The Economic Analysis of Producer Cooperatives

THE ECONOMIC ANALYSIS OF PRODUCERS'
COOPERATIVES
In recent years, an increased interest has been shown in producers'

cooperatives. This has manifested itself in public debate and in the
policy proposals of major political parties. Much of the public
discussion on cooperatives has centred on social, psychological
and political dimensions. However, over the last 25 and particu-
larly the last 10 years there has been an expanding economics
literature which is of relevance to this debate. The Economic
Analysis of Producers' Cooperatives summarises and synthesises
this literature. It deals with a number of theoretical models
devised by economists and points to the importance of institutional
and behavioural assumptions in determining model predictions.
Special attention is paid to the problems of investment and
financing.
The theoretical chapters are complemented by two empirical
chapters dealing with Yugoslavia and western industrialised
economies (including the UK, the USA, France and Spain). These
chapters provide descriptive material on the extent of the labour-
managed or cooperative sectors. They also link up with the earlier
theoretical chapters. An assessment of the performance of
producers' cooperatives in the four western economies discussed is
presented and this is related to key organisational characteristics.
It is concluded that performance is enhanced by a requirement of a
capital commitment by new members combined with a long-term
claim on a significant proportion of retained earnings or where
retained earnings are collectively owned that there are constitu-
tionally entrenched constraints on the distribution of income.
Frank H. Stephen is a Senior Lecturer in Economics at the

University of Strathclyde, Glasgow. He was a Visiting Fellow at
the Program on Participation and Labor-Managed Systems at
Cornell University and has visited Yugoslavia on several occasions
to conduct research. Dr Stephen has published articles in major
economics journals and has edited The Performance of Labour-
Managed Firms and Firms, Organization and Labour, also
published by Macmillan.
By the same author
THE PERFORMANCE OF LABOUR-MANAGED

FIRMS (editor)
FIRMS, ORGANIZATION AND LABOUR (editor)
THE ECONOMIC ANALYSIS OF
PRODUCERS' COOPERATIVES
Frank H. Stephen
Senior Lecturer in Economics
University of Strathclyde, Glasgow
M
MACMILLAN
© Frank H. Stephen 1984
Softcover reprint of the hardcover 1st edition 1984 978-0-333-32620-6
All rights reserved. No part of this publication may be
reproduced or transmitted, in any form or by any means,
without permission
First published 1984 by

THE MACMILLAN PRESS LTD
London and Basingstoke
Companies and representatives
throughout the world
ISBN 978-1-349-06250-8 ISBN 978-1-349-06248-5 (eBook)

DOI 10.1007/978-1-349-06248-5
To Kate and Lucy
Contents
List of Figures viii
List of Tables ix
Preface xi
Acknowledgements X~11
4 Introduction 4
2 The Basic Model 4
3 Modifications of the Basic Model 26
4 Finance and Investment 65
5 Yugoslav Self-Management 97
6 Producers' Cooperatives in Western

Industrialised Economies 143
References 203
Index 214
vii
List of Figures
2.1 The basic model 9

2.2 Comparative static responses of the basic model 11
2.3 A technology exhibiting increasing returns to scale
followed by decreasing returns to scale 14
2.4 The long-run equilibrium of the W-V-M firm 16
2.5 Effect of a price increase on profit-maximising and
W-V-M firm under perfect competition 17
2.6 Adjustment to long-run equilibrium of the
labour-managed firm 19
2.7 Short-run comparative statics of a monopolistic
W-V-M firm 22
3.1 Labour-managed firm facing a 'moderate shortage'
of labour 27
3.2 Labour-managed firm facing an 'excess supply' of
labour 29
3.3 Labour-managed firm with 'minimum solidarity' 33
3.4 The utility maximising labour-managed firm 44
3.5 Unconstrained hours variation 48
3.6 Effect of a price change 54
3. 7 Effect of a change in fixed costs 55
3.8 Group welfare maximisation 57
3.9 Equilibrium of labour-managed firm facing
uncertain price 60
3.10 Comparative statics under uncertainty 61
4.1 Constant returns to scale 74
4.2 Long-run equilibrium under internal finance 77
4.3 Investment and internal finance 87
4.4 Comparison of capitalist and labour-managed firms 94
5.1 Relative influence of plan and market 107
viii
List of Tables
4.1 A loan financed investment project 89

4.2 Effect of loan period on required return 91
5.1 Survey of changes in the investment system 104
5.2 Proportion of sectors in different firm-size
group income ranges 116
5.3 Composition of investment in fixed assets by
source of finance (%) social sector 118
5.4 Gross enterprise saving and investment, 1965-72 119
5.5 Allocations to the funds of enterprises,
manufacturing and mining, 1966-72 120
5.6(a) Enterprise share in total domestic sources of
finance for fixed investment 121
5.6(b) Discretionary savings as a share of enterprise
net income 121
5.7 Real interest rate, 1966-76 129
5.8 Simple regressions of the components of net
product per worker on capital per worker for
1969 134
6.1 Major !COM companies, 1977 and 1980 150
6.2 SCOP affiliates in 1978 by year of formation 152
6.3 Life-spans of US producer cooperatives 158
6.4 Output of three long-surviving barrel
cooperatives 162
6.5 Membership of long-lived barrel-making
cooperatives 163
6.6 Total employment in long-lived barrel-making
cooperatives 163
6.7 Activities of the CLP, 1960-79 177
6.8 Cooperatives, employment, sales and profits by
industry grouping 180
6.9 Percentage of work force according to job
index in Ulgor, 1976 187
6.10 Average size of Mondragon cooperatives 190
6.11 Relative performance of producers' cooperative
groups 196
6.12 Institutional characteristics of cooperative
groups 197
ix
Preface
This book has its origins in some fifteen years of interest

in workers' self-management which began with a visit to
Yugoslavia on an undergraduate project in 196 7. In those
days the literature on self-management was largely descrip-
tive and was rather thin. (I did not discover the seminal
work of Benjamin Ward until a number of years later.) The
Yugoslav system appeared to me to offer, at least in prin-
ciple, a more humane and democratic system of industrial
relations.
My interest in the economics of labour-managed firms was
rekindled several years later when I set myself the task of
finding out the economic 'costs' of self-management. It was
appropriate for a young teacher of, at that time, finance
theory that my way into the literature was the analysis of
the investment decision. Much of my work in the intervening
period has focused on this and was directed towards a PhD
thesis which was completed in 1979. However I also 'dis-
covered' the more general literature stimulated by Jaroslav
Vanek's work. I was fortunate enough to spend a semester's
sabbatical at Cornell in 1977. During this work I was struck
by the absence of any book which drew together this burgeon-
ing literature in a way which made it accessible to non-
specialists and undergraduates. I hope that readers will
find that this volume goes at least some of the way to fill-
ing the gap. Inevitably in a growing subject many contribu-
tors will have been omitted, particularly those published
during the latter stages of the manuscript's preparation.
For this I apologise to both readers and authors.
Nowadays it is not only the Yugoslav experiment which
makes the economics of the labour-managed firm relevant to
policy makers, but also the increasing support being given
to producers' cooperatives as a means of remedying some of
the ills of industrial society.
I have attempted to show the relevance (or otherwise) of
economic theory to such questions, and to assess the per-
xi
xii PREFACE
formance of a number of groups of cooperatives which have

been studied by others.
A book such as this, which reviews a subject area, owes a
great debt to those who have contributed to the subject. The
list of references at the end of this volume gives an indi-
cation of those individuals. However, a number of people
must be singled out for both general and particular ac-
knowledgement. Jaroslav Vanek, more than anyone else, has
been responsible for establishing the subject area by laying
down its foundations and a good part of its superstructure.
Personally, I also owe a great deal to him for the encour-
agement shown to me while I was at Cornell and since. The
empirical study of producer cooperatives owes a great deal
to Derek Jones, who has done more than anyone else to ident-
ify and examine the performance of cooperatives, particu-
larly in the United States and the UK. Similarly, a debt is
owed to Robert Oakeshott, who brought Mondragon to the fore-
front of discussions on cooperatives, and to Henk Thomas and
Chris Logan for compiling the most detailed analysis of its
operation yet produced.
Over the years my work has benefited from discussions with
various people, including Anthony Clunies Ross, Peter Wiles,
Nicos Zafiris, Saul Estrin, Connell Fanning and Trevor Buck.
Henk Thomas has been kind enough to read the section on
Mondragon in this volume, and correspondence with Stephen
Sacks has drawn to my attention an error in some of my
earlier work on investment. Needless to say any errors
remaining in this study are the responsibility of the
author.
The manuscript was expertly prepared for reproduction by
Margaret MacDonald of Marketing Services Agency.
The final acknowledgement is the debt I owe my family, and
my wife, Christine, in particular, for what they have put up
with during the writing of this book.
Tillymet F .H. S.
Acknowledgements
The author and publishers gratefully acknowledge the

permission of the undernoted to reproduce (in part or in
whole) copyright material in a number of the figures in this
text.
Figure 2.2 from J.E. Meade (1971) 'The Theory of Labour-

Managed Firms and Profit Sharing', Economic Journal, vol.
82 (published by Cambridge University Press).
Figures 3.1 and 3.2 from E.D. Domar (1966) 'The Soviet
Collective Farm as a Producers' Cooperative', American
Economic Review, vol. 56 (published by the American
Economic Association).
Figure 3.3 from A. Steinherr and J.F. Thisse (1979) 'Is
there a Negatively-Sloped Supply Curve in the Labour-
Managed Firm?', Economic Analysis and Workers' Management,
vol. XIII (published by IAEWM).
Figure 3.5 from M.D. Berman (1977) 'Short-Run Efficiency in
the Labor-Managed Firm', Journal of Comparative Economics,
vol. 1 (published by Academic Press).
Figures 3.6 and 3.7 from N.J. Ireland and P.J. Law (1981)
'Efficiency, Incentives and Individual Labor Supply in the
Labor-Managed Firm', Journal of Comparative Economics,
vol. 5 (published by Academic Press).
Figures 3.9 and 3.10 from G. Hawawini and P.A. Michel (1979)
'Theory of Risk Averse Producer Cooperative Firms Facing
Uncertain Demand', Annals of Public and Cooperative
Economy, vol. SO(published by CIRIEC).
Tables 5.1 and 5.2 from D. Gorupic and I. Paj (1973)
Workers' Self-Management in Yugoslav Undertakings
(Ekonomski Institut, Zagreb).
xiii
1 Introduction
In this book it is hoped to draw together and synthesise the

developing literature in economics on the labour-managed
firm. This literature has grown considerably over the last
ten years and is interesting an increasing number of aca-
demics. Furthermore, producers' cooperatives have been held
up by many as being capable of making a major contribution
to correcting the ills of the capitalist economies of the
west (see, for example: Clayre, 1980; Owen, 1981; Wales TUG,
1981; Berman, 1982; Vanek, 1982; Horvat, 1982). This volume
is an at tempt to integrate the experience of producers'
cooperatives in western economies and Yugoslavia's
experience of workers' self-management with the theoretical
literature. It must be recognised that this is a difficult
task and the present work does not go all the way in
attaining this objective.
Chapter 1 sets out the basic model of the economic litera-
ture. This has its or1g1ns in a paper by Benjamin Ward
published in 1958. The take-off point, however, for this
field of economic research is Jaroslav Vanek's seminal work
The General Theory of Labor-Managed Market Economies
published in 1970. Some penetrating insights into the model
developed there were made by James Meade in his review of
the book. Thus in Chapter 1, this basic model is christened
the Ward-Vanek-Meade model. The chapter examines the com-
parative static properties of the model. In particular,
attention is focused on what has been described as its
'perverse' supply response.
The subsequent literature is characterised in Chapter 2 as
an attempt to remove this 'perverse' supply response. This
takes, broadly, four forms. Some authors argue that the
supply curve of labour may be less than infinitely elastic.
When the supply curve of labour is explicitly introduced
into the model the perversity may be removed. Other authors
have sought to specify institutional arrangements related,
paticularly, to the way in which employment may be adjusted
1
2 THE ECONOMIC ANALYSI "· OF PRODUCERS' COOPERATIVES
which will modify the behaviour predicted by the W-V-M

model. A third line of development has been based on the
premise that the perverse supply response is the outcome of
the simplistic objective function: maximisation of income
per worker. A number of alternatives are examined. Finally,
the chapter concludes by relaxing the assumption of cer-
tainty. A risky product market is considered. This miti-
gates the perverse response but does not remove it.
The models discussed in Chapters 2 and 3 assume that firms
hire their capital at market clearing prices. This assump-
tion is relaxed in Chapter 4. The chapter proceeds by exam-
ining two schools of thought on finance and investment by
the labour-managed firm. These are associated with Cornell
and Texas Universities. Both schools are concerned with the
disincentive effects of property-rights where assets are
held under collective forms of ownership. The true source of
this effect is traced to the obligation to maintain asset
values. It is argued that this very specific requirement is
not present in all forms of labour-managed firm, nor would
it represent a disincentive where asset claims are indi-
vidualised. The Cornell school argues that much of the fail-
ure of producers' cooperatives is traceable to an absence of
scarcity reflecting rents on capital. This view is con-
sidered in detail and rejected on theoretical grounds. The
chapter concludes by considering investment finance when
external credit is available.
The development of the Yugoslav economic system is dis-
cussed in Chapter 5. As well as the general history of the
system the chapter deals with the specific institutional
reforms at the enterprise level effected during the 1970s.
These involve the splitting of all enterprises into auton-
omous units known as Basic Organisations of Associated
Labour. The nature of these is discussed with reference to
the author's own investigations and a larger study carried
out by Stephen Sacks. The basic model of Chapter 1 predicts
that, in the absence of effective entry by new firms, the
income distribution in an economy of labour-managed firms
will be large because competitive forces do not operate in
the labour market. Evidence on this from Yugoslavia ~s
examined in Chapter 5. The main part of the chapter is
concerned with investigating the validity of the conclusion
of the previous chapter, that collective ownership of assets
will impede the internal financing of capital investment.
Competing views on the evidence from Yugoslavia are
presented and empirical studies reported. Finally, the view
of Jaroslav Vanek and Milena Jovicic, that capital is
underpriced in Yugoslavia, is scrutinised and alternative
evidence presented.
INTRODUCTION 3
The final chapter of the book examines the experience of

producers' cooperatives in four western industrialised econ-
omies: the UK, France, the USA and Spain. Groups of coop-
eratives are identified, their institutional characteristics
examined, and their performance detailed. Although this is
only a sample of the countries which might be covered, the
forms of cooperative are representative of the total range.
Furthermore, it encompasses most of the institutional forms
discussed in Chapter 3. In all, nine separate groups of
cooperatives are identified. They illustrate a wide range of
forms which deviate from the W-V-M model, on which much of
the theoretical literature is based. Examples of collective
ownership, individual ownership, hiring of non-members,
non-trivial membership fees and marketable shares are found.
After examining the performance of these groups of coop-
eratives individually, an attempt is made to provide an
overall assessment of performance. Using a set of six per-
formance criteria first proposed by Derek Jones, an overall
performance ranking is constructed. This performance ranking
is then compared with the institutional characteristics of
each group. Broadly speaking, it is suggested that superior
performance by cooperatives is associated with an individu-
alising of claims on accumulated surpluses or a collectiv-
isation of retained earnings bolstered by entrenched consti-
tutional provisions for retention of surpluses. Hiring of
non-members leads to a degeneracy of cooperatives, particu-
larly when associated with marketable membership shares.
This vo 1 ume seeks to represent the 'state of the art' in
the study of the economics of democratically organised
enterprises. Clearly, much work still remains to be done in
the field. This is particularly true with respect to testing
theory and assessing the performance of both Yugoslav firms
and western producers' cooperatives. It is suggested that a
way forward in this is for research to focus more on insti-
tutional and organisational characteristics. This will allow
the effects of such differences as there are between coop-
eratives on performance to be more accurately assessed. This
implies a delicate mix of case studies of individual coop-
eratives, his tori cal surveys of the producers' cooperative
movements in different countries, and rigorous formulation
and statistical testing of hypotheses which seek to explain
relative performance.
2 The Basic Model
In contrast to the theory of market-socialism developed by

Lange (1938), the economic theory of the labour-managed firm
is a relatively recent development. The first important
paper on the subject was that of Benjamin Ward (1958).[1]
Two factors may perhaps go a long way to explaining this.
Firstly, economists concerned with the study of socialist
economics were largely concerned with 'systems', i.e. the
structure of national economy and the mechanisms by which
production units could be stimulated by the planners to
operate according to the preference function of the planners
(i.e. the plan). Secondly, although a number of cooperative
firms were established in the 19th century, relatively few
have survived. It was largely as a result of one major
development in this field (that of Yugoslavia) that Ward
seems to have been encouraged to consider the micro-economic
implications of self-management. To some extent, however, he
was also concerned with 'some Eastern European countries
groping toward a less centralized form of economic organ-
ization ••• and some Western European socialists struggling
with the implications for democracy (and efficiency) of
further nationalization' (Ward, 1958, p. 566).
It is noteworthy that nearly twenty years later, western
economists have not made much progress in the analysis of
industrial democracy. Few papers exist on the economic con-
sequences of worker participation in western Europe.[2]
There has been no dearth of sociological analysis, but very
little economic analysis. On the other hand, there has been
considerable discussion of the possibilities for improving
resource allocation within centrally-planned economies,
particularly via schemes for decentralisation.
This chapter presents a simple model of the labour-managed
firm which is basic to the literature. I t is essentially
that first presented by Ward and developed by Jaroslav Vanek
(1970) and James Meade (1972, 1974). Since these two authors
have contributed greatly to the understanding of the impli-
4
THE BASIC MODEL 5
cations of this basic model, it seems reasonable to refer to

this genre as the Ward-Vanek-Meade (W-V-M) Model. This
should in no way diminish the significance of Ward's orig-
inal insights, nor the contributions of a number of other
economists to whose work reference will be made below.
Apart from the appearance of Ward's ( 1958) paper which
began the literature of the labour-managed firm, the most
significant event for the theory must be the publication of
Jaroslav Vanek's book The General Theory of Labor-Managed
Market Economies (1970). In many ways, this represents the
take-off point for the literature. In it, Vanek sets out 'to
construct a comprehensive theory of a new economic system
which hitherto has not been studied in a comprehensive
manner' (Vanek, 1970, p. 1). This, as its author admits, was
a formidable task, and should be looked upon as a first step
rather than as a complete and rounded treatment. An insight
into Vanek's motivation in writing the book is given in
Vanek (1969). At that time, students of comparative econ-
omics were increasingly aware of the particular innovations
of the Yugoslavs. The performance of the Yugoslav economy
was being taken as indicative of the performance of an
economy composed of labour-managed firms, and was being
compared to that of other systems. Vanek regarded this as
unfair and wrote 'it is necessary to compare the correspond-
ing theoretical models' (Vanek, 1969, p. 1006). These
remarks clearly indicate the analytical methodology adopted
by Vanek (at least in the early development of his analy-
sis).
The methodology is to build on a set of assumptions which
are in many ways premises necessary to generate a long-run
Pareto optimal allocation of resources. In this respect, it
is very much in the neoclassical tradition. Such a class-
ification will no doubt irritate Jaroslav Vanek. To him, the
study of labour-management goes beyond the 'crossword
puzzles' of the neoclassical paradigm into the realm of
'relevance and application'. However, it should become ap-
parent from what follows below and in subsequent chapters
that the methodology and techniques of analysis which Vanek
and most other researchers in this field use are firmly in
the neoclassical tradition. It is true that from time to
time Vanek points to 1 advantages' of self-management of a
psychic or socio-political nature, but in the main, the
analysis is conducted in terms of the allocation of scarce
resources between competing uses with the objective of
maximising welfare.
In some of his later work, Vanek does not restrain himself
so fully from passing normative comments. Laura Tyson
(1978), in her review of Vanek (1977), is critical of what
6 THE ECONOMIC ANALYSIS OF PRODUCERS' COOPERATIVES
she calls his 'intermingling of positive analysis and norma-

tive fervour'. She does, however, concede that this same
tendency is displayed in the work of others with different
normative positive such as Eirik Furubotn. Professor Vanek
undoubtedly believes that an economy composed of labour-
managed firms would be a better place than a capitalist
economy. In this, however, his scientific methodology dif-
fers little from that of Professors Friedman or Hayek: all
have clearly held normative views. The argument here is that
in Vanek's case, his economic methodology is not normative.
However, neither is it positive.
Vanek (1970) does not set out to devise an hypothesis to
explain behaviour in the real world. This is inevitable,
since the assumptions of his model do not approximate any
known system. Does this make it normative by default?
Holesovsky (1977) classifies Vanek's model among 'normative
models of economic systems', but this would seem justified
only if every neoclassical textbook were also to be de-
scribed as normative. The only sense in which both are
normative is that they say that, given the form of owner-
ship, economic agents ought to behave in a stated manner to
maximise welfare.
The terms prescriptive[3] and analytical[4] economics are
probably more appropriate to Vanek's methodology. In the
former sense, Vanek is prescribing the behaviour necessary
to obtain a stated goal; just as maximum profits require
marginal costs equal marginal revenue. This neither
necessarily describes behaviour in the real world nor does
it suggest that a certain kind of behaviour ought to take
place. The fact that Vanek believes that the world would be
a better place under labour-management is irrelevant because
he does not justify any of his analytical results by re-
course to such value judgements. He merely prescribes the
behaviour and institutions necessary to achieve an efficient
allocation of resources given a collectivised form of in-
dustrial ownership. It should be noted that the concept of
efficiency which Vanek uses is the same as that used by neo-
classical economists: Pareto optimality. It is pure analysis
and therefore not testable by recourse to fact. Therefore it
cannot be positive in the usual sense of that term.
This, then, is the background to the development of the
basic model of the labour-managed firm in the economics
literature. The set of assumptions underlying the model will
now be presented. In the type of organisation whose behav-
iour is being modelled it is assumed that
(a) management is by the majority rule of all of those

working in the enterprise (henceforth called the
THE BASIC MODEL 7
members);
(b) all members share equally in the net income of the
enterprise;
(c) the members are free to determine output and price,
subject only to the discipline of the market for their
product(s);
(d) the size of membership (i.e. employment) may be varied
by the decision of the membership;
(e) a fixed payment is paid on the replacement value of
the fixed assets of the enterprise;[S]
(f) there is complete certainty.
The members of the enterprise are taken as selecting those

levels of inputs and outputs which max1m1se income per mem-
ber (i.e. the dividend). Vanek (1970) argues that this is
the only conceivable objective function of the enterprise.
Others would not agree. However such questions are the sub-
ject of Chapter 3.
Given these assumptions, the W-V-M model for the two
input, single output case when the output is sold in a
perfectly competitive market (or at least a market where
product price is parametric to the enterprise's decisions)
may be expressed as
Maximise s (pX-wL-rK)/L (2.1)
subject to the production function
X = f (K,L) (2.2)
where s is surplus per member,

p is the parametric price of output,
X is the volume of output,
w is the fixed wage per member,
L is the number of members,
r is the parametric charge per unit of capital,
K is the size of the capital stock.
In the Marshallian short run, when capital is fixed at the
level K, the maximum value of s is attained where ds/dL = 0
2
i.e. where [(pXL-w)L (pX-wL-rk)]/L = 0
i.e. where pXL = s + w (2.3)
where XL is the marginal product of labour.
Let y s + w; then
y (2.4)
where y may be defined as income per member (or the divi-

dend).
It should be noted that this first-order condition for
maximisation is not affected by whether or not members re-
ceive any fixed (or accounting) wage prior to the results
for any trading period being known, since s may be positive
or negative. In the latter case, this would imply that work-
ers had been overpaid and that they should each make a pay-
ment of s to the enterprise. As will be seen below, the com-
parative static properties of the model are not affected by
w, which, given the ratio form of the maximand ( 2.1), is
rather like a fixed cost in the maximand of the profit-
maximising firm of conventional textbooks.
The first-order condition for dividend maximisation ( 2.4)
shows that the dividend is maximised when the value of the
marginal member's product is equal to the dividend.[6] Thus
on the assumption that the marginal product of each ad-
ditional member declines as membership expands, new members
will be admitted only as long as the value of the marginal
product of a member exceeds the current dividend, i.e.
existing members are made better off by admitting the new
member. This may be seen by considering Figure 2.1.
The curve ABC shows dividend per worker increasing as mem-
bership, L, increases up to the point B, where membership is
L'. Thereafter the dividend declines. The curve EBD is the
corresponding marginal product curve for changes in member-
ship. By definition, it intersects ABC at its maximum point.
The first-order condition for the maximisation of dividend,
(2.4), is attained at B with a membership of L'.
At membership levels below L', the value of the marginal
product of a change in membership (pXL) exceeds the dividend
(y), and therefore existing members would benefit, through
an increase in y, from an expansion of membership. Con-
versely, where membership exceeds L', a reduction in member-
ship would benefit the remaining members. In the basic
model, it is assumed that such variations in membership may
be costlessly attained.
Equation (2.4) bears a superficial similarity to the cor-
responding condition for short-run profit maximisation in
the profit-maximising firm, i.e. that the remuneration per
unit of labour should be equal to the value of the marginal
product of labour. However, (2.3) indicates an important
difference between the two if w is thought of as a competi-
tive (or at least parametric) wage rate, since p~ in (2.3)
exceeds w. That is, in the short run, the optimum membership
of a labour-managed firm is below the optimum employment
level for a profit-maximising firm with the same production
function and facing the same parametric prices and costs. In
THE BASIC MODEL 9
w'
I
I
I
I
I
I
I
I
I
----------~-----
1
I
I
I
I
I
c
0 L' L
FIGURE 2.1 The basic model
Figure (2.1), 1 2 is shown as the employment level of this

capitalist 'twin' given a parametric wage rate of w2 • The
only exception to this will be where s is zero and the wage
rate is w'. If the competitive wage rate exceeded w', the
labour-managed firm would, under the assumptions of the
basic model, attract no members whatsoever. This discussion
of the short-run condition for dividend maximisation points
to a strong incentive for the labour-managed firm to
restrict membership below the level of employment which
would be Pareto optimal given a competitive labour-market.
However, this short-run sub-optimality[?] disappears in the
long run when capital is variable, as will be shown below.
The more restrictive first-order condition for the labour-
managed firm arises because its maximand is expressed as a
ratio per worker and not as an absolute sum as in the case
of the profit-maximising firm. The former seeks to maximise
an 'average' and the latter a total. The significance of
this difference in behaviour between the two types of firms
is highlighted when their predicted responses to changes in
parameters such as p and r are examined in a comparative
static partial equilibrium framework (see below).

Since y s + w, (2.1) may be rewritten as
y w + pX/L - w - rK/L
pX/L - rK/L. ( 2. 5)
(2.5) emphasises the fact that in the basic model, the maxi-
mand is essentially the difference between two ratios: the
first being revenue per member and the second non-labour
cost per member. The choice of membership size in the short
run is the outcome of two competing forces: one which seeks
to minimise membership and hence maximise revenue per work-
er; and the other which seeks to maximise membership thereby
minimising non-labour cost per worker. These two forces will
be in equilibrium when the rate of change of each is the
same, i.e. when the value of marginal 'product-per-worker'
is equal to marginal 'non-labour-cost-per-worker', i.e.
where
d(pX/L)/dL d(rK/L)/dL (2.6)
therefore pX1 L - pX -rK,
therefore pX1 > (pX - rK)/L = y.

The tension between these two forces may be illustrated in
Figure 2.2
The curve KK' is a rectangular hyperbola showing values of
rK/L for different values of L. Revenue per worker, (pX)/1,
for different levels of work force is shown by UU'. Clearly,
(2.6) is satisfied when the slope of UU' equals that of KK'.
This is given in Figure 2.2 by a work force of size OA. At
A, the vertical distance between UU' and KK' is at a maxi-
mum, i.e. y is maximised.
Note that at a membership of OA, revenue per member (UU')
is not at its maximum, nor is non-labour cost per member at
its minimum. At levels of membership below OA, the former
rises then falls, but when it is falling it does so less
quickly than do non-labour costs per worker, and therefore
the difference between the two (the dividend) is increasing.
Beyond OA, revenue per member falls more rapidly than do
non-labour costs per member, and consequently the dividend
is falling.
The react ions of the enterprise to changes in the par-
ameters (p and r) of the basic model provide the most start-
ling results which are the most widely known (amongst econ-
omists) aspect of the model. These have become known as the
labour-managed firm's 'perverse supply response'.
THE BASIC MODEL 11
0 c L
FIGURE 2.2 Comparative static responses of the basic model
A rise in the interest payment on capital is shown by a

shift of KK' to K1K1 ' in Figure 2.2. The slope of K1K1 ' at
labour force OA ~s no longer equal to that of UU' for a
labour force of the same size. The dividend, y, is now maxi-
mised at the higher labour force of OB. For this firm, an
increase in parametric costs leads to an increase in output:
Such a reaction would not come from a profit-maximising
capitalist firm in the same circumstances. The difference
arises from the maximand' s being a ratio rather than an
absolute amount as in the case of the conventional firm of
economic theory.
Conversely, an increase in the parametric price, p, leads
to a reduction in output. In Figure 2.2, when KK' is the
appropriate cost function and an increase in p shifts UU'
out to u 1u1 •, y is no longer maximised with L = OA but with
L = OC. Once again, the react ion is seen to be the opposite
of that of a conventional profit-maximising firm.
The logic of such seemingly perverse behaviour may be
seen, as suggested by Meade (1972), by considering the im-
pact of a change in parameters on each of the two ratios on
the right-hand side of (2.5). A change in price affects the

first, a change in the cost of capital the second.
The consequence of this analysis is that the labour-
managed firm, as depicted by the basic model, is seen to
have a negatively-sloped supply curve. Stability requires
that the slope of the supply curve be greater than the slope
of the demand curve; otherwise adjustment leads away from
equilibrium in the short run.
When more than one variable is used (say raw materials, M,
as well as labour), certain conditions may lead to an in-
creased demand for labour, in response to a rise in the
price of the product. These conditions are that the marginal
product of M does not fall rapidly as X is increased, and
labour and the material input are highly complementary. If
the price of X increases, the extra surplus generated by the
difference between the cost of M and the price of X may
overcome the desire to reduce the labour force.
However, as Meade (1972) points out, regardless of these
more complicated cases, the output and employment of the
W-V-M firm will be that which equates the value of the mar-
ginal product of labour to its average earnings: following
on a price increase, one more worker will be taken on so
long as he adds more to total revenue (net of additional
costs of the other variable factor) than the existing
dividend per head. Accompanying this new equilibrium situ-
ation there will be a higher dividend and a higher value of
marginal product of labour. The essential point for the
multi-product (as well as the single-product) W-V-M firm is
that labour is taken on only when it increases the value of
its marginal product: labour mobility will not, therefore,
equalise the value of its marginal product between firms and
industries in an economy (or sector) of labour-managed
firms. In other words, in such an economy, wage differences
are not competed away in the short run.
The results of the analysis of the basic model presented
so far are not sympathetic to those advocating labour-man-
aged firms or cooperatives as a means of ameliorating or
banishing the economic and social ills of industrial
society. The picture which these results conjure up is of a
labour-managed economy in which those who are in employment
selfishly protect the economic rent which accrues to them
from a buoyant demand for their product by refusing to ex-
pand output and employment. Output does not respond to con-
sumer demand, and the labour market 'directs' labour away
from its highest valued use to lower valued uses. Such an
economy breaks all the cannons of optimality in the calendar
of neoclassical economics. Such is indeed the picture re-
tained in the minds of many economists whose familiarity
THE BASIC MODEL 13
with the literature on the labour-managed firm extends only

to the results of Ward's (1958) paper, or indeed to a
second- or third-hand account of it. In fact, the picture
need not be so pessimistic even within the restricted bounds
of the basic Ward-Vanek-Meade model, far less in any attempt
to construct a 'realistic' model of cooperative behaviour.
So far, only the short-run behaviour of a labour-managed
firm in a perfectly competitive market has been examined.
Optimality in the model of perfect competition in the
economic literature of the conventional firm is a long-run
phenomenon. What happens to the W-V-M firm in the long run?
In the long run, when capital as well as labour is vari-
able, the conclusion is much more optimistic. It can be
shown that, given the assumptions of perfect competition,
certainty and costless adjustment, the long-run position of
an economy of W-V-M type firms is identical to that of an
economy of perfectly competitive entrepreneurial firms. Such
proofs in terms of a general equilibrium framework have been
presented by Dreze (1976) and Pearce (1977). Here the analy-
sis will be conducted in a partial equilibrium framework by
continuing to examine the position of the representative
firm.
When both membership and capital are variable, the first-
order conditions for maximising the dividend (y of (2.5))
are
and pXK r. ( 2. 7)
The former is simply a repet1t1on of (2.4), whilst (2.7) in-

troduces the new dimension: capital will be used up to the
point where the value of its marginal product equals its
rental rate which, when there is a perfect capital market,
will be the market rate of interest.
Equations (2.4) and (2.7) may be substituted into the
objective function as expressed by (2.5). This yields XL
(X-XK·~)/L which may be rewritten as
X= XLL + ~L ( 2.8)
or XLL/X + ~K/X = 1. (2.9)
Now, XLL/X = eL' where eL is the elasticity of output with

respect to labour. Similarly, ~K/X = eK' and e + eK = e,
where e, the function coefficient, is an expres~ion of the
degree of returns to scale. From (2.9), it is evident that
the W-V-M firm will always experience constant returns to
scale when it is in long-run equilibrium. This result may be

confirmed in another way from (2.8), which is an expression
of Eulor' s Theorem: total product (X) is exhausted under
constant returns to scale when each factor receives its
marginal product. Equations (2.4) and (2. 7) indicate that
each factor does receive its marginal product.
The long-run equilibrium position of the W-V-M firm is re-
stricted to a more limited set of points on its production
function than that of its profit maximising twin. Taking a
general form of production function which exhibits increas-
ing returns then decreasing returns along any ray from the
origin in input space, the possible long-run equilibrium
combinations of inputs for the W-V-M firm are restricted to
those at which returns to scale are constant, i.e. where in-
creasing returns are giving way to decreasing returns. This
is illustrated in Figure 2.3, following Frisch (1965).
K
Q
E D
I
I
I
I
/ F
lG XK
_,_____ = f A
0 L
FIGURE 2.3 A technology exhibiting increasing returns
to scale followed by decreasing returns to scale
Along the ray OA, output is increasing, and it is assumed

returns to scale are declining monotonically from a level
greater than unity to a level below unity. At B, returns to
scale are unity. On the usual assumption of a well-behaved
THE BASIC MODEL 15
production function, OA may be assumed to cut each isoquant

only once as output rises to its maximum. Consequently,
there will be a locus connecting points on isoquants at
which returns to scale are equal to unity. Such a locus
represents what Frisch (1965) calls the 'technically optimum
scale 1 and what Vanek (1970) calls the 'locus of maximum
physical efficiency' and is shown as EE in Figure 2.3. The
long-run equilibrium for the W-V-M firm must be at one of
the points on EE.
The points on EE represent combinations of K and L which
will be consistent with returns to scale of unity if each of
the factors is paid the value of its marginal product. In
the W-V-M firm, the payment to capital is exogenously deter-
mined and is r. The long-run equilibrium quantity of K is,
from ( 2. 7), that at which the value of capital's marginal
product is equal to r.
Following Frisch (1965), it may be assumed that loci of
constant marginal product for each factor may be plotted
which each intersect EE once. Thus any point on EE, such as
G, is also at the intersection of two such loci, e.g. X1 = a
and XK = f. The value of a diminishes to the right and aown-
wards whilst that of f diminishes to the left and upwards.
The long-run equilibrium position of the W-V-M firm will
coincide with that point on EE where f = r/p, and y will be
given as p times the corresponding value of a. This is shown
as point z in Figure 2.4, at which y = p•a and the equilib-
rium values of the inputs are indicated by asterisks (*). If
the W-V-M firm is at any point other than z, its desire to
maximise y will in the long run impel it to move to z. At
any point on EE to the left of z, the value of capital's
marginal product is less than its price, and consequently
labour cannot receive the value of its marginal product
without factor payments over-exhausting the value of their
total product. Conversely, to the right of z, the value of
capital's marginal product is greater than r, and distribu-
tion of the total product implies labour receiving more than
its marginal product.
What does this analysis imply for the long-run optimality
of the W-V-M firm? At z, the payments to both factors
exhaust the value of total product (see (2.8)). This corre-
sponds to a position at which a profit-maximising firm makes
zero profits. If it can be assumed that the W-V-M firm and
its profit-maximising twin face the same market rate of
interest, r, then the zero profit position for the profit-
maximising twin is also at z, with the wage rate being equal
to y. Since such a position for the profit-maximising firm
is known to be Pareto optimal (assuming the absence of ex-
ternalities, etc.), it must also be Pareto optimal for the
K E
I
XL =a
I
I
I
I
~I ------XK = L
K* ----------
.,. . . --,1 - - p
,"' I I
/'' I I
, ,' I
I I
,' I
I
I E
I
L* L
FIGURE 2.4 The long-run equilibrium of the W-V-M firm
W-V-M firm. Thus, given the same technical conditions usual-

ly assumed to be present when discussing the long-run
optimality of perfect competition, the W-V-M firm facing a
perfectly competitive product market will also attain
optimality in the long run. As far as equilibrium states are
concerned, an economy of W-V-M firms will look no different
from one of profit-maximising firms. The black picture con-
jured up by the short-run equilibrium discussed a few pages
earlier disappears in the long run. However, there is a dif-
ference between the two firm types in the conditions which
must be met in order that this long-run position may be
reached.
Consider the effect on a typical W-V-M firm and a typical
profit-maximising firm of an increase in the parametric
price of output, p, when both are at the long-run equilib-
rium of z in Figure 2.4 where a = w/p, where w is the com-
petitive wage rate faced by the capitalist. An increase in p
shifts XL = w/p to the right and ~ = r/p to the left. These
are shown in their new positions in Figure 2.5.
The new long-run equilibrium for the profit-maximising
THE BASIC MODEL 17
K E
w
XL=-
I
' p
I
I
Zw _L-----XK = !._
--
z/'-c
'7 p
I
FIGURE 2.5 Effect of a price increase on profit-maximising

and W-V-M firm under perfect competition
firm is that at which
XL= w/p, ~ = r/p,
at the new product price. This is shown by the intersection

of the two loci at z in Figure 2.5. At z , positive econ-
omic profits are bein~ made: labour and cap~tal are paid the
value of their marginal products, but these payments do not
exhaust the value of output since the firm is now in the
decreasing returns to scale zone. The move from z, the equi-
librium prior to the change in p, to z will represent an
increase in output given any reasonably-~haped isoquant map.
The W-V-M firm will adjust factor inputs to achieve its new
long-run equi 1i brium according to ( 2. 4) and ( 2. 7) and the
implied constraint that equilibrium occurs only where there
are constant returns to scale. This occurs where EE inter-
sects the new Xu = r/p locus, and is shown as z in Figure
2.5. Since, folfowing Frisch (1965) and Miovic w(1976), EE
has been drawn with a negative slope, z implies a reduction
in membership and an increase in capita! as compared with z.
Without specifying the nature of the production function in

more detail, the effect on output of the move from z to z
is indeterminate. Geometrically, it depends on the relativ~
slopes of EE and the isoquant passing through z. If the lat-
ter is the steeper, output at z is lower than that at z,
and the converse if the isoquantwis the less steep at z. The
change in output will be zero if EE is itself an isoquant.
These results are implied by Miovic (1976) and investigated
more systematically by Estrin (1980a, 1982b).
A geometrical presentation of Estrin's analysis will per-
haps clarify these conclusions and also provide some further
insights into the economic rationale of the W-V-M firm's
behaviour. Estrin has shown that the response of the W-V-M
firm to changes in parameters can be decomposed into factor
substitution and scale effects.
Consider the objective function of the W-V-M firm,
y = (pX - rK)/L.
This may be rewritten as
K = pX/r - yL/r. (2.10)
(2.10) is the W-V-M firm's equivalent to the isocost line of

conventional micro-economic theory. However, for the W-V-M
firm, both the intercept and slope of (2.10) may be influ-
enced by its decisions, since both X and y are decision
variables, not parameters of the system.
In Figure 2.6, the initial equilibrium position, z, is on
isoquant x1 • The line AB corresponds to (2.10). I t is the
only isocost line which can have intercept pXrfr and be
tan~e~t~al to x1 • This tangency condition is equivalent to
max1m1.s1.ng y.
If the price of output rises top', the intercept shifts
upwards to p'X 1/r. Let the isoquant x1 coincide with the EE
locus, i.e. returns to scale vary not with K/L ratio but
only with output. Thus x1 remains the optimum output. The
optimum inputs will be g1.ven by drawing the tangent from
p'X 1/r to the isoquant x1 • This is shown as A'B', with the
tangency occurring at z , at which labour has been reduced
and capital increased, ':elative to z. This substitution of
capital for labour takes place because the increase in price
has made labour implicitly more costly than capital, since
labour shares in any rent to be gained from the increase in
demand whereas capital does not. Basic price theory would
suggest that the relatively cheaper factor would be sub-
stituted for the relatively more costly one. Here is the
reason why the W-V-M firms seek to reduce membership when
THE BASIC MODEL 19
FIGURE 2.6 Adjustment to long-run equilibrium of the

labour-managed firm
price rises. The effect on output depends on what Estrin

(1980a) calls the scale effect. In the present example, it
is zero and thus output remains constant. If, however,
returns to scale vary with the K/L ratio, then z can no
longer meet the constant returns to scale constr~int and
cannot be an equilibrium: output must change from x1 • Estrin
( 1980a) has shown that if the partial derivative of scale
with respect to labour is negative, the move from z to z
will increase returns to scale above unity, and thus thl;'
scale effect will be positive, e.g. a move to isoquant x2 in
Figure 2.6 with the resulting equilibrium input after a
number of iterations shown by z' .[8] Conversely, if the
partial derivative of scale wit~ respect to output is
greater than zero, the scale effect will be negative. It
should be noted that in Figure 2. 6 it is assumed that the
partial derivative of scale with respect to labour is nega-
tive, i.e. that returns to scale diminish as output moves
along any ray from the origin. If this were not so, z would
lie to the right of z on X • w
What is the net effect o\: this? It can now be stated con-
fidently that if the partial derivative of scale with

respect to labour is positive, the capitalist twin will
adjust output following from a change in price more than
will the W-V-M firm, since the scale effect will be zero or
negative. However, if the partial derivative is negative,
the W-V-M firm's scale effect may exceed that of the capi-
talist twin and thus its output increases by more. This is a
consequence of the W-V-M firm's more capital-intensive input
mix resulting from the factor substitution effect of the
price change (for further details see Estrin, 1980a, 1982b).
Returning to Figure 2.5, which illustrated in broad terms
the effect of the price change on the W-V-M firm and its
capitalist counterpart, the input mixes of the two new
equilibria (z and z ) differ, but the corresponding inputs
cannot be com'r>ared wlthout the detailed information on the
production function discussed above.
The comparative equilibria in Figure 2.5 are somewhat at
variance with the conclusion reached earlier that, in the
long run, the two types of firm will operate at identical
points in input space. This is because the picture depicted
in this figure is the desired equilibrium of the single firm
following from a once and for all price increase. In neither
the capitalist nor the W-V-M case is the situation depicted
in Figure 2.5 the final equilibrium. The assumption of per-
fect competition means that all firms in the industry will
react in a similar way to the price increase. In the capi-
talist case, the increase in output of these firms may bring
about a dampening of the original increase in market price.
If this dampening still leaves firms in the decreasing
returns to scale zone, and thus making positive profits, new
entrants will be encouraged into the industry until these
profits are competed away and equilibrium is re-established
on EE. This will be at z, unless the increase in the indus-
try's demand for factors alters w or r.
In the case of the W-V-M firm, as discussed, the long-run
effect on desired output depends on the production function.
Where scale is an increasing function of labour input,
existing W-V-M firms will not increase output. This will
mean that the initial increase in price is not damped by the
reactions of existing firms and entry to a long-run equilib-
rium. It is this conclusion which has led Meade (1972, 1979)
to conclude that the free entry or exit of firms to and from
the market is of more importance in attaining optimality in
an economy of labour-managed firms than in a capitalist
economy. The entry of new firms into such an industry de-
pends on workers employed in firms whose dividend is less
than that of the industry concerned and/or unemployed work-
ers forming firms to produce the goods whose price has
THE BASIC MODEL 21
risen. Meade sees this as a question of 'new firm formation

which will certainly be impossible without appropriate
government interventions of the most extensive character'
(Meade, 1972, p. 428). This seems to suggest that diver-
sification is not a possibility for a W-V-M firm, but
Professor Meade himself acknowledges that in a multi-product
firm, an increase in the price of one of its products may
iQduce more of that product to be produced. Could the same
factors not induce firms to become multi-product rather than
single-product enterprises? Notwithstanding this, the analy-
sis does suggest that the ease of entry of new producers
into a competitive market is of greater importance when
considering the W-V-M firm than its capitalist counterpart.
If freedom of entry to an industry is not guaranteed,
there will be imperfect competition and the individual firm
is no longer a price taker. The behaviour of a W-V-M firm
which is a monopoly is now examined. A little economic
insight and a generalisation of the result for perfect
competition should suggest that the only difference between
the first-order conditions for equilibrium of the W-V-M firm
which is a monopolist and that which is a perfect competitor
is that the former will equate marginal revenue products for
each factor to their implicit or explicit price whereas it
is value of marginal product (p. MP) in the perfectly com-
petitive case. Algebraically, this may be demonstrated in
the following manner. The firm is still assumed to be maxi-
mising
y (pX - rK)/L
where X= f(K,L), but now
p p(X,v),
where v is a shift parameter.
In the short run, when capital is fixed, the first-order

condition is y 1 = 0, which implies that
(p + p 1•X)~ = (pX- rK)/L = y. (2.11)
The first term on the LHS of (2.11) is marginal revenue,

whilst the second term is the marginal product of a new mem-
ber. Thus membership is adjusted up to the point at which
the change in revenue brought about by an adjustment in mem-
bership is equal to the dividend. This exactly parallels the
case under perfect competition.
What will the effect of an increase in demand be on output
in the short run? This is illustrated in Figure 2. 7, in

which AB is the relevant portion of the total revenue curve.
With capital stock fixed in the short run at K, the firm has
fixed costs of rK shown by the distance OC on the vertical
axis. Maximisation of income per worker implies maximising
the ratio of the distance between AB and CD (i.e. pX - rK)
to the labour force. This is equivalent to maximising the
slope of a line from C passing through AB. Clearly, this
occurs where such a line is tangential to AB, i.e. when the
labour force is 1 1 , at which the slope of CD (the dividend)
is equal to the slope of AB (the marginal product of
labour). Consider now an increase in demand (i.e. an in-
crease in v) shown by the shift of the total revenue curve
to A'B'. If this is an elasticity-preserving increase, the
slope at any point on A'B' must be greater than the corre-
sponding slope on AB since the elasticity remains constant
due to a proportional increase in price at every level of
output. Given these conditions, the tangent from C to A'B'
must occur at a labour force less than 1 1 , e.g. 1 2 • For the
capitalist twin, the increase in demand will increase
0 L
FIGURE 2.7 Short-run comparative statics of a monopolistic

W-V-M firm
THE BASIC MODEL 23
employment. Where the shift in demand is not elasticity-

preserving, the W-V-M firm may or may not increase its
output, depending on the relative sizes of the proportionate
change in the elasticity of demand, the rise in price, and
the ratio of gross revenue to net revenue. For a detailed
exposition and proof of this see Meade (1974).
What about the long run? Allowing capital to vary yields
the second of the first-order conditions,
therefore
(2.12)
As expected, (2.12) shows that the optimum level of capital

is attained when marginal revenue product of capital is
equated to its rental cost. Bringing ( 2.11), ( 2.12) and the
objective function together illustrates the limited number
of points on the production function at which a long-run
equilibrium can be attained. Substituting the LHS of (2.11)
for y and the RHS of (2.12) for r in the objective function,
and rearranging, yields
therefore
(2.13)
i.e. the long-run equilibrium under monopoly occurs where

the ratio of price to marginal revenue is equal to the func-
tion coefficient whose value is equal to the degree of re-
turns to seale.
However, the LHS of (2.13) must be greater than 1 if the
firm is a monopolist facing a downward-sloping demand curve.
Thus the long-run dividend maximising position of the W-V-M
monopolist is in the increasing returns zone, whereas the
capitalist monopolist is not subject to any such technologi-
cal constraint. It has been demonstrated (Vanek, 1977, chap.
14) that an appropriate combination of price ceilings and
lump-sum taxes can induce the W-V-M monopolist to produce in
a socially optimal manner. Notwithstanding this, it should
be clear to the reader that competition policy is an
important aspect of economic policy in an economy of W-V-M
firms.
This chapter has presented the basic model of the labour-

managed firm of the economics literature: that with which
the names of Benjamin Ward, Jaroslav Vanek and James Meade
have become associated. The model is a relatively simple
one, incorporating the behavioural assumption that opti-
mising behaviour is driven by the desire to maximise the
dividend (or income per worker). It has been shown that,
whilst in the long run under perfect competition and cer-
tainty such a firm (or economy of firms) attains a Pareto
optimal equilibrium, in the short run it behaves in a
'perverse' manner in response to changes in the price of its
output and its non-labour input. Amongst other things, this
would imply that Keynesian counter cyclical policies to
influence aggregate demand in an economy of such firms would
have the opposite effect to that intended: a stimulation of
demand would lead to individual firms reducing employment!
This 'perverse' effect may be mitigated in the long run only
by policies which ensure the free entry of new firms to
particular markets. The conventional wisdom has been that
this would require the active promotion of new ventures by
the authorities, although it has been argued here that this
ignores the potential for diversification among existing
firms in other industries. On the whole, however, this
analysis does not provide an encouraging picture for the
enthusiasts of labour-management, but the story does not end
here. The next chapter considers the response in the litera-
ture to the 'perverse' behaviour of the W-V-M firm: alterna-
tive plausible maximands; institutional arrangements which
neutralise the 'perverse' behaviour; and the removal of the
assumption of certainty.
NOTES
1. Although Domar (1966) refers to Tugan-Baranovsky (1921)

as analysing cooperatives and coming to many of his
(Domar's) conclusions.
2. Notable exceptions to this are Steinherr (1977), Svejnar
(1981, 1982), Heathfield (1977), Pej ovich (1978) and
Fitzroy and Cable (1978).
3. For a more complete discussion of this term's origins
and relevance, see Machlup (1969).
4. McLachlan and Swales (1978) eschew the distinction be-
tween normative and positive in favour of that between
analytical and synthetic-positive.
5. This may be in the form of a market-clearing rental for
capital or a tax paid to the state as appropriate to the
system being examined.
THE BASIC MODEL 25
6. Assuming second-order conditions are satisfied.

