The Democratic Firm

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Chapter 4: Worker Cooperatives

Introduction: Worker Ownership in America

In the second half of the nineteenth century, the first American trade unions of national scope, the National Trade Union and the Knights of Labor, saw their ultimate goal as a Cooperative Commonwealth where the wage system would be replaced by people working for themselves in worker cooperatives. Around the turn of the century, these reform unions were replaced by the business unions which accepted the wage system and sought to increase wages and benefits within that system through collective bargaining. During the Depression, there was an upsurge of self-help cooperatives, and after World War II there was a burst of worker cooperative development in the plywood industry of the Pacific Northwest. The plywood cooperatives used a traditional stock cooperative structure which mitigated against their long term survival as cooperatives.

In recent decades there have been two trends in American worker ownership, one minor and one major. The minor trend was the development of worker cooperatives that grew out of the civil rights and antiwar movements of the 1960s. The worker cooperative or collective was the form of business that suited the alternatives movement of the 1970s and 1980s. Many of the worker cooperatives looked more to the Mondragon cooperatives in the Basque country in Spain than to the American past for their inspiration. We will analyze the Mondragon-type worker cooperative in this chapter, not because it has been numerically important in the American economy, but because it represents a relatively pure form of democratic worker ownership.

The major trend in American worker ownership has been the development of the employee stock ownership plans or ESOPs. The ESOP movement offers many lessons about worker owner­ship, both positive and negative. It is a very interesting case study in the rise of significant worker owner­ship in the midst of a capitalist economy. Of particular interest are the diver­gences between the public ideology of the ESOP movement and the reality of the ESOP structure. ESOPs are discussed in the next two chapters.

Worker Cooperatives in General

Existing worker-owned companies will be analyzed by considering the restructuring (or lack of it) for the conven­tional ownership bundle of rights: (1) the voting rights, (2) the profit or residual rights, and (3) the net asset rights.

All cooperatives have two broad characteristics:

(1) voting on a one-person/one-vote basis, and

(2) allocation of the net savings or residual to the members on the basis of their patronage.

Patronage is defined differently in different types of cooper­atives. For example, in a marketing cooperative patronage is based on the dollar volume bought or sold by the member through the cooperative. A worker cooperative is a co­operative where the members are the people working in the company, and where patronage is based on their labor as measured by hours or by pay. Thus a worker cooperative is a company where the membership rights (the voting rights and the profit rights) are assigned to the people working in the company—with the voting always on a one-person/one-vote basis and the profit allocation on the basis of labor patronage.

Traditional Worker Stock Cooperatives

The most controversial feature of cooperative structure is the treatment of the third set of rights, the net asset rights. How do the members recoup the value of retained earnings that adds to the net asset value? Some cooperatives treat the net asset value as “social property” that cannot be recouped by the members (see the section below on common-ownership firms). Other cooperatives used a stock mechanism for the members to recoup their capital. In the United States, the best known examples of these worker stock cooperatives are the plywood cooperatives in Oregon and Washington [see Berman, 1967 and Bellas, 1972].

The plywood cooperatives use one legal instrument, the membership share, to carry both the membership rights (voting and net income rights) and the member’s capital rights. A worker must buy a membership share in order to be a member, but the worker only gets one vote even if he or she owns several shares. Moreover, the dividends go only to the members but are based on their labor patronage. In a successful plywood co-op, the value of a membership share could rise considerably. For example, in a recent plywood co-op “offer sheet,” membership shares were offered for $95,000 with a $20,000 down payment. New workers often do not have the resources or credit to buy a membership share so they are hired as non-member employees, which recreates the employer–employee relationship between the member and non-member workers.

When the original cohort of founding workers cannot sell their shares upon retirement, the whole cooperative might be sold to a capitalist firm to finance the founders’ retirement. Thus the worker stock cooperatives tend to revert to capitalist firms either slowly (hiring more non-members) or quickly (by sale of the company). Jaroslav Vanek has called them “mule firms” since they tend not to reproduce themselves for another generation.

