Tuesday, March 13, 2007

The Ownership Solution

by Jeff Gates

The moral legitimacy of markets and democracies is based on the premise that they disperse power across a wide range of individuals, and thus benefit from the foresight, concern and common sense that reside uniquely in individuals and their communities. Unfortunately, today's "disconnected capitalism" is very far from this ideal model of dispersed control and constructive feedback. With so much finance capital concentrated in the hands of money managers (more than $12 trillion in 1996), money itself has become the measure of the public good, with capital markets operating as if on automatic pilot, guided solely by the maximization of financial returns.

What is worse, this detached form of free enterprise is combined with a global tendency to enrich the already-rich. Three decades ago, people living in the well-to-do countries were 30 times better off than those in countries where the world's poorest 20 percent live. This gap has since widened to 82 times and, according to the World Bank, is poised to widen further. As this rich-poor divide has widened, it is producing--according to the United Nations--a world "gargantuan in its excesses and grotesque in its human and economic inequalities." An example: the combined wealth of the world's richest 225 people is now equal to the combined annual income of the poorest 2.5 billion of the world's people (47 percent of the global population). The three richest people have assets that exceed the combined GDP of the 48 least developed countries.

The United States is, of course, not exempt from this tendency to inequality. While more American adults own stocks than at any time in history, 71 percent of households own no shares at all or hold less than $2,000 in any form, including stock mutual funds and popular 401(k) plans.1 Though the nation's net worth grew by $5 trillion from 1983 to 1989, NYU professor Ed Wolff found that 54 percent of that was claimed by the half million families who make up the top one-half of 1 percent of the US population. The net worth of the top one percent of households now exceeds that of the bottom 90 percent.

The story with income is similar. In 1996, the US Census Bureau reported record levels of inequality, with the top fifth of American households now claiming 48.2 percent of the nation's income while the bottom fifth gets by on just 3.6 percent. As with wealth, the trends are ominous. In 1973, the income of the top 20 percent of American families was 7.5 times that of the bottom 20 percent. By 1996, it was more than 13 times.

These trends led William McDonough, president of the Federal Reserve Bank of New York, to issue a strongly worded caution: "Issues of equity and social cohesion . . . affect the very temperament of the country. We are forced to face the question of whether we will be able to go forward together as a unified society with a confident outlook or as a society of diverse economic groups suspicious of both the future and each other."

Because these global and domestic trends fuel a system that simultaneously disconnects people from the economy and divides them from one another, we now face serious fiscal, political, social and environmental challenges. How can we respond constructively to these problems?

My answer begins with the fact that private property is an essential element of a private enterprise system. So the solution, I suggest, lies in ensuring that twenty-first century free enterprise draws on its core strength: using ownership itself as the means to reverse today's disconnectedness and division. In short, we must create more owners. Pursuit of this "ownership solution" presents us with three key challenges:

--How to make "capitalists" of those with little capital to invest;
--How to foster a broader distribution of wealth without forcibly redistributing already-owned wealth;
--How to evoke ownership patterns that include a stake by those most affected by commercial activity and those in the best position to affect it. Before presenting the essentials of this ownership solution, I first review four key problem areas whose resolution would be aided by a broader dispersion of personal ownership.

The Problems

Fiscal Unsustainability

In 1996, the US government paid out $839 billion in just three key income-support programs: Social Security, Medicare and civil service pensions. The bulk of these funds were paid to people who had accumulated insufficient assets to sustain themselves. This huge budget burden is our current fiscal reality, and that's well before the first of the nation's 76 million baby-boomers begin to retire.

These entitlement programs are now the third rail of American politics: touch them only at the risk of your political life. Yet without a system that enables Americans to accumulate significant economic assets, they will continue to use their political assets (their votes) to ensure some semblance of economic security. With a more broadly self-reliant populace, much of that fiscal capacity could instead be invested in infrastructure, education, research, health care, environmental restoration--or simply left in people's pockets.

As the world's "mentor" capitalist nation, the irony of this financial predicament is profound. Consider: at present, America's hugely regressive Social Security tax is the largest single tax paid by most taxpayers, accounting for 34 percent of this year's $1.7 trillion in federal tax receipts. Social Security is the only old-age pension for a majority of American workers in private industry. Most revealing of all, the present value of those anticipated payments now represent the most significant "wealth" for a majority of US households.