7. Assuming that a Pareto optimal allocation is regarded as
socially optimal.
8. For a detailed discussion of this, see Estrin (1980a).
3 Modifications of the Basic
Model
The literature on the economics of the labour-managed firm

has developed considerably since the original presentation
of what has been called in the previous chapter the W-V-M
model. Some authors have presented more formal proofs of the
properties of the W-V-M model (for example, Maurice and
Ferguson, 1972; Dreze, 1976; Pearce, 1977; Meade, 1979), but
a major preoccupation has been the identification of circum-
stances under which the 'perverse' short-run supply re-
sponse, which is characteristic of the basic model, disap-
pears. In this chapter, the latter developments are con-
sidered in three broad groupings, i.e. those which consider:
(i) a supply curve of labour which is less than infi-

nitely elastic;
(ii) institutional arrangements which neutralise, if not
reverse, the 'perverse' supply response;
(iii) alternatives to income per worker as the maximand.
The final section of the chapter relaxes the assumption of

certainty by considering those mode 1 s which take the price
of output to be stochastic.
I THE SUPPLY CURVE OF LABOUR
Domar (1966) considered the basic model to be unrealistic,

in that it assumed that membership could be varied at will
in response to output and input price variations. 'Surely,'
he argues, 'the co-op by its very nature, cannot admit or
expel members at will' (Damar, 1966, p. 742). Damar assumes
that if workers have other opportunities for employment or
leisure, the cooperative will be faced with a positively-
sloped supply curve of labour.
The impact of this labour supply curve can be demonstrated
by reference to Figure 3.1 for the one-input, one-output
26
MODIFICATIONS OF THE BASIC MODEL 27
FIGURE 3.1 Labour-managed firm facing a 'moderate shortage'

of labour
case. The cooperative seeks to maximise the dividend as in

the W-V-M model. For fixed capital and land this varies with
the labour input as shown by ABC in Figure 3 .1. The curve
EBF shows values of the marginal product of labour. Thus
far, the situation is the same as in the W-V-M model of the
previous chapter, with an equilibrium labour force of OJ.
Now HKM, a positively-sloped supply curve of members, is
introduced. This reflects the dividend which must be paid to
members in order to attract them from their alternative em-
ployment. The demand on the part of the firm for members is
ABC, the dividend curve. As drawn in Figure 3.1, HKM shows
the case of a 'moderate shortage' of labour. If there is no
hiring of non-members, equilibrium obtains at K with a
labour supply of OS. A fall in the rental charge, r, or an
increase in parametric price, p, will shift up the dividend
curve as shown by A'B'C'. In the basic model, this leads to
a reduction in employment (and presumably output), as shown
by the move from B to B', whilst in the reformulated model
with a r1s1ng labour supply curve, it results in an
increase, as shown by the movement of equilibrium from K to
K'. The 'perverse' supply response is removed by the intro-

duction of the supply curve of labour.
Returning to the initial equilibrium with membership OS,
the 'shortage' of labour prevents the dividend from being
maximised at level JB. Nor can the socially optimum output
be attained without sacrificing the equality of dividend
constraint. The socially optimum output is achieved with a
labour force of OQ, where the value of marginal product
(VMP) of labour (on EBF) is equal to its marginal social
opportunity cost (MC) (on HKM). However, it is quite clear
that the OS members of the firm would actually be better off
by paying the SQ members above the dividend, since for the
latter group, VMP>MC, i.e. the surplus represented by the
area KNM in Figure 3.1 would become available for
distribution (see Demar, 1966).
Consider now the case where there is an 'excess supply of
labour' , as shown by the curve HQS intersecting ABC to the
right of B in Figure 3.2. If the firm has an 'open member-
ship' policy, i.e. admits or retains all those willing to
work at the going dividend, the supply of, and demand for,
membership will be equated at Q and membership will be OR. A
membership of OR does not maximise the dividend. Indeed, a
firm which behaves in this way has been called a 'rent dis-
sipating cooperative' (Carson, 1977), since the marginal
member receives only his/her alternative income. Social
efficiency, by the usual criteria, would suggest the optimum
membership to be OT, at which the opportunity cost of labour
(as shown by the supply curve) was equal to its VMP (as
shown by EBF). Notice that in the case described by Figure
3.2, letting all of those who want to join do so is in the
interests of neither society, nor the OJ members. If mem-
bership is 'open', the comparative static responses with
supply curve HQS are the same as for the case illustrated in
Figure 3.1. On the other hand, if the firm can restrict mem-
bership to OJ, its comparative static responses to parameter
changes will be the same as in the W-V-M firm.
This discussion of labour supply curves has highlighted
the importance of the equality of dividend and the circum-
stances under which membership can be adjusted for the
behaviour of a labour-managed firm. This will now be dis-
cussed more fully, by considering the conditions where a
conflict will arise amongst members and between members and
potential members over entry to, and exit from, the firm.
The question of an inegalitarian distribution of income is
deferred to the next section of the chapter.
As has been noted above, Demar (1966) criticises the W-V-M
model for its assumption that membership of the collective
can be varied at the will of the majority. In his own dis-
FIGURE 3.2 Labour-managed firm facing an 'excess supply'

of labour
cussion, he assumed that work in the collective was open to

any member of a certain group who wanted it. This is en-
tirely appropriate to the purpose which Domar had at hand:
an examination of the relevance of Ward's (1958) model to
the case of the Soviet Kolkhoze. Apart from some minimum
work on the collectively-owned land, those designated as
members are free to vary their contribution. This might be
characterised as the case where the individual is free to
determine his own contribution. On the other hand, in the
W-V-M model, new members enter or leave only in so far as it
is in the interest of other members.
As Meade ( 1972) has pointed out, there is no reason to
suppose that conflicts between the individual's interests
and those of other members will not arise. He suggests that
it is only reasonable that the consent of both parties must
be attained before adjusting membership. Thus he proposes
the following rules.
1. An increase in membership should take place only if

(a) the new member wishes to join, and
(b) the existing members wish to accept him.

2. A decrease in membership should take place only if
(a) the member(s) concerned wishes to leave, and
(b) the remaining members agree to the withdrawal.
Figures 3.1 and 3.2 can be used to illustrate the appli-

cation and logic of these rules. Consider first a collective
whose membership is marginally less than OS in Figure 3.1.
In this case, there exist non-members whose alternative
income (as shown by the supply curve) is less than the
current dividend and who therefore would be willing to join
(rule l(a)). Existing members would be willing to let them
join (l(b)) because the value of the marginal product (shown
on EBF) is greater than the current dividend, and conse-
quently an increase in membership would raise the dividend.
On the other hand, if membership is greater than OS,
although rule 1 (b) is satisfied since the VMP curve lies
above the dividend curve, rule l(a) is violated because the
supply curve lies above the dividend curve (i.e. alternative
income exceeds dividend). Increasing the labour force would
imply forced labour in this case. Consider, however, the
converse situation. The labour force is, say, OQ and because
of some adjustment in parameters the collective finds itself
facing ABC and EBF. Under such circumstances, the SQ members
would wish to leave (2(a)), since the supply curve lies
above the dividend curve, but the OS members would be made
worse off as a result of such a change, because VMP is
greater than dividend. Thus rule 2(b) would be violated by
allowing the members to leave. Would it be reasonable to
restrain those wishing to leave from doing so? The answer is
a qualified yes, since the exit of some members leaves other
members with debts which all have willingly incurred.
Let us now turn to Figure 3.2, the case of 'excess' supply
of labour. Clearly, for labour forces above OR, there is no
conflict: rules l(a) and l(b) or 2(a) and 2(b) are jointly
satisfied. For labour forces between OJ and OR, there is
conflict. The dividend is above the alternative income of
the JR workers. Thus they wish to join, or do not wish to
leave (l(a) or violation of 2(a)). However, since VMP is
less than the dividend, existing members would be unwilling
to accept new members (violating l(b)), or wish them to
leave (2(b)). In the case of members wishing to join, there
is no reason to force those who have incurred past debts,
say for investment, to be made worse off by allowing new
members to share their fruits. Nor does it seem reasonable
to make some existing members worse off solely to make
others better off. For labour forces less than OJ, there is
no conflict in either case.
The potential for conflict between members that has been

identified here does not auger well for labour-managed
firms. This is particularly so since it is often argued that
they provide a means of removing conflicts internal to cap-
italist firms. Are there any means by which such conflicts
might be removed or minimised? A neoclassical economist will
immediately see trade or exchange between parties as a means
of avoiding such conflict. The question remains, however, of
how such trade may take place. This is essentially the sub-
ject matter of the next section on alternative institutional
arrangements. Another means of removing the conflict would
be, as suggested by Domar (1966), to pay the individuals
involved their alternative income.
Looking at Figure 3.1, the OS workers are faced with a
situation in which the addition of more workers (or the re-
tention of other workers) is desirable because the latter
group's VMP exceeds the current dividend but these workers
are unwilling to join (or remain) because their alternative
income is higher than the dividend. What happens if the col-
lective pays them their alternative wage? If the OS members
can act as a perfectly discriminating monopolist, this ad-
ditional cost will be represented by that portion of the
supply curve to the right of K. The benefit to be gained is
shown by each addition to the membership, as given by the
portion of the VMP curve to the right of N. The latter ex-
ceeds the former up to a labour force 0Q, and thus everyone
would be better off by the SQ workers being paid their
alternative wage to join (or remain in) the firm. Note that
although the OS members would receive a dividend greater
than KS, they would not receive QT since the SQ workers
would receive a wage rate above the dividend. Conversely, in
the situation depicted in Figure 3.2, workers between J and
R would be willing to work for less than the dividend and
the OJ workers would benefit from employing JT of them. Both
cases result in the socially optimum level of employment in
the firm since the VMP of labour is equated to its oppor-
tunity cost. The comparative static responses would no
longer be perverse. However, the consequence is that two or
more categories of member are created: one which receives a
dividend and the other a wage. It may we 11 be that those
receiving a wage would not be members but employees. Would
this produce strains within the firm? Perhaps not, given
that it is in everyone's interest, and so long as it is not
excessive the firm might still be regarded as genuinely
labour-managed.
Many firms which are called cooperatives do have non-
member employees (see further Chapter 6 below). They give
rise to a possible degeneration, since it will always pay
the remaining cembers to replace a retiring member with an

employee. In such a case, over the long run, membership may
diminish with the shrinking band of members increasing their
dividend by capturing an increasing economic rent (indicated
in Figures 3.1 and 3. 2 by the distance above the labour
supply curve of the dividend curve).
II ALTERNATIVE INSTITUTIONS
It is, perhaps, somewhat characteristic of neoclassical

economists that, when confronted with behaviour (the 1 per-
verse' supply response) which is either counter-intuitive or
sub-optimal according to the cannons of Pareto optimality,
they respond by devising in a theoretical vacuum, a model of
institutional schemes which modify such behaviour. A sociol-
ogist might tackle the question by finding out how firms
which call themselves labour-managed or cooperative actually
behave and cope with the problem. Similarly, an insti-
tutional economist of the traditional American type or of
the new breed of comparative institutionalists might argue
that those cooperatives which actually survive must have
dealt with the problem and the institutional form which they
have evolved will be superior to the alternatives. The first
response is typical of that part of the literature on the
labour-managed firm which is reviewed in this section.
The first major development in this area may be traced to
Meade's (1972) seminal article which argued that all that
was necessary to remove the perverse supply response was for
the number of shares in the surplus held by members to be
variable. This gives rise to what Meade called the 'inegal-
itarian cooperative'. Before turning to Meade's (1972) pro-
posal, however, a more piecemeal approach based on the
simple economic principle of compensation will be examined.
This was first proposed by Steinherr and Thisse (1979).
These authors sought some 'minimal mechanism of solidarity'
to overcome the 'perverse' supply response of the W-V-M
model. One approach to this is to consider the collective as
having to compensate any worker dismissed for the reduction
in income which he suffers. This is equivalent to maximising
the net income of the enterprise subject to the constraint
that no person who is a member prior to a decision is made
worse off by that decision. Steinherr and Thisse formally
prove that, with such a rule, the level of employment is
maintained at an initial equilibrium level. The burden of
their proof can, however, be demonstrated geometrically with
little difficulty.
A labour-managed enterprise is assumed in an initial equi-
librium where the dividend per worker (y 0 ) is equal to aver-

age incomes (w) of workers in all other enterprises and is
the same for all members. (It is not clearly stated by
Steinherr and Thisse whether or not the other firms are
labour-managed.) Employment in the firm examined is given by
the equality of yB with the value of the marginal product of
labour, and is L in Figure 3.3, which is adapted from
Steinherr and Thisse (1979).
Y1
Yo
0 M L L
FIGURE 3.3 Labour-managed firm with minimum 'solidarity'
Business conditions for this firm are assumed to improve

such that the dividend curve shifts from y0 to y 1 . It is
assumed for simplicity in this diagrammatic exposition that
the VMP curve is the same for y 0 and y 1 • In the basic
model, t~is change in business cond1tions would result in a
reduction of employment from OL to OM and an increase in the
dividend from y 0 to y 1 for these OM workers.
Compensation 1s possible if the total income (net of w) is
greater, given yl' when OM rather than OL are employed. In
the first case, tnis is given by the area wAFN. By maintain-
ing employment at OL, net revenue is higher (after deducting
Ow•ML) by the area NFE. Thus adequate compensation cannot be
paid to the ML workers without reducing the dividend to the

OM workers below OB.
If the average income of labour in the economy were below
w, the capitalist's initial equilibrium would be at a level
of employment higher than OL. The labour-managed firm would
maintain employment at OL under improved business con-
ditions, because non-members excluded from membership have
no rights in the Steinherr and Thisse framework. These
authors fail to solve the problem because they do not allow
the compensation principle to operate fully. If non-members
were allowed to compensate existing members for the dividend
reduction occasioned by expanding membership, 'optimal'
behaviour would result. Such compensation would be the
present value of the reduction in future dividends. Payment
of such compensation in the form of an 'entry fee' retains
the equality of dividend principle which is violated in
Meade's (1972) proposal of inegalitarian cooperatives.
Steinherr and Thisse conclude that 'in those cases where
Ward-Vanek obtain "perverse" results the LMF still does not
increase employment and output as does the capitalist firm.
In the short run, the supply curve is therefore perfectly
inelastic with respect to increases in prices' (Steinherr
and Thisse, 1979, p. 14). They then demonstrate that the
stock of capital adjusts to establish long-run equilibrium.
The implication remains that the labour-managed enterprise
behaves differently from its capitalist 'twin' but does not
exhibit the pure 'perverse' response.
The behaviour of the firm with unequal share distribution,
and subject to the adjustment rules l(a), l(b), 2(a) and
2(b) above, may be demonstrated by some simple modifications
to the maximand of the the W-V-M model. Let the members now
maximise
y (pX-rK-wL)/N, (3.1)
where y is the dividend per share which each member receives

in addition to the externally determined wage rate w per
unit of labour supplied. It should be noted that (as before)
y may be negative as well as positive. L is the number of
labour units supplied (either man-days or man-hours). N is
the total number of shares held by the members of the col-
lective. This maximand is such that, regardless of the
number of shares owned by each member, maximisation of y
maximises each member's income from the collective. The pro-
duction function may now be written as
X= f(K, L, N). (3.2)

Note that this implies that changing N, with L constant,

affects X. In the W-V-M model, Land N are equal, and profit
per worker is equal to y + w. However, in this model, L and
N are not necessarily equal, and the rate at which N changes
relative to L is a policy variable for the collective. We
may now examine the conditions under which (3.1) is maxi-
imised:
2
yN : [NpXN - NwLN - (pX - rK - wL)/N : 0,
therefore
pXN: wLN + y, (3.3)
where LN is the partial derivative of the labour supply with

respect to membership shares;
yK: (pXK- r)/N: 0,
therefore
(3 .4)
y1 : [NpX 1 - Nw - N1 (pX - rK - wL)) 0,
therefore
(3.5)
where N1 is the partial derivative of the number of shares

with respect to the labour supply.
The partial derivatives in (3.3) and (3.5) are decision
variables which in the W-V-M model are equal to unity. In
that model, therefore,
w + y,
w + y
Where hiring of non-members takes place,
N1 : 0,
and therefore (3.5) reduces to

The acceptance into membership of existing hired workers

implies LN = 0, reducing (3.3) to
pXN = y'
i.e. a hired worker's productivity must rise in order for it
to be to the benefit of existing members to accept him into
membership.
A simple rearrangement of (3.5) allows an examination of
how shareholdings may be adjusted as the collective adjusts
the labour force in the long run. From (3.5):
NL = (pXL - w)/y. (3 .6)
Note that the jth member's income will be
w + njy'
where n. is the number of shares held by the jth member. The

optimumJvalues of N and L will obtain where (3.6) holds.
Consider now the potential sources of conflict correspond-
ing to those identified earlier.
If w < pXL and y ) 0 then NL ) 0,
and therefore the collective will benefit from expanding

both the labour force and the number of shares which at the
margin will be increased as indicated by (3.6). Expansion
will take place so long as pXL > w.
Looking now at situations in which from one or other
party's view contraction is desirable: when w ) w + n.y )
pX1 , the jth member will wish to leave and the other members
wiil be willing for him to leave since his current income
(w + n.y) is greater than his marginal product's value. Re-
arrangfng the inequalities implies
0 > njy ) pX1 - w,

which implies y < 0 and pX1 - w < 0; therefore members will
be released.
Where for all members
w + njy ) w ) pX1 , (3.7)
the remaining members would benefit from someone leaving

(since w + n.y ) w ) pX1 ) but no member would willingly
leave (since J + n.y) w). (3.7) implies
J
njy > 0 > pXL - w,
(pXL - w)/y < 0.

This implies, from (3.6), that the number of shares in the
surplus must move in the opposite direction to the labour
supply. This seems paradoxical. What it really means is that
in order to persuade the jth member to leave, the remaining
j - 1 members will transfer some of their share of the sub-
sequent surplus to the jth member. This could be effected by
a lump-sum payment equal to the present value of annual sums
of n.y - (p~ - w) (presumably financed against future earn-
ings~, or by allowing the departing member to retain a share
in the surplus. [ 1] Lump-sum compensation might be seen as
preferable on the grounds that it retains the principle that
only those working in the firm may share in the dividend.
Suppose now that for all existing members
w > pXL - w > njy.

This implies that
(3 .8)
In this case, an existing partner will wish to withdraw

(w > w + n.y) but the remaining partners will not allow him
(pXL > w +Jn.y), except on special terms. The special terms
would be t~ose necessary to make (3.6) hold. Given that
(pX1 - w) and n.y are negative, then (pXL - w)/y must be
pos1tive (assumiJg n. to be positive).
Also from (3.8), J
(pXL - w)/y > nj.

From (3.6), the optimum requires
i.e. that the reduction in the total number of shares occa-

sioned by the withdrawal of the jth (marginal) member must
be greater than the shares which he holds. This may be
looked upon, simply, as in the previous case, as a require-
ment for compensation to be paid.[2] This time it flows from
the departing member to the remaining members.
Permitting workers to hold different numbers of shares
means that the distribution of the surplus is no longer
egalitarian. Workers doing the same work in the firm but who
joined at different times may be receiving different in-
comes. Meade (1972) argues that this may be perfectly jus-

tified in that, in joining at a later date, one worker may
not have shared in the risk borne by the other in the early
years of the firm's development. In his discussion of
shares, Meade (1972) does not discuss the tradeability of
such shares. The inference drawn is that they are not, and
that the issue of new shares and the withdrawal of old
shares is, subject to the constraint discussed above, at the
discretion of the collective. It is, however, but a small
step to consider membership being tradeable. Murat Sertel
(1982) has demonstrated that assuming that appropriate legal
intricacies may be overcome, the joining of a tradeable
share with membership will lead to the labour-managed firm's
long-run equilibrium and comparative static behaviour being
identical to that of its capitalist twin.
Trading in membership must obviously be constrained to
ensure that necessary skill requirements are met. Thus the
transfer of a share and the corresponding right to employ-
ment must be subject to the approval of the other members.
The basis for refusing approval must, however, be very cir-
cumscribed and exclude any attempt by the other members to
do so simply for their own pecuniary gain. The following
analysis leans heavily on the work of Murat Sertel, but is
something of a paraphrase.
It is now assumed that each member is issued with only one
share. Thus where L is the labour supply and N the number of
shares,
(3. 9)
The maximand may still be written as (3.1), interpreting w

to be an externally-determined competitive wage rate. The
introduction of a market in shares, however, constrains the
maximisation of (3.1) because equilibrium will be attained
only where the market in shares is in equilibrium, i.e.
D(N) = S(N), (3 .10)
where D(N), the demand price of a share, will be given by
D(N) = y.
Since an outsider can increase his income above w by that
amount when he joins the firm, at the margin he would be
willing to pay y to join.
S(N) is the supply price of shares, which will be the
amount of compensation which existing members must receive
to make them no worse off as a consequence of the change in
membership. Thus
S(N) = - NyN.
The first-order conditions for maximising (3.1) subject to

(3.2), (3.9) and (3.10) are given by
YN 0,
YK 0'
YL 0
and y - NyN.
The first three yield
pXN w + y, (3.11)
p~ =r (3 .12)
and pXL w + y. (3.13)
(3.11) and (3.13) confirm what intuition should suggest:
The fourth equilibrium condition yields
But, in equilibrium,
therefore
y = - NyN = - pXN + wLN + Y•
But XN =XL and LN = 1, therefore
y = - pXL + w + y,
i.e. pXL = w. (3 .14)
Comparing (3.13) and (3.14) suggests that y = 0 in equilib-

rium; i.e. at the margin, a potential entrant is willing to
pay the surplus to gain entry. The first-order equilibrium
conditions are therefore (3.12) and (3.14), which are ident-

ical to those for the capitalist 'twin'. Thus both long-run
equilibrium and the short-run comparative static properties
of the labour-managed firm with tradeable shares are the
same as for its capitalist twin: there is no 'perverse'
short-run supply response. The tradeable share solution has
the added benefit that every member receives the same share
in the surplus arising from work done in the firm. However,
pre-existing members make capital gains when the membership
is increased so that lifetime earnings by individuals who in
all other respects are identical may differ depending on
when they joined the firm.
A market in membership shares solves the 'perverse' supply
problems without conspicuous inequality. It may appear at
first sight as an unlikely set of institutions, but there
are examples to be found among US plywood cooperatives (see
Berman, 1982, and Chapter 6 below) and a cooperatively-owned
omnibus company in Israel. These examples do show tendencies
to degenerate, and there are problems which arise from share
transfer. However, transferable shares with the possibility
of capital gain, although enabling economic efficiency to be
attained, may be unacceptable to many for ideological
reasons. In particular, some would argue that such share
ownership is incompatible with true socialism. Thus one
would not expect transferable shares to be an acceptable
solution in a socialist centrally-planned economy. Removal
of the 'perverse' supply response may, however, in such a
case be attained by a more direct form of intervention. One
possible framework for this has been presented by Norman
Ireland and Peter Law.
Ireland and Law's (1978) solution to the problem of
encouraging the enterprise to expand its labour force from
below L to L in Figure 3.3 is presented within a
decentralised planning framework. This involves an incen-
tive fund and transfer payments (P.) between it and firms.
Income per head in the ith 1firm now becomes y.,
where y. = (Y. + P.)/L., andY. is the total revenue of tfie
enterprise ne~ of ~on-labour c6sts. The transfer payment is
defined as
P.
1
= (Y. - wL. )(L. -1. )/f...,
1 1 1 1 1
where L. is the number of members before the introduction of

the inc~ntive scheme, and w is the shadow wage of labour for
the economy.
A firm receives P. if Y. - wL. > 0 and labour increases
above L., or if Y. 1 - wL. 1 < 0 knd labour falls below L ..
1
Otherwile the firm 1pays p\ Therefore
1
MODIFICATIONS OF THE BASIC HODEL 41
(Y. -
1
w)/L 1.•
The first-order condition for maximising yi with respect
to L. is that the partial derivative of Y. w1th respect to
L. ls equal to w. This implies that fof all firms that
r~main in operation, the value of the marginal revenue
product of labour is identical. Thus, no re-allocation of
labour between firms can increase welfare.
Since w is the shadow wage rate, Y. - wL. is the 'shadow
profit' at that valuation of labour. 1 The i~come per worker
in the ith cooperative is then the shadow wage plus the
shadow profit per original worker. If the partial derivative
of Y. with respect to L. exceeds w, there will be an incen-
tive1 to increase empllyment, for which there will be a
transfer payment from the incentive fund if Y. ) wL .• Even
if Y. < wL., recruitment will take place, but h\re a ~ayment
will 1 be maae to the fund. When firms reduce membership, the
transfer payment has the effect of being compensation per
member who is made redundant spread over those who remain.
It will flow from the firm to the fund if Y. > wL. and to
the firm when Y. < wL.. The advantages of tbe sch~me over
Meade 1 s inegalifarian ~ooperative, claimed by its authors,
is that the cooperative never discriminates in income pay-
ments between members and no-one ever has to purchase his
release from a cooperative.
The selection of w is made via an iterative process: the
central authority, on the basis of the existing level of em-
ployment, selects w and asks firms to state their planned
adjustments; w is then varied until supply equates with
demand; finally, at the end of the planning period, firms
report their value of Yi and then transfer payments take
place.
The size of payments to and from the fund depends on the
shape of the total income curves and the t:elative sizes of
L. and L .• The aggregate of transfet: payments may well be
n~gative,1 implying a need to raise tax revenue to service
the fund. Ireland and Law say that simulations confirm that
it is reasonable to expect this increase in tax revenue to
come from the increased output at the more efficient level
of operation. They also concede that as a policy prescrip-
tion, the operation of the incentive fund would have to be
modified where monetary valuation of non-pecuniary benefits
and conditions of work is not possible. It is interesting to
note that the operation of 'entrance and exit fee' compen-
sation would be more likely to overcome these problems,
since the valuation of the compensation payments would be
made by those directly involved. It is still possible,
however, where tastes differ radically between members
of a cooperative, that the sum of compensation could not be

agreed. A further drawback of this scheme, not discussed by
its authors, is that it implies the existence of a central
authority, free from political interference, which is
willing and able to set the correct value of w. The exist-
ence of such an authority may represent a different form of
interference with self-determination which might be unaccep-
table in some societies.
The alternative institutional frameworks outlined in this
section show that, with a little ingenuity, the 'perverse'
supply response of the W-V-M model may certainly be removed.
These solutions do have their costs in terms of inequalities
between members, the creation of capital gains, or the
existence of a powerful central authority. It is, of course,
a matter of individual judgement whether the costs (if they
are perceived as such) of these institutions are acceptable
in order to achieve optimal behaviour on the part of the
labour-managed firm.
III ALTERNATIVE MAXIMANDS
Another form of reaction to the 'perverse 1 supply response

of the W-V-M model comes from a number of authors who are
sceptical as to the validity of its objective function (for
example Robinson, 1967; Vanek and Miovic, 1970; Horvat,
1967, 1975; McCain, 1973; Steinherr and Thisse, 1979; Law,
1977; Estrin, 1979). The objective function can be made
somewhat more realistic by including the size of membership,
as we 11 as the dividend, as an argument of the worker-
manager's utility function (Law, 1977; Estrin, 1979).
Worker-managers, however, may be concerned, not simply with
the level of membership in general, but with the likelihood
of they themselves being members after an adjustment to a
parameter change (Steinherr and Thisse, 1979). It will be
demonstrated below that such considerations may lead to a
neutralisation of the perverse supply response. A more
fundamental and far-reaching criticism of the W-V-M model is
that membership is unlikely to be a short-run variable: the
immediate reaction to a change in parameters is likely to be
a change in the intensity of work of existing members (Sen,
1966; Berman, 1977; Ireland and Law, 1981). Membership will
be adjusted only in the long run, and perhaps only over a
period longer than that necessasry to adjust the capital
stock (Estrin, 1980a, 1982b). Such considerations give rise
to models of the short-run labour supply which are examined
later in this section. Some authors (Vanek, 1970, chap. 12;
Tyson, 1979; Ireland, 1981) have argued that another import-
ant dimension of labour-management is that the effort ex-

pended by workers is likely to be higher than under capi-
talism. Whilst the supply of hours might be regarded as a
proxy for the supply of effort, consideration of any differ-
ential in effort between labour-management and capitalism is
omitted here as this aspect of the literature is still in
its infancy.
If the utility function of the worker-managers is thought
to include membership as we 11 as income, the behaviour of
the firm may be modelled as follows:
maximise U = u(y,L),
where U is the utility function of the 'firm'.[3) The first-
order condition for maximisation with respect to membership
(L) is
Uy.yL + UL = 0,
i.e. - UL/Uy = YL• (3 .15)
(3.15) may be interpreted as a requirement that the slope of

the income membership indifference curve should equal the
change in income arising from a change in membership. Note
that for a firm with an egalitarian distribution of income
the right-hand side of (3.15) yields
YL = (pXL - y)/L,
i.e. each member's share of the difference between the value

of the marginal product of membership and the dividend.
Thus, so long as workers have some preference, for or
against, changes in membership (i.e. UL t- 0), the utility
maximising labour force is attained where
Thus the dividend is not at its maximum. This is illustrated

in Figure 3.4, which superimposes an indifference map on the
dividend curve and value of marginal product curve. The
W-V-M firm would be in equilibrium at A with a membership of
L, whereas the utility maximising firm is in equilibrium at
B (where the dividend curve is tangential to an indifference
curve) with a membership of N. The construction of the
indifference curves in this diagram assumes that workers
have a positive preference for both income and size of
membership (i.e. U , u1 > 0).
Law (1977) compates the behaviour of such a labour-managed
FIGURE 3.4 The utility maximising labour-managed firm
firm with a firm bargaining with a union whose utility func-

tion is identical to that used above. In this case, the
firm's demand curve for labour will be the value of marginal
product function and the equilibrium wage (w), and employ-
ment (M) will be given at C, the point of tangency between
the VMP curve and an indifference curve. Note that since the
y curve is net of fixed costs (rK), this firm will be making
economic profits. In the long run, under perfect compe-
tition, with changes in the capital stock and entry of new
firms into the market, the y and pX 1 curves will shift such
that the tangency point C must coincLde with A. If the union
has no preference for employment, the indifference curves
are horizontal and the union will seek to maximise y, just
like the W-V-M firm. Thus, where unions are sufficiently
strong to determine the wage rate and allow firms to adjust
labour and capital so as to meet fixed costs, the capitalist
firm's behaviour will be identical to that of the W-V-M firm
(see also Greenwald, 1979). This presents an interesting
hypothesis for testing in industries with very strong
unions.
Returning now to the case of the utility maximising

labour-managed firm, how does it respond to changes in
parametric prices? This depends on the 'shape' of the
indifference curves, or more correctly the relative weights
on dividend and employment in the utility function (Law,
1977; Estrin, 1979). An increase, for example, in the
parametric price of output will shift y upwards, with its
new slope at labour force L being less than previously. The
response in terms of membership will depend on whether this
new slope is less than, or greater than, the slope of the
appropriate indifference curve. Law (1977) argues that a
plausible utility function could yield a result which
neutralised or reversed the 'perverse' supply response.
However, Estrin (1979) argues that a 'realistic' preference
function for the firm wi 11 involve discontinuities around
what are limits to feasible adjustments in membership for
internal political reasons (e.g. too great an increase
threatens the control of the existing majority). Under these
assumptions, it is argued that the firm would never increase
employment in response to an increase in output price. The
validity of these conclusions depends critically on the
empirical verifiability of the utility function.
Steinherr and Thi sse (1979) also tackle the 'perverse'
supply problem by arguing that an individual worker, when
making a decision which implies a reduction in the labour
force, will not neglect the fact that he himself may be one
of those dismissed. [4] The analysis is set up by assuming
the labour-managed firm to be in equilibrium with labour
force L0 , and dividend y 0 equal to the average income of
labour ~w0 ) elsewhere. Tne objective function now becomes
maximise V(L) with respect to L, where L is positive but
less than infinity, and
for L 0,
V(L) =
/"''
U[y(L)]·(l - p) + U(w )p,
y(L),
0
for 0
for
< L < Lo'
10 ~ L,
where y(L) is the function relating the dividend to employ-

ment and p (L 0 - L)/L is the probability of being dis-
missed.
Steinherr and Thisse prove that the only value of L which
can maximise V(L) is 1 0 • Starting from w0 = y 0 , if business
conditions change, alternative values of L are examined.
(i) If L 0, incomes are w0 < y(L 0 ).

(ii) If 0 < L < 1 0 , the max1mand is formally equivalent
to the sum of the utilities of the original member-

ship, 1 0 • Given the assumption of identical utility
functions, this cannot be greater than U(y(L 0 )), as
has already been demonstrated in Figure 3.3.
(iii) If L > 1 0 , y(L) < y(L 0 ) because of the diminishing
marginal productivity of labour. Therefore L0 ·U(L)
< L0y(L0 ), i.e. the utility of new members 1.s not
considered.
Consequently, 1 0 max1.m1.ses V(L). Note that if the collec-

tive were concerned with the utility of those outside the
collective's membership, it would also select 1 0 membership:
i.e •. 1 0 maximises social welfare. This follows from the
earlier discussion of compensation, when w0 is the average
labour income outside the collective. If, nowever, y 0 > w0 ,
and therefore initial employment is less than L in Figure
3.3, concern for those outside the firm would lead to labour
rising to L.
These attempts to broaden the objective function of the
labour-managed firm show that the 'perverse' supply response
does not rest on terribly firm ground, but the alternative
models require particular assumptions before the reaction of
the labour-managed firm to a parametric price change totally
reverses the established result.
A much more fundamental criticism of the W-V-M model is
that membership is not a short-run variable which is ad-
justed up or down as prices fluctuate. Indeed Vanek, him-
self, acknowledges this fact in several places (Vanek, 1970,
1977) when he says that membership reductions may take place
slowly via natural wastage. However, he does not formally
examine the implications of this, a task which has recently
been carried out by Saul Estrin (1980a, 1982b).
It seems highly plausible that membership changes will not
be made in response to the slightest fluctuations in prices.
If product price is unstable, such changes may require to be
reversed quite frequently. Frequent changes in membership
may result in unstable decision-making for the group as a
whole. Even a minor degree of solidarity between members is
likely to encourage short-run fluctuation in price to be
ignored as far as adjusting membership. Variations in hours
worked by existing members or the hiring of temporary non-
member employees are much more plausible ways of dealing
with short-run and seasonal fluctuations. Berman (1982)
argues that this is precisely how the plywood cooperatives
of the north-western USA behave.
The non-member employee option has already been examined
above. Now the variation of member working hours will be
explored.
The model may be articulated as the maximisation of the

utility of the jth individual, U., subject to a dividend
constraint, i.e. J
max V =U (y.,h.) + z[y.- (h./H)(p f(H,k)- rk)],

J J J J
where y. is the jth worker's dividend,
h~ is the hours worked by the jth individual,
HJis the total hours worked by members of the
collective
pis the price of output,
X = f(H,k) is the production function,
k is the vector of non-labour inputs,
r is the vector of non-labour prices,
z is a Lagrange multiplier.
y. and h. are taken to enter the utility function in a man-
nJr whic" may differ for each worker, i.e. individual util-
ity functions differ.
I t is assumed that there is no job opportunity which at-
tracts the worker away from this firm and that each worker
assumes that variations in his labour input do not affect
the labour input of others; i.e. H is composed of h. which
is variable and h which is assumed by the jth worket to be
constant. The first-order conditions for utility maxi-
misation are then given as
v. 0 u. + z'
JY JY
2
vjh 0 ujh (z/H )[H(hpfh + pX - rk) - h(pX- rk)]
and V.k. = 0 =- z(h/H)[pfk - r.],

J l. i l.
where the subscript i denotes the ith non-labour factor.

The third and first conditions yield
pfk. = ri,
l.
which, as in the basic model, suggests that each non-labour
input should be used until its value of marginal product
equals its price. The second condition, however, presents
some problems. Substituting for z and w = (pX- rk)/H yields
- U.h/U. = (h./H)pfh + [1 - h./H]•w. (3 .16)

J JY J J
The RHS of this equation is the opportunity cost of work to
the jth worker. With only one worker, (h./H) = 1, and (3.16)
reduces to J
- u.h/u.
J JY
= pfh,
i.e. the opportunity cost of labour is equated to its mar-
ginal value product.
However, where h. < H (i.e. more than one worker), the jth
worker is encoura~ed to increase his hours worked beyond
their optimum level from the point of view of the other mem-
bers of the collective (and society as a whole).
The unconstrained hours variation model may be represented
in terms of Figure 3. 5, which is adapted from Berman's
( 1977) Figure 1. The number of hours worked by those other
than the j th worker are shown as h. The curve Y shows the
net income of the collective as a whole, and the curve wh.
the income of the jth worker. The dividend per hour worked
is shown by the slope of a ray from the origin to a point on
Y; e.g. when total hours worked are ~ , the dividend per
hour is the slope of OF. The income of" the j th worker is
given by the heig~ of the wh. curve; e.g. at H1 it is H1 J.
The line joining h and J wil~ have slope w since the Jth
worker works (H 1 - h) hours earning H1J income, and thus the
h1 H1 H2 H
L ______ ---------hi
FIGURE 3.5 Unconstrained hours variation

hourly rate is
Thus hJ must be parallel to OF.

The slope of wh. is the RHS of equation (3.16).
Equation (3.16)Jimplies that the jth worker will work un-
ti 1 the slope of wh. equals the slope of an income/hours
indifference curve. ~uch a position is shown by point B in
Figure 3.5. The slope of the indifference curve at B is
greater than the slope of the indifference curve at G, which
is the marginal product of the last hour worked by the jth
worker. Note, however, as constructed with w > pfH through-
out the range of H, the other workers would prefer that the
jth worker leave the collective.[S]
Berman (1977) has proposed a solution to the problem posed
by equation (3.16) which arises from his view that the prob-
lem has all the attributes of a multi-person oligopoly
game, which may be solved by collusion among the workers. He
suggests that a reasonable rule which may arise from such
collusion is that the jth worker may change the number of
hours which he works only if all other members of the col-
lective change theirs by the same proportion, i.e.
d(h./H)/dh. = 0.
J J
The addition of this constraint to the optimisation problem
yields the following first-order condition, for utility
maximisation by the jth worker, with respect to hours
worked:
Vh = 0 = Ujh- z(hj/H)[pfH•(H/hj)].
This yields
pfH = - U.h/U. • (3.17)

J JY
Berman and Berman (1978) suggest that a condition such as
(3.17) will guarantee that a price increase will be met by
an increase in hours worked, so long as the substitution
effect outweighs the income effect.
Berman (1977) adduces support for his 'collusion' rule
from Berman (1967), who observes that in US plywood coop-
eratives: 'equilisation of the hours worked ••• is care-
fully safeguarded as far as possible'.
This goes further than the constraint suggested by Berman
(1977), which is one of proportionality, not equality, of
hours. However, the first-order conditions for optimisation
are the same.

Berman's (1977) solution is not wholly persuasive. It
clearly does not guarantee a stable overall optimum. Equa-
tion (3.17) may represent a Pareto optimal situation in the
sense that once a value of H has been decided upon, no re-
allocation can make any member better off without making
another worse off, but there are many such optima. Each of
these corresponds to the constrained optimum for each member
of the collective. There is still no determinate solution.
This may be seen more clearly by using Berman's (1977)
analogy with an oligopoly game. He sought a 'collusion' sol-
ution but has, in fact, proposed a 'leadership' solution.
The constraint that
d(h./H)/dh. = 0
J J
is, in fact, the reaction function of the other members to
the choice on hours made by the jth worker. Equation (3.17)
is the optimum condition for him, given his knowledge of
this predetermined reaction function. The 'leadership'
solution to an oligopoly game will be determinate only if
there is a clearly defined leader. This is unlikely in the
situation analysed by Berman ( 197 7), si nee every member of
the collective knows the institutionally-determined reaction
function of the others. Condition (3.17) can yield a
determinate value of H only if all members have identical
utility functions, which is an assumption specifically
excluded by Berman.
Thus far it has been assumed that each member behaves in
the way which maximises his own utility and is totally un-
affected by the impact of his behaviour on others. This need
not be the case. Collectives may be formed by like-minded
people who share common values. There is the advantage of
making the collective form of enterprise more stable if its
members have relatively homogeneous preferences. Thus, for
example, the Kibbutz movement in I srae 1 is divided into
three broad federations which give different weights to dif-
ferent aspects of Kibbutz life (Ben-Ner and Neuberger,
1982). Further, it has been argued that part of the success
of the Mondragon system of cooperatives is due to the par-
ticularly rigorous selection procedures to which new appli-
cants are subjected. In such a case, it might be reasonable
to assume identical utility functions for all members. Even
where preferences are not identical, it might be expected
that over time, at least, workers would be conscious of the
effects of their decisions on the welfare of other members
of the firm and modify them accordingly. In this case, the
worker no longer seeks to maximise U, but may be thought of
as maximising
N
w u.
J
+L. a .. ui'
l.J
0~ a .. ~1.
l.J
i=1
i j
Following Sen (1966), the 'social consciousness' of individ-

ual j is defined as an aggregate measure of his sympathy for
others. This is constrained to be
s.J = <L;a l.J

. . )/N,
with S. lying in the closed range [1/N,l]. It is further
assumedJthat sympathy is symmetric, and thus
S. = S for all j.
J
Maximisation of W subject to the dividend constraint
yields the following first-order condition for the jth in-
dividual's choice of hours:
-U.h/U. = pfh(h./H) + [1 - (h./H)]•w

J JY J J
i;t j l.J
+La ..
<u. /u. )[pfh(h./H) - w(h./H)].(3.18)
t.y JY 1. 1
Since by assumption pfh < w, the third term on the RHS of

(3.18) must be negative. Consequently, concern for others
reduces the labour input. The optimal degree of concern will
be such as to reduce h. to the point where it is socially
optimal, i.e. where J
- u.h/u. = pfh.
J JY
Let a .. = U .h/U. , and substitute this into (3.18), which
becomJJ J JY
N
-U.h/U.
J JY
pfh(hj/H) + [1-(hj/H)]w +1.:1 [pfh(hi/H)-w(hi/H)],
i;tj
i.e.
N
-U.h/U.
J JY
pfh(h/H) + [1 - (h/H)]w + [pfh - w] L (h/H)
i=l
itj
N
w + [pfh - w] E (h./H)
i=l ~
N
since "L: (h./H) 1.
i=l ~
Thus a .. = U.h/U. is the optimal degree of concern and is

equiva!Jnt tJ thJY jth individual evaluating the income and
effort positions of all individuals according to his own
utility function, i.e. he gets the same satisfaction from a
given income/hours trade-off for another as he would if he
were in that position. Thus the individual's welfare func-
tion might be expressed as
N
wj =[:uj (y.~ , h.~ ) • (3.19)
i=l
Equation (3.19) may be thought of as defining one particular
form of altruism. However, even if all members of the col-
lective are altruistic, in this sense, a stable optimum is
not achieved,[6] since that would require
- U.h/U. = pfh for all i

~ ~y
to be satisfied at the same aggregate hours H.

If all members have the same utility function and are con-
cerned about the utility of others, the optimal allocation
of labour for the jth individual becomes
N
- UJ.h = 'L: a .. U. (pfh(h./H) - w(h./H)] + U. w.
i=l ~J ~y ~ ~ JY
However, since all individuals are assumed to have the

same utility function and S. = S, the same amount of labour
is offered by each individudl. Consequently
yi = w for all i
and h. = H/N = h for all i.

~
The optimality condition becomes
N
- U /U
h y
(h/H)[pfh - w] L:::3 a .. + w
i=l ~J
(3. 20)
where B is the ratio of income to total output,

eh is the output elasticity of labour.
Optimality requires that - U /U = pfh' which can be
achieved if S = 1 or B = eh. The hiat!ter of these implies
(pX- rk)/pX = (~·H)/H,
therefore
pfh = (pX - rk)/H = w.

The last of these is the familiar W-V-M result restated in
terms of man-hours.[7]
Note that optimality through B = eh is achieved regardless
of the degree of external concern. B = eh is not a necessary
condition, since perfect sympathy is also sufficient.
Ireland and Law (1981) have proved that, except where S
tends to zero, the optimal hours for individual j may fall
in response to an increase in product price even if the
worker would have increased hours were he an employee
offered a higher wage. Concern for others in the short run
does not rule out the 'perverse 1 supply response. Ireland
and Law show, inter alia, the comparative static responses
of the firm for a specific functional form of utility
function U = w - B(h). The optimality condition (3.20) may
be rewritten
B I (h) Spfh + (1 - S)(B/eh) pfh

Spfh + (1 - S) w;
so when s = 1, BI (h) pfh'

and when s~ 0, B' (h) w.
If the level of membership is optimal and hours in equi-

librium, the total hours worked will be OA in Figure 3.6.
When price increases from p 0 to p 1 , the value of marginal
product curve and dividend curve shift to p 1X and w1 , re-
spectively. Perfect sympathy would produce a s\ort-run sol-
ution of total hours of OB, whilst minimal sympathy yields
OC. Note that OC corresponds to Berman's (1977) solution
only if the individuals have identical utility functions.[8]
Figure 3.6 also emphasises the point made earlier (in a
different context) with respect to (3.18), that concern for
others reduces the labour input. This is because a greater
number of hours per worker reduces w.
In the longer run, [9] when N is variable (thus shifting
B'(h) 1
B'(h)o
0 D ABC H
FIGURE 3.6 Effect of a price change
B'(h)) the equilibrium total hours is OD. Membership will

have fallen, but individual hours (H) must rise since B'(h)
is an increasing function of h and the marginal disutility
of hours is greater at OD than at OA. For this utility func-
tion, it is clear that the individual hours increase in both
the long and short run as a result of the price increase,
but in the longer run output falls (although it rises in the
short run).
The effect of a change in fixed costs may be illustrated
by Figure 3.7. Let the shift from w0 to wL be brought about
by a reduction in fixed costs. The value or marginal product
curve is unaffected. Perfect sympathy (S = 1) would mean
that total hours were not adjusted from the previously
established long-run equilibrium, OA. Minimal sympathy leads
to an increase to OE. In the longer run, since the maximum
value of w must occur to the left of OA, the total hours are
reduced to OF although again individual hours rise.
Vanek (1970, chap. 2) also addressed himself to the prob-
lem of variations in individual effort, but in a somewhat
heuristic manner. He concludes that where production cannot
w,
Wo
0 FA E H
FIGURE 3.7 Effect of a change in fixed costs
be imputed to each individual worker then a 1 group behav-

ioural approach 1 is necessary. This relies on all income
being imputable to the group and the democratic process
engendering a group ethic. Vanek believes that, through such
processes, produc ti vi ty gains can be made through labour-
management.
Analytically, and taken at its most simplistic, this ex-
tension of the model might be thought of as implying a group
welfare function
u u(y,n,H),
where y (pX - rK)/n,

H number of hours worked by the whole labour force,
n number of workers.
The optimisation problem becomes
maximise V = u(y,n,H) + Z [y - (pX- rK)/n]. (3. 21)

V =U +Z=O
y y
therefore
z = - uy . (3. 22)
VH = UH - (ZpXH)/n 0
therefore
- U /U (p~)/n. (3. 23)

H y
V
n
= Un - Z[npX
n
- (pX- rK)]/n 2 0
therefore
- U /U
n y
= (pXn )/n - y/n [pX
n
- y]/n. (3.24)
VK = -Z(pXK - r)/n =0
therefore
(3. 25)
Note that the function U is not based on individual prefer-

ences, but is a product of a 'group behavioural' process.
Equation (3.23) expresses the short-run condition: that the
slope of the cooperative's work-income indifference curve is
equal to the slope of the income per worker curve. This may
be shown diagrammatically as in Figure 3.8, in which
u3 > u2 > u1 and short-run equilibrium is attained at A.
Equation ~3.23) suggests that so long as the substitution
effect outweighs the income effect, an increase in p results
in more hours worked and, given labour is the only short-run
variable, output increases. A point will, however, be
reached where the supply of hours is reduced as income
rises.
In the longer run the membership of the collective may
also be varied. If the 'group' shows no preference as to
size, (3.24) reduces to
(3.24a)
i.e. the optimal condition in the basic model. Where there

is a positive preference for size, membership will be above
this level (i.e. in the phase of diseconomies of scale), and
where there is a negative preference membership will be
pX-rK
n
FIGURE 3.8 Group welfare maximisation
below it (i.e. in the phase of economies of scale). The

optimality condition for the non-labour factor (3.25) is as
before.
The model implicit in (3.21) begs a number of questions.
How is the group utility function derived? How are the H
hours distributed across the n members? These two questions
are probably interlinked, in that the 'shape' of the utility
function will be influenced by the factors which determine
the way in which the hours worked are distributed, in equi-
librium, across the members. Answering this question goes
beyond the scope of the present chapter, and relates to in-
ternal organisation. For the present, it is perhaps necess-
ary to say that in the absence of such a utility function,
an equilibrium quantity of hours can be achieved only under
very restrictive assumptions: in particular, that the mem-
bers of the collective have identical utility functions.
This condition may be achieved by the collective being
formed by 1 like-minded' people, or may be generated, as
Vanek (1970) suggests, by the collective nature of the
enterprise. Under any other circumstances it is unlikely
that (3.21) can be based on individual preferences.

