Building Market Power into Canadians as Canada Grows
The Empire Club of Canada Addresses (Toronto, Canada), 21 Feb 1974, p. 234-249
Kelso, Louis O., Speaker
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A wide-ranging discussion or thesis on economic policy in general, and Canadian economic policy specifically. Thoughts about technological change and what it is supposed to do for us. Why Canadian business strategies don't work well. Effects of conventional finance. Models of financing. Techniques of financing: a comparison and models. A financial model for Canada.
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21 Feb 1974
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Full Text
FEBRUARY 21, 1974
Building Market Power into Canadians as Canada Groins
CHAIRMAN The President, Robert L. Armstrong


Ladies and gentlemen, welcome to this meeting of The Empire Club of Canada. I shall now introduce the guests seated at the Head Table. Will each guest please rise momentarily when named and will you please refrain from recognition until the introductions are completed.

Our guest of honour will be introduced in a moment.

Ladies and gentlemen, your Head Table.

"Poverty is the legacy of Puritan financial theology." So states Louis O. Kelso, our guest of honour, and to quote a controversial and well-known columnist in this morning's Globe and Mail, "People don't come up out of poverty by receiving money; they come up out of poverty by earning money, by having the will to work for it."

"What will save us from poverty?" is the title of an article by Nicholas Von Hoffman in the December 1973 issue of Esquire. His rhetorical answer is "Heed the gospel of Louis O. Kelso". And who better to preach that gospel than an intellectually brilliant lawyer and economist who experienced poverty in his early years during the great depression. Louis Kelso studied finance and law at the University of Colorado, graduating with the degree Bachelor of Science in Finance cum laude and Bachelor of Laws. He was Editor-in-Chief of the Rocky Mountain Lain Review.

Mr. Kelso made an intensive study of economics. Then the second world war came along and interrupted his career. He volunteered for active duty in the U.S. Navy, becoming an Intelligence Officer. He was able to complete his routine work in a fraction of the time allotted and in his spare time pursued his abiding interest in economics. While stationed in the Panama Canal Zone he wrote the first of his three books, The Capitalist Manifesto. Slightly ahead of its time by a quarter century or more, this book was published with the collaboration of philosopher Mortimer J. Adler, economist of Encyclopedia Britannica fame, in 1958. The New Capalists followed in 1961. At the end of the war Mr. Kelso moved to San Francisco and became associated with a patrician law firm which, he later concluded, was exploiting his intellectual savoirfaire. He established his own law firm, Louis O. Kelso Inc., which carries on a large corporation law practice. Patricia Hetter, a brilliant political economist, became a business associate of Mr. Kelso's and jointly they produced the book, Taro Factor Theory: The Economics of Reality, in 1968. They have also written many speeches, papers and briefs too numerous to mention.

Louis Kelso, a director of several corporations, has been hammering relentlessly on the philosophy of Universal Capitalism and his persistence is bearing fruit. He has convinced the Congress of the United States to specify his approach to corporate financing in the re-organization of the bankrupt U.S. Northeast Railroads. This pioneer of broader capital ownership produced the Employee Stock Ownership Plan as the financial vehicle for reconstruction of the aforementioned railways, including the ill-fated Penn-Central.

The Propriety Fund for the Progress of Puerto Rico, which is now being implemented, is largely the idea of Mr. Kelso and Joseph Novak, a graduate of Harvard Law School now practising in San Juan.

No longer a voice crying in the wilderness, this delightful, persuasive gentleman makes his revolutionary ideas sound completely logical and uncomplicated. Rather than trespass further on his time, I am pleased to introduce and ask you to welcome Mr. Louis O. Kelso, who will speak to us on the subject: "Building Market Power into Canadians as Canada Grows".

Mr. Kelso.


Mr. Armstrong, members of the Empire Club and distinguished guests. It is an enormous pleasure to be here with you today and I am delighted to have the chance to share some views with you.

In order to best communicate, I would like to ask you to try and think of what I am saying in essentially physical terms. Two factor theory asserts that to understand the economics of a free industrial society, one need only and must only divide the factors of production into two-people and non-people. And I am not speaking of people when I say non-people . . . in other words, people and things. If you will try and keep that in mind as I go along, I think you will find it quite easy to grasp.

