The Democratic Firm

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Economic Democracy as a Third Way

An economic democracy can be roughly defined as a mixed market economy where the predominance of economic enter­prises are democratic worker-owned firms (see Dahl, 1985). It differs from capitalism primarily in the abolition of the employment relation. The relationship between the worker and the firm is membership, an economic version of “citizenship,” not employment. It differs from (state) socialism in that the firms are democratic worker-owned firms, not government-owned firms, and the firms are interrelated by a market economy with various degrees of macro-economic guidance furnished by the government.

Economic democracy is a genuine third way that is struc­turally different from classical capitalism and social­ism. It can be viewed as an outcome of evolution starting either from capitalism or from socialism.

A capitalist economy within a political democracy can evolve to an economy of economic democracy by extending the principle of democratic self-determination to the work­place. It would be viewed by many as the perfection of capitalism since it replaces the demeaning employer–employee relationship with ownership and co-entrepreneur­ship for all the workers.

A state socialist economy can evolve into an economic democracy by restructuring itself along the lines of the self-management socialist tradition. It would be viewed by many as the perfection of socialism since the workers would finally become masters of their own destiny in firms organized as free associations of producers.

There is more to an economy and certainly more to a socio-political system than the form of economic enterprise. Yet we have intentionally focused only on the firm—not on broader economic or social questions. This has been quite feasible due to the traditional neglect of the firm in both capitalist and socialist economic theory. In neo-classical economics, the firm is seen as a technologically specified black-box or, from the institutional viewpoint, as a piece of property, a capital asset—not a community of work qualifying for democracy. Socialist theory, from Marx onwards, has been notoriously silent about the “socialist firm.”

First Principles

The Labor Theory of Property

The democratic firm is grounded on first principles, the twin pillars of the labor theory of property and demo­cratic theory.

The analysis began by setting aside what we called the “Fundamental Myth” that residual claimancy is part of the ownership of the means of production. The whole question of the ownership of the new assets and liabilities created in production (which accrue to the residual claimant) has been suppressed in capitalist economics because those assets and liabilities were taken as part of the already-existing owner­ship of the means of production. By simply considering the case where the physical means of production are rented or leased, we can see that the residual claimant appropriating those new produced assets and liabilities could be different from the owner of the means of production. The ownership of the capital used in production only determines to whom the residual claimant is liable for the used-up services of capital.

Having conceptually separated the residual claimant’s role from the capital supplier’s role, we then turned to the normative question of who ought to appropriate those new assets and liabilities created in production. We applied the standard juridical principle that legal responsi­bility should be assigned to the de facto responsible party. Regardless of the causal efficacy of the services of capital and land, only the intentional actions of persons can be de facto responsible for anything. Thus the people involved in a productive enterprise, the managers and workers, are de facto responsible for produc­ing the outputs and for using up the inputs. By the standard juridical principle, they should therefore have the legal liability for the used-up inputs and the legal ownership of the produced outputs, i.e. they ought to be the residual claimant.

This argument is none other than the old “labor theory of property” usually associated with John Locke restated in modern terms using the language of jurisprudence. The argument also makes sense out the peculiar dual life that Locke’s theory has always had; it is taken as the basis of private property as well as the basis for a radical critique of capitalist production. We found that there was no contradiction in that outcome. Labor is the natural founda­tion for private property appro­priation, and capitalist production—far from being “founded on private property”—denies that labor basis for appropriation. In that sense, it is private property itself that calls for the abolition of capitalist production (i.e. the employment relation) so that people will always appropriate the positive and negative fruits of their labor.

This same idea occurs in a rather oblique form in the socialist tradition as the “labor theory of value.” The labor theory of value has always had two rather different inter­pretations: labor as a measure of value, and labor as a “source” of value or, rather, of what has value. The measure version of the labor theory of value has been a complete failure—and, in any case, it had no interesting normative implications. Thus capitalist economists want to stick to the measure version of the theory (since it is a failure) and state socialists also want to stick to it (since it has no implications against state socialism). The alternative source version of the “labor theory of value” is the labor theory of property disguised in “value talk.” It has direct implications against capitalist production in favor of the democratic firm, and it has direct implications against state socialism in favor of the alternative tradition of democratic self-managed market economy.

