research issues

[Michael Harrington <mharrington@milken-inst.org>]

Dear Ownership Group,
This is a reposting of an email that was sent to the Homestead Group -
please disregard if you received it there...


I am following up the telephone discussion I had with Deb Olson with this
email posting. My apologies for the rambling length of this posting...

The gist of our discussion was that the issue of broadening capital
ownership and ESOPs is so multidimensional and overlapping that any one
perspective is often too myopic. 
-There is the socio-economic perspective that focuses on the nature of work
and the workplace;
-There is welfare economics perspective that focuses on inequality of wealth
and the issue of poverty;
-There is the IO perspective that focuses worker productivity, efficient
corporate governance or property rights;
-There is the practitioners perspective that focuses on the structure of
ESOP deals and how to get them done;
-There is a political activist perspective that focuses on the power
relationships and injustices of the existing   capitalist paradigm;
etc, etc...you get the idea...

It is a most formidable task to weave these all together into a cohesive
whole and the danger is talking past one another. I don't think anybody
knows how to reconcile all of this simply and quickly but I think that's
beside the point. Certainly we all suffer myopia as I have had to choose to
narrowly focus on certain issues for which I have designed my training and
specialization. So, we need the benefit of many views and individual
strengths that make up this network. That said, there are real differences
of opinion on what's important, what's right and what's wrong, and how to
proceed. These must be worked out through dialogues and perhaps some hard
research...

It might be best to explain my particular perspective and how it developed
so people know where I'm coming from. My own introduction to capital
ownership issues was a result of my experience in portfolio mgmt - where the
main puzzle was how to make money with money.  Investment finance focuses
pretty much on risk and risk-adjusted rates of return. I have generalized
this paradigm to the real world - to make money you have to take risks and
manage them well - mostly through hard and careful work but also employing
the tools available - hedging strategies, insurance pooling,
diversification, etc. This applies to the real economy as well as the money
economy - you take risks by deploying your assets and essentially putting
them at risk by using them up or losing them with the expectation that you
will make a positive return. I believe this is what businesses and
individuals do, whether it be with physical assets, land, human capital,
etc.
My schooling in corporate finance seemed pretty consistent with the way
capital markets worked and people behaved. It also confirmed for me what I
learned at my father's knee - you can't get rich by working for a wage, for
then you're selling your time and unfortunately it's limited.

I became very interested in the social and policy implications of this world
view - people would need to assume the risks of the capitalist system in
order to reap its rewards. So, how can they and why don't they? 
I hypothesized that this was primarily due to human behavior and secondarily
due to the social and institutional structures of the capitalist system -
the practices of internal financing, tax policy and a public consumption
focus. 
It also occurred to me that this may be related to macroeconomic puzzles I
had grappled with in academics.
Thus, I focused primarily on tax policies that deterred risk taking
investment and favored debt leverage of existing owners.

This is the point where I was introduced to the Kelsos and the concept of
the ESOP.
The ESOP seemed to me a great mechanism for transferring the risks and
rewards of equity ownership to employees, and also to use credit to
capitalize future cash flow streams as opposed to relying on self-formed
capital.  

But the puzzle still remained - why doesn't this idea take off? And why
don't economists embrace it?
This (among other things) motivated me to get doctoral training in economics
and political science. 
My intuition pointed me towards the rational behavior assumptions and
theoretical modeling tools  of orthodox economics and this is where I focus
my specialized training. 
My own approach has been to try to link individual behavior with the
macroeconomy using the issue of risk and uncertainty as the focal point of
that link. 

Some of the research questons I have tried to address in the past include:
Did the free distribution of agricultural land contribute to the widespread
distribution of wealth in 19th century US, and set the stage for the
industrial economy that followed? 
What are the macroeconomic implications of corporate governance and the
difference between debt and equity finance as it varies among US, Japan and
Germany? 
Which privatization strategy is more favorable for transitions from
socialist to capitalist societies in East Europe - those of Hungary,
Czechoslovakia or Poland? 
What explains the differences across countries in the generosity of national
social insurance programs, which are the foundation of the modern developed
capitalist economies? 
Why do economic security programs dominate national budget priorities? Does
risk aversion dominate human economic behavior? 
I don't think I've answered all these questions but I have grappled with
them.

My current research agenda regarding ownership issues are to draw out the
issue of economic security and how that is optimally achieved in the
collective by using risk management tools and capital markets. To me, modern
democratic politics has been largely reduced to this insatiable demand for
economic security. The accumulaton and diversification of assets is a most
efficient way to manage risk and finance theory provides us with many of the
tools. Thus, ownership becomes a substitute and a complement to social
insurance as an effective means to manage the risks of uncertainty. This is
primarily a political/policy argument.

My second approach is to employ new computer simulation techniques in
economic science to study feedback mechanisms and non-homogeneous agents. In
other words, our equilibrium, simultaneous equation models impede the study
of problems where people have different preferences that adapt and change
over time. This to me is the reason why economists choose to ignore the
theoretical macroeconomic claims of the Kelsonians, or Jean Baptiste Say,
for that matter. Their propositions violate the equilibrium assumptions and
tools that have served economic science extremely well over the past 75+
years.
There are some good critiques of orthodoxy out there that I could find with
a little searching through my files.
 
A good example of the usefulness of these computer models is a book
published by Josh Epstein and Robert Axtell at Brookings, titled "Growing
Artificial Societies." They generate a proto-economy with heterogenous
agents following simple behavioral rules to demonstrate a variety of
economic and political phenomena - including wealth inequality, segregation,
and conflict. These tools allow us to study aggregate phenomena that result
from uninformed self-interested individual preferences - the proverbial
invisible hand - but also allow us to finetune behavioral assumptions. The
Santa Fe Institute is a hotbed for these ideas. 

Anyway, these theoretical and empirical issues don't inform much on the
practical issues of ESOPs or related policy implementation, so in those
areas I rely much on members of this group. But theory does provide a fairly
solid analytical framework to approach questions as they arise. This is one
contribution I hope I can make.



Michael Harrington, Ph.D.
The Milken Institute
mharrington@milken-inst.org
(310) 998-2699