Traditional economic theory, whether of the left or the right, is actually bottomed on the idea that there is only one factor of production, namely labour, and that the function of capital is to somehow or other, mostly mystically, amplify the productiveness of labour.

Two factor theory asserts that that is nonsense: that people and things produce goods and services in precisely the same way, the same physical way. The same economic concepts are involved, the same political concepts are involved, the same moral concepts. Don't underrate the latter either, because it means that a man can as legitimately justify carrying his weight in the economic world in which we all live through his ownership of the non-human factor of production-land, structures, machines, in some cases intangibles-as he can by rendering labour power, and that the question of whether a particular production process is carried on with more or less labour and more or less technology, machines embodying technology, is not and should not be a political question, a moral question or an economic question. It is a management question, an engineering question, a technical question, a scientific question. The same is true of the macrocosm. In other words, with the economy as a whole, the question of whether you have full employment or not should not be a political question, it should not be a moral question. It should be strictly a technical question.

Thus, when I say think in physical terms, I am really saying, think in terms of reality. Don't think in terms of models doped out by dwellers in ivory towers who don't get out and wrestle with the world of reality.

A business strategy that systematically crippled the power of its customers to buy its products, its goods and services, would be, I think you would have to acknowledge, an absurd strategy.

Now, in a free market economy, the basis for what each individual takes out of that economy is supposed to be what he puts into it. That is what is called the Puritan Ethic, although you quickly realize that the Puritan Ethic is a one-factor term, not a two-factor term. But as an ethic, it is a valid ethic. It is the Aristotelian theory of justice: the exchanging of things of equal value and under freely competitive conditions. It is also the basis for double-entry bookkeeping. The pay is supposed to be pay for production, not attendance.

Now, I would like first to comment on why Canadian business, like American business, has for decades been operated in a way that is ideally designed to destroy the customers of business, to destroy their power to buy what business produces.

The Canadian economic policy, like the economic policy of the United States-and I hope you won't be too shocked-like the economic policy of China and Russia, is based on the idea that there is only one factor of production. The Russian Constitution, for example, has a provision in it that says there is one factor of production-labour. If you don't work, you can't eat.

Full employment, solving the income distribution problem through full employment, is an economic policy in both our countries. I hope you will interpret what I am saying as applicable here, as it is in the United States, to enlarge that economic policy, to drag it, if necessary kicking and screaming, into the twentieth century, or even into the eighteenth century, and recognize that there are two things that produce goods and services-people and things-and that to insist upon full employment when the scientist, the engineer, the manager, day after day are out to destroy employment is sort of nonsense. Those are the men who know what production is all about. They are running it, they are planning it.

If I can convince you, as I hope I shall, of the soundness of just two ideas, then I think you will have to acknowledge my conclusion that business is conducted in a way that destroys its customers. If you want to really accelerate the economic growth of Canada, take over the ownership of its great industries and mines and agriculture and build market power into the people you do not have to depend on welfare and what we call in the United States "'boondoggle" (I don't know what the Canadian term for that expression is but it means phony work subsidized by government), you don't have to rely on those atrocious freedom-destroying things to make the economy work.

The two ideas are these: one, that the nature and function of technological change, that great source of change in history, the number one source of all change, is to take the burden of production off the human factor and to put it onto the nonhuman factor. That is what technological change is supposed to do.

Incidentally, you probably won't find any economists who will acknowledge that because it interferes with their doctoral theses and various other things; but you can find a clear-eyed objective historian like Arnold Toynbee, and there is no confusion in his mind as to that fact.

In a piece published in the London Observer several years ago, Mr. Toynbee said, "The industrial revolution is a revolutionary change in the nature of the agent who does the world's work. It is a replacement of people by machinery. In Britain, where this revolution broke out first, it has been going on for two hundred years and it is continuing everywhere at an accelerating speed." How right he is.

That is idea number one.

The second idea is this: that the conventional techniques of corporate finance, irrespective of the rate of new capital formation, or the absolute magnitudes of the new capital put into place, the improved land, the new structures, the machines, the techniques of corporate finance are conducted so that the ownership of that newly-formed capital is built into a stationary or even shrinking ownership base.

