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Why Economists Are Wrong About Coops

by Ramon Vela

Democracy in America is not perfect, but it is relatively widespread. We elect school boards, judges, sheriffs, city councils, and mayors on the basis of one-person-one-vote. But there is a glaring exception: business. Management does have to answer to the stockholders; but you have to buy stock in order to vote, and those with more money get more votes. Meanwhile people whose lives are intimately connected with the company -- its employees -- have little or no influence on decisions which truly affect them.

Why is that? Many economists argue that there are few democratic companies because they are less efficient than conventional ones, and efficient companies win out in a competitive economy. But there is little evidence to support their conclusion. Worker-controlled businesses are rare because investors, lenders, and entrepreneurs -- those whose money helps businesses form and grow -- have little to gain from them. Yet the myth that democratic companies are inefficient lives on, and may even discourage managers and bankers from taking cooperatives seriously.

Democratic Companies: What and Where Are They?

Businesses are "conventional" or "democratic" depending on who controls them, investors or employees. Usually those in control own the company and get its profits. If you own 50% of a conventional business you get 50% of the profits and 50% of the votes.

An ideal cooperative differs in all three dimensions: ownership, profitsharing, and control. Employees own 100% of the business in equal shares. At least some of their earnings come in the way of profits, which are distributed equally. And each member has an equal vote in running the firm.

Full employee ownership and control -- through cooperatives or other means -- is very rare. The cooperative sector in Italy, probably the largest among industrial nations, has about 250,000 employee-members. The cooperatives in Spain’s legendary Mondragón group account for about 30,000 jobs.

Many businesses, however, fall somewhere in between the typical firm and the ideal cooperative. Some feature a degree of employee participation. Germany, for example, requires every large enterprise to have worker representatives on its board of directors. On the other hand, the U.S. has a significant amount of employee ownership and profitsharing, as in the case of Employee Stock Ownership Plans, often without a lot of employee representation and participation. Nevertheless, most businesses approach the conventional form.

Businesses behave inefficiently if they are less productive, if they allocate resources badly, and if they don’t hunt aggressively for new sources of profit. Democratic firms are supposed to score badly on all three counts. But the evidence is not convincing.

Perhaps democratic firms are inefficient because democracy is too costly. How will employees be able to find and supervise good managers? How can these managers order employee-owners around? And what about the time and effort wasted in endless meetings and discussions? Such obstacles notwithstanding, coops are at least as productive as conventional firms. For instance, in a study of the Pacific Northwest’s plywood industry, Ben Craig and John Pencavel estimated that coops were 6% to 14% more productive than traditional firms.

Maybe existing coops are exceptions that prove the rule. They are small, tightly-knit groups where disagreements are easily resolved. In larger, more complicated organizations democracy would lead to expensive conflicts among worker-owners. Now if democracy is a source of costly disagreements, then more democracy should mean lower productivity, other things being equal. Yet studies of coops with varying degrees of democracy do not support this view. Among Italian coops Derek C. Jones and Jan Svejnar found that the higher the level of employee ownership, participation, and profitsharing, the greater a coop’s productivity. Evidence from conventional firms yields similar conclusions. For instance, employee participation almost never has negative effects and, furthermore, "is more likely to produce a significant, long-lasting increase in productivity when it involves decisions that extend to the shopfloor and when it involves substantive rather than consultative arrangements," say David L. Levine and Laura D’Andrea Tyson.

True, the employee participation some studies examine happens on the shopfloor as opposed to the boardroom -- it may not be the kind of interference which is harmful. Yet participation gives workers more discretion, and so more opportunity to create those expensive conflicts economists talk about. But that doesn’t seem to be the case.

Great Dividends, Bad Profits

Cooperatives are supposed to be inefficient because they do not respond well to temporary changes in demand for their products. For instance, say a publishing cooperative could sell more magazines by hiring an extra worker. Although profits would grow, they would be shared with one more person, and each member’s share might fall. Hence the coop will not hire; the consumers’ demand for magazines is frustrated; and the would-be employee has to go make something that people want less. This is inefficient because the coop isn’t producing what people want in the right quantities.

