Business Organization

 

In the UK businesses are self-employed sole traders, partnerships, or companies. Self-employment increased throughout the 1980s and sole traders are by far the commonest type of business organization, though each sole trader operates on a relatively small scale. Partnerships operate on a larger scale and companies are larger still. The largest companies have sales measured in billions of pounds.

A sole trader is a business owned by a single individual who is fully entitled to the income or revenue of the business and is fully responsible for any losses the business suffers. You might open a health food shop, renting the premises and paying someone to stand at the till. Although you can keep the profits, if the business makes losses that you cannot meet you will have to declare bankruptcy. Your remaining assets, including personal assets such as your house, will then be sold and the money shared out between your creditors.

 

Figure 7-1. THE THEORY OF SUPPLY. Firms' decisions about how much to produce and supply depend both on the costs of production and on the revenues they receive from selling the output. This is the essence of the theory of supply. For the rest of this chapter and in the next chapter we fill in the details of this picture.

 

However, your health food shop may prosper. You need money to expend, to buy bigger stocks, better premises, a delivery van, and office furniture, To raise all this money, you may decide to go into partnership with some other people.

A partnership is a business arrangement in which two or more people jointly own a business, sharing the profits and being jointly responsible for any losses. Not all the partners need to be active. Some may have put up some money for a share of the profits but take no active part in running the business. Some large partnerships, such as famous law and accounting firms, may have over a hundred partners, usually all taking an active interest in the business.

Nevertheless, partnerships still have unlimited liabilily. In the last resort, the owners' personal assets must be sold to cover losses that cannot otherwise be met. This is one reason why firms where trust is involved - for example, firms of solicitors or accountants - are partnerships. It is a signal to the customers that the people running the business are willing to put their own personal wealth behind the firm's obligations.

Any business needs some financial capital, money to start the business and finance its growth, paying for stocks, machinery, or advertising before the corresponding revenue is earned. Firms of lawyers, accountants, or doctors, businesses that rely primarily on human expertise, need relatively little money for such purposes. The necessary funds can be raised from the partners and, possibly, by a loan from the bank. Businesses that require large initial expenditure on machinery, or are growing very rapidly, may need much larger amounts of initial funds. Because of legal complications, it may not make sense to take on an enormous number of partners. Instead, it makes sense to form a company.

A company is an organization legally allowed to produce and trade. Unlike a partnership, it has a legal existence distinct from that of its owners. Ownership is divided among shareholders. The original shareholders are the people who started the business, but now they have sold shares of the profits to outsiders. By selling these entitlements to share in the profits, the business has been able to raise new funds.

For public companies these shares can be resold on the stock exchange to anyone prepared to pay the going price. Trading on the stock exchange, reported in most daily newspapers, is primarily the sale and resale of existing shares in public companies. However, even the largest company occasionally needs to issue additional new shares to raise money for especially large projects.

To buy into a company, a shareholder must purchase shares on the stock exchange at the equilibrium share price, which just balances buyers and sellers of the company's shares on that particular day. In return for this initial outlay, shareholders earn a return in two ways. First, the company makes regular dividend payments, paying out to shareholders that part of the profits that the firm does not wish to re-invest in the business. Second, the shareholders may make capital gains (or losses). If you buy ICI shares for £600 each and then everyone decides ICI profits and dividends will be unexpectedly high, you may be able to resell the shares for £650, making a capital gain of £50 per share on the transactions.

The shareholders of a company have limited liability. The most they can lose is the money they originally spent buying shares. Unlike sole traders and partners, shareholders cannot be forced to sell their personal possessions when the business cannot pay. At worst, the shares merely become worthless.

Companies are run by boards of directors. The board of directors makes decisions about how the firm is run but must submit an annual report to the shareholders. At the annual meeting the shareholders can vote to sack the directors, each shareholder having as many votes as the number of shares owned.

Companies are the main form of organization of big businesses.

 

Text 25

FINANCE

 

Public finance

 

Public finance is concerned with the way public authorities (i.e. the central Government and local authorities) finance their activities - how their expenditure is decided upon and how their revenue is obtained.

Money administered by public authorities can be roughly divided into two categories:

1. The funds of the central Government, raised mainly by taxation, but also in part by borrowing, and paid into and out of the Exchequer in accordance with the proposals of the Government, as approved by Parliament (principally the House of Commons).

There are also funds administered for special purposes by central government departments and wholly or partially maintained by receipts, which do not pass through the Exchequer. The most important one is the National Insurance Fund, administered by the Minister of Pensions and National Insurance and used for the payment of benefits under the National Insurance Scheme.

2. The funds of local authorities, obtained partly from rates (local taxes on dwelling houses and other real estate) and income from property and trading receipts, partly from grants and loans from the Exchequer, and partly from loans raised in the open market.

The following broad account of government finance is concerned mainly with the Exchequer and only incidentally with local government and other public funds.

Financial control, as exercised by the House of Commons, is based on law, parliamentary rights and custom.

