The Kelso Institute - Publications: Download Spanish

Democracy and Economic Power, by Louis and Patricia Kelso, is a short cross section of economics, finance and public policy. First published in the United States in 1986, this book culminates a long career of creative work which Louis began while still in his youth. Driven by his desire to understand the cause of the Great Depression, he made his first indictment of the conventional economic paradigm in “The Fallacy of Full Employment” in 1945. This unpublished work was the precursor to The Capitalist Manifesto published eleven years later. Numerous other writings followed. Although never ceasing his intellectual labors, his personal life circumstances and his desire to put his ideas into practice made Louis choose corporate and financial law as a profession – a rare occurrence among scholars, who prefer analysis to praxis.

The founding of the merchant bank Kelso & Company gave Louis the ideal venue for applying the financial techniques he had invented to achieve his objective of making capital ownership accessible to corporate employees. Having observed the economic evolution of his own country, the United States, from the Great Depression through the decade of the nineties, he had the advantage of perspective. Nor had the Kelsos failed to observe the worsening distribution of wealth that was taking place in their country during the 1980s, demolishing the myth of middle-class affluence along with the images exported around the world for the past fifty years idealizing an ever-expanding Capitalist economy and the American Way of Life.
The opportunities arising in his professional practice permitted Louis to launch a new movement intended to correct the economy’s wealth-concentrating tendencies. Over time his focus was extended to include various other financing techniques, all designed to broaden the ownership of capital. The success of this movement brought about a general acceptance of the idea that participation of employee shareholders in the work place is not only desirable but viable.

Louis and Patricia Kelso’s book summarizes all of this experience, theoretical reflections as well as practical applications, drawn from a lifetime of economic, business and social innovation. Since this work stimulates discussion of both economic theory and public policy, it is a pity that it has not been available to Spanish-speaking readers until now.

To support both their theory and the practical changes they propose, the Kelsos introduce a financial model illustrating income distribution under the private property, free market system. This model shows that labor is not the sole creator of “value,” as asserted by the labor theory of value, a fundamental tenet of classical economic theory. Capital is a factor of production in its own right. With the advance of technological change, capital assumes new forms that make it more productive, but also more expensive.

A worker earning only a salary is not able to acquire capital goods – an airplane engine, for example, much less an industrial plant with all its machinery. He, on his salary, cannot hope to share in the fruits of the accumulation process, for the value generated in the production process is allotted to the owners of labor and to the owners of capital according to the value of their respective contributions. It is clear that those who receive the most from this process are those who have made the largest productive contribution, namely the owners of capital. If capital owners represent a small group, their income share will not return to the market as purchasing power for goods and services; the non-capital owning families, representing the great majority, do not earn enough to fill the resulting purchasing power gap. The inevitable result is an economic crisis like the Great Depression.

But suppose the masses of working people received not only wages or salary for their labor, but in addition received an income from the annual earnings of their capital, thus increasing their power to buy consumer goods while expanding effective demand in the macro-economy. The Kelsos do not in their theoretical discussions take up the Keynesian theory of the marginal propensity to save. According to this, if income saved in a given period is proportionately greater than income spent, the result is insufficient demand. It would be interesting to reconcile this theoretical view with that of the Kelsos, but in general the higher income levels are associated with a larger propensity to save; therefore the risk of problems arising from insufficient demand increase with wealth concentration. Subtracting savings from the income streams flowing back into the economy retards economic growth in the following period. Here there is a link, though a slight one, between Keynes and Kelso. Assuming that the risk of crisis is greater with concentration of income and that the propensity to save is greater in the higher income groups, then it is urgent for public policy to promote the capacity to save and invest in productive capital among successively larger groups. The Kelsos do not analyze in their model the implications of the imbalance of external accounts, that is to say, the importance for countries to balance from time to time exports and imports. But it is evident that nations that accumulate income which is concentrated in groups with a high propensity to save must eventually seek external markets to absorb surplus production. Moreover it is impossible for all of the nations that simultaneously accumulate excessive savings to sustain external trade surpluses with the rest of the world.

