By Louis O. Kelso and Patricia Hetter Kelso

“The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consists always of either in the immediate produce of that labour, or in what is purchased with that produce from other nations.”
—Adam Smith¹

 

“Labour is the source of all wealth and of all civilization; and since it is only through society that generally productive labour is possible, the whole product of labor, where there is a general obligation to work, belongs to society — that is, to all its members, by equal right, and to each according to his reasonable needs.”
—Karl Marx and Friedrich Engels, 1875²

In 1990, the philosopher Mortimer J. Adler asked the Kelsos to contribute a background paper for his Aspen Institute executive seminar. The discussion topic, “Capitalism, Communism and the Future,” had been inspired by Mikhail Gorbachev’s book, Perestroika, in which the then Secretary General of the U.S.S.R. challenged the keepers of the conventional socialist wisdom to update concepts that had outlived their usefulness in the modern world.

“The political economy of socialism is stuck with outdated concepts and is no longer in tune with the dialects of life,” Mr. Gorbachev wrote. “Philosophy and sociology, too, are lagging behind the requirements of practice. Historical science must undergo a major revision.”³

Although Mr. Gorbachev did not identify the concepts responsible for impeding socialism’s success, he did point out problem areas — alienation, demotivation, inefficiency, shortages, poor quality — which were clearly related to socialism’s most sacred dogma, the duty and necessity of labor work.

The Kelsos decided to write an Open Letter to Mikhail Gorbachev.

In our letter, we said that the Soviets were not the only ones burdened with obsolete ideas. Despite the west’s technological superiority and our commitment to free enterprise, the western industrial nations had built their economies on the same fallacy as the Soviet Union. This is the belief that there is only one factor of production, labor, and its corollary that the only legitimate way for people to earn a living is through their labor.

Adam Smith himself had sanctified this pre-industrial view of the economic order in the opening paragraph of The Wealth of Nations; it became embedded in the western economic tradition. Despite his contempt for “bourgeois political economists,” Marx himself accepted Smith’s seminal misconception as self-evident. He made it the center of his own theoretical structure.

“Before the world can accommodate its institutions to the Industrial Revolution,” we advised Mr. Gorbachev, “it must recognize and correct this 200-year old mistake. The nation which does this first at the level of economic policy will not only take the brakes off its own economy, it will lead the world into the 21^st century.”

Western economists claim that they long ago consigned the labor theory of value to the attic of history. But the pre-industrial idea that labor is the sole factor of production was left intact in western institutions and the premises underlying them. Economists believe — or pretend to believe — that tools, machines, structures, processes and other forms of capital, and even technology itself, simply make labor more productive. This assertion is at the core of the west’s primary measure of economic growth: the “productivity of labor,” or man-hours worked per unit of input.

It is also the heart of our pre-industrial belief that the only way for people to earn income is through jobs and employment. This is the message of our official economic policy, the Employment Act of 1946. A harsher version of the same message is set forth in Article 12 of the Soviet Constitution: “Work in the U.S.S.R. is a duty and a matter of honor for every able-bodied citizen, in accordance with the principle: ‘He who does not work, neither shall he eat.’”

This backward-looking, pre-industrial economic policy is totally blind to the fact that in the real world, there are two ways to produce goods and services and earn market-sourced income: through one’s privately-owned labor power or through one’s privately-owned capital. Capital is an input factor on the production side of the market equation, just as labor is; capital, like labor, performs economic work and earns a distributive share on the outtake side of the equation. The effect of technological change is to make production ever more capital-intensive and less labor-intensive.

Louis Kelso and Mortimer Adler explained the logic of the free market system in 1958 in The Capitalist Manifesto. Although publicly denounced by Pravda as theoretically feeble, ideologically impoverished and intellectually impotent, this book was taken very seriously in the Marxian orbit. It was translated into Russian, Ukrainian, Polish, Hungarian and the other languages of the Soviet bloc — even Chinese — and distributed in “eyes only” numbered copies to Soviet ideologists who, Louis Kelso and I learned years later, were fascinated by its thesis but powerless to act.