This chapter has illustrated how sensitive the 'perverse'
short-run supply response is to the very simple assumptions
of the W-V-M model. The importance of the various adap-
tations to the model depends on how appropriate they are as
descriptions of the real world. The question of insti-
tutional form is relatively straightforward, and may be
answered through a detailed analysis of existing and his-
torical forms of cooperative. The appropriateness of par-
ticular objective functions as descriptions of the motiv-
ations of cooperatives is something that is probably not
open to empirical verification (just as the appropriateness
of profit maximisation in the conventional literature has
not been verified or otherwise). However, it may be poss-
ible, using historical data, to test subsidiary propositions
(e.g. does membership fluctuate in the short run?). Some
readers, however, may be willing to accept some of the
models purely on the basis of their intuitive appeal. Thus I
would argue that membership should not be regarded as a
short-run variable. Inter alia, empirical evidence on insti-
tutional form is examined in Chapter 5.
IV RISK
So far, it has been assumed that the firm operates in a

world of certainty. This assumption is now relaxed, and its
consequences examined. Discussion in the literature has
primarily been concerned with the case of product price non-
certainty (Pestieau, 1979; Hawawini and Michel, 1979;
Ramachandran et al., 1979; Muzando, 1979), but Kerchove
(1979) deals with uncertain demand and a firm which seeks to
make consumers absorb the uncertainty. Hey (1981), in ad-
dition to considering price non-certainty, deals with non-
certainty associated with the firm's inputs. Ireland (1981)
has developed an approximate relationship between parameter
uncertainty and parameter changes. The presentation here
relies heavily on Hawawini and Michel (1979).
Assume that a W-V-M firm faces uncertain demand, and seeks
to deal with this by a strategy of setting output ex ante.
Thus product price becomes a random variable,
p = D(X, ii),
where u is the random element which is assumed to be addi-

tive and normally distributed; i.e.
p = D(X) + u,
E ['j)] D(X),
s (!)) s(ii),
where E is the expectation operator and s denotes standard

deviation.
The objective function now becomes the maximisation of the
expected utility of the dividend, E[U(y)]. The utility func-
tion is assumed to be of a Von Neumann-Morgenstern type such
that the firm is risk-averse and exhibits a declining mar-
ginal utility of money. Consideration is restricted to the
period over which capital is fixed but labour is variable.
The expected dividend is
E[y] = (D(X)X- rK)/L, (3.26)
and its variability is measured by its standard deviation:
s{y) = s ('i))X/L. (3. 27)
The situation faced by the firm is depicted in the first

quadrant of Figure 3.9.
The feasible opportunities open to the firm may be seen by
substituting (3.26) into (3.27), which yields
ErJ] = [D(X) s(y)/s('i))] - [rK/L]. (3. 28)
I t can be shown (Hawawini and Michel, 1979, Appen.) that

(3.28) may be represented by a concave curve in the first
quadrant of Figure 3.9. The objective function is rep-
resented by a set of indifference curves u1 , •.• ,U • The
optimum is obtained at the point of tangency, A, betJeen an
indifference curve and the opportunity set. At A, the firm's
marginal rate of substitution (MRS) of risk for expected
income equals its marginal expected income (MEI). From
(3.27), the relationship between risk and employment may be
derived:
ds(y)/dL = s(p)[XL- (X/L)]/L. (3.29)
Since it may reasonably be assumed that XL < X/L over the

relevant range, (3.29) is negative. Corresponding to the
optimum, A, there is an optimum labour force, LA' and out-
put, XA' as shown in the third and fourth quadrants of the
figure.
The comparative behaviour of the firm under certainty and
risk may be illustrated by considering the equilibrium con-
dition that
E[y]
FIGURE 3.9 Equilibrium of labour-managed firm

facing uncertain price
MRS risk/income = MEl.
Following Hawawini and Michel (1979), to simplify the

exposition, it is assumed that the demand function is linear
in X and the production function is Cobb Douglas with elas-
ticity of one-half: i.e.
D(X) =a - bX, a > 0, b > 0,

and X= L1 /2.
On these assumptions, MEl dE[ 'y]/ds( y) is linear in risk,

dE[y]
ds[y]
G
H s[y]
L
FIGURE 3.10 Comparative statics under uncertainty
as shown in Figure 3.10 (Hawawini and Michel, 1979). It can

also be shown that the MRS curves, which are the deri va-
tives of the indifference curves with respect to risk,
assuming risk aversion, are upward-sloping and pass through
the origin. The intersection of these two curves at A yields
the equilibrium under risk and perfect competition in the
product market. The equilibrium under certainty obtains at N
since under certainty dy/dL = 0, and this condition is
implied by dE[ y]/ds( 'Y> = MEl = 0.
Output under certainty is thus less than under risk. This
result is the opposite to that for the profit maximising
firm (see Sandmo, 1971; Newberry, 1978; Ishii, 1977). Why
should this be so? Note, however, that (3. 29), which de-
scribes the variability of dividend as membership changes,
is negative; i.e. as employment rises, the variability of
the dividend falls. Thus risk is reduced by producing more.
This reversal of the situation under profit-maximisation
means that the labour-managed firm facing risky price may
produce more than its profit maximising twin.
Before the reactions of the firm facing non-certain price
to parameter changes is examined, a more precise definition
of risk aversion must be used. This is the Arrow-Pratt index
of absolute risk aversion (Arrow, 1965; Pratt, 1964). A firm
is said to display increasing, constant or decreasing ab-
solute risk aversion as -U~v/U~ increases, remains constant
or decreases. YY Y
Only the case of decreasing absolute risk aversion will be
examined here, as this seems to be the most likely according
to empirical studies. Hawawini and Michel (1979) show that
the MRS curve of Figure 3.10 rotates clockwise as the firm
moves to a higher indifference curve. Thus for each indif-
ference curve there is a different MRS curve. Under constant
absolute risk aversion, there is a single unique MRS curve.
Let that be represented by MRS 1 in Figure 3.10.
Under the technological assumptions made and with perfect
competition in the product market,
where p is the expected price. Note that this2 is a straight

line with intercept p/s(p) and slope [-2rK/s (p)]. Thus an
increase in fixed costs decreases the slope of the MEl line,
as shown by the movement from BN to BM in the figure. Under
constant absolute risk aversion, this leads to an increase
in output as shown by the increase in the labour force from
LA to LC. With decreasing absolute risk aversion, since the
increase in fixed costs reduces expected income, the firm
moves on to lower indifference curves, and thus MRS 2 will be
to the left of MRS 1 and employment rises to L0 • Thus with
non-increasing abso1.ute risk aversion, output moves in the
same direction as fixed costs. Leland (1972) has shown that
the profit maximising firm holds output constant (decreases)
with constant (decreasing) absolute risk aversion when fixed
costs rise.
If the expected price changes, the intercept of the MEl
function changes, i.e. an increase in expected price pro-
duces a parallel shift in the MEl schedule, as from BN to GH
in Figure 3.10. Under constant absolute risk aversion, this
produces a fall in output as shown by the employment level
LE' Under decreasing absolute risk aversion, the price
increase increases expected income, and the move to a higher

indifference curve shifts MRS to the right, e.g. MRS 3 • The
consequence here is also a fall in output, with employment
at LF. Again this is in the same direction as under cer-
tainty but in the opposite direction to a profit-maximising
firm facing a risky price (Hey, 1981). Note, however, that
the price increase will produce a higher output than it
would under certainty for the labour-managed firm (compare
LF to LH).
Thus with, risk, the 'perverse' supply response remains, in
the sense that the labour-managed firm reacts in the op-
posite direction to its profit-maximising twin. However,
with a given price and degree of risk, the labour-managed
firm's tendency to produce a lower output than its capital-
ist twin in the short run is mitigated and may be reversed.
This section, however, has not dealt in any way with dif-
ferent ways in which risk is borne in a labour-managed firm
compared with its capitalist counterpart. In the labour-
managed firm, risks associated with employment and capital
are borne by workers, whilst under capitalism,~ese are
borne separately. Furthermore, the capitalist can diversify
his risk, whereas the worker-manager cannot.
NOTES
1. The equivalence of the retention of some shares by the

j th member and lump-sum compensation may be shown as
follows.
Where N < n., the remaining members (who hold, say,
N' sharesr do nbt receive a dividend of
y (pX* - rK* - wL*)/N',
where * denotes the optimum value of the variables. Each

share in the surplus is now
y = (pX*- rK*- wL*)/(N' + n' .),

J
where n'. is the number of shares retained by the jth
member dfter he leaves.
n'.
J
therefore
(pX* - rK* - wL*) - N'y n' .y •

J
The amount n' .y is what the departing member receives:

J
n'jy = njy- NLy.
For the number of shares to move to the optimum,
NL = (pXL - w)/y,
therefore
n' .y
J
Since by assumption (pXL - w) is negative in this case,
the jth worker is better off than if he had remained in
the collective and received n.y.
2. The analysis of Note 1 above Jpplies mutis mutandis.
3. The utility function h~ay be thought of as a group
utility function or the utility function of a manager
acting on behalf of and in the interests of the worker
managers (see Estrin, 1979).
4. Horvat (1975) quotes Parrinello (1971) as developing a
model in which workers derive disutility from sacking
fellow workers or from increasing membership.
5. This result is mitigated if there are fixed costs in the
short run. In such a case, Y = (pX - rk) must cut the H
axis to the right of the origin. Consequently, there
will be some value of H for which w = p~, and if this
occurs beyond h, it will be in the interests of the
other workers for the j th worker to work up to that
point.
6. Except, possibly, where the jth individual correctly
predicts the response of the other members to his hours
choice.
7. This derivation of the result is taken from Sen (1966).
That paper contains, inter alia, a footnote which states
the general result which was independently derived by
Vanek (1970): that under perfect competition in the
product market (implying zero abnormal profits), so long
as the collective owns no non-labour assets, equilibrium
obtains where there are locally constant returns to
scale.
8. However, Berman (1977) assumes different utility func-
tions.
9. Ireland and Law ( 1981) assume that L may be varied only
over a time period longer than that over which capital
is varied.
4 Finance and Investment
In the two preceding chapters, it has been assumed that the

labour-managed firm, of whatever type, hi res its capita 1
assets at a market-clearing rate of interest. This assump-
tion is identical to that employed in traditional models of
the entrepreneurial firm. How far do these models correspond
to the structure of capitalist firms and workers' cooperat-
ives? Dubravcic (1970) argues that the capitalist firm may
be represented as a joint-stock company and as such is a
capital cooperative. Meade (1972), however, points out that
the typical capitalist firm is not a joint-stock company but
an inegalitarian joint-stock company. The inegalitarian
joint-stock company behaves identically to a profit-maxi-
m~s~ng enterprise. The difference between a joint-stock
company and an inegalitarian joint-stock company is that in
the former, the members contribute physical capital whilst
in the latter, they contribute financial capital. The
importance of this distinction may be seen from Meade's
(1972) own example.
Ordinary shares of a firm are traded in a perfect capital
market where their ruling price is Ps• If all capital is
financed through the issue of ordinary shares, of which
there are S, then the yield on these ordinary shares is
where Px is the price of output, X, and w the wage rate of

labour, L. The total return per existing share (pXX-wL) / S,
can be raised by raising more capital if the value of the
marginal productivity of capital is greater than rpK' where
pK is the cost of a unit of capital. New shares of value T
provide for the purchase of T/p units of capital, which,
with marginal product capital of~, increases total revenue
by (T/pK)(pxXv). Maintaining current dividend rates requires
that the new Shareholders receive rT in dividends. Thus, the
issue of new shares is justified if
65
(4.1)
This differs from the case of a capital cooperative (joint-

stock company), for which the corresponding condition is
pXXK > (pXX - wL)/K.
The significance of (4.1) can be seen by substituting for r

in it:
Px~ > pKK(pXX - wL)/pSSK,
i.e.pXXK > (pKK/pSS) • (pXX- wL)/K. (4.2)
The second term on the RHS of (4.2) shows that there is a

tendency to increase K if marginal product exceeds the ex-
isting return per machine. In addition, the first term on
the RHS suggests a further incentive when the firm's stock
exchange valuation ratio is high. The second point means
that if pKK/pSS is low, the issue of new shares (at the
current prtce pS) increases the physical capital stock by a
greater proportton than it increases the number of shares.
Consequently, new shareholders 'own' fewer 'machines' per £1
of capital subscribed. Hence the adjective 'inegalitarian'.
Condition (4.1) for the inegalitarian joint-stock company
corresponds to the capital adjustment condition for the PME
(profit maximising enterprise) of traditional theory.
However, this conclusion is subject to two important
qualifications. Firstly, existing shareholders may not wish
to dilute their control of the firm: hence the popularity of
rights issues. Secondly, this discussion is restricted to
quoted companies. Unquoted companies are what Meade (1972)
calls joint-stock companies, which therefore behave like
capital cooperatives with their own type of perversity (see
Dubravcic, 1970; Hey, 1981). The conclusion is therefore
that the 'capitalist twin' of the labour-management litera-
ture behaves like a PME only when the former is a quoted
company. When it is unquoted, it behaves as a capital coop-
erative, and when it is a partnership, it behaves rather
more like a labour cooperative.
Turning now to the labour-managed firm, does it behave as
if it hired its capital as an inegalitarian joint-stock
company does? In answering this question, the work of two
schools of thought on the investment behaviour of the
labour-managed firm will be examined. These will be referred
to as the Texas School and the Cornell School, reflecting
the academic affiliations of their main proponents.
The principal exponents of the Texas School are Eirik
FINANCE AND INVESTMENT 67
Furubotn and Svetozar Pejovich, who in a number of papers

(Furubotn, 1974, 1976, 1980; Furubotn and Pejovich, 1970,
1972, 1973; Pejovich, 1969, 1973) have used a stylised ver-
sion of Yugoslav property rights to examine the investment
decision of the labour-managed firm. The burden of the Texas
School's analysis is that the incentive for investment in
the labour-managed firm is diminished below that of a cor-
responding capitalist firm. It will be argued below that the
property-rights which they assume relate to a particular
species of labour-managed firm, not the whole genus. The
argument here is a reflection on the different institutional
forms which were examined in the previous chapter. Further-
more, even within the context of the property-rights system
which they posit (which corresponds to that of Yugoslavia),
they over-emphasise the role of bank credit on the invest-
ment decision, because they neglect to take account of other
factors peculiar to the Yugoslav context.
The Cornell School, whose principal member is Jaroslav
Vanek, see the method of financing as crucial to the healthy
development of labour-managed firms. In particular, they
argue that the collective financing of assets, and the cor-
responding absence of scarcity reflecting payments for their
use, is crucial in explaining the poor historical perform-
ance of cooperatives. The theoretical basis for this argu-
ment is set out in Vanek (1971) and developed in Vanek
(1973, 1982) and the empirical evidence is examined in Jones
(1980a, 1982a), Jones and Backus (1977), McGregor (1977) and
Vahcic (1976). It will be argued below that the analysis of
the Cornell School neglects the fact that funds used to pur-
chase capital assets will have an opportunity cost, whether
or not any current financial cost is involved.
A feature common to both schools of thought is the pre-
sumption that workers are unable to capitalise future income
from the firm when they leave it. It is assumed that members
may derive benefits from the firm only as long as they work
in it: they have no shares which they can sell nor any ear-
marked savings accounts with the firm based on foregone
earnings from the past. Where such institutions exist, given
perfect capital markets, workers will be indifferent between
current income distributions and increases in the firm's
assets which promise future incomes.
Consider an example. A particular labour-managed firm's
performance over the accounting period yields income over
costs and advances paid to members, who must decide whether
this surplus should be distributed to members in the form of
higher incomes or retained within the firm, say to finance
the purchase of new machines. These new machines promise
higher incomes for the members over the next ten years. What
is involved is an investment project with a current cost

(reduced current income) and returns spread over a number of
years. If workers can obtain this return only when working
in the firm, they will be concerned as to whether they will
remain within the firm for all of the project's life. Put
another way, in assessing the worth of the project, they
will take account of the cash flows only over the period for
which they will remain in membership. Since this may be less
than the economic life of the project, they will evaluate it
over a truncated planning horizon and consequently, ceteris
paribus, will reduce its Net Present Value.
This 'truncation' problem does not exist in the capitalist
firm. A shareholder may be faced with a similar problem,
should he accept a reduced dividend in order to finance the
purchase of physical assets. Finance theory indicates that
such a project will be approved only if it increases the
value of the firm (over what it would be in the absence of
investment). An increase in the value of the firm will show
up as an increase in share values. Thus if the shareholder
leaves the firm before he receives the promised increase in
dividends, he will receive a higher price for his shares.
This higher price is a capitalisation of the dividends yet
to be received. Clearly tradeable shares of the type dis-
cussed in the preceding chapter would in principle remove
the truncation problem for a cooperative. Another mechanism
which would have the same effect would be to credit foregone
dividends to a member's account, pay him interest at the
going rate, and return the credited sum to him when he
leaves the enterprise. This is what happens in the Mondragon
system (see Oakeshott, 1982; Thomas and Logan, 1982; Chapter
6 below).
Where the truncation problem exists, a bias in the selec-
tion of projects is created. Those projects yielding a quick
return are likely to be preferred over those earning a
higher return but over a long period. As Zafiris (1982)
points out, this does not affect the hurdle rate of return
which projects must earn to be undertaken. This will still
be the opportunity cost of the funds, which may be taken to
be the market rate of interest. However, truncation changes
the portfolio of projects which will be selected. Thus, in
one sense, they will not be the socially optimal portfolio
of projects. [1]
Even if there is no truncation of planning horizons, and
the worker-manager expects to be in the firm beyond a speci-
fic project's life, a problem is created by capital mainten-
ance. The source of this problem is more explicit in the
work of the Texas School than in that of the Cornell School.
It concerns the treatment of depreciation allowances
(Stephen, 1978, 1979a, 1980). Furubotn and Pejovich, by

specific reference to the Yugoslav system of property-
rights, and Vanek, by reference to the 'collective nature of
investment 1 and the early work of Furubotn and Pejovich,
imply that the value of the firm's assets may not be reduced
in order to increase members' incomes. In other words,
having created an asset, the collective has taken on a
perpetual obligation to increase the physical and financial
assets of the firm by that amount. This is a very specific
obligation, and cannot really be thought to apply to all
cooperatives. It corresponds to a Yugoslav definition of
property-rights where worker-managers may sell assets but
cannot distribute the proceeds as higher incomes nor can
they consume the asset by allowing it to depreciate since
they are compelled by law to accumulate depreciation allow-
ances.[2] French producer cooperatives are obliged by law to
maintain the value of assets at no less than a specified
proportion of the highest value which they have reached.
Once again, this presents no problem where marketable shares
are issued, since the accumulation of these allowances will
be reflected in share price. In other circumstances, it will
make all projects less attractive to the worker-manager.
Before discussing the required return on an investment in
a labour-managed firm, it will be useful to consider some
general points regarding project evaluation and economic
depreciation. This discussion is based on Bierman and Smidt
(1975, pp. 292-308). The value of a project at the end of
any year t (Vt) is defined as the present value of the
annual cash flows yet to be received; i.e.
where R = cash flow to be received in year t,

Tt = terminal year of project's life.
The economic depreciation in year t (D ) is the fall in
the project's value during that year, i.e.t
Thus, over the project's life, its depreciation will be

T t
=lJRt/(l+r).
t=l
For the marginal investment,
where I 0 is the initial investment.

Thus for the marginal investment,
The marginal investment earns merely enough to cover the

opportunity cost of funds and depreciate the asset. The de-
preciation of the asset provides the recovery of the sum
originally invested for the investor. A project whose IRR
equals the market rate of interest is able to return, via
depreciation, the initial outlay.
If, however, depreciation payments must be retained within
the firm, as in the type of labour-managed firm analysed by
the Texas and Cornell Schools, and there is no opportunity
for capitalisation, a project whose IRR (internal rate of
return) equals the market rate of interest does not repay to
the worker-managers their initial investment. Such a project
would not be undertaken. The worker-managers will accept
only projects whose IRR exceeds the market rate of interest,
or whose IRR on the cash flows net of depreciation equal the
market rate of interest.[3] Here, the gross of depreciation
form wi 11 be used in order that the comparison with the
capitalist and transferable share cooperative is direct. The
criterion for acceptance of a project may then be expressed
as
IRR ), r + d,
where d is a premium whose size depends on the worker-

manager's expected membership of the firm, or the project's
life, whichever is the smaller. It is the annual amount
necessary to amortise the worker-manager's initial invest-
ment. I t is somewhat similar to what Oi (1962) has called
the 'periodic rent of labour', which is the amount necessary
to amortise the training costs of labour. In that case, the
optimal utilisation of labour is attained where
pX1 = w + R,
where w is the wage rate and R is the periodic rent. Thus,

in the case considered here, capital will be expanded only
if
IRR ~ r + d.
A project generating a constant cash flow with an initial

outlay of 1 may be thought of, at the margin, as yielding an
IRR equal to the marginal value product of capital. Conse-
quently, the criterion for undertaking such an investment is
that
pXK = r* > r + d.
This result has been referred to in the literature as the

Furubotn-Pej ovich effect. It must be remembered that the
existence of this effect depends crucially on depreciation
funds being retained within the firm, and there being no
marketable shares. Its size depends on the worker-manager's
planning horizon (the shorter the planning horizon, the
higher is the value of d), and upon the opportunity cost of
funds. If the planning horizon is only one year, the value
of d will be 100 per cent. If the opportunity cost of funds
is 10 per cent, the value of d will be 16.37 per cent (6.27
per cent, 3.15 per cent) when the planning horizon, T, is
5(10, 15) years. The value of d is
r I (( 1 +r) T-1) ,
which yields
r* = r(l+r)T/((l+r)T-1). (4.3)
For the case of a constant annual cash flow from an invest-

ment of 1, this may be seen as follows. The project, to be
marginally profitable, must yield a return equal to the
market rate, r. Let the annual return be r*, so that
T
L r*/(l+r)t 1·
'
t=l
therefore
r* t
t=l
1/ (l+r)t 1.
The term inside the summation sign is the present value of

an annuity of 1, therefore
t
t=1
1/0+r)t = [(l+r)T-1]/r(l+r)T;
so
r* = r(1+r)T/[(1+r)T-l]
d r* - r T T T
r[(1+r) T- (1+r) + 1]/[(1+r) -1]
r I [ (1 +r) -1] •
The amount d represents the portion of the annual cash flow

which, if invested at the market rate of interest r over the
planning horizon, will accumulate the initial investment.
Where the initial investment is 1, then
2::: d(l+r )T-t

T
1,
t=1
therefore
S
t=1
d(l+r)T/(l+r)t 1,
T
i.e. d(l+r)rs 1/0+r)t 1,
t=1
i.e. [r(1+r)T/((1+r)T-1)]•[(1+r)T-1]/r(1+r)T 1'

therefore
1 = 1. QED
The disincentive to investment ar~s~ng from the capital-

maintenance problem[4] is a feature common to both the Texas
and Cornell Schools. They, however, address themselves to
different aspects of the financing of investment by labour-
managed firms, and indeed look at very different contexts.
The early work of the Texas School talked of a Yugoslav firm
rather than a labour-managed firm, but lately they have gen-
eralised their conclusions to the 'labour-managed firm' or
the 'socialist labour-managed firm'. A major thrust of their
argument has been that the disincentive to investment is

increased when credit is available. [ 5] The Cornell School,
however, is concerned to explain the disappearance of tra-
ditional producers' cooperatives in western economies and
argues that this is a consequence of their not paying a
scarcity-reflecting price for capital which is typically
financed from internal funds. The theses of the two schools
will be critically examined in the remainder of this chap-
ter. The Cornell School's case, in which all investment is
internally financed, will be discussed first, and then the
Texas model, in which credit is available.
I THE CORNELL MODEL
It is argued by the Cornell School that much, if not most,

of the investment undertaken by traditional producers'
cooperatives in western Europe is financed from retained
earnings and is thus collective in nature. No scarcity-
reflecting price is paid for its use. Vanek regards this as
understandable, since
Not only are - especially in the Western World - banks and

other external creditors unwilling to finance the total-
ity, or even a major portion, of a labour-managed firm's
assets, but, and this is more important, the firm itself
will generally not want such financing because this would
jeopardise its autonomy and thus undermine its very nature
and raison d'~tre (Vanek, 1971; 1977, pp. 186,7).
For Vanek, the absence of a scarcity rent for capital and

the collective nature of investment in such instances 'are
so powerful in explaining the short-comings of traditional
or conventional forms of producer cooperatives and partici-
patory firms that they offer an ample explanation of the
comparative failure of these forms in history' (Vanek,
1971b; 1977, p. 187). Therefore, Vanek (1971) articulates a
model of the internally-financed cooperative (which he later
(1975) christened the worker-managed firm). Subsequently,
Vanek (1972, 1973, 1978) has argued for the introduction of
scarcity-reflecting rents for capital, or a tax which
proxies them wherever a worker-managed sector is estab-
lished. Indeed, the critical significance of the method, of
financing capital expansion within cooperatives, is the main
theme of the Cornell School.
Vanek's analysis of the 'worker-managed' firm may be pre-
sented in the long-run framework used in Chapter 2. Here,
however, the case of a constant returns to scale technology,
as well as the variable returns to scale technology, will be

examined, since the former provides the more dramatic of
Vanek's results.
Figure 4.1 illustrates the case for constant returns to
scale. The long-run equilibrium of the W-V-M firm will be
any point in the K-L plane (since returns to scale are con-
stant) where the marginal product of capital equals r/p,
where r is the opportunity cost of funds. The marginal
product of capital is constant along any ray from the origin
when there are constant returns to scale. Thus any point on
the ray ~ = r/p in the diagram may be a long-run equilib-
rium.
FIGURE 4.1 Constant returns to scale
Attention is now focused on the main subject matter of

this section: the case of a labour-managed enterprise which
finances its capital stock from its own retained earnings.
The locus eL = 1 (where eL is the output elasticity of
labour) corresponds to the minimum labour input for any
capital inpwt. This follows since eL > 1 implies X/L < X ,
under which circumstances L would be expanded until X we~e
reduced to equality with X/L, i.e. until eL = 1. ThisLlocus
corresponds to the dividing line between Carlson's (1939)

Stage I and Stage II of production. Production takes place
only in Stage II.
An internally-financed labour-managed (or worker-managed)
firm is assumed by Vanek (1971) to face no current charge
for the capital which it uses. Thus income per worker is
given by
y = pX/L.
The equilibrium labour input is obtained when
dy/dL 0,
i.e. x1 X/L, (4.4)
e XKK/X + X1 L/X,
(4.4), however, implies for the internally-financed case

that
e = 1 + ~K/X, (4.5)
i.e. so long as the marginal product of capital is pos1t1ve,

the equilibrium output for the internally-financed labour-
managed firm occurs where increasing returns apply. It will
occur in this zone along the locus e 1 = 1.
These conditions of course imply that under a constant
returns to scale (CRS) technology there is no equilibrium.
Vanek's (1971) analysis assumes, for simplicity, that
capital is infinitely durable. He examines the case of the
internally-financed firm first when it faces a CRS tech-
nology and then when it faces a 'U' technology comparing the
equilibrium inputs with those of the externally-financed
labour-managed firm.
Consider, now, an internally-financed labour-managed firm
facing the CRS technology illustrated in Figure 4.1. It has
already been shown that income per worker will be maxi-
mised for given K along e = 1.
Consider a collective finding itself at Q in Figure 4.1.
There is no tendency to increase the capital stock at that
point, since
~ = (r + d)/p,
which corresponds to the marginal criterion identified earl-

ier for investment to be financed internally. However, given
diminishing returns to labour, output per worker and there-
fore income per worker may be increased by reducing the
labour force. Vanek calls this the first self-extinction
force. This does not necessarily imply compulsory expulsion

of members according to Vanek, but may be achieved over a
period via natural wastage.[6] In Figure 4.1, this may be
illustrated by the move from Q to S.
Vanek (1971) then argues that at a point such as S, the
enterprise cannot be in equilibrium since ~ < (r + d)/p.
This brings into play what he calls the second self-extinc-
tion force: since the collective will want to reduce its
capital stock, it moves to T. At T, the optimum capital
labour ratio will obtain, but the first force will again
come into play. Effectively, the enterprise moves down
X., = (r + d)/p towards the origin, and it 'extinguishes'
itself. It might be more realistic to suggest that this
process will cease when the collective has one member.
Vanek (1971) identifies two other forces: the under-
investment force and the never-employ force. The under-
investment force corresponds to the capital maintenance
effect identified earlier in this chapter, and is implied
because the marginal value product of capital will always be
higher than the rate of time preference, r, of the members
of the collective: hence under-investment. The never-employ
force exists because at capital-labour ratios below that
along~= (r + d)/p, income per worker may be increased by
increas1ng capital but never labour. Indeed, it may be
achieved by reducing labour, e.g. it could move from V to T
or Q, from which point the self-extinction forces would
operate.
In the increasing returns to scale case, it has already
been demonstrated that under internal finance the equilib-
rium point must lie in the increasing returns zone on the
locus of factor combinations for which e = 1. This is shown
in Figure 4.2. The equilibrium point unker Vanek's analysis
~s at a* where the locus of eL = 1 intersects ~ = (r + d)/p
1.e. X, = r*/p.
In die absence of externalities and other imperfections,
the socially optimum position would be at z if r was a
social rate of time preference.
How does the change in technological assumption affect
Vanek's four 'negative' forces? Vanek (1971) argues that the
fact that the firm operates along eL = 1 is the analogue of
the self-extinction force, but that 1ncreasing returns means
that it will never be reduced to the single member case. To
the extent that the firm is at any point other than a*, a
reduction of either labour or capital is implied and one of
the self-extinction forces--is activated. However, under
increasing returns, the reduction of one factor does not
necessarily imply the reduction of the other. This occurs
only when the capital stock is above K* and the labour force
K
eL =1
I
I
I
I
I
K*
e=1
FIGURE 4.2 Long-run equilibrium under internal finance
is above L*. Conversely, when the capital stock is less than

K* and the labour force less than L*, both factors will be
increased. The movement towards a* is not, therefore, self-
extinction, but is likely to mean that the firm will remain
small compared to its externally-financed analogue.
The under-investment force still remains, since the mar-
ginal product of capital is always greater than the subjec-
tive rate of time preference of the collective. Like the
self-extinction force, the never-employ force also disap-
pears, except in a meaningless sense. Under the constant
returns case, the never-employ force means that all growth
in the firm is produced by increasing capital, never labour.
However, under increasing returns, if the firm begins to the
left of L*, increasing the labour force is required for the
move towards a*. Thus it cannot be concluded that the firm
will never increase employment.
Before going further, it is necessary to examine the ex-
tent to which the model that has just been outlined justi-
fies the claims of the Cornell School. They ciaim that it
offers 'an ample explanation of the comparative failure of
[producers' cooperatives] in history' (Vanek, 1977, p. 187),

is 'of fundamental importance in explaining the tendency of
P.C.s to self-destruct' (Jones, 1980a, p. 148), and that the
failure to pay a scarcity-reflecting remuneration for the
use of collectively-owned capital is responsible for the
frequently short life-span of producer cooperatives (Jones
and Backus, 1977, p. 488). Vanek's (1971) model justifies
these claims only where the enterprise operates under a
technology exhibiting constant returns to scale. Where the
technology is of the 'U' or 'L' type the theory only pro-
vides an explanation of the small size of cooperatives, not
their short life-span. The Cornell School provide no argu-
ment as to why a small size necessarily implies a short
life. Indeed, under perfect competLtLon, the internally-
financed cooperative always provides higher labour incomes
than do its externally-financed and capitalist analogues.
Therefore, it will have a plentiful supply of potential
members.
II AN EVALUATION OF THE CORNELL MODEL
In the preceding section, Vanek's model of the internally-

financed labour-managed firm (or worker-managed firm) has
been described largely without comment. This section
contains a critique of the model arguing that different
parts of it are based on inconsistent assumptions as to the
motivations of and constraints upon the behaviour of the
worker-managers. This inconsistency centres on whether or
not the capital employed by the collective has an oppor-
tunity cost. The main distinction which Vanek (1971) makes
between a labour-managed firm (what is called the W-V-M
model in this book) and a worker-managed firm (an intern-
ally-financed labour-managed firm) is that the former hires
its capital whilst the latter finances it from within and
incurs no current cost for using it. Thus Vanek (1971)
argues that the worker-managed firm maximises revenue per
worker. It is this choice of maximand which generates the
most distinctive results of the model: the disappearance of
the firm under constant returns to scale and its small size
under increasing returns to scale. Otherwise, internal
financing will result only in a preference for a more
labour-intensive mode of production than would occur under
external financing. Here, it is argued that not only does
capital have an opportunity cost, but also that some parts
of Vanek's model imply that it does.
This section proceeds by examining three of Vanek's four
forces, to identify the circumstances under which they might
exist and whether these circumstances are consistent.

Consider first the under-investment force, which is the
one which most directly follows from the distinction which
Vanek makes between a labour-managed and a worker-managed
firm: that capital expansion is internally-financed. Earlier
in this chapter, it has been argued that this force is de-
rived from a capital maintenance requirement which requires
that depreciation allowances must be accumulated within the
firm. Thus the existence of the 'under-investment force'
implies that capital must be maintained in perpetuity. This,
at least formally, is the position in Yugoslavia. However,
it would be unnecessarily restrictive to require that
specific physical assets should be so maintained: this might
require not only the continued use of obsolete machinery but
also the production of goods for which there was no demand.
The constraint on capital consumption will normally take the
form of maintaining a capital fund which is composed of
physical and liquid capital, with a requirement of financial
depreciation being made on the physical stock, but that this
need not be applied to the physical maintenance of specific
assets.
A problem with this interpretation of Vanek's under-
investment force is that it is set forth in a paper in which
it is assumed that 'capital has infinite durability, and
thus there are no problems of depreciation' (Vanek, 1971;
1977, p. 187). Whilst, for some purposes, assuming away
depreciation simplifies analysis, in this particular case it
assumes away the basic problem. It is presumed that Vanek
was seeking to make economies in presentation. Nevertheless,
it is a revealing assumption.
In summary, what is argued here is that the existence of
the under-investment force implies an institutional struc-
ture which precludes the consumption of the assets by the
members of the collective.
The first self-extinction force is essentially generated
by the assumption that the collective is motivated by the
maximisation of income per member. In general terms, this
applies whether it is internally or externally financed so
long as other considerations such as employment or hours
worked per member do not enter the objective function. This,
in itself, is questionable, and a number of models which are
based on maximising a utility function with a number of
arguments in addition to income per worker have been exam-
ined in Chapter 3. However, this is really a wider issue
than that being explored in this section. Therefore, for the
present, it will be assumed that the objective function in-
cludes only income per member. In this respect, the only
difference between external and internal finance is what
must be deducted before arriving at the income to be dis-

tributed. Rational economic behaviour requires account to be
taken of the opportunity cost of any resources used. Vanek
(1971) implies that when the capital stock is financed
internally it has no opportunity cost and therefore there is
no deduction from revenue (net of material costs) to be
made. The general thrust of the present argument is that,
even under internal finance, unless maintenance of specific
physical assets is required, there is an opportunity cost:
it is the return to be earned from liquidating the asset and
investing the proceeds (either in a physical or a financial
form). In this case, the force dictating the size of the
labour force is the same as that in the case of an exter-
nally-financed firm. Here, the objective function becomes
the maximisation of y = (pX - gK)/L, where g is the return
(or interest) on liquidating the capital stock or a portion
of it. Clearly, this might involve capital losses, but the
principal is vitally important and applies to a profit-
maximising firm.
Against this line of reasoning, it might be argued that
adjusting the labour force is a short-run phenomenon and
must be done with the capital stock fixed. Thus, with a
given capital stock, the enlightened self-interest of the
collective requires maximising the average product of the
labour force. Vanek's objective function would, in this
view, be the correct short-run function. However, Vanek
himself argues that the natural tendency to reduce members
will only occur over the long term: 'Obviously, the working
community will try to prevent this happening through pro-
hibiting the expelling of members. But through attrition,
retirement, or voluntary withdrawal, it will always be
possible to reduce the numbers in the long run' (Vanek 1971;
1977, pp. 189-90). In Chapter 3, it has been argued, in the
context of an externally-financed labour-managed firm, that
the period over which membership may be adjusted is at least
equally as long as that over which capital may be adjusted.
This applied mutas mutandis to the internally-financed firm.
To see that opportunity cost considerations enter the ob-
jective function, consider the following example. A group of
L workers inherit a stock of capital (either because it has
been built up by their predecessors or because a benevolent,
or bankrupt, capitalist or state has given it to them). If a
perfect secondary market for capital equipment exists, this
capital stock may be regarded as a fund of liquid capital
capable of earning interest at the market rate. Therefore
the decision to commit all, or part, of it to the production
of goods hinges on such productive activity generating a
return greater than the market rate of interest. The optimal
quantities of physical capital and labour are chosen simul-

taneously to max1m1se income net of opportunity cost of
capital per worker, i.e. to maximise y = (pX- gK)/L.
Note, however, that if the collective is considering
committing additional funds to the physical capital stock,
the opportunity cost becomes r + d (see further below).
The second self-extinction force is the one which it is
most difficult to justify. The literal interpretation given
in Vanek (1971) is in apparent conflict with the under-
investment effect. The second self-extinction force is
described as operating 'through a gradual disinvestment and
capital consumption on the part of those remaining in the
enterprise' (Vanek, 1971; 1977, p. 190). This phraseology
suggests the reduction of the capital stock which is, in
fact, precluded by the institutional arrangements which (as
has been argued above) give rise to the under-investment
effect. Of course, the institutional underpinning of the
under-investment effect outlined above does not require the
maintenance of specific physical assets or their continued
use. Thus the second self-extinction force might be inter-
preted, simply, as the creation of idle capacity, i.e. a
reduction in the flow of capital services extracted from a
given capital stock. No sale is implied. However, this can
benefit the collective only if income per worker rises as a
consequence of this reduction in capital services. Clearly,
this cannot happen under conditions of constant returns to
scale, since in that case income per worker is a function of
the capital-labour ratio, and the second self-extinction
force involves a reduction in that ratio. Indeed, recog-
nising this fact makes clear that, under CRS, the combined
effects of the first and second self-extinction forces ben-
efits no-one, since it implies a movement down a ray from
the origin in input space along which income per worker is
constant. This is not so clear-cut in the case of increasing
returns to scale. Income per worker decreases (increases)
along the locus of maximum output per worker, if that locus
is negatively (positively) inclined in input space. The
slope of the locus depends on the particular production
function. It is interesting to note that while Vanek typi-
cally draws it negatively-sloped, Miovic (1976) and Frisch
(1965) draw it positively-sloped. The implication from
Miovic (1976) and Frisch (1965) is that this follows if
production has an absolute maximum. In general terms, there-
fore, it cannot be concluded that the second self-extinction
force benefits the collective directly.
It may be thought that this 'idle capacity' interpretation
of the second self-extinction force is a 'straw man'. A more
plausible interpretation is that assets are not replaced or
are sold off. The institutional framework underlying the

under-investment force precludes the distribution of such
proceeds as income to workers. Presumably, what is envisaged
is that the proceeds so raised are invested elsewhere, at
least earning the market rate of interest. This, however,
implies that the capital does have an opportunity cost, and
thus contradicts the objective function adopted by Vanek.
Indeed, the whole motivation behind this particular extinc-
tion force is that worker-managers require a specified re-
turn from the assets employed, and that they maximise income
subject to achieving that return. Otherwise, once physical
assets had been purchased, the magnitude of the marginal
product of capital would be of no interest to the worker-
managers. Their only concern would be to maximise income per
worker. However, as pointed out above, maximisation of in-
come per worker does not, in general, require the second
self-extinction force to operate.
To sum up, the second self-extinction force makes sense
only if income per worker rises as the collective moves
along the locus of maximum output per worker as capital is
reduced, or if the use of capital has an opportunity cost.
The former case exists only under some of the production
functions exhibiting increasing return to scale. The latter
case undermines the distinction Vanek seeks to make between
labour-managed and worker-managed firms. In any event, it
seems reasonable to expect such opportunity cost consider-
ations to apply.
Admitting that it is opportunity cost considerations which
give rise to the second self-extinction force naturally
prompts the question of what is the opportunity cost of the
continued use of an asset. As suggested earlier, it is the
return foregone on the liquidated value of the assets which
can be taken to be the market rate of interest; i.e. if a
physical asset can be costlessly liquidated and the proceeds
invested, the worker-managers would receive income equal to
the market rate of interest times the liquidated value of
the assets (rK). Note that this opportunity cost is less
than the hurdle rate required for the purchase of an asset
to be made internally, because the hurdle rate recognises
that a change in property rights takes place, i.e. that the
principal of the investment is forever committed to the col-
lective funds of the enterprise. No such change takes place
if such funds are transferred from one use to another. Thus
the second self-extinction force implies reducing capital
not until x1 = (r + d)/p, but only until ~ = (r + d)/p.
This also applies to decisions as to what to do with
depreciation allowances. Since these allowances cannot be
dispersed as incomes, they should be applied to maintain
assets so long as the return on doing so is equal to the

market rate of interest, not the hurdle rate.
It should be noted that the self-extinction forces come
into play only when a disequilibrium state exists due to a
change in the parameters of the model, i.e. product price
and the rate of interest. Vanek (1971) begins the story with
such a disequilibrium state, but does not explain how it
arises. The difficulty which has to be faced in reconstruct-
ing the model is the problem of capital having two opportun-
ity costs: one prior to purchase, but a different one after-
wards. As suggested earlier, the situation is somewhat
analogous to Oi' s (1962) treatment of labour as a quasi-
fixed factor. Oi points out that when labour is hired, fixed
costs of hiring and training are incurred which must be
amortised over the period of its employment.
These give rise to what Oi (1962) calls the 'periodic
rent' of labour. 'The periodic rent, representing the amort-
isation of these fixed employment costs, drives a wedge
between the marginal value product and the wage rate. In the
short run, any fixed employment costs associated with the
acquisition of a labour force in prior periods are sunk
costs; as such they should not affect the firm's short run
decisions' (Oi, 1962, p. 541).
By the short run, Oi means the period over which output
adjusts to a fall in price. Thus, in his analysis, if the
firm is in long-run equilibrium and product price declines
under perfect competition, a quasi-fixed factor will adjust
only if the wage rate exceeds the value marginal product of
labour. On the other hand, if product price increases, the
quasi-fixed factor is increased only if the value marginal
product of labour exceeds the wage rate plus the 'periodic
rent of labour'. Returning now to our consideration of an
internally-financed labour-managed firm, it can be seen that
Oi's periodic rent is analogous to 'd' in the earlier
analysis. In other words, worker-managers incur a fixed cost
when they internally finance capital acquisition. Thus
capital can be increased only if this fixed cost can be
amortised over the worker-manager's planning horizon. How-
ever, if the firm is in long-run equilibrium and product
price falls, capital will be adjusted downwards only if
~ < r/p. The property-rights structure 1 drives a wedge'
between the opportunity costs of upward and downward
adjustments in the capital stock. Consider the case of a
movement towards long-run equilibrium. The opportunity
cost of investment is (r + d)/p. Thus the firm seeks to
maximise
y (pX - (r + d)K]/L,
which will yield optimum L and K where
XL =y and ~ = (r + d)/p.
If product price falls to p', the XK loci all shift to the

right. If d is fairly small, ~ = r/p 1 may be greater than
the former ~ = (r + d)/p. This would lead the collective to
seek to maximise y = (p'X - rK)/L, which is attained when
~ = r/p' and X = y. If ~ = r/p', however, is less than
XK = (r + d)/p, \here is no incentive to adjust the physical
capital stock, and the adjustment to the price change will
be borne by adjusting L so as to maximise y = (p'X- rK)/L.
This section has critically reviewed Vanek's (1971) model
of the 'worker-managed' firm. A number of contradictions in
Vanek 1 s analysis have been demonstrated which, when re-
solved, lead to a characterisation of it which is much
closer to the Ward-Vanek-Meade model of the externally-
financed labour-managed firm. In particular, the objective
function incorporates the notion of capital having an
opportunity cost even when no financial payment for its use
is made. The objective function may be written as the maxi-
misation of
y (pX - gK)/L,
where g is the opportunity cost of capital. However, g takes

on different values in different phases of the firm's exist-
ence. When new (internally-generated) funds are being com-
mitted to the enterprise, g = r + d where d is an annual
return necessary to amortise the loss of principal to indi-
vidual workers. However, when making decisions on how to
utilise such funds once they have been committed to the
firm, g = r. This suggests an important difference in behav-
iour between established and new firms. Established firms
(whether they have been cooperatives for a long while or are
just being converted to the cooperative form) will have a
large fund of capital, and thus depreciation funds whose
opportunity cost is r. Such firms will be more responsive to
changing investment opportunities than will a newly-
established firm which is still building up a capital fund,
and for whom the opportunity cost of capital is r + d.
In terms of Figure 4.2, this analysis suggests that the
long-run equilibrium point is at b rather than a* as
suggested by the Cornell School. If product price is subject
to downward fluctuations over time, the equilibrium may lie
one = 1 between b and z.
When analysing the investment decision of a labour-managed
firm with the property-rights structure assumed above, and
no opportunity to borrow funds, the Texas School conclude

that investment will take place only up to the point where
r* = r + d.
The Texas School use a partial equilibrium framework in

which only the adjustment in the capital stock is
considered. When set in the general equilibrium framework
used above, their analysis would lead to b as the long-run
equilibrium, so long as the internal supply of funds was
infinitely elastic at the market rate of interest.
It is to be recalled that the analysis of both the Cornell
and Texas Schools relies on there being no possibility of
worker-managers capitalising their share in future divi-
dends. Where such capitalisation is possible, there will be
no capital maintenance (or under-investment) effect and the
long-run equilibrium will be at z.
The above analysis of the long-run equilibrium of the in-
ternally-financed firm is subject to one limitation: it
assumes that worker-managers are at all times willing and
able to provide the funds necessary for all capital expan-
sions. Except for a well-established cooperative which need
make only very marginal adjustments to its capital stock,
this seems an unwarranted assumption. It would be more
reasonable to assume that the firm's supply of internal
funds is a positive function of the prospective return
(Furubotn, 1974; Pejovich, 1973; Stephen, 1978, 1979a,
1980). In other words, the opportunity cost of funds in-
creases as successive increments of investment are under-
taken in any one period. Thus the required rate of return
becomes an increasing function of the level of investment.
The effect of this may be to move equilibrium from b down
the locus e = 1, thus diminishing the equilibrium capital
labour ratio. Alternatively, b may be viewed as an equilib-
rium attained only after a series of adjustments to the
capital stock over successive long-run periods. The latter
may be the more plausible outcome, since the former implies
the level of membership rising above the level at b and then
being adjusted downwards. Nevertheless, the supply curve of
funds does provide a key to the performance of 'worker-
managed' firms or traditional cooperatives relying on
internally-generated funds. The collective is starving it-
self (or being starved by financial institutions) of the
funds necessary to provide it with the optimal capital
stock.
This notion of a supply curve of internal funds may be
illustrated in the partial equilibrium framework utilised by
the Texas School. The level of saving from net income of
members of a collective may be reasonably regarded as a

function of the return on the savings. This is shown as SS
in Figure 4.3. It seems plausible that the slope of SS will
increase as the level of saving increases. The schedule SS
does not, however, represent the supply curve of funds for
internally-financed investment, but relates the level of
saving to the return on an investment, the principal of
which is returned to the investor, e.g. a bank deposit. To
obtain the supply of funds for internal investment, account
must be taken of the capital maintenance requirement. Thus,
given the planning horizon T of the worker-manager, d must
be calculated for each value of r and a new schedule plotted
relating r* to saving within the cooperative. This is plot-
ted as S'S'. Note that the larger the value of r, the
smaller is the vertical distance between SS and S'S'.
If the market rate of interest, representing the oppor-
tunity cost of retaining surpluses within the cooperative,
is r 1 , then the minimum return on an investment within the
firm that is sufficient to depreciate the asset, and return
to worker-managers the principal amount invested (which they
receive as higher incomes during their planning horizon) as
well as earn r 1 , is r 1 *. The supply curve of funds for in-
ternal investment is r 1* ZS'.
The demand curve for funds for internal investment is
shown in Figure 4.3 as II. It is drawn to show that the rate
of return is a monotonically-diminishing function of the
level of investment. When there is no recourse to external
finance, the firm will choose the level of investment indi-
cated by the intersection of r 1 * ZS' and II, i.e. OB. Note
that the return at the margin on this level of investment is
r 1*> r 1 +d. If, as is implicit in the Cornell School model,
internal finance is infinitely elastic at the return r 1 *,
the level of investment would be OA. The size of the diver-
gence between B and A will depend on how steep the supply
and demand curves are. Reliance on internal finance where
the supply of funds is not infinitely elastic will clearly
hamper the growth of the cooperative's capital stock.
The empirical evidence adduced by the Cornell School in
support of Vanek's financing hypothesis is equally consist-
ent with the hypothesis presented here (see further Chapter
6). In such a case, 'Ocum's Razor' would suggest that the
simpler of the two hypotheses (i.e. that of capital star-
vation) is to be preferred.
III EXTERNAL CREDIT
The capital starvation problem may, of course, be obviated

r
S' S
C D B EA G F S,l
FIGURE 4.3 Investment and internal finance
by borrowing funds externally. Historically, this may not

have been possible due to a bias on the part of lending in-
stitutions. Increasingly, this is no longer the case, es-
pecially where public funds are being made available to
support the establishment of a cooperative sector. In the
Yugoslav case there is a considerable reliance on borrowing.
The use of such credit has been one of the areas concen-
trated upon by the Texas School, and on which the discussion
here now focuses.
Before the effect of the availability of credit can be
analysed, some subsidiary points must be clarified. Firstly,
is a labour-managed firm which borrows funds to expand its
physical assets to be subject to the requirement to maintain
the value of the asset as well as repay the loan? It would
seem reasonable to suggest that this should be so. If the
capital maintenance requirement is justified when assets are
financed internally, consistency requires that it also apply
when they are financed externally. It derives from the col-
lective nature of the enterprise, not the source of its
funds. Were this not the case, it would clearly generate a
preference for external financing on the part of a collec-

tive. Indeed, one factor which led the Texas School to argue
that there would be an excessive preference for external
finance in much of their earlier work (e.g. Furubotn, 1974,
1976; Pejovich, 1973) can be traced to this point. They did
not apply the capital-maintenance requirement to assets
purchased by the use of borrowed funds. This may have been
because they identified truncation as the source of the
problem. Furubotn (1980), however, seems to recognise that
the 'under-investment' problem remains even when credit is
used, so long as capital-maintenance is required. Conse-
quently, an adjustment must be made to the required return
from credit-financed investment. Where the loan repayment
period is greater than or equal to the planning horizon, the
period over which the loan is amortised replaces the
worker-manager's planning horizon in making the adjustment.
Thus, for loan-financed investment subject to the capital-
maintenance requirement, the required rate of return is
r* = r + f,
where r is the market rate of interest (which, in a perfect

capital market, will be equal for borrowers and lenders),
and
f = r/[(l+r)J- 1],
where J is the loan repayment period.

