Written by a guest, Kent Reynolds. This post should not be taken as a statement of Tomat0’s personal views or endorsement of the contents.

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Introduction

Discussions concerning capitalism and socialism often involve comparing state ownership with private ownership, or the nationalization vs the privatization of industries such as USSR vs USA, East Germany vs West Germany, or North Korea vs South Korea. One part of the debate that is often overlooked is direct worker control of industries and economic sectors. This includes things such as cooperatives/labour owned firms, co-determination policies, Employee Stock ownership plans etc…

Libertarian socialists, syndicalists, market socialists, and anarcho-communists often support cooperatives on both a moral and economic principle. They believe that it is more moral if a workplace were to be managed democratically by the workers who operate in it rather than by a few shareholders. They argue that workers would feel more engaged, They also believe that these firms would be far less wasteful, more efficient, and a meaningful countermeasure against inequality.

A relevant example to cooperatives is Mondragon in Spain. Mondragon is a federation of cooperatives, that is owned and managed by its workers. They mostly focus on retail and small scale industry. Mondragon has been able to climb all the way to the top, amassing more than 80 thousand workers, and having a total asset value that is one of the biggest in all of Spain. Such examples show that cooperatives are not entirely alien to our world and can even achieve a lot of success. However, what are the advantages and disadvantages of this model? Are there any to begin with? Would a partial, or even complete transformation be justified? What other types of employee ownership are there?

In this essay, I will attempt to answer those questions with the available data at hand. I will draw comparisons and parallels over a set of multiple criteria.

Productivity

Which structural firm is more productive?

This question is extremely difficult to answer. The reason is that finding company “twins” with controlled variables is not easy at all, and even if we were to find a difference in performance, it’s hard to gauge how much the structure of the firm contributes to that difference and not local factors and fluctuations.. Evidence remains rather inconclusive, and there is yet to be a consensus formed around the issue. However, I will use existing empirical evidence in order to formulate some form of general statement.

A 1995 study analyzed cooperative firms, and classical firms in Plywood production. The cooperatives were shown to be, on average, around 6 to 14 percent more productive than capitalist firms. Cooperatives were also shown to adjust the wage ratio between workers rather than laying off employee or cutting their hours, as classical firms usually do (the effect of this will be covered in a later section)

However, interestingly enough, the cooperatives have not been able to drive out classical firms. As a matter of fact, the number has remained consistent within the Pacific Northwest region: seven firms are classical, while eight are cooperatives. According to the study, this is because the difference is not significant enough. To be more specific, it is not significant enough to offset the disadvantages that these cooperatives go through: Primarily the lack of external equity investment and capital markets within cooperatives. As explained within the paper:

“The experiences of the plywood co-ops in the Pacific Northwest testify to the relevance of these capital market problems. The workers have constituted the major source of capital both through the sale of shares at the founding of the company and through subsequent loans (in the form, for example, of the sale of further stock or deferred earnings). Often a co-op was constrained in its attempt to raise capital by two factors: first, it attempted to restrict the number of shares to the number of workers expected to be employed in the mill; and, second, it tried to keep the price of the shares to a level within range of a typical working household’s wealth. Given these constraints, it is not surprising that, soon after the founding of a co-op venture, it was common for the mill to return to its worker-owners for more funds.” [1]

These difficulties in acquiring capital also explain why the Plywood cooperatives have been unable to expand into the South like the classical firms have. Another factor that could potentially explain the inability to expand, but the ability to compete and even surpass classical firms in aspects is cultural ties and background:

“The establishment and success of the first coop in the plywood industry in Washington state were the product of the foresight of some shrewd men who, prior to its formation, were already skilled in the work relevant to plywood production and who shared a common Scandinavian heritage. This co-op served as the model for many imitators in the area. These factors seem to be present in other sectors where cooperatives have been important. In many instances, a group of workers with training in a given line of work and who share cultural ties form a collective organization that enjoys remarkable success. It serves as a prototype, and other firms are established along the same lines so that the cooperative form of organization constitutes a substantial component of the industry”

Another interesting feature is that classical firms exhibited higher output elasticity, implying that classical firms are more responsive to changes in input overall and have more constant/increasing returns to scale (i.e increase in input leads to a proportional increase in output)

Looking at other studies, yields different, yet somewhat similar results. For example, a study on Italian cooperatives showed that there were no differences in productivity between cooperatives, and classical firms, but also adds that capital intensity was significantly smaller in cooperatives, which implies that they’re less likely to invest and expand overall [2]. Research on firms in Portugal, found that cooperatives might perform worse, however, the evidence is still inconclusive. [3]

Conclusion: While the results are inconclusive, the evidence we have does show that cooperatives have the potential to compete with capitalist firms and that worker decision making does not have bad effects on the efficiency of a firm, and in some cases, might be even positive. Overall, there is no significant divergence from classical firms, no matter if the performance is slightly better or worse. However, even in a case of productivity gains, cooperatives can run into certain limits such as capital market constraints.

