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Labor's Untapped Wealth

An Address Delivered by Louis O. Kelso at the Air Line Pilots Association Retirement and Insurance Seminar, March, 1984, Washington, D.C.

My thinking about ESOPs began in 1931 in the bottom of what we call the Great Depression. I was about 16 years old —- a year before I entered college — and lived in a small suburban town outside Denver called Westminster.

In those days, I was constantly bothered by the oppressive effects of the depression. My father had lost his job, and my mother had a desperate time making ends meet with a little grocery store she had managed to put together to support the family.

I was impressed by the fact that our economy seemed to have the capability to climb out of the depression. By that, I mean it had then — as it has today — the raw materials, the technological know-how, the manpower, and the skills, along with enormous unsatisfied needs and wants. Those are the elements of a prosperous society producing and enjoying a high level of general affluence. But it wasn't happening. And that really bothered me. Why wasn't it happening? After all, here were grown-up people with all the means to make the economy go, and it wasn't going.

We lived next to a railroad — the Colorado & Southern Railroad — that ran through Westminster. The passenger trains went by empty. They would have a couple of conductors, a brakeman, a fireman, and an engineer, but no passengers. The freight trains went by loaded — with people but no freight; millions of people were roaming the United States looking for jobs that didn't exist. A large number of farms were untilled, except for the farmers' own use; they couldn't sell any surplus output.

I brooded about this situation and after a year or so struck upon a way to study it. The one thing everyone seemed to agree on was that this is a "capitalist" society, a capitalist economic system. Since the word "system" means "logic," I thought to myself, I'll just find out what that capitalist logic is. So I set to work reading as much as I could on history and economics while working my way through college and trying to keep up my grades.

After two or three years, I found the answer to my question: there wasn't any logic; there wasn't any theory of capitalism. "Capitalism" is a behavioral term. Up until World War I, when Britain was the great creditor nation of the world, anything that Britain did was considered capitalist. It didn't make any difference what happened in the British economy. If it happened there, it was still capitalistic.

In World War II, the United States became the creditor nation, and after that capitalism was whatever the United States did in any official capacity or in any other context that supported our national interest.

Well, you don't have to be too much of a genius to know that if you are talking about a system where nobody understands the logic, there must be something wrong. After all, it has all the earmarks of a system — that is, an arrangement for the production and distribution of goods and services, and the consumption of good and services — so it should follow some kind of natural law. Being undaunted at that early age, I was certain that I would figure it out.

By 1945, at the end of the war, I had written a manuscript for a book that, among other things, laid out a theory of capitalism. The manuscript was called "The Fallacy of Full Employment," which referred to the fallacy of trying to solve the income distribution problem by relying on only one of the two ways that people participate in production to earn income.

In fact, the mixture of labor input and capital input had been rapidly changing for 200 years in step with the Industrial Revolution and had even been changing long before that with the discovery of the first tools. Alfred North Whitehead, I think, gave the best definition of the beginning of the Industrial Revolution. He said it was the point in history where "man invented the art of invention." In other words, from about 1670 in Britain and 1776 in the United States, we no longer relied entirely on accidents, inspiration, or hunches to invent ways to improve the quality, quantity, and variety of goods and services and to save toil. Instead, the process became more and more specific. And with that, of course, industrial change accelerated at an exponential rate.

What I discovered was not a new economic theory, but a missing fact. Copernicus, after watching the stars and playing with the mathematical formulas that he thought explained their activities, concluded that geocentric theory was wrong. He deduced, instead, that all the heavenly bodies in our galaxy moved not around the earth, but around the sun.

But he was dealing with something that was so distant it couldn't be easily seen or accurately measured. And when Galileo, almost a century later, picked up the same idea and tried to get it accepted by conventional science, the establishment almost fried him. They made him recant heliocentric theory to save his life. What each had discovered, without realizing it, was not a new theory, but a missing fact. You just couldn't see it until the invention of the telescope.

Later, when Pasteur came forward with germ theory and struggled over much of his lifetime to get the medical profession to accept it, he was dealing not really with a new theory, but with a missing fact. The only problem was that the germs were so small you couldn't see them until the invention of the microscope.

We don't need telescopes and microscopes to understand the fact I want to talk about now. We do need shovels to dig through the tons of mythology that cover it up.