As the power of Parliament grew in late medieval and Tudor times, the principle that taxation by the Crown required parliamentary consent was gradually evolved. The principle was established, at the end of the constitutional struggles of the Stuart period, by the Bill of Rights 1689.

In medieval, Tudor and Stuart times, it is broadly true to say that once the King was granted the right to raise a given sum by taxation, he was free to spend it as he chose. In the eighteenth and nineteenth centuries, the House of Commons gradually developed the modern system of controlling expenditure through the device of Appropriation which was embodied in the Exchequer and Audit Departments Act 1866.

From the very early days of Parliament it had been established that such financial control as Parliament possessed should be exercised by the House of Commons. This control became effective, as regards taxation, in the seventeenth century, but as regards expenditure it was not effective until the nineteenth century. The controlling power of the House of Commons is acknowledged today in the Speech from the Throne at the opening of a new session of Parliament, which is addressed to both Houses but contains a special paragraph on expenditure addressed to the Commons alone.

The Commons have traditionally claimed that the Lords have no power to modify financial provisions, though they may reject such provisions; thus, to minimise the chance of rejection, the practice was started in 1861 of embodying the main financial provisions for the ensuing year in a single Bill. Since the passing of the Parliament Act 1911, however, a Bill certified by the Speaker to be a Money Bill may be presented to the Queen for the Royal Assent and become law without the consent of the House of Lords if it has not been passed by them within one month.

Today, the authority of the House of Commons has to be obtained for all expenditure by the central Government itself and for the raising of revenue by taxation or borrowing. All government revenue, other than sums received by government departments in the course of their normal activities (known as appropriations-in-aid), is paid into the government account with the Bank of England - known as the Exchequer Account or the Consolidated Fund. With certain exceptions (the main one, as previously stated, being National Insurance benefits), all payments by the Government come out of this account.

The following sections outline the machinery by which expenditure and revenue are authorised and controlled, the purposes on which public money is spent and the sources from which revenue is obtained.

 

The Budget

 

The annual speech of the Chancellor of the Exchequer explaining his proposals for balancing revenue and expenditure.

The Budget speech is normally the main occasion of the year for reviewing the Exchequer finances and the economic state of the nation, and its formal basis is the Chancellor's proposals for raising money by taxation. By the time the Budget is introduced (usually in April) the Estimates of expenditure under various headings will have been presented to Parliament and published, and the expected total of government expenditure for the year will be known. The Chancellor estimates the yield of the revenue on the basis of existing taxation and proposes such changes in taxation as he considers desirable on economic grounds. These proposals are later embodied in detail in a Finance Bill. The interval between the Budget Statement and the Royal Assent to the Finance Bill (usually given in July) is covered by the Provisional Collection of Taxes Act 1913, whereby changes in income tax and customs and excise duties have immediate statutory effect if adopted by Resolution of the House of Commons. In 1957 the Act was extended to include purchase tax.

The Budget speech also gives figures relating to loans from the Consolidated Fund for which the Government has statutory power to borrow. In 1964-65 over half the net issues from this fund were loans to nationalised industries; about a quarter were loans to other public bodies, largely the local authorities; the remainder were loans to overseas governments, private industry, housing associations, and other bodies. Since 1961 they have been set out in a White Paper issued immediately before the Budget.

 

Budget Policy

 

The original purpose of the Budget was purely financial - to provide money for government expenditure. From an early stage, however, it was appreciated that taxation would affect the distribution of income and property and the level of expenditure on particular goods and services. At a later period it was realised that taxation also affected the nation's total expenditure and therefore the general level of economic activity. Since the second world war. Budgets have been consciously designed in greater or lesser degree to bring the total demand for goods and services into balance with the supplies which could be made available.

Direct taxation on income and property affects the distribution or wealth because the rates vary according to the size of income and property, the proportion of a high income taken in tax being much greater than the proportion of a small one; at the same time, the services provided by the Government (whether in cash or kind) are generally available to all, irrespective of wealth, but in some cases they are specially designed to benefit people with lower incomes. Indirect taxes, or taxes on expenditure, do not affect the distribution of income; their main purpose has always been the raising of revenue, but by discouraging or encouraging consumption of particular goods they can be used to influence the allocation of resources and the pattern of trade.

The Budget affects the general level of expenditure and, therefore, the total demand for goods and services in the following way: if there is an increase in government expenditure without an increase in taxation then total demand for goods and services will tend to rise; the same thing will happen if there is a decrease in taxation without a decrease in government spending. In this way the Budget can be used to counter unemployment. On the other hand, if there is an increase in taxation without an increase in government expenditure or a decrease in government expenditure without a decrease in taxation then the total demand for goods and services will tend to fall. In this way the Budget can be used to counter inflation or deflation. For example, the aim of the Budget of April 1959, which provided for some important reductions in taxation, was to give a further stimulus to economic activity. The 1960 Budget was designed to consolidate and fortify the progress of the economy, and that of 1961 to counter inflation and encourage exports. The 1962 Budget's aim was to keep the economic position in balance. The purpose of the 1963 and 1964 Budgets was to contribute towards achieving the target of a 4 per cent growth rate in the national economy: in 1963 by giving a stimulus to demand and in 1964 by restraining consumption. A second Budget was introduced in the autumn of 1964 to give effect to the Government's proposals to improve the balance of payments and to adjust the level of demand. The 1965 Budget aimed at reducing the net outflow of long-term capital and decreasing the pressure on domestic resources.