Now, the soundness of the first idea, namely that technology substitutes things for people in the production process, is so self-evident that I am not even going to bother to try and prove it by argument to you unless, perhaps, someone should later question it, because it is easy enough to prove.

I would like you, to just get some idea of the magnitudes, to take a look at the top of three little charts that were put at your place. It shows that in the period between 10,000 B.C. and 2,000 A.D., the input mix into production between labour and capital (labour input representing all the shaded area above the line, and capital the shaded area below the line) have almost totally changed places. Actually, we are terribly generous on the lower end of that scale with labour. Had we said 99% in 10,000 B.C., we would have been more accurate.

Thus, the very basis for personal out-take from the economy over a period of time has radically changed from being primarily dependent on labour input to being primarily dependent on capital input.

Now, it is axiomatic that business strategy is built upon three very simple tenets and you will all recognize them. These tenets are: maximizing production and sales, minimizing costs, and staying out of trouble-or some people call it being good corporate citizens. That is where the lawyers come in.

That famous novelist who masquerades as an economist, John Kenneth Galbraith, once wrote a story about the Affluent Society. It was five per cent affluent. . . which is more sound than many of his ideas. He said that economics is a very good thing. It provides employment for economists.

Well, keeping corporations out of trouble is a very good thing. It provides employment for lawyers. By the way, I play in both games so I sort of hedge my bets, you might say.

But think about that corporate strategy for a moment. That corporate strategy in any rational terms is woefully deficient. It does not explain how the customers get the money to buy. I don't need to tell you that mass production implies mass consumption. As a matter of fact, that strategy explains why they don't get the money to buy because when you minimize costs you boot people out of jobs. There are other ways to do it but none has ever equalled that one.

So you have a corporate strategy that through admission eliminates the labour constituents of business, that is to say, the customers who need money to buy. I will show you in a moment that through conventional finance it also eliminates the other possible constituents of business, namely the stockholders who would get dividends and who would have money to buy. The result is, of course, to force government into operations of the private economy in order to take from the rich and from the middle-class and to give to the poor in order to make the system work, because it is not rational enough to work on its own terms.

When it does, it violates what I regard as perhaps the most basic law in economics. It is called Machiavelli's Law of Economics. As you know, in The Prince Machiavelli was advising the dictator of an Italian city state how to stay in power. Superficially, you would think that is easy, but it is not all that easy. Machiavelli thought the whole problem of economics, so far as the dictator was concerned, was such a simple one that he did not devote a chapter to it. He didn't even devote a paragraph to it. He packaged the whole thing up in one neat little sentence, a kind of "throwaway" line as the comedians call it. He said "Remember, Prince, a man will forgive you for killing his father before he will forgive you for taking his patrimony", meaning in Italian terms his capital estate.

Modern man is no different than Middle Ages man. Mr. Allende tested that out and found the answer to be still a very sound one. He started to take the trucks away from the little truck owners, the land away from the little land owners, the businesses away from the small businessmen, and those people, together with the peons who wanted to rise into that position of being a small truck owner or a small land owner or a small businessman, blew his head off.

The destruction of the property of anyone is a source of civil strife and when you see taxpayers mobilizing to resist the redistribution of wealth, you are not seeing anything but Machiavelli's Law in action and it will ever be thus. Nobody is going to change the acquisitive instinct of the human being. Marx predicated his whole philosophy of Communism on the idea that if you lived under totalitarian socialism long enough it would purge you of your acquisitive instinct. Where the hell he got the idea I will never know. It is like sending a bunch of sailors off to sea and saying if you stay out there long enough, you will lose your sex urge. It doesn't work that way.

Now, let me try and point out to you in a most graphic way why it is that conventional corporate finance faces a need to broaden the proprietary base, because the labour base is shrinking and growing less and less adequate. Again, back to physical terms. Think of technology as something that renders labour power progressively less adequate. By the way, it has nothing to do with whether you have full employment or not. If you have full employment but 90% of the input is made by capital, under the logic of our system and under the maturity of our system, most men have to own capital so that each man with his labour power and capital ownership can make enough input into the production mix to entitle himself to his share of the out-take.

Let me show you why conventional finance has this effect. If you will, turn to the second chart and look at a little diagram entitled Model One.

