEs have an immense environmental and societal impact and will increasingly play an influential role in the sustainability agenda.

Internationally, innovation in many countries is taking place in garage workshops and factories of SMEs. It would be overly presumptuous therefore to assume that all expertise and good CSR practices are solely the domain of the larger multinational firms. Indeed, despite resource constraints and a highly competitive market place, SMEs around the world are achieving commercial success by incorporating elements of good environmental and societal practices within their businesses.

The factors leading to the tipping point 

Increasingly SMEs are showing greater commitment to environmental, social and community responsibility. There are a number of reasons why there has been a shift in the mindsets of SMEs leading to a tipping point in favour of greater sustainability.

The personal values and passion of the founders and owners of SMEs play a huge role in driving CSR for their businesses. SMEs that have the benefit of founders whose personal convictions, values and ethical core philosophy shape the business strategy and operations will inevitably have sound CSR practices implemented within.

Another key factor driving SMEs towards sustainability is that the implementation of CSR initiatives within a firm has a compelling business case. It helps minimise risks and maximise opportunities for SMEs. The introduction of social and environmental supply chain requirements has led to SMEs implementing a CSR framework within their organisations. Larger multinationals are now looking to increase the level of transparency and clarity within their supply chains. They demand greater accountability from their suppliers as part of their due diligence. Therefore, SMEs that display greater transparency and clarity about their sustainability and CSR practices are better positioned to effectively compete in the larger global supply chain of multinationals and in the process improve their overall revenue and profitability.

A good CSR and sustainability framework for SMEs will also become crucial as they seek to attract, retain and develop motivated employees and increase their sense of identity and belonging to the company. As the knowledge-based economy puts a greater premium on human capital; attracting and retaining capable individuals will become a critical factor for SMEs to effectively compete and survive a highly-competitive market. The younger generation of employees are looking towards job fulfilment, good working conditions, responsible employers and a good work-life balance. SMEs that can demonstrate their commitment to corporate responsibility and are transparent about their sustainability practices will attract the talented staff they require.

Sustainability is about being efficient, delivering a better product or service using as few resources as possible, and incorporating sound and responsible practices within the entire business operation to become more competitive. This encourages a culture of innovation and creativity within SMEs which will in turn give the SMEs a competitive advantage in a resource-constrained world. Furthermore, there will be product, market and process innovation which will be instrumental in differentiating an SME from its competitors. It may also be integral to driving down costs and attracting new customers, leading to improved overall profitability. The impacts CSR has on the bottom line have been essential in the growing role of CSR amongst SMEs.

An SME’s commitment to good CSR practices has also been vital in mitigating the effects of rising costs. For instance, an SME that is committed to reducing its carbon footprint and greater environmental stewardship will look to implementing energy efficient measures within its workplace, reduce wastage and effectively address production inefficiencies. This will have the effect of controlling the cost profile which is especially essential for an SME looking to properly manage its finances.
Another key driver responsible for the take-up of CSR and sustainability practices amongst SMEs is the growing importance of trust and reputation in a closely networked economy. There is a great deal of currency placed on relationships in a highly inter-connected world and good CSR practices will be essential for an SME seeking to interface effectively with all its different stakeholders. Stakeholders; both internal (including employees, customers and suppliers) and external (including the community, government, regulators and the general public); increasingly demand from businesses responsible practices that focus not only on the financial gains but also proper management of the businesses’ impacts on the environment and the wider society in which it operates.

Commercial success will increasingly be redefined not merely in terms of profitability but in terms of a positive impact on the environment as well as society. This is why SMEs must focus on how they can implement sustainability issues within their businesses to ensure lasting success.

The obstacles that may arise in an SME’s journey towards sustainability 

Despite the powerful arguments in favour of CSR for SMEs, they may still face some obstacles that may prevent them from incorporating CSR initiatives. Firstly, SMES operate in a highly competitive environment and are therefore forced to prioritise day-to-day operations and short-term cash flow issues over long-term sustainability.

