Codetermination: A Seat At The Table

Episode Summary

Last year Elizabeth Warren proposed the controversial Accountable Capitalism Act. One of its most talked about proposals was focused on "codetermination." Kate & Luigi explain how it works, its effectiveness and examine one country that's been trying it out since the 1950s.

Episode Notes

Last year Elizabeth Warren proposed the controversial Accountable Capitalism Act. One of its most talked about proposals was focused on "codetermination." Kate & Luigi explain how it works, its effectiveness and examine one country that's been trying it out since the 1950s.

Episode Transcription

Kate: Last year, Elizabeth Warren proposed a controversial bill aimed directly at corporations.

Speaker 2: Elizabeth Warren is introducing a new bill today: The Accountable Capitalism Act. It would require corporations with at least a billion dollars in annual revenue to answer to stakeholders, and therefore, not just to shareholders. By stakeholders, she’s talking about, for example, employees. It would require employees to have more say in company policy.

Luigi: The bill contained a lot, as we discussed in the previous episode, but one of the standout proposals was a focus on codetermination, essentially forcing corporations to allow employees to have a say in how the company operates.

Elizabeth Warren: This is saying to businesses, “Hey, what you need is, you need a little more diversified board, and you need CEOs and top executives who are incentivized, not just to think in the next quarter, but to think longer-arc about how this business works.” That’s going to be good for everybody.

Kate: The bill caused a lot of debate. Should companies focus on stakeholders or shareholders? And should the government be making companies give more power to employees?

Speaker 3: The last thing I want is Elizabeth Warren telling companies what they can or cannot do. The private market will reward those that take care of their stakeholders.

Luigi: I am Luigi Zingales at the University of Chicago.

Kate: And I’m Kate Waldock from Georgetown University.

Luigi: And this is Capitalisn’t, a podcast on what is working in capitalism today.

Kate: And, most importantly, what isn’t.

On today’s episode, we’re going to take a look at the broader ideas around the concept of codetermination, its effectiveness, and we’re going to look at one country in particular that’s been trying it out since the 1950s.

We asked on a prior episode whether people would be interested in hearing more about codetermination, and we got a lot of responses that said, “Hell yeah, please talk about codetermination.” So, you asked, and we’re responding.

Luigi: The big support for our episode comes from the fact that the idea of codetermination is incredibly popular, even in the United States. Not surprisingly popular among Democrats, but even Republicans seem to like it. Kate, to begin with, I think it’s important to start by defining the term. So, what is codetermination?

Kate: I think we should start broadly. The idea of codetermination is just workers and managers or CEOs cooperating to make corporate decisions. They are codetermining things. I think that’s a little bit different than what most Americans have in mind. Americans have in mind this very specific system in which workers sit on corporate boards.

Luigi: Why is it such a big deal to have workers on the board of directors, Kate?

Kate: I think that this is a pretty deep, fundamental question that cuts to the core of, what is capitalism? If you think about production from an economic perspective, how do we make things? There’s two elements. There’s labor and there’s capital, where capital is machines and computers and stuff like that, and labor is labor—workers, obviously. Now, it’s not clear who should necessarily get profits. Should profits go to labor, or should profits go to capital?

The whole idea behind capitalism is that the people who own the machines and the computers and stuff like that, they’re the ones who should get the profits. Whereas laborers should just get paid a fair wage that’s determined by the labor market, assuming that the labor market works. Now, if you’re a person who supports codetermination, or specifically having worker representation on boards, then you might support it for two different reasons. One, you just might not like capitalism. You might believe that laborers should be allowed to share in the profits of the corporation. 

Or, two, even if you support pure capitalism, you might think that labor markets don’t really work perfectly. So, there are what economists call frictions. That might lead to laborers not getting paid a fair wage, or having to work in unfair conditions or unfair hours or things like that, so maybe we need codetermination. Or, if you support codetermination, maybe you need to have a system like that in order to restore labor markets to efficiency.

