In an effort to rebuild New England’s cod industry after the war of independence, George Washington signed a law in 1792 giving shipowners “allowances” (i.e., subsidies) to offset the tariffs they had to pay on their inputs. Two conditions were attached to the support: shipowners had to sign a profit-sharing agreement with their crew, with whom they also had to split the allowance. Thus one of America’s first tax breaks was designed to encourage owners to share profits with their workers.
This was no accident, according to “The Citizen’s Share,” a new book by Joseph Blasi and Douglas Kruse of Rutgers University and Richard Freeman of Harvard University. The authors argue that America’s founders put priority on shared rewards and the broad ownership of capital, and were not afraid to use the federal government to advance them. This mindset, the authors explain, has periodically motivated American business and politics ever since, from the 19th-century Homestead Acts (which distributed land free to those willing to till it) to the 1974 legislation creating employee stock-ownership plans (ESOPs), tax-advantaged trusts that borrow money to buy shares for workers.
As a result, surprisingly large numbers of American workers share in some way in their employers’ success. Based on a series of national surveys, the authors reckon that some 47 percent of full-time workers have one or more forms of capital stake in the firm for which they work, whether from profit-sharing schemes (40 percent), stock ownership (21 percent) or stock options (10 percent). About a tenth of Fortune 500 companies, from Procter & Gamble to Goldman Sachs, have employee shareholdings of 5 percent or more. Almost a fifth of America’s biggest private firms, including behemoths like Cargill and Mars, have profit-sharing or share-ownership schemes. Some 10 million people work for companies with ESOPs.
In most cases the stakes are fairly small: the median employee shareholding is worth $10,000. The scale of workers’ equity has not increased enough to counter two bigger trends that have dramatically increased inequality of incomes in America over the past 30 years: the widening gap in pay between the top 1 percent and the rest, and the overall squeeze in the share of national income going to wages. To counter this concentration of wealth, and live up to the ideals of the country’s founders, Messrs. Blasi, Freeman and Kruse argue that America needs another dose of Washington’s medicine: more incentives for employees to build ownership stakes in the firms they work for.
These academics — two economists and a sociologist — are on the center-left. The same logic, however, is currently motivating policy in the Conservative-led government of America’s former colonial master. Britain also has a tradition of employee share ownership. John Lewis, a big retailer that is owned by a trust on behalf of its employees, is one example. To boost what is often dubbed the “John Lewis economy.” the government has made it easier to set up employee share schemes, and created some £50m ($81 million) of tax incentives to encourage ownership by employees. In the recent privatization of the Royal Mail, one-tenth of the shares were distributed to the firm’s workers.
The political appeal of employee share ownership is not in doubt. Broader stock ownership appeals to the right. Helping squeezed workers appeals to the left. Economically, however, the merits of using government incentives to encourage the phenomenon are less clear.
Most academic analyses of employee ownership have focused on the gains to firms. Worker participation plainly does not guarantee success: Lehman Brothers was 30 percent employee-owned. A flagship firm in Mondragon, a huge Spanish co-operative, recently filed for bankruptcy. But a host of studies show that workers at firms where employees have a significant stake tend to be more productive and innovative, to retain staff better and to fire them less readily. These findings come with a proviso, however. The effects often depend on whether the employees’ ownership stake also brings a greater say in how the firm is run.
Would larger stakes benefit employees? There, too, the answer is not clear. If share ownership comes at the expense of wages, workers may simply be shifting from a stable and liquid form of compensation to a riskier one. Messrs. Blasi, Freeman and Kruse argue that share ownership should be, and usually is, additional compensation. Surveys suggest that over 70 percent of workers who benefit from a profit-sharing or other share-ownership scheme say their wages are at or above prevailing market rates — presumably thanks to their firms’ superior performance.
Reward and risk
Even if the compensation is genuinely additional, employee share-ownership can have disadvantages. It may lead workers to hold too much of their wealth in their own company’s stock. The authors acknowledge this risk and recommend that workers should diversify their portfolios. But since most Americans have very few savings, that caveat sharply limits the potential expansion of employee share schemes, especially for poorer people.
All this casts doubt on the merits of bigger government incentives to promote employee share ownership, especially in light of the cost and distortions inherent in any tax break. Growing inequality and concentration of share ownership are troubling, but there are better ways to address them. Capital-gains taxes could be made more progressive: today richer workers benefit disproportionately from the lower tax rate on capital gains. Tax breaks that encourage the concentration of capital, such as the carried-interest loophole, which dramatically lowers private-equity partners’ bills, should be eliminated. America’s founding ethos of broad-based capitalism is admirable. But it is best promoted by getting rid of special incentives, not by creating new ones.
© The Economist Newspaper Limited, London (November 23, 2013)