In a democratic labor-based firm, the membership rights (voting and profit rights) are partitioned away from the net asset or capital rights, and the membership rights become personal rights attached to the workers as workers. A new social invention, the Mondragon-type internal capital accounts, is used to carry the capital rights of the members. The mistake in the stock cooperatives is that they use one instrument, the membership share, to carry both the mem­bership and capital rights. The new workers who qualify for membership based on their labor nevertheless cannot just be “given” a membership share (carrying the membership rights) since that share also carries essentially the capital value accruing to any retiring member.

With the system of internal capital accounts, a new worker can be given membership (after a probationary period such as six months) but his or her account starts off at zero until the standard membership fee is paid in (for exam­ple, more like one or two thousand dollars than $95,000). The firm itself pays out the balances in the capital accounts either in cash or in negotiable debt instruments such as perpetuities or participating debt securities.

Since the workers do not acquire membership based on their labor in these traditional worker stock cooperatives, they are not labor-based democratic firms. They represent a confused combination of capitalist features (membership based on share ownership) and cooperative attributes (one vote per member).

Common-Ownership Firms in England

A labor-based democratic firm is a firm that assigns the membership rights (the voting and residual rights) to the functional role of working in the firm. But there are two different ways to treat the third rights, the right to the net asset value. Some democratic firms treat the net asset value completely as social or common property, while other demo­cratic firms treat it as partially individualized property.

The common-ownership firms in the UK or the former Yugoslavian self-managed firms are examples of worker-managed firms which treat the net asset value as common or social property. These firms do assign the membership rights to the functional role of working in the firm, but deny any individual recoupable claim on the fruits of past labor reinvested in the firm. Most of the worker cooperatives in the United Kingdom today are organized as common-owner­ship cooperatives.

There are a number of problems with the social property or common-ownership equity structure which can be resolved using the Mondragon-type individual capital ac­counts. We consider here some of the problems in Western firms with this social property equity structure. The related difficulties in the Yugoslav self-managed firms will be considered later.

The “common-ownership” equity structure has some rather curious ideological support in the United Kingdom. Having a recoupable claim on the net asset value of the company is considered as illicit in some circles. The reason is far from clear. Perhaps the antipathy is to a capital-ist equity struc­ture where the membership rights are treated as “capital.” But then the antipathy should not extend (as it often does) to the Mondragon-type cooperative structure where the member­ship rights are personal rights attached to the functional role of working in the company.

Perhaps there is a lack of understanding that the only capital-based appreciation on the capital accounts is interest which has always been allowed in cooperatives. The only other allocations to the capital accounts are the labor-based patronage allocations, but those allocations are analogous to depositing a wage bonus in a savings account. A deposited wage bonus increases the balance in the savings account but it is not a return to the capital in the account. An internal capital account is a form of internal debt capital. Apparently there is no general antipathy in common-owner­ship companies to workers having explicit debt claims on retained cash flows. The largest common-ownership com­pany, the John Lewis Partnership, has “paid out” bonuses in debt notes to be redeemed in the future. The total of the outstanding debt notes for each member would be a simple form of an internal capital account.

The social property equity structure is best suited to small, labor-intensive, service-oriented cooperatives. None of the complications involved in setting up, maintaining, and paying out internal capital accounts arise since there are no such accounts. Since there is no recoupable claim on retained earnings, the incentive is to distribute all net earnings as pay or bonuses, and to finance all investment with external debt. But any lender, no matter how sympathetic otherwise, would be reluctant to lend to a small firm which had no incentive to build up its own equity and whose members had no direct finan­cial stake in the company.

Firms which have converted to a common-ownership structure after becoming well-established (e.g. Scott Bader Commonwealth or the John Lewis Partnership in England) can obtain loans based on their proven earning power, but small startups lack that option. Thus the use of the common property equity structure in small co-ops will unfortunately perpetuate the image of worker cooperatives as “dwarfish,” labor-inten­sive, under-financed, low-pay marginal firms.