If the loan-repayment period is greater than the planning
horizon (i.e. J > T), then f < d and external finance is
cheaper than internal finance.
When the loan-repayment period is less than the planning
horizon then any investment must be seen as a combination of
credit and self-financing. [7] If the repayment period is J
years and the planning horizon is T years, the collective
has to evaluate the following project. A loan of 1 is taken
in year 0 to purchase capital assets, interest of r is paid
annually until the loan is repaid at the end of year J; the
repayment of the loan means that from year J onwards, the
project is self-financed, and the collective must recoup its
investment over T-J years with an opportunity cost of r.
Table 4.1 illustrates this for a project whose constant
annual return (net of depreciation) is r*.
For the marginal project, r* will be such that the present
value of the terms in row (3) (discounted at the market rate
r) is zero, i.e.
0 z=
J
t=l
[(r*-r)/(l+r)t] - 1/(l+r)
J T
+ ~ r*/(l+r)
t=J+l
t
T J t J
lJ r*/O+r)t - }J [r/(l+r) ] - 1/(l+r)
t=l t=l
r*[(l+r)T-1]/r(l+r)T - r[(l+r) 3 -l]/r(l+r) 3 -l/(l+r) 3
therefore
Table 4.1 A loan financed investment project
Year 1 2 J J+l T
1. Cash-flow r* r* r* r* r*
2 • Outflow to
service and
amortise loan -r -r -(l+r)
3. (1)-(2) (r*-r) ( r*-r) r*-(1 +r) r* ••• r*
Thus, when the borrowing and lending rate are the same,
the required return for a project financed by a loan which
is repaid within the planning horizon is the same as that
for an internally financed project, i.e.
r* = r + d.
A second aspect which must be recognised is the nature of

the capital market in which the collective borrows its
funds. A proper analysis of the labour-managed firm's in-
vestment decision when there is a credit market must isolate
imperfections in the credit market from inefficiencies on
the part of the labour-managed firm. In analysing the
effects of credit on firms with Yugoslav-style property-
rights, the Texas School (Furubotn, 1974; Pejovich, 1973)
seem to be ascribing inefficiencies due to an imperfect
capital market to Yugoslav property-rights (Stephen, 1978,
1980). In the following discussion, a perfectly competLtLve
capital market will be assumed. In particular, the collec-
tive will be able to undertake as much borrowing as it

desires at the market clearing rate of interest.
The consequences of credit being available to finance in-
vestment can be analysed using Figure 4.3. If r 1 is the rate
of interest in a perfect capital market (i.e. fhe same rate
applies to borrowing and lending), the required return may
be calculated, as above, for any loan period J. When the
loan period is the same or less than the worker-manager's
planning horizon, the required return on both internal and
credit finance (assuming capital maintenance is required in
both cases) is r 1*. The worker-managers would undertake
investment of OA, with the amount CA being borrowed and the
collective financing the portion OC. The availability of a
loan which must be repaid during the planning horizon does
not affect the level of investment when the borrowing and
lending rates are equal. In the unlikely case that T < J,
the hurdle rate on external finance would be below r 1 *, and
all investment, which would exceed OA, would be externally-
financed. If there were no capital-maintenance requirement
on external finance, the required rate would be r 1 , and the
level of investment OF. If the capital market were perfect,
all of this would be supplied by external sources. Thus the
capital-maintenance requirement severely restricts invest-
ment, even when credit is available.
Imperfections in the capital market, such as transactions
costs, may lead to a divergence between the rate at which
members can lend funds (r 1 ) and the rate at which the col-
lective may borrow funds, with the latter being the greater,
e.g. r 2 •
If J = T, then r 2* will exceed r 1 *· The analysis is more
complex when J < 'I. The cash-flows are as in Table 4.1
except that in row (2), r 2 should be substituted for r. The
major difference from the perfect capital market case is in
the selection of the discount rate. The cash-flow should be
discounted using r 2 while the collective is a net borrower
(since that is the opportunity cost of funds in that case),
but at the rate r 1 after the loan is paid off. Once again,
for r* to yield a marginal project, the discounted value of
the sum of items in row (3) of the table is equal to zero,
i.e.
J T 1 t
0 L [(r*-r2)/(l+r2)t] + Ll r*/(l+rl) '
t=l t=J+l
so
therefore
J J T T
r* = l/{[(l+r 2 ) -l]/r 2 (l+r 2 ) + [(l+r 1 ) -l]/r 1 (l+r 1 )
J
- [(l+r 1 ) -l]/r 1 (l+r 1 ) J }.
Since the third term in the denominator will always exceed

the second term when T exceeds J,
When the loan period is very short, r* is close to
When J > T, the required return may still be greater than

r 1*, depending on the relative sizes of J and T, and r 1 and
r2.
Thus, in the realistic case of different borrowing and
lending rates, it is likely that r* is greater than r 1*, say
r 2*. As Figure 4.3 shows, this would reduce the level of in-
vestment to OE, with OD being financed internally.
Table 4.2 illustrates how r* varies as the length of the
loan period varies forT= 10, r 1 = 0.05 and r 2 = 0.08.
Table 4.2 Effect of loan 12eriod on reg,uired return
J ;:t:ear 5 ;:t:ears 8 ;:t:ears

J J
[(l+r2) - l]/r 2 0+r 2 ) 0.92593 3.9927 5.74664
T
[ (l+r 1) - 1] I r 1 (1 +r 1 ) T 7.72176 7.7216 7.72176
J
[(l+rl) - l]/r 1 0+r 1 ) J 0.95238 4.32948 6.46319
r* 0.1299 0.1354 0.1428
When J = 10, r* = 0.149. Only when J = 13 will r* fall to

less than r 1* (i.e. 0.1295). Thus, when the borrowing and
lending rates differ, it is still highly likely that the sum
borrowed will be less than the total investment, i.e. there
will be some self-financing.
It should be clear from the preceding analysis that the
capital-maintenance requirement has a disincentive effect on
investment, even when credit is available. This is so
because investment will be below that which it would be for
a capitalist firm facing the same market rate of interest.

However, this cannot be generalised to a statement about
economies composed of labour-managed firms, since it has
been derived in a partial equilibrium framework. The dis-
incentives to investment by individual firms suggest a lower
demand for funds in such an economy; i.e. compared with its
capitalist counterpart, the demand curve for credit shifts
to the left. This suggests that the market rate of interest
will be lower in an economy of labour-managed firms than in
its capitalist counterpart, ceteris paribus. Under these
circumstances, it cannot be unambiguously stated that in-
vestment will be lower under labour-management; it will
depend on the relative shifts in the supply or demand func-
tions. However, it can be concluded that the isolated coop-
erative facing an external capital market in a predominantly
capitalist economy will under-invest compared to its capi-
talist twin when capital-maintenance is required of the
cooperative.
What would happen if the capital-maintenance requirement
applied only to internally-financed investment? In such a
case, the opportunity cost of borrowed funds could be below
the implicit cost of internal finance. The level of invest-
ment would be the same as for the capitalist twin (e.g. OF
when r 1 is the market rate of interest). All of this will be
financed by credit, since the implicit cost of self-finance
is r 1 *· However, the savings function indicates that the
worker-managers would be willing to save OC outside the firm
at the rate of interest r • Thus the net demand on the capi-
tal market arising from t~is cooperative is CF, which is the
same as for its capitalist counterpart. The differential
treatment of credit-financed and internally-financed invest-
ment leads to more transactions taking place via the capital
market, but si nee the net demand for credit on the part of
any firm remains the same, the equilibrium aggregate level
of investment and the rate of interest will be the same as
under capitalism. It should be recognised, however, that
when transaction costs lead to a borrowing rate which
exceeds the lending rate, the cooperative subject to a
capital-maintenance requirement on self-financed capital
will have a greater net demand for credit than will its
capitalist counterpart. This can be seen from Figure 4.3 if
r 1 is the lending rate and r 2 the borrowing rate. The capi-
talist undertakes investment of OG, since at that level the
return on the marginal project equals r 2 • It will, however,
self-finance OD, since only at that po~nt does the oppor-
tunity cost of internal funds equal r 2 • A cooperative sub-
ject to capital-maintenance on internally-financed invest-
ment will have a higher implicit cost of self-finance, r*.
However, if it is not subject to a capital-maintenance

requirement on borrowed funds, the cost of those will be r 2 •
Therefore it will wish to undertake the investment OG 6y
borrowing the full amount. The members wi 11 wish to lend
privately OC, at the lending rate r 1 • The net demand for
credit by this cooperative will exceed that of the capi-
talist by CD.
The situation may not be quite so straightforward as
suggested here. A great deal depends on how the absence of
the capital-maintenance requirement is actually implemented.
It would presumably take the form of allowing depreciation
allowances to be used to repay the loan. This would have the
effect of reducing the amount which the collective had to
self-finance in year J to replace the loan. This would have
the effect of reducing r* below the level which it would be
if capital-maintenance were required on externally-financed
assets. Indeed, if loan repayments could be made from the
firm's general accumulated depreciation allowances, i.e. not
specific to the asset under question, then r* would equal
r 2 , the rate at which funds were borrowed. This is essen-
t1ally an extreme case, but it is the one implied by the
text. The collective would not be bequeathing an asset to
its heirs, beyond its immediate life, as it does when assets
must be maintained. Thus each generation would be financing
(or borrowing to finance) its own assets. On the other hand,
if the rules are such that once a loan is repaid, the
asset's full value is transferred to the firm's books and
must be fully depreciated within the planning horizon, the
situation is the same as in the full capital-maintenance
case, except that capital is being recovered to 'top-up' the
depreciation fund rather than compensate the workers for
having to pay off the loan. Clearly, the nature of these
rules will be crucial in determining the level of investment
in, for example, Yugoslavia (see Vanek, 1972; Stephen, 1978;
Zafi ris, 1982). This discussion also presupposes that the
productivity of the asset is not affected by using de-
preciation to repay the loan. Clearly, when 'depreciation'
is true economic depreciation, its use to repay the loan
reduces the productivity of the asset by definition. On the
other hand, where it is an arbitrary accounting definition
of depreciation, there may be a period during which the
asset's productivity is not being impaired by its use, and
thus the depreciation allowances could be used to pay off
the loan.
It is probably necessary at this stage to try to summarise
the implications of the preceding analysis. It has been
argued that any tendency to 'under-invest' on the part of
cooperatives arises from a capital-maintenance requirement.
Where there is no such requirement, the level of investment

by a cooperative should be the same as for its capitalist
twin. Clearly, the extent of the problem will vary with the
degree of precision with which capital-maintenance is de-
fined.
Capital-maintenance results in a loss to society of the
economic rents on investments not undertaken by the cooper-
ative. It is worth looking at this again, as at least one
author (Zafiris, 1982) seems to suggest that the problem may
be formal but not substantive. He argues (pp. 69, 70) that
since capitalist firms usually maintain the value of their
assets, they are in the same position as a cooperative which
is subject to a capital-maintenance requirement. This would
be true if the level of investment were the same in both
cases, but they are not. Consider Figure 4.4. The schedule
II indicates the relationship between return and level of
investment for a given firm. In order to sharpen the com-
parison between the capitalist firm and a cooperative facing
such a schedule, let it be defined net of depreciation, i.e.
0 s T I
FIGURE 4.4 Comparison of capitalist and labour-managed firms

r is the annual return after allowance has been made for

depreciation of the assets. Formally, the capitalist firm
may distribute such allowances to shareholders, but, fol-
lowing Zafiris ( 1982), it is assumed that they do not. Thus
at the end of the physical asset's life, both the capitalist
and cooperative firms still have assets equal to the value
of the investment.
If r 1 is the market rate of interest, the capitalist will
undertake investment of OT, and the e~onomic rent per time
period which its shareholders receive will be equal to the
area bounded by II, the vertical axis, and r 1 B. A cooper-
ative subject to the full capital-maintenance requirement
will apply a higher hurdle rate, r* = r + d. The term d
represents, as argued in Section I, ehe annual amount
necessary to amortise the original investment, i.e. in order
to repay the foregone incomes of the worker-managers, the
sum borrowed or a combination of both. The impact of
Zafiris's point is taken to be that the shaded area still
represents the net gain to society from the investment OS,
but that whilst under capitalism it is all net gain to the
shareholders, for the cooperative the rectangle r 1 r 1 *CA
(which equals d) is not regarded as a surplus by the worKer-
managers. Put another way, from a social standpoint, r 1 r 1*CA
if invested would represent net investment since the de-
preciation on the initial investment OS has been taken care
of. However, Zafiris seems to neglect the fact that, ceteris
paribus, investment is greater under capitalist property-
rights. What is lost to society is the triangle CAB: the
economic rent on the projects not undertaken. In an economy
of cooperatives, these projects would not be undertaken. If
the economy has a mixture of capitalist firms (or market-
able-share cooperatives) and cooperatives, perfect infor-
mation and mobility of factors would, however, result in
other non-cooperative firms undertaking the ST investments.
IV CONCLUSION
This chapter has examined the existing literature on the

financing and investment behaviour of labour-managed firms.
Two schools of thought within that literature have been
identified, and their positions critically ex ami ned. Both
schools take common ground on the disincentive to intern-
ally-financed investment generated by collective ownership.
It has been argued here that such a disincentive is the
consequence of a requirement (implicit in both models) that
the value of the collective's assets must be maintained in
perpetuity. There is no disincentive to investment in the
absence of such a requirement, or when individual members

hold tradeable shares. These results apply both when credit
is available and when it is not. It was also argued in this
chapter that the poor performance of cooperatives in western
industrialised economies is not explained by Jaroslav
Vanek's (1971) theory of financing. The analysis here
demonstrates inconsistencies in his argument and concludes
that the source of the problem is more likely to have been a
shortage (for whatever reason) of funds to finance expan-
sion.
NOTES
1. That is, they will not be the portfolio of projects

which would generate a Pareto optimal allocation of
resources under capitalist property-rights. However, as
Schmid (1976) and Nutzinger (1982) have correctly
argued, the optimality comparisons can be made only
within a given distribution of property-rights. Thus, in
a system where property-rights are such that capital-
maintenance is required, the set of projects identified
according to the rules outlined in the text is Pareto
optimal.
2. For a full discussion of Yugoslav property-rights see
Milenkovitch (1971, pp. 94-9) and Wiles (1977, pp.
41-5). For a more general discussion of property-rights
see Macpherson (1975), Wiles (1977, Ch. 3) and Becker
(1977).
3. The Texas School are fairly explicit on this point; less
so the Cornell School. In particular, Vanek (1971),
which is the seminal paper on investment-financing, from
within the Cornell School assumes infinitely durable
capital. The argument here is that this assumes away the
problem which Vanek is examining. A detailed examination
of the various investment criteria used in the litera-
ture is to be found in Zafiris (1982).
4. Although the analysis here is similar to that in a num-
ber of papers, the exposition here has benefited from
Nicos Zafiris's (1982) explicit distinction between what
are called the truncation and capital-maintenance prob-
lems in this text.
5. There has been something of a shift in this position in
a later paper (Furubotn, 1980).
6. See further below for a discussion of this statement.
7. This point has been drawn to the author's attention by
Stephen Sacks.
5 Yugoslav Self-management
The preceding three chapters have reviewed the economic

theory of the labour-managed firm. This theory is not an end
in itself. It has been developed to further the understand-
ing of how democratically-owned and -managed enterprises
might be expected to behave. This chapter and the next turn
to the actual experience of such organisations. As was
mentioned in Chapter 2, the theory was originally developed
with the evolving Yugoslav system of self-management in
mind. Much of the material of Chapter 4 was also evolved to
the same end. In view of this, because of its unique nature
as the only wholly self-managed industrial system, and the
peculiar historical and political position of that country,
this chapter is given over wholly to a discussion of
Yugoslavia. The following chapter examines groups of pro-
ducers' cooperatives in four western industriali .led econ-
omies, and discusses the relationship between instttutional
characteristics and performance.
The most extensive system of formally democratic enter-
prises is the Yugoslav system of workers' self-management,
which extends throughout the industrial sector. This chapter
is an attempt, in limited space, to review the evolution of
this system, describe its main features (as they were known
at the time of writing), and examine the evidence from
Yugoslavia on some of the predictions which arise from the
theoretical models of Chapters 2 and 4. Since no empirical
investigation of any aspect of the Yugoslav economy can be
conducted in ignorance of how and why the system has devel-
oped in a particular manner, the chapter begins with a brief
outline of its history.
In some ways, it is perhaps wrong to talk of the develop-
ment of the Yugoslav system. Two systems have been develop-
ing: the---'economic system' and the 'system of workers'
self-management'. The former refers to the development of a
broadly market -oriented economic system, whi 1st the latter
is concerned with the internal organisation of the enter-
97
prise. These two systems have developed sometimes in tandem

and at other times in apparent conflict. The early reforms
which led to the development of these two systems had very
separate ideological origins, as is related by Milenkovitch
(1971, pp. 66-8) and Wiles (1977, pp. 42-5). However, the
two systems are not wholly unrelated.
Deborah Milenkovitch argues that 'the two notions were
bound together in logic. If the workers were to have some-
thing to manage, there had to be some meaningful autonomy of
decision-making at the enterprise leve 1' (Milenkovi tch,
1971, p. 66).
Wiles also argues that there is an important connection
but takes a slightly different perspective. He sees Kidric,
the economic reformer, aligning himself with the political
reformers Djilas and Kardelj, not only because 'workers'
councils, unlike state-appointed directors, must have
something to direct but [because] Kid ric 1 s own dry nostrum
[i.e. 'socialist commodity production'] could not have
stirred the world in the way Ti to's did, when he said in
parliament, "the factories to the workers"' (Wiles, 1977,
pp. 42-3).
I EVOLUTION OF THE YUGOSLAV SYSTEM
The Yugoslav system of self-management is not a static

phenomenon. It has developed over the last thirty years in
response to changing political and economic circumstances.
One cannot fully understand its current state of development
without examining the system at different stages in its
evolution. Indeed, it is in many ways a paradox that what
for some is the most developed form of socialism in Europe
has been brought about by evolution rather than revolution.
Full self-management was not achieved in a day or even a
decade. The process has not yet finished, and may be a long
way from its final form. It is therefore useful to look at
the origins of the system and its various stages.
After the Partisans' victory during the Second World War,
the communists dominated the government of Yugoslavia. They
then began a process of centralisation and collectivisation
on the typical Soviet model. This immediate post-war period,
with its rigid administered planning, has been called the
'etatist' period. It lasted until 1952.
However, perhaps the most important single event in modern
Yugoslav history occurred in 1948: this was the split with
the Soviet Union. [ 1] The split was brought about by dif-
ferences between the communist parties of the two nations on
party matters, as well as Soviet criticism of the slow pace
YUGOSLAV SELF-MANAGEMENT 99
of Yugoslav agricultural co llec ti visation. Yugoslavia was

expelled from Cominform, and an economic blockade followed.
The Yugoslav reaction was to attempt to prove the Soviet
Union wrong by proceeding with centralisation and collec-
tivisation. Thus, the etatist period continued until 1952.
However, from about 1950, the Yugoslavs began openly to
criticise Soviet political and economic centralisation. This
debate was allied to ideological argument over the tran-
sition period from capitalism to communism, and the 'wither-
ing away of the state'. The Yugoslav rejection of the Soviet
model was therefore based on both theoretical and practical
politics.
Economics also played an important role. During this
period of collectivisation, the economy's performance was
deteriorating: by 1950, national income was only 17 per cent
higher than in 1947, and by 1952 had fallen to only 9 per
cent above the 1947 figure. Much of this was as the result
of a massive fall in agricultural production. The plan which
had envisaged national income in 1951 being twice that of
1939 was clearly failing to work. There continues to be
division of opinion as to whether the economic performance
of Yugoslavia in this period was a consequence of the econ-
omic system or of other exogenous factors. [2] Nevertheless,
the Yugoslavs laid a major share of the blame at the door of
centralisation.
It was against this background that the political and
economic reforms were conceived and brought to life. The
watchword became 'factories belonging to the workers'.
Yugoslav writers found ideological justification for the
changes in the writing of Marx, with his references to free
associations of workers. They were to make this operational
through the establishment of workers' councils in every fac-
tory. Initially, however, these councils were merely advis-
ory, and the economy continued to have many of the outward
symbols of central planning until 1954 when the 'full'
transition to the market determination of prices had been
completed. The years marking the change from one stage in
the development of modern Yugoslavia to another are not
clear-cut. This is particularly so because many of the legal
enactments follow the adoption of changes rather than pre-
ceding them.[3]
Arguing that administrative planning was appropriate only
to economies in the early phases of industrialisation, the
Yugoslavs began to decentralise economic and political
decision-taking. The decentralisation was, however, to take
place within the framework of an overall economic plan. The
overall plan set the macro-economic framework within which
individual enterprises would operate. However, at the micro
level, the workers were given greatly enhanced control over

the production and employment decisions within each enter-
prise. It was felt that, in this way, production would be
enhanced by relating workers' earnings to their pro-
ductivity.
A major innovation in the field of property-rights was
required at the beginning of this period to give effect to
self-management. [4] At this stage, much of the Yugoslav
economy had been brought into social ownership. This meant
that except for very small (one-man) businesses, all of the
productive capital assets were owned by the state. The ques-
tion was how the workers could exercise true self-management
if they had no rights over the capital assets which they
used. The increased efficiency which was expected to arise
from decentralising economic decisions required the workers
to have some control over the capital which they used. This
was achieved by creating a 'right of use'.
The 'right of use' invested workers' councils with control
over the way in which their productive assets were used, and
allowed them to sell the assets and create new assets. There
were, however, constraints on these rights. Workers were not
allowed to consume the assets, i.e. current wages could not
be increased by selling off equipment. This restriction was
enforced through a system of compulsory depreciation, which
required the value of the enterprise's capital assets to be
maintained. Capital assets could be disposed of, but had to
be replaced.
Thus the Yugoslav self-managed enterprise is what might be
called a constrained (or collectivist) labour-managed
enterprise. Individual worker-managers do not have an indi-
vidual claim on the property of the collective: society at
large is the 'residual owner'.
In what sense, then, could it be said that capital was
socially owned? Could it not be argued that group ownership
had replaced social ownership? This was not so, while a
tax [ 5] was levied on the book value of assets of every
enterprise. Effectively, each enterprise could be thought of
as hiring homogeneous capital from society, and enjoying its
usufruct.
Apart from this ideological effect, the capital assets tax
stopped firms regarding capital assets (financed by the
government) as free goods. They now had an interest charge
(tax) to pay on them.[6]
Gradually during this period, workers had an increased say
in the distribution of the enterprise's 'profits' between
increased wages and investment. Workers now received a fixed
wage plus a share of the 'profits', up to a limit decided by
the government. This upper limit gradually increased during
the period, but was still calculated according to a formula

laid down by the government.[7]
One of the functions of this formula was to ensure that
workers could not increase wages by increasing prices. By
the end of this period, workers' wages were no longer re-
garded as a cost of production, but as part of the residual
or surplus. [8]
During this period, the banking system played an increas-
ingly important role in linking macro-planning objectives of
the government to the micro-decisions of enterprises. This
was achieved through its function as the distributor of in-
vestment funds. In 1952, 98 per cent of all investment in
fixed capital was financed by social funds. By 1964, only 36
per cent was financed by social funds, and 32 per cent by
the banks. Enterprises now had to compete (within the sec-
tors identified by the plan) for investment funds, in
addition to supplying a large proportion from their own
retained profits (32 per cent of investment in 1964).
Prices were no longer administratively set, except in the
case of basic industrial inputs (e.g. fuel and power) and
some foodstuffs. Other prices were subject to registration
in order to control monopoly power.
Overall, then, the Yugoslav economy in 1964 was organised
along very different lines from the Soviet-type economy of
1949. Most of the day-to-day decisions of enterprises were
taken by workers' councils, which had considerable freedom
in setting output, prices, wages and the level of invest-
ment. This economic decentralisation had been paralleled by
political decentralisation which had given more freedom to
the governments of the constituent republics and those of
the communes.
In 1965, as a result of a number of economic problems in
the system, e.g. inflation, and balance of payments diffi-
culties, a resolution was passed by the Federal Assembly
extending decentralisation. The major effect of this was to
free enterprises of most of the remaining restrictions on
their freedom of decision. More of the 'profits' made by
enterprises were left within the firm (i.e. corporate taxa-
tion was reduced). The workers 1 council was now free to
determine for itself how the remaining 'profit' should be
distributed between increasing workers' incomes and invest-
ment in new plant and machinery.
In this period, the Yugoslav enterprise most closely re-
sembles the labour-managed firm of the theory developed
elsewhere in this book.[9]
It became the official policy that prices should be
adjusted to reflect relative prices prevailing in world
markets. While still the official policy, this has not yet
been achieved fully.

The banking system continued to increase its role as the
distributor of investment funds. In the period from 1965 to
1972, banks were providing 40-50 per cent of the investment
funds, enterprises just under 40 per cent with the various
government funds providing, directly, less than 20 per cent.
The period 1965-72 was one of maximum decentralisation.
Firms were almost totally free in their economic decision-
making, and the economy was, to all intents and purposes, a
market economy with social ownership. However, it may be
argued that the term social ownership is inappropriate, and
'collegiate' more appropriate since the demise of the
Business Fund Tax. The only constraint on individual collec-
tives was that imposed by compulsory depreciation. To an
increasing extent, firms were able to lend money to each
other, and the charge of group ownership was being more and
more voiced.
The economic problems of inflation and unemployment were
again apparent, and the government acted by restricting the
freedom of enterprises. These restrictions were applied to
the distribution of net income between wages and other
funds. The various economic bodies within localities were
encouraged to draw up 'social compacts' laying down guide-
lines for incomes, and within industries, enterprises and
other bodies concluded 'se If-management agreements' deter-
ml.mng the actual leve 1 s of incomes for individual
firms. [ 10]
Thus, there has been a step back from complete economic
self-management. However, at roughly the same time, changes
were being brought about in the structure of self-manage-
ment. There had been extensive dissatisfaction with the
bureaucratisation of the existing system. The new system was
intended to give a greater say to the ordinary worker. There
is, therefore, the paradox of reducing the freedom of de-
cision-taking at the level of the enterprise, while breaking
enterprises into smaller units in order to reflect more
accurately the view of the workers.
In summarising this brief historical sketch of the evol-
ution of the Yugoslav system, four main phases have been
identified:
(i) 1945-52 administrative planning;

(ii) 1952-65 partial self-management and decentralis-
ation;
(iii) 1965-72 'maximal' self-management;
(iv) 1972- 'controlled' self-management.
As noted above, these subdivisions are not hard and fast.

Various authors define different phases, depending on the

purpose of their analysis. The subdivisions presented above
are useful in the context of the present study because they
broadly correspond to significant changes in the powers and
functions of workers' councils. The first three are also
used in Gorupic and Paj ( 197 3) to chart the changes in the
relative weight given to planning and market criteria. Con-
veniently, from the point of view of the present study,
these authors also use the same periodisation when analysing
the changing role of economic and political agents in in-
vestment decisions. A similar subdivision is used by
Bendekovic and Teodorovic (1975) in their detailed dis-
cussion of the institutional framework of the investment
decision process in Yugoslavia. Figure 5.1 and Table 5.1 are
reproduced from Gorupic and Paj (1973, pp. 28-9) and illus-
trate their periodisation. Figure 5.1 is clearly designed to
illustrate the more or less complete reversal in the influ-
ence of plan and market criteria. However, the introduction
of social compacts (drustveni dogovori) in the post-1972
period represents an increase in coordination and a dimin-
ution in the self-organisation of the economy. In the same
period, se if-management agreements ( samoupravni sporazumi)
have become a vehicle for greater coordination of investment
decision-making as well as of other aspects of economic
behaviour.
Other commentators on the development of the Yugoslav
economic system prefer a rather different periodisation
(e.g. Sisevic, 1976; Horvat, 1976).
It is not within the scope of this study to present
detailed arguments concerning the nature and causes of the
various reforms of the Yugoslav economic system in the post-
war period. The discussion here has been necessitated by a
desire to indicate the changing nature of the Yugoslav sys-
tem and the relevance to it of the theory of the labour-
managed firm. More specifically, it has been to justify the
restriction of discussion of empirical studies to the
1965-74 period, since that represents a close approximation
to a 'labour-managed market economy'. A more general frame-
work for the analysis of post-war Yugoslav economic history
is suggested in separate ways by Branko Horvat and Oliver
Williamson.
Horvat writes:
until recently, attention was focused mainly on what

Yugoslav economists call the 'economic system'. Economic
policy in the traditional sense - the use of a set of in-
struments to achieve desired results in a given framework
hardly existed. Problems encountered were generally
Table 5.1 Survey of changes in the investment system
First period
(1947-52)
1. Source of investment decision:
(a) general decision-rate of State economic plan
capital accumulation and
basic conditions for
distribution;
(b) specific decision-rate and State economic plan

structure of development
and the composition of
investments;
(c) the individual investment The state and its

decision. agencies
2. Role of the banks Distribution of state

investment funds ac-
cording to the plan,
and follow-up
3. Form of coordination of State economic plan

investment initiative and in detail
decisions
4. Formation and use of Completely centralised

investment funds
5. Financing of investments Non-reimbursable
6. Mobility of investment funds Complete, in that

investment funds were
appropriated and
distributed
Second period Third period

(1953-64) (1965 and thereafter)
Social plan Social plan and the
undertaking
Social plan in broad The undertaking and the

outlines, and the social plan
undertaking
The state through the Predominantly the under-

bank, and the taking, and the banks
undertaking
Mobilisation and place- Mobilisation and placement

ment of the investment of investment funds at its
assets of the social own risk
investment funds,
foreign resources, and
undertaking resources
according to the social
plan
Social economic plan in The market, social economic

broad outlines, the plans in broad outlines, pro-
market, and production duction and financial coopera-
cooperation between tion between undertakings and
banks and undertakings banks and the self-organisation
of the economy
Partially centralised, Mostly decentralised

partially decentralised
Loans and internal Internal financing, loan

financing sharing arrangements,
and joint investments
Considerable, through Predominantly by the

the social investment banks and associations
funds and to a smaller in the economy, but par-
extent the banking tly also through central
mechanism transfers
solved by changing the institutional framework itself. For

a long time, and to a certain extent even today, economic
policy consisted of an endless series of re-organisations.
The search for an appropriate economic system was the main
preoccupation of economic policy (Horvat, 1971, p. 72;
1976, p. 5).
Williamson, commenting on Horvat (1971), writes:
Although the survey lacks a systematic interpretation of

successive post-war organisational reforms, it neverthe-
less provides a fascinating statement of an adaptive
system attempting to cope with complex and often
unanticipated events within a particular ideological
framework. I submit that much of this history can be
interpreted in a reasonably systematic manner using the
verbal organisational failures framework that I have
proposed elsewhere (1975). By contrast, the formal
modelling apparatus of 'Illyrian' (and related) firms is
relatively unhelpful in attempting to place successive
Yugoslav reforms in perspective (Williamson, 1977, p.
622).
I share Williamson's view that the development of the

Yugoslav system is a series of adaptations within the
constraints imposed by the 'essential ideological attribute'
of collective (as opposed to state) ownership. Where the
formal model of the labour-managed firm fits in, is at a
specific phase in the development of the system, i.e.
1965-74.
II THE INSTITUTIONS OF SELF-MANAGEMENT
The structure of self-management institutions within the

Yugoslav enterprise was altered with the new Constitution
approved by the Federal Assembly in February 1974. What had
previously been referred to as an 'enterprise' (broadly
equivalent to a factory or plant in UK parlance) was re-
defined as an 'Organisation of Associated Labour' (OAL).
Each OAL is seen, depending on its size, to be composed of a
number of 'Basic Organisations of Associated Labour' or
BOALs. [ 11]
The BOALs are based on groupings of workers, seen to have
similar interests, who contribute to the production of a
marketable output.[l2] They represent an attempt to bring
se If-management to as low a leve 1 within an enterprise as
possible. It can be seen as a process similar to designation
1947-52 1953-64 1965

1 The directive and 1 o-----,
2 o-----,
organisation
role of the state
,,
~
\
2 Theplan ' ' ,,,,

,,,,
3 The market ,,,
4 Undertaking autonomy 3
5 Self-organisation of the ~ ~~~~J::=:::=-J~~::__:_~--oJ

economy
FIGURE 5.1 Relative influence of plan and market
of 'profit centres' within a western company, or indeed

setting up of divisionalised companies. Each SOAL is an
economic entity in its own right, its primary economic
relations being with the other BOALs with which it is
associated through a 'self-management' agreement.
An individual BOAL is permitted to produce for the direct
market outside its own enterprise. Such a system should en-
sure that one group of workers is less able than under the
previous system to exploit another. Under a monolithic
structure, only the final product is gubject to market
transactions. Thus, there is a problem in assessing the
varying contributions of workers at different stages of the
process. The BOAL structure permits market transactions
between such groups of workers, and ensures that each group
will receive the market price for their product or service
(otherwise they would sell it outside the enterprise).[l3)
An important reason for the re-structuring of the system
was its apparent failure to involve the shop floor worker.
[ 14) This is confirmed by aggregate data and micro data on
the shipyard in Split (Stephen, 1976). Whilst voting at
elections to workers' councils was generally high (e.g.

averaging 88 per cent in the Split shipyard for the period
1967-71), membership of the councils was biased towards the
managerial groups and highly-skilled workers. Analysis of
the electoral records of the Split shipyard reveals that,
over the period 1967-71, only 71 per cent of the members of
the council were 'blue-collar' workers. Furthermore, only 52
per cent of the total were classified as 'direct production
workers' • This is broadly representative of the situation
throughout Yugoslavia in this period: in 1970, 68 per cent
of members of workers' councils throughout Yugoslavia were
blue-collar workers. [ 15] Similarly, in 197 2, only 53.7 per
cent of members of workers' councils were classified as
production workers.
This domination of workers' councils by 'white collar' and
higher skill categories may be thought of as the selection
of the best qualified for the job. A developing country such
as Yugoslavia has a very immature working class (mostly
first-generation industrial workers); therefore, there are
few people who are capable of understanding the intricacies
of business decisions. However, there seems to have been
little improvement in the situation over the last decade or
so.
A higher degree of participation by blue-collar workers is
more evident in the departmental workers' councils. [ 16] In
the Split shipyard, 79 per cent of the membership of depart-
mental councils over the period 1967-71 were blue-collar
workers. Indeed, 68 per cent of all such councils' members
were classified as direct production workers over the same
period. [ 17] One might be led to suggest that shop-floor
workers feel themselves much more competent to deal with the
problems involving their own department than those of the
shipyard as a whole.
During this period, however, much of the real decision-
making was not in the hands of the workers' councils but lay
with the managing board. The managing board was, in essence,
an executive commit tee of the workers' counci 1, which met
more frequently and was much more involved in the formu-
lating of plans and policy. This body was e lee ted by, but
not necessarily from, the workers' council. [18] The member-
ship of managing boards was generally much more weighted
towards 'managerial-type' personnel. The figures for
Yugoslavia for 1972 show that 19.5 per cent of the members
of 'collective executive organs' were managers, 26.5 per
cent technical workers, and only 35 per cent product ion
workers.
In Split, the situation seems to have been no different
(although this is based on more limited evidence). The board
in 1967 was 60 per cent white collar. Figllres for 1972-73

show 52 per cent of the board's members classified as
'managers', while only 42 per cent were classified as manual
workers.
The situation in Yugoslavia generally and in the enter-
prise visited by myself, clearly points to domination of the
system in this period by managers and other non-production
groups. Impressionistic evidence at Split did suggest,
however, that a large group of the 'non-production' members
of these bodies were foremen. Since foremen were elected
from among the manual workers in this enterprise, it might
not be unreasonable for the same people to be elected to the
workers' council. Thus, the 'production-worker' figure may
under-represent the extent of true participation.
Nevertheless, when one allies the domination of the
representative organs by 'managers and experts' with the
powerful position of the General Director (Chief Executive)
and departmental heads, the scope for the shop-floor worker
to influence decisions is further reduced. The General
Director during this period had control over the day-to-day
running of an enterprise.
Overall policy was determined by the workers' councils,
but the means of achieving this was often solely in the
hands of the chief executives. They were the initiators of
most discussion, and formulated the basis on which decisions
were made. One might characterise the system as 'management
by approval'. All major decisions had to be approved by
workers through the council (and some directly), but seldom
would such a decision go against the recommendation of the
expert staff.[l9]
It was against this background that the system was
reformed. Each enterprise was to be broken down into Basic
Organisations of Associated Labour, with many powers given
directly to mass meetings of workers. Self-management was to
be brought much closer to the working man. Many Yugoslavs
argue that this will achieve the ultimate form of socialism
with a complete removal of bureaucratisation.[20] It is
obviously too early as yet to make judgements of this
nature. However, Article 101 of the new constitution lays
down that workers' councils should reflect the social
composition of the work-force. It is clearly too soon after
the passing of the 1974 Constitution and the Associated
Labour Act of 1976 (SFRY, 1977) to provide a definitive
assessment of how well the new decentralised system is
operating. There are, as yet, little published data, and
thus the discussion which follows is based on my visits to
three enterprises over the period 1967-76, supplemented by
information contained in a paper by Stephen Sacks of the
University of Connecticut.
Sacks (1979) reports on interviews conducted in nineteen
Yugoslav enterprises during 1977. His sample seems biased
towards relatively large enterprises, as it has an average
size per enterprise of 11,410 workers with a range of
1014-32,000. The number of BOALs per enterprise ranged from
4 to 120. The mean number of workers in each BOAL is 379,
with the average size per enterprise ranging from 71 to 800.
According to Sacks, the data show no tendency for BOAL size
to increase with the size of the enterprise.
A point made in Sacks (1979) is amplified by the infor-
mation collected by myself: there is no consistent in-
terpretation of what constitutes a BOAL. It is defined as
follows:
A Basic Organisation of Associated Labour ••• is the funda-

mental form of association of labour ••• A basic organis-
ation of associated labour is formed for each unit of a
work organisation which makes up a working whole (a plant,
a technological unit, etc.) in which the results of joint
labour can be expressed in terms of value on the market or
within the work organisation concerned (SFRY, 1977, p.
404).
This definition suggests marketable products as the basis

for defining a basic organisation. However, Sacks (1979)
points out that Article 410 of SFRY ( 1977) signifies that
each BOAL shall produce only a single product. The literal
interpretation of this seems nigh impossible, and Sacks
suggests that it is honoured as much in the breach as in the
observance. He also provides evidence that differing bases
for de fining a BOAL are used within a single enterprise
(particularly where the enterprise operates over a wide geo-
graphical area).
Not all units within an enterprise are BOALs. Two other
important forms of unit which have appeared since the 1974
Constitution are work communities (radna zajednica) and work
organisations (radna organizacija). Sacks (1979) discusses
the former but not the latter. Work communi ties (RZs) are
units which provide common services to BOALs, such as
administration, book-keeping, personnel administration,
etc., but perform no functions outside the enterprise. RZs
have no assets of their own, and remuneration of members is
linked to the overall performance of the enterprise. The
rights of RZs in the collective decision-making process of
an enterprise may be restricted (see below). Sacks (1979, p.
5) points out that the status of a unit may quickly change
from that of RZ to that of BOAL when an opportunity to sell
its services outside the enterprise arises. However, the law

does delineate what services of common interest to BOALs can
be performed by an RZ or a BOAL (see SFRY, 1977, pp. 265-
70). A work organisation (RO) is defined as
an independent self-managing organisation of workers

interlinked by their collective interests in the sphere of
labour and organised in basic organisations within such
work organisations or directly linked by the unity of the
labour process, in which work organisation they shall
jointly plan development ••• determine JOLnt grounds and
scales for the distribution of income and the allocation
of resources for personal incomes ••• organise joint
services (SFRY, 1977, Article 15, p. 47).
This definition suggests two forms of RO: one which is a

group of BOALs whose activities are coordinated, and another
which is essentially a 'super-BOAL' within which, although
it could be split into a number of BOALs, there are suffi-
cient common interests ('unity of the labour process') to
justify a single unit. The latter of these two forms may
amount to a convenient way of avoiding the decentralisation
implicit in the 1974 Constitution. Evidence from the Split
shipyard, gathered by myself, gives some support to this.
Stephen (1976) outlines how the system of BOALs was intro-
duced in the Split shipyard. This involved the conversion of
sixteen working units[21] into ten BOALs. However, one of
these BOALs (ship-production) was essentially the same as
the manufacturing side of any shipyard, and by its sheer
size must have dominated the relations between BOALs. There
is a clear market relationship between each of the other
BOALs and ship-production, as each of the others clearly
supplies a service. However, it would seem that meaningful
divisions could also be found within the ship-production
BOAL.
An important difference between the workers' councils
under the BOAL system and those of the previous system is
that the members of the former are delegates and are man-
dated ":>y their 'constituents' via the workers' meetings.
Furthermore, the principle of unanimity was adopted by the
central workers' council: each BOAL must be in agreement
before a proposal is approved.
As has been mentioned already, the roles of the various
bodies are subject to a 'self-management' agreement between
the BOALs. The Shipyard Council (Central Council) was
responsible for a range of general matters, e.g. bye-laws,
allocation of jointly-owned resources between BOALs, as-
sociations and technical agreements with outside bodies.
Investment in joint resources required agreement of the

BOALs.
The Central Council was responsible for the drawing up and
monitoring,of the long- and medium-term plans of the enter-
prise. However, the plan was devised after a process of
consultation with the BOALs. More details on this process
will be given below.
A major function of the Central Council was that of rec-
onciling different points of view among the BOALs. This
particularly applies to the criteria for division of the
surplus and the allocation to personal incomes, and the
policy towards outside purchases of materials, etc. It was
also responsible for supervising agreements between BOALs.
In 1975, further changes took place in the organisation of
the Split shipyard. It was expanded to include a nearby
ship-repair yard. Following on from this, ten units were
designated, of which seven are work organisations (ROs) and
three work communities (RZs). The ROs are five of the former
BOALs (ship-production, engine works, outfitting factory,
special products and welfare centre), together with the
ship-repair yard and what was described as the 'sales
service'. The three RZs are general services, purchasing,
and energy supply and maintenance. The central workers'
council has been reduced in size to twenty members: two from
each of the ten ROs and RZs.
In most respects, the overall structure is still the same,
except in so far as the change in status of some BOALs to
that of RZs has reduced their flexibility of operation. It
was pointed out to me that the appointment of the director
of each RZ could be made only in consultation with ROs,
whereas ROs appointed their own directors. Within the
central workers' council, delegates from RZs are not allowed
to vote on questions of investment or distribution of
resources, since the RZs have no resources. The central
workers' council was involved in income determination only
to the extent of setting maxima and minima for different
grades of worker. It was also pointed out that each RO
should have its own business fund, but that this had not
been implemented.
The relationships between ROs is set out in self-manage-
ment agreements which must be approved by meetings of work-
ers. The transfer-prices charged by one RO to another are
determined in advance by agreement, but work is usually done
for outside organisations only if there is spare capacity.
The size of the shipbuilding RO is well outside the range
found by Sacks ( 1979). As reported above, the largest BOAL
which he identified had 800 members. I t is presumably a
desire to maintain this larger unit which has led to the
choice of work organisation as the smallest unit, rather

than BOAL. This may suggest that the dominant force in
deciding the structure was not the need for greater democ-
racy but some other factor.
The law and self-management agreements provide a consider-
able freedom of operation to an individual RO within an
organisation of associated labour. Liability for the finan-
cial obligations of one RO can be extended to the other ROs
within an OAL only if that is specifically agreed to in a
self-management agreement. This was frequently referred to
in interviews conducted by myself as the question of
'solidarity'. The legal pos1t1on on liability for obli-
gations is fully set out in SFRY (1977, Articles 251-64, pp.
189-94).
In the case of the 'Split shipbuilding industry', such
prov1s1ons exist. Any proposal to extend the capacity of an
RO requires an 'investment programme 1 to be produced and
agreed to by other ROs, since they would be required to
repay any loans on which the initiator defaults. It is poss-
ible under this particular self-management agreement for
individual ROs to raise funds externally with the approval
of others. However, in most instances major extensions of
capacity involve more than one RO and are treated as
'community investments'. In such a case, the development
department coordinates and evaluates the project and
presents detailed proposals to the workers' council of each
RO and perhaps a meeting of workers, and finally to the
central workers' council.
In the case of minor repairs and maintenance of existing
capacity within an RO, information has to be provided to
other ROs, but the decision is that of the originator which
might supply the finance from its own funds or by raising it
externally. Much of the internal funds will come from
accumulated depreciation payments.
Another enterprise visited by this author is the Niksic
steel plant. At the initial organisation into BOALs, seven
were created, together with a single 'common services' BOAL
comprising the commercial, financial and manpower functions.
The common services BOAL was later reconstituted as an RZ.
At Niksic, however, there was no 'unlimited solidarity'
(i.e. mutual responsibility for debts). The RZ has no funds
of its own.
A small aluminium plant at Titograd was a third enterprise
visited by me. It was initially formed as five BOALs, and
later two of these became RZ s (i.e. general services and
maintenance). Here, there was unlimited solidarity, and con-
sequently approval on all investment decisions must be ob-
tained from each BOAL. However, the RZs were not permitted a
vote on investment decisions of the BOALs.

