Re: Yes, the Earth is Round (2) With self-financing depreciation cashflows

[Shann Turnbull <sturnbull@mba1963.hbs.edu>]

I am very much encouraged by David Ellerman's response.  However, David
states "the intellectual fog has not quite lifted". 
Perhaps some progress has been made, so lets see if we can blow away a bit
more fog.
David numbered three points and I respond accordingly:

1.  I never claimed that the word "procreative" was a new term.  I
attributed the term to Harold G. Moulton.
What I do claim is that both the word and the concept have been overlooked
by many analysts.  More importantly I claim that it provides a powerful
intellectual tool for understanding: 
(a) the role played by self-financing or "procreative" assets in the
process of economic development, and
(b) how to use the self-financing character of procreative assets to
"democratise the wealth of nations", and
(c) how the need for international development lending organisations could
largely be avoided if countries built internal institutional arrangements
to make their economic development self-financing.  

The utility of the concept and the word is only reinforced by David's
observation that a productive asset may be procreative under "a certain
array of prices and not under others".  Indeed, this is shown in Table 1 on
page 7 of my 1975 book where I show "procreative assets (expected)"
dividing into "actual" "non-viable" and "viable" assets.  

There is always a risk that an asset or business will fail to become
self-financing or what I described in my "New strategies" paper in the COG
library http://cog.kent.edu/library.html as a "degenerate" asset such as
equipment used to produce the "buggy whips" noted by David.   For economic
development to occur, and to assist international development bankers get
their money back, the loss in economic value in constructing degenerate
assets (e.g. buggy whip manufacturing equipment) in a country needs to be
off-set by the surplus values generated by procreative assets.

So without the distinction between procreative and non-procreative assets,
international development bankers could well be flying blind in a fog
lending money which they cannot get back!  The need for billions of dollars
of loans to be forgiven supports a view that this could at least be
contributing factor.  I would like to raise these points again when I next
discuss with Jimmy Wolfensohn the most effective methods by which the bank
can change its role to teach countries how to become self-financing rather
than lending them money and avoiding the issue.  Perhaps David and Joe
Stiglitz might also like to participate?
 
2. As David notes, my extension of his model was not to argue against
David's conclusion as to who pays for ESOP shares.  The purpose was to show:
(a) how the ownership of all viable (procreative) assets are self-financing
and how this point can be obscured by not identifying depreciation cash flows.
(b) with different institutional arrangements (rules of the game for
ownership, tax, etc.) anybody could acquire ownership provided they can
obtain finance during the self-financing period.  How this can be achieved
democratically is demonstrated by Mondragon which David knows well and who
I cite in my article 'Innovations in Corporate Governance: The Mondragón
Experience', Corporate Governance: An International Review, 3:3, 167-180,
July, 1995, Blackwell, Oxford.
http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=6455

I believe that institutional arrangements should be considered a variable
rather than a given in developing an economic theory and practice of
ownership.  Only in this way can we design and implement or more equitable,
efficient and sustainable form of capitalism.

Our differences about "paying twice" illustrates how David and I think
differently.  I think of payments as a contractual cash flow, David thinks
of them as a non-contractual entitlement to value in the form of stock.
This difference is crucial to distinguish the difference between debt and
equity.  Debt is a contractual obligation to pay cash and equity is not.
Many corporate take-overs fail because people will not accept payment in
equity stock, they want cash or a creditable promise to deliver cash in the
future.  Common stock makes no promise to provide cash.  

I have detected this different way of thinking in others trained in
economics.  Many use a profit framework of analysis rather than a cashflow
framework.  Some compare rates of return on equity with rates of return on
debt without making an allowance for the fact that accountants hide what is
normally the larger part of the cash flow return as a cost! (depreciation),
 Modern bankers and financiers use and rely on cash flows rather than
accounting figures.

3.  Contrary to Davids statement, I am very much concerned with the public
policy debate.  Specifically the basis on which investors can obtain tax
deductions for writing off the cost of their investments from
depreciation/depletion deductions.  I have put forward the suggestion
earlier that these tax write-offs should be tied to ownership write-offs
implemented through ownership transfer to strategic stakeholders.  In other
words changing the rules of the game to democratise the wealth of nations.
In this way cash flow returns in excess of the incentive to invest (defined
in my 'New strategies' paper in the COG library as "surplus profits") would
be directly distributed to finance welfare and/or greater consumption
without government transfers.  It would also reduce the rate of wealth
concentration.

However, David sees such ownership transfers as a "weird" gift which could
inhibit new investment.  But these so called weird gifts are commonly found
in leasehold and many other types of investments.  The investor commits new
money on the basis that it will all be recovered with sufficient surplus to
provide the incentive to invest before the property rights expire.  All
residual "surplus" values then become available to others.  Such time
limited equity investments are found with mines, oil fields, films,
theatrical shows, patents and joint ventures in foreign countries which
deny perpetual claims by foreigners.

