Economics for Democratic Socialism

Economics for Democratic Socialism Drexel University Spring Quarter 2009

Reading • Rather than handouts or library reserve, we will rely on Wikipedia readings for this week. Three (short) ones are added to the original two. • http://en.wikipedia.org/wiki/History_of_the_cooperative_movement • http://en.wikipedia.org/wiki/Cooperative • http://en.wikipedia.org/wiki/Worker_cooperative • http://en.wikipedia.org/wiki/Mondragón_Cooperative_Corporation • http://en.wikipedia.org/wiki/Co-determination

The Social Economy • A number of economists in Europe, Canada and Latin America -- and a few in the US -- use the term “the social economy” to refer to not-for-profit corporations and cooperatives. • Most of the focus today will be on cooperatives, but a few comments on not-for-profits will be needed.

Mission-Driven Enterprise • Nonprofit corporations and Non-Governmental Organizations (NGOs) generally refer to similar organizations. • They are not prohibited from earning profits but are not permitted to distribute their profits. • Instead, they are required to use profits and other resources at their command to advance their mission, which generally is stated in the charter. • Thus, I prefer the term “mission-driven enterprises.”

Some Noted Nonprofits • Drexel University • Mission: higher education -- “I want them to have good lives.” • The Barnes • Mission: promote Dr. Barnes’ ideas on art. • IKEA • Mission: promote the arts and sciences of domestic comfort • Museums, symphonies, many hospitals, etc.

Governance • A Mission-Driven Enterprise is controlled by a board of directors or trustees. • It is their responsibility to assure that the organization operates in accordance with its mission. • If they fail to do so they may be guilty of failure of trusteeship, a criminal offense. • Many MDE’s depend on gifts, and that can keep them on the strait and narrow path.

Cooperation 1 • A cooperative (also co-operative or coöperative; often referred to as a co-op or coop) is defined by the International Co-operative Alliance's Statement on the Co-operative Identity as an autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise. • Wikipedia • In other terms it is a membership organization that operates an enterprise and with membership open to those who have a particular (non-owner) relation to the organization.

Some Types of Cooperatives • Worker cooperatives • Membership is open to employees • Consumer cooperatives • Membership is open to customers • Financial mutuals • Membership is open to depositors • Farmer cooperatives • Membership is open to farmers as raw material producers and supply buyers.

Cooperation 2 • The primary significance for this course is the democratic governance of worker cooperatives -- production carried on by a free association of the workers. • Recall the sense of “democratic” that I endorsed in the first week: “In a democratic system, any person who holds a position of authority is responsible to those over whom the authority is exercised.” • Worker cooperatives are democratic in that sense. Other cooperatives and profit-seeking firms are not. • This is not to say that other cooperatives have not made valuable contributions. • Historically, there have been some conflicts between advocates of worker and consumer cooperatives.

Cooperation 3 • In game theory we distinguish between “cooperative” and “noncooperative” solutions. A familiar example is the Prisoner’s Dilemma. • In a “cooperative solution,” the players may form a “coalition” to choose a joint strategy for mutual benefit. • There is a rough parallel. Cooperatives of all kinds are based on the principle of joining together for mutual benefit. • This should not be pushed too far. Cooperative game theory is too abstract to tell us much about cooperative enterprises -- and cooperative “coalitions” are not necessarily democratic.

Cooperative Principles • 1st Principle: Voluntary and Open Membership • 2nd Principle: Democratic Member Control • 3rd Principle: Member Economic Participation • 4th Principle: Autonomy and Independence • 5th Principle: Education, Training and Information • 6th Principle: Co-operation among Co-operatives • 7th Principle: Concern for Community • --International Cooperative Alliance

By the way, • Here in the USA and elsewhere, worker cooperatives have often come about through the bankruptcy or closure of capitalist enterprises. • One example -- here in the Delaware Valley -- was the O&O supermarket chain, based on stores that A&P closed as unprofitable in the 1970’s when A&P was in bankruptcy. • They continued to operate into the 1990’s -- but are largely closed now. • So cooperatives can sometimes survive where capitalist firms cannot (why?) But it doesn’t always work.

A Halfway House • Most large German corporations are required to adopt “mitbestimmung” -- codetermination -- either with parity or near parity. • Codetermination with parity means the employees elect half of the board of directors. • In some smaller companies, the minimum is one-third worker directors. • This seems a highly successful system.

