A ballad of accounting and technology

A currency reflects the net social returns of all value-creating activities for all entities (profit, non-profit, households) that choose to account on it. The cost of a currency regime is the cost of protecting these value-creating activities, plus the rents the protectors extract.

“Returns” is the typical black box of economic effort. Inputs: efforts, ideas, investment, resources, are committed and, inside the black box, transformed into returns, after delay.

In an entrepreneurial setting, when the key dimensions of this black box transformation are still unknown: probability, delay, amount, we observe an overshoot of expectations (the hype cycle) as the promise of a new idea reverberates through the gossip network we call humankind.

This shouldn’t be all too surprising, since entrepreneurial effort suffers from a huge truncation problem: We don’t get to observe the returns of those efforts which don’t receive the necessary amount of investment. This is also a false positives/false negatives problem.

Social returns is the aggregation of the returns to all efforts (private returns) minus the cost of these efforts to others (externalities). In an economy without externalities private and social returns are in sync.

In currency regimes where enforced subscriptions (taxes) are translated into public goods (protection and infrastructure investment, social transfers) with 1. efficiency loss (this is also a black box), and 2. rent extraction, private returns and social return can diverge widely.

Rent extraction happens on all levels. Besides the efficiency loss and extraction on the supply side of protection, both enterprises and households can engage in free-riding on the demand side: take advantage of public goods and protections while avoiding their contributions.

Which brings us back to accounting: Our attempt to peek into the black box while it is trying to transform inputs into returns.

Accounting is both inside-looking: corporate accounting as means to steer the ship (kybernetes = the steers[wo]man), and outside-looking-in: auditing as a means to protect the investors (audire = to perceive). It’s also, like all monitoring efforts, costly and imprecise.

Accounting and technology have been intricately linked since we settled down in the Fertile Crescent to become an agricultural society. Public accounting can be traced back to when we moved to becoming a hydraulic (irrigation farming) society. Water, like data, is a tricky resource.

Two of the earliest monitoring technologies intricately linked with accounting and governance: writing and calculation. Letters and numbers. Also persistence and systems of record. Protection against falsification.

Changes in accounting technologies lead to improved governance lead to better survival lead to displacement via technology. Productive technologies and accounting technologies go hand in hand, but only the former get the attention they deserve.

The accounting areas of productive entities are delineated by the similar but subtly different exigencies of search costs, monitoring costs, measurement costs, enforcement costs, (mis)allocation costs, protection costs… This is the “limit of the productive entity”: state, firm, household…

This whole bundle we know in the new institutional literature as the “transaction costs” of the accounting entity. Transaction costs (efficiency losses and contractual hazards) also determine the optimal organizational form: market, hierarchy, something inbetween, or other forms.

The somewhat truncated dichotomy of market vs hierarchy, buy or make, decentralized vs centralized control, follows us around since the “cradle of civilization” on all levels. Turns out it’s trickier than expected. Because transaction costs and externalities.

Civilization is largely about all efforts to align private and social returns via the best (or least worst) combination of governance modes in the collective value-creating process. Market, hierarchy, voting, participation, leaving things to chance…

Turns out they all have their scope, read: advantages and drawbacks. Simplified: hierarchies are productive, markets are allocative, votes and participation are (re)distributive, chance is (re)directional.

Watching competing institutional regimes means watching competing bundles of compromises, taboos, lores and habits that often go back centuries. The process of finding the best mix of governance modes for a technology regime is slow-moving and never-ending.

The basic unit of measure for an institutional regime is the instrument it uses to account internally and signal value creation to the outside world. In a private production (firm) context, they diverge: the former is a currency, the latter a security.

In a public (provision of public goods & protections) context the currency is the security. It hinges on two somewhat contradictory metrics: internal (accounting) stability vs external (productive) ascendancy. Currencies that increase in value are good at providing public goods.

The stability mandate comes from simple measurement theory. Just like we use “kg”, “mm, “Joule”, “Kelvin”, as shorthands so that we can ignore all the massive efforts that go into stabilizing these units of measure, we want the same for accounting units of measure.

If there were no other mandates on a currency, a perfectly stable currency would be perfect.

Among the other mandates: keep the economic unit productive, pay for the protections and monitoring needed to make this happen. These conflict with perfect stability.

For a public economic unit, the two means of raising the funds to pay for public goods provision are taxation and inflation. Taxation levies the private returns of value-creating production, inflation levies the non-use of potentially productive units.

The big advantage of inflation: It is unavoidable. This is why we see higher inflation in regimes that have problems with monitoring taxation. But high inflation undermines the measurement quality of both corporate accounting and auditing, which taxation doesn’t touch.

Deflation on the other hand undermines the incentive to use savings to invest in value-creating black box processes (enterprises).

The challenge for a public economic unit is to align these conflicting mandates in a way that socially useful productive activity rather than rent extraction from access/information advantage or creation of negative externalities, is at the center of all entrepreneurial activity.

“Blockchain” is simply an accounting technology that shifts record-keeping and auditing from inside the productive unit to between productive units, which is where the basic unit of economic activity, the transaction, happens.

It is an M2M technology that bridges a gap within the P2P value-creation process stemming from coordination of productive activity among peers. But it does not bridge the full P2M2M2P gap, and ignoring the P2X2P part is perilous.

The challenge is to get these parameters right, to redesign governance modes, and to demonstrate that accounting inbetween (instead of or in addition to accounting within) lowers transaction costs over pure accounting-within economic regimes. That’s the job for the next years.

This thread was brought to you by the Beige Academy of talking about accounting technology when everyone just wants free magic internet money.

I write about how technology shapes the world we live in.