They may face staff resource constraints and hence may not have enough staff to deal with and implement CSR initiatives within their businesses. Also, they may not have the necessary finances, resources or time to focus on environmental and social issues. A perception also arises that implementing CSR and sustainability initiatives within an SME may be too costly. They may also incorrectly assume that CSR and sustainability are matters that belong exclusively in the domain of big businesses and may not fully realise that their collective impacts on the environment and society can be significant.
Another obstacle that is faced is that SMEs may lack awareness of the business benefits arising through CSR practices. This failure to fully understand the significant capacity and value that good CSR practices will imbue an SME with, will severely hinder its development of good sustainability initiatives within the business.
One other issue that SMEs normally encounter is the lack of technical know-how and knowledge as to how they can implement good responsible practices within their companies and an information gap arises. SMEs may not be able to find external sources of assistance which can act as enablers for their sustainability practices. SMEs may not necessarily correctly relate CSR as a mainstream business issue and make the appropriate business case for it. This will be yet another stumbling block in their efforts to incorporate good CSR practices into their businesses.

Critical factors that lead to success 

Corporate responsibility can be a very effective catalyst for SMEs to reap significant benefits. It must be noted though that there are a number of critical success factors which SMEs should consider to effectively embed and inculcate CSR within their business strategies.

Firstly, there must be a commitment by the owners of SMEs to run their business on the principles of sustainability. They should aim to integrate CSR initiatives within their management and operational practice.

They must also convince their key stakeholders, especially their employees, that actively engaging in CSR will be in the best interest of the company. Getting buy-in from their stakeholders will support SMEs as they embark on the path towards sustainability.

SMEs should also network more with other like-minded organisations and industry leaders in the field of CSR and sustainability. This will allow them to learn from their peers and implement best practices within their organisations.

Sustainability reporting, or the practice of analysing, measuring, disclosing and subsequently reporting the environmental, economic and social impacts a business has on the market in which it operates, will also support an SME as it seeks to develop its CSR credentials. The reporting process can help them with their internal management and give SMEs an opportunity to innovate their businesses from within. External communication of their CSR practices will also give greater assurance to stakeholders on the sustainability of the business.

It must be stressed that SMEs should adopt a staged approach when building a CSR and sustainability framework for their organisations. They should avoid being overwhelmed by the huge number of CSR initiatives they could implement and instead approach it in an incremental fashion. This will ensure that their road to sustainability does not become too daunting or onerous. They should look at the areas in which they could easily implement CSR initiatives and look to ‘build’ this over time as they build capacity and incorporate shorter-term benefits into the vision of long-term sustainability.

There is however a real danger that CSR initiatives and sustainability may be seen as a panacea for poorly managed companies. Mere focus on CSR initiatives will not support a business that is economically unfeasible and commercially unsustainable. Rather, sustainability initiatives should be viewed a catalyst to enhance an SME’s value proposition and allow it to position itself robustly to its various stakeholders.

Small should not just be sexy, but sustainable too 

That many SMEs are committed to environmental, economic and social responsibility is certainly clear. A large proportion of SMEs are already incorporating sustainability practices within their organisations though they may not be aware of it and may actually be practicing “silent” CSR. For instance, they may have started using recycled paper for their organisation, installed energy efficient light bulbs resulting in lower electricity costs and a lower carbon footprint, implemented a work-life balance policy for its employees, maintain a non-discriminatory hiring policy, encourage staff volunteerism and encourage recycling within the organisation. Many successful SMEs also regularly provide excellent products and services and put something tangible back into their local communities.

All of these fall under the umbrella of sustainability practices though the SME may not view it as such. Therefore, it is important that SMEs closely examine the policies and activities within their organisation and understand how these activities and policies may align with sustainability and subsequently report on it. Thereafter, SMEs can look into increasing the scope and scale of their sustainability practices, and contribute as socially responsible corporate citizens in their country’s economic landscape.

In conclusion, SMEs, much unlike their larger counterparts and multinational corporations, cannot simply pack up and transplant their operations elsewhere should the factor conditions in the locations in which they operate in become unfavourable. SMEs are very much entrenched in their communities in which they operate. As local residents, the issues of their community’s environment, society and economic welfare are close to their hearts. They care about proper corporate stewardship of the environment and society as it is where their children, friends, family and roots are. The commitment to CSR is therefore more personal to SMEs and will remain a guiding force for them as they embrace sustainability.

“The price of greatness is responsibility,” declared Sir Winston Churchill. Ultimately, SMEs that aspire to greatness must infuse the values of social responsibility within themselves for this will surely pave the way forward for a truly sustainable future.