This model is intended to depict corporate finance, conventional corporate finance. The assumptions underlying both models are the same. A typical one-a corporation is engaged in business. It is successful. It believes it can sell some more of its products or some more of its services during the forthcoming period. It has done a feasibility study. Feasibility studies relate to the logic of corporate finance. The logic of corporate finance is that a corporation should invest in things that will pay for themselves, pay for themselves within a reasonable period of years. So corporate management has done a feasibility study here.

The assumption is that it finds that its new plant or tools or rolling stock, or whatever it is, will require a million dollars of financing to acquire. It has also been determined that it will pay for itself in five years. A general rule of thumb in business is three to five years. If it takes any longer than that, there is a good chance the business should invest in something else. Obviously, it takes longer in a depression than in a boom time. It takes longer in some businesses than others, but that is a rule of thumb.

Okay. One of the ways to finance this is for the corporation--as indicated in Model One--to go to a lender, the Dominion Bank or some other illustrious lending institution, maybe an insurance company, and to lay the feasibility study on the banker's desk, to explain the whole picture. The feasibility study will analyze the competition and the market and the engineering and the legal work and so forth and the banker may give you a very bad time because he too believes in feasibility and he is not easily snowed, but sooner or later, let us say, management convinces him and the loan is made.

That puts the cash in the corporation. It pays it out and buys its tools or builds its plant or whatever.

Now, Model One also represents certain other techniques of finance. The corporation can, of course, earn profits, pay its corporate income tax on those profits and accumulate them and when it gets enough, it can buy its expansion, its new tools or plant.

Under our tax laws, and I understand there are somewhat similar provisions under your tax laws, there are certain tax devices that help finance business. We have an investment credit that permits if you acquire newly-formed capital through the year to divert 7 per cent of your corporate income tax into the payment for that newly-formed capital. You can take accelerated depreciation for tax purposes. In other words, you can depreciate it faster for tax purposes than the real life depreciation. That helps finance growth and depletion in the natural resource industries and so forth.

If you add all these techniques of finance together in the U.S. economy over the last fifteen years they account for 98 percent of total new capital formation, and from what I have been able to discern from the Canadian economy, the percentage is about the same in Canada. Roughly 98 percent of new capital formation is financed out of cash flow or borrowings repaid out of cash flow.

Now, at the bottom of the box entitled "Corporation" are some lines representing the people who own the corporation. As a matter of law they are its owners. Those are the stockholders.

Those techniques of finance which account for the overwhelming new capital formation, decade after decade, have one thing in common: they assure that when the financing process is completed the ownership of that incremental productive power is built into a stationary ownership base. There is nothing in any one of those techniques that creates so much as one new shareholder.

In the U.S. economy, that brings into existence well over 100 billion dollars worth of new capital every year. You can see what that means in terms of building-and think in physical terms now-incremental productive power into the five per cent of families and individuals who own it all today and in the past, building that incremental productive power into people who have no unsatisfied needs and wants, and denying that incremental productive power to people who have nothing to sell but their labour power, which is being rendered less and less capable, less and less adequate by technology. A more massive case of invisible violence, of economic castration, if you will, is almost impossible to conceive.

Now, I have left out one technique of finance, namely the sale of new stock to the public for cash. Unfortunately, that does not change the picture at all. The overwhelming bulk of the tiny bit of new capital formation that is financed by the sale of stock is bought by that same five per cent, because they are the ones who have productive power to produce not only enough to satisfy their consumer needs but vastly more, enough to invest in additional productive power.

So you have 100% of finance working to maintain a stationary or shrinking proprietary base and you have technology whittling away at the adequacy of the only thing that a man is born with-his labour power to support him.

If that were all you knew about the world you could sit down and think your way through to some very alienated people, people who might kidnap the children of the rich and hold them for ransom, or newspaper editors or publishers or what have you. Or they might engage in riots or they might simply try to use the democratic process and convert the society into a totalitarian socialist one in which the government systematically redistributes the income while unifying total political power and total economic power in the hands of the ruling bureaucracy.

I would give you the wrong impression if I tried to convey to you that this is a deliberate conspiracy. It is not at all. It is just that it has not been examined by the right people, namely the people who run business, the professions, the business leaders who have the power to change it. Change in this area is not going to come out of government, or if it did you would not like it anyway, neither would I. It is within the power of business to change this situation.