Thus, in the world's avowedly most capitalist economy, the most important asset for a majority of its citizens is an assurance that someone else will be taxed on their behalf. Adding insult to injury, that tax is on employment, the sole linkage that most Americans have to their capitalist economy.

Globalization exacerbates the problem by reducing the ability of governments to tax highly mobile capital, ensuring that a growing share of the tax burden is shifted to labor. Adding outrage to insult, Congressional discussion of income security is now focused on how best to finance Social Security rather than on the more obvious and more disturbing issue: Why, 63 years after its inception, are so many Americans still so reliant on it? Why do we still not have a capitalist system widely populated with capitalists?

Americans have yet to see an economically sustainable response to their precarious economic security. To date, the policy agenda has been a mind-numbing array of income-redistribution proposals, ignoring the need for policies that could connect them to income-producing assets, the only conceivable route to economic self-sufficiency in a private property economy. While unworkable ownership patterns are left largely intact, those who grow dependent on this "downstream" tinkering foster a fiscal inflexibility aptly characterized as "demosclerosis."

Constitutional Unsustainability

In the prologue to the Declaration of Independence, Thomas Jefferson altered John Locke's classic trilogy of "life, liberty and estates," or "life, liberty and property," to read "life, liberty and the pursuit of happiness." Perhaps there was something to Locke's original formulation. After all, the pursuit of happiness has material preconditions.

For example, a malnourished child is not enjoying a "right to the pursuit of happiness." Yet presently one in five American children live in poverty. Undereducated or poorly educated youth are not enjoying a "right to the pursuit of happiness" because they are denied access to the skills and the attitudes required to cope successfully with life in an increasingly globalized economy. Yet the GAO reports that a majority of the nation's 42 million public school students could not use computers (even if their schools could afford them) because of obsolete structures (half of the nation's 80,000 schools lack adequate electrical wiring while a third lack sufficient power). To force students into poor schools condemns them to a future of incapacity and poverty.

The constitutional mandate is clear: the government's duty is to actively advance the general welfare, and the general diffusion of the material basis for happiness is an indispensable component in ensuring the general diffusion of the right to the pursuit of happiness. The "pursuit of happiness" in a private property economy requires a government committed to broad-based property ownership as an essential material basis not only for happiness but also (per the Declaration) as a means to "provide for the general welfare, and secure the blessings of liberty to ourselves and our posterity." The power granted government to promote the general welfare suggests an affirmative duty to ensure that the nation's welfare-- including its material wealth--is diffused not partially but generally, thus remedying a system that harbors a socially corrosive and increasingly divisive gap between haves and have-nots.

Social Unsustainability

Today's fast-widening wealth and income gap is wreaking civil havoc. Fully a third of American men between the ages of twenty-five and thirty-four do not earn enough to keep a family of four out of poverty, with all that implies for the strains on marriage and the prospects for young families. This growing rift is also racial. The Census Bureau disclosed in 1991 that the meager median wealth of white households is seven times that of Hispanic households and ten times that of African-American households.

This ever widening gap has disturbing social and political implications. Two-tier societies are not fertile ground for robust democracies. Extreme economic disparities threaten open political systems, as the possession of great wealth by a few confers on their holders inordinate power, which they are typically tempted to use in ways that run counter to the general welfare. Nor is the gap confined to narrowly economic conditions. In Unhealthy Societies: The Afflictions of Inequality, Richard Wilkinson draws attention to the fact that societal factors have emerged as a key limiting component in the quality of life in developed societies. Documenting "the overwhelmingly social and political nature of population health," he found that "death rates from about 80 percent of the most important 80 or so causes of death are more common in blue-collar than white-collar workers."

The marketplace is fundamentally indifferent to this inequality and divisiveness. Retailers have adjusted to social polarization by turning to a "Tiffany/Kmart" marketing strategy, tailoring their products and pitches to two very different Americas. Saatchi & Saatchi Advertising Worldwide warns its clients of "a continuing erosion of our traditional mass market--the middle class," while Paine Webber Inc. cautions investors to "avoid companies that cater to the 'middle' of the consumer market." In 1997, both Kmart and Tiffany reported earning surges while the mid-scale chains such as J.C. Penney suffered. The Affluent Market Institute predicts that by 2005 America's millionaires will control 60 percent of the nation's purchasing dollars (sales of high-end luxury yachts are already at record levels).