Luigi: Kate, I feel that your version of the firm is a bit 19th-century, because if I’m an airline, I don’t own the planes. The planes are owned by the company leasing the planes. I probably don’t own anything, so the reason why I get the profits is because I’m the residual claimant, I’m the equity owner. So, it doesn’t necessarily have to do with the issue of the ownership of physical assets, so much as it’s to do with, who has the residual claim?

Kate: Right, so I think it’s easier to latch onto the idea of capital being a machine, but you’re totally right that in today’s society, capital means a contractual claim to whatever profits are left over after you pay your workers and your suppliers and things like that.

Luigi: But can you explain to our listeners, how does it really work in Germany? Because I imagine that many of them have no idea how this codetermination works.

Kate: The idea behind codetermination has actually existed for a really long time, since the 1800s. The first evidence that we saw of codetermination was actually instituted in Germany after World War I. Then, workers fought with the fascists, and Hitler got rid of that system. Then, after World War II, a bunch of laws were passed that made worker representation on the supervisory board mandatory for certain firms.

Luigi: As most listeners probably know, in the United States, the ultimate decision body for a corporation is the board of directors. In Germany, the situation is a bit more complicated, because there are, in fact, two boards of directors. There is the management board, and there is the supervisory board, where the management board makes the day-to-day decisions, and the supervisory board is making more of the long-term decisions to appoint the people on the management board, to appoint the auditors, inspect the books, so on and so forth.

Kate: The way that this works now, with a bunch of laws that were passed, the most recent one being the Codetermination Act of 1976, is that for really large firms, so firms with over 2,000 employees, there’s equal representation on the supervisory board between workers and shareholders. In terms of the number of directors for large companies, there’s equal representation. For medium-sized companies, workers only get to appoint a third of directors.

There’s another important element to codetermination that I think gets less attention from Americans, which is that there are also these work councils, which aren’t necessarily unions. So, unions exist in Germany as well. They’re large. They’re powerful. But within each firm, there is a work council, and these groups are responsible for negotiating with management directly. Firms with more than five employees can elect a work council. Those with over 200 employees actually have to have at least one full-time work council member who is paid for by the company. These people negotiate wages, work hours, safety measures, retirement plans, things like that. Some scholars actually argue that the existence of these work councils is more important than workers’ roles on the supervisory board.

Luigi: Not surprisingly, these different institutional arrangements have generated a lot of research, trying to figure out whether it makes a difference, whether the workers are more productive, they’re paid better, companies are more profitable, so on and so forth. We’re going to review now some of this evidence. But I want to give a warning. In economics, we’re pretty good at figuring out the effect of something, if we can control for the reasonable alternative.

Unfortunately, here, all the big German firms are being forced to do that, so it’s hard to identify the counterfactual, because using a French or a British firm as a counterfactual will not be particularly successful. Even the best papers that look at the choice of some firms not to adopt the partial codetermination, the one with a third of the board members, the fact that this is a choice might be correlated with a lot of other variables. So, is the fact that we find the difference a result of the codetermination, or is it the fact that firms that chose not to follow the rule are intrinsically different firms? Now, with all these caveats, what is your reading of the data?

Kate: I guess we’ll start with productivity. One of the most natural questions is, does codetermination make workers more productive? I was able to find four papers that showed a positive relationship, two papers that found a negative relationship, and two papers that showed that there was no correlation between codetermination and worker productivity.

I’d like to point out one paper in particular, which was from 2010, so it’s the most recent one that I was able to find in this literature. It’s by Boneberg. I think it’s still a working paper, unfortunately. But in order to address this causality issue, she compares LLCs in Germany, for which, even though the same sorts of rules exist, only 50 percent actually follow this rule. I think that there’s sort of an opt-in system, so there’s many reasons to believe that this sort of experimental setting is not actually perfect. But her finding is that the existence of board codetermination leads to more productivity. If you just look at the raw numbers, I think that there’s some evidence, even though it’s not perfect evidence, that codetermination makes workers more productive.

Luigi: Yeah, but it’s like comparing firms who pay taxes with firms that don’t pay taxes, and saying that firms that pay taxes are more productive. I think that if you don’t follow a rule, there is a reason why you don’t follow a rule. Either it’s because you want to abscond with part of the product, or you are not particularly well managed. So, I think we are really comparing apples with oranges here.