At the bottom of that same page is a little diagram entitled Model Two. This happens to be fitted into the U.S. tax structure and there are a couple of rather minor changes that could be made which would enable it to be fitted into the Canadian tax structure. It is only a model of financial design that represents a whole host of potential models built around the two factor theory, namely, the theory that society, the government, the financial institutions should think in double-entry bookkeeping terms. If you want mass consumption to support your mass production, and you want to have it without inflation, you have to build market power into your people and you have to make it possible to finance growth as rapidly as you can grow.

Let us see what happens in Model Two. Model Two is simply harnessing the logic of corporate finance, the recognition that in well-managed businesses new capital formation is expected to pay for itself. If that is the way it works, and with very minor errors that is the way it works, then it is merely a case of legal and financial design as to who receives the benefit of credit to enable him or her to buy that capital, to pay for it out of what it produces, and after that to own it and husband it and take care of it and receive the income that it produces.

The courts are now beginning to realize that a number of very easy, almost imperceptible changes could be adapted to greatly amplify the usefulness of these tools. In Model Two a tax shelter trust, called a stock bonus trust, is plugged into the financial structure of the corporation, welded right into the financial structure. It bears some resemblance to a profit-sharing trust, or a pension trust, but it is not used in the same way that a pension trust or a profit-sharing trust is used. They are used as kind of glorified piggy banks. The corporation channels funds into them. Then people with investment discretion dash out into the market place and buy recycled, second-hand securities that are churning around back and forth. You don't have to be a financial genius to know that that won't finance your growth. It will finance some people's growth but it won't finance the growth of real business, that is the production of useful goods and services.

Instead of using this as a giant piggy bank, we use it simply as a converter device designed to give access to the employee, the man you want to motivate, to work with capital to get a high output at a low cost.

The loan financing is arranged into the trust. The people with investment discretion buy stock in the corporation at its current market value. If it doesn't have a market at the current appraised value, then we determine one that our Treasury in the U.S. will accept as a reasonable value, and there is plenty of expertise to do that.

A trust gives back its note to the lender. That puts the cash in the corporation which buys its tools and the corporation makes a guarantee to the lender that periodically as the amortization on the debt falls due the corporation will make a payment into the trust to enable the trust to pay it off.

Now, under U.S. law, and I think under your law too, those payments are deductible for corporation income tax purposes, so you get to the pre-tax dollar.

I believe the main impediment under your legal system is that your trust can only own a very limited amount of stock in the sponsor corporation. I think that is something that should be changed.

The end result has nothing to do with diversification. You can use this to finance the corporation forever prior to distributing the portfolio. At the time when a man retires or leaves the company, you can swap blocks of that stock for a diversified portfolio if that is what he wants. In other words, there is no diversification problem.

Let me compare the two very quickly. In case one, you are building incremental productive power into a stationary base and you are denying market power to the masses with the unsatisfied needs and wants. In case two, you are building additional incomes and economic self-sufficiency over a reasonable working lifetime into the working man, the guy who today, when he finishes his working lifetime takes his social security and his private pension, if he has any, and drops to a poverty-level income. That is not the American economic dream and I am pretty doggone sure it is not the Canadian economic dream, either.

Let me compare it from the standpoint of the logic of corporate finance. Looked at from the stockholder's standpoint, Model One gives the stockholder access to non-recourse credit-the purpose of the corporation is to cut off personal liability-which he can use or which the corporation uses for him to buy incremental productive power to put behind his stock.

Model Two does exactly the same thing for employees. Through their trust, they have access to non-recourse credit, which is used to buy newly-issued stock which is used to buy incremental productive power, with a promise-this is the guarantee by the corporation-with a promise to make a high pay-out of the wages of capital, like the wages of labour, in pre-tax dollars so that the employees can pay for their stock out of what the underlying capital produces.

When it has paid for itself, then we like to design these trusts so that any dividends paid on it go right through the trust into the employee's pocket.