The end result of this reformulation of the basic issues is that a new “villain” emerges, the employment relation. The villain of capitalist production is not private property or free markets (far from it), but the whole legal relationship of renting, hiring, or employing human beings. It was the employment relation that allowed some other party to hire the workers so that together with the owner­ship of the other inputs, that party would be the residual claimant.

An old inalienable rights argument, originally developed against the self-sale contract, was applied against the self-rental contract, the employment contract. As illustrated by the example of an employee obeying an order to commit a crime, de facto responsible human actions, i.e. labor services, are not factually transferable—so the legal contract to transfer labor is natural-law invalid.

Instead of abolishing the employment relation, state socialism nationalized it. Substituting state ownership of slaves for private ownership would not abolish slavery, and substituting employment of the workers in the name of the “public good” for employment in the interest of “private greed” does not abolish the employment, hiring, or renting of workers.

Only the democratic firm—where the workers are jointly self-employed—is a genuine alternative to private or public employment.

Democratic Theory

The residual claimant has the direct control rights over the production process. The application of democratic principles to work has thus been clouded by the Fundamental Myth that residual claimancy is part of the ownership of the means of production. As the leasing movement in the former Soviet Union discovered, the renting or leasing of capital separates the direct control rights over production from capital ownership.

The ownership of capital only gives the owner an indirect control right, a right to say “No, you may not use the capital,” the right to make the worker into a trespasser. To acquire the direct control and authority over workers, the capital owner must also be an employer. Indeed, a “capitalist” is a capital owner who is also an employer. Without the employment relation, a capital owner is not a “capitalist” but is only a capital supplier to worker-managed firms.

The same logic holds when the capital owner is a corpora­tion. Of course, the shareholders have the control rights over the affairs of the corporation. But it is the employment con­tract or its opposite, a capital leasing con­tract, that determines whether the “affairs of the corpora­tion” include authority over the workers in the production process (when labor is hired in) or simply the leasing out of capital to the workers or some other party undertaking the production process.

Traditional liberalism’s inability to significantly raise the question of applying democratic principles to the workplace (see any standard economics text) has been fostered by the public/private distinction. Democracy governs in the “public” sphere while property supposedly governs in the private sphere. But that misinterprets the rights of property. Property only includes the indirect control right, say, to make a worker a trespasser. Authority or direct control over the worker only comes from the employment relation. Property is only relevant as giving the bargaining power to make the employment contract rather than the capital leasing contract.

Capitalist liberalism has also misrepresented the whole question of democratic or non-democratic government in the public sphere as a question of consent or coercion. That is super­ficial intellectual history (see Ellerman, 199219921992 ) which allows capitalist production to be presented as analo­gous to public democracy since both are based on consent. Marxists typically miss the point by questioning whether or not capitalist production is “really” voluntary. The real point is that there is a whole liberal tradition of apologizing for non-democratic government based on consent—on a volun­tary social contract alienating governance rights to a sovereign, e.g. the Hobbesian pactum subjectionis. The employment contract is the modern limited workplace version of that Hobbesian contract.

The critique of capitalist production is a critique of the vol­untary employment contract, the individual contract for the renting of people and the collective Hobbesian pactum subjec­tionis for the workplace. The critique is not new; it was developed in the Enlightenment doctrine of inalienable rights. It was applied by abolitionists against the voluntary self-enslavement contract and by political democrats against the voluntary contractarian defense of non-democratic government.

Today’s economic democrats are the new abolition­ists trying to abolish the whole institution of renting people in favor of democratic self-management in the workplace.

It might be noted that we have purposely refrained from emphasizing the efficiency arguments customarily used in favor of the democratic firm. Both capitalism and state socialism suffer from the motivational inefficiency of the employment relation. Thus efficiency provides the principal “practical” reason for the two-sided evolution in the direction of greater participation and democracy in the workplace.

