RE: Developing an economics of ownership

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

Dear Ownership Group,

I would like to respond to Shann's comments below with a few questions to
help reconcile my own thinking. I must add that Shann has volumes of
writings that I have tried to catch up with but have not had the time to
digest sufficiently, so bear with me. 
First, I am curious about this notion of surplus, especially surplus
profits.
Second, I am trying to think how we distinguish between procreative and
degenerative assets ex ante.

My perspective is colored by my background in finance and portfolio
management, but I think for valuation purposes financial assets are
comparable to real assets in that they are claims upon those real assets and
the cashflows associated with them (financial assets are considered passive
as opposed to procreative in Shann's schema). 

When I think about deferring consumption and investing over time, my
decisions are governed by expected values and probabilities that are best
represented in a risk/return ratio. I diversify to manage the unsystematic
risk associated with any singular investment (or buy insurance if I can't
diversify).

The logic, as we know, is if one investment in my portfolio pays off big, it
will cover any potential losses from other investments. If this investment
is valued ex post as surplus profits and taxed or appropriated, my
diversification strategy has been contravened, no? If a priori I know that
my gains will be constrained while my losses are self-limited, I would
imagine that the set of feasible investments will greatly shrink. Why would
I assume the risk? This is why an onerous capital gains tax really
constrains investment choices.

So, how do we know what is procreative or degenerative beforehand? i.e.
before we see the positive or negative cashflows? This seems consistent with
David's objection to valuation based on a particular array of prices at a
moment in time.
If a farmer invests in tools and seed, plants a crop and there is a drought
and he loses the farm, was he foolish to invest in the first place? was the
machinery degenerative? am I missing something obvious?

from this point of view, uncertainty is a critical factor in decision
behavior,

Regards,
Michael




-----Original Message-----
From: Shann Turnbull [mailto:sturnbull@mba1963.hbs.edu]
Sent: Wednesday, October 27, 1999 11:06 PM
To: ownership@cog.kent.edu
Cc: jeffgates@mindspring.com; William C. Frederick; Richard Hattwick;
Richard M. Coughlin
Subject: Developing an economics of ownership


David Ellerman states in point 2 below:

>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?

The reason why I persist with the term "procreative assets" is that this
concept makes it explicit that labor could own the assets WITHOUT ANY
REDUCTION IN THEIR COMPENSATION as indicated by my extension to David's
model to show the size of the depreciation cash flows.  (I try not to use
the word "capital" because it is so ambiguous.)

If you put the word "depreciation" in the "find" facility of your browser
and search both contributions from David's book at
http://cog.kent.edu/lib/ellerman.html and
http://cog.kent.edu/lib/ellerman2.html posted in the COG library
http://cog.kent.edu/library.html the word "depreciation" will not be
located anywhere!

This is consistent with Table 1 of my paper also posted on the COG web page
with the title 'New strategies for structuring society from a cashflow
paradigm' click http://cog.kent.edu/lib/turnbull1/turnbull1.html  Table 1
identifies how economic analysis based on profit is different from analysis
based on cashflows.   

While many economists do utilise cashflows, they are not always fully
recognised as explained in my 'New strategies' article and in Chapter 10 of
my book, which is also now in the COG library
http://cog.kent.edu/lib/turnbull5.html  

The inclination of some analysts to overlook cashflows may help explain why
the potential for ESOPs to both introduce a process for self-financing
economic development and democratise the ownership of productive assets has
also been overlooked.

The objective of this discussion group is to develop an "Economics of
ownership".  To achieve this objective I believe it is useful to:
1. Base our analysis on cashflows rather than profit to allow the values of
ownership to be related and integrated with the value of goods and services;
2. Identify the cashflow characteristics of different assets so we can
determine if they add value to society or absorb value.  
3. Identify why new assets are created and how well they achieve their
purpose.
4. Identify the mix of value adding and value absorbing assets in a
community.

I use Moulton's word "procreative"  to describe those assets that add value
and I coined the term "degenerate" to describe those assets that absorb
value.  However, some degenerate assets will intentionally be constructed
or acquired because they provide a useful service.  Investment in these
assets will increase as the standard of living increases as more people can
afford greater services and self-indulgences.  