This is the missing fact: in the real world, goods and services are produced by two things, not just one. At present, the universally accepted idea is that, morally, if you want income, you must produce something; you must contribute to production something the public will buy. That's the moral principle. Charity is a way to cope with the system when justice doesn't work — that is, when someone can't earn an income. Our national economic policy is: work is the only way. In other words, full employment. It doesn't make any difference what's going on in the scientific world or the business world or the industrial world, we still believe full employment will solve our income distribution problems. This is what major political figures have always maintained. Full employment is the national economic policy of Russia; it is the national economic policy of the United States, and it is the national policy of just about every nation on Earth.

I say we've left out a fact. A human individual can earn income just as legitimately through privately owned capital as through privately owned labor. By capital I mean land, structures, machines, and certain intangibles that have the characteristics of property, such as patents and trade names.

The whole function of technology is to change the way in which goods and services are produced from labor intensive to capital intensive. Let's look at that for a moment. The American Constitution has a lot of undiscovered wisdom in it. In the field of economics, the constitutional wisdom couldn't be discovered as long as men were locked into the mythology of one-factor economics.

The prologue to the Constitution — that is, the Declaration of Independence — recognizes in every person the right to life, liberty, and pursuit of happiness. What is the right to life? In economics, it is the right to earn income to support life. That's not the way it's being interpreted today. It's being interpreted as the right to biological life, supported on other people's earnings — "entitlements." It means the "right" to be a dependent under the ever-more-dominant economic policy of coerced redistribution. Mere "trickle-down" isn't the way it works; "coerced trickle-down" is.

The implications of this are profound. They call for very close scrutiny of our economic institutions. Because a society that falsifies how it earns its bread — that is, how it produces goods and services — and legitimates the right of individuals to buy food, shelter, and other things, is an immoral society from the top down and from the bottom up. If you want to know why immorality is beginning to pervade every area of our society, you can trace it to that. We lie about what's going on in the world regarding our subsistence. We lie to live. That's not a trivial matter.

In the two books which Mortimer Adler and I wrote, and in the third one I wrote with my wife, Patricia, the main message was simply this: as the production of goods and services changes from labor intensive to capital intensive, the way in which every person -- not just a few, but every person -- earns his or her income must change in the same way. You can't do that unless two things happen: (1) you have to broaden the ownership of capital, and (2) you have to tighten up the laws of property so that the capital owners collect the wages of their capital with the same faithfulness that the labor workers now collect the wages of their labor.

At present, we do exactly the opposite. We pretend there is only one way to earn income — namely, to work. And we therefore conclude that it doesn't really make any difference who owns the capital. Consequently, nobody gets very excited about the typical equity capital owner's getting only one-twelfth of the income that flows from the assets represented by the stock he or she owns. Only one-twelfth! If you find that hard to believe, it's easy to illustrate.

State and federal corporate income taxes, plus the employer's share of Social Security — which does nothing for the employer — take over half of corporate net income. Over 50 percent goes to taxes. Boards of directors, lacking a logical way to finance growth, take up to three-fourths of what's left. That leaves you with one-eighth or so of what you started with. And the infighting, under the advocacy system, between management and labor shrinks that eighth to a twelfth. About one-twelfth is what the shareholders get. Put another way, this means that capital, even in a badly structured economy, is about 12 times more powerful than it appears to be.

That takes me back to another historical note. The manuscript I finished as a young man came with me to San Diego on a destroyer in 1945. At that time, I looked around at what was going on in the United States. Congress was debating the Full Employment Act of 1945, which basically said there's only one way to earn income. And I said to myself, "Louis, you'd better settle down and practice law, which is what you're trained to do, and let the country recover from the war. Stick your manuscript in the closet, and if after 25 years you still think the thesis is valid, dig it out, update it, and publish it." Well, I got about five years into the seasoning process, with no conversations about it, before Mortimer Adler, who had just finished his Great Books of the Western World, moved to San Francisco and set up his Institute for Philosophical Research.