This dual society means that separate and decidedly unequal markets are becoming the norm--for example, private banking for the well-to-do alongside record levels of check-cashing outlets (the United States now has 5500 check-cashing outlets, more than double the number in 1988). The Gap recently remodeled and expanded its upscale Banana Republic clothing stores, adding 68 new outlets since 1992. Meanwhile, it created a lower-end chain called Old Navy, opening more than 200 outlets since 1993 (compared with just 21 new middle-income Gap outlets).

Environmental Unsustainability

Americans relate to their environment largely through their wallets and through market signals. At present, those signals are incapable of guiding us toward environmental sustainability. Pricing alone--whether for products or for property (such as share prices)--cannot convey the complex information required for a sustainable future. And the combination of concentrated and disconnected capital ensures a decision-making process in which environmental effects are too distant in time or place to be incorporated as a value in a system that defers to the very limited information reflected in financial values (particularly net present value).

Environmental sustainability has local roots. Acid rain is not an abstraction; it begins with a specific facility in a specific location emitting identifiable toxins that travel in highly predictable patterns. Similarly, when solvents show up in an aquifer, it is because of a particular producer at a specific locale manufacturing explicit products for specific clients. Though we can often identify the immediate physical cause of environmental damage, little attention has been paid to identifying the underlying institutional cause, particularly the economic and social conditions that evoke, mask, condone or even reward such behavior.

One of the key challenges to sustainability is the notion that every environmental problem can be tackled by a technical or regulatory fix--cleaner refrigerants, a better smokestack scrubber, quicker clean-up and so forth. Though technical, regulatory, and after-the-fact remedies are all helpful, sustainability requires prevention: better to build a fence at the top of the cliff than station ambulances below.

For example, imagine an annual shareholders' meeting of an electric power company at which a question is raised about the potential effect on the community from the disposal of the utility's effluents. Imagine further that there is potential for long-term damage to the health of that community's children depending on the choice of waste-disposal method. There's nothing quite like a contingent of concerned, vocal, informed, and empowered parents showing up at a shareholders' meeting--as shareholders.

That change in context could change both the tone and content of the meeting, transforming what is typically an impersonal, financially oriented, technical discussion into a forum in which the full range of relevant considerations--emotional, nonfinancial, personal, and moral--come into play. Broadening the range of opinions presented (and feedback solicited) could result in a very different decision-making process, particularly where the environmental effects are local but uncertain or difficult to quantify. Corporate decision-making looks very different when your family is at stake, not just your financial return. By crafting the legal environment of free enterprise to ensure a component of up-close capitalists, we enhance the likelihood that we'll see the emergence of sound environmental decision-making in today's finance-dominated commercial environment.

Inclusive Capitalism

Crafting an ownership solution to these fiscal, political, social and environmental problems will require a mix of private and public leadership. To improve social equity and enhance intelligent, people-responsive feedback, we need a more broadly participatory capitalism. However, capitalism is presently engineered not to create capitalists but to finance capital. Until those two very different objectives are combined, free enterprise has no chance of becoming widely populated with capitalists. Currently, the corporate sector finances itself within a "closed system of finance" that's wired for highly exclusive ownership when what's needed is a financial and a policy environment that ensures a steady broadening of capital ownership.

To grasp fully the challenge facing those who prefer a more inclusive capitalism, it's essential to realize just how "the rich get richer." Everyone knows it happens; surprisingly few understand the quite simple mechanics of how. As a quick glance at Table 1 indicates, companies fund themselves in a way that is designed not to create more owners but to raise more capital for existing owners.

The second practical challenge is to address the role played by personal versus business saving. As the chart below indicates, business saving (i.e., internally generated funds) have long been the dominant form of national saving--and is steadily becoming more so. Yet business saving fuels the rich-get-richer "closed system of finance" (see Table 2).