But efficiency considerations always leave the structure of rights under-determined. If it is only efficiency that counts, then non-democratic structures can always be designed to try to simulate participative democratic struc­tures (e.g. profit-sharing and participation programs in capitalist firms). If a simulation fails, then there will always be other variations that might provide a better simulation.

Real social change, when it comes, is driven by ideas and principles, not simply by “efficiency considerations.” Absolute government as well as slavery sagged after centuries of inefficiency, but it was their illegitimacy in the light of first principles that drove the democratic revolu­tions and the abolition of slavery in the eighteenth and nineteenth centuries. Thus we have focused on the basic principles that drive towards economic democracy.

The Democratic Firm

The democratic firm was defined by showing how the conven­tional bundle of ownership rights is restructured and reassigned so as to satisfy democratic theory and the labor theory of property.

Democratic theory is implemented in an organiza­tion by treating the ultimate direct control rights, i.e. the voting rights to elect the board, as personal rights assigned to the functional role of being governed.

The labor theory of property is implemented by assigning the rights to the produced outputs and the liabil­ities for the used-up inputs whose net value is the residual or net income to the functional role of working in the enterprise.

Thus the twin pillars of democratic theory and the labor theory of property imply that the two membership rights, the voting and profit rights, should be assigned as personal rights to the functional role of working in the firm. Since the member­ship rights become personal rights, the democratic firm becomes a democratic social institution rather than the traditional piece of property.

The remaining rights to the net value of the corporate assets and liabilities remain property rights represented in the internal capital accounts. The individual accounts represent property originally put in by the workers (e.g. membership fees) and the net value of the fruits of their labor reinvested in the firm.
Restructured Ownership Bundle in a Democratic Firm

Membership rights (#1 & #2) assigned as personal rights to worker’s role.

1. Voting rights (e.g., to elect the Board of Directors),

2. Net income rights to the residual, and

Net asset rights (#3) are property rights recorded in internal capital accounts.

3. Net asset rights to the net value of the current corporate assets and liabilities.

The system of internal capital accounts is not an afterthought. It is an integral part of the structure that corrects the property rights deficiencies of “social property” involved in the self-managed firm.

Worker-owned Companies in the USA and Europe

The best examples of democratic firms in the world today are the worker cooperatives in the Mondragon group of the Basque country in Spain. One of their important social inventions is the system of internal capital accounts which they pioneered over the last quarter century.

Another major example of worker ownership in the West is the employee stock ownership plan or ESOP developed in the United States over the last 20 years and more recently in the United Kingdom. The ESOPs have been heavily promoted in America with tax advantages so that there are now about 10,000 ESOPs covering about 10 per cent of the workforce. The real innovation of the ESOP is allowing the workers to use the leverage of the company to take out a loan to buy stock, and then to have the company pay back the loan as a tax deductible expense. The ESOP also uses a trust to keep the worker shares from being individually salable and thus it provides ownership stability that is important to get the long-term commitment of the workers and managers to the firm.

The lessons of the Mondragon-type worker coopera­tive and of the democratic ESOP were combined in a new model, the hybrid democratic firm, which could be implemented in other countries of the East and West.

Employee Sovereignty in the Japanese Firm

The Japanese-model firm is quite important in the history of the development of the democratic firm because it demonstrates that a firm with employee sovereignty (although without democratic worker ownership) can not only survive but prosper in the modern economy. Instead of being inefficient, it has set the standards in productivity and quality for the rest of the world to follow.

The Democratic Firm and East/West Convergence

In the West, democracy will not forever remain alien to “what people do all day long.” Even without explicit worker owner­ship, many firms in the capitalist world (including Japan) are evolving in the direction of recognizing the workforce as the primary stakeholders or “owners” of the firm. The ESOPs and other worker-owned companies are only the tip of the iceberg in this long-term trend in the direction of the democratic firm.

In the world of transitional economies, centralized state socialism is giving way to social market economies where worker ownership is a major form of ownership.

The East and West are thus showing signs of convergence towards the common ground of the democratic firm.


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* The findings, interpretations, and conclusions expressed in this paper are entirely those of the author and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to the members of its Board of Directors or the countries they represent.

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