Resilience and Stability

Which form of business is more likely to survive during a recession? Which structure gives more stability to its employees?

According to the empirical evidence we have, cooperatives enjoy a significant advantage. For instance, the average three year rate survival rate for all cooperatives in France is at 80-90 percent, while in classical firms, it remains at 66 percent. [4] Cooperatives have also been shown to have higher survival rates both during the 2008 recession and the COVID-19 epidemic in the United States. [5] A significant factor is that, as previously mentioned, worker cooperatives tend to distribute the damage between their members, by lowering the wages of some, in order to make sure that no one gets fired. This leads to more employment stability in contrast to capitalist firms which usually rely on either firing employees or cutting hours. This employment stability results in increased engagement in the workplace, and better long term survival.

Another contributing factor could also be self-selection into industries. As explained here:

“the fact that WMFs survive longer may partially reflect self-selection by both WMFs into industries and workers into organizational forms. It may be the case that WMFs are not randomly sorted into industries but, in other words, enter industries where they might have better survival prospects. Moreover, workers may be self-selected into organizational forms according to unobservable characteristics that might also affect firm survival. As Chiappori and Salanié (2003) pointed out, the combination of unobserved heterogeneity and endogenous matching of agents to contracts is bound to create selection biases toward the parameters of interest. For instance, cooperatives may be able to attract highly motivated workers (Elster 1989). This selection problem is a potential identification threat common to all studies on WMFs based on observational data (Kremer 1997: 13).” ^[6]^

A great example of this is that many grocery store chains are cooperatives. This is important because grocery stores tend to be one of the more resistant types of businesses to recessions mainly because demand for basic good remains the same or even increases during recessions due to people avoiding restaurants [7] However, when looking at the technological sector, one notices that it is dominated by venture capitalist firms, which matters a lot given that the technological sector has one of the lowest survival rates of any industry.

Conclusion: Cooperatives are able to give more stability to employees, especially in times of recessions. However, it is not entirely clear to what extent this is caused by internal structural factors, or self-selecting factors or something else completely.

Wages

Which firm structure offers better wages?

The answer to this question is rather complex and not clear cut. For starters, due to the already mentioned effect of wage distribution in cooperatives, there are significant variations between studies on this subject. The wage flexibility in cooperatives means that a direct comparison is very difficult and perhaps not very meaningful. However, there are a couple of trends that are extremely important and evident. [8]

Let’s start with the first one: worker cooperatives tend to exhibit less inequality overall. Cooperatives in France were shown to have less inequality by 14 percent compared to classical firms. [9] Another example: In Mondragon, workers usually vote on the ratio of inequality between the lowest and highest paid members, which tends to be around 1:9, a far cry from the high inequality at firms like Amazon or Google. This means that cooperatives have a more compressed structure with less inequality. This, however, leads to a problem….

An analysis of cooperatives and classical firms in Uruguay points out significant differences between cooperatives and classical firms when it comes to wages. According to the analysis, cooperatives offered a small wage premium to workers at the very bottom. This wage premium, however, disappears almost entirely when you go to the middle portions, and is actually negative at the top. This is where the second trend comes in: Brain Drain. Logically speaking, if cooperatives have much less inequality, but cooperative workers at the very bottom earn around the same as ones in classical firms, this can only mean one thing: High skilled workers in cooperatives earn significantly less than their counterparts in conventional firms. This means that highly skilled workers are much more likely to leave than low skilled ones. Indeed, this is the case, according to the analysis. Workers in the top 20th percentile of cooperatives were 4.5 times as likely to voluntarily leave to work at a conventional firm than low skilled workers. This “Brain Drain” effect was not observed to happen in conventional firms (i.e the inverse of this did not happen). As a matter of fact, by merely being a highly skilled worker in a cooperative, your “survival time” (employment duration) is lowered by around 77% . This could be one of the reasons that cooperatives have been unable to dominate in Uruguay, despite having a similar level of productivity [10]

However, There are two things that usually limit the brain drain: 1) If conditions in capitalist firms in terms of growth don’t look too good and 2) When the workers were more ideologically and emotionally attached to their workplace, they were less likely to leave overall. Another interesting trend within these Worker managed firms is that the employees in WMFs were older on average than those in conventional firms, and that WMFs tended to employ less women on average, implying that cooperatives tended to be founded and operated by more experienced members (since women are still new to those industries) with a lot of social cohesion between them. This could lead more credence to the idea that cooperatives are more selective about their employees and industries, and explains why, despite their ability to compete with capitalist companies, they usually do not expand regionally, let alone internationally.