"Productive" assets could mean either procreative or degenerate assets.
The fact that a machine, enterprise or industry produces goods and services
does not necessarily mean that the machine, enterprise or industry adds
value to society.  While such asset may have been constructed or purchased
to add value as well as goods and services, they might well operate to
absorb cashflows rather than add value.  While the community obtains more
goods and services it achieves this by losing ownership values.  The loss
becomes very obvious to the owners of the machines, enterprise or industry,
but it will not be detected by economists unless a balance sheet is
constructed for the community.  However, this not commonly done by either
economists or even development bankers.  A balance sheet is one of the most
crucial document required by commercial bankers and financiers before
approving a loan.

The net ownership values in the community will increase only if the values
absorbed by degenerate assets are off-set by the surplus values produced by
its procreative assets.  Beside off-setting the values absorbed by
degenerate productive assets, the surplus values would need to off-set the
values absorbed by consumption assets. 

In point 1 below David questions the utility of the concept of procreative
assets because the cashflows are "not an attribute of the asset itself but
the array of prices in the economic context".  In my posting yesterday
(Wednesday October 27th at 4.25) I said that this supported the utility of
the concept and referred to Table 1 of my 1975 book.  I forgot to mention
that this table can be found in the COG web page as Table 2 in my "New
strategies" paper.

The need to distinguish between assets which are self-financing and those
that are not would seem to be of a fundamental interest to development
bankers, especially international ones with public responsibilities like
the World Bank.

Likewise, the need to distinguish between investments which increase
productivity and reduce prices and those which do not and fuel inflation
would seem to be of fundamental interest to Central Bankers.  It provides a
basis for developing selective monetary policies to control inflation.  The
concept provides a way of turning the accepted "blunt instrument" of
interest rate policy into a precision surgical instrument to selectively
target low cost finance for investments that reduce prices.  The "Capital
Homestead Act" http://www.cesj.org/homestead/cha-summary.htm  is based on
the introduction of selective polices, but also note the overview provided
by David Spitzley http://cog.kent.edu/lib/kelso.html

I use the term"surplus value" to describe the cashflows produced over the
operating life of a productive asset which are in excess of all its costs
before transfer prices of interest and tax.  In other words, surplus values
can ONLY be produced by procreative assets.  So surplus value in this sense
becomes part of the economics of ownership.  It also means procreative
assets provide the ONLY way to increase incomes without people working
harder or longer.  This I believe provides a fundamental insight for
understanding the process of economic development.  I cannot understand why
the Economic Advisor to the Chief Economist of the World Bank rejects its
utility.

Another term with which economists will not be familiar is "surplus
profit".  This may be part of surplus value but necessarily.  It is the
cashflows beyond the time horizon used by investors to obtain the incentive
to invest.  Surplus profits can be greater than the original value of the
investment as shown in Figure 3 of my "New Strategies" paper.  

Surplus profits is a key concept because:
1. Wealth is concentrated from surplus profits (ie it is the poison of
capitalism)
2. It provides the opportunity to democratise wealth without creating
disincentives for new investment.

Point 2 may be difficult to comphrend for some people who are not
experienced with modern investment analysis which discounts future value
for both opportunity costs and risk.  But understanding modern investment
analysis is not required to understand the concept as by definition surplus
profits are those not required to provide the incentive to invest.  So by
definition, the transfer of surplus profits to others, such as through
changing property rights, cannot create any disincentive for new
investment.  This provides the basis for the prescriptions in my book for
'Democratising the Wealth of Nations'.  

As the concept of procreative assets appears to be no longer accepted by
economists, and as the concept of surplus profit is not part of economics,
this may explain why economists do not have an effective framework of
analysis to consider either the problems of modern capitalism or the
solutions.

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
>
(Other points raised by David in his posting were responded to in my
previous posting recorded in the COG archives on October 27 at 4.27 click
http://cog.kent.edu/archives/ownership/index.html)

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
code
Life long E-mail: sturnbull@mba1963.hbs.edu
http://www.mpx.com.au/~sturnbull/index.html