The three cases reported here together with the evidence
reported by Sacks (1979), throw up some interesting points.
Firstly, the size of BOALs and the number in each enterprise
vary greatly. There is, however, no evidence of any corre-
lation between enterprise size and BOAL size. Secondly,
there is no uniformity in the basis for dividing enterprises
into BOALs. The evidence presented here is consistent with
the view that technical factors determine this, but Sacks's
evidence suggests more heterogeneous criteria. Two factors
may, however, explain this: the three enterprises visited by
me are in manufacturing industry, whilst a number in Sacks's
sample are services or manufacturing enterprises with their
own chains of retail outlets; furthermore, his sample
includes enterprises operating in several disparate
locations. A more consistent set of criteria might evolve
for enterprises in one type of industry. Thirdly, the struc-
ture at Split (ROs as opposed to BOALs) does not feature in
Sacks (1979). It would be useful to examine the extent to
which ROs with no subsidiary BOALs are widespread, and the
reasons behind their formation. The formation of such ROs
may be a means for avoiding the decentralisation and in-
creased participation demanded by the 1974 Constitution and
the Associated Labour Act of 1976. Fourthly, the evidence
presented here confirms Sacks's suggestion that the distinc-
tion between BOALs and RZs may be rather more pragmatic than
the law suggests. For example, the setting up of laboratory
and technical work at Titograd as a BOAL may be a response
to potential external opportunities. The position of main-
tenance workers in the three cases reported here highlights
this. At Split, they are in an RZ, whilst at Niksic and
Titograd they are in BOALs. It seems likely that the dis-
tinction may follow from the nature of the production pro-
cesses concerned: continual working of plant is probably
more important in steel and aluminium production than in
shipbuilding where there is greater scope for individual
manual workers. Energy supply at the shipyard is covered by
an RZ whilst in the steel plant it is provided by a BOAL.
Again, this probably reflects the technological importance
of power in the two industries.
The limited studies reported here and the more extensive
one of Sacks (1979) suggest that a more systematic examin-
ation of the BOAL structure is required before any general
conclusions on the nature of its implementation can be
reached. In particular, it would be interesting to examine
how the Yugoslavs cope with the inefficiencies which authors
such as Williamson (1975, 1981) and Alchian and Demsetz
(1972) suggest would arise from a dismembering of modern
enterprises. It may, however, be that the decentralisation

into BOALs with seemingly market relations is a chimera
behind which extensive integration exists via such pro-
visions of 'unlimited solidarity' and self-management con-
tracts.
III ECONOMIC THEORY AND YUGOSLAV EVIDENCE
The Yugoslav economy presents a seemingly ideal laboratory

in which to test the economic theories of the labour-managed
firm, particularly those outlined in Chapters 2 and 4 above.
Indeed, the original developers of those theories were
specifically interested in the Yugoslav economic system.
However, there has in fact been a limited amount of direct
testing. This is largely due to problems of access to data
at the appropriate (enterprise) level as well as the usual
problem in testing economic theories of formulating a
refutable hypothesis. This section presents evidence on two
aspects of enterprise behaviour in Yugoslavia:
(a) the dispersion of incomes; and

(b) the financing of investment.
(a) The Dispersion of Incomes
In Chapter 2 it was argued that a long-run equilibrium of an

economy of labour-managed firms would be Pareto optimal,
provided that the entry of new firms took place to compete
away the excess profits of existing firms. Given the objec-
tive function of maximising income per worker a labour-
managed firm could not be relied upon, as a capitalist firm
could, to expand output and so employment until the value of
labour's marginal product was equal in all industries. Thus
the entry of new firms is required for the competitive
equilibrium to be attained in the long run.
In 1965 when the Yugoslav economy was in the transition to
one of genuine self-management, the structure of markets was
far from perfectly competitive (Sacks, 1973; Estrin, 1978).
Thus it would be predicted from theory that income inequal-
ities would persist in the absence of new entry or signifi-
cant diversification.
A study which examines Yugoslav data for such evidence has
been carried out by Saul Estrin (Estrin, 198la, 1982).
Estrin examines data on income dispersion in Yugoslavia for
the period from 1956 to 1975 at various levels of aggre-
gation. His main findings are summarised here.
At the sectoral level the measure of dispersion (the co-
efficient of variation) was higher for Yugoslavia after the

reforms than for capitalist countries and it was less
stable. It had been lower than that for capitalist countries
during Yugoslavia's period of central planning. These
results were still maintained when adjustment was made to
take account of the different skill compositions of dif-
ferent industries. When the level of aggreg.ation is reduced
from sectors to industries similar findings prevailed
although, as is common for such di saggregations, the
dispersal widened. Estrin (198la, 1982) also investigated
the dispersion within industries which he argues will be a
reflection of relative efficiency. Because of the relatively
small numbers of firms in each industry, the data source
used by Estrin is a reasonable proxy for inter firm differ-
ences. This revealed that earnings differences were on
occasion 10:1 within industries.
Estrin's most striking results are obtained when he com-
bines the data on firm size groups and skills to provide an
overall picture of income inequality as it developed after
the introduction of self-management.
The data in Table 5.2 shows that the income range in the
bulk of sectors was from 150 to 300 per cent. However Estrin
(1982) points out that more than 40 per cent of the cat-
egories paid between 80 and 120 per cent of the industrial
average. Nevertheless the overall income range was very
large. It exceeded 1000 per cent in every year and reached a
peak of 7160 per cent in 1966. When extreme observations
were excluded the maximum range lay between 650 to 750 per
cent.
Table 5.2 Proportion of sectors in different firm-size group

income ranges
Income range in Proportion of sectors (%)

sector (%) 1966 1968 1969 1970 1971 1972
< 150 4 5 35 18 23 18
151-200 32 35 25 32 18 41
201-300 46 20 20 27 27 27
> 300 18 40 20 23 32 14
Source: Estrin (198la)
It was also found that the sectoral dispersions were of

comparable importance to the skill dispersions. Thus com-
parable labour in different industries received very differ-
ent incomes. This would not be expected in a conventional
labour market. Estrin's results are therefore consistent
with the theory of the labour-managed firm although Estrin

( 1982) is careful to point out that they may also be con-
sistent with other explanations, which he regards as less
likely given the institutional circumstances of Yugoslavia
in the period which he was investigating.
(b) The Financing of Investment
The theories on investment financing discussed in Chapter 4

suggest that in circumstances such as those of Yugoslavia,
where workers have a limited claim on the assets financed by
them from foregoing incomes, there will be bias towards ex-
ternal finance and away from self-financing. Once again
Yugoslavia may be thought a reasonable source for evidence
on which to test such theories. What, then, is the evidence?
Various authors have drawn different conclusions from the
published data for this period. Furubotn (1974) and Pejovich
(1973) conclude that the self-financing of investment is
low. Horvat (1976) suggests that it is increasing.
Dimitrijevic and Macesich (1973) argue that it is high.
These authors reach their conflicting conclusions via what
amounts to casual empiricism: each author presenting a table
of ratios which, they argue, points to their conclusions.
The sort of evidence which they cite is similar to that on
the sources of finance for fixed investment presented in
Table 5.3, and to that on gross enterprise saving and
investment in Table 5.4. The conflicting conclusions can be
explained largely by the different measures of investment
used. Evidence of this nature is not, however, very strong.
A seemingly more thorough analysis has been carried out by
Tyson (1977), who concludes that 'savings rates in many
Yugoslav firms are positive and substantial rather than zero
as predicted by theory' (Tyson, 1977, p. 407). Enterprise
saving, defined as 'Allocations to the Funds of Enter-
prises', is clearly non-zero, as illustrated in Table 5.5.
The question to be answered is whether such allocation to
the funds of enterprises are significant levels of volun-
tary savings and, as such, run counter to the predictions of
the theory of financing of the labour-managed firm outlined
in previous chapters.
(i) Evidence on Enterprise Saving
Tyson (1977) presents well-known data on the share of

enterprise financing in the purchases of fixed capital by
Yugoslav enterprises. Her Table 3, reproduced here as Table
5.6(a), reveals this to be around 30 per cent in most years
from 1965 to 1972. She also provides, in her Table 2 (Table
......
......
00
~
1:'1
(")
0
z
§l
H
(")
Table 5.3 Composition of investment in fixed assets by source of finance (%) social sector
1951/5 1960/3 1964 1965 1966 1968 1969 1970 1971 1972
~
o<
en
H
en
Social funds & budgets 84.2 59.2 28.7 14.4 16 16 15.8 15.5 15 19.9
Work organisations 15.6 37.6 36.1 42.9 46 37 34.9 33.4 34 37.5
Banks 0.2 3.2 35.2 42.7 39 47 49.4 51.1 51 42.6
.,~
~
Sources: Horvat (1976, p. 222, 'Utrosak za investicije u osnovne fondove', Statisticki Godisnjak g
(")
Jugoslavija (SGJ) (1967/74), and 'Izvori kreditiranja i finansiranja investicija, SGJ (1962/6). t'1
~
en
(")
0
~
1:'1
~
H
;1
en
"'
E-<
z~ Table 5.4 Gross enterprise saving and investment, 1965-72 (millions of dinars)
::E:
~
f.!)
1965 1966 1967 1968 1969 1970 1971 1972
z< 1. Gross savings 19,000 18,865 18' 155 20,416 20,637 26,237 39,318 40,223
~I 2. Investment 22,609 27,394 29 '242 28,479 33,087 45 '291 54,074 54,642
r.r.. in fixed assets 14,552 16,804 16,412 20,953 24,087 31,359 33,185 38' 135
...:1
~ in changes in stocks 8,057 10,590 12,830 7,526 9,000 13,932 20,889 16,507
Cll
Self-finance (%) 84.0 68.9 62.1 71.7 62.4 57.9 72.7 73.6
> (1)/(2) Changes in stocks
<
...:1
Cll
as a % of investment 35.6 38.7 43.9 26.4 27.2 30.8 38.6 30.2
0
g Source: 'Money flow accounts of economic organisations', Annual Report, National Bank of Yugoslavia (1971).
><
,_.
N
0
Table 5.5 Allocations to the funds of enterErises,* manufacturing and mining,
1966-72 (millions of current dinars)
1-l
::c
t>:l
Sector Year 1966 1967 1968 1969 1970 1971 1972
t>:l
('")
Manufacturing & mining 8179.4 5841.2 6243.2 4672.8 6059.4 11,835.7 13' 260 0
Electric power 689.6 555.9 567.9 550.4 581.7 847.0 1194 z
Coal 173.6 86.0 147.9 28.4 91.7 70.8 164 ~
H
Oil 295.4 405.8 508.6 66.6 16.7 258.9 399 ('")
Ferrous metals 341.3 90.9 -18.0 90.2 180.4 434.1 414
Non-ferrous metals 544.8 319.5 297.9 197.1 138.9 300.4 466 ~
Non-metallic minerals
>
t"'
234.4 137.3 134.9 131.8 180.5 344.4 286 ...::
Metal manufacture 1564.6 936.3 887.6 718.1 1146.6 2229.0 2109 en
H
Shipbuilding 197.7 85.6 157.6 68.1 191.3 55.7 43 en
Electrical products 484.8 407.0 494.4 429.0 412.0 620.5 533
Chemicals 807.8 635.2 639.6 521. 1 579.4 1038.0 1279 ~
Building materials 210.1 235.9 275.1 284.8 366.9 634.4 609
Wood products IX'
""
296.9 193.4 257.0 323.1 509.7 853.6 845 0
c;l
Paper manufacture 22.3 -69.1 -36.4 -34 .o -16 .o 84.4 34 c:::
Textiles 1095.6 ('")
567.1 640.4 364.1 569.9 1463.6 2015 t>:l
Leather & footwear 160.6 122.3 165.0 93.5 75.7 328.4 555 IX'
en
Rubber 143.9 143.6 136.5 154.4 124.4 319.9 278
Food processing 632.8 488.3 459.5 329.1 482.3 1071.4 1044 ('")
Printing 457.0 378.4 383.6 283.0 357.4 591.7 584 0
Tobacco products 89.0 47.3 86.5 28.3 2.0 166.2 273 ~
t>:l
Others 71.9 64.3 67.5 45.9 68.0 123.0 135 IX'
~
H
Source: 'Osnovni podaci o privrednim organizacijma drustvenog sektora',
Statisticki Godisnjak Jugoslavija (various issues). <
t>:l
en
Note: *These comprise allocations from the net income of the enterprise to the business
fund, reserve fund and collective consumption fund.
Table 5.6(a) Enterprise share in total domestic sources of finance for fixed investment (%)
1960-3 1964 1965 1966 1967 1968 1969 1970 1971 1972
30 26 29 39 33 31 28 27 27 30 ><
§
Source: Tyson (1977), Table 3, p. 397. 0
en
t"'
~
en
txl
t"'
"l
Table 5.6(b) Discretionary savings as a share of enterprise net income (%) I
1958 1960-3 1964 1965 1967 1968 1969 1970 1971 1972 1973 1974 ~
~
X
Yugoslav est. 42 42 45 txl
47 43 42 37 37 41 41 42 45 z
IBRD est. o-,l
41 38 33 34 42 41 31 28 32
Source: Tyson (1977), Table 2, p. 396.
.....
N
.....
5.6(b) here), evidence to suggest that the share of dis-

cretionary saving from enterprise net income (after allowing
for personal taxation) is over 40 per cent on Yugoslav data
and 30-40 per cent on IBRD adjusted data. This is cited as
prima facie evidence that the extant theory is wrong. How-
ever, since both of these data sets are influenced heavily
by depreciation allowances, they may not, in fact, be
evidence of the voluntary saving which refutation of the
theory requires.
Yugoslav law requires that enterprises maintain their
assets, which are thought of as social property. To this end
minimum rates of depreciation are set for various classes of
fixed assets. These allowances, however, cannot be distrib-
uted as incomes to workers but must be retained within the
enterprise or applied to the maintenance or creation of
fixed capital. Although in a national-income-accounting
sense this may be saving, it is not so within the meaning of
that term in the theoretical literature on the labour-
managed firm. The term is used there to describe the portion
of the distributable income of the enterprise that is re-
tained, after the maintenance of existing assets, to pur-
chase fixed assets. The figures for enterprise saving quoted
by Tyson, for example, have two major elements: depreciation
and 'allocation to the funds of the enterprise'. It is the
latter element which is the voluntary saving of the
theory. [ 22]
In discussing the financing of investment in fixed assets
it is necessary to distinguish between gross and net invest-
ment. A high level of self-financing of investment may
merely mean that depreciation allowances are being used, not
that voluntary saving is taking place. It would be quite
consistent with the theoretical arguments of Furubotn and
Pejovich for self-financed investment to arise solely from
the use of depreciation allowances.
One note of caution is necessary here. Tyson ( 1977, p.
402), cites evidence from Miovic (1976) that manufacturing
firms in Slovenia depreciate at more than twice the minimum
rate. Can this additional depreciation be regarded as vol-
untary saving? Whilst being above the minimum required rate,
such depreciation is not a legal requirement. Miovic himself
seems to suggest that it is necessary merely for survival
since he takes it to be a sign 'of the importance of being
able to replace its [the enterprise's] capital stock when
worn out and with inflation the minimum rates are insuf-
ficient' (Miovic, 1976, p. 113). The minimum depreciation
rates are set as a percentage of historic cost, and it would
seem prudent, therefore, for workers to depreciate at a
higher rate to ensure the continuity of fixed assets and
therefore their own employment. Furthermore, there is the

question of why such 'savings' (if they are savings) should
be made in the form of additional depreciation allowances
and not by allocations to the business fund. In many
countries, there would be a tax incentive, but this would
not seem to be the case in Yugoslavia, as Lamers (1976, p.
99) states: 'there is no incentive ••• for the enterprise to
increase its depreciation charges so as to decrease its tax
liabilities'.
It seems reasonable to conclude that little of the 'ad-
ditional' depreciation is voluntary saving in the sense
implied in the theory of Furubotn and Pejovich, and Vanek.
The test of the investment financing theory used by Tyson
(1977) is an indirect one. Her fitted relationship is
derived from combining the permanent income hypothesis with
Miovic's (1976) view that the adjustment process is a grad-
ual one influenced by past earnings.
Tyson estimates the following equation:
(5.1)
where wt is average earnings per worker deflated by the

retail price index (this variable is a proxy
for the target level of real current earn-
ings);
where is annual enterprise net income deflated by a
retail price index and divided by the average
number of workers employed during the year
(net income is defined as the sum of de-
preciation, wages and allocations to the
business funds);
where is a dummy variable to pick up the effects of
incomes policies during 1971-4;
g is the coefficient of wage adjustment;
k is the desired share of earnings in permanent
net income;
vt is a random error term.
The equation is estimated by Tyson separately for sixteen of
the industries in the manufacturing and mining sector, using
annual observations from the period 1965-74. The results are
significant for eleven of the sixteen industries.
How does this relationship relate to the hypothesis of
little or no voluntary saving to finance the purchase of
fixed assets? Tyson argues that if k is significantly dif-
ferent from unity, then the financing theory must be
rejected. This is tested using the null hypothesis that
gk + (1-g) = 1.
This hypothesis may be rejected in eight of the eleven in-

dustries, i.e. in 50 per cent of the original sample of
industries. Consequently, Tyson (1977, p. 407) concludes
that 1 savings rates in many Yugoslav firms are positive and
substantial rather than zero as predicted by theory' (empha-
sis added). This would seem to be a very strong conclusion,
given the nature of the evidence.
It is clear that k < 1 is a necessary condition for vol-
untary saving to take place, but it is not a sufficient
condition. The term ye/L contains depreciation allowances
and allocations to the business fund. That k is less than
one merely implies that depreciation or allocations to the
business fund, or both, are positive. It has been argued
above that little or none of depreciation is voluntary
saving in the sense of the financing theory. Attention is
now focused on allocations to the business funds.
The major fund of an enterprise is the business fund,
which comprises both fixed and working capital. In a number
of their papers, Furubotn and Pejovich write of savings from
current income for the purchase of fixed assets as being
allocations to the business fund. However, allocations to
the business fund also include repayments on loans (Gorupic
and Paj, 1973; Bendekovic and Teodorovic, 1975). Are these
loan repayments to be regarded as part of voluntary saving?
As discussed in Chapter 4, if a loan is to be repaid within
the worker-manager's planning horizon, the required return
will be at least as great as if it were self-financed where
depreciation allowances must be accumulated. However, it has
been suggested to me that depreciation allowances may also
be used to repay loans, and thus pass capital-maintenance on
to subsequent generations of workers. Furthermore, the rate
of inflation in Yugoslavia over the period was such that the
real loan repayments would be less than the real value of
the loan. The least that can be said is that a preference
for borrowing as opposed to self-financing may exist and
must be explained. In one sense at least, loan repayments
are not voluntary saving at the time they take place, for
they are contractual obligations carried over from a
previous period. Tyson's evidence is, therefore, not as sub-
stantial as it might at first seem. Her test of the financ-
ing theory is an indirect one. Ideally, one would like to
measure directly the amount of self-financed net investment
but no data exist on this. However, inference~ay be drawn
from the determinants of other variables.
It has been argued above that a positive level of self-
financed investment is not a refutation of the extant theory
since no distinction has been made between self-financed net
investment and self-financed gross investment. An hypothesis

consistent with the theory is that self-financed investment
is occasioned by the use of depreciation allowances.
This hypothesis suggests the following relationship:
SF.1t /L.1t =a+ b (A.1t /L.t) + ui..t' (5.2)

l.
where SFit is self-financed investment by firms in industry
i in year t, measured in constant prices;
A. is depreciation allowance of firms in industry
I.t i in year t, again in constant prices;
L. is the number of unskilled labour equivalent
l.t workers in the ith industry in year t;
u. is a random error term.
The r~lationship is expressed on a per worker basis since
the theory relates to individuals. As industry data are
used, it is necessary to standardise for different ski 11
mixes across industries. The method of standardisation is to
divide the total 'wage' bill for the industry, in a given
year, by the average 'wage' of an unskilled worker in that
industry in that year.[23] This method allows for wage dif-
ferences between unskilled workers in different industries
but implicitly assumes that the basis of calculating dif-
ferentials is the same between industries. Thus the number
of unskilled labour equivalents in the ith industry in
period t is given by
L. (5.3)
l.t
where yit is the average net income of an unskilled worker

in industry i during period t;
yjt is the average net income of a worker in the jth
skill class in industry i during period t;
Njt is the average number of workers in the jth skill
class of the ith industry during period t.
Equation (5.2) has been estimated using pooled data from
the nineteen industries in the Yugoslav mining and manu-
facturing sector for the years 1969, 1970 and 1971. These
three years were chosen as they provide data on a consistent
basis from the period under study. An F-test verified the
pooling of the data. The estimated relationship, with t
statistics in parentheses, is shown by
SF.t/L.t =- 0.000606 + 1.030167 (A1.t/L 1.t),

l 1 (-0.02) (19.86)
2
R = 0.8776, F = 394.36.
C!early, the intercept term is not significantly different
from zero, while the coefficient on the explanatory variable
is. However, a null hypothesis that the latter is equal to
one cannot be rejected (the standard error of the estimated
coefficient is 0.051875). Put another way, the 95 per cent
confidence limits forb are 0.928492 and 1.131842. Given the
high value of the coefficient of determination, one cannot
reasonably reject the hypothesis that the underlying
relationship is
SFit/Lit = Ait/Lit + uit' (5.4)
Such a relationship leaves little room for any self-financed

net investment being generated from allocations to enter-
prise funds.
The theory of financing investment by the labour-managed
firm suggests that allocations to the business fund to
finance fixed assets will be low or zero. Table 5.5, how-
ever, does indicate positive allocations to the funds being
made during the period under investigation. The insti-
tutional evidence cited above suggests that positive allo-
cations to the business fund may arise from the need to
repay loans contracted in previous periods. A further need
for enterprise saving may be working-capital requirements.
There has been little discussion in the literature on the
labour-managed firm on this question of working capital.
Fluctuations in the demand for a firm's product will bring
about a need for it to augment its working capital. This
tendency will be more so in a labour-managed firm, which
will be reluctant to lay off its members temporarily when
demand falls. The fall in demand is absorbed by stockpiling,
and thus a temporary fall in incomes. Such an explanation
has been put forward by Horvat (1976, p. 226) to explain the
behaviour of the Yugoslav economy during the downswing of
the business cycle.
Clearly, there wi 11 be an at tempt to finance such stocks
from credit, thus maintaining income and employment. How-
ever, the financing of working capital is not subject to the
same disincentive under labour-management as is the financ-
ing of fixed assets. Increasing contributions to working
capital by worker-managers which lead to a reduction of
income in one year may be recouped in subsequent years by a
reduction in such contributions below any trend level. In a
financial climate where there is excess demand for credit,
enterprises may be forced to finance some fixed or some
working capital. In the case of the labour-managed firm,
self-financing of working capital will be preferred to self-

financing of fixed capital.
These considerations and the extant theory of financing
would suggest that allocations to the business fund may be
determined by the following relationship:
(5.5)
where st is allocation to the business fund during the

year t;
Lt-l is the loan outstanding at the end of the year
(t-1);
RWCt is the change in the desired level of working
capital during the year t;
e is a random error term.
Unfortuaately, it is not possible to estimate this relation-
ship, because data are not available on all variables at the
same level of aggregation. No measure of either explanatory
variable, or any proxy for them, is available at the in-
dustry level. Stephen (1979b) provides a highly aggregated
test using Yugoslav National Bank money flow data. It must
be recognised, never the less, that the aggregation in such
data is considerable, and the theory being investigated
relates to the individual enterprise. Such a test, there-
fore, is subject to the severest qualification, and is
reported here as an indication that tendencies counter to
that of Tyson (1977) may exist.
The evidence from Stephen (1979b) is that savings of
enterprises net of long-term loan repayments and de-
preciation are determined by changes in stocks and the
repayment of short-term loans. Different specifications of
this relationship yield results suggesting that between 85
per cent and 91 per cent of variations in net savings may be
explained in this way. In other words, the results are
suggestive of little voluntary saving by the enterprise
sector. Indeed, the estimated coefficients suggest that if
working-capital requirements were static, there would be net
dis-saving.
The evidence reported here goes some way to explaining the
conflict between the different authors mentioned at the
beginning of this section. Although the analysis has been,
in the main, carried out at a highly-aggregated level, it
runs counter to the conclusion reached by Tyson (1977). The
institutional evidence cited clearly points to different
possibilities in the interpretation of her indirect evi-
dence. Other empirical investigations conducted by Stephen
(1979b) support an alternative explanation which is consist-
ent with the theory outlined in earlier chapters. Clearly,
empirical investigations are required at the level of the

individual enterprise, in order to test the theory ad-
equately. Unfortunately, appropriate data are not generally
available to researchers in the west.
(ii) Underpricing of capital
A number of difficulties in testing the theories of the

labour-managed firm using Yugoslav data have already been
detailed. A further problem in relation to the theories of
financing discussed in Chapter 4, on which evidence has been
presented in the preceding section of this chapter, is that
capital in Yugoslavia is underpriced.
The normal rate of interest charged by banks on long term
loans to finance investment in fixed assets in Yugoslavia is
determined not by market forces but by administrative fiat.
This rate, for a number of years, is shown in Table 5. 7,
along with the rate of inflation in each year. Given the
high rates of return on investment likely to be obtained in
a country at Yugoslavia 1 s level of development (see for
example, Frankovic, 1974; Vahcic, 1976; Miovic, 1976; Vanek,
1978, for empirical evidence on the marginal product of
capital in various years), this seems indicative of an
underpricing of capital. A negative real rate of interest on
investment credits (as applied in Yugoslavia during many of
the years since 1965) makes investment in capital assets
excessively attractive, and, if the demand can be met, would
lead to a degree of capital intensity unwarranted by the
relative availability of capital and labour. This will be
reinforced by any tendency on the part of labour-managed
firms to operate with a more capital-intensive technology.
In reality, of course, such negative real rates of interest
are likely to lead to an excess demand for credit, which
will result in various forms of rationing. Non-price-
rationing will lead to distortions in the allocation of
credit. The projects with the highest productivity will not
necessarily receive funds, thus reducing the growth of the
economy's productive potential. Political influence and
connections may become more significant in obtaining credit
than economic viability. This will be particularly true
under the Yugoslav banking system, where banks are, in
effect, owned by enterprises and socio-political organis-
ations (these are known as the 'founders' of the bank).
Where non-price-rationin g of credit is necessary, it is
highly likely that preference will be given to founder
enterprises.
The underpricing of capital which is implicit in the
negative interest rates in Yugoslavia during the early
"'
N
~
r.:l Table 5. 7 Real interest rate (%) 1966-76
X
I
r...
...:l
r.:l
C/)
Interest rate on credit

Rise in index of industrial producer prices
Real interest rate
1966
8
11
3
1967
8
2
6
1968
10
1
9
1969
8
3
5
1970
8
9
-1
1971
8
15
-7
1972
12
11
1
1973
12
13
-1
1974
12
29
-17
1975
12
22
-10
1976
12
6
6
Note: Interest rates are not weighted averages, but prevailing rates reported by banks for long-term
~
...:l
preferential credit •
C/) Source: Schrenk, Ardalan and El Tatawy (1979).
0
g
><
seventies will have two important ef fee ts. Firstly, labour

will be appropriating rents imputable to capital. Secondly,
the mis-allocation of credit will retard the economy's
growth. Here, discussion is confined to the former question.
The factors affecting Yugoslavia's growth during the post
1965 period are examined in Estrin (1980b), Sapir (1980) and
Vahcic (1976, 1980).
Estrin ( 1980b) argues that the reduction of the rate of
growth of output in Yugoslavian manufacturing industry after
the reforms of 1965 can be explained by the theory of the
labour-managed firm. In particular, he emphasises that part
of the literature which suggests that a labour-managed firm
wi 11 have a preference for a capi tal-intensive techno logy.
The argument here is in no way at variance with this; it
merely suggests that when the price of capital is below its
true opportunity cost, this tendency will be exacerbated.
Sapir (1980) seems to be arguing along much the same lines
as Estrin (1980b), but he relies for his evidence on an
estimated CES (constant elasticity of substitution) pro-
duction function. Unfortunately, the validity of this
evidence is called into question by some of the assumptions
which he makes. In particular, it is assumed that the
production function exhibits constant returns to scale, and
that the share of labour and capital in output may be
implicitly estimated. The former assumption is at variance
with Vanek's (1971) theory, which Sapir (1980) seems to
accept as valid, although it has been argued in Chapter 4
above that capital does have an opportunity cost, and
therefore Vanek's theory is invalid. The second assumption
is valid only where there are perfectly competitive factor
markets. Again, such a situation is at variance with most of
the theoretical literature on the labour-managed firm and
the empirical evidence on Yugoslav factor markets (see the
work of Estrin discussed above).
The thesis underlying Vahcic (1976, 1980) is that
Yugoslavia's growth rate is retarded not because its enter-
prises are labour-managed, but because there are substantial
distortions in the capital and foreign-exchange markets.
This is examined using the performance-evaluation procedure
of Koopmans and Montias (1971), which implies that if
Yugoslavia's growth rate can be reasonably accurately
predicted by a model estimated from a cross-section of
capitalist countries, there are no systemic factors (i.e.
ar1s1ng from labour-management) which influence Yugoslav
growth. The model of capitalist growth used is that devel-
oped by Singh (1975), which involves disequilibrium indices
for capital and foreign exchange markets. Vahcic (1976,
1980) concludes from his empirical work that Yugoslavia's
growth rate is explicable in terms of these indices and not

any systemic differences between Yugoslavia and a 'typical'
capitalist economy. However, Vahcic's model implicitly
assumes that labour is rationally priced, since there is no
disequilibrium index for labour. This would seem to be un-
warranted on both theoretical and empirical grounds (see
Estrin, 198la, 1982).
Vahcic' s conclusions are also thrown somewhat into doubt
by his own work on employment growth in manufacturing and
services (see Vahcic, 1976, ch. 4). There it is concluded
according to the Koopmans-Montias methodology, that there
are systemic differences between Yugoslavia and the typical
capitalist economy. These differences are explained by
Vahcic in terms of Vanek's (1971) theory of the financing of
labour-managed firms. He concludes that the scarcity pricing
of capital is of greater importance to a labour-managed
economy than to a capitalist economy. This seems to be in
direct contradiction to his own conclusions on growth rates.
Notwithstanding these criticisms, Vahcic' s general meth-
odology, of using a model based on international cross-
section data to predict Yugoslav growth rates, is somewhat
dubious. One cannot expect the coefficients from such a
model to be appropriate to any individual country, otherwise
they would constitute a law of economics. It should be
clarified that the point being made here is methodological,
and relates to the validity of Vahcic's (1976, 1980) empiri-
cal evidence, and not to his suggestion that the under-
pricing of capital in Yugoslavia has lead to distortions.
The rest of this chapter is devoted to studies on
Yugoslavia which estimate the extent to which rents due to
capital were appropriated by labour during the late 1960s.
Vanek and Jovicic (1975) estimated the marginal product of
capital from the following equation
yi =a + bk2i + ui, (5.6)
where yi is net product per unskilled labour-equivalent in

the ith industrial branch;
k 2 i is capital stock per unskilled labour-equivalent
in the ith industrial branch (capital stock
measured at its depreciated value);
ui is a random error term;
a,b are parameters.
Equation (5.6) as estimated by Vanek and Jovicic is
y. = 2.1337 + 0.098 k 2 ., R2 = 0.1978. (5. 7)

1 (0.0479) 1
Vanek and Jovicic argue that in the Yugoslav economy,

capital formation is internally-financed and, as a conse-
quence, labour incomes include a rent imputable to capital.
By regressing net product per worker on the capital labour
ratio, they estimate the marginal product of capital. They
then argue that this estimate (the slope coefficient in
Equation (5.7)) is the 'shadow price (or accounting price)
of capital that would eliminate the correlation if incomes
were recomputed as incomes after payment of such shadow
prices' (Vanek and Jovicic, 1975, p. 433, original empha-
sis). They later state that their two [ 24] estimates of P k,
the shadow price of capital, of 7 and 9 per cent are reason-
able in view of other studies of the marginal productivity
of capital.
Whilst other authors (e.g. Vahcic, 1976; Stephen, 1979a;
Staellerts, 1981) confirm the second estimate of the mar-
ginal product of capital, it is argued that this cannot be
taken to be the price which should be charged for its use,
given existing Yugoslav institutions. If charged, such a
rate would more than account for the capital rents accruing
to labour and, if decisions within enterprises are respon-
sive to changes in personal incomes, there would be an
excess supply of capital. The argument underlying this
conclusion can be shown clearly by developing a model of
enterprise behaviour which explicitly takes account of the
institutions within which Yugoslav enterprises operate. In
particular, it is not justifiable to regard the marginal
product of capital, as estimated in Equation (5.7), as
showing that labour is capturing rents due to capital since
the dependent variable (net product per unskilled labour
equivalent (ULE)) does not accrue to labour. Indeed, the
relationship between net personal income per ULE (after tax)
and capital per ULE is radically different from that esti-
mated by Equation (5.7). Stephen (1979a) estimates it as
0.9657 + 0.0132k 2 ., (5.8)

R2 (0.00751) L
0.1541,
where y 1 . is net personal income, after tax, per ULE in the

ith indu~trial sector.
When ( 5. 8) is compared with ( 5. 7), it can be seen that
only 13.5 per cent (i.e. 0.0132/0.0971) of capital's net
productivity accrues directly to labour.[25]
Vanek and Jovicic (1975) estimate an equation similar to
(5.8), which is reproduced here as (5.8a);
0.9321 + 0.016lk2"' (5.8a)

(0.0065) ~
R2 = 0.261.
However, they do not seem to at tach much significance to
this in estimating their 'shadow price for capital'.
Vanek and Jovicic discuss Equation (5~8a) only in compari-
son to a regression of 'income (net of all taxes)' per ULE
on capital per ULE. (The latter measure includes 'contrac-
tual obligations' , 'legal obligations' and 'allocations to
the funds of the enterprise', as well as personal incomes.)
This is reproduced as Equation (5.9);
2
1.6762 + 0.0654ki' R = 0.492, (5.9)
(0.0161)
where y . is income (net of all taxes) per ULE of the in-

dustry.rTbey suggest that the increase in the coefficient of
determination between (5. 7) and (5.9) shows that Yugoslav
enterprises' business decisions are sensitive to taxes. How-
ever, it would seem more likely that the increase in the
coefficient of determination arises from the fact that y .
is more heavily dominated by 'contractual obligationsr~
'legal obligations' and 'allocations to the funds of the
enterprise 1 , which are much more closely related to capital
stock than any of the other components of net product per
worker. Contractual obligations include interest payments on
loans; the major component of legal obligations is the tax
on the business fund (capital stock), and as has been argued
above, it is likely that a significant component of a11o-
cations to the business fund is loan repayments. Vanek and
Jovicic's spurious conclusions are a consequence of a fail-
ure to pay due regard to Yugoslav institutions and account-
ing conventions.
These points are emphasised by Table 5.8, in which are
presented simple regressions of the various components of
net product per worker on capital per worker.[26] As was
suggested in the previous paragraph, legal obligation per
worker, contractual obligations per worker and a11ocations
to the funds per worker have a higher correlation with capi-
tal per worker than other components. The first of these is
by far the most highly correlated with capital per worker
which explains over 81 per cent of its variability.
Vanek and Jovicic further conclude that the reduction in
the coefficient on the explanatory variables between
Equation (5.7) and (5.9) 'means that in their internal
income distribution capital-intensive sectors allocate far
Table 5.8 Simple regressions of the components of net

product per worker on capital per worker for 1969
(1) (2) (3) (4~

Dependent Constant Coefficient R
variable (st. error) (st. error) (F-statistic)
1 • Net income 0.9657 0.0132** 0.154

per worker (0.0502) (0.0075) (3.1)
2. Personal tax 0.4464 0.0053*** 0.132

per worker (0.0222) (0.0032) (2.59)
3. Legal
obligations 0.1448 0.0139* 0.812
per worker (0.0108) (0.0016) (73.44)
4. Contractual
obligations 0.1437 0.0203* 0.261
per worker (0.0553) (0.0083) (6.01)
5. Allocations
to funds of 0.1913 0.0227* 0.289
enterprise (0.0577) (0.0086) (6.91)
per worker
6. Net product 2.200 0.0970** 0.160

per worker (0.3560) (0.0538) (3. 25)
7. Gross product 2.3470 0.1720* 0.307

per worker (0.4187) (0.0626) (7. 55)
* Significant at 1% level for one-tailed test.

**Significant at 5% level for one-tailed test.
*** Significant at 10% level for one-tailed test.
Notes: The equations relating to the turnover tax and

expenditure on non-productive investments were, predictably,
insignificant and have therefore been omitted. The co-
efficients in column (3) are estimates of the amount of the
increase in the dependent variable brought about by a unit
increase in capital per worker. Most of the variables are
clearly influenced by factors other than capital per worker,
the major exception being legal obligations, which are
mostly the tax on the business fund (or capital stock).
[Notes continued on p. 135]

Taking the point estimates shows that these variables

account for about 75 per cent of the increase in net prod-
uct. However, this cannot be a precise estimate since each
of the components is subject to different standard errors.
The difference between the items in column (3) of rows 6
and 7 is due to depreciation increasing as capital in-
creases. Thus, about 44 per cent of the increase in gross
product brought about by an increase in capital goes on
depreciation.
The term gross product is used here for net product plus
depreciation, although the official translation of the
Serbo-Croat term 'drustveni proizvod' is 'social product'.
It is, in fact, the gross value added in production.
Source: 'Osnovni podaci o radnim organizacijama drustvenog

sektora' in Statisticki Godisnjak SFRJ, various
years.
more to investment funds and other non personal incomes

(collective consumption) than do capital-poor sectors'.
Again, this conclusion seems unwarranted since the former
effect is simply due to higher taxation of the business fund
and probably higher loan repayments and interest payments by
the capital-intensive sectors.
The second effect does not seem to be present at all since
an attempt to regress non-productive investment per ULE on
capital per ULE produced insignificant results. Vanek and
Jovicic seem rather ambiguous in interpreting Equation
(5.8), since they argue that the comparative equalisation of
income indicated by it does not imply the correct scarcity
pricing of capital. 'The funds allocated to investment still
will be used in incorrect proportions as long as effective
underpricing of capital, notorious in Yugoslavia, is per-
petuated.' This suggests that they regard Equation (5.7),
rather than Equation (5.8), to be the measure of under-
pricing. It seems more reasonable to take the view that
equation (5.8) shows that, given a recognition of Yugoslav
institutions, capital is more adequately priced than is
normally recognised.
The general approach of Vanek and Jovicic (1975) may be

used validly in trying to measure the underpricing of capi-
tal if adequate recognition is given to Yugoslav accounting
conventions. It must be recognised that some of the elements
of net product are, in fact, costs which, if regressed
against capital stock, will yield marginal costs associated
with increases in capital. The capital rental being captured
by labour will be the difference between marginal (net)
product of capital per worker and the sum of these other
marginal 1 costs of capital' per worker. [ 27] What remains,
therefore, is to identify which of the components of net
product are costs which increase as capital per worker
increases.
There are two aspects to evaluating the marginal cost
items which are 'hidden' in the net product:
i. identifying which items are functionally related to

capital per worker; and
ii. identifying which of these can be regarded as cost
items.
Table 5.8 presents evidence on the first of these points.

The items of this table are related according to the net
income system described in Gorupic and Paj (1973), i.e.
Net producd6) gross product(7) - depreciation

legal obligations(3) + contractural
obligations(4) + turnover tax + net
income to the enterprise,
Net income to gross personal incomes(l+2) +

the enterprise expenditures on non-productive invest-
ments,
Gross personal net personal incomes(!) + personal
incomes taxes(2).
Numbers in parentheses identify the corresponding rows in

Table 5.8.
All of the items in column (1) of the body of Table 5. 8
are significantly related to capital per ULE. Thus, the only
items of net product per worker which are not so related are
turnover tax per ULE and non-productive investment per ULE.
The third item in column (1) of Table 5.8, legal obli-
gations per ULE, is the one most clearly determined by the
capital per ULE, with 81 per cent of its variation being
explained. The main component of this item is the tax of the
business fund, i.e. a capital tax on the assets. This item
is also unambiguously a cost of expanding the capital stock;
therefore the corresponding item in column (3) of the table

is a marginal 'cost' of capital. The other items, however,
cannot be allocated so unambiguously.
It should be recalled that some items which would be re-
garded as costs under capitalism are not so for the labour-
managed firm. In particular, this applies to workers'
incomes, since it has been assumed that the objective of the
labour-managed firm is the maximisation of income per
worker.
For the purpose of examLnLng the extent to which rents due
to capital are diverted to labour, it seems reasonable to
use personal incomes gross of tax. Thus, taxes on (or
1 contributions' from) personal income are not treated as a
cost.
Most of the items under the heading 'contractual obli-
gations' are clearly costs of current production, e.g. pay-
ments for bank services, insurance premia and membership
fees. Also included under this heading is interest on bank
credit, which is not a cost of current production. In
estimating the maximum rate of interest which could be paid
for capital, such interest payments should not~educted.
However, available data do not allow contractual obligations
to be calculated net of interest payments and consequently
in what follows, all contractual obligations are treated as
a cost. It follows from this that the difference between the
marginal (net) product of capital and the sum of the various
marginal costs of capital is not the maximum interest rate
which could be charged, but that figure net of interest
actually paid, i.e. the capital rent which is captured by
labour.
The greatest problem arises in deciding how to treat
allocations to the funds of the enterprise. Superficially,
this item is similar to retained earnings under the capital-
ist system, and as such would not represent a 'cost'. How-
ever, the results reported in Stephen (1979b, ch. 5) and
discussed above suggest that a substantial proportion of
allocations to the business fund is, in fact, destined for
the repayment of loans. Under Yugoslav property-rights, it
might be proper to regard this item as a 'cost', unlike its
counterpart under capitalism. In the latter case, repayments
of loans represent a transfer of items within the balance
sheet: an increase in the claims of shareholders to the
assets of the firm, and a decrease in those of bondholders.
Worker-managers in Yugoslavia have no claim on the assets of
the enterprise, and their claim on the income generated is
limited to their tenure. Therefore, loan repayments are, in
current terms, a cost. It is not possible on the basis of
the data used here to separate out such loan repayments from
other aspects of allocations to the funds. The analysis of

Stephen (1979b) suggests that loan repayments may account
for a substantial proportion of them. Estimates of the capi-
tal rents accruing to labour are now estimated by calculat-
ing a measure of labour 'income' which includes both direct
and indirect incomes. The former is income received in the
form of higher current gross personal income, and the latter
is deferred income in the form of allocations to the busi-
ness fund which are, in this estimate, assumed to increase
the supply of collective goods and future personal incomes.
Two figures for this are obtained, an upper and a lower
estimate, which are then expressed per ULE and regressed on
capital stock per ULE.
The 'upper' estimate is obtained by subtracting from Net
product: legal obligations, contractual obligations, expend-
itures on non-productive services and the turnover tax. The
'lower' estimate is obtained by further subtracting allo-
cations to enterprise funds. Equations ( 5.10) and ( 5.11)
present the results of regressing the 'upper' and 'lower'
measures of 'labour-income' per ULE, respectively, on capi-
tal per ULE for 1969:
yui = 1.6114 + 0.0545k 2 ., (5.10)

(0.140) (0.02094) ~
R2 0.2849, F = 6.77;
1.4201 + 0.0318k2.' (5.11)

(0.1277) (0.0191) ~
R2 = 0.140, F = 2.77.
The capital rents accruing to labour are given by the

estimated slope coefficients of these equations. Equation
(5.11) differs from Equation (5.8) above because the latter
measures personal incomes net of taxation. Whilst the slope
coefficient in Equation (5.10) is significantly different
from zero at the 5 per cent level on a one-tailed test, that
for Equation (5.11) is not. Thus, the range for capital
rents captured by labour according to these estimates is in
the region of zero to 9.003 per cent.
In order to obtain a more reliable estimate of these lower
and upper limits on the underpricing of capital, it would
have been useful to re-estimate Equations (5.10) and (5.11)
from pooled data for a number of years during the period
1965-72. This period is the most market-oriented in the
post-war development of the Yugoslav economy. However, as
always, data limitations preclude this. In 1971, there was
revaluation of assets, which means that there is no direct

comparability between capital per worker prior to that year
with the same measure in 1971 and 1972. Revisions also took
place in the accounting system in 1969 which render measures
of gross product and net product before and after that date
incomparable.
However, it is possible to adjust the data for 1968 in
such a way that comparable values for the 'upper' and
'lower' estimates of labour 'income' (in the sense used in
Equations (5.10) and (5.11)) may be derived for each of
nineteen industries in the manufacturing and mining sector
for the years 1968, 1969 and 1970. These data were used to
estimate Equations (5.12) and (5.13). An analysis of
covariance was used to verify that, in both cases, the
pooling of the data for the three years was a valid pro-
cedure. The data for 1968 and 1970 were adjusted using the
consumer price index to produce figures in 1969 prices.
1.6365 + 0.0514k2. ' (5.12)

(0.0916)(0.0140) Lt
R2 0.1965, F = 13.45;
1.442 + 0.02413k2. ' (5.13)

(0.0670)(0.0103) Lt
R2 = 0.0914, F = 5.53.
In both cases, the estimated coefficients and the coef-

ficients of determination are lower than those in the single
year estimates. The standard errors of the estimates have
also been reduced, and in greater proportions than the re-
gression coefficients, indicating that the estimated coef-
ficients are more accurate. [ 28] These two estimated
equations provide further supportive evidence consistent
with the view that Vanek and Jovicic (1975) overestimate the
extent to which capital rents are accruing to labour, and
that, as a consequence, resources were being misallocated.
It should be remembered that the estimated coefficients of
k 2 .t in Equations (5.12) and (5.13) are estimates of the
am6unt by which the average marginal cost of a unit of
capital could be increased, i.e. the amount by which the
rate of interest or the capital tax could be increased. From
an allocational standpoint, it would be desirable for all
enterprises which increase their capital-labour ratio to pay
such a charge.
The range of 2.4 per cent to 5.1 per cent for the under-
pricing of capital provided by equations (5.12) and (5.13)
is clearly different from the estimate of 9.8 per cent in

Vanek and Jovicic (1975). Since they have deducted no
interest payments in arriving at their figures, it could be
regarded as the market clearing rate of interest, as it is
equal to the marginal product of capital after allowing for
depreciation. This would be valid so long as depreciation
allowances represent recovery of capital; it is arguable
that, under the Yugoslav system of property-rights, they do
not. Under Yugoslav law, the capital of any self-financed
investment cannot be recovered. Whilst it is possible to
repay loans from the depreciation fund, this is only a
short-run phenomenon, since the value of the business fund
(capital stock) must still be maintained in the long run. It
may be asserted, therefore, that depreciation is best
regarded as a form of tax in a self-managed system and
therefore a charge on capital. Vanek and Jovicic's estimate
of the capital rents accruing to labour must be an over-
estimate, since it does not allow for capital recovery.
Furthermore, the Yugoslav measure of net product is gross of
a number of items which may be validly regarded as costs.
Thus, regardless of the question of property-rights and
capital recovery, Vanek and Jovicic (1975) do overestimate
the extent to which labour captures rents due to capital.
IV COt>CLUSIONS
This chapter has sunnnarised the development of Yugoslavia's

economic system and the changing organisation structure of
its industrial firms, and examined some aspects of its
economic performance. The evidence on income dispersion is
consistent with the theory of the labour-managed firm of
Chapter 2. The evidence on investment finance is not so
clear-cut. A prudent judgement on the view expressed by
Tyson that there is substantial voluntary saving, contrary
to the theory, would be 'not proven'. Evidence pointing in
the other direction has been presented, but it is also
subject to reservations. The rate of inflation coupled with
a low nominal interest rate has meant that external finance
has been cheap (and sometimes at a negative real cost). This
obviously makes credit finance more attractive. However, the
view of Vanek and Jovicic that labour in Yugoslavia extracts
significant rents due to capital has been shown to be
erroneous. On one interpretation, these may be of the order
of only 2.4 per cent when Yugoslav property-rights are
correctly accounted for.
NOTES
1. This period is dealt with in some detail in Milenkovitch

(1971), Horvat (1976) and Rusinow (1977).
2. The major exogenous factors were the economic embargo
mounted by the Cominform powers, and the drought of
1952.
3. The Yugoslavs have both declarative laws and operational
laws. An appropriate analogy might be to regard the
former as being akin to UK 'White Papers'. After de-
clarative laws have been tabled, many of the changes
mentioned are implemented, and the operational law often
marks the end of the transitional period.
4. More detailed discussions of the debate on property-
rights in this period are given in Milenkovitch (1971,
pp. 94-9) and Wiles (1977, pp. 41-5). For a more general
discussion of property-rights, see Macpherson (1975) and
Wiles ( 1977, ch. 3).
5. Known as the tax on the business fund (Kamata poslovni
fondova).
6. However, the rate of the tax was never more than 6 per
cent, and was not uniform for all industries (see World
Bank, 1975, p. 250; Horvat, 1976, p. 186).
7. Furubotn and Pejovich (1970).
8. Wachtel (197 3, p. 99) suggests that this process was
legally complete by 1961.
9. Yugoslav pensions are financed through local 'communi-
ties of interest', and are not dependent on the post-
retirement performance of the enterprise.
10. See Furubotn and Pejovich (1973).
11. An Organisation of Associated Labour is defined in the
glossary attached to the official English translation of
the 1974 Constitution as 'a generic term for those
economic and non-economic organisations which carry out
their act1v1t1es with socially-owned resources and
organised on a self-management basis. This is in fact
what was earlier referred to as an "enterprise" (for the
economic sector)' (SFRY, 1974, p. 307).
The English abbreviation (BOAL) is used here. The
Serbo-Croat term (and abbreviation) is Osnovna
organizacije udruzanog rada (OOUR).
12. Article 36 of the 1974 Constitution.
13. An analysis of the economic case for and against de-
centralisation within the self-managed enterprise is
presented in Sacks (1979). An economic analysis of
transfer pricing in a decentralised labour-managed firm
may be found in Sacks (1977).
14. A fuller discussion of empirical studies of self-manage-
mentis given, for example, in Warner (1975).