Conclusion: Cooperatives usually exhibit significantly less inequality. Yet, Cooperatives do not offer much if any advantage to workers at the bottom and middle in terms of wages. However, the lower pay for the more talented workers at the top drives a brain drain that could be detrimental to a company’s growth and productivity.

Yugoslavia

Sadly, we do not have many large scale cases of cooperatives dominating an entire region/country. This is why the example of Yugoslavia is both intriguing and important. The region, while starting out as a state socialist regime, later developed into something resembling (but not quite) market socialism under Titoism. Studying the economic policies of Yugoslavia at the time and their effects can yield valuable insight.

From the 1950s to the 1970s, Yugoslavia carried out a process by which it reduced the state’s role and control over the economy. However, private property was very much still banned, so instead they handed over control to worker councils and cooperatives as a part of a mix of policies that fostered worker self-management. This led to more self-determination in the workplace. Despite using market mechanisms, Yugoslavia also enjoyed a much more modest level of inequality (Gini coefficient) compared to other capitalist market economies. The level of GDP growth was also impressive compared to other soviet economies. There was also more trade with Western Europe, which represented a larger share of the Yugsolavian economy compared to other countries in the eastern bloc. However, these reforms were not fully realized. For instance, 40 percent of prices were still fixated by the government. The party still retained a lot of control over the economy and even within the democratic workplaces. [11]

“for large and important enterprises, some workers’ rights were curtailed because Republican governments and through them the Republican Communist Parties appointed its nomenclatura members to top positions. It was thus a “controlled” workplace democracy. Very often these appointees were not well qualified to run companies. They were basically Party hacks who tried to pretend to be businessmen. Slobodan Milošević is the most famous example. He became the head of one of the largest Yugoslav banks and although he always bragged of dealing skillfully with Rockefeller and Chase Manhattan he probably knew very little about banking”

Perhaps most disappointingly, the reforms did not help much with investment or unemployment. As a matter of fact, they exacerbated them:

“The first flaw has to do with the maximand of SME (Self-Management enterprises). Like US cooperatives, they maximize average output per worker because at that point the wage is the highest. This means that SMEs will not go all the way to marginal products of labor=wage and would thus employ fewer workers than an entrepreneur-run company. This is indeed something that was confirmed in practice. Yugoslav SME were loath to expand employment. Unemployment in Yugoslavia, despite massive workers’ emigration mostly to Germany, always stayed around 10% through the 1970s and 1980s As Friedman rightly says in the interview, Yugoslav policy-makers constantly complained that companies were distributing too much in wages, and tried to set, through heavy wage taxation, incentives to move more money into investment. But the results were nugatory.” [12]

This culminated in a severe stagnation with little GDP growth (and even a decline) in the 1980s. Speaking of which, one of the main reasons that Yugoslavia relied heavily on IMF loans in the first place was the fact that the labour managed firms did not commit to investment. While this system had its advantages, it was not sustainable in the long run, and eventually, after the dissolution of Yugoslavia, each country privatized its economy, some at a higher pace than others such as Slovenia, which already had a higher GDP than pre-transition by 1997. Other states were not lucky due to war and political turmoil. While the experience in Yugoslavia could sour some on the idea, it is still worth mentioning that Yugoslavia still used a lot of state efforts, and that political instability and corruption can have bad consequences regardless of the system.

Co-determination and ESOPs

Since finding more empirical evidence specific to cooperatives is limited and exhaustive, I decided to look at other forms of employee ownerships and found two interesting examples: Co-determination, and Employee Stock Ownership Plans.

