We need decentralization because only thus can we ensure that the knowledge of particular circumstances of time and place will be promptly used. But the man on the spot cannot decide solely on the basis of his limited but intimate knowledge of the facts of his immediate surroundings. There still remains the problem of communicating to him such further information as he needs to fit decisions into the whole pattern of changes of the larger economic system. (F. Hayek, 1945)

Introduction

This chapter deals with incentive issues involved in workers' collective participation in information-processing (e.g., problem-solving on manufacturing site, horizontal coordination, on-the-job learning, R&D) in the context of large firms. In exploring this theme, it specifically tries to make the following two points: first, the critical basis of “workers' power” in the firm in accord with internal and allocative efficiency lies not so much in the “democratic rule” per se that workers' majority voting (or unanimous will) is explicitly applied to management decisions (or selection of management) of the firm. Nor does it lie in the workers' exclusive property rights which allow them to appropriate all gains arising in the associated firm. Rather, workers' power is derived more fundamentally from their ability to generate information value through active, collective participation in information-processing within the firm. By “workers' power,” I mean their capacity to have due influence over management decisions relevant to their own economic welfare, learning opportunities, membership status in the firm, etc.

Introduction

Two fundamental reasons why firms should be owned and run democratically by their workers may be given. (1) Accountability: because the employment relationship involves the exercise of power, its governance ought on democratic grounds to be accountable to those most directly affected. (2) Efficiency: the democratic firm uses a lower level of inputs per unit of output than the analogous capitalist firm.

Neither claim is obvious. If wage labor is a voluntary exchange in a competitive market, how can it exhibit a well-defined power relationship? If the democratic firm is more efficient, what prevents the capitalist from replicating it and reaping the profits? And if capitalist firms cannot capture the efficiencies of democratic firms, why do democratic firms not simply outcompete capitalist firms? In this chapter we will substantiate these claims through a comparative analysis of a capitalist and a democratic firm facing incentive incompatibilities concerning worker effort, managerial performance, and risk-taking.

Our approach differs from much of the literature on economic democracy in two ways. First, our focus on the agency problems associated with the regulation of the intensity of labor allows us to define precisely the exercise of power of employers over workers in a competitive capitalist economy, to advance specifically democratic criteria for the evaluation of the organization of the firm, and to demonstrate the superior efficiency characteristics of the democratic firm. Neither the political nor the efficiency argument, we think, can be sustained in a framework that ignores agency problems. Indeed, the elimination of agency problems by assumption, typical of much of the literature on worker self-management, reduces the case for the democratic firm to the curious claim that it would mimic the capitalist firm.

Introduction

In an era of major changes across the globe in economic as well as political institutions, there should be little argument about the need for an analytical framework to help us understand the observed phenomena. In the past, the development of such a framework was obstructed by imperfect communication between “theorists” and “institutionalists.” Our objective here is to facilitate communication by integrating institutional phenomena into models that have been developed for the study of economies, voting systems, and organizations. Primarily, we are interested in economic institutions, but certain aspects of the model are general enough to be applicable to political and other social institutions as well. Indeed, these non-economic aspects cannot be ignored, since introduction, implementation, and enforcement of the rules are essential features of the model.

Our point of departure will be the theory of economic mechanisms (formalized, for example, as adjustment processes or game forms). Although this theory has had a normative orientation, we intend our framework to be usable for descriptive and explanatory analysis as well. We do not share the view that at the present stage formalization is premature. It seems important to make institutional phenomena amenable to analysis with tools that have resulted in progress in many areas of economics and other social sciences.

Before proceeding with details, let us clarify the intended meaning of the term “institution.” In common parlance, this term has two distinct meanings. To illustrate by example, we refer to such organizational entities as a university, a central bank, an ombudsman's office, or a state as institutions.

Introduction

Recent events in the (former) Soviet Union and Eastern Europe have awoken the field of comparative economic systems from its quiet backwater. Spurred by the delegitimation of an undemocratic system which no longer delivered the goods, these changes challenged standard comparative systems' assumptions of placid, obedient workers, and unchanging economic and political systems.

The economic problems result from the inherent “shortage” character of centrally planned economies (CPEs) (Kornai, 1982), which causes input hoarding by managers, unfulfilled plans and a shortage of consumer goods, in turn weakening work incentives. The problems are also linked to the paternalistic, and often corrupt, nature of the state, which failed to represent citizens (Nove, 1983).

Underlying these failures are agency problems between owners and managers, between managers and workers, between producers and consumers, and between the state and citizens. These same four types of agency problems are common to all economies, although the specific forms they take in CPEs result from the particular institutional structures of these societies.

In spite of the importance of agency problems in CPEs, the agency-theoretic approach is conspicuously underdeveloped in the field of comparative economic systems. The dominant paradigms in the field have examined only one agency problem closely, the principal–agent problem between planners and managers. Other agency problems have rarely been addressed. Further, the planner–manager problem has been examined exclusively in the context of comparing problems arising under state ownership and central planning to that of an ideal market economy in which agency problems are assumed away.

