by Louis O. Kelso and Patricia Hetter Kelso

 In October 1929, when the U.S. economy began to sink into that deep morass later immortalized as the Great Depression, I was not quite 16 years old, and at a loss to understand this mysterious catastrophe.

To my innocent young mind, the Depression seemed absurd.  Here was an economy endowed by Nature with more than enough of everything necessary to produce a high standard of living for all.  Why, then, were factories running part-time or shut down?  Why were valuable tools and machinery allowed to rust?  Why were millions of threadbare and ragged people foraging in garbage cans or standing in soup lines, when farmers could grow mountains of food and fiber on land now lying idle and manufacturers were as eager and able to make clothing and every other useful thing as storekeepers were to sell them?  Why did growers saturate entire orchards of sweet ripe oranges with gasoline before throwing them into rivers to float past starving children?  Why did trains meant to carry people rattle along with coaches almost empty, while freight trains were loaded down with homeless, jobless vagrants?

These and other equally inexplicable questions — prompted by what I saw, read and heard around me — constantly roiled around in my mind.  None of it — the foreclosures, the unemployment, the low wages, the suffering of millions of innocent people — made any sense.

But what I saw as the economy of the absurd my elders stoically accepted.  For them it was business as usual.  They took it for granted that a capitalist economy would sooner or later collapse, just as volcanos periodically erupt, locusts darken the sun and rivers swell into raging floods.  In 1931 President Hoover reminded the nation that “depressions are not new experiences, though none has hitherto been so widespread.  We have passed through no less than fifteen major depressions in the last century.  We have learned something as the result of each of these experiences.”

Fifteen major depressions in a single century?  What knowledge could the elders have gleaned from these grisly lessons when they still didn’t know the cause of depression, the cure for depression or how to prevent future depressions?  (And in case anyone should be feeling smug about our own generation’s intellectual progress, the fact is that, sixty years after the event, economists still do not agree on what caused the Great Depression.)

So the brash young man I was then decided to launch his own investigation.  This economic mystery had to have a rational explanation.

Several years of hard intellectual detective work led me to conclude that the problem lay with the assumptions underlying the concept of the free market.  One of them was wrong.  And the original error was sown by none other than the father of modern economics, Adam Smith, himself.

It was simply not true, as Smith had assumed and economists after him still assume, that only human labor produces goods and services, i.e., real wealth.  Nor is the corollary true, that, therefore, labor jobs and labor employment are the only ways people can produce and earn income.  In the real economic world there are in fact two ways in which people can make productive input.  One is through labor.  The other is through capital — land, structures, tools, machines and processes — the creatures of scientific and technological advance.

Nor was it true, as Smith also assumed, and as U.S. national economic policy, the Employment Act of 1946, also assumes, that productive power was as democratically and effectively distributed after the Industrial Revolution as it had been in the pre-industrial eons before technology harnessed the energy of Nature, although — and this is at the heart of the problem — it was in that pre-industrial era that our ideas about free market economics and our principles of democracy were formed.

We have been running the economy on a myth — the “rising productivity of labor” — to protect ourselves from the fact that technological progress really substituted capital input for labor input.  Regardless of whether new jobs came into being to replace those destroyed, as capital input increased, labor’s input, relative to capital’s, declined.  Under the property rule of the free market, each participant receives the value of his or her contribution.  Therefore, working people’s legitimate income share was proportionally shrinking, while capital owners’ was increasing.  Technological advance was causing the productiveness of capital to rise.  But working people owned no non-residential capital.

The problem was that, although the logic of a market economy had not changed, the facts of production had changed.  Free market logic still compelled every consumer to be a producer, i.e., to make productive input.  But the Industrial Revolution had changed the idea and nature of work or production from labor-intensive to capital-intensive.  And in the process it changed the way people must earn incomes if we are to avoid the political and economic ills that flow from coerced income redistribution from those who earn to those who need.  The Industrial Revolution changed “work” from something people once did primarily by the power of their bodies and brains to something increasingly done via (other peoples’) privately owned capital instruments.