What is Co-determination? Co-determination within Western Europe refers to a policy by which workers elect a part of the executive board within the company. It is similar to Elizabeth Warren’s plan by which 40 percent of the executive board would be elected by workers in large companies. One of the most famous examples is the Mitbestimmungsgesetz policy within Germany, by which mid sized and large firms have anywhere from one third to 50 percent of their supervisory board (Aufsichtsrat) be elected by workers directly. This policy emerged after WWII when worker unions, who were thrown out entirely after Hitler nationalized many industries, demanded from the allies that the industries be privatized again, but on the condition that they get a say in the decision making process. While this is not entirely reflective of cooperatives, it does share the essence of worker self-determination so it is worth observing nevertheless.

According to studies, co-determination has no negative effects on productivity, and as a matter of fact, increases productivity as workers feel more engaged with the decision making process. However, co-determination has shown a negative effect on profitability. As the paper states:

“Summing up, then, productivity appears to be higher and profitability likely lower in corporations that have a co-determined supervisory board. This result is congruent with the idea of Freeman and Lazear (1995), who claim that worker participation raises productivity as the employees put more effort into their work, but lowers profitability as highly productive workers exert more influence on the distribution of a company’s rent” [13]

Overall, this mode of corporate governance has led to more employment stability within Germany [14] However, it has had some shortcomings. For example, an analysis that compared firms with 50 percent representation with those that had one third worker representation showed that:

“We find that companies with equal representation of employees and shareholders on the supervisory board trade at a 31% stock market discount as compared with companies where employee representatives fill only one-third of the supervisory board seats. We show that under equal representation, management board compensation provides incentives that are not conducive to furthering shareholders’ interests, possibly because labor maximizes a different objective function than shareholders.” [15]

It was also observed that companies with equal representation often had longer payroll, implying that negotiations took longer to find a consensus and act than in companies with one third representation.

Some feel like the system of co-determination adds more layers of rigidity that often stifle innovation within Germany. A great example of this is the Telekom internet provider, which often opted out for investing in copper instead of fiber optics, due to the tendency of workers wanting to keep their benefits and save up rather than invest in new technologies. This is one of the key reasons that Germany has some of the worst internet in the entirety of the EU, especially compared to countries like Romania or Estonia that opted out for a more free market approach. [16] Such cases have led some in Germany to rethink co-determination, and in some cases, some corporations would even change their public legal entity type as a loophole to avoid having to implement co-determination. [17] Although, overall, co-determination does remain an industry standard within Germany that promotes stability in times of recession, and fosters long term strategies that include the interest of workers.

Most important to point out is that there are difficulties with implementing this system of co-determination elsewhere. For starters, Collective bargaining agreements and unions are an important part of the German economy, with around 80 percent of workers in Germany having some form of collective bargaining, and a unionization rate of around 22 percent. This means that German employers, in general, are familiar with negotiating with unions and thus the policy of co-determination wouldn’t represent a huge barrier. However, compare this to America, where unionization is below ten percent and declining. This means that a policy of coercive co-determination laws could lead to a lot of tensions as a Harvard report on corporate governance finds. Furthermore, Germany has a two tier structure: The Management board that governs day to day tasks, and the supervisory board that governs long term strategies. The Management board has no elected members in Germany, which means that elected workers would probably not translate into the same benefits and disadvantages within the one tier board structure of the US. Finally, Germany has a significant part of its industry dedicated to manufacturing and industry, while the US mainly a service economy. Unionization and worker determination usually diminishes in the transition from industry to service economy, which also explains why unionization rates in Germany have been falling off as the service sector has been growing rapidly. [18]

Moving over to ESOPs now. ESOPs are employee stock ownership plans where the worker’s savings and retirement fundings are invested into a private security in the company that is owned by the worker. A relevant example of this is the 401k plan which is very popular among Americans, as around 14 million workers are covered using ESOPs especially in the manufacturing and technology sectors. Companies that offer ESOPs are often more productive as workers are more attached to their company and are more invested in the welfare of the company. [19, 20, 21]. However, cases like the famous company Enron also show a darker side of employee ownership. Enron infamously faked their data and stock value, and managed to raise their stock price partially through the usage of ESOP plans. This, in return, meant that when the stock price fell from 200 dollars to 0.25 cents, that multiple workers lost their entire retirement funds. Generally speaking, there is a huge risk that often comes with employee ownership, and that’s why it’s usually advised to diversify. However, diversification might not be so simple for the average worker. [22] Some cooperatives like Mondragon have found a way around this by giving out non-voting shares, and hiring workers with no ownership in the company. However, this has led a tendency, in which workers with no ownership have been growing at a much faster pace than worker-owners, and as noted by Vincent Naravvro, there are multiple grocery stores operated by Mondragon where the workers with no ownership far outnumber worker-owners, resulting in a “capitalism-lite” sort of situation. [23].