The system of internal capital accounts in Mondragon-type cooperatives is not a panacea for the prob­lems of the worker cooperatives. But it does represent an important lesson in how worker cooperatives can learn from their past experiences to surmount their problems, self-inflicted and otherwise.

Mondragon-type Worker Cooperatives

The Mondragon Group of Cooperatives

The Mondragon worker cooperatives in the Basque region of Northern Spain provide one of the best examples of worker cooperatives in the world today. The first industrial cooperative of the movement was established in 1956 in the town of Mondragon. Today, it is a complex of around 100 industrial cooperatives with more than 20,000 members which includes the largest producers of consumer durables (stoves, refrigerators, and washing machines) in Spain and a broad of array of cooperatives producing computerized machine tools, electronic components, and other high technology products. The cooperatives grew out of a technical school started by a Basque priest, Father Jose Arizmendi. Today, the school is a Polytechnical College which awards engineering degrees.

The financial center of the Mondragon movement is the Caja Laboral Popular (CLP), the Bank of the People’s Labor. It is a cooperative bank with 180 branch offices in the Basque region of Spain. The worker cooperatives, instead of the individual depositors, are the members of the Caja Laboral Popular. The bank built up a unique Entrepreneurial Division with several hundred professionally trained mem­bers. This division has in effect “socialized” the en­tre­preneurial process so that it works with workers to systematically set up new cooperatives (see Ellerman, 1984a). The division is now split off as a separate cooperative, Lan Kide Suztaketa or LKS.

The CLP is one of a number of second-degree or super­structural cooperatives which support the activities of the Mondragon group. There is also:

— Arizmendi Eskola Politeknikoa, a technical engineering college which was the outgrowth of the technical school originally set up by Father Arizmendi;

— Ikerlan, an advanced applied research institute that develops applications of new technologies for the cooper­atives (for example CAD/CAM, robotics, computerized manufacturing process control, and artificial intelligence);

— Lagun-Aro, a social service and medical support cooper­ative serving all the cooperators and their families in the Mondragon group; and

— Ikasbide, a postgraduate and professional management training institute.

The whole Mondragon cooperative complex has developed in a little over 30 years. It has pioneered many innovations, including the system of internal capital accounts. A worker’s account starts off with the paid-in membership fee, it accrues interest (usually paid out currently), and it receives the labor-based allocation of retained profits and losses. Upon termina­tion, the balance in a worker’s account is paid out over several years. There is also a collective account which receives a portion of retained profits or losses. The collective account is not paid out; it is part of the patrimony received by each generation of workers and passed on to the next generation [for more analysis, see Oakeshott, 1978; Thomas and Logan, 1982; Ellerman, 1984a; Wiener and Oakeshott, 1987; or Whyte and Whyte, 1988].

Implementing the Mondragon-type Co‑op in America

A Mondragon-type worker cooperative is a labor-based worker cooperative with a system of internal capital accounts. There are several ways to implement this legal structure in the United States. A firm can incorporate under standard business corporation law and then internally restructure as a Mondragon-type worker cooperative using a special set of by-laws [e.g. ICA, 1984].

The key to the by-law restructuring of a standard business corporation as a Mondragon-type worker coopera­tive is to partition the conventional bundle of owner­ship rights attached to the shares so that the membership rights can be transformed into personal rights assigned to the workers. Since the net asset rights need to be partitioned off from the membership rights, two instruments are required (unlike the one membership share in the traditional stock cooperatives). Thus either the net asset rights or the membership rights must be removed from the equity shares in the restructured business corporation. The net asset rights are separated off from the shares, and kept track of using an­other mechanism than share ownership, namely, the inter­nal capital accounts.

After a probationary period (typically six months), an employee must be accepted into membership or let go (the “up or out rule”). If accepted, the worker is issued one and only one share, the “membership share.” Membership has obligations as well as rights. Just as a citizen pays taxes, so a member is required to pay in a standard membership fee usually out of payroll deductions. This forms the initial balance in the member’s internal capital account. When the member retires or otherwise terminates work in the company, the membership share is forfeited back to the firm. The person’s internal account is closed as of the end of that fiscal year, and the closing balance is paid out over a period of years.

