RE: Ellerman Chapter on ESOPs

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

Dear Ownership Group,

In response to Shann's email below, I would concur that there is mostly a
conceptual problem with economic orthodoxy. I will try to refer to Moulton's
book to get a clearer understanding of the concept of "procreative assets"
but it sounds very much like the productiveness of capital of which Kelso
writes. 

My recent experience within an economics department has been that the
assumptions of general equilibrium theory preclude the assertions that the
distribution of capital matters. According to the orthodox paradigm, what
matters is the efficient allocation of capital - it matters because it
maximizes aggregate economic growth and wealth creation which can then be
redistributed according to political or social maxims. 

The economist insists that normative questions of economic justice and
distribution are moot if we can't get the whole pie to grow. This conclusion
flows from the assumptions that markets are efficient in that prices adjust
to efficiently allocate resources - labor, capital, etc....
The sociologist retorts that the price adjustment (i.e. unemployment,
declining wages, poverty, etc. ) is exactly the issue and should not be the
regretable, but inevitable consequence of economic efficiency through market
adjustments.

Economists make no connection between the distribution of wealth and capital
and the volatility of economic growth (the business cycle)-- that investment
and capital formation derive from demand and aggregate demand derives from a
wider distribution of the product of growth. But the economy is a cyclical
feedback mechanism over time where decisions over consumption, savings and
investment are constantly adjusting to price signals and changing
preferences. 

So, is there a connection between capital concentration and
underconsumption? I would think so and seek to demonstrate it convincingly.
But the macro modeling I learned did not allow for heterogenous agents (only
representative agents); nor for changing preferences or adaptability (only
fixed preferences that don't change over time). These are the necessary
assumptions for simultaneous equation models - very powerful tools for
certain economic puzzles. 

So, with these tools how does one construct a feedback cycle with
heterogenous, adaptable people? Not likely.
I think this is an important reason why economic science is stalled in a
cul-de-sac on the issues.

Cheers,
Michael Harrington



-----Original Message-----
From: Shann Turnbull [mailto:sturnbull@mba1963.hbs.edu]
Sent: Wednesday, October 13, 1999 9:52 PM
To: ownership@cog.kent.edu; 'ownership@cog.kent.edu'
Cc: Michael Harrington; dellerman@worldbank.org;
jeffgates@mindspring.com
Subject: RE: Ellerman Chapter on ESOPs


The only point  I wish to add to Michael Harrington's reply to David
Ellerman is that non-democratic firms flourish because it allows their
controllers (managers and/or owners) to maximise their personal returns. 

Michael points out that David simply dismissed, in Chapter 6 of his book,
the possibility that productive assets provide a source of greater
productivity, income and growth.  Does this mean that economists and the
World Bank dismiss this possibility and so also dismiss a basis for
devising equitable self-financing economic development programs?  Is this
why Bank does not have the confidence to match its rhetoric with the
reality of teaching client countries how to internally finance their
development without going into external debt?

Ellerman's Chapter 6 (available at http://cog.kent.edu/library.html listed
as "ESOP Analysis and Evaluation") recognises how employees can become
owners of productive assets
without giving up any personal income from the "Self-financing" attributes
of ESOPs.  He uses "a number of extreme-case assumptions" to show that this
is achieved through diluting the interests of other Stockholders.  However,
this dilution is only possible because bankers makes it possible to
finance additional investment without ownership sharing.  Ellerman
implicitly accepts
that this is the given "rules of the game".  New rules could be made so
that finance was only made available on the condition of ownership sharing.
The World Bank is in an excellent position to introduce such equitable
rules of economic development.

However, the Ellerman Chapter reveals what may be a more fundamental
problem.  It would seem that Ellerman believes that economic development is
created by the productivity of labor rather than the productivity of
productive assets or what Harold G Moulton describes as "procreative
property".  Moulton was the President of the Brookings Institution and on
pages 10/11 of his 1935 book he states "We are interested in
the processes by which society expands its power to make nature yields its
resources more abundantly; and from this point of
view we are concerned with procreative property".  (It was Louis Kelso who
referred me to Moulton)

Procreative assets increase productivity and so provide the only way to
increase income in a community without individuals needing to work harder
or longer.  Procreative assets are a special class of productive assets
which over their useful life create more value than the cost of their
establishment and operations before the transfer of any value in the form
of interest payments and taxes.  That is, all procreative assets must by
definition become self-financing.  It would seem that modern economists no
longer use the concept of procreative assets and so have lost an
intellectual tool to understand how the technology embedded in procreative
assets can create economic development without people working longer or
harder.

Without the concept of procreative assets, economist may not be able to
appreciate the role of ESOP's.  These ideas are developed at greater length
in my article "New Strategies for Structuring Society from a Cashflow
Paradigm" which can also be downloaded from the COG library at
http://cog.kent.edu/library.html

I would look forward to anybody's comment on my speculation as to why
economists do not appreciate ESOPs.

