CAPITAL DEMOCRATIZATION

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• Abstract
  Although principles underlying binary economics were first published in 1958 (Kelso and Adler), the many books
  and papers that discuss the subject, with the exception of Kane (2000) and Kurland (2001), do not utilize
  conventional economics language. To facilitate the teaching of binary economics in beginning and intermediate
  college courses in economics and business, the paper explains some major microeconomic and macroeconomic
  fundamentals of binary economics by utilizing conventional neo-classical economic models. It then compares the
  theoretical results reached in a non-binary economic environment to those that may be reached in a binary one. The
  most important result from the comparison is that, in a non-binary environment, the economy would employ less
  than full potential capital and thus generate less than optimum output, consumption, saving and investment. The
  authors hope the article will help the reader to (a) understand the binary principles and (b) analyze the ‘binary
  promise’ of greater growth based on a broader distribution of capital ownership.
  Conventional wisdom effectively treats capital (land, structures, machines, and the like) as
  though it were a kind of holy water that, sprinkled on or about labor, makes it more productive.
  Thus, if you have a thousand people working in a factory and you increase the design and
  power of the machinery so that one hundred men can now do what a thousand did before,
  conventional wisdom says, 'Voila! The productivity of the labor has gone up 900 percent!' I say
  'hogwash.' All you've done is wipe out 90 percent of the jobs, and even the remaining ten
  percent are probably sitting around pushing buttons. What the economy needs is a way of
  legitimately getting capital ownership into the hands of the people who now don't have it."
  (Louis O. Kelso, 1982, http://www.kelsoinstitute.com)
  I. Introduction
  Binary economics asserts that capital has a potent distributive relationship to growth. If this proposition is
  true, then the democratization of capital acquisition (by reforming the economic system to extend to everyone the
  competitive opportunity to acquire capital with the earnings of capital) will enable all people, rich and poor, to
  become wealthier and an under-capacity producing economy to grow up to its potential level and perhaps beyond
  “full potential” as that term is generally understood.
  As emerges from the writings primarily of Kelso et al (58, 61, 67, 86), Ashford (90, 96, 98, 02, 05), Gauche
  (1998), Ashford and Shakespeare (1999), Kane (2000), Kurland (2001), and others, binary economics provides a
  positive and normative answer to the following question: In the face of ever increasing automation, how should we
  deal with our under-capacity producing capitalistic economies?
  2
  The binary answer to the question is the democratization of capital acquisition. In most modern economies,
  most capital is acquired with the earnings of capital; whereas relatively little capital is acquired with the earnings of
  labor. Generally only high income earners (well-capitalized people) can afford to spend a portion of their earnings
  (savings) for the acquisition of financial assets and only they have the wealth to secure financing to acquire capital
  and pay for it with its future income. Middle income and low income individuals, are by and large excluded from
  substantial participation in the capital acquisition markets because their income and savings are inadequate or nonexistent,
  and because they are unable to secure capital credit. From a binary perspective, institutions that support
  this process are both undemocratic and inefficient. They have the effect of suppressing both democratic
  participation and economic growth.
  According to binary economics, a true democracy requires individual participation in both political power
  (universal suffrage) and economic power (universal participation in production by way of both labor and capital
  ownership). By this definition, it is undemocratic that only some individuals are able to acquire capital with the
  earnings of capital. Believing that the distribution of capital ownership has a potent distributive relationship to
  growth that is suppressed in under-producing capitalist economies (because institutional barriers prevent and
  discourage efficient, growth-enhancing ownership-broadening transactions), binary economists propose institutional
  reforms intended to open capital acquisition more competitively to all people.
  The logic underlying the principle of binary growth can be understood and implemented by considering the
  three thousand largest companies in the USA, and then focusing on a subset comprised of prime-credit-worthy
  companies. Seemingly, most of these companies exhibit the frustrating essence of unutilized productive capacity.
  At diminishing unit costs, they can produce much more of the goods and services people dearly need and want; but
  there is lacking the consumer spending power to render more production profitable.