15. Yugoslav Survey, no. 4, vol. XV (November 1973) p. 22.
16. Prior to 1974, the larger Yugoslav enterprises had, in
addition to a workers' counci 1 for the enterprise, a
workers' council for each working unit (or department)
within the enterprise.
17. Yugoslav Survey, op. cit., p. 23.
18. Kolaja (1965).
19. The evidence at Split fits with the pattern suggested by
the much wider study reported in Obradovic (1973).
20, This was the view expressed to me by Professor Naj dan
Pasic, Dean of the Faculty of Political Science,
Belgrade University, and a member of the Constitutional
Commission.
21. For a discussion of the system of working units, see
Gorupic and Paj (1970, pp. 118-26).
22. Strictly speaking, only allocations to the business fund
are in this category, but allocations to the reserve and
collective consumption funds are relatively minor.
23. This method is slightly different from that employed in
Vanek and Jovicic ( 1975), which uses, in so far as can
be deduced from that paper and Popov (1973), the 'wage'
bill divided by the national average 'wage' of an un-
skilled worker. Data on self-financed investment are
taken from Investicija (various issues) and on the other
variables from Statisticki Godisnjak SFRY (various
issues).
24. In addition to the results reported here as (5.7) Vanek
and Jovicic estimated the relationship with capital
stock measured at acquisition cost per ULE as an ex-
planatory variable. This yields an estimate of marginal
product of capital of 0.07.
25. Slight differences in coefficient estimates arise
between Vanek and Jovicic (1975) and Stephen (1979b) due
to differences in the method used to calculate numbers
of unskilled labour-equivalent workers.
26. A similar breakdown is presented in Vahcic (1976) and
Staellerts (1981).
27. It should be noted that the marginal cost of capital as
used here is rather different from the use of the term
in conventional finance literature to refer to the mar-
ginal opportunity cost of capital.
28. Remembering, however, that they are possibly biased
estimates because of the omission of other explanatory
variables which may be correlated with k 2 it"
6 Producers' Cooperatives in
Western Industrialised
Economies
This chapter focuses on various forms of producers' coop-

eratives found in four western industrialised economies: the
United Kingdom, France, the United States and Spain. These
are not the only economies in the west where producers'
cooperatives operate; they merely represent a sample for
which material was readily accessible. A major omission is
that of Italy, which has the largest number of contemporary
cooperatives in western Europe (Oakeshott, 1978; Thornley,
1981). The only justification for this otherwise arbitrary
selection is that, at the time of writing, a more detailed
secondary literature was known to this writer.
For an academic economist, the desired objective of this
'empirical' chapter would be to test the theories outlined
in Chapters 2, 3 and 4. However, as will become clear, this
is possible only at the crudest level. Adequate data are not
always obtainable, even by researchers at the primary level.
Often the theories themselves are not amenable to testing.
Thus the objectives set for this chapter are somewhat more
modest: to provide a description of the extent of and insti-
tutional forms found in the cooperative sectors examined; to
identify the relevant model (or models) in the theoretical
1 i terature; to out 1 ine and, where appropriate, assess the
economic performance of the sector; and, finally (and most
tentatively), where possible, to examine the degree of
congruence between the predictions of the theoretical models
and the empirical phenomena.
I THE UNITED KINGDOM
In 1980, the Cooperative Development Agency (CDA, 1980)

estimated that there were 365 producers' cooperatives in the
UK. Of these, 175 were 'industrial' and 151 were in 'ser-
vices' (mostly wholefood shops and distributors). Derek
Jones (1976) has estimated that the peak in the formation of
producers' cooperatives prior to their recent resurgence was
143
in 1893, when there were 113. The current cooperatives have

been classified into three types by Oakeshott (1978):
'cloth-cap coops', ICOM cooperatives and Wedgewood-Benn
cooperatives.
The first group are those with their origins, often prior
to 1914, in the labour and cooperative movements. They are
associated with the Cooperative Union and, prior to its
demise, the Cooperative Productive Federation (CPF). The
latter was formed in 1882, and it is its membership which
provides the basis for Derek Jones's estimate for 1893. The
number of these 'productive' societies has fallen steadily:
1 seventy-one in 1913; sixty-four in 1924; fifty in 1936;
forty-four in 1950; thirty-seven in 1960; twenty-six in
1970' (Oakeshott, 1978, p. 65). Jones (1982b) estimates a
figure of seventeen for 1975. They are registered as 'indus-
trial and provident societies'. The important organisational
characteristics of this group are that membership is usually
attained by purchasing a share, usually of a nominal value,
not all workers need be members, and many members are not
workers (e.g. former workers, trade unions, etc.). Employees
share in the income remaining after the payment of material
costs. Voting is usually on a one-member, one-vote basis,
regardless of the number of shares held. Jones and Backus
(1977) state that 'substantial collective ownership of
assets by employees exists such that substantial capital
rents accrue to workers and most investment is financed by
retained earnings which cannot be recovered by individual
employees during the life of the enterprise' (p. 491).
With the exception that there are non-worker shareholders,
these cooperatives would seem to correspond to Vanek's
worker-managed firms (see Chapter 4 above). However, it must
also be recognised that these organisations had many non-
member employees. In printing for example, this accounted
for more than 50 per cent of the cooperative labour force in
1968. Indeed, some printing firms coming into this category
of cooperative did not, in fact, allow individual worker
membership, seldom distributed surpluses to workers,[l] and
should not, therefore, be classified as producers 1 cooper-
atives. Consequently, the number of bona fide productive
societies may be less than the figures quoted above. No
societies have been formed since 1950.
The second group of cooperatives identified by Oakeshott
(1978) are those associated with the Industrial Common
Ownership Movement ( ICOM), or who have adopted I COM-type
rules. These rules have now been enshrined in the Industrial
Common Ownership Act 1976, which defines a common ownership
enterprise as incorporating the following provisions:
PRODUCERS' COOPS. IN WESTERN INDUST. ECONOMIES 145
(i) (a) it is a company with no share capital, is

limited by guarantee and is a bona fide coop-
erative society, or
(b) is registered or deemed to be registered under
the Industrial and Provident Societies Acts 1965
and 1975;
(ii) only persons employed in the enterprise are eligible
for membership;
(iii) each member has an equal vote;
(iv) assets may not be made over to members;
(v) members may share in profits;
(vi) if the enterprise is wound up, any residual after
meeting debts must be transferred to another common
ownership enterprise or a central common ownership
fund.
These common ownership enterprises correspond fairly

directly with the labour-managed firm of economic theory in
its purer forms: there are no non-member workers, no non-
worker members, and assets are collectively owned. Individ-
ual common ownership enterprises, however, enshrine in their
rules certain restrictions on the way in which profits may
be used. The Scott-Bader Commonwealth (the largest ICOM
firm) restricts the distribution to 60 per cent for taxes
and reserves, 20 per cent to employees, and 20 per cent to
charities (Thomason, 1973, p. 163). Some ICOM firms such as
Scott-Bader and Bewley's Cafes have convoluted consti-
tutional arrangements which entrench rights of the founders.
Both these cases and others are what Oakeshott (1978) has
described as 'high-minded companies' within the ICOM format.
They have their origins in the voluntary handing over (or in
some cases selling) of a firm to its workers by an owner. A
number of these, including Scott-Bader and Bewley's, operate
more in a paternalistic manner than in a cooperative manner.
In 1977, according to Oakeshott (1978), there were ten
major ICOM companies with 1200 members and a turnover of
about £20 million. In addition, there were a number of
associate members, being relatively small cooperatives and
those in the process of foundation. Since that time, there
has been a substantial increase in numbers (see further
below).
The third group identified by Oakeshott ( 1978) are the
Wedgewood-Benn cooperatives. These were formed in an attempt
to preserve employment after the closure of privately owned
firms. Anthony Wedgewood-Benn (at that time Secretary of
State for Industry) aided their formation with the provision
of public funds. The three enterprises involved are Meriden
Motorcycle, Scottish Daily News and KMB. These were, by
cooperative standards, large firms, and two of them had

spectacular but short lives. They are not discussed further
here, as they are not thought to be typical of British pro-
ducers' cooperatives. A number of other smaller and longer-
lived anti-redundancy cooperatives exist. Subsequent dis-
cussion will focus on the 'cloth-cap' cooperatives, and
those ICOM enterprises which give their workers a direct
influence on decision-taking.
Formal economic analysis has been restricted to the first
group (i.e. long-established cooperatives). These studies
have sought to compare the relative performance of cooper-
ative and capitalist enterprises with that predicted by the
basic theory of the labour-managed firm (Jones, 1974; Jones
and Backus, 1977, Normand, 1982), and to test the Cornell
School theory on the consequences of internal financing
(Jones and Backus, 1977).
It has already been argued (Chapter 4) that the Cornell
School are erroneous in their modelling of the consequence
of self-financing. Jones and Backus's (1977) study of foot-
wear cooperatives finds no evidence of returns to scale for
pooled time series/ cross-section data. However, they argue
that since the theory postulates a scale coefficient that
diminishes with output, it is appropriate to divide the
sample into output ranges. They choose to estimate their
production functions for two subsamples, taking 100 em-
ployees as the dividing line.[2] When this is done, it is
found that returns to scale are significant for the small
firms but not for the large firms, and that the difference
between the two is significant. This is taken by Jones and
Backus (1977) as support for the Cornell view. Is this so?
Why should the large cooperatives not also demonstrate
returns to scale? w~y are some large and some small in
long-run equilibrium, as Jones and Backus assume them to be,
when the Cornell theory suggests that all will tend to be
small? The alternative view expressed in Chapter 4, that a
collectively owned self-financed firm may, in effect, starve
itself of funds for investment, could also be consistent
with Jones and Backus's (1977) results for the divided
sample: the small firms have remained small, failing to
exploit the increasing returns to scale because the members
are unwilling to invest; the larger firms are those whose
members have been willing to invest (perhaps by borrowing).
Without further detailed information, it is not possible to
choose between these competing rationalisations of the
findings. Evidence of increasing returns could also be
explained by the cooperative operating in an imperfect
product market.
Notwithstanding the above, Jones and Backus's (1977) test
of the Cornell financing theory is a rather weak one. They

take evidence of returns to scale as support for the theory.
However, the theory is rather more precise in its predic-
tion. Not only does it predict that the long-run equilibrium
of the firm will be in the area of increasing returns to
scale it also predicts that it will lie on the locus e 1 = 1.
One form of production function estimated by Jones and
Backus (1977) is a Cobb Douglas function of the following
form:
ln (V/L) = ln A + rt + a ln (K/L) + (a+b-1) ln L+u.
The test for returns to scale is whether the estimate of

(a + b - 1) is significantly different from zero. This is
found to be the case for the small cooperatives. The
stronger prediction that e 1 = 1 implies for the Cobb Douglas
function that b = 1, and therefore that a+ b - 1 =a. A
test of this would be a test of equality for the estimated
coefficients on ln (K/L) and ln L. However, the information
contained in Jones and Backus (1977) is not sufficient for
such a test to be made.
Jones and Backus (1977, p. 490) also test the following
predictions of the Cornell theory:
(1) the internally-financed cooperative will have lower

output in equilibrium than its capitalist twin;
(2) since it under-invests, it will operate with a lower
capital-labour ratio.
It has been argued in Chapter 4 that neither of these pro-

positions is valid, in general; they depend on the nature of
the technology. In fact, they seem to be based on Vanek's
diagrammatic presentation, which differs from that of Miovic
(1976) and Frisch (1965). Thus the evidence evinced by Jones
and Backus (1977) on these points should not be regarded as
tests of Vanek's theory, but simply as empirical data on the
relative performances of cooperatives and capitalist firms.
These results are that, by-and-large, the 'average' footwear
cooperative was smaller than the 'average' firm in the foot-
wear industry, and that the capitalist firms were growing at
a faster rate than the cooperatives. These results are
broadly confirmed in a recently-completed study by Charles
Normand of the University of Stirling. [ 3] This study in-
volves a comparison of matched pairs of 'cloth-cap' coop-
eratives and capitalist firms. Normand's study therefore
avoids the problems of comparing 'averages' of cooperative
data with 'averages' of non-cooperative data. The cooper-
atives in the sample had all operated for 30 years prior to
the period investigated, and remained in operation through-

out the period. This provided twelve cooperatives. The
comparators were matched by location, technology and size.
These comparisons showed that there was a clear tendency for
the capitalist to be more capital-intensive. The results on
output per worker were not so clear-cut. For example, in the
footwear industry, tests on the relative output to labour
ratios of capitalists and cooperatives are inconclusive,
whilst in the three other industries covered, output per
worker was higher in the capitalist firms. There was also a
tendency for the capitalists to invest more per worker.
Given the matching process, this does suggest that the
cooperatives were not willing to take opportun1t1es for
expansion that were available. Furthermore, Normand suggests
that some of the cooperatives might not have been covering
reasonable depreciation. Both of these findings could be a
consequence of cooperators exhibiting a higher discount rate
for collective investment.
As far as testing the various theories outlined in Chap-
ters 2, 3 and 4 are concerned, more recognition needs to be
given to the particular institutional context of cooper-
atives than has been to date. The 'cloth-cap' cooperatives
are not all pure labour-managed or worker-managed firms:
most employ non-members; some, at least earlier in their
history, paid bonuses on wages to non-member workers as well
as to members, who also received bonuses on capital (Jones,
1894); some also shared profits with their customers (Jones,
1894). The studies reviewed here assume that all producers'
cooperatives are identical in organisation, or at least that
such differences as there are do not affect their economic
behaviour.
The richer detail required to overcome this problem (or
even to test the validity of assuming it to be insignifi-
cant) suggests that economists working in this area should
widen their research techniques to include the case study as
a method of investigation. Such an approach, if it could be
applied to cases where the cooperative had gone out of busi-
ness, would yield direct evidence on the circumstances lead-
ing to the disappearance of cooperatives, which might be a
more fruitful test of the Cornell thesis.
The Directory of Industrial and Service Cooperatives,
published by the Cooperative Development Agency (CDA, 1980),
which identified over 360 cooperatives, also identifies
about 210 of these as being registered as industrial and
provident societies using ICOM model rules. These range in
size from a handful of part-time workers, to Scott-Bader
with 450 employees and sales of £22.75 million. A large
number of these ICOM-type cooperatives had been formed in
the two years preceding the publication of the Directory,

and will by now have ceased business. Indeed, for over 60 of
those listed, the CDA was unable to find any trace other
than the initial information which provided the name. On the
other hand, there is no reason to doubt that others will, by
now, have taken their place. Oakeshott (1978) identified ten
'major' !COM companies. Table 6.1 presents the comparative
output and employment figures for nine of these. (Bewley's
Cafe, being in Dublin, is outside the scope of this study.)
Of those cooperatives listed in CDA (1980) as having !COM-
model rules (other than those in Table 6.1) for which
employment data are given, 42 per cent employed five or
fewer people full-time, 52 per cent six to twenty-five, 4
per cent twenty-six to fifty, and 1 per cent fifty-one to
one-hundred. About 75 per cent of the !COM cooperatives
listed in CDA ( 1980) had been formed in the preceding two
years.
Oakeshott (1978) splits the cooperatives in Table 6.1 into
three categories: the 'high-minded' conversions from capi-
talist firms made at the initiative of the owner; those
which began as cooperatives and an intermediate group. The
'high-minded' group includes Scott-Bader, Michael Jones and
Air Flow Developments, each of which has maintained its
performance. In the second group comprising Sunderlandia,
Trylon, Rowen Onllwyn and Little Women, only the first two
remain in business. By 1980, Sunderlandia had only half the
labour force of 1977, which in turn was about half of the
original labour force. Trylon was formed with the help of
Scott-Bader, and its constitution resembles that of the
larger cooperative. Oakeshott (1978) argues that it bears
the marks of its 'high-minded' parentage, but Thornley
(1981) argues that its small size and act1v1t1es since
founding indicate that it is truly democratic, and in no way
paternalistic. It would, however, seem to have adopted a
non-growth policy. The two companies in Oakeshott' s third
category are KER (which is registered as Northampton
Industrial Commonwealth Ltd) and Landsman's (co-ownership).
The first of these is a plant-hire cooperative which has
shown considerable expansion between 1977 and 1980. It was
formed as a cooperative in mid-1976. Its entry in CDA (1980)
includes waste disposal and building, in addition to plant
hire, as its activities. It operates an amended form of !COM
rules, which may account for the fact that although it has
70 workers, it has only 50 members. Further information
would have to be obtained to examine whether it has devel-
oped through abandoning its !COM format.
To a certain extent Landsman's may be regarded as a 'high-
minded' conversion. Its exclusion by Oakeshott from that
.....
U1
0
1-i
;i
1:>:1
C"l
0
z
Table 6.1 Major !COM companies, 1977 and 1980
!i
H
C"l
Sales (£) Workers ~

Name Product 1977 1980 1975 1980 ~
><:
fJl
Scott-Bader Plastic resins 15,000,000 22,750,000 450 450 H
fJl
Michae 1 Jones Jewellers 458,000 764,480 30 40 (incl. part time)
Air Flow Developments Industrial systems 2,500,000 6,000,000 200 210 ~
KER Plant hire 200,000 I, 000,000 25 70
"tt
Landsman's Industrial caravans 300,000 300,000 36 12
Sunderlandia Building 225,000 n.a. 27 14 g
Trylon Plastic mouldings 290,000 330! 134 15 15 (+ 6 part time) c::
C"l
Rowen Onllwyn Outdoor furniture 90,000 0 17 0 1:>:1
::0
Little Women Re tai 1 store n.a. 0 8 0 fJl
Sources: 1977: Oakeshott (1978); 1980: CDA (1980). 8

0
"tt
1:>:1
H
s
~
fJl
group is probably due to the manner in which the conversion

was effected. Landsman's hires (and, until 1977, manufac-
tured) mobile industrial units. It was founded by David and
Anne Spreckley shortly after the Second World War. It was
given over to its workers during a five-year period, begin-
ning in 1964. However, the transfer of ownership was not by
gift but (as described by Oakeshott, 1982, pp. 102-7) by a
means rather like the proposed Swedish Wage Earners Fund
(see Meidner, 1978). In 1964, the original owners converted
their shareholdings into fixed interest, but voting, debt.
These 'A' shares were to be redeemable but non-transferable.
Thereafter, all profits were to accrue to workers, partly as
incomes (usually about 40 per cent of profits), and partly
in the form of shares. These 'B' shares were given twice the
voting strength of 'A' shares, and within five years were
sufficient to give the workers control of the firm. Over the
period, according to Oakeshott, workers' attitudes to the
company changed, and when an assistant manager left, it was
found unnecessary to replace him because workers monitored
themselves.
Accumulated share capital may be withdrawn on retiral,
otherwise a member who leaves may run down his capital only
over a five-year period (cf. Mondragon, below). Landsman's
however, has no compulsory reserve allocations from profit.
Oakeshott suggests that this is a defect which cost the
cooperative dearly during 1977, when its business decreased.
Consequently, the manufacturing side of the business closed
down, reducing the labour force radically. The sale of the
factory protected the capital of its workers. Oakeshott ar-
gues that Landsman's difficulties were due to the external
market, rather than any organisational defects, although
indivisible reserves might have helped to avoid the cutback.
On the whole, the performance of !COM cooperatives which
were not largely paternalistic in organisation does not seem
very successful. The individual circumstances of the failing
companies, however, makes it difficult to judge whether
their problems would have been avoided by adopting a differ-
ent institutional form. The 'cloth-cap' cooperatives demon-
strate the problems that arise from the freedom to employ
non-members. Their moderate size is probably attestable to
the disincentives to invest outlined in Chapter 4 (although
further details on depreciation provisions etc. are re-
quired). The 'high-minded' !COM companies are difficult to
evaluate because of the role of former owners. Constraints
on the distribution of the surplus would seem to contribute
to their relative success. The other !COM cooperatives come
close to Vanek 1 s worker-managed firm. Their problems, how-
ever, arise not from the sort of forces which he predicts
(as outlined in Chapter 4), but from more general market and
organisational sources.
II FRANCE
Workers' production cooperatives (Les Associations

Ouvrieres) have been operating in France for about 150
years. [4] Although inspired by the writings of political
philosophers such as Buchez, Fourier and Prudhon, they began
largely as organisations of artisans seeking to exercise
'the craft', and to rise above the status of wage labourers.
There has been a strong political philosophy behind them,
and it is, therefore, not surprising that growth in their
numbers was associated with revolutionary periods such as
1848 and the Paris Commune. But rapid growth also took place
after both world wars in the twentieth century. Vienney
(1966) has estimated that between 1884 and 1960, 2250 coop-
eratives were formed. When allowance is made for cooperative
failures, this averages out at a net addition of seven coop-
eratives for each year of the period. In 1978, there were
556 enterprises affiliated to SCOP[5] according to Oakeshott
(1978, p. 123). Most of these (about 300 according to
Oakeshott (1978)) are relatively small, employing less than
fifteen workers. On the other hand, some are very large. The
largest is AOIP, employing more than 4500 in the manufacture
of telephone equipment with sales in 1976 of fr. 603
million. (Oakeshott, 1978). About 5 per cent of SCOP
affiliates are in building and civil engineering, with a
further 15 per cent in printing. However, about 30 per cent
of the value of sales of SCOP affiliates arise in engineer-
ing, which has only 10 per cent of SCOP firms but includes
the two largest. The longevity of French cooperatives is
illustrated by Table 6.2, which shows that one third of SCOP
affiliates in 1978 had been founded prior to 1945. It should
also be noted that 24 per cent were under five years old.
Table 6.2 SCOP affiliates in 1978 by year of formation
Date Number Percentage

pre-1914 61 11
1914-45 123 22
1945-75 240 43
1975-8 132 24
TOTAL 556 100

Source: Oakeshott (1978), Table 8.3, p. 125.
Although many of the longest surviving cooperatives are

very small indeed, some of the larger members of SCOP have
developed from very modest beginnings. The largest, AOIP,
was formed by instrument-makers in 1896. In its first year
of operation, it could provide employment for only one man
but by 1978 it was employing 4650 (Thornley, 1981, p. 140).
The total employment of SCOP affiliates in 1975 was 30,000.
Antoni (1957, p. 388) points out that prior to 1914, most
cooperatives were of the 'workshop type', and were in trades
with a strong central trade union organisation. Since 1914,
the majority of cooperatives have been in the building and
public works fields, and other areas with weak trade union
organisation. Antoni explains the growth of building coop-
eratives in terms of the low initial capital required for
firms in that industry. This view is also supported by
Oakeshott (1978). In addition, Oakeshott points out (p. 124)
that 'these cooperatives have also enjoyed advantages- such
as exemption from tendering below a certain price level and
from obligation to supply bonds - both from central govern-
ment and from local authorities' (see also Thornley, 1981,
PP• 145-8).
Eric Bat stone has argued that French cooperatives,
although formally committed 'to the idea of a solidary
collectivity of workers rather than a democracy of small
capitalists' (Batstone, 1982, p. 102), in practice lie
somewhere between the two. There are 'capitalist' elements
such as individual shareholdings, outside shareholders,
non-member workers. However, the individualistic elements
are mitigated by important collectivist constraints. Shares
may be sold only at their nominal value. Cooperatives are
required to build up collective funds.[6] In the event of
the firm ceasing to exist, its assets must be donated to
another cooperative or a cooperative organisation. Shares
may not be paid back to shareholders if this would reduce
capital below one-quarter of its highest value. Outside
shareholders may be bought out at the discretion of the
working members. Outside shareholders may not constitute
more than one-third of the board of directors. Non-member
workers are entitled to a share in the financial surplus.
The interest on capital paid to shareholders is limited to 6
per cent, and the proportion of the surplus going to such
payments to capital must be less than that paid to labour.
Voting among members is on the basis of one-man, one-vote,
irrespective of shareholdings (Batstone, 1982, p. 103;
Oakeshott, 1978, p. 141; Thornley, 1981, p. 139).
Antoni (1957) points out that from the earliest days of
French cooperatives, three principal characteristics are to
be found: ( 1) the association could not be dissolved; (2)
its capital was indivisible and not assignable; and (3)

membership, although open to all, was dependent on a contri-
bution of capital. These facets of the organisation of
French cooperatives suggest that it would be rather diffi-
cult to model these organisations in the manner of Chapters
2 and 3 above. The high ideological tone of French cooper-
atives suggests that the selection of an individualistic
objective function might be unwise. On the other hand, it is
unlikely that cooperatives would continue to recruit members
(as those of France have done) if the economic needs of
members were not met at least as well in the cooperatives as
outside.
The various constraints imposed by French cooperative law
on the pursuit of individualistic objectives may be inter-
preted as ways of avoiding the problems of degeneracy ident-
ified by early students of cooperatives (e.g. the Webbs).
These writers pointed to many cooperatives which gradually
fell under the control of a diminishing band of members, who
eventually ran the cooperative to all intents as a capital-
ist partnership (see the discussion of US plywood and barrel
cooperatives, elsewhere in this chapter). French legislation
nullifies this by ruling out a profitable liquidation or
takeover and by insisting that non-member workers (called
auxiliaries) share in the profits. Thus it is not appro-
priate to analyse French cooperatives according to the mar-
ketable-share or hired-worker models of Chapter 3. The em-
phasis on the collective nature of ownership might suggest
that Vanek's model of the worker-managed firm might be
appropriate (gainsaying, for the present, the logical draw-
backs of this model pointed out in Chapters 3 and 4). How-
ever, in this case reserves cannot be dispersed, and must be
at least equal to the cooperative's capital. Furthermore,
the capital of a cooperative cannot be reduced below 25 per
cent of its highest attained level. However, the French
cooperatives would seem to be likely cases for investment
disincentive of the Cornell and Texas models of Chapter 4,
except that there is no compulsory depreciation. The minimum
level of capital does represent a restraint on the extent to
which capital can be eroded, but it is in no way as rigorous
as, for example, the (nominal) Yugoslav position. Consider
the options by which a revenue surplus may be used to pur-
chase capital equipment. One way would be to use the devel-
opment fund. This would be the truly collectivist way of
operating, since it would yield to no individual any claim
to income or capital in the future. A worker would be giving
up current income, and the return on this 'collective
investment' would take the form of higher incomes in the
future, so long as he remained a member of the collective. A
literal interpretation of the rules would seem to suggest

that the assets so purchased could be allowed to depreciate
in value, through use, to a leve 1 of 25 per cent of their
purchase price. This obviously reduces the disincentive to
investment, but it would pose problems for successive gener-
ations of workers in providing the capital which they
require. The alternative means of internal finance would be
to issue to members new shares to the value of the new
assets. This would mean that the principal of the investment
had to be returned to the member on his departing from the
cooperative. He would then be compensated for his abstention
from consumption via interest on his shares (up to a maximum
level which might be below the market rate of interest), and
his share of any increased distribution of surplus to
workers in the future. Since this method guarantees the
return of principal, it would seem to be the preferable one
for a risk-averse worker. It would imply a continuous pro-
cess of issuing new shares to finance physical capital. Some
evidence exists that this happens. In 1978, members of AOIP
who were 35 per cent of its work force were giving 5 per
cent of their annual wages as new share capital (Thornley,
1981, p. 140).[7] On the other hand, L'Association des
Ouvrieres en Materiel Electrique (ACOME), who in 1978
employed 760 workers all of whom were members, financed all
of its investment internally from collectively owned funds
(reserves) which had increased at 20 per cent per annum for
the previous decade. In 1976, ACOME's share capital was less
than 7 per cent of its reserves, and it was a net investor
in banking. I t should be noted, however, that all of the
return from ACOME's investment could accrue to members since
there were no auxiliaries sharing in the compulsory 25 per
cent share of profits going to workers. Nevertheless the
members still had the option of financing any capital expan-
sion via redeemable shares, and had seemingly rejected this.
It should also be noted that ACOME's large reserves and
financial investments may be indicative of a perception that
investing in physical assets within the firm has a high
opportunity cost. Indeed, Batstone (1982, p. 107) reports
that the cooperatives which he studied in printing and con-
struction held their assets in a much more liquid form than
did the comparable industrial averages. Batstone attributes
this to risk aversion. However, the same firms had less than
80 per cent of the capital per worker of their industries,
and overall a lower level of 'funds per worker' this
suggests a lower level of financing but a greater degree of
financial investment. Is the risk simply that of a need to
repay the shares of withdrawing members? If so, then does it
not imply a bias against physical investment?
The information provided in the studies examined here is

insufficiently detailed or formalised to permit a judgement
on the objectives of French cooperatives i.e. whether mem-
bers seek to maximise their pecuniary returns or whether the
organisation pursues collective goals of growth in employ-
ment, output, etc. Clearly French legislation constrains the
worst excesses of egoistic behaviour, as exhibited by
Olympia Plywood and North Star Barrel Company in the USA
(see below). Further research is required to establish the
means by which French cooperatives finance capital expansion
(e.g. via the development fund or via new shares), as this
would provide insights into the motivations of members. [8]
The continued growth and success of French cooperatives
seems to run counter to the pessimism of Vanek, Furubotn and
Pejovich, where collective financing is concerned. Their
continued success may, in part, be due to preferential
legislation, the existence of a strong national federation
and a strong ideological commitment. This last clearly
varies between cooperatives, in that membership is not
universal. Batstone (1982) quotes proportions of members
according to the age of cooperatives: the proportion of
cooperatives with more members than auxiliaries being 60 per
cent for post-1968 cooperatives, 19 per cent for the 1945-67
generation, and about 50 per cent for the older generations.
Antoni (1957) says that the overall average proportion of
members was 55 per cent, but in building it was 30 per cent,
while in printing 80 per cent. Further research might ana-
lyse the relative performance of cooperatives with different
degrees of membership, particularly in relation to the
extent of egoistic behaviour on the part of members.
III THE UNITED STATES
Recent studies (Aldrich and Stern, 1981; Jones, 1977, 1979,

1980b, 1982a) have identified over 700 producers 1 cooper-
atives in the United States in the last two hundred years.
The vast majority of these are no longer in existence. It is
also unlikely that as many as 300 were ever in existence at
any one time. These numbers, even if they underestimate by
orders of magnitude the number of cooperatives actually in
existence at any time, indicate that cooperatives have never
been a significant portion of the total number of productive
organisations in that country. On the other hand, the US
experience indicates that cooperatives can exist success-
fully for many years. It also provides a number of cases of
different organisational forms against which to evaluate the
models of earlier chapters.
Although cooperatives have been formed in many industries

and in most states, Derek Jones has classified them into a
number of clusters. These are: five industrial groupings -
foundry, cooperage, shingle weaving, plywood and refuse
collection; two miscellaneous groupings, which Jones calls
early general (founded 1860-90) and late general (1890-
1940); those sponsored by the Knights of Labor (1880s); and
self help cooperatives, which were largely government spon-
sored during the 1930s depression.
Jones (1980b) argues that US producer cooperatives were
formed in two long cycles, (a) 1790-1900s, peaking during
the 1880s; (b) 1900-1940s, peaking in the 1930s. Aldrich and
Stern (1981) argue that there were three waves: (i) 1865-74;
(ii) 1885-94; and (iii) 1915-34. They point out that they
identify more cases in the decade 1865-74 than does Jones.
Aldrich and Stern's analysis also shows that there were
important differences between the waves. Their second wave
(which corresponds with the peak of Jones's first cycle)
drew quite uniformly across industries. This reflects (on
Jones's classification) the impact of the Knights of Labor,
an oganisation of trade unionists which sought, initially at
least, to promote cooperatives as a means of social trans-
formation. The first wave was dominated by two industry
groupings (metal and leather products), and the second
primarily of food and wood products. Thus one wave has
general characteristics, whilst the other two are industry
related. If the self-help cooperatives, formed under govern-
ment auspices as an anti-depression strategy during the
1930s, are excluded as a special and short-lived case, the
first half of this century looks not so much a wave as a
ripple of around 20 cooperatives being formed each decade.
Furthermore, Jones's ( 1980b) breakdown suggests that three
industry clusters account for 64 per cent of the non-self-
help cooperatives founded in the first half of the twentieth
century. These clusters are: shingle-weaving, plywood and
refuse collection. They were also fairly localised geo-
graphically: Washington and Oregon; Washington, Oregon and
California; and California, respectively. The other 36 per
cent of those formed in this period are part of Jones's
heterogeneous cluster - late general. The information on
these is scant, and not much can be deduced from it.
Derek Jones has shown that, taken as a whole, the US his-
torical experience demonstrates that although many cooper-
atives failed, many others operated successfully for a
number of years. Table 6.3 illustrates this in terms of the
life span of seven of his clusters.
The space available here, and my own expertise, do not
permit a detailed assessment of the success or otherwise of
,_.
V1
00
~
tzl
C')
0
Table 6.3 Life-sEans of US 2roducer coo2eratives z
!i
H
Early Knights Late C')
Cluster Foundry Cooperage general of Shingle general
2
Plywood
Labor
CJ)
Range (years) 1->!4 1-53 1-)38 1<10~ 1->27 13-37 1>35
~
H
CJ)
Average (years) <101 12 n.a. < 51 <10 19 21
Median (years) < 5 4 n.a. < 5 <10 18 25 fil
% with lifespan: 'lj
> 10 years 10.0% 31.0% 5.0% 0 ::0

20% 18.0% 90.0% g
> 20 years 8.5% 18.7% 3.8% 0 20% 7.9% 65.6% 0
C')
tzl
Notes ::0
CJ)
1. These figures are regarded by Jones as less reliable.
C')
2. In 1978, 17 plywood cooperatives were still operating. 0
n.a.: no data available. sa
tzl
Source: Jones (1982), Table 3.2.
H
s
til
CJ)
producers' cooperatives in the United States over the last

200 years. It is more relevant here to examine how the evi-
dence from the United States squares with the models devel-
oped in earlier chapters. Attention will be focused on three
of the clusters identified by Jones, which have been docu-
mented in most detail in the secondary literature. These are
shingle-weaving, coopering and plywood. They are, in terms
of Table 6.3, the groups with the highest percentage sur-
viving for more than 10 years. According to Jones (1982a),
these three groups performed best according to various
measures of socio-economic performance, and were the most
'cooperative' of all the groupings. The implication here and
elsewhere in the work of Derek Jones (e.g. Jones, 1980a) is
that performance is a function of the degree of cooperative-
ness maintained.
(a) Cooperage Cooperatives
The origins, development and structures of this group of

cooperatives is documented in Virtue (1905, 1932) and Jones
(1979, 1980b, 1982a). Jones (1982a) identifies 16 such coop-
eratives as being founded in the city of Minneapolis between
1860 and 1910. Virtue (1905), citing Shaw (1888), says that
the first such cooperative was formed in 1868, but ceased
operating after four months due to a temporary stoppage of
the main customers for the finished barrels - the flour
mills of Minneapolis. A second cooperative was formed in
1870, and lasted for two years. It failed when its treasurer
diverted its customers to a private operation under his own
ownership. Virtue (1905) suggests that the real growth in
cooperative cooperages began with the boom in flour-milling
in Minneapolis during the 1870s. The boom increased the
demand for barrels, and attracted a large number of coopers
to the city. However, employment was not readily available
for all in the convent iona 1 firms. In 1874, sixteen unem-
ployed journeymen formed the Cooperative Barrel Manufactur-
ing Company. This firm continued to operate until 1918, when
it was taken over by another cooperative, North Star. At the
time of the takeover, Cooperative Barrel had twenty-six
members. However, in the intervening period, the number and
employment in cooperative cooperages had expanded greatly.
By 1886, two-thirds of the men employed in cooperages in
Minneapolis were in cooperatives. Derek Jones (l980b) says
that the cooperatives were formed because of the deep dis-
satisfaction felt by journeymen coopers with the existing
system at a time when their industry was expanding.
Before discussing further the performance of these coop-
eratives, it may be useful to discuss such organisational
features as may be deduced from the secondary sources. Jones

(1982a) states that membership was restricted to skilled
craftsmen currently working in the cooperative. Thus there
were no outside members. However, unskilled workers were not
eligible for membership. Voting was on the basis of one-man,
one-vote. Members usually held an equal shareholding (Jones,
1980b).
The manager and principal officers were elected by all
members. Initially, according to Virtue (1905), all gains
and losses made by the firms were apportioned pro rata to
wages. In the 1890s, North Star was the first to move away
from this. It, in Virtue's words, became a joint-stock com-
pany in all but name, with 40 equal members. Jones (1980b,
1982a) says that surpluses resulting from ordinary business
were distributed according to hours worked, but extraordi-
nary gains due to increases in the value of stocks and land
etc. were distributed according to shareholdings. However,
Virtue (1932) says that Hennipin continued to pay dividends
on the basis of wages until 1920.
It is not clear whether there was a market for shares in
these cooperatives. Jones (1980b) does indicate that there
was prov1s1on for new members to 'buy out' retirees. Virtue
(1905) writes of share values of between $1000 and $2500.
However, this may have been a price based on valuations of
firm's assets, rather than a price at which shares were
changing hands in an open market. Jones (1980b) points out
that new members seldom had to fully subscribe the amount of
stock. This could be made by deductions from wages, with
interest being paid on the amount outstanding.
In terms of the models discussed in Chapter 3 the
Minneapolis cooperages clearly fall into the case of non-
member employees, and the implication from the secondary
sources is that membership was to a certain extent trade-
able; if not on a market, at least departing workers re-
ceived compensation for their foregone dividends via an
estimate of their share of the value of the enterprise.
Thus, assuming a favourable product market, theory would
predict that there would be no truncation or capital-main-
tenance problems, but there would be a tendency to substi-
tute non-member employees for members, when the opportunity
arose.
Although the product market was not favourable, the three
long-surviving cooperatives seem to bear out these predic-
tions. Although the production of flour in Minneapolis
continued to expand, the demand for barrels did not rise
apace. According to Virtue ( 1905) the price differential
between barrels and sacks widened largely because of the
increasing cost of raw materials due to a rapid depletion of
sources. The number of cooperage shops in Minneapolis fell
from eleven (seven of which were cooperatives) in 1886 to
five (three of which were cooperatives) in 1905. The value
of the assets of the surviving cooperatives clearly rose,
since in 1886 the aggregate assets of the three cooperatives
who survived until 1905 was $118,000, whilst in 1905 it was
$160,000. In the same period, however, membership of the
cooperatives was falling. In 1886, the seven cooperatives
had 324 members (of whom 201 were in the three who survived
in 1905), whilst in 1905 there was 146.
In the last decade of the nineteenth century, sales of
barrels in Minneapolis fluctuated around 3,250,000, falling
to 2,718,125 in 1895, and being over 3,300,000 at the turn
of the century. These steady sales, however, represented a
declining share of the flour-container market. In 1890 44.7
per cent of flour was packed in barrels, whilst in 1904 the
figure was only 20.7 per cent. By 1910, the figure had
fallen in absolute terms to 1,440,000 or 9.3 per cent of the
market, and in 1917 to 771,500, or 4.3 per cent. Clearly the
barrel faced increasingly effective competition from other
containers. This was in large measure due to the increased
cost of raw materials for barrel-making. Virtue (1932)
states that by 1931, the difference in cost between the
alternatives was 70c per barrel (barrels were selling at SOc
in 1919).
Four cooperative cooperages in Minneapolis which operated
in 1886 had ceased operating by 1905. Two had been destroyed
by fire; although one tried to re-establish itself, it was
opposed vigorously by its competitor cooperatives; the other
was dissolved. In both cases, about half the members went to
other cooperatives. The other two were described as being
subject to poor management and factionalism, in one case,
and finding competition too severe in the other. One of
these con sol ida ted with the Hennepin Cooperative in 1896.
One other cooperative was formed in 1895, but it seems to
have been totally dependent on a former employer, who ex-
tinguished it in 1902. The only two other cooperatives
founded around the turn of the century were vigorously op-
posed by the three long standing cooperatives as contribu-
ting to the depression in the price of barrels. Both were
forced out of business, with the members of one being taken
on as employees of the other cooperative.
Table 6.4 presents estimates of the output (in physical
terms) of the thre2 long-surviving cooperatives.
Clearly, in the period from 1888 to 1905, the cooperatives
which survived increased output dramatically, but this may
have been in part due to the demise and subsequent takeover
of business from other cooperatives.
Table 6.4 Ouq~ut of three long-surviving

barrel coo2eratives
North Cooperative
Year Star Barrel Henne2in
1888 160,000 1 n.a. 400,000 1

1901 716,756 638,232 n.a.
1902 690' 715 750,347 n.a.
1903 651,567 577,993 n.a.
1904 662,898 623,093 890,115 2
1905 618,3191 618 '956 n.a. 1
1919 300,000 212,000
1927 23,000 n.a.
Notes
1. Converted from sales figures given in Jones (1979).
2. Estimated by author from Virtue's (1905) statement that
the three cooperatives produced three-quarters of
Minneapolis output in 1904.
n.a.: no data available.
Sources: Virtue (1905, 1932), Jones (1979).
On the other hand, membership (as distinct from employ-

ment) in the three cooperatives fell during this period,
from 201 to 146. The membership of the seven extant coop-
eratives in 1886 had been 324. Known membership figures for
the three major cooperatives are given in Table 6.5. Figures
for total employment are somewhat sketchy, and are reported
in Table 6.6.
Virtue adds (presumably for 1905) that about one-third of
wages in Cooperative Barrel went to non-members, and that
North Star regularly employed 30 non-members and in a good
season employed a further 25-30 journeymen. Although the
data in Tables 6.4 to 6.6 is incomplete, it is suggestive of
output among the cooperatives rising until the turn of the
century and then holding steady, with membership r~s~ng
initially then falling (or holding steady apart from two
instances, in the case of Hennepin), with members being
replaced by employees in the last 20 years of the period.
Virtue (1905) concludes that the increase in output and
decrease in membership implies that the cooperatives had
become less democratic, i.e. increased the proportion of
hired labour. However, output could have risen due to the
introduction of machinery. Hennepin introduced machinery in
1882, and North Star and Cooperative Barre 1 in 1885, the
last two suffering a rapid and significant reduction in
Table 6.5 Membership of long-lived barrel-making

cooperatives
North Cooperative
Year Star Barrel Hennepin
1874 16
1877 >10 n.a.
1880 n.a. n.a. 24
1884 80 120 n.a.
1886 65 90 46
1888 n.a. n.a. 62
1889 n.a. n.a. 80*
1896 n.a. n.a. 60
1897 n.a. n.a. 96*
1898 n.a. n.a. 66
1905 89 57
1918 34 26 n.a.
1919 60* n.a.
1928 n.a. 32
1929 26
Notes
* increase because of members transferred due to a
consolidation
n.a.: no data available.
Sources: Virtue ( 1905, 1932), Jones (1979).
Table 6.6 Total employment in long-lived barrel-making

cooperatives
North Cooperative
Year Star Barrel Hennepin
1874 16
1885 120
1888 90 92
1905 115
Sources: Virtue (1905), Jones (1979).

membership immediately following this. The introduction of

machinery could have resulted in the substitution of non-
members for members as only skilled coopers could be mem-
bers. Hennepin's membership did increase in the years fol-
lowing the introduction of machinery.
Virtue (1905, p. 538) states: 'Whenever it has become
necessary to increase membership, in the process of getting
rid of a competitor, the problem has soon presented itself
of getting rid of the increase.' This would seem to refer
particularly to the experience of Hennepin after 1888 and
1896. Virtue later adds, somewhat confusingly given the
figures in Table 6.5: 'The membership of the companies is
remarkably permanent, changes being but rarely made' (p.
542). Possibly, he may have meant that there was little
turnover of members.
After 1905, barrel-making for the flour industry in
Minneapolis went into steep decline. By 1910, output had
fallen to 1,440,000 barrels, taking only 9.3 per cent of
flour output, and by 1917 it was down to 771,500 barrels and
4. 3 per cent of output. Further development of machinery
reduced to almost zero the demand for skilled men. Output of
North Star fell to 300,000 barrels in 1919, one year after
it had taken over Cooperative Barrel and taken its 26 mem-
bers into membership, later selling off that company's
premises at a profit. Subsequently, North Star's membership
diminished to 26, with the company buying up the shares of
retiring and withdrawing members 'not always at full value'
(Virtue, 1932). In 1929, North Star sold its plant for
$45,000 and, after working down its stock, had $106,000 to
divide amongst its 26 remaining members, yielding them $4080
each.
Hennepin Cooperative Barrel Company had produced 212,000
barrels in 1920, but after that year failed to make any
profits. It was unable to take up the shares of retiring
members in 1924, and therefore gave up its cooperative
charter. When it ceased operating in 1928, it had 32 mem-
bers, only one of whom was under 65 years of age.
The general picture of the cooperage cooperatives seems to
be consistent with the theoretical models expounded in Chap-
ter 3. Within the limits of their industry, they were as
viable as their competitors, but members were gradually
replaced by non-members. However, they did not appear to be
adaptable institutions, in that they did not cope well with
the changing nature of their industry and the decline of
their product. They existed to make barrels, and did not
look for an alternative product when the market collapsed.
Virtue (1.932) in fact argues that these firms survived as
they did only because privately owned firms did not see the
market to be one worth competing for.
(b) Shingle-Weaving Cooperatives
The shingle-weaving cooperatives of Washington and Oregon

states were formed between 1910 and 1920. These were rela-
tively small concerns, utilising craft skills manufacturing
lattice-like sections for roofing and house facias. Janes
(1924) traces their origins to a depression in the industry
during which the owners offered to sell or lease plants to
their workers. Jones (1982a) takes the total number to have
been 20, whilst Cooperation (1924) states: 'eighteen shingle
mills and three lumber mills maintain a central organisation
called the Mutual Timber Mills Inc., and there are several
independent cooperative mills outside this Central'.
The conversion of the original shingle mills to the coop-
erative form was done in concert with the trade union, which
laid down certain conditions. The product, according to
Janes (1924), was marketed through 'union channels'. The
initial capital requirements were not heavy, as it was a
relatively labour-intensive industry, and in many cases the
mills were leased. Also according to Janes (1924), turnover
was quick. Little detail of their economic performance has
been recorded, except that earnings were typically above
union rates. The Cooperation (1924) article identifies them
as probably, at that time, the most successful cooperatives
in the country. Jones (1982a) identifies four of the group
as having operated for over 20 years, with the largest life
span being 27 years. The last reference to a cooperative
shingle mill is given as the April 1947 issue of Monthly
Labor Review. Membership was clearly an attractive prop-
osition in some cases as shares were selling well above par
value. Cooperation (1924) quotes two cases of shares selling
for 300 and 2500 per cent of their par value.
Janes (1924), Cooperation (1924) and Jones (1982a) agree
that only workers within these mills were eligible to own
shares. Initially, it would seem that almost all workers
within the plants were members. Although the employment of
non members became a connnon practice, members remained in
the majority for many years. According to Jones (1982a, p.
66), it was only after 1929 (when, by implication, the
cooperatives concerned were at least nineteen years old)
that non-members were in the majority. In its 14th, year the
original cooperative mill (Mutual) had 78 per cent of its
workers in membership, and its $600 shares valued at $1800,
while the Olympia Shingle Co. had 62 per cent membership in
its 9th year, with its $150 shares having sold for as much
as $3800 (Cooperation, 1924, p. 73). As with the plywood
cooperatives, in the shingle mills the firm had the right to

purchase the shares of a retiring member at the market
value. The shingle mills operated one-man, one-vote, amongst
members and equal numbers of shares. Profits were distrib-
uted according to shareholding, which was equal, as between
members,
Janes (1924) states that the concentration of ownership
was due to retiring members' shares being purchased by
existing members, rather than non-members being hired as
part of an expansion. He also suggests that these cooper-
atives had difficulty in raising finance through banks.
This cluster of cooperatives is a mixture of two models
identified in Chapter 3: having marketable shares and em-
ploying non-members, They follow the pattern suggested in
that chapter, in that the relative balance of members to
non-members fell as the firms declined in size, and that
non-members are substituted for members as the latter
retire. It is not possible to evaluate the investment per-
formance on the evidence available, but there would seem to
be no suggestion of degeneration on the basis of Vanek's
model. But, of course, given the theory outlined in Chapter
3, Vanek's model is not appropriate, since marketable shares
exist. Most authorities, Janes ( 1924), Cooperation ( 1924)
and Jones (1982a), regard the performance of the shingle
mills as being good. However, little evidence is provided on
the reasons behind their gradual demise.
(c) Plywood Cooperatives
The best documented, and 1.n many respects most successful

group of US cooperatives, are the plywood cooperatives.
Berman (1982) identifies at least 27 such enterprises having
operated for periods of 8 to 37 years.[9) In 1979, she esti-
mates that 15 were still operating. The first cooperative,
Olympia Veneer, was formed in 1921, and sold out to a pri-
vate firm in 1954. It began with 125 worker-shareholders
subscribing $1000 per share. In 1954, when the cooperative's
interests were sold to United States Plywood Corporation,
the purchase price was $15 million. The story of Olympia
Veneer provides a useful case study of an economically suc-
cessful producers' cooperative which, over time, was trans-
formed, via reductions in worker-members, into a conven-
tional enterprise. It will be reviewed in detail below,
Olympia Veneer was one of the first eight plywood firms to
be formed in the US. By the time the US entered the Second
World War, there were a total of four cooperatives in the
industry, operating six plants. The number grew in the
1950s, when they accounted for 20-5 per cent of output. The
24 operating in 1964 represented 15 per cent of the plants

in the industry, and, on Berman's (1967, p. 94) estimate
about 15 per cent of output. The number decreased to 15 in
1979, with an estimated 10 per cent of industry output, but
a major share of the market for finished 'sanded' plywood
(Berman, 1982, p. 75). Although some of the cooperatives
that have disappeared since 1964 sold out to capitalist
firms, most ran into financial difficulty arising from raw
materials shortage due to their lack of owned timberlands.
Berman (1982, p. 75) notes that higher equipment require-
ments and costs have narrowed the labour cost margins on
which the cooperatives had depended.
The organisation and financial operations of the cooper-
atives in this industry have been broadly similar, being
based on those of Olympia Veneer. The discussion which fol-
lows is based on Berman (1967, 1982) and Gunn (1980). Mem-
bership of the cooperative is obtained via purchase of a
share which entitles the member to employment in the coop-
erative. Shares are transferable, but in most cases the
rules provide that the share must first be offered to the
cooperative, which, if it does not exercise its option, must
approve the purchaser. Shares are not sold on an organised
market, buyers being located by word of mouth or through the
'business opportunities' columns of local newspapers. Gunn
(1980, p. 403) cites shares in the summer of 1979 selling at
$100,000. These were purchased on the basis of $20-25,000
down and $500-600 per month, with interest on the balance
being paid somewhat below the prime rate. Researchers seem
to disagree over the extent to which the cooperatives have
issued new shares (i.e. expanded membership). Gunn, refer-
ring to Bernstein (1976), states: 'The cooperatives do not
generally create new shares, primarily out of fear of
diminishing each owner-member's annual income. They have in
some cases retired shares by exercising their option when a
share comes up for sale. Through that process, some coop-
eratives have gradually shifted their mix of workers to
fewer owner-members employing more non-members' (Gunn, 1980,
p. 403). This was certainly so in the well-documented case
of Olympia Veneer. When Olympia Veneer required to expand
its capital base from the original $62,500, it did so by
first requiring the 125 shareholders to double their sub-
scription of $500, and then later issuing two new $1000
shares to the existing shareholders in compensation for two
years of undistributed dividends. In many cases, the issued
shares of cooperatives have been reduced by buying those of
retiring or withdrawing members, and substituting non-member
employees. Olympia Veneer had initially 125 shareholders;
after four years, this had fallen to 92; while in 1922, it
employed 100 unskilled non-members. As a result of plant

purchases and sales, Olympia was transformed into Associated
Plywood which, when it sold out to US Plywood Corporation in
1954 for $15 million, had only 69 shares outstanding. Since
1925, each shareholder had 3 shares, which suggests to
Berman (196 7, p. 91) that there were only 23 shareholders
sharing the $15 million at $652,000 each. Not all of these
were original shareholders who had contributed $3000 (and
what amounted to a year's free labour in 1921), since Berman
(1967, p. 91) estimates that only four or five of the orig-
inal shareholders were still working in the plants in 1953.
(She also quotes an estimate that, in 1952, there were less
than 50 worker-shareholders and 1000 non-member employees.)
Thus the capital gain for most of the shareholders was less
dramatic than the almost 2000-fold suggested by the compari-
son of the par value and sale prices. The purchase price of
Olympia Veneer shares had quickly risen above par. Berman
(1967, p. 89) quotes a $1000 share selling in 1923 for
$2550. Furthermore, the purchase of shares by the company
must have reduced dividends, in the year of purchase at
least, so that implicitly a further investment had been
made. Finally, the general price level had risen by about 60
per cent between 1921 and 1954. A substantial capital gain
was made, provided that the purchase of shares had not re-
quired substantial reductions in dividend or injections of
new funds by remaining shareholders to finance the pur-
chases.
However, Berman (1967, p. 149) argues that Olympia
Veneer's example had not been followed by the majority of
the cooperatives operating in 1964. In a few of these the
number of shareholders had dropped by between 7 and 16 per
cent since inception. One of the companies had retired a few
shares in order to increase productivity. On the other hand,
she argues that many more had increased the number of share-
holders, by issuing more shares in connection with expansion
(Berman, 1967, p. 150). However, more than a decade later,
the same author writes: 'In practice, however, institutional
difficulties and the availability of the non-member employee
option have limited plywood cooperatives expansion through
the addition of members' (Berman, 1982, p. 78). She further
argues that the absence of an organised market has limited
the increasing of membership during major expansions. In
such circumstances, capital outlays would be high, and there
would be delays due to registration procedures, probationary
periods, etc. However, the increase in hired labour has not
been of the same degree as with Olympia Veneer (Berman,
1982, p. 84). Expansion of cooperatives' act~v~t~es have
largely been financed by internal funds or loans.
This reluctance or inability to use new shares as a means

of expanding the cooperative is perhaps indicative of a gen-
eral problem: making a market in cooperative shares. Berman
(1982) discusses this in the context of share transfers. She
states that cooperative members have not always obtained a
'fair return for deferred earnings'. The problem of making a
market is likely to be most acute when large numbers of
shares are involved, as in an expansion. In this case, also,
the valuation of shares is all the more difficult because
the expansion renders previous share values irrelevant. It
would be possible, in principle, to finance the expansion
internally or by loans, and then gradually admit new mem-
bers, perhaps with shares being purchased in instalments.
The problem with this is that it requires existing members
to make a sacrifice or undertake the risk and then sell off
the fruits of the investment to someone else. They might
justifiably feel that the fruits of the investment are
rightly theirs. A perfect capital market would, of course,
give them this, but if there were a perfect capital market,
there would be no share transfer problem anyway. Capital
market imperfections would seem to reinforce a tendency on
the part of worker-managers to concentrate on distributed
earnings rather than capital gains (Berman, 1982, p. 86).
All commentators seem to agree that, by-and-large, the
plywood cooperatives have been successful in generating
above (industry) average incomes for their members. Berman
(1982) states that tax cases have conceded higher pro-
ductivity per man-hour, and higher quality of work. Waste is
also less. Hourly incomes have been found to be higher than
in non-cooperative plants. In some cases, the excess has
been consistently 50 per cent. Incomes have been even higher
relative to the industry, because cooperative plants have
consistently operated for more of the year and with greater
overtime than the others. These higher earnings, however,
must be judged against the requirement for worker-members to
purchase a membership share for entry into the firm. The
$100,000 share price quoted by Gunn (1980) would require
very high wages to justify its purchase. Where higher wages
are due to higher productivity and effort on the part of
workers, can they be said to be a return on the investment?
They are a reward for higher effort, which was the point
which the court cases cited by Berman sought to establish;
i.e. the higher than average incomes of the members of the
cooperatives were not dividends (and subject to a high rate
of tax) but wage payments made possible by higher effort and
productivity (taxable at the earned income rate). Why, then,
pay to join the cooperative? A number of reasons suggest
themselves. Firstly, the funds are necessary simply as a
means of transferring title to the assets of the cooper-

atives, thus keeping intact its means of production. How-
ever, annual interest in the form of a dividend would be
necessary to cover the opportunity cost of these funds, but
plywood cooperatives do not pay dividends other than via
wages. Secondly, the higher wages, although in the main
resulting from higher productivity, do actually represent a
return on the investment because without the investment the
higher productivity would not have materialised. In this
interpretation, the share price amounts almost to a perform-
ance bond. The payment of this bond by the worker-member is
a guarantee to his fellow worker-members that he will not
shirk or free-ride. Since this applies to all worker-
members, productivity and effort is higher for all. If there
were no such 'bonds', free-riding would be costless to the
individual, and would thus be encouraged. Thirdly, ownership
of the share provides greater continuity of employment than
is available elsewhere and thus greater annual incomes,
regardless of effort. Fourthly, in some cases at least, part
of the return on shares is via speculative gains on timber
stocks (both standing and cut). Fifthly, as Berman (1967, p.
150) suggests, the ownership of a share is seen as a form of
unemployment insurance. Shareholders receive preference in
employment over non-shareholders. Therefore, even if in
times of a high demand for labour, wages in the cooperatives
are not high relative to alternatives, in times of low
demand for labour they might be. Berman (1967, 1982) points
out that, often, shareholders will leave the plant to work
for higher wages elsewhere, but will retain the share to
guarantee re-employment more-or-less at will when the out-
side opportunities diminish.
The plywood cooperatives mix two of the organisational
forms modelled in Chapter 3. They combine marketable shares
with the hiring of non-member employees. Berman (1982, p.
81) states the non-member numbers vary amongst the cooper-
atives from below 10 per cent to more than 50 per cent of
total employment. In her 1967 study, Berman found one plant
with only two non-members: these were the superintendent and
an electrician. Dahl (1957) reported that six cooperatives
employed only shareholders, but the average proportion of
non-shareholder employees was 23 per cent. There is a wide-
spread practice amongst the cooperatives of hiring managers
and superintendents, and those with specific craft skills
(e.g. electricians). These are likely to be occupations
which would command salaries above those of general plywood
workers (cf. Domar's model, p. 26 above). Plywood cooper-
atives also use hired employees to deal with seasonal peaks
in production. This allows the cooperatives to adjust output
in response to demand. If this were not the case, supply