ESOPs • Most worker-coops are owned by their members. But worker-ownership may not mean cooperation. • Employee Stock Ownership plans are fairly common, but usually prevent any worker participation in firm governance -- somewhat the opposite of cooperation. • However, in a few cases, coops have been based on worker ownership via ESOPs.

Labor-Managed Enterprises • For economic theory, the broader distinction is between labor-managed, profit-seeking, and other kinds of enterprises. • Labor-managed enterprise=LME. • A conventional corporation is managed by a “court of directors” (A. Smith) elected by investors and that is supposed to direct the enterprise in their interest. • An LME is managed by a “court of directors” elected by the employees and that is supposed to direct the enterprise in their interest. • A worker cooperative is (ideally) a worker-owned LME; but in practice there may be non-member employees.

Worker Coops as LME’s • Historically, many worker coops have been established that are very near approximations of LME’s, and the evidence from observation of these enterprises is a basis for a judgment of the workability of an economy founded on LME’s. • Many of those worker coops have been long-lasting and successful by any reasonable standard. • Several will be considered in the following.

Yugoslav LME’s 1 • Yugoslavia broke with the Soviet Union in about 1948, and a few years later, beginning in 1952, began to build a “superior” socialist economic system, based on labor management. • This was probably originally meant to be mostly show. Certainly the state retained a major role in the 1950’s. • One-party Communist rule was also maintained. • However, the workers’ councils and market allocation became the main economic forces by 1960. • Subsequent rounds of “reform” to “perfect” labor management were probably more disruptive than helpful.

Yugoslav LME’s 2 • On the whole, the Yugoslav economic system was pretty successful 1952-1980. • However, it was export dependent, quality was poor (the Yugo was notorious) and after 1980 dependent on exports to eastern Europe and the Soviet Union. • The collapse of those countries in turn depressed the Yugoslav economy (as it did those of Sweden and Finland). • Specifically Yugoslav problems -- hatred and wide contrasts of economic development between the nationalities -- were always a handicap to the Yugoslav system.

Yugoslav LME’s 3 • The Yugoslav Federation collapsed in 1991, and much of its economy was destroyed in the wars that followed. • “Privatization” largely took the form of turning over formal title to the workers themselves. • In Slovenia and Croatia, the more industrialized regions, there have been efforts (in the enterprises themselves) to retain labor management, although this is inconsistent with European Community regulations and the government has pressured them to eliminate it. • Anyway, the first economic theory of LME’s was based on the Yugoslav system and was initiated by a paper of Benjamin Ward. (1958)

Ward’s Model Simplified 1 • Maximize per-worker (or average) dividend • dividend is revenue minus cost, not including labor cost • If Q is the quantity of output L is the quantity of labor K is the quantity of capital

Then, if labor and capital are the only two inputs, the production function (which shows relationship between output and inputs) is: Q = f(L, K) In the short run, capital (K) is fixed Suppose that the enterprise pays a “rent” or total cost (T) for the capital it is using since K is fixed in the short run, T is fixed So if we let Y = total dividend and P = the price of the output, then Y = PQ - T Ward’s Model Simplified 2

This equation says that dividend is revenue (PQ) minus the total cost of capital a more complicated (i.e., more realistic) production function would include more inputs (like fuel, intermediate products, etc.) but would not change the basic result we are after here Per-worker dividend (which Ward’s model will maximize) is just Y divided by L Y/L = (PQ - T)/L Ward’s Model Simplified 3

A little wizardry (i.e., calculus) shows that when per-worker dividend is maximized the following relationship holds: VMPL = (PQ - T)/L where VMPL is the value of marginal product of labor = P*MPL Ward’s Model Simplified 4

Relationship Between VMP and Y/L • If VMPL>Y/L, then adding an additional unit of labor will raise Y/L • If VMPL<Y/L, then reducing L will raise Y/L

Comparison With Capitalist Firm • Assuming profit (J) maximization J = PQ - wL - T where w = wage • At the profit maximizing employment of labor VMPL = w • Value of labors’ marginal product equals wage

Long Run • This is a short run analysis. As Ward notes, the conditions for long run equilibrium are identical to those for a capitalist economy. • J. Vanek built an extensive economic theory of LME’s and LM economies on this. • It has been criticized on the grounds that the assumptions are unrealistic. • They are -- but they are equally unrealistic in their application to capitalist economies. • The correct implication is that all arguments that markets lead to efficient resource allocation are unsound.