Now you have put management in a position where it can raise employee incomes without raising costs. Think about that for a moment. You have also put the employees in a position where, not overnight, but down the road a few years if they demand more and more pay for less and less work they are destroying the value of their own capital investment and I submit that in that way, and in no other way, you can make the labour force make sense. It is perfectly clear to British railway workers and British coal mine workers in their nationalized industries that if they push a little further, they will sink the whole economy into the sea, but they giggle and say, "What the hell's the difference? We don't own any of it."

There is a Middle Eastern story about a peasant who asked a Wise Man, "What is the best manure to make my crops grow?" And the Wise Man said, "The eye of the owner." The object of this game is to give every workman the eye of the owner and I think that that is the way to begin to build incremental productive power into your masses so you have market power where you want to produce goods and services.

Now, because my time is short, let me quickly turn to the last chart because it says quite a bit and I hope that you will take it home and study it and think about it.

This is a variation of Model Two. It is simply the schematic of how the concept can be applied to the Canadian economy. Here you have a corporation-it can be anything. You have an employee trust, you have a lender, which can be anything. I have added two additional things that tell you something about its significance for the national economy. First, I have added a device called a Capital Diffusion Insurance Corporation. That is the equivalent of your Home Loan Insurance Corporation. What it does is insure a bank or an insurance company that makes a loan conforming to certain rules, and makes it easier to get housing finance. What this does is insure the bank so that the risk of feasibility error, which is very small and easily insurable, is spread literally over the whole society.

Second, I have plugged in one additional thing, your central bank, to show you how you can totally free yourself from dependence on foreign capital and how after a few years, you can shrink foreign ownership to virtually nothing.

We have plugged in your central bank because it has that most charming of all devices, a printing press that prints money legally. A perfectly lovely machine. Aladdin never thought of that!

Now, your first inclination may be to say, "My God, that is funny money all over again!" It is not funny money. I will tell you where the funny money is. The funny money is used for government to go into debt to subsidize consumption . . . attacking, attacking, attacking the effects of poverty and leaving untouched the cause of poverty which is the low productiveness of the human being who does not own capital. That is where your funny money is. Funny money is welfare. Funny money is boondoggle. Funny money is government debt. Funny money is used to subsidize someone, instead of building up the productive power of every individual so he can pay cash for what he wants.

You really don't do any great favour to anyone by showing him how to buy an over-priced house by paying for three houses. That may be the only thing available to him but, believe me, it does not solve the problems of the economy and it does not solve the problems of the individual either. That interest cost is sandbagging his purchasing power forever.

Let me tell you what this new idea involves. It involves the Central Bank monetizing tools, or plant, or whatever is required, under conditions where corporate managements vouch for the fact that the new capital will pay for itself, and where bankers, lenders, and insurance companies looking over corporate management's shoulder are agreeing that it will pay for itself. Finally, an insurance arrangement so that in the rare case where there is amiss, there is no damage.

Thus, each year as the newly formed capital pays for itself, the credit is reversed back to the Central Bank and in five or six years in most cases, the credit is totally reversed.

But what about the tools? Do they go bye-bye in the sky? No. The tools are about as close to immortal as anything that you can conceive of because the technique of the wise accountants who supervise corporate accounting sets aside enough out of the stream of gross income as depreciation to restore the productiveness of those tools, so that the tools go on pushing goods and services into the society years after the credit is reversed.

This gives you a deflationary monetary system, a system of unlimited convenience, a system in which your growth rate is limited only by physical factors and not by institutional errors as it is today. Finally, a system that builds market power into the people that you want to have market power. It does not make sense to make it easier for a John Paul Getty with two billion dollars of capital to get a third billion than it is for the average Canadian in a total working lifetime of self-deprivation to accumulate enough capital to give him $500.00 a year. Nothing could be more absurd.

The message I would like to leave with you is that these problems are as easy to solve as rolling off a log. They require very slight change. They involve using the genius of your institutions to the maximum. I hope you will give it some thought. Thank you.

The appreciation of the Club was expressed by Lieutenant-Colonel Peter W. Hunter.

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Building Market Power into Canadians as Canada Grows

A wide-ranging discussion or thesis on economic policy in general, and Canadian economic policy specifically. Thoughts about technological change and what it is supposed to do for us. Why Canadian business strategies don't work well. Effects of conventional finance. Models of financing. Techniques of financing: a comparison and models. A financial model for Canada.