  Presently through these corporations, almost all new capital is acquired with the earnings of capital, and
  much of it is acquired with borrowed money, Brealey et al. (06). At the same time, as reported by Wolff (1995,
  1995) the ownership of this corporate wealth is highly concentrated so that approximately 1% of the people own
  50% of the wealth and 10% own 90% of the wealth, leaving 90% people owning little or none. Thus, capital
  returns its value at a rate reflective of its long-term (suppressed) earning capacity as it buys itself for a small
  minority of the population.
  To acquire capital with the earnings of capital, existing owners (primarily the rich) use (1) the pre-tax
  earnings of capital, (2) collateral, (3) credit, (4) market and insurance mechanisms to diversify and reduce risk, and
  (5) a monetary policy intended to protect property. Binary economics holds that the same institutions and practices
  that work profitably for well-capitalized people can also work profitably for all people. Moreover, in an economy
  operating at less than full capacity, because demand for capital goods is a derivative of demand for consumer goods
  in a future period, Moulton (35, 75), if capital can competitively pay for its acquisition costs out of its future
  earnings primarily for existing owners, it can do so even more profitably if all people are included in the acquisition
  process.
  Accordingly, to enable all people and major, prime-credit-worthy corporations to capitalize on the potent
  distributive relationship between voluntary ownership-broadening capital acquisition and growth, a binary economy
  requires modest reforms in the market infrastructure governing corporate finance so that all people (not merely a
  minority of the people) are vested with competitive capital acquisition rights to acquire capital with the earnings of
  capital. In the more democratic binary system of corporate finance, the major credit-worthy corporations of an
  under-producing capitalist economy would have a practical means of meeting their capital requirements while
  encapitalizing their employees, consumers, neighbors, and others.
  Combining the salient principles of (1) the Homestead Acts (intended to broaden capital ownership), (2) the
  employee stock ownership plan (ESOP) technique of corporate finance, which uses tax exempt, limited liability
  trusts (as fiduciaries for employees) to acquire shares of employer stock with non-recourse credit, (3) a market for
  capital credit insurance (such as that profitably provided by the Federal Housing Administration), and (4) a return of
  the Federal Reserve to its original Congressional mandate under Section 13 of the Federal Reserve Act to allow for
  the discounting of eligible productive private credit, binary economic strategies offer an entirely voluntary means
  that enables major prime-credit-worthy companies to meet any portion of its capital requirements while
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  simultaneously enabling their employees, customers, neighbors and others to acquire (with non-recourse credit) fulldividend
  shares of the participating companies which would pay their full return (net of reserves for depreciation,
  research, and development) first to retire the acquisition loans and then to provide a capital source of income to
  supplement wages and welfare benefits. With the prospect of central bank discounting, the cost of capital to the
  corporation for prime credit-worthy capital investment has been estimated at less than six percent.
  Once the enabling legislation is passed, ownership-broadening “binary financing” would be entirely
  optional. Major corporations would have a new way to finance their capital requirements while encapitalizing their
  workers, their customers, and other; lenders and credit insurers would have a new source of business; fiduciaries
  would have enhanced ways of enriching their beneficiaries; advocates for the economically disadvantaged and
  government officials would have new ways of serving their constituencies. The overall effect of these proposals is
  not to socialize or redistribute private property, but rather to democratize the credit needed to acquire private
  property. [See Ashford (98).] However, in this paper, we set forth minimalist models of aspects of a binary economy
  intended to capture the essence of the binary approach in ways conducive to analysis within an orthodox micro- and
  macro-economic framework.
  To democratize the process of capital acquisition consider a lending system that would, under specified
  conditions, allow banks to make special N-period “binary” loans (like mortgages) to individuals to enable them buy
  assets represented by full-dividend-paying shares of corporate stock. The loans would non-recourse as to the
  individual borrowers, but would be secured by a claim on the projected earnings of the assets acquired. The loans
  would be further collateralized by those assets and by such other collateral or loan insurance as may be negotiated.