Unrealistic • The key assumption is that capital is supplied by “perfectly competitive capital markets.” • Horizontal supply curve of capital to the firm: • No such thing has, ever will, or can exist in the real world. • It would imply infinite leverage. • In the real world, the allocation of resources depends on the distribution of wealth. • No neoclassical nor Austrian economic theory allows for that.

Arguments in Favor of LMEs • Eliminates capitalist dichotomy between management and labor • Greater social justice in distribution of income • distribution according to decision of the workers involved

Criticisms of LMEs • Misallocation of labor. Cooperatively managed firms tend to hire less labor. • efficiency requires equality of VMP in all uses • if VMPL = w and all firms face same wage, then all firms’ VMPL will be the same • no such mechanism to equate VMPs in market socialism. If VMP1 > VMP2 then greater value can be produced by reallocating labor from Enterprise 2 to Enterprise 1

We can show that the cooperative monopolist restricts output (i.e., misallocates resources) even more than the capitalist monopoly Labor managed enterprises may underinvest in capital in the long run because workers will drain firms of extra income in the short run, especially the lack of property rights in firm assets reduces their incentive for supporting long horizon investment. Further Criticisms of LMEs

Coop Experience as Evidence 1 • In the 1970’s a group of economists formed around Vanek with an interest in research on LME’s. • When we learned about the century-plus of experience with worker cooperatives, some of the group did empirical research on enterprises of that kind. • The most intensively studied cases were • US Pacific Northwest worker-owned plywood companies • A complex of enterprises at Mondragon, Spain. • Other important, but less-studied instances include Legacoop, Northern Italy, especially Emilia Romagna, experiences in several other European nations.

Preliminary Results 1 • The Ward model was not supported, at least in the simplified form given here. • There is also little or no evidence of underinvestment. • However, the enterprises typically are undercapitalized because of inability or unwillingness to raise capital from “capital markets.” • Worker cooperatives show differences in form and legal definition that imply differences at least where incentives to invest are concerned. There may be no “general” model.

Preliminary Results 2 • Another (hypothetical) criticism from opponents of LMEs is that labor productivity would be very low. • The argument: • Effort is a public good to the members • Public goods are underprovided • Therefore, effort being underprovided, labor productivity would be low. • In fact, labor productivity is no lower, and often higher, than in comparable capitalist firms.

Plywood 1 • Worker-owned plywood companies were formed in Washington, Oregon, and nearby largely in the period 1921-1950. • About 1950 they produced about 25% of output, all of which came from the Pacific Northwest region. • Many were quite successful, but some of the most successful were sold to private-enterprise corporations at premium prices. • Others have gone out of business due to the “successor problem.”

Plywood 2 • Membership was based on the purchase of a share. In some cases I have observed, the price of a share would approximate the price of a modest house. • The Board of Directors often must approve the purchase of a share. • One man, one share, one vote. • The members elect the board of directors who hire the management. • Some nonmembers might be employed (in a few cases a majority) but shareholders have priority when there are job openings, and nonmembers would be laid off first.

Plywood 3 • Dividends on shares were limited, and usually not paid at all. Some associations prohibited them. • Hourly wages were equal. • Jobs could be quite different, some dangerous and physically demanding. Job rotation was common. • Managers had great power to shift job assignments, and discretion generally, though they sometimes complained that the members took too much interest in management. • They also complained that the members were too short-term in their interests.

Plywood 4 • The plywood coops spent less on supervision than comparable firms -- a fraction as much. • “When one cooperative was converted to a privately owned mill, the number of supervisors and foremen was immediately quadrupled.” • Labor productivity was no less, and some studies indicated that it was greater, than in comparable capitalist firms.

Hypothesis

Plywood 5 • The cooperative firms responded differently to changing circumstances than comparable capitalist firms. • In the face of a decline of demand, they reduced wage levels but were less likely to lay off and laid off fewer workers. • In the other firms, the main response is a reduction of labor hours, employment, and production. • This is consistent with the criticism that LME’s would “misallocate labor” but also suggests that, in a system dominated by LME’s, recessions would be less contagious. • (The evidence is also consistent with Marxist theory of wage determination.)