The by-laws require that the membership share is not trans­ferable to anyone else. The company issues it upon acceptance into membership, and the company takes it back upon termination. Since the share is not marketable, it has no market value. It functions simply as a value-less membership certificate. Having two membership shares would give one no more rights than having two ID cards or two identical pass­ports. One would just be a copy of the other. In this manner, the allocation of the shares is transformed from a property rights allocation mechanism (whoever buys the shares) to a personal rights allocation mechanism (assigned to the functional role of working in the firm beyond the probationary period).

Since the value has been stripped away from the share-as-membership-certificate, the internal capital ac­counts are created to take over that function of recording the value to be ultimately paid back to the member. That value balance remains a property right representing the value of the members’ paid-in membership fees, the reinvested value of the fruits of their labor, and the accumulated interest. If a member dies, the membership rights (as personal rights) revert to the firm while the balance in the person’s capital account would be paid out to the person’s estate and heirs.

In America, corporations are chartered by state law, not federal law, so there are fifty state corporate statutes. The cooperative by-laws could be used in a business corporation in any of the states. However, some states have now passed special statutes for Mondragon-type cooperatives using internal capital accounts. The first worker cooperative statute in America explicitly authorizing the Mondragon-type system of internal capital accounts was codrafted by ICA attorney Peter Pitegoff and the author, and was passed in Massachusetts in 1982 [see Ellerman and Pitegoff, 1983]. Since then, mirror statutes have been passed in a number of other states (such as Maine, Connecticut, Vermont, New York, Oregon, and Washington). Similar legislation is being prepared for other states. A British version of the statute has been accepted in Parliament as Table G of the Companies Act.

Risk Diversification and Labor Mobility

There are two conventional arguments against worker owner­ship that need to be considered in light of the Mondragon experience. One argument is that worker owner­ship impedes the birth and death of firms by cutting down on labor mobility. The other argument is that worker owner­ship forces the workers to bear too much risk since they can­not diversify their capital in a large number of enterprises.

Both arguments tend to assume that the approach to these problems in a capitalist economy is the only approach. For instance, labor mobility—by contracting or closing some firms and starting or expanding others—is not the only mechanism of industrial change. In Mondragon, management planning takes the membership in the firm as a given short-run fixed factor not under the discretionary control of the management [see Ellerman, 1984b]. When a business is failing in its current product line, the response is not to contract the firm by firing workers. The response is to convert the business in a deliberate manner to a more profitable line. The crucial element in the conversion is the socialization of entre­preneurship through the CLP’s Empresarial Division-LKS. The Empresarial Division-LKS uses its broad knowledge of alternative product lines to work with the managers on the conversion. Thus the social function of allowing old product lines to die and promoting new products is carried out in a manner that does not presuppose labor mobility.

The other argument is that, under worker ownership, the workers cannot reduce their risk by diversifying their equity capital holdings. Since a worker typically works in only one job, attaching equity rights to labor allegedly does not allow diversification of risk. All the worker’s eggs are in one basket. But there are other ways to address the risk reduction problem, namely the horizontal association or grouping of enterprises to pool their business risks. The cooperatives are associated together in a number of regional groups that pool their profits in varying degrees. Instead of a worker diversifying his or her capital in six companies, six companies partially pool their profits in a group or federation and accom­plish the same risk-reduction purpose without transfer­able equity capital.

Suppose that with some form of transferable equity claims a worker in co-op 1 could diversify his or her equity to get (say) 50 per cent of firm 1’s average income per worker and then 10 per cent each from firms 2 through 6 to make up his or her annual pay. The alternative is risk-pooling in federations of cooperatives. The six cooperatives group together so that a member gets 40 per cent of average income per worker from his or her firm plus 60 per cent of the average of all the six firms. A co-op 1 worker would receive the same diversified income package as the previous annual pay obtained with transferable equity claims. Thus transferable equity capital is not necessary to obtain risk diversification in the flow of annual worker income.

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