Australia has become a world leader in time limited equity investments to
finance infrastructure development.  I suggested this approach in a report
for the NSW State Premier in 1977 which was adopted for a large power
station with Jimmy Wolfensohn arranging the finance.  The approach is now
described as Build Own Operate and Transfer (BOOT) or Build Own Transfer
(BOT) projects.  Refer to  http://www.ozemail.com.au/~auscid/auscid.htm

Refer also to my paper: "Should Ownership Last Forever?" Journal of
Socio-Economics, Vol. 27, No. 3, 1998
http://papers.ssrn.com/paper.taf?ABSTRACT_ID=132108  This explains why
corporations do not have limited life because they were developed by the
English as a device to colonise foreign lands.  After limited life public
corporations were mandated throughout the US after the war of independence
to maintain political independence, US management connived with State
legislatures in the latter half of the last century to obtain unlimited
life charters to allow management and owners to entrench themselves.  

I suspect that the basic problem is that David does not recognise the
possibility of procreative assets generating surplus profits.  I only first
became exposed to surplus profits when working for a multi-national oil
company in NYC as described in my "New strategies" paper in the COG library.

The concept of "surplus profits" is another key intellectual tool for
democratising the wealth of nations.  Some intellectual fog will remain
until this concept is appreciated.  Surplus profits can be shown to exist
in practice as indicated above.  Their existence in theory can be shown by
using present value cash flow analysis which discounts the future for both
opportunity costs and risk.

The emergence of surplus profits can be problematical and so they can be
considered in the discussion on risk/return that David wishes to engage.
However, while their emergence can be problematical their size can be
excessive.  This is shown in a case study of General Motors Corporation who
invested half a million pounds in 1949 in Australia and were remitting 40
times their investment for over 10 years while also capturing windfall
gains in land ownership.  The case study is presented in my seminal article
'Time Limited Corporations', Abacus: A Journal of Business and Accounting
Studies, Sydney University Press, 9:1, pp. 28-43, June ,1973, see also
'Time Limited Corporations', Economic Society of Australia and New Zealand,
N.S.W. Division, Monograph No. 340, August, 1973.  I had never heard of
Kelso when I wrote this paper but colleagues who read this paper suggested
that I should.

Regards

Shann

At 01:41 AM 27/10/1999 , you wrote:
>
>
>
>Shann replied to "Yes, the Earth is Round" in three parts.  I will comment on
>the three parts here so as not to further clog  inboxes.
>
>1. This part was rather terminological in the sense that it emphasized using 
>new
>terms like "procreative capital" when there was no new concept.  Moreover
it is
>not good terminology to label an asset with a property that it would have
under
>a certain array of prices and not under others.  A buggy-whip-producing
machine
>may have been "procreative" around the turn of the century but not now so
it is
>not an attribute of the asset itself but the array of prices in the economic
>context.  All this is well known in the economic theory of capital, and I
won't
>waste anyone's time debating terminology.
>
>2. This part analyzed the dilution+taxbreak argument, and in spite of much
>darting off in many other directions, agreed with the argument.  Shann 
>wanted to
>make the depreciation calculations explicit rather than implicit (prior to the
>EBIT) which is fine but does not change the dilution argument in the
slightest.
>He gives a long numerical example which only reiterates my point that you need
>some change in labor compensation or productivity to prevent the result that 
>the
>ESOP shares are paid for by dilution and tax breaks.  He uses a $200 dollar
>reduction in labor costs to precisely counterbalance the $200 ESOP 
>contribution,
>and that is exactly the sort of thing that is needed to counteract the
dilution
>effect.  My only puzzlement in the submission is that if Shann now understands
>his own example of the shares being paid for by reductions in labor
>compensation, why does he continue the rhetoric full-force about procreative
>capital?  I am afraid the intellectual fog has not quite lifted.
>
>The "answer" to the twice-paid-for argument seemed to only be that not both
>payments were in cash.  No one said both payments were in cash so I fail
to see
>the point.  The cash injected into the company is paid for twice: once in the
>shares issued to the ESOP and the second time in the loan payments packaged as
>ESOP contributions.  Since the shares don't come back to the company when the
>ESOP contributions are made and since each transaction is a stand-alone quid 
>pro
>quo transaction, that makes the injected cash "twice-paid-for".  But the
second
>payment is attenuated with the tax break, etc etc.
>
>3. Here again, I couldn't find much counterargument about dynamic expiring
>property rights.  There were a few paragraphs on the virtues of saving upfront
>costs with leasing rather than buying property.  Nothing controversial there.
>He emphasized that he is only considering voluntary changes, not expropriation
>or state-mandated attenuations of property rights, which takes it out of the
>realm of public policy debate (which is where I thought we were) and into the
>realm of personal financial or estate planning.  Of course, any property owner
>could choose to parse the bundle of usual property rights and sell certain
>expiring or lease-like rights to a current user and the remaining long-term
>ownership could be sold or gifted to a land trust or community land bank.
That
>does not answer either of the problems I raised about paying for the 
>transfer to
>the land trust (assuming a gift reminds me of the old economist joke about
>"assume a can opener") and about the supply effects of attentuated property
>rights on produced property.  If the construction firm building a chemical 
>plant
>could only be paid the value of a short-term capitalized lease and had to gift
>the remaining value to a procreative asset trust, then it would have a large
>effect on the supply of procreative assets--that is the the "funny" (in the
>sense of weird, not ha-ha) part of the idea.  If the lease period is
around the
>lifetime of the asset, then one is only kidding oneself to make a big
>distinction between owning an asset and buying a long-term lease.
>
>Moving on:  Since no one has yet dented the dilution+tax break argument, I
will
>stop reiterating those points and move on in later submissions to the
>risk-bearing arguments discussed by Harrington and Upton.
>_______________________________
>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
>
>