Friday, December 30, 2011


Most people who make investment decisions for themselves or for business probably have technical investment skills like the ability to read balance sheets or calculate net present values. But developing an investment strategy requires a broader perspective, such as the ability to distinguish between fundamental and incremental change.  Using that example, I would like to show how the history of ancient business can usefully contribute to such challenges.

My interest in ancient business did not begin as a quest for investment strategies.  As manager of a small manufacturing and distribution company, I was stomping around my office late one night, frustrated with our antiquated business practices.  I heard myself mutter, “this place is run like a Roman blacksmith shop!”  I stopped.  Did they even have any blacksmith shops in ancient Rome, I wondered?  How did they run, and what did they do?  In fact, how did business, to which billions of us now devote our working lives, even begin, and what are the important differences between ancient businesses like Roman blacksmith shops and the computerized, outsourced, internet-linked, machine-based businesses of today?  Such questions led to The Origins of Business, Money, and Markets.

Satisfying curiosity is fun, but knowledge of history has practical functions as well.  Often, the easiest way to understand complex phenomena like business is to watch their development unfurl over time.  The earliest phases of development often display its driving forces most clearly, thus constituting a relatively simple model of what may now be something of bewildering complexity.

In the back of my mind, then, I hoped that by learning about ancient business and what affected its standing and profitability, I might gain insight into investment strategies applicable today.  As a wise old man once said, if you want to know where the train is going, look at the tracks.
In modern life we face an endless succession of changes, many of which appear dramatic, or are claimed to be so.  Important investment and policy decisions turn on the question of just how fundamental a change may be.  For business, a fundamental change is one that disrupts existing practices in major ways, often hard to foresee.  A leading modern example would be the Industrial Revolution.  Incremental changes have consequences too, but that’s just life; they do not change the nature, role, or operations of business, and they have a more limited, more predictable impact.  Distinguishing between one type and the other is not easy, but has major investment implications.

While change came much more slowly to the ancient world than it does today, there are some interesting examples of the difference between fundamental and incremental change.  For instance, the coming of the Iron Age around 1000 BC, a development of immense political importance, would seem to have fundamentally changed business as well.  After all, the Iron Age led to gigantic empires in the Middle East—the Assyrian, Babylonian, and Persian—as it dramatically undercut the previous Bronze Age cost of tools, armor and weaponry.  A Bronze Age cooking tripod was worth three women or twelve oxen to Achilles, but iron tripods performing the same function cost a small fraction of that.

On closer observation, however, iron technology changed business very little.  Yes, blacksmiths came into their own, and yes, iron tools made farming more productive.  But the Iron Age did not noticeably improve the marginal role of business in the economies of the Middle East, change business practices, or lead to disruptive new industries.  Business played no different or larger role in the economies of the Assyrian, Babylonian, and Persian Empires than it had in the Sumerian and Egyptian societies that were the first civilizations 2000 years earlier.

By contrast, the second great change—the invention of coinage—dramatically altered the role and practice of business in the Greek world.  Coins were invented late in the 7th century BC, when in order to pay Greek mercenaries the Anatolian kingdom of Lydia began minting pure gold coins in a size equal to a year’s pay.  As the Greeks learned of this innovation, they began issuing their own coins.  Over the course of the 6th century BC, these became smaller and more useful as a medium of exchange in their markets.  Coins vastly increased Greek purchasing power.

This revolutionized the nature and role of business.  As trade in coin replaced barter, economic exchanges became much more frequent, stimulating consumer demand.  With more trades in terms of money, prices became visible indicators of value, and provided instant information about supply and demand.  So useful were these money-based markets that they, and the traders and manufacturers who worked them, became central to many city-state economies and were considered defining features of Greek life.  The conquests of Alexander the Great and the Romans later made this nexus of business, money, and markets the dominant form of urban economy throughout the western world.

The difference between the impact on business of the Iron Age and of coinage cautions us to ignore the “shock and awe” of change as a general proposition, and focus on the practical details of exactly how the change might work in reality.

Consider now two of the most famous changes taking place currently: globalization and the computer revolution.  With the rapid growth of nations like China, India, and Brazil, plus the wonderfully written books of Thomas Friedman, globalization has attracted enormous attention.  It has certainly wreaked havoc with US and European labor markets, as many formerly well paid jobs have been shipped to low wage nations, and it has led both to a great new wave of business consolidation as firms have bulked up for international competition, and also to new competition as formerly protected national markets have opened up to firms and products from outside their borders.  It has also permitted a vast expansion of international investment, and with new players gaining advantage, provided many new investment opportunities.

Based on the example of the Iron Age, however, I would argue that despite its dramatic political and personal consequences, globalization does not represent a fundamental change for business. The expansion of supply chains, the addition or subtraction of competitors, the creation of new investment opportunities, even the internationalization of labor—these are all normal conditions of business life. Globalization has not produced radically new industries, altered the role of business in modern economies, or fundamentally changed the nature of business activity.  Its investment implications are by no means trivial, but they hardly point to dramatic innovations, a proliferation of new businesses, or changed perspectives on the business landscape.

By contrast, the computer revolution (really, the microprocessor revolution) that started in the 1960’s does indeed seem fundamental, comparable in scope and impact to the Industrial Revolution.  Only with computers could many scientific calculations even be made, leading to vital new industries like genomics and virtually the entire modern field of microbiology.  Computer-aided design and manufacturing permit products and tolerances never before possible.  Computers power virtually instantaneous communication and information capabilities that are transforming the modes of buying, selling, innovation, marketing, and business organization.

In finance, computers have greatly increased the trustworthiness of promises to repay, resulting in a vast expansion of purchasing power by way of credit.  Computers have reduced the risk creditors must bear by supporting an explosion in options and other hedging instruments.  Risk has also fallen because computers facilitate the creation of credit instrument portfolios whose risk is lower than that of the components.  By allowing “quants” to create complex structured finance vehicles that allocate credit risk to parties with different risk preferences, computers have greatly increased the supply of credit. Computers also crunch vast quantities of data to provide rapid and massive evaluations of consumer creditworthiness, making predictions of future repayment far more accurate.  In these and other ways, computers make it far more rational to provide credit to many more people and businesses than ever before: that is, to increase the purchasing power that fuels business activity.

In short, the computer revolution resembles the invention of coinage far more than it does the advent of the Iron Age.  As such, it offers vast and fertile possibilities for investment, and requires a much greater focus of attention than do the comparatively simple implications of globalization. That conclusion, I submit, is important for framing investment and even public policy strategies. I am sure that it could be reached without historical knowledge, but for me history has greatly clarified where the train tracks lead.