  The shares would distribute all earnings (which of course exclude from revenues depreciation, research and
  development expenses) first to repay the loans and then to provide a capital income to their binary owners to
  supplement labor income and welfare benefits. After N periods, the assets will become loan-free property of the
  borrower. Thus, such capital democratization will enable individuals to earn income in a binary way (i.e., from two
  sources: labor and capital.)
  To promote this ownership-broadening process, the government might take additional steps:
  1. (to make available sufficient cash flow to finance the transaction) provide for a deduction from
  corporate income taxes for dividends on binary shares used to repay the acquisition loans or to
  provide capital income to the binary stockholders;
  2. (to encourage the growth of a private system of capital credit insurance) establish a Capital Credit
  Reinsurance Corporation, modeled after the profitable operation of the Federal Housing
  Administration (FHA); and
  3. (to reduce the cost of binary lending by eliminating the use of existing financial savings) discount
  binary loans, under Section 13 of the Federal Reserve Act (rather than purchase government
  obligations through the Federal Reserve’s Open Market Committee).
  With or without these government actions, however, binary economists predict that the effect of voluntary
  capital acquisition transactions in such a system would be higher income, and higher rates of savings, capital
  formation, and growth and higher consumption levels for all. Moreover, in an under-capacity producing economy,
  the higher consumption levels will be non-inflationary.
  4
  I.1. Non-Binary Economy and Automation
  According to binary economists, by a process called technological advance, epitomized in
  automation, production has become increasingly capital intensive. From the binary perspective, the basic
  rule of invention and business is to produce more with more productive capital and less labor. The work of
  capital (such as robot-assembly lines, computers, etc.) has been displacing and vastly supplementing the
  work of labor. Casual observation reveals that, over time, in most work places, work done by labor (labor
  productiveness) has been diminishing relative to work done by capital or automated machines (capital
  productiveness) while total output has increased. This process whereby more is produced by using more
  productive capital and relatively less labor (whereby capital productiveness both displaces and vastly
  supplements labor productiveness) cause incomes of capital owners to rise relative to incomes of nonowners.
  1
  Consider Figure 1. Owners of profit-making firms (O) introduce into their business automation
  (+ΔA); A generates output (+ΔQ), inventories (+ΔI) and eliminates employment possibilities (-ΔE); in turn,
  owners and retained employees (RE) experience an increase in the their income (+ΔYO,RE) while the
  income of displaced employees (DE) declines (-ΔYDE). If, hypothetically, the economy consists of ‘n’
  identical business entities and ‘m’ identical employees, the final result may be one of the following three:
  I.2. Binary Economy and Automation
  Consider Figure 2. This figure is similar to Figure 1; additionally, it displays the ‘Lending
  Institution’ from which displaced employees and ‘Other People’ (retained employees, stakeholders and
  anyone else) may borrow money to purchase ownership shares (subject to the conditions described above)
  issued by any credit-worthy, corporation profit-making entity in the economy. Figure 2 also includes the
  (+ΔYC) that reflects the possibility of income earned by capital (Yc) acquired by displaced employees and
  other people. Operating on the assumption that an essential purpose of capital investment is to produce
  more with more productive capital and less labor, the binary promise is that, in an efficient economy, the
  “>” and the “=” signs in (1.1) are more likely than the “<” sign. Operating on the assumption that the
  distribution ownership has a potent distributive relationship to growth, the binary promise for any economy
  is:
  In the remaining sections, an effort is made to explain the fundamentals of binary economics and
  the promise of binary distribution, efficiency, and growth by utilizing conventional neo-classical models.
  II. Automation & Isoquants
  Suppose the economy consists of identical firms. Conventionally, let the representative firm
  maximize output (Q) subject to a total cost (TC) constraint. Let Q=f(L,A) and TC=wL+aA, where
  f=production function, L=labor, A= units of automation, w=price for L=1, a=price for A=(a0, a1, …); TC, w
  and a are all given; the TC line is an isocost line. Let (Q0, Q1) be two isoquants and e=equilibrium.