would be inelastic, as in the W-V-M model. Hired labour is
also used to replace owners who find it more profitable to
work elsewhere, but who wish to retain their share as a form
of security of future employment. Again, an insistence on
members only would introduce an element of inflexibility.
Berman (1967, p. 149) points out that her survey revealed
that those cooperatives with the highest proportions of non-
owner employees were 'either cooperatives that had greatly
expanded their capacity without a corresponding increase in
the number of stockholders, or companies that have been
paying relatively low wages so that many shareholders prefer
to work elsewhere, necessitating employment of outside
help'.
A feature of the plywood cooperatives emphasised by Berman
(1982) is their general insistence on equal incomes (via
equalisation of work) for members. This removes a major
source of contention in a cooperative, and avoids the inef-
ficient distribution of work that might arise from members
acting in a self-interested manner (see Berman, 1977, and
Chapter 3 above). The plywood cooperatives do seem to use
variations in hours worked (as opposed to membership) to
cope with demand fluctuations (Berman, 1982, p. 78), not-
withstanding the use of non-members.
The theoretical discussion of cooperative financing in
Chapter 4 would suggest that the plywood cooperatives would
be less troubled than most by problems of financing. The
members have full property-rights, and thus are no more
susceptible to the problems of 'truncation' and 'capital-
maintenance' than are shareholders in a conventional
company. However, Berman (1982, p. 86) says: 'Workers who
become cooperative members tend naturally to think like
workers rather than owners, concentrating on take-home pay.
Even when they have learned to think of the welfare of the
enterprise as a whole, many have failed to appreciate the
importance of investment to the company's success. This may
be the crucial difference between successful and unsuccess-
ful cooperation'. Gunn ( 1980) also sees investment, or at
least financial matters, as being problematic for some
plywood cooperatives. The cooperatives would, however, seem
to have been as successful in dealing with these problems as
have most businesses of a similar size. Some have grown,
others have not. Olympia Veneer grew spectacularly, and
inevitably lost its cooperative character. The evidence from
secondary sources on recent financial performance is not
very systematic. The tenor of Berman's (1982) remarks gives
the impression of a reluctance on the part of members to
forego current earnings in order to finance capital expan-
sion. This was certainly not the case in the early years of
Olympia Veneer. In 1921 and 1922, the members worked for
almost no wage. At the end of 1922, a bonus was voted which
gave the members an hourly rate about equivalent to that
averaged outside the company. Again, in 1923, although
bonuses were earned and credited to individuals, only part
was paid in cash. However, this and the undistributed bonus
for 1924 were taken as payment for two additional shares of
$1000. This procedure, together with similar examples from
other cooperatives, given below, gives perhaps an insight
into the psychology of worker-owners. Why was it necessary
to issue additional shares? The claims of each member on the
firm were not altered in any way by this. They would have
been in exactly the same position financially if no new
shares had been issued to them. This perhaps indicates a
desire to receive something tangible (additional share
certificates) for their foregone incomes, rather than an
intangible increase in the value of the shares. They were
perhaps mistrustful of the differences between market values
and par values.
Berman (1967, 1982) and Gunn (1980) talk of financing as
being the major problem of cooperatives. Berman (1982), in
particular, frequently uses the term 'capital shortage'.
However, the cooperatives do not seem to have been reluctant
to borrow either from members or outsiders. Berman (1967, p.
134) states that most of the plywood cooperatives have at
some time received long-term loans from outside sources.
Whilst in a number of cases these have been from the Small
Business Administration (SBA) (and thus predicated on an
inability to secure financing elsewhere), many have received
loans via mortgages on plant and equipment, or on inven-
tories. Indeed, mortgage-financed bank loans were as often
mentioned as the SBA in Berman's survey. Smaller loans have
often been received from suppliers, customers, sales agents
and others. Although Berman states (1967, p. 137) that lack
of capital, especially working capital, has been a major
problem, she also states (p. 136) that they have generally
been able to obtain short-term financing without difficulty.
Their need for working capital has been reduced by a re-
liance on sales-agency agreements under which the agent pays
on delivery and bears the customer credit-risk.
Most capital for these cooperatives has, nevertheless,
come from the members themselves. As mentioned earlier, a
number of them have raised capital after the initial sub-
scriptions by a subsequent (and presumably compulsory) issue
of new common stock to existing members. Berman (1967, p.
131), however, says that this has been an 'infrequent' prac-
tice. More common, it would seem, has been the issue of pre-
ferred stock. This, of course, is non-voting stock, except

if the firm fails to pay the dividend on it over some speci-
fied period. Loans from members have also been in the form
of debentures and promisory notes. Some of the cooperatives
have, in the past, made use of 'loan funds' which are based
on sums withheld from wages but credited to members. Berman
(1967) states that these may be sold or retained by members
when they sell their shares.
Berman (1967, pp. 133-4) demonstrates that one successful
cooperative had used a great variety of forms of raising
funds. It was founded by issuing shares at $5000 each, and
within a year it was selling promisory notes to its share-
holders (although, because of a technical problem, these
were repaid). Later, as part of a major financial plan to
maintain the firm in existence, it issued 50 Class B common-
stock shares, with voting rights delayed one year, at $5000,
reduced wages to just lOc; above the union rate, raised a
mortgate of $750,000, and obtained standby agreements with
creditors to postpone maturity of debts of $350,000. Later
still, in more prosperous times, this firm issued 1410, $500
6 per cent cumulative preference shares to existing share-
holders. This was financed by deductions from salary when
the hourly wage exceeded $2.55. This was to be used to
finance the purchase of standing timber. This debt had been
repaid within four years. The search for alternative avenues
of finance was a factor which ensured the successful oper-
ation of this cooperative, which in 1964 had doubled its
capacity and quadrupled its net work since inception. It
made over $6 million profit in 1963. However, its financial
policy was probably atypical, given that Berman (1967)
singles it out for particular discussion. It should be
noted, also, that this cooperative, when raising additional
funds from members (even via cuts in wages), did so by
issuing new paper. Members were not persuaded to reduce
wages by the prospect of enhancement of future salaries or
capital gains on existing shares. This may have been due to
risk-aversion, a lack of appreciation that capital values
would rise, or the fact that the market in cooperative
shares imperfectly reflects their intrinsic value.
Whilst the experience of the financial strategies of these
plywood cooperatives contrasts somewhat with the optimistic
theoretical appraisal of marketable shares in Chapters 3 and
4, it does show that they do not behave in the collective
financing mode of Vanek's 'worker-managed firm'. It is dif-
ficult to evaluate the true role of share price within the
plywood group. Vast capital gains have been made in some
cases, but these have been largely from selling out to con-
ventional firms. Possibly, this suggests inadequate valua-
tions of the fi nos in the share market, or merely that in

the very successful cooperatives, share values are too high
for potential workers to raise the money. Either way, this
does suggest imperfection in this capital market. This is
also supported by the evidence that reductions in wages to
raise finance has typically been accompanied by the issue of
preference shares or other loan paper which would not be
necessary in a perfect capital market.
The history of these plywood cooperatives is one of rela-
tive economic success. It certainly could not be used
against the cooperative form. The overall impression is that
the granting of full ownership rights to members has con-
tributed to their success. However, the imperfect nature of
the market for shares has reduced the ability of share
values to capture the gains from investment. The case of
Olympia Veneer dramatically demonstrates how the employment
of non-members and the buying back of shares by the company
can convert a successful cooperative into a capitalist part-
nership. On the other hand, the employment of non-members
would seem in general to have increased the flexibility of
operation of these cooperatives.
IV MONDRAGON
The Mondragon group of enterprises in the Basque country of

Spain provides the most spectacularly successful evidence of
the viability of cooperative production. The group's origins
lie in technical education classes started in 1943, and a
small firm with 24 employees producing cookers and stoves
which began production in 1956. By 1980, it had developed
into a system of some 70 producers' cooperatives, with over
15,000 members linked by a cooperative credit bank with 93
branches and 300,000 deposit accounts (Thomas and Logan,
1982, p. 1). The example of Mondragon is held up by advo-
cates of cooperative industry as clear evidence of what can
be achieved (e.g. Oakeshott, 1978; Owen, 1981), and by those
seeking alternatives to capitalist depression and unemploy-
ment as a prototype with a proven record of success (Wales
TUC, 1981). A number of accounts of the Mondragon group have
been published in English in the last few years (Oakeshott,
1973, 1978, 1982; Anglo-German Foundation, 1977; Gutierrez-
Johnson, 1978; Gutierrez-Johnson and Whyte, 1977; Eaton,
1979; Wales TUC, 1981). The most recent and detailed econ-
omic study is that by Henk Thomas and Chris Logan (Thomas
and Logan, 1982). This is a study for which all students of
cooperatives will be grateful. It is detailed, thoughtful
and analytical.
The town of Mondragon is situated in the Basque province

of Guipuzcoa in northern Spain. In February 1941, a 26-year
old Basque Catholic priest, Don Jose Maria Arizmendi-
Arrieta, arrived in Mondragon which, like much of the Basque
country, had suffered greatly during the Spanish Civil War
and the subsequent Francoist dictatorship. Mondragon was to
be Don Jose Maria's first and only parish. He died there in
1976. He was to provide the vision and inspiration for the
Mondragon group through his teaching of Catholic social doc-
trine and his provision of technical education classes. It
is not relevant to this book to assess the role of Don Jose
Maria in the development of the Mondragon group, nor to
detail its early history and development. These have been
dealt with elsewhere (e.g. Oakeshott, 1978, ch. 10, 1982,
ch. 6; Thomas and Logan, 1982, ch. II).
Thomas and Logan (1982, p. 47) provide an estimate of the
development of the group for 1979: 70 industrial cooperat-
ives, providing employment for 15,672 people. In addition,
there were a small number of agricultural, consumer and
service cooperatives which, according to Thomas and Logan
(1982, p. 171), raised employment in the Associated Cooper-
atives (other than those in education, social security and
social services) to 17,170. Associated Cooperatives are
linked by a contract of association with the group's cooper-
ative savings bank, the Caja Laboral Popular (CLP), which in
1979 employed 892 people. The original industrial cooper-
ative began production in 1956, with 24 workers. In 1979,
the cooperatives provided 12.5 per cent of the industrial
employment in the provence of Guipuzcoa (Thomas and Logan,
1982, p. 47). Mondragon is thus not a single cooperative but
a complex system of cooperative organisations. Oakeshott
(1982) identifies two classes of cooperatives in the system:
base cooperatives, controlled by those who work in them; and
'second degree' cooperatives controlled by those who work in
them and by elected representatives of the base cooperat-
ives. 'Second degree' cooperatives provide services for the
production cooperatives and their members. They include the
CLP, the social insurance organisation (Lagun-Aro), a re-
search and development unit (Ikerlan), a technical college
(Escuela Profesional Politecnica), and others. EPP itself
has a productive enterprise (Alecoop) run by its students as
part of their training.
The central role in the group is played by the CLP. It is
through their contract of association with the CLP that the
cooperatives are linked. It is these contracts of associ-
ation which define the structure, organisation and financial
arrangements of each cooperative. The CLP mobilises the
savings of its 300,000 account-holders to provide much of
the group's financing. Its Management Services Division

provides to cooperatives advice and professional services of
the following types: promotion of new cooperatives, engin-
eering, physical planning, building, overall development of
the group, personnel questions, accounting, housing, etc.
(Anglo-German Foundation, 1977, pp. 41, 42). Critics of the
Mondragon system see the role of the CLP, and its Management
Services Division in particular, as one of controlling the
cooperatives and constra1n1ng their ability to be truly
democratic organisations (see particularly Eaton, 1979).
The CLP was formally constituted in 1959, in response to
the perceived need of ULGOR (the original industrial cooper-
ative in the group) for a means of providing a legal guaran-
tee for the financial support which it had received from the
community. It also required an organisation to deal with the
social security of its members. Under Spanish law, members
of cooperatives are excluded from the state social security
system. Don Jose Maria also discovered that workers' savings
organisations were permitted under Spanish law to pay in-
terest at half a percentage point above the 'normal rate'
(Anglo-German Foundation, 1977, p. 37).
The performance of the CLP in mobilising resources and
planning the financial development of the group is examined
in detail in Chapter IV of Thomas and Logan (1982). Table
6.7 presents some of the main indicators of the CLP's
expansion. These figures demonstrate a phenomenal growth
over the twenty-year period. The last two rows in the table
show the extent of resources which the CLP has available to
finance the activities of the group. It should be noted that
the balance between capital and reserves in the CLP' s own
resources shifted from 0.95:0.05 in 1965 to 0.38:0.62 in
1979. This is a consequence of the rules governing the dis-
position of surpluses in the Mondragon system (see further
below).
As a credit cooperative, the CLP is permitted to give
credit only to its members (i.e. cooperatives and individual
depositors), thus this rapid mobilisation of resources rep-
resents a major source for investment and credit finance for
the cooperatives in the Mondragon group. Certain minimum
percentages govern the asset structure of Spanish credit
cooperatives (e.g. 5.5 per cent held as cash, obligatory
investments in bonds under the supervision of the state
bank, etc.), and thus limit what can be made available to
members. Nevertheless, in 1979, 14,787 million pesetas of
medium- and long-term credits were given. This had risen
from a level of 12 per cent of assets in 1968 to 32 per cent
in 1979. Conversely, the proportion of CLP resources used to
discount bills of the member cooperatives fell from 50 per
"tt
g
c::
Table 6.7 Activities of the CLP, 1960-79 C"l
['1j
l'<l
1960 1966 1970 1979 en
C"l
No. of branches 21 28 - 93 0
No. of employees 2 58 2 240 892 ~
en
No. of accounts - 21,653 87,807 300,000 3
Deposits (m. pesetas) H
5 660 3,204 41,100 z
Capital & reserves (m. pesetas) 0.315 61 312 4,981
Total CLP resources (m. pesetas) 766 3,745 461110 ~
- en
t-'l
['1j
Notes l'<l
z
1. This figure is for 1959. H
2. This figure is for 1965. E3
3. An estimated figure for December 1979 given in Thomas and Logan c::
en
(1982). t-'l
Sources: Anglo-German Foundation (1977, pp. 37, 57), Oakeshott tzl

(1982, p. 132), Thomas and Logan (1982, pp. 78, 79, 84). C"l
0
z
~
H
tzl
en
.....
.....
.....
cent in 1968 to 28 per cent in 1979. The 12,864 million

pesetas which this represented in 1979 is a major source of
working capital for the member cooperatives. The CLP counts
on handling about 80-5 per cent of the sales of member coop-
eratives (Thomas and Logan, 1982, pp. 87, 88).
The change in the proportion of CLP assets used for
medium- and long-term credit as opposed to the discounting
of bills is indicative of a shift in the CLP's activities
from that of passively providing banking services to
actively promoting the growth and development of member
cooperatives. Of course, the existence of such a source of
investment finance does not guarantee the generation of
worthwhile projects. This requires that the cooperatives
themselves must be profitable productive units with a desire
for expansion. On the other hand, the provision of these
banking services by the group itself prevents the draining
away of resources from the group via the payment of interest
and fees to commercial banks, whose priorities for invest-
ment may lie elsewhere. The activities of the CLP have con-
tributed greatly to the economic success of the group. It is
an institution which many promoters of cooperative develop-
ment in the UK and elsewhere have sought to replicate (e.g.
Wales TUC, 1981; Thomas and Logan, 1982, ch. VIII).
The first producers' cooperative in the Mondragon system,
Ulgor, was founded as a conventional firm in 1956 by five
graduates of Don Jose Maria's technical school. These five
had gone on to part-time study for engineering degrees at
Zaragoza University, and to employment in the local
(Mondragon) firm, Union Carrajera. They left this firm be-
cause of dissatisfaction with its ethos. Ulgor adopted a
formal cooperative constitution in 1959 (Oakeshott, 1982).
Ulgor grew, despite attempts to keep its size down to
manageable cooperative proportions, to 3855 in 1979. In
1964, Ulgor linked up with three other associated cooperat-
ives, to form Ularco. This grouping has no legal status, but
allows common marketing and purchasing organisations and
closer planning and coordination of four companies whose
production was already linked. Employment in the Ularco en-
terprises was 6680 in 1979, compared with 1350 in 1964. The
members of the Mondragon group produce in a wide range of
industries. Anglo-German Foundation (1977, App. C) lists the
associated cooperatives in 1976, detailing primary activity,
location, year of foundation and employment in 1976. Table
6.8 shows the number of cooperatives and their employment,
sales and profits by main product group for various years.
In the period covered by the table, the consumer durable
category has gradually replaced heavy machinery as the most
important provider of employment. Absolute employment has
risen in all sectors. The machine-tool group has shown the

greatest relative improvement in profitability, but,
although its share of group profits has declined, the
consumer-durable group is still the most profitable.
As has been stated earlier, it is the contracts of associ-
ation between each cooperative and the CLP which cements the
group together. It is these contracts of association which
lay down principles for the organisation of each cooperat-
ive, its financing, how earnings are to be arrived at and
how the surplus is to be distributed. A translation of the
text of the Contract of Association appears as Appendix B in
Anglo-German Foundation (1977). It is also discussed in
Thomas and Logan ( 1982, pp. 22-9). The formal governing
structure is laid out in each cooperative's Statutes
(Estatutos Sociales), which are discussed in Oakeshott
(1978, pp. 186-9) and Gutierrez-Johnson (1978). As this book
is concerned with the economic dimension of Mondragon, the
reader interested in the organisational features is referred
to these more detailed discussions.
The contract of association lays down six cooperative
principles to which all associated cooperatives must adhere.
1. Open door principle

2. Democratic principle
3. Limited interest on capital and distribution of profits
4. Creation of community funds
5. All workers must be members
6. Cooperative spirit
The 'open door' principle is seen by commentators on

Mondragon as being its major motivational force (Oakeshott,
1982, pp. 129, 135-6; Thomas and Logan, 1982, pp. 71,
168-9). It commits the associated cooperative to open mem-
bership 'to all persons who can render the services for
which it was established, provided they agree to assume the
responsibilities membership entails' (Anglo-German Foun-
dation, 1977, p. 60). The judgement as to 'who can render
services' and 'assume responsibilities' leaves some scope
for interpretation on the part of cooperatives. In practice,
all prospective members are screened for suitability, and
must pay hefty entrance fees (see further below). However,
the growth record in employment for the group, as indicated
by Table 6.8, is impressive. Thomas and Logan (1982, p. 168)
state that if a cooperative's return on own funds exceeds 15
per cent it will be urged to expand employment. They also
give brief details (p. 169) of the method by which the Man-
agement Services Division of the CLP assesses each cooper-
ative's contribution to employment creation.
.....
00
0
>-l
;i
t"l
C)
Table 6.8 Cooperatives, employment, sales and profits by industry grouping (% of total) 0
z
Cooperatives Employment Sales Profits !i
H
C)
1976 * 1979 '67 '70 • 75 '79 '67 '70 '75 '79 '67 '70 • 75 • 79
~
Consumer-durables 16 16 20 35 32 31 47 47 37 38 45 23 21 34
Machine-tools 24 31 19 17 20 21 12 15 22 20 5 10 26 14
~
Cll
Intermediate goods H
Cll
and components 41 36 27 24 24 26 13 16 16 19 21 25 9 24
Heavy machinery 10 10 24 15 14 13 19 13 13 14 16 29 26 18 lil
Construction 9 10 9 10 9 9 9 11 9 13 13 20 10 '"CI
:>:l
(m. pesetas) (m. pesetas) 0
Total 58 70 5,082 8,570 12,543 15,672 3,350 7,100 17,900 50,000 251 497 1,074 2,000
g
C)
t"l
Note: * The product groupings in this column may not correspond to those in the rest of the table since they are :>:l
Cll
taken from a different source.
Sources: Number of cooperatives in 1976: Anglo-German Foundation (1977) App. C. Percentages for each year: Thomas C)
and Logan (1982) Table 7, p. 114. Figures in Total row calculated from data in Thomas and Logan (1982) pp. 46, 47 0
(Table 1), p. 116 (Table 9), p. 101 (Table 1). 56
t"l
H
s
~
Cll
The democratic principle lays down that each cooperative

shall be run by those elected or appointed by the members
and accountable to them.
The third principle lays down that providers of capital
shall receive only a fixed rate of interest (as opposed to a
share of profits). Profits shall be distributed in 'pro-
portion to work contributed'. In fact, this last point is
adhered to only if 'work contributed' is taken to be
composed of the member's labour and capital contribution
during the period, since it is measured by earnings and
interest on capital payments (see further below).
Associated cooperatives are obliged by the fourth prin-
ciple to create collectively owned reserves 'large enough to
ensure that new workers can be brought into the cooperative
sector'. They must also contribute a share of profits (10
per cent according to Spanish cooperative law) to a social
fund devoted to cooperative projects in the community but
outside that particular cooperative.
It is the normal rule that all workers within a cooper-
ative must be members, but under special circumstances, up
to 5 per cent of the work force may be hired.
The final principle commits the members of an associated
cooperative to 'maintain due flexibility in their working
relationships and make sure that all posts, and especially
those of an executive and management nature are filled in
accordance with cooperative guidelines'. The members, es-
pecially management, should be committed to the cooperative
and its development.
Cooperatives have become associated in a number of ways.
Thomas and Logan (1982, pp. 34, 35) have identified five
basic sources.
(1) As in Ulgor, founding members get together, estab-

lish an enterprise, and develop it.
(2) Divisions are hived off from existing cooperatives
which are growing too large.
(3) The Management Services Division of the CLP identifies
an opportunity for the establishment of a new cooper-
ative. This is usually as a result of an approach to
the CLP by a group of prospective cooperators.
(4) Existing cooperatives outside the group apply for
association. Thomas and Logan cite figures from
Gorrono (1975) showing that in 1972 cooperatives
associated with the CLP were only 25 per cent of those
in the Basque provinces although they provided nearly
56 per cent of the employment in cooperatives.
(5) The conversion of existing (but often financially
endangered) capitalist firms. In 1979, four such con-
versions took place.
When a new cooperative is being founded, its initial mem-

bers will be required to put up a significant capital con-
tribution. This is estimated by Oakeshott (1982, p. 128) to
be typically just under £2000. Anglo-German Foundation
( 1977) suggests that the founder's contribution will be 20
per cent of the necessary capital, 20 per cent will come
from the state's Cooperative Loan Fund (at 3 per cent
interest) and the rest from the CLP. The bank will be deeply
involved in the planning stages of a new cooperative. A
member of staff of the CLP' s Management Services Division
will be seconded to a new cooperative, to nurse it through
its early stages. He is known as the 'godfather'. A priority
in the early years of a new cooperative is to pay off the
capital received from the CLP. The new cooperative will also
be required to build up reserves. The capital provided by
the founders will be credited to their individual capital
accounts, except that 15 per cent is nowadays allocated to
the cooperative's reserves (Thomas and Logan, 1982, p. 149).
[ 10] The capital account of the worker will increase (or
fall) in accordance with the profits (losses) allocated to
it each year. Interest is paid on it at a fixed rate, which
may not exceed by more than 3 per cent that paid by the Bank
of Spain. Only interest of 6 per cent of the capital account
may be taken as income.[ll] Any excess over this is credited
to the capital account. Interest on the capital account
takes priority over wages. In the formative years of a
cooperative special provision is made to protect founders'
capital accounts from depletion during periods of inevitable
financial loss.
Subsequently, when new members join the cooperative they
must also contribute capital. A percentage of this contribu-
tion (see above) is credited to the reserves[l2] and the
rest to the individual's capital account. The payment is
seen as a contribution towards the creation of the new job.
The contract of association lays down that this should be
80-120 per cent of the current initial contribution required
of new individual members of the CLP (Anglo-German Foun-
dation, 1977, p. 62). This suggests a figure of between £650
and £1000 for 1977.[13] This payment need not be paid all at
once. Often a down payment of 25 per cent is required and
the remainder can be paid over 24 monthly payments. Partici-
pation in the surplus does not begin until the capital con-
tribution is fully paid.
Evidently, the contribution of a new member is subject to
a more precise calculation than suggested in the Contract of
Association. Thomas (1980, p. 388) and Thomas and Logan
(1982, pp. 149, 150) present a more precise formula. This is

designed to take account of two things. First, each year the
required entry fee of a new member is increased by the rate
of inflation over the previous year. This provides equity
between members joining at different times. All asset
values, reserves asnd individual capital accounts are re-
valued annually, according to an appropriate inflation
index. Thus the real values of capital accounts and reserves
are maintained. The second function of the formula is to
ensure that new members contribute to the reserves in a way
which reflects the current balance of reserves to capital
accounts. If this were not done, new members would benefit,
it is argued, at the expense of old members. Although the
proportion of reserves and capital contributions is the same
( 15 per cent and 85 per cent), the old members wi 11 have
contributed more to reserves from the distribution of the
surplus (which allocates a m1n1mum of 20 per cent to the
reserves). The formula used is
C =C 1 •[(Res/Cap)/(Res 1 /Cap 1 )J•(Price/Price 1 ),

n n- n n n- n- n n-
is new capital contribution;
is capital contribution in previous year;
is total reserves in year indicated by sub-
script;
Cap is total level of capital accounts in year
indicated by subscript;
Price is price index in year indicated by subscript.
The last term clearly deals with the inflation adjustment,
and will be dropped from the subsequent discussion. The
other part of the formula would seem to be justified, along
the following lines. It clearly represents a chain index,
since
Thus the formula reduces to
where 1 is a base year in which the ratio is
which would probably be the year of initial operation.

The relationship can be manipulated into a form that more
clearly illustrates its purpose:
Res /Cap [Cn/C 1 ]·[Res 1/Cap 1 ]

n n
[Cn•Res 1 ]/[C 1•Cap 1 ]. (6.1)
The LHS of (6.1) is simply the ratio of collective funds to

individual funds. The numerator of the RHS is the contri-
bution to reserves made by a member joining in year n,
whilst the denominator is the amount allocated to the indi-
vidual capital account in year one of a member who joined in
year one, Thus C is the entrance fee such that the allo-
cation to the renserve fund from it gives a ratio to the
capital account of a founder member in year 1 which is the
same as the ratio of reserves in year n to capital accounts
in year n, For example, if c1 = 100, Res I Cap = 0. 66 7 and
Res/Cap 1 = 0.176, then C = 377.78. Thne co-gtribution to
reserves of a member joini%g in year n is therefore 56.667
(i.e. 377.78 x 0. 15), and the capital account allocation
from an original member's contribution is 85 (i.e. 100 x
0.85); therefore
Thus the formula for C essentially seeks to preserve equity

between new members an~ existing members in terms of their
contribution to collective reserves. An alternative means of
doing this would be to maintain C = c1 , but adjust the pro-
portion of the new member's contr1bution such that his con-
tribution to reserves relative to an initial member's capi-
tal account equalled the LHS of (6.1), i.e.
(6.2)
where Res* was the proportion of the new member's contribu-

tion whic~ was allocated to reserves. Rearranging (6.2)
yields
Res*
n
= [Res n /Cap n ]•Cap 1 ,
which, for the earlier numerical example, would give
Res* 0.5667,
n
i.e the new member in year n would pay 100 to join the coop-
erative, but his capital account would be credited with only
43.33. In the system as described by Thomas and Logan
(1982), he pays 377.778, of which 321.111 is credited to his
capital account and 56.667 is credited to the reserves.
Thus, under both systems the same absolute contribution is
made to reserves, but the total contribution to reserves and

capital accounts is much higher. The new member is lending
much more to the cooperative than is the earlier member: in
this example, 741 per cent more. This of course is an
extreme example, in which collectively owned assets have
reached 40 per cent of owned assets. If the proportion of
assets collectively owned were lower, e.g. 20 per cent then
Res /Cap would be 0.25, and C = 141.667 whilst Res*
21. 25. n n n
Thus, under the actual system, the 'loan' (i.e. contri-
bution to capital account) would be 120.417, and under the
alternative it would be 88.75. Thus the loan in the actual
system is 36 per cent higher than it need be to preserve
equity. Note that we are abstracting from inflation here.
The conclusion must be that in attempting to preserve equity
between generations of members, the formula used in fact
requires the latest generation to invest more in the cooper-
ative than did the earlier generations. Compensation for
this is, of course, made through the higher share of profits
which will accrue to the latest generation in later years.
However, what the system does is to increase the rate of
capital accumulation.[l4]
It has already been mentioned that the members of a coop-
erative receive a share in the profits (losses) of the coop-
erative which is credited (debited) to their capital ac-
counts. The division of the surplus between members' capital
accounts and collective funds is governed by the contract of
association. The surplus itself is arrived at by deducting
from total revenue, material costs, wages and salaries
(which are technically advances on profits), interest on
loans, amortisation and interest on capital accounts. It is
equivalent to net profit. Spanish cooperative law requires
that 10 per cent of this be allocated to the social fund.
The contract of association lays down that a further minimum
of 20 per cent must be allocated to the collectively owned
reserve fund. Thus a maximum of 70 per cent may be allocated
to the capital accounts of members. A formula is laid down
in the contract of association by which the proportion of
surplus going to collective funds (a) is calculated. This
yields the proportion going to individual capital accounts
as
1- a= 1- [y/(y + z)],
where y is the pure surplus

z is the computable base which is equal to total wages
and salaries paid plus the amount of interest paid
on capital accounts.
Each individual's capital account is credited pro rata to

his salary and interest receipts. The distribution is
further constrained in that only 60 per cent of the sum of
the computable base may be paid to members accounts (Thomas
and Logan, 1982, p. 150). As the absolute size of profit
rises, a smaller proportion will be credited to individual
accounts once a reaches 30 per cent.
This means of apportioning the surplus suggests that in
addition to members sharing in the surplus according to the
labour which they have contributed, they are also receiving
it according to capital contributed. As was mentioned
earlier, this seems to be somewhat at variance with a
literal interpretation of the third principle laid down in
the contract of association, i.e. that the surplus should be
divided in proportion to work contributed to the associated
cooperative. What it does is to bias the distribution of
surplus towards the longer-serving and lower-paid members,
since the capital contribution is independent of the
worker's grade. Thus the surplus distribution could be seen
as a means of retaining worker loyalty. Indeed, the whole
capital account system could be seen as the use of deferred
compensation as a means of ensuring worker compliance.
Capital accounts are not normally withdrawable until re-
tirement. A worker who leaves to take another job outside
the system risks losing up to 20 per cent of his accumulated
capital (Anglo-German Foundation, 1977, p. 29).
Having discussed how initial capital contributions and the
distribution of the surplus are determined, attention now
focuses on the third economic pillar of the Mondragon sys-
tem: basic wages and salaries. These are technically ad-
vances (Anticipos) on the total return to labour. Anticipos
are determined by a very formal system of job evaluation and
relativities. This system is based on three principles of
solidarity:
(a) external solidarity is achieved by relating wages

within Mondragon cooperatives to those in capital-
ist enterprises in their immediate environment;
(b) inter-cooperative solidarity is achieved by using a
common system and base for determining all anticipos
in all member cooperatives;
(c) intra-cooperative solidarity is achieved by restric-
ting wage differentials within a cooperative to a
narrow ratio of 3:1 between highest and lowest paid.
The system and how it operates is discussed in particular

detail in Gutierrez-Johnson (1978), Thomas (1980) and Thomas
and Logan (1982, ch. 6). Here, the detailed mechanisms and
procedures are eschewed for a review of the basic prin-

ciples.
All jobs within a Mondragon cooperative are assigned a
number of points based on various aspects of it such as
physical demands, experience, decision-making, relational
skills, etc. An index is then assigned to all jobs, within a
specified points range. The indices run from 1.15 by inter-
vals of 0.05 to 2.8 (Thomas and Logan, 1982, p. 67). This
process of job evaluation involves a considerable degree of
participation by members, and the final version has to be
approved by the elected Supervisory Council. This index is
then adjusted, where appropriate, by deductions for inex-
perienced workers and supplements for particularly outstand-
ing performance and hardship (e.g. noise, danger, etc.).
Table 6.9 shows how workers were distributed between
indices in 1976 in Ulgor.
Table 6.9 Percentage of work force according to job index

in Ulgor, 1976
Index % of men % of women % of total

1.00-1.25 1.0 8.0 2.5
1.25-1.50 36.5 77.5 45.0
1.50-1.75 40.0 12.0 34.0
1. 75-2.00 13.0 2.0 11.0
2.00-2.25 0.5 0.5 4.0
2.25-2.50 2.5 0 2.0
2.50-2.75 1.5 0 1.0
2.75-3.00 0.5 0 0.5
Source: Thomas and Logan (1982)' Table 4, P• 69.
Wages and salaries are thus determined via an index with a

maximum range of 3:1. This range is very narrow for any firm
in the industrialised world. It clearly contributes to the
disappearance of a 'them and us' attitude between shop-floor
workers and managers, and promotes intra-cooperative soli-
darity. Inter-cooperative solidarity is maintained by each
of the associated cooperatives employing the same job evalu-
ation process and the same index range, 3: 1, although the
inference is that each cooperative devises its own points
allocations to particular jobs.
Actual earnings are determined with reference to those
obtained outside the cooperative by trade unions operating
in capitalist firms. In the case of Ularco, the basis of
comparison is with the local firms: ~ Cerrajera and
E lma. Each cooperative is free to choose the comparator
within its own geographic zone. However, Thomas and Logan

(1982, p. 138) quote figures that suggest about 95 per cent
of the cooperatives in the group follow Ularco' s proposals
in determining the average level of gross earnings as well
as differentials.
The 3:1 ratio between highest paid and lowest paid is, in
fact, subject to some erosion. In 1974, it was accepted that
in exceptional cases the 3:1 ratio could be increased by 50
per cent, and that a 10 per cent, premium could be paid for
overtime. It must also be recognised that, under Spanish
cooperative law, members of cooperatives are not eligible
for membership of the state social security system.
Mondragon cooperatives operate their own social security
system. It was originally operated by the CLP, but there is
now a separate second-degree cooperative, Lagun-Aro, which
performs this function. The earnings of Mondragon members
are calculated gross of their contribution to Lagun-Aro.
From 1968 to 1974, this contribution was a fixed sum per
member. It of course has the effect of widening the earnings
(net of social security payment) differential. Thomas and
Logan (1982, p. 134) suggest that these two adjustments
together could have raised the ratio from 3: 1 to 6: 1. In
1974, the social security system was changed so that the
contribution was a flat rate plus a percentage of gross
earnings. By 1979, the latter component was 14.5 per cent of
gross earnings. The net earnings ratio for Index 3:Index 1
was 3 in 1964, 3.86 in 1969, 3.51 in 1974 and 3.39 in 1979.
As has been noted, the actual money salaries are deter-
mined via an external comparator. The procedure is complex
(see Gutierrez-Johnson, 1978, pp. 274-6), but would seem to
involve fixing wages so that weighted median earnings are
the same. Given the narrower differentials in the Mondragon
system, this implies that the lowest paid workers in a
Mondragon cooperative receive more than their equivalents in
the comparator, whi 1st the highest paid (i.e. managerial
grades) receive considerably less. It should be noted that
this is with respect to earnings net of social security
payments. Thomas and Logan (1982, p. 137, Table 1) present
figures indicating that gross earnings in Ularco are lower
than those in Union Cerrajera and Elma for all grades in
1976. Similar evidence is presented in Gutierrez-Johnson
(1978, pp. 274-5).
The outcome of all of this is that managers in Mondragon
receive much less than managers in comparable firms else-
where. Top salaries in Mondragon in 1974 were about 558,000
pesetas per annum, whilst the Managing Director of a company
with sales comparable with those of Ulgor might expect to
receive 1.5 million pesetas. Yet the calibre of Mondragon
management seems to be high, and the results achieved by the

cooperatives are at least as good as those achieved else-
where in Spain. The Mondragon manager will also receive a
share of the cooperatives surplus (although this is in the
form of deferred income). A rough estimate of the magnitude
of the annual allocation to individual capital accounts
would be that they were, on average, equivalent to 14 per
cent of earnings in 1971, 17 per cent in 1976 and 11.4 per
cent in 1979. [ 15] They would be higher in the more profit-
able cooperatives. Thus some of the disparity between man-
agement salaries would be compensated for by capital shares.
According to Thomas and Logan (1982, p. 137), those in
senior and technical positions in Ularco in 1976 received
net earnings 14.6 per cent below those in Union Cerrajera
and Elma. This would have been less than the 'average' allo-
cation to capital account quoted above. Ularco, however, is
one of the most profitable parts of the Mondragon system,
and thus the share of profits going to capital accounts
would have been well above 17 per cent. In other words it is
reasonable to suppose, therefore, that when capital accounts
are considered, managers in Ularco receive a higher remuner-
ation than tilose in Union Ce~a and Elma. A corollary of
this is that the lowest grades of worker in Ularco receive
substantially more than those in their capitalist compara-
tors. The fact that some of this is in the form of forced
saving does not really reduce the significance. It is poss-
ible for some of an individual's capital account to be paid
out, but the conditions on this are very severe. [ 16] Apart
from this, however, any reasonably functioning financial
system would grant loans to individuals against the col-
lateral of their accumulated capital accounts. Accordingly
to Oakeshott (1978, p. 191), this does happen. Obviously,
since there is a risk that an individual's capital account
may diminish if his cooperative makes losses, a potential
creditor may not grant loans to the full value of an indi-
vidual's capital account.[l7]
The performance of Mondragon may be evaluated in two ways:
against comparable capitalist firms and against the objec-
tives which the Mondragon movement has set for itself.
Thomas and Logan (1982) present evidence on the former, and
conclude that in aggregate, the Mondragon group outperforms
Spanish capitalist firms in terms of growth (p. 106), pro-
ductivity (p. 109) and profitability (p. 112).
A more exacting test of performance is that against the
movement's own objectives. This is a difficult task for most
organisations, since objectives are often imprecisely de-
fined (if stated at all) and mutually contradictory. In the
case of Mondragon, the objectives are fairly well stated and
laid out in various documents.

The ultimate objective of Mondragon cooperatives would
seem to be to provide the maximum long-run level of employ-
ment compatible with a reasonable return on capital, and
payment of wages broadly in line with other firms in their
area. The 'open door' policy enshrined in the contract of
association commits them to providing employment for all who
wish it. The principle governing the accumulation of com-
munity funds states that the reserve fund should be large
enough to ensure that new workers can be brought into the
cooperative sector. These two together imply an objective of
employment growth. Clearly, aggregate growth of the group
has been quite dramatic. Even with the formation of new and
therefore quite small cooperatives, employment per cooper-
ative has grown as shown in Table 6.10.
Table 6.10 Average size of Mondragon cooEeratives
1961 1965 1970 1975 1979

Number 12 30 40 so 70
Average size 49.4 113.2 214.3 250.9 223.8
Source: Calculated from Thomas and Logan (1982' P• 47),
Table 1.
Average employment has continued to rise with the exception

of the most recent period. In that period, however, the num-
ber of cooperatives rose by 40 per cent.
Employment in the cooperatives in the Ularco complex has
grown continuously in all years except -one(l975). This
overall growth far exceeds that of employment growth in the
Basque province of Guipuzcoa, for example. Only one
Mondragon cooperative (a fishing venture) has ceased to
trade, although in 1975, 35 per cent of cooperatives re-
ported a loss. Loss-making does not seem to be a continuing
problem in individual cases given the absence of bankruptcy
and other evidence cited by Thomas and Logan (1982).
As well as the overall objective of employment growth,
three subsidiary objectives have already been noted: exter-
nal solidarity, inter-cooEerative solidarity and intra~
erative solidarity. When evaluation of these is restricted
to earnings (anticiEos), each would seem to be met in broad
terms. However, the lower grades in Mondragon cooperatives
do have net earnings above comparators, and the 3: 1 ratio
has at times been rather stretched, although it is still
narrow in comparison to elsewhere. When these criteria are
extended to anticiEos plus allocations to individual capital
accounts, external and intra-cooperative solidarity, inevi-

tably, break down (the latter assuming some cooperatives
perform better than others). This could be avoided only if
all profits were collectivised, which might seriously reduce
the commitment of individual workers. Part of Mondragon's
success must be attributable to the harnessing of individual
incentives (through profit-sharing) to capital accumulation
within each cooperative. An economic purist might argue that
all profits should be distributed in order that individual
producers could make their own consumption/saving decision.
The banking system would then allocate savings to the most
profitable projects available. However, the Spanish capital
market is not a perfect market, and cooperatives have, any-
way, been subject to bias on the part of bankers. Further-
more the investment of individual cooperatives is monitored
by the CLP to ensure that an adequate return is made. The
system adopted by Mondragon does seem to work well in terms
of the principle objective: capital accumulation for employ-
ment generation. This mitigates the disparities that it
gives rise to in terms of the wealth of cooperatives vis-~
vis the rest of the community, and cooperatives in one in-
dustry vis-a-vis those in an other.
How does the economic theory of the labour-managed firm,
developed in the earlier chapters of this volume, relate to
Mondragon? The system does not seem to be subject to the
perverse supply elasticity of the W-V-M model (Chapter 2)
and its concomitant low employment. Although much capital is
internally-financed, there seems to be no Furubotn-Pejovich
effect (Chapter 4), and certainly no self-destruction a la
Vanek (Chapter 4). Individual incentives via a privatising
of a substantial proportion of the net worth of the cooper-
atives is attained without the difficulties of making a
market in cooperative shares (Chapter 3). The designers of
the Mondragon system certainly seem to have solved these
problems without the benefit of economic theory. Indeed,
they seem to have solved most of the problems before modern-
day economists had conceived of them.[l8] What, then, is the
Mondragon model? Thomas and Logan (1982, p. 169) suggest
that it is 'similar to that first postulated by Horvat for
Yugoslav enterprises and later analysed in depth by Miovic
and Vanek' (Horvat, 1967; Vanek and Miovic, 1977; Miovic,
1976). However, these two models differ. Horvat's model has
as its maximand
R pX - (w + d)L - rK,
where w is last year's wage and d is an aspired-to increase

in that wage. Thus R is profit net of an aspiration wage
rather than a market wage. The Vanek and Miovic model

involves maximising
F (pX-wL)/L
pX/L - w,
i.e. the difference between revenue per worker and the ac-
counting wage.
These two models differ in important respects. In particu-
lar the former maximises an aggregate sum and the latter a
ratio. The latter objective function is embodied in an in-
come change equation,
Y'= AF - C,
where A and C are parameters, C determining a fixed sum to

be allocatd to non-income purposes and A the proportion of F
going to individual incomes; and Y' is the change in income.
There is clearly some similarity between this and the
Mondragon system of allocating surplus between collective
funds and individual capital accounts. However, the crucial
difference between the two models really lies in whether the
maximand is an aggregate or an individual phenomenon. The
structure and ethos of Mondragon suggests it is an aggregate
one. If the objective is employment growth and the individ-
ual cooperatives do not subvert this for their own narrow
self-interest, then the former suggests itself: profit maxi-
misation with all profits retained to generate new employ-
ment. A number of limited surveys of workers' attitudes are
mentioned in Thomas and Logan (1982, pp. 189-91). The
workers interviewed seem to value the job creation objective
as a positive factor in Mondragon. This objective is clearly
stated, and the fact that membership is voluntary (unlike
Yugoslavia, where there is only one form of industrial firm)
and workers are screened on their attitudes before entry,
suggests that it may well be adhered to. Furthermore, the
system of entry fees means that new workers bring some
'capital' with them, and thus do not necessarily reduce the
marginal product of labour. The short-run objective function
for Mondragon would seem, therefore, to be maximisation of
m
R pX-LJw.l.-rK,
i=l1 1
where the w. are the anticipos of the ith category of

labour. Giveh that the w. are set with reference to the
1
competitive labour market, this approximates the capital-

ists' short-run objective function. However, in the long
run, R is used to increase employment. It is used with the
entry fees of new members to purchase the capital necessary
to expand employment without harming the economic interests
of existing members. It should also be noted that since the
anticipos of higher categories of labour are below market
salaries, this suggests that Mondragon labour will be rela-
tively human capital-intensive. This is borne out by a com-
parison between Ularco and Union Cerrajera and Elma (Thomas
and Logan, 1982, p. 137, Table 1).
These theoretical conclusions seem to fit well with em-
pirical findings for Mondragon, and auger well for its
future. However, the group will have to weather the problems
of large-scale retirals and withdrawals of capital accounts,
new generations of workers, and the increased competition in
Spanish markets arising from Spain's entry into the EEC.
V SUMMARY
In the preceding four sections of this chapter, nine groups

of cooperatives have been discussed in detail. These are (i)
UK 'cloth-cap', (ii) 'high-minded' !COM, (iii) !COM
'starts', (iv) 'intermediate' !COM, (v) French SCOP, (vi) US
cooperage, (vii) US shingle, (viii) US plywood and (ix)
Mondragon. Even this small sample indicates a range of
institutional forms which enterprises generically called
cooperatives can take. None of these correspond directly
with the W-V-M model of Chapter 2, since none are wholly
externally-financed. However, a range of the institutional
characteristics of models examined in Chapter 3 have been
met (e.g. hiring of non-members, marketable shares). Pervad-
ing almost all of them have been the questions of financing
discussed in Chapter 4. Two characteristics of the cooper-
atives which neither a priori theorising nor inductive mod-
elling have produced are the existence of non-worker members
and institutionalised constraints on surplus distribution.
The latter is the most serious omission, since it is a
fundamental characteristic of the relatively more successful
(in economic terms, anyway) Mondragon and 'high-minded' !COM
cooperatives.
How do the predictions of the models fare? The evidence
considered in this chapter (and it is a reflection of the
literature as a whole) is not very thorough, and formal
tests of the models have been few. Data availability and
appropriate benchmarks for comparison are limited, making a
high standard of evaluation almost impossible. However,
evidence from a number of the groups examined does tend to

support the suggestion in Chapter 3 that there will be a
tendency for retiring or withdrawing worker-members to be
replaced by hired labour, unless there is a strongly
entrenched constitutional barrier. Only Mondragon and the
ICOM groups have such barriers. In France, where there is a
requirement that auxiliaries share in the surplus, the
incentive to employ labour is reduced, but in certain
sectors there is considerable hiring. It is something of a
paradox that cooperatives, for which the most simple
definition would be that of 'a firm owned and managed by its
workers', show a fairly widespread tendency to degenerate in
this manner. Possibly, it can be traced to a basic drive of
self-interested economic behaviour. Another prediction in
Chapter 3 was that entry fees and marketable shares would
overcome the perverse behaviour with respect to membership
demonstrated by the W-V-M model. The evidence on this is
mixed. Where the non-member employment option has been open,
marketable shares have possibly exacerbated the tendency for
membership to be concentrated. In Mondragon, where entry
fees combined with individual sharing in the profits proxies
shares, it is associated with success. The evidence from the
plywood cooperatives is that tradeable shares do not wholly
resolve the financing problem, because of imperfections in
the market for them. However, the individualising of
returns, which marketable shares represents, is to a large
extent proxied by the Mondragon system of individual capital
accounts. These may be looked upon as a distribution of new
shares at par in lieu of dividends on the initial invest-
ment. There is little evidence to support the Cornell
school's thesis that degeneracy arises from an absence of
scarcity-reflecting rents for capital.
VI PERFORMANCE
It has been argued earlier in this book that much of the

economic theory of the labour-managed firm can be seen as an
attempt to find an institutional form for a democratic firm
that would behave in a manner which was economically ef-
ficient. Efficiency in this sense is not unambiguous. The
conventional criterion has become that of Pareto optimality.
There is an extensive literature which demonstrates the
limited applicability and validity of this criterion (see
Nath, 1969; Mishan, 1981). A less value-loaded interpret-
ation would be to regard this process as being the search
for institutions which would guarantee that worker-managers,
behaving in their own interest, would react to economic sig-
nals at least as well as theory predicts capitalist, profit-

maximising, firms should. [19] Chapter 2 suggested certain
adaptations to the basic W-V-M model towards this end.
Earlier in this chapter, the varied experiences of pro-
ducers' cooperatives in four industrialised western econ-
omies has been outlined. An attempt is now made to bring the
two together, to examine what institutional characteristics,
if any, are associated with the performance characteristics
of producers' cooperatives.
The first stage is to settle on performance character-
istics and a means by which relative performance may be
judged. Derek Jones has proposed the following set of six
indicators of socio-economic performance (Jones, 1979,
1980a, 1982a).
(i) Ability to survive