There is no doubt that “binary economic theory” (the term which the authors coined to depict the role of labor and the role of capital in the creation of value) opened our eyes to the commanding necessity of broadening ownership of capital for reasons beyond the humanitarian. This is the only way a worker will be able to achieve security; once he or she owns a share of the common capital heritage, the worker will be able to participate in production with more than his hands. This participation will also bring him to identify his interests as an individual with the interests of the company in which he works.

The Employee Stock Ownership Plan (ESOP), the great method for financing capital ownership for workers, has made considerable headway in the United States, where thousands of companies have used it. The ESOP is a fiduciary trust set up within a company. The trust borrows money from a bank, insurance company or other lender, in return for a promissory note from the company guaranteeing repayment of the loan.

Once received, the loan proceeds are used to buy common stock of the employer company. Dividends earned by the stock are paid into the ESOP to repay the loan. As shares are paid for they are allocated to the individual employee participants. After the loan is completely paid off, employees receive a dividend income which they may spend or save.

It is not surprising that with the acceptance of this financing method in the United States, the number of families owning capital property has increased. And it is this form of economic democracy that Louis and Patricia Kelso propose in their book.

In 1989, Louis visited Mexico to take part in a seminar sponsored by the University of the Americas on privatization of state-owned enterprises. On that occasion and afterwards, he expressed his strong reservations about simple schemes for handing over government-owned assets to groups of capitalists without including capital ownership broadening schemes like the ESOP. Today, after more than a decade, his forebodings have been confirmed.

Not only was the administration of Carlos Salinas indifferent to the distributive consequences of privatization, but also to the absence of a democratic distribution of capital, which became instead concentrated in a small group. In many cases, this group did not even represent legitimate businessmen. Because of this, less than six years later, the Mexican government had to use taxpayers’ money to rescue banks, construction firms, the tourist industry, airlines and other producers from insolvency. Successful privatizations were exceptional. The failure of this scheme summarily discredited the idea of privatization without democracy to such an extent that to this day the Mexican government has been unable to persuade Congress to approve constitutional changes that would open up a number of public sectors to private investment. In 1997, the head of the government of Mexico City, Andres Manuel Lopez Obrador, described the privatization of the nineties as a model of “privatization of profits and socialization of losses.”

The same thing happened, although to a lesser degree, in the rest of Latin America. It is hardly a surprise that majority public opinion rejects simple privatization models as a means of modernizing their economies. This is confirmed by the opinion poll Latinbarametro, which showed that from 1998 to 2000 opposition to privatization increased from 43% to 57%. Today, despite the Argentine crisis and poor economic recovery in the greater part of the region, where high unemployment remains undiminished, opposition would undoubtedly be much higher, even though the public knows that state-owned businesses are not models of either efficiency or profitability.

For all of these reasons, this work by Louis and Patricia Kelso has today a natural place in Latin America. Considering the great difficulties Mexico faces, for example, in opening up electrical power generation and natural gas exploration to private investment, it is clear that there is only one new approach addressed to reforming the liquidation of state-owned property. That form is democratization of capital; the only proven method for achieving it is the ESOP.

Students and policy makers in Latin America have here an excellent practical tool that without question would improve the distribution of income and provide a solid foundation for long-term economic growth. The ESOP is not only relevant for publicly-owned companies but for the private sector as well. The authors discuss in this valuable work all of these applications, a work that felicitously is now available in Spanish.

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Dr. Rogelio Ramirez de la O is an independent economist living in Mexico City and one of the best known analysts of Mexico’s development. His predictions of economic fluctuations and structural change have established one of the best records for accuracy. He is President of Ecanal S.A., which publishes his economic reports and provides analyses for the private sector, including some of the largest multinational corporations. He consults regularly with investors, industrialists, think tanks and multilateral organizations on issues relating to Mexico’s economy. He is a frequent speaker at international conferences, sits on a number of corporate boards, and has been designated as “best contact” by Institutional Investor.

Dr. Ramirez de la O holds a Ph.D. in economics from Cambridge University, as well as a Licenciatura in Economics from the National Autonomous University of Mexico. He may be reached at ecanal1@attglobal.net.