Business Ethics

Ethical issues within classical firms is by no means uncommon. These issues range from lobbying, environmental damage, forging documents, anti-competitive practices, and worker exploitation. Are cooperative inherently more ethical or do they have the potential to be as unethical as some other corporations?

Sadly, there are multiple cases of cooperatives committing unethical business practices, For instance, as Noam Chomsky points out, Mondragon usually exploits workers in South America. Furthermore, cooperatives have been contributing to environmental damage in forest lands, yet the international cooperative alliance has done little to fix the issue. [24] The Wheatsville retail and food cooperative also runs into many issues where worker demands are not implemented, despite being structured in a democratic way [25]

What this all seems to imply is that cooperatives are susceptible to the dark side of market mechanisms, and are thus in need of regulation just like regular companies.

Concluding Thoughts

Employee ownership is a viable method of organizing economic life. It shares similar characteristics to private ownership of the means of production, but has its own set of advantages and disadvantages. It is very important to be aware of these differences before implementing any sort of radical policies. Encouraging employee ownership could be a band aid solution to some of the issue pertaining our economic lives, but evidence remains skeptical of a full transition, and whether they can entirely replace the classical firm.

References

1. https://www.brookings.edu/wp-content/uploads/1995/01/1995_bpeamicro_craig.pdf
2. https://www.researchgate.net/publication/235304990_The_Productive_Efficiency_of_Italian_Producer_Cooperatives_Evidence_from_Conventional_and_Cooperative_Firms
3. https://ideas.repec.org/a/bla/annpce/v89y2018i2p377-414.html
4. https://www.researchgate.net/publication/287576212_The_relative_survival_of_worker_cooperatives_and_barriers_to_their_creation
5. https://truthout.org/articles/pandemic-crash-shows-worker-co-ops-are-more-resilient-than-traditional-business/
6. https://journals.sagepub.com/doi/10.1177/001979391406700108
7. https://www.investopedia.com/financial-edge/0811/9-businesses-that-thrive-in-recession.aspx
8. https://web.archive.org/web/20170113124521/https://www.uk.coop/sites/default/files/uploads/attachments/worker_co-op_report.pdf
9. https://ideas.repec.org/a/liu/liucej/v14y2017i2p303-329.html
10. https://core.ac.uk/reader/205579470
11. https://doc-research.org/2018/03/rise-fall-market-socialism-yugoslavia/
12. http://glineq.blogspot.com/2020/10/milton-friedman-and-labor-managed.html
13. https://www.leuphana.de/fileadmin/user_upload/Forschungseinrichtungen/ifvwl/WorkingPapers/wp_177_Upload.pdf
14. https://www.bloomberg.com/opinion/articles/2018-08-24/why-german-corporate-boards-include-workers-for-co-determination
15. https://econpapers.repec.org/article/tprjeurec/v_3a2_3ay_3a2004_3ai_3a5_3ap_3a863-905.htm
16. https://www.handelsblatt.com/english/companies/fiber-optics-high-speed-internet-a-hot-button-election-issue/23572118.html?ticket=ST-1053903-IamcQGnmRrEihqHAOpdX-ap6 https://www.handelsblatt.com/english/opinion/boardroom-battles-its-time-to-rethink-co-determination/23502360.html
17. https://www.economist.com/business/2020/02/01/deutschland-ag-rethinks-workers-role-in-management
18. https://corpgov.law.harvard.edu/2020/04/28/co-determination-a-poor-fit-for-u-s-corporations/
19. https://www.di.net/articles/employee-stock-ownership-plans-the-pros-and-cons/#:~:text=Research%20shows%20ESOP%20companies%20are,recruit%20and%20retain%20top%20talent.
20. https://www.nceo.org/articles/employee-ownership-by-the-numbers#2
21. https://www.bizjournals.com/kansascity/stories/2002/02/25/smallb2.html
22. https://digitalcommons.law.seattleu.edu/cgi/viewcontent.cgi?article=1266&context=sjsj
23. https://www.counterpunch.org/2014/04/30/the-case-of-mondragon/
24. https://www.theguardian.com/social-enterprise-network/2013/aug/09/cooperatives-and-ethical-business
25. https://www.austinchronicle.com/news/2019-09-06/wheatsvilles-frustrated-employees-call-for-change/