An idea: The Greek financial tragedy – a suggestion for resolution

An overview

Greece is battling to save itself from bankruptcy. It is estimated that Greece owes up to €350 billion (approximately US$465 billion). Greece’s biggest creditors are France, Germany, UK and US. Widespread tax evasion by the wealthy and elite coupled with unsustainably high public sector debt and wages have led to this current situation. A sharp downturn for the European economy has also meant that the Greek economy’s output also was not enough to service the excessive debt. As a result, there have been painful public sector cuts and tax rises – both which have not helped the ordinary man in the street.

In recent months, the IMF, the European Central Bank (ECB) and the European Commission (EC) have all been trying to get Greece to accept a package of austerity measures that have been set as preconditions for any further help/bailout support.

The Greek picture

Essentially, all of the powers that be want Greece to undertake a series of reforms that will increase taxation, reduce benefits, reduce public sector spending as part of an international rescue package that will prevent Greece from sliding into bankruptcy. Whilst this prevents default to major creditors, this will not necessarily help the Greek people. Cuts in government expenditure are the last thing a government should do in a recession – it sucks the country into a vicious spiral which will possibly not only bankrupt a country economically, but socially and spiritually as well.

So what can the Greeks do?

A possible solution

Now, we know the Greeks have a debt of about US$465 billion. That’s a lot of money to be paid back. Greece’s GDP per annum is only about US$300 billion! With a downward spiraling economy, how is Greece going to make enough to just pay back the interest on the loan, let alone pay off the entire loan quantum itself?!

Now, one thing to note is, despite the huge debt, the Greeks have the 30th largest holding of gold in reserves in the world. Greece currently holds up to 112 metric tons (MT) of gold. At the current gold price of about US$54m per MT, Greece has a total holding of about US$6 billion worth of gold.

What does this mean? Am I suggesting that the Greeks sell off all their gold and try to lower the debt? Nope. US$6 billion is a small drop in a huge well of US$465 billion debt!

My suggestion is that perhaps the Greeks should utilise this gold in a more creative manner.

But before going any further – a primer on financial derivations (‘put options’ in particular)

A stock option (which is a financial derivative which big banks use so artistically to lose not their wealth but the wealth of nations) is basically a contract between two parties in which the option buyer buys a right (but not obligation) to buy or sell 100 shares of an underlying stock at a predetermined price from/to seller at a determined date.

Options are one of the most risky investment products available (which explains why banks love them so much) with the potential to lose all your money – but there is also the opportunity of making heck of alot of money too. (With great risk comes great reward – if you’re lucky).

An option to buy a stock at a given price is known as a ‘call option’ while an option to sell a stock at a given price is known as a ‘put option’. The predetermined price agreed between both parties is known as a strike price.

So to surmise, a ‘put option’ gives the buyer the right (but not the obligation) to sell a stock at a specified price (‘strike price’) within a period of time.

Let’s assume you are a tad bearish (and you expect the stock price of a company or an index – such as the DJIA/FTSE/etc to fall) – you can take a position of ‘going long’ on the puts – which is basically another way of saying you will BUY the ‘put option’.

What does this mean in practical terms?

Let’s say Goreng plc (GOR) is currently trading at $50. You think that GOR is going to drop to about $30 in a month’s time. Since you have a bearish view of GOR, you decide to ‘go long’ on GOR ‘put options’. You go to your friendly brokerage agency and they sell you the ‘put option’ for $5 for 100 stocks of GOR (which means it costs you a total of $500) with a ‘strike price’ of $45 (which means you have the right to sell GOR for $45) in a month’s time.

In one month, let’s say, your oracular sense of pricing was right, and GOR does fall to $30. Although you don’t own any share of GOR at this time, you can still invoke your right to sell your 100 stocks of GOR for $45 even though the market price is only still $30. You can then go to the open market and buy 100 shares of GOR at $30 a pop and sell them immediately for $45. This will make you an immediate profit of $15 per stock – or $1500 for 100 stocks.

Your total profit therefore will be $1500 (profit on the sale of GOR) – $500 (price of options you paid) = $1,000.

Which means, you’ve just made $1,000 on an investment of $500. Small outlay – big return.

If on the other hand, your prediction on GOR’s price movement was as good as the Australian cricket team (i.e. rubbish), and GOR’s price did not go down, then the only thing you would have lost would be your purchase of put options for $500.