Kate: Yeah, I think that’s a totally fair criticism, which is why we’re not trying to argue that codetermination definitely leads to more productivity. If you just look at the numbers, four versus two, it seems like there’s a slight indication that there’s a positive relationship with productivity. But you’re right, that particular study does have some empirical issues, as do they all.

Luigi: But what about profitability?

Kate: The jury is really out on that one. There’s one paper that indicates a positive relationship, one that indicates a negative relationship, and then a few that indicate no significant relationship. So, I just don’t think that codetermination affects profitability that much.

Luigi: But most importantly, I think that many people in the United States think about codetermination as a way to increase wages. Is there any evidence that codetermination does increase wages?

Kate: You’d think that that would be the first thing that people would study, and where the overwhelming number of papers were, and I actually couldn’t find it.

Luigi: Actually, it’s interesting, because I think in an earlier version of a paper by Gorton and Schmid before it was published, they say that workers are overpaid and overstaffed in firms that have codetermination. But I didn’t see it in the published version, so I don’t know what happened to it. I’m old and cynical, and so when an obvious result is not even discussed, I infer that it’s not there, because as a researcher, you have a strong incentive to look for it. You have a strong incentive to tout a result when it’s there. If you don’t mention it, it must not be there.

Kate: Well, I think that that’s an important point. One of the results that I do believe is that there’s actually a negative relationship between codetermination and stock price. Going back to the Gorton and Schmid paper that you just mentioned, they compare firms that have this one-third rule, a third of the board members are elected by workers, versus larger firms that have the one-half rule that says half of the board members are elected by workers. They find that firms with the one-half rule actually have a 31 percent lower stock price. This is backed up by another paper.

Now, there are also several papers that indicate that there’s no significant relationship between codetermination and stock prices, so it’s not 100 percent clear that there’s necessarily a negative relationship. But to the extent that you do believe that codetermination leads to lower stock prices, then that necessarily means that labor must be receiving some of that benefit. Right?

Luigi: No, you can just be inefficient. If you have your classroom run by the janitors, probably the classroom is not run very well. It’s not obvious that the janitors are getting your salary. It’s just that it is a mess.

Kate: OK, so if we accept the fact that productivity is not worse off, and if we accept the fact that profitability is probably unchanged, but stock prices are lower, that to me is an indication that labor is capturing some of those profits.

Luigi: No, it could be that you invest in things poorly. You don’t expand in the right sector. You don’t take advantage of a new investment opportunity.

Kate: You would think that would manifest in profitability and productivity.

Luigi: No, so suppose that I am Nokia. Instead of expanding from the pulp industry to the cell phone, I remain in the pulp industry. I am very profitable in the pulp industry, but I miss a great opportunity to expand into cell phones at the right time. You don’t see that in profitability numbers. But you do see it in the stock price.

Kate: OK, that’s a fair point. There’s a lot of moving parts here. There’s also the question of, how does codetermination affect investment? Once again, the jury is out here. There’s one paper that seems to suggest that it leads to more R&D. There’s another paper that shows that it has no significant effect on the number of patents that firms file. So, actually, I don’t think that there’s anything showing that there’s a negative relationship between codetermination and investment, but again, this is all very hazy.

Luigi: You have done a fantastic job summarizing the academic literature. What I would like to do is dispel the notion that having workers on the board makes companies behave better on average. I was actually going through the list. It’s quite shocking how bad many German companies are. I start with a famous corruption case of Volkswagen in 2005, 2007, where, actually, the company was paying the worker representatives in cash and with prostitutes, so that they would do what they wanted. Not to mention the corruption—

Kate: Leave it to Luigi to come up with an example that involves prostitutes.

Luigi: Wait, wait, it’s not finished. Then, Daimler-Chrysler and Siemens were both accused and found guilty of corruption of officials. Now, when it comes to pollution, we all remember Volkswagen and what they did in terms of pollution, so they’re not particularly good with the environment. And they’re not good in terms of competition. ThyssenKrupp actually was convicted in 2006 of a major case of price fixing that involved most of Europe. You would expect at least that they would care about worker safety. But do you know that the former CEO of ThyssenKrupp has been sentenced to nine years and eight months in jail for the culpable murder of seven steel workers?