  Consider Figure 3. The Figure displays isocost lines and isoquants. The axes measure L (vertical)
  and A (horizontal.) The vertical intercept of the isocost is TC/w; because w=1, TC/w=TC. The horizontal
  >
  |nΔYO,RE| = |mΔYDE|. (1)
  <
  |nΔYO,RE, C| $ |mΔYDE|. (1.1)
  5
  intercept of the cost constraint is TC/a. Upon maximization of the production function subject to TC0=
  L+a0A, equilibrium is reached at e0 which generates A0 and L0, the optimum levels for A and L. At these
  optimum levels, the firm’s maximum output is Q0.
  Suppose now that the firm devotes a portion of its budget equal to (TC0-TC1) on labor-displacing
  automation systems and at the same time pays a lower price (a1) for each ‘automation unit’ (machine) it
  uses. Upon maximization of the production function subject to TC1= L+a1A, equilibrium is reached at e1
  which generates a higher optimum level for A at A1 and a lower level for L at L1. At these optimum levels,
  the firm’s maximum output is Q1 which is higher than Q0.
  Thus, the decrease in the price of A (-Δa) causes a positive change in A (+ΔA), a positive change
  in Q (+ΔQ) and a negative change in L (-ΔL). In turn, the +ΔQ causes a positive change in income (Y) for
  the firm’s stock holders and retained employees (+ΔYF) [where YF = YO, + YRE] and the -ΔL causes a
  negative change in income for the displaced laborers (-ΔYDL); where F=firm and DE=displaced laborers.
  Figure 4 summarizes these changes. Obviously, the *ΔYF* may be equal to, less than or greater than
  *ΔYDE*.
  To illustrate the relationship that connects the distribution of ownership with increasing growth
  capacity of under-producing economies, imagine that the economy consists of one firm. In the first time
  period, the firm employs only one employee; he along with the owner produce 3x, where x is a perishable
  good; the owner pays the employee 1x and keeps for herself 2x; thus, the employee’s income is x and the
  employer’s income 2x. In the next time period, the employer replaces the employee by a costless machine;
  the firm produces 4x; the employer keeps for herself 3x - that’s all she needs; what happens to the 4th x? If
  the displaced worker savings are worth x, or if he can borrow against future income or collateral, he will
  buy the 4th x and the wealth of the firm’s owner will increase. If the displaced worker has no savings and/or
  he cannot borrow (for lack of earning capacity and collateral) to buy the 4th x, the unit (and perhaps the
  employee) will perish. If, however the employee can also acquire an ownership share of the costless
  machine (say 25%), the 4th unit of x will not perish, but will be enjoyed by the employee, without taking
  anything from the employer.
  Of course, in the real world, machines are not costless; but in a sense they are frequently costless
  to the acquirer when they are acquired on credit and paid for with their future earnings. Competitive access
  to capital credit is usually a key to capturing the ownership benefits of technology generally and
  automation in particular. In analyzing the importance of access to credit, binary economics distinguishes
  between consumer credit and capital credit. Consumer credit, in theory, is generally used to help
  consumers minimize transaction costs associated with purchasing. In practice, however, consumer credit is
  frequently marketed to entice people to consume what their earnings cannot afford. Capital credit enables
  people to acquire capital (with the earnings of capital) so that they can afford (with their capital income) to
  purchase more consumer goods and producer goods. However, in addition to sufficient, risk-adjusted,
  expected earnings to repay the acquisition debt, capital credit generally requires at least one additional
  source of repayment (in the form of collateral or insurance) in the event the income projections fail to
  materialize. In a non-binary economy, capital credit is generally available only to well-capitalized and
  well-connected people, so that the capital acquired cannot be employed to its full potential. With modest
  reforms of the market system, binary economists maintain that the same processes can enrich all people by
  distributing the demand necessary to employ the incremental productive capacity of capital.
  In general, as shown in Figure 5, the +ΔA will cause a change in the economy’s total income (Y)
  that may range from N1 to N2 (in a non-binary economy) or from B1 to B2 (in a binary economy.) In other
  words, the binary promise is that the +ΔA would cause Y to range within higher minimum and maximum
  levels.