How are options priced? Options are priced in a number of ways, but one of the more common ways is a model known as the Black Scholes model – which I will not be going through in a great level of detail – particularly since I have forgotten the derivation of it since 2001 when I did my last Corporate Finance exams! But a simple Google search should come up with various calculators, etc.

Anyway this is how some of corporate history’s greatest insider traders made a lot of money illegally. They know of a piece of news that will dramatically affect the stock price negatively. But since they are in a privileged position (ie perhaps they are part of the management team), and the market does not know of the news yet, they decide to go long on put options in the hope that the downward spiraling of the stock price helps them make money – which hopefully they don’t have too much time to spend as they should be locked up way before they are escape with their ill-gotten gains.

Hope you’re with me so far…and so moving on…

A possible solution (continued)

And so, I thought of the Greek problem from a purely academic point of view and considered the following course of action (mind you I am not advocating that Greece should do this – but will be interesting to note what the reactions will be if it does)

  1. So Greece decides that it will liquidate its current gold reserves – and does so in a systematic but careful manner – so as not to arouse too much suspicion – and sells all of its gold for US$6 billion and holds it in US$.
  2. They then go to their nearest friendly (and extremely discreet brokerage firm) and decide to go long (or buy) put options on index options of some of the largest indices in the world (including Dow Jones Industrial Average – DJIA of the USA, CAC of France, DAX of Germany, FTSE of UK, SGX of Singapore, Hang Seng of Hong Kong) on very short expiry terms (of perhaps a month at most).
  3. The Greek Parliament (who will all have to be part of this enterprise) should then reconvene and make a statement to the world (and all their major creditors) that they will default on all of their loans.
  4. This will create extreme volatility in the major stock indices of the world, causing index prices and general share prices to fall precipitously. It will also lead to international outrage and condemnation of Greece.
  5. The Greek government – after a delay of about two weeks – should then quietly dispose of their put options which will be ‘in the black’ or be profitable.
  6. So how much will they make??
  7. Let’s say that Greece decides to go only with the DJIA Index Options. The Dow Jones Industrial Average index option contract has an underlying value that is equal to 1/100th of the level of the DJIA index. The Dow Jones Industrial Average index option trades under the symbol of DJX and has a contract multiplier of $100. Currently the DJIA Index stands at 11,231 which means it trades at $112.31 (11,231/100). Let’s say that the Greeks decide on 30 days (expiration) and a strike price of $111.00 (which means they have a right to sell the DJX at $111 in 30 days).
  8. This will mean that each put option will cost the Greeks approximately US$1.33 per option. Let’s assume that the Greeks invest ALL of their US$6 billion and purchase 48 million contracts (each contract is worth 100 put options). After the announcement of the news, let’s say that the DJIA matches its worst ever fall in 1987 of 20% drop. This will mean that the DJIA will fall to about 9,000 points and the DJX will therefore trade for $90. If at this point, the Greeks decide to exercise their rights and sell all of their put options or basically buy DJX for $90 and sell them on at $111 (as per their strike price), they should make about close to $100 billion. Other indices may fall even more – and the Greeks can make more money off it.
  9. Greece then says no to bailout – try and pay off the loans and move on with life.

What will happen – and can it work?

As I stated earlier, this is a purely academic exercise. I am not sure how practicable this would be in the real world.

However, if this were to happen, then it would be the first instance of the history of the world for an entire Parliament to have committed insider trading. And what is anyone going to do about it? It will shock the global financial system – but it will not necessarily cause a meltdown. It will also result in Greece being international pariahs (at least for a while), but come on, we cannot stay mad at the guys who gave us the likes of Socrates, Plato and Aristotle for too long?

It may also force the world to reconsider this bullshit notion that we can magically make money out of nothing – and force us to re-examine the way international finance is being conducted – just by machines and making money off ‘flash trading’ or basically super-fast trading done by computers with no real understanding of context.

We need a sustainable world – and this may be the trigger that forces us to rethink and retool ourselves.

And if the Greeks do pull it off – I can see them all dancing to Bob Marley/Inner Circle’s “Bad Boys”

Bad boys, bad boys whatcha gonna do whatcha gonna do?

When they come for you?Bad boys bad boys whatcha gonna do?

Whatcha gonna do whatcha gonna do when they come for you?