Mondragon 1 • Mondragon Cooperative Corporation is a group of worker cooperatives in the Basque country of Spain. • A leading figure was Catholic Father Arizmendi, who founded a polytechnic school in 1943. • The first company was FAGOR, 1956, which originally manufactured kitchen equipment. • (My wife has a FAGOR pressure-cooker.) • Caja Laboral Popolar, a mutual bank, was founded in 1959. • Its credit supported the start-up of new cooperatives and the conversion of some bankrupt firms to coops.

Mondragon 2 • The group of enterprises is highly interdependent -- finances are through the Caja Laboral, they give discounts to one another, and when one coop fails or has to lay off labor, they may be shifted to other coops. • The group constitutes the largest corporation in the Basque country and the seventh largest in Spain. • Their retail store chain is the largest in Spain. • Governance is federal, with an elective Cooperative Congress for the whole group but also autonomous workers’ councils in member coops.

Mondragon 3 • Among the requirements for membership in the group, and access to finance through the Caja Laboral, is the requirement that a proportion of net revenues be reinvested. • Members are required to buy in, a fairly substantial investment, though it can be financed partly by a loan from Caja Laboral. • As a result, the group has grown consistently and rapidly. • The group operates a university, and about half of the graduates work in the Mondragon companies.

Mondragon 4 • The group employs about 100,000+, though in 2007 only about 1/3 were members. • Most non-members are at locations outside the Basque region. Globalization has required expansion, including other countries were membership is considered impractical. • Within Spain, many are members of the retail chain, Eroski. • It is expected that the membership will be increased to about 70%, with Eroski employees offered buy-ins to membership.

Mondragon 5 • Mondragon is widely seen as a model to be emulated by worker coops elsewhere. • There have been other such initiatives in Spain, with some success, and in Canada (which has a long cooperative tradition of its own.) • Could it be done in the US?

Other Studies • The Legacoop, in Northern Italy, includes both worker and consumer coops, and mutual banks. • Its regional success has been comparable to that of Mondragon, mainly in Romagna-Emilia. • Labor productivity studies parallel those for the plywood coops. • So do studies in several other countries. • In France, worker coops are required by law to reinvest some part of their net revenues, and cannot distribute it on dissolution. • There is evidence that French coops are pretty long-lasting.

Capital • It seems clear that capital funding remains a problem for worker coops -- a soluble problem (as in Mondragon) but a problem notwithstanding. • Reinvestment is useful but could hardly lead to an efficient allocation of investment. • But cooperators are very reluctant to raise capital on capital markets, as they believe they would lose control to shareholders, and even with loans they might lose control in bankruptcy. • In 1977 I made a proposal that I thought might enable worker coops to participate in capital markets, but it is untried.

Conclusion • The evidence from worker cooperation seems to establish that democratic worker participation in the governance of firms is feasible. • There is no sacrifice of labor productivity. Indeed, on the whole, it may be advanced. • Investment decisions might be distorted, but this seems to vary greatly depending on the details and form of the cooperative and the cooperative sector -- so probably soluble. • Could a society based on the ideals of democratic cooperation be established?

Postscripts • So what if a group wanted to form a coop this year? • Here is a proposal I made at a conference at Mondragon in 2006: • Charter 2 corporations, one conventional for-profit and one not-for-profit. • The mission of the not-for-profit would be to promote employment and incomes through financing and encouraging worker cooperatives. • The founders would lend whatever capital they can raise to the nonprofit.

PS, continued. • The nonprofit would buy all the stock of the for-profit. • The nonprofit would delegate governance of the for-profit to the elected representatives of the for-profit, on the condition that the shares pay dividends proportional to the average compensation of employees. For some principles to determine the proportion, see http://home.comcast.net/%7Eromccain/coco.html#Investor-Owned-Corporations • The dividends are used to repay the loans to the coop and subsequently to finance further expansion of coops.

Another Postscript • Recall, from third week, the contrast of the Marxist and Schumpeterian theories of the self-destruction of capitalism. • Neither quite corresponds to the facts of the twentieth century. • Here is a synthesis: • Capitalism leads to recurring, increasingly severe crises. • To mitigate them, governments introduce, in the interest of the capitalist class,noncapitalist elements that gradually abolish capitalism.

Economics for Democratic Socialism