How much of a problem is this? What evidence we have is not too alarming. The plywood coops do appear to expand production more sluggishly than other firms when demand picks up, and to cut production less rapidly when demand falls. Yet in a 1989 study Katrina and Matthew Berman found that "the misallocation of labor which economists have long associated with labor-managed firms is not apparent among the plywood cooperatives." Studies of coops in Sweden and Denmark also turn up little evidence of inefficiency.

We do not know why this is. Part of the reason may be that many coops -- including the plywood firms -- employ nonmembers, who can be hired and fired as demand changes. But it may also be that coops have other ways of adjusting to demand. For instance, a traditional business will cut production and employment when demand falls; a coop may prefer to lower prices and maintain production, cutting wages until demand picks up. Both choices are efficient.

In any case, there are ways to tap the benefits of temporary employment in a cooperative economy. In Spain’s Mondragón group individual coops are able to "loan" their workers temporarily to other cooperatives. Italian and French coops must share profits with hired workers and offer membership on request, gaining flexibility without blatant exploitation. Of course, any coop in a capitalist economy is tempted to exploit outsiders. The members may believe this is necessary to compete. Or they may want to keep their profits. But these are matters of competition and economic power in a dog-eat-dog world, not efficiency.

Democracies Are Too Tame

Democratic companies may be inefficient -- especially in the long run -- because they are not aggressive. After all, employee-owners have more to lose than investors. Their jobs are on the line. All of their investment is in the company. And they have less money to fall back on. So worker-owners may be more cautious, and their business may not expand efficiently.

There is little solid evidence on this question. We do know, however, that institutional innovation can go a long way. In four decades the Mondragón group created 30,000 jobs. Between 1975 and 1985 the Basque region of Spain lost 100,000 jobs while these coops added workers. They did this partly by devising a central bank to help coops expand and adapt. In Italy, coops are nonprofits legally required to reinvest a portion of their surplus. Similarly, a democratic economy might have competing entrepreneurial firms which raise capital, find profit opportunities, and set up cooperatives. Hence we can devise ways for coops to pool resources and share risks. The institutions performing this role in our economy -- banks, stock and bond markets, insurance companies, etc. -- did not materialize out of thin air, but developed over time.

Even if democratic companies are less aggressive -- and hence less competitive -- than conventional firms, they may not be less efficient. When conglomerates become too big they have to be pruned, which is costly. Much of the money that companies spend on marketing and advertising is arguably wasteful. And sometimes risky investments can lead to huge losses. On the other hand, if a democratic business is too tame its members will make less money, and it may be driven from the market by hungrier firms. So it’s not clear how much lust for profits is efficient, nor how closely conventional and democratic companies approach it.

So What’s the Problem Then?

If democratic companies are efficient, then why are they so rare? The reason is that in a capitalist economy, it just doesn’t take much to stand in the way of even efficient cooperatives.

The key obstacle is probably access to capital. Businesses need money, often lots of it. And most people don’t have the capital to risk in a speculative venture. Hence those who control the resources for investment can decide whether companies will be democratic or not.

Usually they decide against democracy. Why? Probably because traditional companies give investors and entrepreneurs an ownership stake, and allow them to keep more of the profits. They allow them to have more control, to run things without employee interference. Conventional businesses also may be more profitable than democratic ones; cooperatives are less likely to expand and more likely to invest in employee participation, worker training, and so on. On balance, this may be efficient. But it’s not the kind of behavior that maximizes profits in an economy crawling with conventional firms.

This means that building a democratic economy is difficult. It would require new institutions to help coops develop and grow. And it would require a redistribution of economic power from investors to everyone else.

But the same is true of politics. Even the limited democracy we enjoy today took centuries to build, and it came at the expense of those with political power. Indeed, enlightened opinion once had it that democracy and good government were incompatible. Every major extension of democracy — human rights, elections, women’s suffrage, etc. — has been resisted on grounds of political efficiency. Such concerns proved unwarranted. Perhaps economic democracy today is only as hopeless as political democracy five centuries ago.

Issue #219, September-October 1998

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Dollars & Sense magazine, 29 Winter Street, Boston, MA 02108, USA, provides left perspectives on economic affairs. It is published six times a year and is edited by a collective of economists, journalists, and activists committed to social justice and economic democracy.

Copyright © 2002 Economic Affairs Bureau, Inc.