Some of his patrons were clients of mine, and they introduced us, which led to my becoming his lawyer and helping him organize the Institute. About four years later, in the mid-1950s, he and I spent a weekend together at the ranch of Prentiss Cobb Hale, chairman of the board of Hale Brothers. We were sitting around the swimming pool after horseback riding, and Mortimer, who never forgets anything, said, "Lou, last winter, in one of the classes that you attended at the Institute, we were reading Marx and several other texts, and during the discussion you voted one way on a certain issue and everybody else, including me, voted the other way. What I'd like to know is how did you get on the other side of the argument?" At that point, I could see that the aging period of my secret manuscript was about to end. I said, "Mortimer, if I had taken any other position, it would have violated the theory of capitalism." He said, "Oh, come on now; there isn't any theory of capitalism. I've just finished putting together the Great Books of the Western World. I had more than a hundred scholars working under me. That was one of the questions we tried to answer. I can tell you there is no theory of capitalism." I said, "Mortimer, I'm sorry, but your research is incomplete." Well, naturally, he was a little irritated by that, so he said, "Give me the citation. Where do I find it?" I said, "In my closet." He thought he'd been had. He said, "Wait a minute. Don't come back here Monday morning bringing me a big pile of dog-eared papers. I don't have time to read that kind of stuff. Just give me the five-minute version." I said, "All right, the five-minute version is this: conventional wisdom has it that only labor produces wealth. Everybody knows that. But I discovered another fact. There are two ways to do it. You can do it through your privately owned labor power or through your privately owned capital."

Mortimer jumped about 12 feet off the ground. "There's no justice," he said. "I've spent 22 years studying this subject, and you stumble across the answer with no effort at all." Well, it may have looked like no effort to him, but I thought I had worked pretty hard at it.

Mortimer then started badgering me, saying, "You're a coward for not speaking out on this. What do you care whether you get martyred; this is truth. The world needs it." I said, "Yes, I understand, but I'm already working long hours, and I've just got to do it in my own time."

He kept on bugging me, and finally, when he and I were in New York some months later, he came down to breakfast one morning and said, "Lou, I've got it! Suppose you and I take the highlights out of your manuscript and publish it under the title The Capitalist Manifesto?" So that's what we did. We rewrote the manuscript four times in one month and sent it off to four publishers, all of whom accepted it. It made the best-seller list.

In that book, Adler took the view that what we were saying required some kind of reaction. Either you tried to refute it or you made some effort to apply it. Unfortunately, we got neither. It's only now — 25 years later — that we're starting to see some response.

In 1955, three years before publication of The Capitalist Manifesto, I was a junior partner in the third largest law firm in San Francisco. A client from the San Francisco peninsula had come in to talk with one of the partners about a legal transaction. The client had founded a local newspaper company. Now that he was almost 80 years old, he wanted to sell the newspaper to his employees. He was a good person. He said to his employees, "Believe me, if I were rich, I would give it to you. You've done a tremendous job building this paper. I want you to own it. But the paper is my entire capital estate. I have children and grandchildren to think about. I feel I have to leave as much of the estate to them as I can. So, do you want to buy it?" With one voice, they said, "Yes, we do."

It happened that the No. 2 man at the newspaper — a fellow named Gene Bishop — had been my commanding officer in the Navy. It was he who sat down with the corporate finance people at our law firm. And the attorneys on the case called in Crocker Bank to make a survey of the employees to determine what kind of payroll deductions they could manage, how much savings they could invest, whether their houses would stand second mortgages, whether their relatives would put up money, etc.

A few weeks later, the bank called in the unions and announced its findings: "Gentlemen, we've got some good news and we've got some bad news. The good news is that you can afford to pay the interest on this purchase indefinitely. The bad news is that you can't afford to pay the principal." Well, the owner of the paper had in mind some generous terms, but not quite that generous.

When Gene Bishop passed my office that day, I said to him, "Hey, Gene, are you a newspaper owner now?" He said no and told me the story. I said, "Gene, I think it's very possible you were given bad advice." He looked around, a little shocked, and closed the door. "Do you know where you are?" he asked. I said, "Yes, I do, but you and I are old friends. I'm not going to lie to you. I don't know for certain, but I think you were given bad advice." He said, "What should we have done?" I said, "I don't know yet. I would have to look at all the information. If you want me to, I'll pull the file and tell you whether I think the deal can be done." He said, "Listen, this is a life-and-death matter for me. I'm not going to stay with this newspaper if it's going to be sold to Hearst or some other chain. I like it the way it is."

The next day, after studying the file, I called him. "Gene," I said, "this thing will fly like a birdie. You don't have to take anything out of your pockets or out of your paychecks. You don't have to mortgage your house. You don't have to do any of those things. Five or six years downstream, the employees will own the business free and clear. And the present owner will have his money and his interest." Gene thought I was kidding, but I was not.

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