But we never adjusted our economic institutions to accommodate this important new environment.  We went on acting as if the Industrial Revolution had never taken place, or if it had, as if it had not changed anything as basic and vital as the Puritan work ethic.  And when World War II ended, we hastened to pass the Employment Act of 1946, enshrining into national economic policy the false notion that a nation can solve all its economic problems and avoid depression by providing as many people as possible with labor jobs, genuine or “created.”

Nor is it irrelevant to my story that while Congress was furiously debating this anachronistic piece of legislation, I had just completed writing my own economic analysis.  I called my manuscript, “The Fallacy of Full Employment,” later published as The Capitalist Manifesto.

Now, after more than a half-century of running our economy on employment and jobs while disregarding that most goods and services are produced through capital, people are disillusioned to discover that:

• A good education, professional skills, good character and hard work are not enough to keep growing numbers of families in the middle class, much less give them entry to it.
• Hard work during their most productive years by both husband and wife will probably not provide a decent living, particularly should either lose a job, become disabled or retire.
• Two working parents holding average jobs, even with moonlighting thrown in, cannot provide as well for their children as their own parents did for them on the earnings of a single breadwinner.
• With ominously increasing frequency, two working spouses, especially if they have children, cannot afford to buy and maintain a home.

People once expected technological progress to provide better livings with less toil and more leisure, not just for a career meritocracy but for the average population.  Instead, we have a falling general standard of living, the need to work harder and longer, often at more than one job, while leisure, even as an ideal, has virtually disappeared.  Indeed, our failure to harness the producing and income-earning power of capital (land, structures, machines and capital intangibles, normally represented by the ownership of common corporate stock) to directly satisfy the needs and wants of families and single individuals throughout the economy is reflected in ways other than contrived privation.  It shows up as well as stratospheric national debt and debt service costs, trade deficits, loss of international competitiveness, inflation and human alienation.

These modern symptoms of a miswired economy testify to the validity of the message first made public in The Capitalist Manifesto, i.e., that labor employment alone is no longer the key to a good economic life.  Full employment is no longer an adequate or rational goal for an industrial economy.  It is most certainly not an adequate goal for a democracy dedicated to the ideal of equal economic opportunity for all.

Meanwhile, what about the other way of earning income, capital work?  Well, official policy is that it doesn’t matter who owns the nation’s productive capital.  To economic policy, capital is invisible.  Capital is important not because it provides productive input and produces income, just as labor does, but because it “creates” employment for labor.  It is a mere catalytic agent.  The employment and income-producing potential of capital ownership is ignored.  Consequently, capital ownership in the U.S., for generations confined to the top 5 percent of families, is being super-concentrated through mergers, acquisitions and non-ESOP leveraged buyouts (LBOs) at a rate the nation has not seen since the days of the robber barons.

And how do the already-rich make themselves even richer?  Their most efficient new instrument is the leveraged buyout, which I invented in 1956 for quite the opposite purpose — namely, to build capital-sourced earning power into the middle class and the working poor.  The original leveraged buyout is the Employee Stock Ownership Plan, or ESOP.  So far, there are about 10,000 ESOPs in the U.S., with new ones being added at an accelerating rate each year.  These ESOPs are painlessly enabling some 10 million corporate employees to become capital workers by permanently adding the earning power of capital to their wages and salaries.  Over $6 billion in employee capital ownership was acquired by U.S. corporate employees in 1987.  But that figure is dwarfed by the over $600 billion in capital acquisitions through the Wall Street rip-off of my invention, which has merely exacerbated the nation’s super-concentration of capital ownership.

So, even if the economy has so far staved off collapse, the forces which cause depression are still at work.

A powerful free market economy must have powerful consumers, as well as powerful producers.  Adam Smith was right about that.  But today that requires consumers who have the combined earning power of their labor and their own capital.  Unless we change our Stone Age economic policy, however, and begin to democratize capital ownership through the ESOP LBO and related financing methods based on private property and free market principles, while discouraging methods of finance that foster Wall Street rip-offs of the ESOP — our standard of living and world leadership position will continue to decline.

—  Originally published as a feature article in LEADERS, October, November, December 1989, Vol. 12, No. 4