  III. Automation, Marginal Labor Reduction & Marginal Labor Costs
  Next consider Figure 6. The vertical axis measures (1) Marginal Labor Reduction (MLR) or
  Marginal Labor Income Reduction Cost and (2) Marginal Labor Cost (MLC). The horizontal axis measures
  6
  automation (A). The MLR curve is increasing and it is defined as the labor income reduction to employee
  per additional unit of automation; the MLC curve is diminishing and it is defined as the labor cost to
  employer per additional unit of automation. (NB=non-binary, B=binary.)
  First, consider the MLC curve. A* corresponds to maximum automation. At A0 total labor cost to
  the employer is equal to the area (A*e0A0) whereas at A1 total labor cost is the area (A*ZA1) which is less
  than (A*e0A0) by an amount equal to the area (A0e0ZA1).
  Second, consider the MLRNB curve. AT1 corresponds to the level of automation that does not affect
  marginal labor reduction. At A0 total labor reduction is equal to the area (AT1e0A0) whereas at A1 total labor
  reduction is the area (AT1KA1) which is greater than (AT1e0A0). Thus, in a non-binary economy, at A0 total
  costs are (AT1e0A*) whereas at A1 total costs are (AT1KZA*).
  If a binary economy generates additional income for employees and others, the additional income
  will act as a shifter of the MLR curve to the right from MLRNB to MLRB and thus reduce total costs from
  (AT1KZA*) to (AT2ZA*). Notice that the shift of the marginal labor reduction curve to the right or, the move
  from point K (Binary e2) to point Z (Binary e1) is Pareto superior: the employee is better off and the
  employer is as well off as she was prior to the shifting of the marginal labor reduction curve.
  IV. Leisure-Income Choices
  One could use the popular leisure-income choice model to highlight a few of the microeconomic
  principles associated with binary economics.
  Conventionally, the employee maximizes utility U=U(L,G) subject to Y=wL+pG; where,
  U=Utility, L=leisure in hours (a normal good), G=other goods, Y=income, w=hourly wage rate and
  opportunity cost of leisure, p=price of other goods, T=available time in hours. Let Y=wT and p=1.
  Consider Figure 7. If T=24 and the employee wants to work no more than 8 hours – without opportunity to
  shirk, she will reach her highest indifference curve (Ue) at e.
  Consider now Figure 8. If the employee receives a fixed daily salary of $F and she has the
  opportunity to shirk, she will maximize U at e0 on indifference curve U0 and thus devote all eight hours to
  leisure and zero hours to work.
  The ESOP Effect. ESOPs (Employee Stock Ownership Plans) - one of many binary techniques of
  corporate finance – are a means whereby employees can acquire an ownership share in the profitability of
  their employer over and above a fixed salary. Consider Figure 9. In this figure, because of the incentive of
  ownership, the employee’s constraint has changed from ($F e0 8H) to (B e1 e0 8H). As in Figure 8, the
  employee receives a fixed salary of $F and an owner’s percentage of profit which gives her the incentive to
  spend less time shirking than in Figure 8 (for example, 3 hours.) Thus, the employee reaches e1 on
  indifference curve U1 which provides more utility than the more opportunistic one. Thus, this binary tool
  has the potential to improve the well-being of the employee and the employer. Specifically it may
  encourage employee productivity, reduce opportunism, and foster a friendlier environment for more
  innovation and, ultimately, profit. 2
  The General Binary Effect. In a binary economy, the process by which capital acquires itself for
  existing owners is opened to all people. Corporations with credit-worthy capital requirements and with a
  policy of broadening ownership could rely on ESOP-like trusts to meet a portion of their capital
  requirements while "encapitalizing" their employees and others. After repayment of the loans used to
  acquire the shares, the new owners will earn spendable capital income to supplement their income from
  employment and/or their welfare benefits. With a capital cost recovery period of five years, a capital
  investment horizon of three years, and an anticipatory wealth-effect spending by the new binary owners, an
  under-producing economy might show distribution-based binary growth within the first few years of its
  operation. 3
  7
  Suppose all income earners in a binary economy are represented by Figure 10. Originally, let the
  representative employee be at equilibrium at e on indifference curve Ue which is tangent on the dotted
  budget line; at e, the employee’s income comes only from employment. Assume now that the employee’s
  income is enhanced by Ys (income from stocks); the new budget line is TevK. Subject to this kinked budget
  line, the employee may reach ev on indifference curve Uv, retire, and live a ‘Victorian’ life style for the rest
  of her life; if the employee is a ‘workaholic’, she will reach ew on Uw; if she is ‘normal’, she will reach en
  on Un, laboring somewhat less but earning more from the sum of her labor and her capital.