Kate: I did not know that. I feel like we’re going on a conspiracy theory tangent.

Luigi: Now, maybe it’s because the workers were in Italy, so they only care about German workers, and not about the other workers, but—

Kate: Oh, that is definitely true, yeah. No, one thing that’s clear about German codetermination is that it only applies to German workers. An interesting point that you raised on an earlier episode was, how do you practically implement this in a world that’s globalized? If we were to implement board codetermination in the United States, what does that mean for US multinationals that employ potentially a majority of their workers abroad?

Luigi: I think this is a huge issue, because if you go by the number of workers, probably no US workers would get a majority. But also, I think that this tension, in my view, highlights the fundamental problem of worker-managed firms. It’s just the idea of cooperatives and worker-managed firms is beautiful. But in practice, it runs into the problem that not all workers are created equal. They have very conflicting objectives. Pretty quickly, either you have the dominance of one group over the other, or you have continuous infighting that makes the one in Congress look easy. So, I think that there is a reason why the cooperative system tends to be limited to either very small firms, or firms where the workers are super homogeneous, because the moment they’re not homogeneous, these tensions are going to rip apart a firm. I think the tension between more-educated US workers and less-educated, non-US workers will be enormous.

Kate: Yeah, so to this point, I think it’s good to clarify. The German system of codetermination only really applies formally to German workers. This is definitely an issue that’s come up for Germany itself. There have been cases in which companies have been able to reach a harmonious solution. You could argue that the US, if we were to adopt codetermination, could have a similar system, where really the rules only apply to US workers. But US workers could coordinate and reach some sort of benevolent solution with foreign workers. It’s not obvious to me that that would necessarily happen.

Kate: This is an idea that isn’t mine. It was put forth by Viet Dinh. The argument is that there’s actually a potential downside here, which is that if you have US workers having power, and then you have US shareholders against them, and then you have foreign workers, you create a situation in which there are incentives for the US shareholders to collaborate with foreign workers against the US workers. This can lead to even great tensions in the system. The fact that we exist in a globalized, multinational world, that just creates even more challenges for the system of codetermination. I think that that’s an issue that Germany has been grappling with.

I think that German companies, and there’s research showing this, have been increasingly establishing their legal domiciles abroad, so that they can avoid these codetermination laws, even if they’re headquartered in Germany.

Luigi: But so, I think jumping to the conclusion that having workers on boards is great ... I’m skeptical, let’s put it this way. The question is: Why is there so much excitement in the United States about it?

Kate: That is a great question. I think that Americans, particularly on the far left, tend to fetishize Europe and socialism in Europe and worker rights in Europe. And so, there’s this idea that codetermination has led to all this harmony between workers and managers in Europe, and that’s why they haven’t elected someone like Trump yet, at least in Germany.

Regardless of how you feel about whether codetermination has been successful, one thing that we should understand is that the same sorts of labor-rights issues that we’ve experienced in the United States, like the secular fall of US union participation from 20 percent in the ‘80s to 10 percent now, that’s also been going on in Germany. There’s a lot less participation in unions, and there’s also a lot less ... There are many fewer firms that are actually engaging in codetermination, because German firms are finding ways around the system. In some sense, they’re dealing with the same sorts of gutting of labor-rights issues that we have here.

Luigi: But there is one aspect which is difficult to prove or disprove. Industrial relations in Germany have been relatively mild, at least historically. In particular, in mid-2005, 2006, Germany went through a major labor reform with the agreement of the unions. You can argue that the reason why workers were willing to tolerate that is because they trust the management. And they trust the management because they were represented in the boardroom.

Kate: Right, I think Americans have in mind this view that codetermination is about bargaining for higher wages. When, actually, just the broad state of labor relations in Germany has much more to do with other elements of better work/life balance. For example, the purpose of unions in these work councils is often said to be to reduce the incidence of strikes, and to reduce the incidence of tensions with management, rather than to actually organize strikes. And so, there’s a lot more harmony between labor and management in Germany.