The Kelsos’ letter to Gorbachev was, of course, meant for the corporate executives at Aspen. Mr. Gorbachev never saw our letter. His modest attempt to initiate reform from within unleashed forces that caused the Soviet Union to self-destruct. Now it is China that the free-market missionaries are trying to make safe for western investment.

China is now in the process of privatizing its state-owned assets. It wants our latest technology; we insist that the only way it can get it is to open its doors to foreign capital and its markets to foreign competition. China sees no alternative. But this country is not yet prepared to jettison its socialist ideas. At Nanjing University, a young business school student told me: “We sacrificed efficiency for fairness; and now we are being asked to sacrifice fairness for efficiency.”

The Socialist Revolution was a protest movement against the western market economy — a system that worked spectacularly for some, but poorly or not at all for the majority. Marxian-schooled people fear that in reinstating private property and the free market, they are simply jumping back into the frying pan from the fire. They remember Karl Marx’s warning: “The country that is more developed industrially only shows, to the less developed, the image of its own future.” He did not mean this as a compliment.

Enviable as western affluence undeniably is to nations still mired in various stages of pre-industrial poverty, not a single one of the western models is adequately meeting the needs of its own citizens. As President Bill Clinton himself pointed out before his election and after, the American standard of living has been falling for a generation. Despite constant technological progress, and ever-larger accumulations of productive power in the form of capital instruments, the western economies have never been able to eliminate domestic poverty; within their borders, in good times and bad, millions of families remain poor generation after generation and many lack food and shelter.

Marxian-schooled populations observe the market economy’s dark side. They also observe that booms fueled by western investment capital and government credit routinely turn into busts. Will that happen to them as well? Why not? What is to prevent it?

The Fatal Flaw

The Marxists had one thing dead right. There is a structural defect in the private property, free market economy. Marx called it capitalism’s fatal flaw.

Chief Sitting Bull told Annie Oakley: “The white man knows how to make everything, but he does not know how to distribute it.” Shortly before the Southeast Asian debacle, Malaysia’s prime minister, Mahathir, told William Greider: “Spreading wealth evenly in a market economy is far more difficult than spreading poverty evenly in a command economy.”

Where in the free market structure does this chronic distribution bottleneck originate, and why?

When Adam Smith, writing in 1776, the date historians assign to the start of the Industrial Revolution, analyzed the economic order around him, he reasoned more or less as follows:

Nature herself had invented the ideal economic system, simultaneously with the creation of the human race.

Nature uniquely endowed each human being with the power to produce goods and services.

Nature gave each human being this unique power: the power to deliberately produce goods and services. Human labor power was the original form of economic power. And Nature’s distribution was democratic: one person, one labor power.

Nature clearly intended each human being to be self-supporting — neither slave nor parasite, but an autonomous producer.

Nature clearly implied what both Aristotle and Adam Smith understood as the first premise of political-economics: The purpose of production is consumption by the producers themselves.

In Adam Smith’s day, economic power was naturally diffused because every free human being owned his or her own labor power. Smith conceived the free market economy to organize — on the national scale — the democratic economic plan Nature had devised for the individual. But Smith overlooked an important piece of human experience. In the real economic world, people found that labor dependence doomed everyone except slave owners to lifelong, back-breaking toil, rarely for more than bare subsistence.

Subsistence toil denied not only affluence but leisure — the prerequisite for education, the arts, culture — all that we call civilization. Human bodies require creature comforts but human minds and souls require leisure, and the activities and fruits of leisure, because human beings are spiritual and creative beings as well as animals. However cruel and unjust, the enslavement of some enabled others to create and enjoy civilization.

Thus the human race, long before 1776, had begun to mobilize a rebellion against perpetual labor servitude. It discovered fire; invented tools; developed industrial processes. And right under Adam Smith’s nose, it was launching the final onslaught against primordial toil and poverty. It was launching the Industrial Revolution — transferring the burden of production from the muscles of men and animals to the forces of nature captured in machines and other increasingly powerful capital instruments.

