The Democratic Firm

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Chapter 7: Self-Management in Former Yugoslavia


The Western press and many Western scholars look at the world in bipolar terms: capitalism or (state) socialism. State ownership and central planning have failed to deliver a modern economy so “socialism” is being abandoned in favor of capitalism. But the reality is more complicated. There are many “socialisms” and there are many “capitalisms.” If “capitalism” means a decentralized economy of independent firms with definite property rights and interrelated by input and output markets, then that also fits certain types of “socialism.”

There are two broad traditions of socialism: state socialism and self-management socialism. State socialism is based on government ownership of major industry, while self-management socialism envisions the decentralized firms being worker self-managed and not owned or managed by the government [see Horvat et al., 1975].

It is a thesis of this book that an economic democ­racy, a market economy of democratic firms, represents a common ground for the East and West. There are forces of convergence towards that common ground from both sides. An economic democracy could be seen as the humanization and democratiza­tion of a market economy where the renting of workers is universally replaced by democratic membership in the firm. An economic democracy can also be represented as the result of decentralizing and democratizing a state socialist economy in favor of a market economy of self-managing firms.

Yugoslavian Self-Management: Pitfalls of a Pioneer

The current economic reforms in the transitional economies actually began with Yugoslavia (see Sacks, 1983; Estrin, 1983; or Prasnikar and Prasnikar, 1986) which from the 1950s moved from the state socialist model towards a model of self-management socialism.
The only genuinely new model—i.e. different from the various versions of the basic Soviet-type model—already in existence, is the Yugoslav model. [Nuti, 1988, p. 357]
Being a pioneer is not all glory; the pioneer may stumble many times like one who walks at night holding the lantern behind him—of no help to himself but illuminating the path for those who follow.

In the former Yugoslavia, there was no centralized command plan­ning over production. The enterprises were embedded in factor and output markets. The workers in each enterprise elected the workers’ council which, in turn, through a committee structure selected the enterprise director. Legally, the director is responsible to the workers’ council and the collectivity of workers, but there were strong indirect influences from the League of Communists (the party) and/or the various levels of government. The assets of the enter­prise were considered to be “social property.” Even though the assets may have been built up by retained earnings (that could have been paid out as pay bonuses), the enterprise only had use rights over the assets and the workers have no individualized claim against the company for the value of those assets.

In the Yugoslav self-managed firm, the two member­ship rights, the control rights and the net income rights, were at least partially assigned as personal rights to the workers in the firm. The assignment of the control rights to the working collectivity of the firm was attenuated by the hege­mony of the League of Communists in the surrounding social structure, e.g. in the local government. The assign­ment of the net income to the workers was also attenuated since the income that accrued to the workers was a function of the disposition of the income. If the income was paid out in wages and bonuses then it accrued to the workers. If, however, the income was retained in the firm, then it reverted to “social property” and the workers lost any re­coupable claim on it.

The weakness in the net income rights can be traced to the treatment of the third right in the traditional owner­ship bundle, the rights to the value of the net assets of the firm. That right was treated as disembodied “social prop­erty.” The problems in the former Yugoslav economy, of course, could not be traced to any one source. But surely one of the most important sources of malfunction was this social property equity structure which had broad ramifications for efficiency and motivation throughout the economy.

If retained earnings become social or common prop­erty, the workers had less of a long-term interest in the company. Reinvestment of earnings to buy a machine might not penal­ize younger or middle-aged workers who would be around to depre­ciate the machine. But an older worker near retirement or a worker thinking about leaving the firm would be simply losing what could otherwise be a pay bonus. Since the different responses are due to different time horizons with the firm, the original property rights deficiency is called the “horizon problem” of the Yugoslav firms [see Furubotn and Pejovich 1970, 1974; Ellerman, 1986b; or Bonin and Putterman, 1987].