Also, when they do argue, so when workers do argue for more rights, they often argue for more training, more specialized expertise, rather than necessarily higher wages.

Luigi: And actually, I think that what people underestimate is to what extent the workers on the board end up being captured by the rest of the group. I’m not talking about the extreme case in which they offer prostitutes and money. I’m talking about simply a cultural issue. You all of a sudden go to a very sophisticated place where there are very smart people making very complicated arguments, that they feel very important themselves. To what extent are the workers really willing to put up a fight, and disagree, and resist, and to what extent do they become part of the system, because they are invited to the same dinners, to the same trips, and so on?

Kate: I think that that’s a rather dire and cynical view. I think maybe you are overly influenced by this prostitution story that you brought up. But, I mean, it’s an empirical question, Luigi. You should write a paper on the pervasiveness of corruption in German boards.

Luigi: It’s not corruption. It’s more capture. It’s much more subtle but more pervasive. I think you end up being captured by the environment. It’s like all the NGOs that show up in Davos, they tend to actually go along with the elite. Why? Because once you go to Davos, you start to enjoy that flavor, and you lose some of your radicalness and your edge.

Let’s talk about the United States. First of all, why do you think that everybody wants to impose this idea? Is this because it sounds good, or because they want to achieve a specific objective, and which objective, if so?

Kate: Well, there’s one thing that we haven’t talked about yet, which is equality. Does having codetermination lead to more equality? It’s really impossible to answer that question. I mean, there’s one cross-country study that says countries with more codeterminationish laws are less unequal. But really, the only country with these strong, mandatory codetermination laws is Germany, and so it’s really hard to do a cross-country comparison. And even if you do, how much can we trust that there aren’t other confounding factors?

Luigi: Actually, you could say that speaking German makes you more equal, because if you do a correlation and it’s only Germany and maybe Austria, then you get that you have less inequality in places that speak German. You can make the same—

Kate: France has some codetermination laws—

Luigi: Actually, they speak German is some parts of France, too.

Kate: Yeah, they speak German in parts of ... That’s a good point. Actually, Massachusetts has a codetermination law.

Luigi: Really?

Kate: Yeah, since, I think, the end of World War I. But it’s not mandatory, and it only applies to manufacturing firms, so it’s one of those things that’s on the books, but it doesn’t really matter.

Luigi: But actually, you bring up an excellent point, which we need to discuss. Why, if this stuff is so good, does it need to be imposed? Why won’t the marketplace naturally do this? Why does codetermination exist only in places where it’s forced by the government?

Kate: I think that’s a good question. I think the answer is that, A, it holds the potential to actually disrupt capitalism. Whether or not you agree that this actually happens, if codetermination were functioning as it’s supposed to, there’s a possibility that workers are going to capture some profits. Obviously, shareholders aren’t going to love that, so that’s one answer. 

Another answer is that to the extent that it makes workers feel better, it makes workers more productive. It gives them more accessibility to management. It creates this system in which there is more harmony with managers and you feel more equal. You feel like you’re on a more level playing field with the owners of capital. Then, I think that there are spillover benefits. There’s positive externalities, which means that this is a system that the government actually needs to come in and force, because those externalities aren’t being internalized by the corporation.

Luigi: OK, so let’s divide your two arguments. The first one, owners don’t want to introduce it because it reduces their profitability. However, if this is so great for workers, when I decide to start my own little company, instead of offering stock options to workers, I offer codetermination. I should be able to attract better workers and pay them less, and we’ll have a lot of startups with codetermination. I’m not aware of any startup choosing codetermination, so I don’t think that’s the argument.

If the argument is, this is good because there is a feel-good system that will spill over, I think that may be true. It’s hard to prove but may be true. However, I’m an economist. I look at costs and benefits. The benefit is a little bit of feeling good. The cost can be gigantic. If it is true, the estimates that we saw in the literature by Gorton and Schmid, that drops the stock price by 30 percent. Doing a back-of-the-envelope calculation, today the stock market capitalization in the United States is roughly $30 trillion. A 30 percent drop means $9.3 trillion. This is a $9.3 trillion tax for feeling good.