One thing that's abundantly clear: individual stock purchases alone are inadequate for expanding ownership. We can't expect wage earners to buy their way into significant ownership from already stretched paychecks. If ever we hope to experience the benefits of a property system that favors more than a privileged few, we need not a "level playing field" but a field engineered to ensure that more players have a reasonable chance of making it onto the field. The intelligent reengineering of conventional financing techniques can steadily broaden ownership-based on the same financial principles that have proven so successful in concentrating ownership.

Planning for Participation

In Economic Policy for a Free Society, libertarian theorist Henry Simons argued that "the libertarian good society lies in the maximum dispersion of property compatible with effective production." How can we achieve that dispersion?

The ownership solution suggests an answer--or really, an hypothesis. Because we've never had an economic system engineered for inclusion, we can't know for certain what the results will be--whether inclusive firms will be better producers, better environmental stewards, or more socially responsible. We don't know whether an inclusive society will more cohesive, less violent, and more humane. We don't know for sure how much ownership engineering is too much--or too little. And it is not yet clear how quickly the need for government will shrink as we see a shrinkage in the need for income redistribution. To find out, we need to experiment.

But we need the right sorts of experiments, ones that are grounded in financial pragmatism. The widely popular employee stock ownership plan (ESOP) is one such experiment. Since 1975, the tax code has encouraged the use of ESOPs as an ownership-broadening technique of corporate finance. Where shares are acquired for employees on a debt-financed basis, ESOP-sponsor companies are allowed a tax deduction not only for interest expense but also for principal payments on the loan. That enables employees to acquire shares on a self-financed basis, paying for shares with the future earnings of the company rather than with the past savings from their labor.

For example, through an ESOP, founders of a company have a tax-favored way to sell their shares (potentially deferring payment of capital gain tax), companies get a tax deduction for funding an employee benefit plan, and employees get ownership on a tax-deferred basis. In essence, employees gain access to today's "closed system of finance" to build a nest egg, often without having to lay out cash.

Some 11,000 American corporations now have ESOPs and similar employee ownership plans, covering almost eight million employees. Ninety percent of ESOPs are in unlisted companies though ESOPs are also popular in publicly traded firms. For instance, United Airlines is 55 percent employee-owned through an ESOP. But while broad-based employee stock options are becoming popular, ESOPs are growing quite slowly, with 1996 ESOP transactions totaling less than $1 billion in a year when the US economy saw almost $1,850 billion in total capital financing (capital expenditures plus mergers and acquisitions). To make employee ownership attractive, companies need additional encouragement--such as a preferred corporate income tax rate for maintaining a prescribed level of broad-based ownership.

Or ownership-broadening firms might receive more favorable depreciation rates. And a tax deduction might also be allowed for, say, half the proceeds realized on an estate's sale of stock to an ESOP, thus encouraging today's well-to-do to ensure that part of their shares end up in the hands of the company's natural owners--the employees. The ESOP notion could also be expanded through a "RESOP"-related enterprise stock ownership plan--to create an ownership stake for those employed by firms (including micro-enterprise suppliers or distributors) related to an ESOP- sponsoring firm.

Cash Flows, Ownership Grows

As an ownership-engineering rule of thumb, remember: where the cash flows, ownership grows. That rule can be used to make owners not only of employees--as with ESOPs-but also of customers and even the general public. For example, CSOPs (customer stock ownership plans) could be implemented in investor-owned power companies that are financially reengineered so that their customers own a portion of their shares. As investment bankers know, practically any revenue stream can be used to "owner-ize" income-producing assets over time. In the case of a power company, the company's value is based on its customers paying their bills. Without their patronage, the company's financial value as a going concern would quickly vanish. The goal of the CSOP is to craft a capital structure that will capture some of that financial value for those whose patronage maintains that value.

Doubtless you pay two utility bills each month, power and water. Unless you're a rare exception, you don't own shares in those utilities. Yet each bill you pay includes a financial return for someone who does. You can live in a utility district for 100 years and still pay a return each month to someone who may live thousands of miles away. Why not, over time, localize a component of that ownership so that you pay some portion of that return to yourself? That's a CSOP.

Similar self-financing techniques can be used to create individual ownership based on geography or citizenship. Thus, consider GSOCs--general stock ownership corporations. They would "owner-ize" natural resources like mining deposits or drilling rights on public lands. A GSOC could, for instance, retain a royalty interest in an oil field, while a more traditional company, say with a combination ESOP/RESOP, is awarded extraction rights. Some shares (or warrants) could be allocated to fund local education or infrastructure.