Wage employment: fixed rate, subjection, and job insecurity

The standard employment contract has three main features:

1. (i) A fixed rate (whether in money or in indexed contracts, targeted in real terms) per unit of time at a monitored effort supply above a minimum level.

2. (ii) Subjection to the employer's authority in the workplace.

3. (iii) Job insecurity (i.e., exposure to unemployment risk), depending among other things on the enterprise's success or failure.

Alternative employment and payment systems involve modifications of these three features, introducing:

1. (i) Profit-sharing or payments related to other indicators of enterprise performance (e.g., group productivity in physical terms, sales, value added); this includes collective participation in enterprise capital (Employee Stock Ownership Schemes or Trusts, ESOPs and ESOTs). Personal share ownership (PEPs in the UK) and wage-earners' funds at national or regional level (such as the Meidner Plan or its blander implementation in Sweden) do not alter the fixed nature of earnings with respect to the performance of the employee's enterprise.

2. (ii) Workers' participation in enterprise decision-making, which we could call power-sharing (as in the German-style Mitbestimmung).

3. (iii) Job security.

Permutations of the employment contract

There are only eight possible combinations and permutations demonstrating the presence or absence of profit-sharing, power-sharing and job security; all are actually observed or have been proposed, and their main types are illustrated in Table 3.1. Of course each combination contains any number of alternative degrees of intensity of any of the three features actually present.

Introduction

Suppose that there were a determined social consensus in favor of workplace democracy such that conventional employment relationships were ruled out by custom, by constitution, or by law. That is, assume that it has been decided that most enterprises will be so organized that the right to choose their boards of directors, managers, or other decision-making bodies and personnel, or directly to determine major enterprise policies, is assigned to their workers and only to their workers (including managerial personnel), on the basis of one worker, one vote. What problems should be anticipated, and how might these be dealt with by appropriate institutional design or policies? In this chapter, I attempt to apply the results of the theoretical and empirical literatures on worker-managed firms, along with some personal rumination, to the question of the costs and dangers of implementing enterprise democracy in a market economy.

The chapter is organized as follows. Section 2 briefly reconsiders the old question of why capital hires labor, in other words why worker-run firms are not the norm, in market economies. Section 3 is equally brief, giving a preliminary discussion of the question of society-wide institutional change viewed as a change in the regime of rights. The next three sections provide the core discussion of what past studies of self-management imply for the transition to an economy of worker-managed firms. Section 4 deals with issues of employment, membership rights, and product market behavior. Section 5 treats financing of worker-run firms and property rights in capital goods. Section 6 deals with some less standard topics, including decision-making mechanisms, work organization, and job satisfaction.

Introduction

While worker participation in decision-making has been a popular topic in the business press for much of the last decade, substantive participation by workers remains relatively rare in the USA (Levine and Strauss, 1989). Many economists have concluded that the low incidence of participatory arrangements in the USA implies that such arrangements are inefficient – for if participation were a good idea, then the market would favor companies with participation (Alchian and Demsetz, 1972a; Jensen and Meckling, 1979; Williamson, 1980).

The argument that “survival of the fittest” implies efficiency is not correct if there are externalities from work organization – that is, if one company's choice of work organization affects the costs of other firms. Several examples of such externalities are presented in Chapters 1, 11, and 6 in this volume (by Bowles and Gintis, Dow, and Pagano, respectively; see also my survey article with Tyson, 1990).

The current chapter focuses on a single externality of participatory work organizations, a macroeconomic externality that stems from the tendency of participatory workplaces to avoid layoffs when product demand declines. To see the basic argument, consider two fictitious auto plants X and Y. Plant Y has a highly trained work force and a participatory work organization with a no-layoff pledge. Its competitor in the auto industry is plant X, which utilizes a traditional US labor relations system. At both X and Y nominal wages are set once a year. Plant X lays off workers whenever there is a downturn in demand. Plant Y, on the other hand, avoids layoffs during downturns by retraining workers, freezing hire, transferring workers within the firm, and ultimately hoarding excess labor.

Introduction

A growing body of econometric evidence suggests that worker participation in firm decision-making increases productivity (Defourney, Estrin and Jones, 1985a, 1985b; Jones and Svejnar, 1985; Estrin, Jones and Svejnar, 1987). Labor-managed firms (LMFs), however, have only a marginal place in Western market economies. LMFs most commonly engage in professional, craft manufacturing, or service activities where capital requirements are modest. The principal exceptions involve worker takeovers of capitalist firms (KMFs) in financial distress (Ben-Ner, 1988a, 1988b).

At first glance, this situation seems paradoxical: why should the bulk of production activity in market economies be organized in hierarchical capitalist firms, when worker control appears to have a significant positive impact on productivity? Writers who have addressed this question can (at some risk of caricature) be classified as skeptics and proponents. Skeptics draw normative conclusions from evolutionary outcomes: if contemporary economies are dominated by capitalist firms, then such firms must have some efficiency advantage relative to more democratic rivals. Authors who have expressed this view include Nozick (1974, Ch. 8), Jensen and Meckling (1979), and Williamson (1985). Skeptics often grant that the LMF might have merit in the specialized niches where it has already proven viable (Hansmann, 1988, 1990a, 1990b), but doubt that widespread adoption of this organizational form would provide net social benefits.