Kate: We don’t necessarily know that. To the extent that you believe that, we don’t know that that’s $9.3 trillion that’s disappearing into thin air. That could easily be $9.3 trillion that’s going into the pockets of workers, which, yeah, it makes them feel good, because they’re more equal. But it also makes them feel good because they’re getting paid more.

Luigi: But, actually, if that’s what you want to do, why don’t we put on a tax or a transfer that puts $9.3 trillion more in the pockets of workers?

Kate: Yeah, it’s called the minimum wage.

Luigi: At least we are sure that it gets in the pockets of workers, that it doesn’t get dissipated along the way.

Kate: That’s called the minimum wage. However, I think that part of the issue with that is that, A, it only applies to workers along the lower bound. It doesn’t mean that any profits might be shared, in theory, with more-skilled workers, which is what you want. Also, you want the bargaining process to vary with the business cycle. One example that’s often given—and I honestly don’t know how true this is—but one example that’s given is that in German unions or German work councils, they actually coordinate among workers lower wages during recessions, because they know that the company can’t afford to pay them that much, because they’re hurting. They know that when the economy gets better, they’ll eventually get paid more. And so, they’re much more flexible, and they argue for the right sorts of things. Whereas if you just say, “OK, we want to replace codetermination with a minimum wage,” I mean, that’s just flat across the business cycle. That’s not necessarily what you want.

Luigi: What about a mandatory profit-sharing system?

Kate: OK. Yeah, sure. I think we’d be happy with that. Done.

Luigi: It seems cheaper, less disruptive, and not taking a risk for something that we don’t know that … if we’re guaranteed that this will lead to all these benefits. But it’s very uncertain that it leads to any benefit. It seems to me that, why don’t we identify what the problem is, and try to find the least costly solution to fix this problem? If the problem is that wages are too low, then maybe we should have a profit-sharing system that would be easy to administer and less costly.

Kate: I think that that’s a great solution. Look, I don’t know how all of a sudden I was pinned as the person who is supporting codetermination. I’m just trying to push back against what I think are maybe some logical leaps you’re making. But I don’t even necessarily think that codetermination is the right answer. It’s not clear that it would function in any way similarly in the US to how it does in Germany. And I agree, if the problem is that workers aren’t getting paid enough—which they aren’t, by the way, wages being stagnant is one of the huge political issues of our time—then, yeah, I think that a mandatory profit-sharing system sounds like a great idea.

Luigi: So, Kate, is this a capital-is, or a capitalisn’t?

Kate: I think that this one is particularly complicated. It depends on how narrowly you define the question. If we’re just talking about codetermination—

Luigi: You sound like a lawyer.

Kate: Hey, I love lawyers, so I’m happy to sound like a lawyer. If we’re just asking the question of, should profits be shared with workers, I think the answer is yes. There should be more profit sharing, especially in the United States, where inequality is a huge problem, where wages have been stagnant. I think that there’s some evidence that maybe codetermination contributes to profit sharing. But it’s definitely not dispositive.

There are a bunch of bigger issues here, which are, how do we deal with codetermination in a globalized world? If firms are faced with codetermination, are they likely to just replace laborers with robots? Or are they likely to just outsource jobs? I think that that’s a real threat to the introduction of the system of codetermination, as well as just ways to avoid the rules legally. And so, I think if we’re talking about how does it work in practice, it’s not ... I don’t necessarily support bringing codetermination to the US. I like the idea of profit sharing that you mentioned earlier, and I also like the idea of having stronger rules that incentivize skilled-labor training in the United States. But is codetermination the answer? Probably not. What about you?

Luigi: I’m much simpler: capitalisn’t. I don’t think that it will work, that the system would work in this way. I think I understand the reasons why people are trying to bring this in. I am sympathetic with the reasons, but I think it’s the wrong answer to the right question.

Kate: That was a much more direct and less legalese way of saying what I said, so I think we actually agree.