In the only version of this concept thus far enacted into federal law, legislation was passed in 1978 enabling a for-profit GSOC that would have allowed Alaskan citizens to acquire British Petroleum's stake in the TransAlaska Pipeline Service Corp. A self-financing element would have paid the acquisition costs from future dividends. But the plan, championed by Senator Mike Gravel of Alaska, was never implemented, for local political reasons. Alaskan voters did, however, establish the Alaska Permanent Fund Corp., funded with lease payments and royalty income from the state's oil fields. Since 1977, it has paid out over $5.8 billion to 500,000 Alaskan residents from a principal now exceeding $20 billion.


Mechanisms like these are easily crafted. What's required is the public will to put them to use. That might be kick-started with an opinion poll, asking people if they'd like Congress to enact policies that create more capitalists. It was just such a poll--asking whether Congress should enact policies fostering full employment--that brought political credibility to the Employment Act of 1946. That act established the President's Council of Economic Advisers, requiring that it publish an annual report appraising the condition of the US economy--with the glaring exception of any requirement to appraise the condition of the nation's ownership. The 1946 act could be amended, creating a new Cabinet-level Department of Capital Ownership (similar to the job-oriented Department of Labor) that, working with the council, could include in each year's Economic Report of the President a survey of current ownership patterns and an appraisal of progress toward expanded capital ownership. What gets measured gets managed.

Similar use could be made of ownership impact reports, analogous to the environmental-impact assessmentsrequired by government agencies. For instance, government contracts could require an ownership impact analysis, identifying both the short-term and long-term effect on ownership patterns. Imagine if we'd had such a requirement when Eisenhower approved contracts for building the interstate highway system. Or during Reagan's $1 trillion defense build-up. Or to identify the ownership impact of his 1981 tax bill providing $872 billion in deficit-financed supply-side investment incentives. Similar reporting could accompany the granting of broadcast licenses, the opening of timber or oil resources to extraction, the granting of loan guarantees, or the provision of export/import assistance.

Taking that one step further, the government's purchasing power, for items ranging from aircraft carriers to airline tickets, could be directed to corporations with certifiably broad-based ownership. The value of these firms is often largely dependent on taxpayer-funded purchases. Taxpayers would realize far more value for their money if contract awards enhanced the economic self-sufficiency of a broad rather than a narrow base of their fellow taxpayers. Any government contract -- federal, state or local -- could likewise be limited to companies with broad-based ownership.

Through non-invasive ownership engineering, a shared capitalism can gradually replace today's exclusive, detached, divisive, and socially corrosive ownership patterns. This shift requires a mix of policy and private-sector initiatives focused on a steady broadening of ownership because only such a mix will, in time, change the current concentration. While full employment can remain a centerpiece of economic policy, it must be complemented by an ownership participation policy.

Oddly enough, this could fill the gaping policy void in either the Republican or the Democratic Party. That's because an ownership solution offers a unique political hybrid--lending itself to populist rhetoric while practical prescriptions are typically rock-ribbed conservative and appealingly progressive.

Toward a Connected Capitalism

Ironically, those most disadvantaged by today's neoclassical model and the fast-emerging impact of globalization may find their best philosophical ally in Adam Smith, who cautioned two centuries ago about the abuses likely to accompany excesses of economic liberty: "Those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments."

Both Smith and Thomas Jefferson were forceful advocates for systems of widely distributed control; both markets and democracies trace their origins to the concept of genuinely self-designed systems. Achievement of that still-elusive goal awaits an institutional environment engineered to incorporate the aspirations and ideas of those whose lives are affected by the commercial forces that surround them. We are only at the beginning stages of understanding how to foster such a system. At the very least, however, we must think more broadly, more deeply, and more creatively about how property--as an intrinsic element of free enterprise--can itself be engineered to ensure a more broadly shared prosperity.

1See James M. Poterba and Andrew A. Samwick, Stock Ownership Patterns, Stock Market Fluctuations, and Consumption (Washington DC: Brookings Institution, 1995), pp 295-357, 368-72.

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