  V. Growing to capacity
  At the macroeconomic level, one may envision the aggregate economy in both a binary and a nonbinary
  environment. Consider Figure 11, which depicts a simple growth model similar to the one developed
  by Solow (1957). Let xY=F(xK,xL), where Y=national output, K=capital, L=labor and x=1/L. Therefore,
  Y/L=y, K/L=k and L/L=1. Thus, output per worker is a function of capital per worker or
  y=f(k). (2)
  Additionally, let y be divided between consumption per worker (c) and investment per worker (i).
  Thus, y=c+i. Let c be the difference between y and sy (where s=saving rate) or c=y-sy. These last two
  equations imply that investment per worker is
  i=sy. (3)
  To complete the simple model add depreciation (D);
  D=(e/"")k (4)
  where e=rate of depreciation and ""=rate of automation. Equation (4) modifies the Solow model by
  allowing the rate of automation to discount the rate of depreciation thus causing a rotation of the D line
  clockwise. Intuitively, automation contributes to gains: it produces more with the same or less amount of
  resources; additionally, for these gains, the automation investor is rewarded with tax deductions 4. Hence, ""
  is a positive function of the rate of gains and tax deductions and, as such, it counters the losses attributed to
  depreciation. Figure 11 displays functions (2) to (4). D is displayed with constant e (ē) and two different
  levels of "": ""0 and ""1. The economy is initially at k0 producing y0 with automation ""0 and D=(ē/""0)k.
  Suppose now that automation improves to ""1; the increase in " causes D to rotate around the origin to the
  right.
  In a binary environment (B), with a broadening distribution of capital ownership and income, an
  under-producing economy would have greater incentives to employ its potential k at kB, move to greater
  possible y at yB, achieve greater consumption cB and greater saving and investment at sB=iB. In a nonbinary
  environment (NB) the economy would employ less than potential k (e.g. kNB) which generates less
  than optimum y (yNB), c, s and i.
  VI. Summary & Conclusion
  We have endeavored to explain some major microeconomic and macroeconomic fundamentals of
  binary economics by utilizing conventional neo-classical economic models. Using these models, we
  examined the distribution-based binary growth claims by comparing the theoretical results reached in a
  non-binary economic environment to those that may be reached in a binary one. The most important results
  from the comparison are:
  • Output/income would range within higher minimum and maximum levels in a binary environment
  than in a non-binary environment.
  • A binary economy generates additional income which eases the income reduction imposed upon
  labor by automation (and perhaps other structural factors.)
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  • Binary instruments have the potential to improve the well-being of both the employee and the
  employer.
  • If leisure is a normal good, a binary environment may enable individuals to enjoy a Victorian style
  of life or work less. On the other hand, if leisure is viewed as a non-normal good ‘workaholic’
  employees may reach higher levels of income in a binary environment relative to a non-binary
  environment.
  • A binary economy would employ more capital which, in turn, would generate more growth,
  maximum output/income, consumption, saving and investment.
  • In general, binary economists recommend a system that will enable laborers (and other
  stakeholders) to become owners through the democratization of capital acquisition. As owners
  they will be able to supplement their labor earnings and/or welfare benefits with capital earnings.
  Binary principles promise increased, more broadly owned, productive capacity and therefore more
  income for all.
  9