 

The Bank of England

 

The Bank of England is the central bank and its principal business is to act as banker to the Government and to the other banks, as the agent of the Government for important financial operations and as the central note-issuing authority; it also maintains relations with central banks overseas. It was established in 1694 by Act of Parliament and Royal Charter as a corporate body, and its entire capital stock was acquired by the Government under the Bank of England Act 1946.

As the central bank, the Bank of England is responsible for co-ordinating the application of the Government's monetary policy. One of the main instruments for this purpose is the Bank Rate - the minimum rate at which the Bank of England will discount approved bills of exchange and a key factor in the general pattern of interest rates.

As banker to the Government, the Bank of England holds the main government accounts and it acts as the Government's agent for the issue and registration of government loans. It also operates, as agent for the Treasury, the administration of exchange control which has been in force since 1939.

The commercial banks maintain large balances with the Bank of England and these balances form part of the banks' cash reserves. In addition, under an arrangement made with the London clearing banks and Scottish banks in 1958, the Bank of England might call on these banks for 'special deposits' which, not being freely disposable, do not rank as part of their liquid assets. Deposits under this scheme, designed to restrict the liquidity of the banking system should the need arise, were made with the Bank of England between June 1960 and December 1962 and again in May 1965. The Bank of England has also given guidance on a number of occasions to the main banking and financial organisations on the advances policy the authorities wish them to adopt.

 

The Stock Exchanges

 

There are 23 stock exchanges in the British Isles, of which 15 are in England and Wales, five in Scotland, one in Northern Ireland and two in the Irish Republic. In addition the Provincial Brokers' Stock Exchange operates in no cities and towns throughout Britain and the Irish Republic. The Federation of Stock Exchanges in Great Britain and Ireland, comprising with one exception all these organisations, was set up in July 1965 to co-ordinate their work. Four of the Scottish stock exchanges are linked, as are also the stock exchanges in the north of England.

The London Stock Exchange is by far the most important of these stock exchanges and is one of the world's two foremost free markets in securities. Some 9,300 securities are quoted on the London Stock Exchange; at the end of March 1965 these had a total market value of ^{^}75,000 million. Nearly 8,400 companies are quoted, including a number of leading overseas companies. At nominal values 38 per cent of the securities represented company issues and the remainder British and overseas government and corporation stocks; at market values the proportion was about three-quarters.

The London Stock Exchange is linked by cable or telephone with stock exchanges all over the world. Therefore, a quoted company, subject to any limitations imposed by the exchange control regulations, has a world-wide market for its issues. This is an important factor in the raising of new capital by government and commercial borrowers. Arbitrage transactions by brokers - the buying or selling of a particular security on one stock exchange with the intention of reversing it on another - play an important part in equating price differentials between different markets and maintaining a continual flow of business between centres.

The stock exchanges do not fix dealing prices; the terms on which bargains are made between members reflect the interaction of supply and demand for the securities concerned. All the stock exchanges operate under strict rules of conduct which they formulate themselves.

In recent years there has been a constantly rising demand for ordinary (equity) shares, partly in expectation that such shares will maintain their real value or grow in value in periods of rising prices. Insurance companies and pension funds now invest a larger proportion of their assets in these shares than formerly, and the Trustee Investments Act of 1961 permits trustees, under certain conditions, to invest up to half the funds they hold in trust in equity shares.

The ownership of Stock Exchange securities in the United Kingdom is much more widespread than formerly: it is estimated that there are about 3 million shareholders and that their shareholdings are widely distributed. The largest public company in Britain has nearly 600,000 shareholders and there are several others with more than 100,000.

 

Text 26

Central Banking and the Monetary System

 

Today every country of any size has a central bank. There are two basic tasks that such a bank performs. It acts as banker to the commercial banks, ensuring that the banking system runs smoothly; and it acts as banker to the government, taking responsibility for the control of the money supply and the funding of the government's budget deficit.

Originally private institutions in business for profit, central banks have come under increasing public control as their activities as bankers to their respective governments have grown in importance, and as governments have placed increasing emphasis on manipulating the quantity of money in circulation. Founded in 1694, the Bank of England was not nationalized until 1947, and the Federal Reserve System, the central bank in the United States, was not set up until 1913.

In this chapter we look in detail at the role of the central bank. Having examined its functions, we then show how it influences equilibrium in the markets for financial assets in general and money in particular. Since the central bank influences the supply of money, it is necessary to consider what determines the demand for money before a complete analysis of monetary equilibrium can be undertaken.

We conclude the chapter by discussing the techniques of monetary control available to the central bank and showing the problems that arise in practice when the Bank of England attempts to-implement the money supply targets set by the government.