It might be noted parenthetically that there is a whole academic literature on what is called the “Illyrian firm” [see Ward 1967; or Vanek, 1970] named after the Roman province that became part of Yugoslavia. The main peculiarity of this model is that it assumes the firm would expel members when that would increase the net income of the surviving members. The resulting short-run perversities have endeared the model to capitalist economists. Yet the Illyrian model has been an academic toy in the grand tradition of much of modern eco­nomics. The predicted short-run behavior had not been observed in Yugoslavia or else­where, and worker-managed firms such as the Mondragon cooperatives take membership as a short-run fixed factor [see Ellerman, 1984b]. Moreover, in spite of intensive aca­demic cultivation in the Illyrian field for almost two decades, not a single practical recommendation has emerged for the structure of real world labor-managed firms—other than “Don’t start acting like the Illyrian model.” Hence we will continue to treat the Illyrian model with its much-deserved neglect.

The valuable analysis of the property rights defi­ciencies in the “social property” structure of many labor-managed firms is often packaged together with the perver­sities of the Illyrian model in academic literature. Yet the two are quite inde­pendent. Property rights problems arise with labor taken as a fixed factor and for a wide range of firm objectives. Unlike the Illyrian model, the academic analysis of the property rights problem in labor-managed firms is an important contribution to the theory and practice of workers’ self-management.

With social property, the incentive is to distribute all net earnings as pay (wages and bonuses) and to finance all invest­ment with external debt. The resulting consumer de­mand and the upward push on money supply to satisfy the demand for loans will both fuel inflation—which had become a serious problem in the former Yugoslavia.

The social property structure also creates an unneces­sary bias against bringing in new workers. Economic neces­sity as well as government regulation in the case of Yugoslavia would lead social property firms to retain some earnings to finance invest­ment in firm assets (in spite of the pressure to finance all investment by borrowing). One way the workers could try to recoup “their investment” was through higher wages—which, in part, were an implicit rent on the new assets. Any new workers would receive the same “wage” for the same work but would not have contributed to that investment. Allowing new workers in would be forcing the old workers to share the rent on their implicit equity. Thus the social property structure led to a bias against new workers—who often had to find jobs as “guest workers” in Northern Europe. With the system of internal capital ac­counts, the old workers receive the rent or interest on their explicit account balance, that rent is not shared with new workers, and thus that forced-rent-sharing bias against new workers is removed. The problems with social property equity structure can be solved using the Mondragon-type individual capital accounts.

A Decentralizing Model for Restructuring Large Firms

The restructuring of ownership should be accompanied by splitting up and decen­tralizing the huge firms so as to reduce socialist gigantism at one end of the scale and to fill the need for small and medium-sized firm at the other end at the other end of the scale. The resulting worker-owned firms should be medium-sized or small businesses that are human-scaled, more competitive, and perhaps even entrepreneurial. They will be joined together as in a keiretsu or as in Mondragon in a federation to keep some of the benefits of acting together.

We will sketch a restruc­turing model might be used in transitional countries. The details might change with implementation since the actual legal con­straints on restructuring will only be discover­ed as the restructuring takes place.

The restructuring can be divided into steps:

(1) The workers and managers in the original socialist firm are divided into divisions perhaps with some remaining in a central unit.

(2) The people in each division, as independent citizens, set up joint stock companies with each person making a small but mandatory contribution of cash.

(3) The same people in the Workers’ Assembly of the original socialist firm then vote to convert the firm into a joint stock “apex” company and to issue its stock to the various companies set up by the divisional members in return for some of their cash. The value of the original assets is balanced by the collective equity account, so the value of the original assets would not determine the issuing value of the new stock. The stock could be issued—as with a new company—for an arbitrarily set cash price. Each of the smaller divisional firms might own a part of the new apex company in propor­tion to the number of workers in the divisional firm. Some of the shares in the apex firm might be retained as worker shares for the people who remain in the original firm.

Separate Worker-owned Divisional Firms

(4) The separate divisional firms and the remaining parent firm join together in a federation with the parent firm as the apex organization performing appropriate functions such as strategic planning, marketing for the group, import-export for the group, and settling conflicts between the divisional firms. The money paid back to the apex firm would allow it to also act as a development bank for the group.

(5) Then each of the divisional firms buys in an ESOP-type credit transaction the assets it needs for its operations from the apex firm. The apex firm might also obtain some of the preferred (profit-sharing) or common shares in the divi­sional firms in exchange for the assets.

(6) The operations of the divisions is switched over to the separate democratic worker-owned companies.

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