Smith did not notice that capital stock, as he called it, represented a new method of engaging in production — a means which had the potential to liberate the human race from subsistence toil and compulsive poverty. This method also enabled the owner of capital shares to engage in production vicariously. True, the Industrial Revolution did not, and never will, completely eliminate the need for labor. But labor work becomes less and less adequate as technology changes the input mix from labor intensive to capital intensive, with corresponding changes in personal earning power and the distribution of income and purchasing power in the national economy.

As an incomparable scholar and philosopher, Smith should have been familiar with Aristotle’s speculation in Book I of Politics. There was no alternative to slavery, Aristotle thought, unless, in some distant future, looms would weave and musical instruments play by themselves without the touch of human hands — in other words, until human ingenuity succeeded in launching a successful industrial revolution. Then, said Aristotle, everyone would have mechanical slaves to perform subsistence toil on his behalf and in his stead. Capital instruments would act as supplemental or surrogate producers to liberate people from economic servitude.

Aristotle’s utopian vision was actually coming to pass in 1776. But Smith, blinkered by the labor theory of value, failed to see it. He assumed that the future would be essentially like the past. Smith failed to understand that capital represented a second input factor on the production side of the market equation, a far more powerful input factor than labor. Consequently, he did not see that ownership of productive capital must become as widely distributed as labor power — and for precisely the same reasons that labor power is democratically distributed by Nature. Otherwise, Smith’s free market principles could not work.

If a single producer, through his or her privately-owned capital, produces and earns significantly more — even hundreds of times more — than his or her dependents can or will spend on consumer goods, then Say’s Law — which holds that “supply” creates its own “demand” — cannot work. Even the most lavish standard of living has practical limits. Income not spent in the consumer markets is invested to accumulate ever more excessive productive power, which channels ever more capital-produced income to owners who cannot or will not recycle it back into the system through consumption, as free market logic demands.

Nevertheless, Smith’s basic insights into the dynamics of the private property, free market were sound. The Industrial Revolution in no way invalidated the principles he identified. It did not change the rules. All it changed was the physical and technological facts from which the concepts of working and earning were derived. It did not change the rule that in order to earn income from production you must provide productive input. But it changed the nature of work from labor intensive to capital intensive. It invented a new kind of worker — the capital worker. To work today means to work increasingly with and through capital.

Therefore, universal capital ownership is not an option but, just as Aristotle foresaw, a necessity. People must earn incomes from capital ownership and use those incomes in the consumer markets if we are to avoid the political and economic ills that flow from widely erratic and unreliable income distribution, or the need for coerced income redistribution from those who produce and earn to those who cannot because they are not capital-equipped to do so. Free market logic equally commands every producer to be a consumer, and every consumer to be a producer. The income generated by the free market must be spent to buy that market’s current output. Otherwise we make depression inevitable.

Karl Marx, whose Communist Manifesto in 1849 was indeed a salvo heard round the world, made the same mistake as Smith. But he was writing three-quarters of a century later. Thus he had less excuse for failing to see that not only was the Industrial Revolution changing the nature of work, that was what was intended. Marx’s stirring descriptions of the gigantic, self-powered capital instruments of his day (Nasmyth’s steam hammer was one) are unequalled in economic literature. How could Marx describe these autonomous machines in action, and record the human labor they destroyed, yet still proclaim that only labor produces wealth?

Marx thought that capital (improved land, structures, machines, processes and capital intangibles) was merely congealed labor power; that the value of capital represented theft by its owners — the capitalists — from helpless labor, and that the evils arising from privately concentrated economic power could only be corrected by abolishing private property in all producer goods and transferring ownership to the state. Today the world is awakening to the fact that Karl Marx’s solution was not a solution at all, but a tragic mistake that destroyed both political freedom and the hope of affluence.

We do not think that Marx could have erred so disastrously had he understood Aristotle’s utopian vision of automated production, in which every human being was endowed with economic power through the ownership of mechanical slaves. But Western leaders are in no position to criticize either Smith or Marx. They remain no less oblivious to the meaning of the Industrial Revolution, and to its effect on work, income distribution and political democracy.