Proponents of the LMF place less weight on the verdict of the market, although they are encouraged by the recent upsurge in the LMF population relative to capitalist firms (Ben-Ner, 1988a). They also take heart from favorable empirical findings about LMF productivity performance.

Introduction

The possible connection between economic and political systems is one of the great issues of classical political economy. However, the subject is not much discussed by straight economists today, nor does it typically appear in contemporary economics courses.

This is too bad. The topic of “capitalism and democracy” is obviously of enormous general importance in its own right. Furthermore, the possible connections have lately become a more immediately operational issue. Without some sense of the logic behind possible relations between capitalism and democracy it is very difficult to understand many aspects of the economic “reforms” now taking place in formerly orthodox socialist countries. The connection between the economic and political spheres in the area of socialist reforms is usually of overpowering significance, typically overshadowing straight economic aspects of reform even for narrowly posed economic issues.

Advocates of free market economics, like Hayek and Friedman, have long perceived and articulated a link between capitalism and freedom or democracy. Now there is new evidence from the recent experiences of the former USSR, Eastern Europe, China, and other reforming socialist countries, and also from newly industrialized capitalist countries like Korea and Taiwan, hinting that capitalism and freedom or democracy tend to “go together.”

In view of its importance, even for an understanding of straight economic issues, it is somewhat puzzling that mainstream economists have not devoted more professional research to the linkage problem. Perhaps one reason has to do with the technical difficulty of formalizing the ways capitalism and democracy might be connected.

The contributions to this volume encompass a wide range of subjects pertaining to the analysis, understanding and evaluation of economic systems in regard to their structural as well as to their behavioral and evolutionary aspects: capitalism, socialism, institutions, rules, ownership, power, participation, agency, incentives, conflict, cooperation, productivity, and investment behavior. But it seems to me that the underlying common denominator is somehow related to the quest for an economic régime that is able to bring about an acceptable trade-off between efficiency and participation (democracy) in modern society. It may be held that this quest has seemingly been removed from the agenda as a consequence of the decline and fall of socialism in the world. But such a conclusion would certainly be premature, and for several reasons. In the first place, it is debatable whether the socioeconomic system in Eastern Europe had anything more in common with traditional images of socialism than collective ownership of the means of production and planning.

Introduction

Does it matter who owns and directs the means of production? In particular, does the structure of ownership and command influence the choice of production technique in any important way? Given complete and competitive markets, the answer to the latter question is “no,” as illustrated by the first welfare theorem for production economies: existence of Walrasian equilibrium implies that only efficient techniques are adopted, no matter how ownership is divided or who directs production. This is an example of what Bowles and Gintis (1988) have termed the principles of “neutrality of property assignment” and “irrelevance of command.”

These principles may not be supported in the absence of complete and competitive markets. In this chapter, we explore the implications of distributional conflict in labor markets for the choice of production techniques in capitalist firms. Such conflicts stem from possible bilateral monopoly conditions arising from the presence of significant mutual costs of exit from given employment relationships. Potential sources of exit cost in labor markets derive from such problems as search, factor-specificity, asymmetric information, and task idiosyncrasy, which are frequently encountered in such markets.

We study the distribution of production rents in capitalist firms as a bargaining relationship between owners of firms and the labor teams they employ. Following the seminal work of Rubinstein (1982), we model the relationship as a game in extensive form in which bargaining proceeds over real time and is costly to the participants. We relate equilibrium outcomes to the structure of ownership, and suggest that the choice of production technique in capitalist firms may be driven by considerations of bargaining power as well as of efficiency.

Introduction

In the New Institutional economics firm ownership or its governance system is endogenously and efficiently determined by the characteristics of the resources which are used in the organization: namely their degree of specificity and their monitoring requirements. Section 2 of this chapter summarizes the New Institutional view. Section 3 inverts the New Institutional view by arguing that the characteristics of the resources, employed in the firm are, in turn, determined by the nature of its ownership and/or governance system. This view supports some of the claims of the Radical economists who have traditionally argued that the technology and the internal organization of the firm are often not due to the need for increasing efficiency and can be better explained as an outcome of given property relations. The two arguments are integrated by introducing the concept of property rights and technological equilibria and, more generally, the concept of organizational equilibria. In section 4 these equilibrium concepts are developed by means of a simple model. There, we argue that institutionally stable property rights' equilibria need not be efficient. In section 5 we consider Williamson's contracting scheme and suggest two ways in which the scheme can be generalized. Finally, in the concluding section 6 we apply briefly the framework developed in this chapter to two issues. The first concerns the diversity of institutions which characterized the major Western capitalist countries after 1945 in spite of their different efficiency. The second is related to the possible inability of democratic institutions to come about in spite of their greater efficiency.