Ellerman also raises the question as to why so few "worker-capitalists"
firms emerge and/or survive.  One reason could be because they do not
introduce the six fundamental conditions identified by Paul Bernstein as
described in my article "Employee Governance" which is also listed in the
COG library.

Regards

Shann

At 03:24 AM 8/10/1999 , Michael Harrington wrote:
>David - 
>thanks for the chapter - now I think I remember your book on The Democratic
>Worker-Owned Firm. I found the chapter very interesting because it offered
a
>little different perspective than my own on employee ownership and the idea
>of economic democracy.
>
>Before I get into that I should say that I don't think it really addresses
>Kelso's macroeconomic claims about "binary economics" or "two-factor
theory"
>in a critical fashion beyond dismissing or ignoring them. (I'm not a member
>of a flat-earth society but I do believe there is some merit to the claim
>that the distribution of capital ownership does matter to the macroeconomy
>as well as to the firm.) I especially liked your comparison of political
>democracy to ownership-based economic democracy and the discussion of human
>rights vs. ownership rights - it sharpens some of the philosophical issues.

>
>That said, it seems to me that your discussion veers more toward industrial
>organizational issues and then on to financial accounting analyses. Your
>points about the issues of control and governance of the firm and the role
>of labor are well-taken but IO is a different issue than capital ownership
>and another puzzle that Kelsonians really don't address directly. But it is
>an important issue that I agree you can't really separate from the
ownership
>one. I suspect that firms have evolved as hierarchical structures rather
>than democratic ones for important functional reasons relating to
>coordination and information costs. Thus we have labor contracts rather
than
>partnership sharing. In the meantime ESOPs adhere to the proven material
>success of the property rights paradigm and shun "stakeholders' rights"
>beyond ownership. 
>But I also think the evolution of the firm has a lot to do with who is
>willing to assume residual risk and this is something the ESOP can address.
>
>
>Your financial analysis of the ESOP is insightful on the tax issues but I
>was looking for something that focused on the difference between renting
>capital (borrowing) and owning capital (equity). Returns on equity
>theoretically and empirically exceed the cost of debt (interest), due to
the
>distribution of ex-ante risk through residual claimancy and subordination.
>Otherwise why would anyone ever borrow to invest. This provides the
>financial leverage to which you allude.
>
>Thus, when an ESOP borrows to buy equity, the expectation is that profits
>will exceed interest costs and that is what pays for ESOP shares--this is
>enhanced by the differential tax treatment of equity and debt. Risk shifts
>from former owners to employees and they get paid for it. If they are
>successful (lower costs, expand markets, improve productivity, increase
>profits), their incomes should reflect that. If not, they will be an
unhappy
>lot. 
>The risk of falling profits then is an important one. Who pays for losses?
>the banks won't assume that risk nor will the previous owners. I think the
>intransigence of risks associated with ESOP valuations is one of the major
>impediments. Kelsonians suggest a form of risk insurance - which may need
to
>be subsidized.
>Dilution is another important consideration as financing new investment
with
>equity goes against the very human desire to leverage a good thing by not
>expanding equity partners. 
>
>Anyway, I will revisit your book as I think it raises a lot of important
>related issues to ESOP-type ownership. 
>
>Cheers,
>Michael Harrington
>
> 
>
>-----Original Message-----
>From: Dellerman@worldbank.org [mailto:Dellerman@worldbank.org]
>Sent: Wednesday, October 06, 1999 7:21 AM
>To: Michael Harrington
>Subject: Re: book chapter
>
>
>
>
>
>Sure, I thought they were going to post it, but here it is in word 97.
>(See attached file: ESOPkels.doc)
>cheers, David
>
>
>
>
>
>Michael Harrington <mharrington@milken-inst.org> on 10/05/99 07:43:32 PM
>
>
>To:   David P. Ellerman
>cc:
>
>Subject:  book chapter
>
>
>
>
>Dear David,
>Deborah Olson forwarded to me your email mentioning your critique of
Kelso's
>binary economics. I would be very interested in reading it. I am a
political
>economist doing research on broadening ownership at the Milken Institute -
a
>quasi- think tank in Santa Monica.
>Hopefully you can email it? Thanks,
>
>
>Michael Harrington, Ph.D.
>The Milken Institute
>1250 Fourth St.
>Santa Monica, CA 90401
>
>mharrington@milken-inst.org
>(310) 998-2699
>
>
>
>
>_______________________________
>David Ellerman
>Economic Advisor to the Chief Economist
>World Bank, Room MC4-335
>1818 H St., NW
>Washington, DC 20433
>Ph: 202-473-6368
>Fx: 202-522-1158

Shann Turnbull
P.O. Box 266 Woollahra, Sydney, Australia, 1350
Phone: 02 9328 7466 office; 02 9327 8487 home
Fax: 02 9327 1497 home & office.  Mobile 0418 222 378
Outside Australia, replace first "0" with "61" after international access
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Life long E-mail: sturnbull@mba1963.hbs.edu
http://www.mpx.com.au/~sturnbull/index.html