There is more to Marx, however, than his erroneous views on private property in capital. There is also the “Marxian analysis.” Marx greatly admired capital as the embodiment of technological change — the prize of the Industrial Revolution. He lauded the awesome power of capital to turnout vastly greater quantities of goods and services of higher quality than labor ever could do on its own. But he also realized that if only a few people were able to acquire and own the economy’s capital assets, they would be in a position to exploit and dominate the great non-capital owning, labor-dependent majority. Concentrated ownership of capital’s productive power would destroy Nature’s original plan for economic democracy. This insight reinforced his belief that private property in capital was a luxury society could not afford. Marx considered capital as much too beneficial and necessary to society and humanity to allow the advantages and benefits of ownership to be monopolized by a few. Can we really fault Marx on this? Do we want to?

Where does this leave us today?

Public ownership of capital, because it consolidates political and economic power, leads to the totalitarian state. But in private property economies, capital ownership is concentrating faster than ever, while technological change makes capital ever more productive.

Smith said: every consumer a producer, and vice versa. But what neither Smith, nor Marx, nor the economists who have followed them have noticed is that capital workers are doing more and more of the producing.

If a tiny percentage of families monopolize for themselves progressively more of the earning power of capital, the free market cannot function on the distributive side of its equation.

So what do we do now? What should the western market economies do? What should the restructuring socialist economies do? What should the less-developed economies do?

Our answer is: adopt economic policies that acknowledge the need of every citizen to become a capital worker as well as — or eventually instead of — a labor worker. Louis Kelso spent the latter part of his life inventing and innovating techniques of finance to accomplish this. The best known of these is the Employee Stock Ownership Plan (ESOP). An estimated 10,700 U.S. corporations are enabling about 8.7 million employees to acquire a capital stake in their employer corporations, including some of the biggest and best. ESOPs hold an estimated $500 billion in assets.

Quite as important, authentic ESOP companies are more profitable and competitive. Most are expanding, hiring more people, paying more taxes. It is not uncommon for ESOP participants in successful companies to retire with hundreds of thousands of dollars in company stock. Sold back to the ESOP, or retained for its earnings, this stock — assuming that the company remains employee-owned so as to motivate new generations of labor workers — should provide comfort and security as long as they live. Only capital ownership enables people to take part in production and earn income after leaving the labor force. Labor work is temporary; capital work provides (what the Japanese thought they had but did not) true lifetime employment.

Other financing methods employing the ESOP’s logic can make capital workers of civil servants, teachers, nurses, artists, senior citizens and others outside the corporate sector. Like the ESOP, these techniques of business finance exploit the fact that, contrary to the conventional economic wisdom, people do not have to save to buy capital but can buy and pay for it out of its own earnings. Binary financing techniques open up capital ownership to those who are born without capital — most of the human race.

Any nation, industrialized or developing, can use these financing tools to speed up economic development; to free itself from foreign ownership; to privatize government-owned assets, and to build economic power into its own citizens and consumers so that neither they nor business and industry needs government redistribution. The national economic policies of all market economies — the United States, Canada, Great Britain, France, Germany, Japan, Mexico and all the rest — are obsolete. They are oblivious to the cause and effects of the Industrial Revolution. They still assert, as a matter of policy, that everyone can live well on jobs alone. They assume that industrial poverty can be cured through jobs and employment. They do not recognize that the human right to life implies a right to earn a good living, and a right to earn a good living in an industrial economy implies the right to acquire capital out of its own income.

Capital is central to the life support system of every society. All people, as families and individuals, need to legitimately acquire and own a reasonable part of that life support system, so that they may live as well as the prevailing state of technology and resources permit, and so that the private property, free market will work as well as Adam Smith envisioned and Nature planned.

FOOTNOTES

¹ Wealth of Nations, 1776.

² Point 1, the Gotha Programme, 1875.

³ Gorbachev, Mikhail, Perestroika, Harper & Row, New York, 1988, p. 35.