Can we cure world poverty? A book in review

Curing World Poverty: The New Role of Property

Reviewed by Steven W. Mosher

Reading this book, I vacillate between feelings of admiration and pessimism: admiration for the sheer virtuousness and moral appeal of the author’s program to achieve widespread ownership of newly created wealth without resort to the failed redistributive policies of the past; pessimism over the practical difficulties of establishing the new economic institutions and processes necessary for this to happen.

The ideas which form the core of the book belong to the late Louis Kelso. Best known as the investor of Employee Stock Ownership Program, or ESOP for short, Kelso’s contribution to economic thought was much broader.

He developed a new economic theory called binary economics which, neither capitalist nor socialist, nor the uneasy amalgam of the two which characterizes most of the world’s industrial democracies, may properly be described as a “third way.” “Binary economics,” in the words of contributor Robert Ashford, “provides a new explanation for poverty in an industrial economy and suggests a new strategy for making all people self-sufficient without taking property from others.” (italics in original)

People remain poor, Kelso argued, because they lack the capital necessary to supplement their labor income with investment income. The traditional capitalist solution to this dilemma is that people must decrease their consumption, that is, save money, and invest these savings wisely.

While this obviously worked for many people in the past, when labor inputs were far more important than capital inputs to production, today the reverse is true: Labor is producing an ever small percentage of U.S. goods relative to machines. The declining incomes which result mean that growing numbers of people have insufficient savings and earnings to meet their consumption needs, much less to retain sufficient capital to begin investing.

As Ashford notes, “Dependence on current earnings and savings for capital formation ensures that almost all new capital will be acquired by existing capital owners.” Over time, wealth will inevitably become more and more concentrated.

It was as a corrective to this increasing concentration of wealth that Kelso proposed an alternative system that extends to all people the right to acquire private property on market principles. Specifically, Kelso would have the U.S. Congress pass legislation which would enable all people, on a voluntary basis, to have access to what he called “capital credit.” By capital credit he meant credit extended for the sole and exclusive purpose of making a productive investment, in contrast to consumer credit, which is used for the consumption of goods and services. Capital credit would provide individuals and families with the means to buy corporate stock and pay for it out of the pre-tax income it generated.

His actual proposal was much more complicated, of course, but it came down to this; With borrowed money, stock ownership trusts would acquire stock on behalf of various groups of beneficiaries, such as employees, consumers, the unemployed, welfare recipients, etc. investments would be limited to those companies or projects with a projected income sufficient to amortize the acquisition debt within a reasonable period, which he projected at five years. Only when the initial loans had been paid back would the trust begin to pay dividends to its shareholders.

Kelso’s proposal is more familiar to us as a “leveraged buyout,” or LBO, in which the buyer pledges the profits of the enterprise he is acquiring as collateral for a loan with which to complete the purchase.

Indeed, Kelso is generally credited with inventing the leveraged buyout, and was once quoted as saying that the first ESOP buyout he orchestrated in 1964 was also the first LBO. But instead of using LBOs to make himself and his friends richer, as did many others, Kelso touted them as a means of broadening the ownership of property.

Now the notion that wealth could be more widespread, that all or most people could enjoy the benefits of investment dividends, has tremendous appeal.

Who would disagree with contributor Kathy Friendman that the dividend cheek is preferable to “the Social Security (retirement) check, the unemployment cheek, food stamps, and education vouchers?” Who would not see a system where most citizens are shareholders in private corporations as preferable to “the endless forms, bottomless bureaucracy, and an infinite regress of new constituencies discovering ‘rights’ that we now have?”

Poverty cannot be cured by handouts which, as Charles Murray has so eloquently pointed out, only foster dependency. The poor must be empowered with a moral and effective means of acquiring productive property.

If we are agreed upon this end — and I am convinced that most people of good will would not hesitate to give their assent — then by what means shall we arrive there?

In the U.S., President Clinton has signed a welfare reform bill which places strict limits on welfare benefits. The bill limits anyone’s stay on welfare to two years, and places a lifetime cap of five years on these benefits. Once these time limits are reached, regardless of whether the welfare recipient has any other source of income, the benefits will stop. The rationale for setting limits is that the welfare recipient, knowing that the benefits they are now receiving will one day cease, will busy themselves finding gainful employment. If the only employment they are able to find is a minimum wage job at the local McDonald’s, however, their chance of escaping poverty is virtually nil.

Other proposals to alleviate poverty are even less promising. One such is the negative income tax, which would effectively return the poor’s taxes to their pockets. Since the poor pay little in the way of taxes anyway, this is unlikely to make a substantial difference.

Enterprise zones in inner cities, a proposal championed by Republican vice-presidential nominee Jack Kemp, is a step in the right direction. But while it would bring enterprises back into desolate urban areas, creating substantial numbers of jobs, few of these would pay well enough for wage-earners to accumulate capital.

Then there is the Kelso proposal. Now the practical hurdles to be overcome in the course of implementing binary economics are formidable.

First there are the economic questions. For example, nearly all capital credit loans are at present secured with collateral. Kelso proposes that loans to his “stock ownership trusts” be secured by something which does not at present exist, namely, future profits. To overcome lenders fears he proposes that banks and other lenders be insured against loss by a system of private “capital diffusion” insurance and government reinsurance.

So far, so good. But Kelso’s estimates of the cost of private insurance (he initially estimated 2% of the loan value, later raised to 5%) seems to me too low.

After all, the risks involved in such novel economic arrangements are substantial and, unless governments are prepared to assume all or most of this risk (through Kelso’s proposed government reinsurance program), are likely to cost well over 10% of capital over the lifetime of the loan, and may be much higher. There is, in addition, the cost of managing the stock ownership trust itself.

For this method of financing to succeed, legislation will have to be passed giving stock ownership trusts significant tax incentives and cost-reductions which are not available under conventional methods of finance, as well as establishing a government reinsurance program which will necessarily assume a large proportion of the risk of default.

This is not without precedent. It was only after Employee Stock Ownership Trusts (ESOPs) were given tax exempt status through specially designed trusts that they became popular.

The success of Kelso’s program to enable the majority, or at least a sizable plurality, of citizens to become capital owners will ultimately be decided in the political arena. If political leaders in the U.S. and elsewhere grasp its merits, they will move to pass legislation which allows their citizens to accumulate significant holdings of capital in a tax-free manner during their working years.

Would this, as the book’s title claims, completely eliminate poverty throughout the world? Probably not. Would it move large numbers of the impoverished into the middle class? Undoubtedly yes. And it seems likely that both democracy and the family would benefit.

Curing World Poverty reads unusually well for an edited volume, and is logically organized around the central theme of Kelso’s binary economics. It should be read by all who are concerned with the future of democratic capitalism and the establishment of a more just economic order.