(ii) Persistence of democratic governance (i.e. the
absence of a tendency to degenerate towards control
by outsiders or a limited group of workers)
(iii) Growth and size in comparison with capitalist firms
(iv) Efficiency, which Jones (1980a) suggests may be
measured in terms of labour productivity, profit-
ability and ability to introduce technical change
(v) The ability to create and sustain levels of employ-
ment comparable to capitalist firms
(vi) The level and internal differentials in money
incomes (Jones, 1980a, p. 143)
This set of criteria is a useful basis for comparison,

covering as it does economic ((i), (iii), (iv), (v), (vi))
and socio-political ((ii), (vi)) objectives. How do the
groups of cooperatives examined earlier in this chapter per-
form on these criteria? Nine groups of cooperatives were
discussed in detail. One of these (US shingle mills) is
dropped because there is limited evidence on a number of the
criteria. Only two ICOM categories are used below. KER is
dropped because its excess of workers over members seems to
conflict with ICOM rules. Landsman's, since its conversion
was initiated by its capitalist owners, is included below in
the 'high-minded' ICOM category. This leaves seven groups
identified by the following letters in Table 6.11: UK
'cloth-cap' (A); 'high-minded' ICOM (B); other ICOM (C);
French SCOP (D); US cooperage (E); US plywood (F); Mondragon
(G). Where groups perform at a broadly similar level, this
is indicated by giving them the same rank number in the
table. A similar ranking may be obtained for the groups
covered here by interpreting the symbols used in Jones
(1980a, Table 1, p. 149) as a five-point ranking scale. One
difference between these two sets of rankings, however,

occurs because Jones ( 1980a) has only one !COM group wl.ich
by inference reflects the performance of what is called
'high-minded' !COM here. Another is that Jones treats
'cloth-cap', footwear and printing as separate groups,
largely, it would seem, because the former seem to have
maintained a majority of worker-members on committees of
management whilst the latter have not. It is not clear that
this distinction follows from any organisational or consti-
tutional characteristic. Therefore, the two groups are
treated as major constituents of a single 'cloth-cap' group.
Table 6.11 Relative 2erformance of Eroducers'

coo2erative grou2s
Criteria Life- Growth Effie- Democ- Employ- Incomes

\Rank sean & Size iencl racl ment
1 G G G G G G
2 B,D,F F B,D,F c B,D,F,E F
3 B E E
4 D D,F B,D
5 E E A
6 A A E B A A
7 c c c A c c
Inspection of Table 6.11 suggests the following overall

ranking: (1) Mondragon; followed some way behind by (2)
'high-minded' !COM, French SCOP and US plywood; a little way
behind this comes (3) US cooperage; and some way behind (4)
UK 'cloth-cap; and then (5) other !COM.
Is there any relationship between performance and insti-
tutional characteristics? Chapters 3 and 4 suggested some
adaptations to the basic model which would enhance ef-
ficiency. The charging of non-trivial entrance fees, having
marketable shares with claims on asset values, and hiring of
non-members were seen, in theory, to overcome employment
adjustment problems. Permitting individuals a claim on the
assets was seen as a way of overcoming the problems of
investment financing. Earlier in this chapter, another
characteristic of some cooperative groups was identified:
entrenched constitutional constraints on how the surplus
should be distributed between current incomes and collective
funds. Usually, such provisions are designed to enforce the
accumulation of funds within the firm. Table 6.12 indicates
the distribution of these characteristics among the cooper-
ative groups.
IX'
"'g
c:::
C"l
tzl
IX'
Table 6.12 Institutional characteristics of cooperative groups en
C"l
Claim on 0
Constraint Entry fee
Performance retained on surplus Hired or marketable ~
en
ranking Group profits distribution workers shares
1 Mondragon l+C X
.....
- X z
2 'high-minded' !COM C X
French SCOP I,C X X
~
en
....;
US plywood I X X tzl
3 US cooperage I X X ~
4 UK 'cloth-cap' C X .....
5 Other !COM C ~
c:::
en
....;
tzl
C"l
~.....
1:>:1
en
\0
......
-
The third column on its own shows no pattern of associ-

ation between the existence of individual or collective
claims and performance ranking. However, if the third and
fourth columns are considered together, it can be seen that
those groups where collective claims on profits exist with-
out a constraint on surplus distribution are at the bottom
of the performance ranking. This suggests that successful
retention of profits requires either compulsion or individu-
alisation. In Mondragon, of course, both occur. The influ-
ence on the overall ranking of these characteristics can be
seen to be via the performance characteristics which are of
a dynamic nature, i.e. lifespan, growth and size, and the
profitability and technical change components of efficiency.
One group of cooperatives which would bear further inves-
tigation with respect to these institutional characteristics
is the French SCOP cooperatives. Whilst there are con-
straints on the distribution of the surplus, there is still
considerable scope for distributing the surplus. Some non-
compulsory retentions do take place, but the members have
the option of individualising these. If individual cooper-
atives maintain a pattern of individualising or collectiv-
ising such retentions, it would be interesting to examine if
performance differs between the options.
The hiring of non-members does not seem to be associated
in a positive way with the overall ranking. In part, this
may be because it does not contribute directly to the more
dynamic performance characteristics which are largely capi-
tal-determined. Also, hiring non-members inevitably rates a
poor score on democracy. When it is combined with marketable
shares there does seem a tendency to concentrate membership
as in the spectacular American cases. The employment adjust-
ment problem of the W-V-M model seems to have been obviated
in Mondragon by the use of a significant entrance fee which,
if not compensating existing members for past sacrifices,
imposes a relatively similar sacrifice. A non-trivial en-
trance fee or marketable shares (without the hired-worker
option) are ways of solving the employment adjustment prob-
lems of the basic model in both static and dynamic terms.
The non-member option deals only with the static dimension
since it does not contribute to solving the accumulation
problem. It has the further defect of detracting from the
socio-political dimension of cooperation.
All of this suggests that cooperative performance will be
enhanced by the following institutional characteristics:[20]
(a) membership should be acquired by payment of a non-

trivial entrance fee or the purchase of a marketable
share; and
(b) individual members should retain a long-term claim on

a significant proportion of retained earnings;
or
(c) where retained earnings are collectivised, there

should be entrenched constitutional constraints on the
distribution of the surplus which guarantee accumu-
lation for investment.
Item (c) would make it clear, ab initio, what the ideo-

logical posLtLon of such a cooperative was. It would
therefore attract only those who shared that ideology, so
that there would be less of a problem of conflict between
individualism and collectivism. A common ideology could
overcome many hurdles to economic success. It has already
been suggested that a commitment to employment growth within
the Basque provinces is a positive feature of the Mondragon
example. It is probably also true in the case of the
American cooperatives who chose the marketable share model.
There, however, the ideology may be that of the small capi-
talist. Eric Batstone (1982) has pointed to the conflict in
the ideologies of French cooperatives: 'solidary collec-
tivity of workers' versus 'democracy of small capitalists'.
It would be interesting to compare the performance of those
French cooperatives which have made a choice between the two
and those that have failed to do so.
Further research by economists on cooperatives must com-
bine a more formal testing of theory with more detailed
attention to the niceties of institutional differences.
NOTES
1. An example in this category would have been Civic Press

of Glasgow, which although registered under the indus-
trial and provident societies legislation (and presum-
ably counted in Jones' (1980a) figures), had no worker-
members, all of its shareholders being Trades Unions.
Civic Press has now ceased to trade (Findlay, 1981).
2. It is not clear from Jones and Backus (1977) whether or
not the same firm can appear in one subgroup at one time
and the other at another time.
3. The author is grateful to Charles Normand for allowing
him to quote the re su 1 t s of this, as yet unpublished,
study.
4. The development and origins of the movement are re-
viewed in Antoni (1957), Oakeshott (1978) and Batstone
(1982). Antoni (1957, p. 368) cites the first workers'

production cooperatives as being one of carpenters
formed in 1831 with the help of Buchez, and another of
gilt workers promoted by Leroy in 1834. However,
Oakeshott (1978, p. 126) suggests that the first was
inspired by Buchez, and was formed in 1834 by jewellers
working in gold.
5. The Confederation Generale des Societes Cooperatives
Ouvrieres des Production (SCOP) is the central organ-
isation which promotes the interests of cooperatives in
France.
6. A cooperative is obliged to put 15 per cent of its
profits into its reserve fund until that equals the
amount of share capital (Thornley, 1981, p. 139).
7. Thornley refers to members giving 5 per cent of annual
wages in the form of new shares. It is presumed here
that formally this is an allocation of the surplus to
new shares (see Antoni, 1957, p. 384) equivalent to 5
per cent of members' annual wages, not a deduction from
the members' share of the distribution of surplus to
workers, which would leave members worse off financially
than auxiliaries. Oakeshott (1978, pp. 132, 134) refers
to members of La Vererie Ouvriere d' Albi (VOA)
increasing their contribution to capital from a standard
'4 per cent of gross earnings' to 10 per cent. Oakeshott
does not define what he means by gross earnings or what
form the contribution takes, so that it is not clear
whether this is an agreed contribution to the develop-
ment fund or an agreed increase in shares issued to each
member equal to 10 per cent of his annual earnings.
Given that Oakeshott refers to 'their capital contri-
butions', it is likely that this is also a case of
financing capital by issuing new shares.
8. Cf. the preference for the issue of new paper by US
plywood cooperatives.
9. In an earlier study, Berman (1967, p. 93) gives the num-
ber of plywood cooperatives as 32. The lower figure
probably includes a number of short-lived plants. She
also discusses (in footnote 15 on p. 94) the conflicting
evidence as to the number of cooperatives and their
share of industry output during the 1950s. In the pres-
ent discussion, it is assumed that the figures pre-
sented in Berman (1982) are the more authoritative.
10. Anglo-German Foundation (1977) and Oakeshott (1978,
1982) state that 20 per cent is allocated to the
reserves. The translation of the contract of association
which appears in Anglo-German Foundation (1977) states
(p. 62) a maximum deduction of 25 per cent.
11. It is not clear from any of the sources consulted what

the actual rate of interest paid on capital accounts has
been. The impression given by some is that the rate has
been 6 per cent (e.g. Thomas and Logan, 1982, pp. 156-7,
footnote to Tables 7a and 7b), but this may refer to
only that part received as income.
12. Gutierrez-Johnson (1978, p. 275) refers to this as an
'entrance fee', whereas Thomas and Logan (1982) use this
term to describe the total capital contribution (i.e.
that allocated to the individual's capital account as
well as the non-returnable allocation to the reserves).
13. This calculation is based on Thomas and Logan's state-
ment that individual membership of the CLP in 1977 was
115,000 pesetas (Thomas and Logan, 1982, p. 95, fn. 6).
Anglo-German Foundation (1977) and Oakeshott (1982)
quote a figure of just under £1000 for existing coop-
eratives.
14. It should be noted that if this formula quoted by Thomas
and Logan (1982) were applied to the CLP, members join-
ing it in 1977 would have to pay 16.859 times the real
contribution of those who joined in 1965: in 1977
Res /Cap was 0.887, whilst in 1965 it equalled 0.0526.
How~ver, n membership of the CLP is complicated by the
fact that employees, associated cooperatives and members
of associated cooperatives are in membership. It is
understood that this formula is not applicable to the
CLP.
15. These figures are based on 70 per cent of total surplus
divided by total earnings for the industrial cooperat-
ives, using data from Thomas and Logan (1982, p. 171,
Table 1).
16. For these, see Anglo-German Foundation (1977), pp. 62,
63, item 6.4 of the contract of association.
17. Such loans would bear a considerable resemblance to the
method by which UK insurance companies provide endow-
ment policies to finance mortgage repayment. In this
case, an individual purchases a house via a building
society mortgate, but rather than repaying the loan in
instalments, only interest payments are made. The repay-
ment of the loan at the end of the period is financed by
the individual purchasing an endowment policy which will
mature at the same time as the mortgage is to be repaid.
If the endowment accumulates profits, the premiums on it
will be less than those necessary to repay the mortgage
by instalments. The benefit to the individual is, thus,
that he repays the loan at a lower average annual outlay
than under conventional repayments. Application of this
principle to Mondragon would mean that an asset such as
a house could be purchased via a loan from a financial

institution which agreed to accept repayment of the loan
at the time of the individual's retiral from a Mondragon
cooperative; i.e. the individual's capital account (or a
portion of it) performs the role of the endowment pol-
icy.
18. Of course, commentators on cooperatives earlier this
century (e.g. Sidney and Beatrice Webb) had pointed out
what they believed to be the poor record of producer
cooperatives. For a further discussion of early economic
thought on cooperatives, see Jones (1974, 1976).
19. This, of course, begs the question of whether capitalist
firms do actually maximise profits.
20. Other authors have suggested what amount to necessary
conditions for successful cooperatives. Vanek (1975, pp.
33-6) proposes a long list of 'Fundamental rules for
efficient labour-managed systems'; Bernstein (1976)
proposes six 'key components'; and Horvat (1982) ident-
ifies seven 'crucial factors' of 'crucial importance' in
designing a cooperative strategy. Bernstein is concerned
mainly with ensuring the maintenance of the socio-
political goals of cooperatives, rather than their
economic viability. Both Vanek and Horvat include the
need for a 'supporting structure' or 'shelter organis-
ation', which Mondragon and possibly SCOP seem to sup-
port, but ICOM, the Cooperative Productive Federation
(UK 'cloth-cap') and the Cooperative Union have not been
so successful. A crucial difference between success and
failure may, however, be a financial support structure.
A number of Vanek's 'fundamental rules' are based on the
Cornell model discussed in Chapter 4.
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Index
ACOME (L'Association des 102, 104, 105, 128

Ouvrieres en Materiel Base cooperatives (in
Electrique), 155 Mondragon), 175
AOIP, 152, 153, 155 Basic Organisation of
Air Flow Developments, 149, Associated Labour
150 (BOAL), 2, 106-15, 141
Alchian, Armen, 114 defined, 110, 114
Aldrich, Howard, 156, 157 groupings of 111
Alecoop, 175 size of 112
Altruism, 52 'super' 111
Analytical economics 6, 24 Batstone, Eric, 153, 155,
Anglo-German Foundation, 156,199
174, 176-180, 182, 186, Becker, L.C., 96
200' 201 Bendekovic, J., 103, 124
Antoni, A., 153, 156, 199, Ben-Ner, Avner, 50
200 Berman, Katrina V., 1, 40,
Arizmendi-Arr ieta, Don Jose 46, 49, 166-173, 200
Maria, 175, 178 Berman, Matthew D., 42, 46,
Arrow, Kenneth J., 62 48, 49, 50, 53, 64
Asset ownership Bernstein, Paul, 167, 202
in British Cooperatives, Bewley's Cafes, 145, 149
144 Bierman, Harold, 69
Asset values British producers'
in capitalist firm, 95 cooperatives, xi, 3,
in cooperage cooperatives, 143-52
160' 161 asset ownership in, 144
in cooperative, 95, 196 capital rents in, 144
obligation to maintain, 2, capitalist firms: com-
79 parisons with, 147,
Associated Plywood, 168 148
'cloth cap', 144, 146-8,
Backus, D.K., 67, 78, 144, 151, 193, 195-7; per-
146' 147' 199 formance of 146-8
Bank finance, 67, 73, 88-96 committees of management
Banks in Yugoslavia, 101, of, 196
214
INDEX 215
as common ownership enter- branches of, number of,

prises, 145 177
Cornell School and, 146, contract of association
148 with, 175, 177, 179,
in footwear industry, 182
146-8' 195 employment in, 175, 177
!COM and, 144-6, 148, functions of, 175
193-7 interest rates of, 176
as industrial or provident lending to new cooper-
societies, 144 atives of, 182
investment behaviour in, Management Service
146 Division of, 176,
as labour-managed firms, 179, 181, 182
145' 148 member of, 182, 201
membership of 144, 145, origins of, 176
148, 195 and social security, 188
non-member employees in, California, producers' coop-
151' 194 eratives in, 157
numbers of, 143, 148 Capital, 2
in printing industry, 144, collective, see social
195 ownershipof
and Scott-Bader Common- consumption of, 81
wealth, 145, 148 depreciation of, 79, 82,
Shares in, 144, 145, 151; 93
non-worker, 144, 145 durable, 79
Wedgewood-Benn and, 144, founders' (Mondragon),
145 182
as worker-managed firm, in French cooperatives,
144, 148 153, 154, 200;
workers' attitudes in, 151 interest on, 153, 155·
Buchez, P.J.B., 152, 200 purchase of, 154, 156'
Buck, Trevor, xii hired, 65
Building industry, cooper- intensity in Yugoslavia,
atives in France, 153, 12-18
156 interest on, 11, 12, 90,
Business Fund (Yugoslavia), 181; in French coop-
112 ' 123 ' 124 ' eratives 153, 155; in
allocations to, 117-28, Mondragon cooperat-
133' 137' 138' 142 ives, 181, 182, 185,
tax on, 102, 133, 136, 186' 201
139, 141 internally funded, 73-86,
191
Cable, John, 24 maintenance requirement,
Caja Laboral Popular (CLP), 68, 69, 79, 87, 90-6;
1 7 4 ' 1 7 5 ' 20 1 in cooperage cooperat-
Accounts in, 177 ives, 160; in plywood
asset structure of, 176, cooperatives, 171; in
177 theory of l.m.f., 86,
216 INDEX
160, 171; in theory of underpricing of, 2, 131,

internally financed 128-40
l.m.f., 80, 85, 86, variability of, ~n long
92' 93 run, 13
marginal cost of, in in W-V-M model, 13
Yugoslavia, 136, 142 Workers' (in Mondragon),
marginal product of, in 182-6, 189, 191, 194
Yugoslavia, 128-40, Working (in Mondragon),
142 178
market for: imperfect, 90; Capital accounts, workers'
nature of, 89; per- (Mondragon), 182-6, 189,
fect, 13, 65, 89, 191; 191' 193' 194
in Yugoslavia, 130, interest on, 182, 185, 186
131 Capitalist firm, see Profit-
in Mondragon cooperatives: maximizing firm, com-
interest on, 181, 182, panies
185, 186, 201; social Carlson, Sunni, 175
ownership of, 183-5 Carson, R.G., 28
for new cooperatives Civic Press, 199
(Mondragon), 182 Clayre, A., 1
opportunity cost of, 78, 'Clothcap' cooperatives,
80, 81' 82, 84 144, 146-8, 151, 193,
pricing of, in labour- 195-7
managed economy, 131 performance of, 146-8
purchase of, in French Clunies Ross, Anthony, xii
cooperatives, 154, 156 Collective financing, 67,
rationing of, 128 173-86, 148
rents on: in British coop- Collective ownership, 2, 3,
eratives, 144; 6, 40
scarcity reflecting, of capital, 100, 198
2, 24, 65, 73, 90, in France, 153
131, 194; in in Mondragon, 183-5
Yugoslavia, 131-40 in UK, 144
revaluation of, in in Yugoslavia, 106
Yugoslavia, 138, 139 Cominform, 98, 141
social (collective) owner- Committees of Management
ship of, 100, 198; in in British cooperatives,
British cooperatives, 196
144; in labour-managed Common Ownership Enterprise,
firm, 67-86; in 145
Mondragon cooperat- Communities of Interest
ives, 183-5; in (Yugoslavia), 141
Yugoslavia, 106 Companies,
sources of, in theory of quoted, 66
labour-managed firm, unquoted, 66
65-86 Competition,
starvation of, 86 imperfect in W-V-M model,
tax on, 24, 100 21-3
INDEX 217
perfect in W-V-M model, 188

7-21 Cooperative Loan Fund
policy, in a labour- (Spain), 182
managed economy, 23 Cooperative principals
Computable base (Mondragon), (Mondragon), 179, 181
185' 186 Cooperative Productive
Concern for others, 51-3 Federation, 144, 202
Constant returns to scale, Cooperatives, producers',
see Returns to scale xi, xii, 1, 24, 195
Constrained labour-managed ability to survive of, 195
firm, 100 asset values in, 95, 196
Contract of association (in Basque, 181
Mondragon), 175, 179, British, xii, 3, 143-52,
181, 182, 185, 186, 200, 193, 195-7, see also
201 separate entry
Cooperage Cooperatives, Cooperage, 134, 157-65,
154, 157-65, 193, 195-7 193, 195-7, see also
asset values of, 160, 161 separate entry
and capital maintenance Cornell School analysis
problem, 160 of, 73-8, 146-7
development of, 159 degeneracy of, 3, 31, 40,
employment in, 159, 77, 78, 154, 194
162-4 democratic governance of,
industry conditions, 160, 195' 198
161' 164 efficiency of, 195, 196,
as labour-managed firms, 198
160' 164 employment in, 195, 196
membership, 160, 162-3 in France, 3, 69, 152-6,
non-member employees in, 193-5, 197-200, see
160' 162 also separate entry
origins, 159, 160 growth of, 195, 196, 198
output of, 161, 162 ideological position of,
shareholdings in, 160 199
structure, 159 income differentials in,
surpluses, 160 195
technical change in, 164 incomes in, 196
and truncation problem, inegalitarian, 32, 41
160 institutional character-
'Cooperation', 165, 166 istics of, 3, 32, 148,
Cooperative Barrel Manufac- 151, 193, 195-9
turing Co., 159, 162, in Israel, 40, 50
164 in Italy, 143
Cooperative, capital, 65, 66 Kibbutz and, 50
Cooperative Development and labour-managed firm,
Agency , 143, 148, 149 143, 145, 148, 160,
Cooperative Law, 164, 170
in France, 154 lifespan of, 196, 198
in Spain, 176, 181, 185, membership fees of, 3,
218 INDEX
196, 197 dividend variability

Mondragon system of, xii, under, 62
3, 51, 151, 174-93, Democratic governance, 195,
197, 198-201, see also 198
separate entry Demsetz, Harold, 114
non-member workers in, 3, Depreciation,
31, 46, 151, 193, 194, of capital, 68, 69, 70,
197, 198 79, 82, 93; in French
non-worker members in, cooperatives, 69, 154;
144' 145' 193 in Yugoslavia, 69,
objectives of, 195 100, 112, 122-5, 135,
performance of, 3, 67, 85, 136, 140
147' 151' 194-9' 202 economic, 69
plywood, 40, 46, 49, 154, and internally-financed
157-9, 166-74, ~ l.m. f., 79, 82
also separate entry retention within firm of,
rent dissipating, 28 69' 70
shares in, 3, 193, 196-9 Differentials in wages in
shelter organisation for, Mondragon system, 187,
202 188
shingle weaving, 156-9, Dimitrijevic, D., 117
165' 166 Dividend,
size of, 195, 196, 198 equality, 28
supporting structure for, in W-V-M model, 7, 8, 12,
202 13
surplus distribution of, Djilas, Milovan, 98
constraints on, 193, Damar, Evsey D., 24, 26, 28,
196-199 29' 31' 170
survival of, 32 Dreze, Jacques, 13, 16
truncation problem in, 68 Dubravicic, Dinko, 65, 66
in United States, xii, 3,
156-74, 196 Eaton, Jack, 174, 176
Cooperative Union, 144, 202 Efficiency,
Cornell School, 66-85, 95, in producers' cooper-
96, 146, 194, 202 atives, 195,196,198
and British producer coop- Effort in labour-managed
eratives, 146-8 firms, 43, 54, see also
and French producer coop- Intensity of work
eratives, 154 Elasticity of output
Costs, with respect to labour,
in labour-managed firms, 13' 74
137 Elma, 189, 193
Credit, see Finance Employment, 195, 196, see
also Membership
Dahl, H. G. , 170 in cooperage cooperatives,
Demand management, 24 159, 162-4
Demand uncertainty in in Mondragon cooperatives,
W-V-M model, 58-63 175, 178-80, 190, 192,
INDEX 219
199 collective, 67, 73-86, 148

of non-members, 3, 31, 46, external, 2, 67, 86-93,
151, 193, 194, 197, 140; repayment period
198; in British coop- for, 88
eratives 151, 194; in in French cooperatives,
Cooperage Cooperat- 153' 154
ives, 160, 162; in internal, 67, 73-86, 88
French cooperatives, opportunity cost of 67,
153-5, 194; in 68' 85' 90
Mondragon, 181, 194; in plywood cooperatives,
in plywood cooperat- 167, 168, 171-3
ives, 167, 168, 170, repayment of, 93, 124,
171, 174; in shingle 127, 133, 135, 137,
weaving cooperatives, 138
165; in theory of supply of, 85, 86
l.m.f., 31, 36,46 Findlay, Isobel, 199
in Yugoslavia, 131 Fitzroy, Felix, 24
Enterprise incentive fund, Fixed costs, changes in,
40-2 in utility maximizing
Entrance fees, see Member- model, 54
ship fees in variable hours model,
Entry of new firms, 24, ll5 64
and W-V-M model, 20 Footwear industry, cooper-
Equilibrium, atives in UK, 146-8, 195
in long run: in labour- Fourier, C., 152
managed economy, 115; Frankovic, V., 128
in W-V-M, 13-21, 74 French producers' cooper-
in short run, W-V-M model, atives, 3, 69, 152-6,
7' 9-12 193-5, 197, 198
Escuela Profesional ages of, 152, 156
Politecnica, 175 auxiliaries in, see Non-
Estrin, Saul, xii, 18-20, member worke~
25, 42, 45, 46, 64, Buchez and, 152
115-17' 130' 131 in building industry, 153,
Eulor's theorem, 14 156
Excess supply of labour, 28 capital in, 153, 154, 200;
External solidarity interest on, 153, 155
(Mondragon), 186, 190 purchase of, 154, 156
characteristics of, 153,
Failure of cooperatives, 198
190, see also Perform- collective funds in, 153,
ance in Mondragon system 154
Fanning, Connell, xi collectivist constraints
Ferguson, C.E., 26 on, 153, 200
Finance, 1, 196 depreciation in, 154
bank, 67, 73 Fourier and, 152
in British cooperatives, growth of, 152, 156
146 historical background to,
220 INDEX
152 ment of non-members

ideo logy of , 199 Historical background of,
investment in, 154; French cooperatives, 152
financing of, 155 Mondragon system, 174,
law governing, 154 175' 178
membership of, 152, 154, United States cooper-
156 atives, 157-9
non-member workers, 152, Holesovsky, V., 6
154, 155, 194 Horvat, Branko, 42, 64, 103,
objectives of, 156 106, 117, 141, 191, 202
in printing industry, 155, Hours of work,
156 in plywood cooperatives,
reserve funds of, 200 171
shareholdings in, 153, 155 supply of, 43, 46-50, 63
size of, 152
and the worker-managed ICOM cooperatives, 144-6,
firm, 154 148-51' 193-7
Friedman, Milton, 6 Ideology, 199
Frisch, Ragnar, 14, 15, 17, Ikerlan, 175
81' 147 Income, 196, see also Wages
Function coefficient, 13 differentials, 187, 188,
Furubotn, Eirik, 6, 67, 69, 195
71, 85, 88, 89, 96, 117, distribution in W-V-M
122, 124, 141, 156, 191 model, 2
Furubotn-Pejovich effect, 71 in labour-managed firm:
distribution of, 2;
Gorrono, Inaki, 181 non-capitalization of,
Gorupic, Drago, 103, 124, 67' 85
Greenwald, Bruce, 44 in Mondragon: foregone, 68
growth in plywood cooperatives,
of producers' cooper- 169, 171, 173
atives, 195, 196, 198; in Yugoslavia, 100-2, 112,
in France, 152, 156 115-17, 125, 131-40
Guipuzcoa, province of, 175, Increasing returns to scale,
190 see Returns to scale
Gunn, Chris, 107,169, 171, Industrial Common Ownership
172 Act, 144
Gutierrez-Johnson, Anna, Industrial Common Ownership
174, 179, 186, 188, 201 Movement, see ICOM
Industrial and~ovident
Hawawini, G., 58, 59, 60, Societies, 144
61' 62 Inegalitarian cooperative,
von Hayek, Friedrich, 6 32' 41
Heathfield, David E., 24 Inflation in Yugoslavia,
Hennepin Cooperative Barrel 102, 124, 128, 140
Company, 160-4 Initial financial contri-
Hey, John D., 58, 63, 66 bution (Mondragon), 182,
Hired workers,~ Employ- 198' 201'
INDEX 221
method of calculating, depreciation and, 179, 82,

183-5 84
Institutional arrangements and French cooperatives,
of l.m.f., 1, 24, 26, 154
32-42' 194 with increasing returns to
Institutional character- scale, 75, 76-8, 81
istics of producers' maximand of, 78, 80, 82,
cooperatives, 3, 32, 84
148, 151, 193, 195-9 never-employ force in, 76,
in cooperage industry, 159 77
in France, 153, 198 new vs established, 84
in Mondragon system, 175, opportunity cost of capi-
179 tal in, 84
in plywood industry, 167, parameter change, response
170 to, 83, 84
in United States, 156 plywood cooperatives, 173
Insurance, social self-extinction forces in,
(Mondragon), 175, 176 75, 76, 79, 81, 82, 83
Intensity of work in l.m.f., supply of funds in, 85, 86
42, see also Effort test of theory of, 146,
Inter-cooperative solidarity 147
(Mondragon), 186, 190 Texas school analysis of,
Interest 84, 85
on capital, 11, 12, 90, under-investment force in,
181; in French coop- 76, 77, 79, 81, 82
eratives, 153, 155; and W-V-M model, 84
in Mondragon cooper- and Yugoslavia, 131
atives, 181, 182, 185, Intra-cooperative solidarity
186, 201; rates in (Mondragon), 186, 190
Yugoslavia, 128, 139 Investment, 2, 66-96
on loans in Yugoslavia, in British cooperatives,
Internal rate of return 146
(IRR), 70-1 in French cooperatives,
Internally-finance d labour- 154
managed firm, 73-86 internal finance of, 2,
and British producer 67. 73-86, 88
cooperatives, 144, in a labour-managed
148, 151 economy, 91, 92
capital maintenance in, in Mondragon system, 177,
80, 85, 86, 92, 93 191
with constant returns to in plywood cooperatives,
scale, 74-6, 78, 81; 171
compared with capi- in theory of labour-
talist firm, 78; com- managed firm, 66-96;
pared with externally- bank credit and, 67,
financed l.m.f., 78; 88-96; capital main-
equilibrium of, 84, tenance problem and,
85' 146' 147 68, 69, 79, 87, 90-6;
222 INDEX
Cornell school analy- compet1t1on policy, 23

sis of, 66-86, 95, 96, demand management, 24
146; Furubotn-Pejov ich entry of firms in, 24, 115
effect and, 71; investment in, 91, 92
required return on, labour market, 2, 12
70-2, 81; Texas school long-run equilibrium of,
analysis of, 66-73, 115
85-9, 95, 96; trade- Labour-managed firms,
able share cooperative altruism in, 52
and, 95; truncation capital in, sources of,
problem and, 68, 87, 65-86
96; workers' planning capital maintenance
horizons and, 68, 71, problem in, 86, 160,
72 170
in Yugoslavia, 100, 101, certainty, and removal of,
117, 135; decisions 24, 26
on, 103-5, 112-14; concern for others in,
financing of, 104, 51-3jconstrain ed, 100
105, 115, 117-40, 142 and cooperage cooper-
Ireland, Norman J., 40, 42, atives, 160, 164
53, 58, 64 costs in, 137
Ishii, Y., 61 depreciation and, 68-70
Israel, cooperatives in, 40, economic, 69; in French
50 cooperatives, 69;
Italy, producers' cooper- internally financed,
atives in, 143 79, 82; retention of,
within, 69, 70; in
Janes, G.M., 165, 166 Yugoslavia, 69
Jones, Ben, 148 economic theory of, 1, 2,
Jones, Derek C., xii, 67, 4, 26, 97, 103, 143,
78, 144, 146, 157-60, 194
163, 165, 166, 195, 196, effort in, 45, 54, see
199, 202 also Intensity ~work
Jovicic, Milena, 2, 131-6, enterprise incentive fund
140, 142 and, 40-2
evaluation of models of,
KER, 149, 150, 195 193, 194
KMB, 145 group: behavioural
Kardelj, Edward, 98 approach to, 55-6;
de Kerchove, A.M., 58 utility maximizing,
Kibbutz, 50 55-8, 64
Kidric, Boris, 98 hours, supply of, to, 43,
Knights of Labor, 157, 158 46-50, 53
Kolkhoze, Soviet, 29 income: distribution in,
Koopmans, Tjalling, 130, 131 2; non-capitaliz ation
of, 67, 85
Labour-managed economy, institutional arrangements
capital pricing in, 131 of, 1, 24, 26, 32-42,
INDEX 223
194 101' 103' 106' 115-40

intensity of work in, 42, Legal obligations
see also Effort (Yugoslavia), 133-8
internally financed, Labour market, see Market
173-86, see also for labour
separate entry Labour supply, see Supply
investment behaviour of, curve of labour
66-96 , see a 1 so Lagun-Aro, 175, 188
Investment Lamers, E.A.A.M., 123
labour: hired, 31, 36, 46; Landsman's Co-ownership,
market, 2, 12, llS; 149-51' 195
supply, 1, 26-32 Lange,Oskar, 4
maximand of, 24, 26, 42-58 Law, Peter J., 40, 42, 43,
membership: in maximand of1 45, 53, 64
34, 42, 43, 46; vari- Leland, H.E., 62
ations in, of, 28-30, Leroy, 200
115' 198 Lifespan of cooperatives,
and Mondragon system, 196, 198, see also
191-3' 198 Survival
planning horizons in, 68, in France, 152, 156
71 ' 72' 83' 86 ' 88' 90 Little Women Cooperative,
and plywood cooperatives, 149' 150
170-1 Logan, Chris, xii, 68,
and producers' coopera- 174-82, 184, 186-93, 201
tives, 143, 145, 148,
160, 164, 170 McCain, Roger, 42
response to parameter Macesich, G., 117
change of, 9, ll McGregor, Andrew, 67
returns to scale in, 13, Machlup, Fritz, 24
14 McLachlan, Hugh, 24
risk and, 58-63 Macpherson, C.B., 96, 141
saving in, 85, 86, 117-28 Managers, see also
shares in, tradeable, Employees, non-member
38-40' 68' 69' 154' in Mondragon system, 188-9
160' 194 in Yugoslavia, 109
socialist, 72 Managing Board (Yugoslavia),
solidarity, minimum 108' 109
mechanism of, 32-4 Market
tra~sfer pricing in, 141 for capital, 13, 65, 89,
Ward-Vanek-Meade model of, 90, 191; in
5-24' 26' 27' 28' 29' Yugoslavia, 130, 131
53' 78 ' 84' 193' 194' entry, importance of, 20
see also separate for labour, 2, 12, 115
entry for shares: in plywood
and worker utility maxi- cooperatives, 168,
mization, 42-54, see 169, 173, 174
also separate entry 1n Yugoslav economic
and Yugoslav enterprise, system, 103-5
224 INDEX
Market socialism, 4 producers' cooperatives,

Marx, Karl, 99 xii, 3, 50, 151, 174-98,
Maurice, S.C., 26 202
Maximand activities of associated
of internally-financed cooperatives in, 178,
l.m.f., 78, 80, 82, 84 180
of l.m.f., 24, 26, 42-58 adjustment of membership
of W-V-M firm, 2, 7, 13, in, 198
18' 42' 59 anticipos in, see Wages
Meade, James, 1 , 4, 5, 11 , base cooperati;;; in, 175
12, 20, 21, 23, 24, 29, capital in:
32' 38' 41 ' 65' 66 collective, 183-5;
Membership founders', 182; in new
of British cooperatives, cooperatives, 182;
144, 145, 148, 195 rate of interest on,
of cooperage cooperatives, 181, 182, 185, 186,
160, 162, 163 201; workers', 182-6,
fees, 3, 196, see also 189, 191, 194
Members capital con- computable base in, 185-6
tribution contract of association
of French cooperatives, of, 175, 179, 181,
152' 154' 156 185' 186' 200' 201
of labour-managed firm, cooperative credit bank
8-10 of, see Caja Laboral
and maximand of l.m.f., Popular
34, 42, 43, 46 cooperative principals of,
of Mondragon coopera- 179, 181
tives, 59, 181,190, 198 distribution of surplus
non-worker, 144, 145, 193 in, 176, 181, 185,
of plywood cooperatives, 186' 189
167' 168 employment in, 175,
of shingle weaving coop- 178-80, 190, 192, 199
eratives, 165 failures in, 190
variations of, 28-30, 115, finance of, 175, 182
198; and compensation, financial contribution of
32-4, 37; and unequal members, initial, 182,
shares, 34-8; in W-V-M 198, 201; method of
model, 8-10, 18, 19, 28 calculating, 183-5
Meriden Motorcycle, 145 foregone incomes in, 68
Michael, Jones, 149, 150 hired workers in, 181, 194
Michel, P.A., 58-62 industrial cooperatives
Milenkovitch, Deborah, 96, in, 175, 178, 180
98' 141 interest rates in, 176
Miovic, Peter, 17, 18, 42, investment in, 191;
81, 122, 123, 128, 147, sources of, 177
191' 192 job evaluation in, 186-7
Mishan, Ezra J., 194 and labour-managed firms,
Mondragon system of 191-3, 198
INDEX 225
managers in, 188-9 L82, 185, 186

new cooperatives in, 181-2 working capital in, 178
new members in, 182 Monopoly
number of cooperatives, in W-V-M model, 21-3
174, 180, 190 profit maximizing, 23
number of members, 181, Montias, J. Michael, 130-1
190 Morgenstern, Oskar, 59
objectives of, 189-91, Mutual Timber Mills Inc.,
192; attainment of, 165
190-91 Muzando, T.R., 58
organization of coopera-
tives in, 175, 179 Nath, S.K., 194
origins of, 174, 175, 178 Neuberger, Egon, SO
performance of, 189-91 von Neuman, John, 59
profits in, 179-181, 185 Never-employ force, 76, 77
research and development New cooperatives,
in, 175 in Britain, 148-9
reserves of, 181-5, 200 in Mondragon, 181-2
retirement of members in, Newberry, D.M.G., 61
193' 202 Niksic steel plant, 113, 114
sales of, 180 Non-member workers, see
second degree cooperatives Employment of non-
in, 175, 188 members
selection procedures in, Normand, Charles, 146-8, 199
so' 179 Normative Economics, 6, 24
social fund of, 181, 185 North Star Barre 1, 156, 159,
social insurance in 175-6 160' 162-4
solidarity objectives in, Northampton Industrial
186' 190 Commonwealth Ltd., see
Spanish Cooperative Law KER
and, 176, 181, 185, Nutzinger, Hans G., 96
188
statutes (Estatos Oakeshott, Robert, xii, 68,
Sociales) of, 179 143-5' 149-51' 152' 153'
structure of, 175 174, 175, 177-9, 182,
Supervisory Council, 186 189, 199-200.
Surplus in, 201; rules Objectives of cooperatives,
governing distri- 195, see also Maximand
bution of, 176, 181, in France, 156
185' 186' 189 in Mondragon, 189-91, 192;
technical education in, attainment of, 190, 191
175 Occum's razor, 86
wages in, 182, 185-93; Oi, W.Y., 70, 83
differentials in, Olympia Shingle Co., 165
187-8 Olympia Veneer, 156, 166,
workers' capital accounts 167, 168, 171, 172
in, 182-6, 189, 191, 'Open door principal'
193, 194; interest on, (Mondragon), 179, 190
226 INDEX
Organization of Associated 122, 124, 141, 156, 191

Labour (Yugoslavia), Pensions in Yugoslavia, 141
106, 113, 141 Performance of producers'
Organization of producers' cooperatives, 3, 67,
cooperatives, 3, 32, 185, 147, 151, 194-9,
148, 151, 193, 195-9 202
in cooperage industry, 159 'cloth cap', 146-8
in France, 153, 198 in Mondragon, 179-81, 185,
in Mondragon system, 175, 189-91, 201
179 in United States, 159, 199
in plywood industry, 167, 'Perverse' supply response,
170 1' 2' 10' 12' 24' 26' 34'
in United States, 156 42, 58, 171, 191, 194; see
Origins of Cooperatives, ~ also W-V-M model
also Historical back- and concern for others, 53
ground to neutralised, 42, 45, 46
in Mondragon system, 174, Pestieau, P., 58
175, 178 Planning horizons, 68, 71,
Osnovnia organizacije 72, 83, 186, 88, 90
udruzanog rada (OOUR), and Yugoslav enterprise,
see BOAL 99' 104' 105
Outp~of cooperage cooper- Plywood cooperatives, 40,
atives, 161, 162 46, 49, 154, 157-9,
Owen, David, 1, 174 166-74
Ownership, capital maintenance
collective, 2, 3, 6; in problem and, 171
UK, 144; in financing of, 167, 168,
Yugoslavia, 106; 171-3
individual, 2, 3 hours of work in, 171
incomes in, 169, 171, 173
Paj, Ivan, 103, 124, 142 investment in, 171
parameter changes, response and labour-managed firm,
to 170, 171
in internally-financed market for shares in, 168,
l.m.f., 83, 84 169, 173, 174
in labour-managed firm, membership of, 167, 168
9-10 non-member employees of,
in W-V-M model, 10-11, 167, 168, 170, 171,
16-23 174
Pareto optimality, 5, 6, 9, organization of, 167, 170
15' 16' 24' 25' 32' 96 ' productivity in, 169
194 risk aversion in, 173
Paris Commune, 152 share of industry output
Parrinello, S., 64 of, 166, 167
Pasic, Najdan, 142 share values in, 166,
Pearce, Ivor, 13, 26 167-8,170,172,1 73
Pejovich, Svetozar, 24, 67, shareholdings in, 167-9,
69, 71, 85, 88, 89, 117, 172, 173
INDEX 227
truncation problem and, truncation problem and, 68

171 and W-V-M firm, 8, 9, 14,
and unemployment, 170 15, 21, 61-3
Popov, S., 142 Profits, see also Surplus,
Positive economics, 6, 24 performance etc.
Pratt, J., 62 in Mondragon, 179-81, 185
Prescriptive economics, 6 in Yugoslav enterprise,
Price change, see also 100
Parameter change Property rights, 2, 83
response of, to: collective, 2
internally financed and optimality, 96
l.m.f., 83, 84; in Yugoslavia, 67, 69, 89,
profit-maximizing 96' 100' 102' 137' 140
firm, 9-11, 16-21; Proudhon, P.J., 152
W-V-M firm, 10-11,
16-21, 21-3 quasi fixed factor, 83
Printing industry, coop-
eratives Ramachandran, R., 58
in Britain, 144, 195 radna organizacija, ~Work
in France, 155, 156 organization
Production function, 8, 14, radna zajednica, see Work
15 community
Cobb Douglas, 147 Refuse collection
and long-run behaviour of cooperatives, 157, 158
w-v-M firm, 18-20 rent on capital, 2, 24, 65,
in risk model, 60 73, 90, 131, 194
for UK cooperatives, 146-7 rent dissipating cooper-
when unequal shares, 34 ative, 28
for Yugoslavia, 130 Research & Development in
Productivity in plywood Mondragon system, 175
cooperatives, 169 Reserve fund,
Profit-maximizing firm, 8, of French cooperatives,
202 200
asset values in, 95, of Mondragon cooperatives,
capital in, 65,66, 68; 181-5' 200
maintenance of, 94, of Yugoslav enterprise,
as inegalitarian 142
joint-stock company, Retirement of workers
65' 66 (Mondragon), 193, 202
and internally-financed Returns to scale
l.m.f., 78 constant: and internally
as joint-stock company, 65 financed l.m.f., 74-6,
optimum employment in, 8, 78' 81
9 increasing: and intern-
and producers' coopera- ally-financed l.m.f.,
tives; in Britain, 75, 76-8, 81
147, 148; in Mondragon in W-V-M model, 13, 14,
system, 189 17, 19, 74
228 INDEX
Risk, in cooperage cooperatives,

Arrow-Pratt index of, 62 160
aversion 59, 62; absolute, in French cooperatives,
62; in plywood coop- 153, 155
eratives, 173 in plywood cooperatives,
compared with: certainty, 166-70, 172, 173
59-61, 63; profit in shingle weaving coop-
maximization, 61-3 eratives, 165, 166
and labour-managed firm, tradeable, 38-49, 68, 69,
58-63 154, 160, 194
reduction, 62, 63 share values in plywood
Robinson, Joan V., 42 cooperatives, 166,
Rowen Onllwyn, 149, 150 16 7-70' 17 2' 17 3
Rusinow, D., 141 Shelter organization, 202
Shingle-weaving cooper-
SCOP (Confederation Generale atives, 156-9, 165, 166
des Societies financing, 166
Cooperatives Ouvrieres membership, 165
des Production), 152, non-members, 165
153, 193, 195, 200, 201 numbers, 165
Sacks, Stephen, xii, 2, 96, shares in, 165, 166
109, 110, 112, 114, 115, origins, 165
141 Shirking, 170
Sandmo, A., 61 Shortage of labour, 27, 28
Sapir, Andre, 130 Singh, S.K., 130
saving Sisevic, Bozidar, 103
in labour-managed firm, size of cooperatives, 195,
85-6, 117-28 196, 198; see also
in Yugoslavia, 117-28, 140 Membership
Schmid, Alan, 96 in France, 152
Scott-Bader Commonwealth, Smidt, Seymour, 69
145' 148-50 Social compacts
Scottish Daily News, 145 (Yugoslavia), 102, 103
Second degree cooperatives Social fund (Mondragon),
(Mondragon), 175, 178 181, 185
Self-extinction forces, 75, Social insurance (Mondragon)
76' 79' 81' 82' 83 175, 176
Self-help Cooperatives, 157 Solidarity, minimum
Self-management agreements mechanism of, 32-4
(Yugoslavia), 102, 103, 'Solidarity',
107, 111-13, 115 in Mondragon, 186, 190
Sen, A., 42, 51, 64 in Yugoslav enterprise,
Sertel, Murat, 38 113, ll5
Share ownership, 3, 193, Split shipyard, 107-9, 112,
196-9, see also Workers' 114
capital accounts Spreckley, David and Anne,
in British cooperatives, 151
144' 145' 151 Staellerts, R., 132, 142
INDEX 229
Steinherr, Alfred, 24, 32-4, cooperatives, 154

42, 45 and internally financed
Stephen, Frank H., 69, 85, l.m. f., 84, 85
89, 93,107, 127, 132, Thisse, J.F., 32-4, 42, 45
137' 138' 142 Thomas, Henk, xii, 68,
Stern, R.N., 156, 15 7 174-82, 184, 186-193,
Sunderlandia, 149, 150 201
Supervisory Council Thomasen, Raymond, 145
(Mondragon), 186 Thornley, Jenny, 143, 153,
Supply curve of labour, 1, 200
26-32 Titograd aluminium plant,
Supporting structure, 202 113' 114
Surplus, see also Profits Traditional cooperatives in
constraints on, distri- Britain, see 'Cloth cap'
bution of, 193, 196-9; transfer pricing, 112, 141
in Mondragon, 176, truncation problem, 68
181' 185' 186' 189 and cooperage cooper-
in cooperage cooperatives, atives, 160
106, 160, 201 and plywood cooperatives,
in Mondragon, 201; govern- 171
ing distribution of, Trylon, 149, 150
176, 181, 185, 186, Tugan-Baranovsky, M.I., 24
189 Tyson, Laura D'A, 6, 42,
Survival of cooperatives, 117. 122-4' 127' 140
32. 95
Svejnar, Jan, 24 Ularco, 178, 187, 190, 193
Swales, J. Kim, 24 ULGOR, 176, 178, 181, 187,
synthetic-positive 188
economics, 24 size and growth, 178
Uncertainty of demand
TUC, Wales, 1, 174, 178 in W-V-M model, 58-63
tax on business fund and dividend variability,
(Yugoslavia), 102, 62
133, 136, 139, 141 Under-investment force, 76,
on capital, 24, 100 77' 79' 81' 81
technical change, see also Unemployment
Research and development and plywood cooperatives,
in cooperage cooperatives, 170
164 in Yugoslavia, 102
technical education in Union Carrajera, 178, 187-9,
Mondragon, 175 193
technology US producers' cooperatives,
'L' type, 75 xii, 3, 156-74, 196
'U' type, 75 asset values of, 100; in
Teodorovic, I., 103, 124 coopering industry,
Texas school, 66-73, 85-9, 160' 161
95 in barrel-making, see
and French producers' Coopering
230 INDEX
in California, 157 170, 171, 174; in

and capital maintenance shingle weaving, 165
problem: in cooperage numbers of, 156: in
cooperatives, 160; in plywood, 166, 167; in
plywood cooperatives, shingle weaving, 165
171 in Oregon, 157, 165
clusters of, 157 organization in plywood
in cooperage industry, industry, 167, 170
154, 157-65, 193, output in cooperage
195-7, see also industry of, 161, 162
separate entry performance of, 159, 199
early general, cluster of, in refuse collection, 157,
157 158
employment in, see also self-help, 157
membership; in cooper- shareholdings in: in
age, 159, 162-4 coopering, 160; in
financing: in plywood plywood, 161-170, 172,
industry, 167, 168, 173; in shingle weav-
171-3; in shingle ing, 165, 166
weaving, 166 in shingle weaving, 156-9,
in foundry industry, 157, 165, 166, 193, 195,
158 see also separate
historical development of, entry;
157-9; in cooperage, shirking in, 170
159, 160; in shingle truncation problem and:
weaving, 165 in cooperage, 160; in
hours of work in plywood, plywood, 171
171 utility maximization, see
incomes in plywood cooper- Worker utility maxi----
atives in, 169, 171, mization
173 in Washington State, 157,
institutional characteris- 165
tics of, 161
Knights of Labor, 157, 158
as labour-managed firms, VOA (La Vererie Ouvriere
160, 164, 170, 171 d'Albi), 200
Late general cluster of, Vahcic, Ales, 67, 128,
157 130-2' 142
market for shares in ply- Vanek, Jaroslav, xi, xii, 1,
wood, 168, 169, 173, 2, 4, 5, 6, 7, 15, 23,
174 24, 42, 46, 54, 5~ 57,
membership of: in cooper- 64, 67, 73, 75, 76, 78,
age, 160, 162, 163; in 79-81, 83, 84, 86, 93,
plywood, 167, 168; in 96. 128' 130-6. 140.
shingle weaving, 165 142, 147, 151, 154, 156,
non-member workers in: in 165, 173, 191, 192, 202
cooperage, 160, 162; Vienney, C., 152
in plywood, 167,168, Virtue, G.O., 159-64
INDEX 231
Wachtel, Howard M., 141 10, 12, 24, 26, 34,

Wage rate 42' 58' 171' 191' 194;
competitive, 8, 9 with uncertain price,
Wages, 187, 188, see also 63
Income differentials price as random variable,
in Mondragon, 182, 185-93; 58-63
differentials in, 187, 188 profit maximizing (or
Ward, Benjamin, xi, 1, 4, 5, capitalist) firm,
13, 24, 29 comparisons with, 8,
Ward-Vanek-Meade Model, 9, 14, 15-21; with
5-24' 26' 27' 28' 29' uncertain price, 61-3
53, 78, 84, 193, 194 returns to scale in, 13,
assumptions of, 6, 7 14, 17' 19, 74
capital in, 136 and utility maximizing
dividend in, 7, 8, 12, 13 model, 43
equilibrium in, 10; short- uncertain demand in,
run, 7, 9-12; long- 58-63; dividend
run, 13-21, 74 variability and, 62
imperfect competition in, 'worker-managed' firm,
21-3 comparison with, 84
income distribution in, 2 Warner, Malcolm, 142
marginal product of Washington State, 157, 165
labour, 7, 8, 12 Webb, Sydney and Beatrice,
market entry, importance 154' 202
of, 20 Wedgewood-Benn, Anthony,
maximizing behaviour, 144' 145
7-10' 24 Whyte, William Foote, 174
membership of, 8-10, Wiles, Peter, J.D., xii, 96,
18-19, 28; restriction 98' 141
of, 9; not short-run Williamson, Oliver E., 103,
variable, 42 106, 114
and Mondragon, 191 Work communities, 110, 112,
monopoly, 21-3 113
multiple inputs, 12 Work organizations
multiple products, 12, 21 Yugoslavia), 110-14
objective function, 2, 7, Worker-managed firm, see
13, 18; Internally-financ~
validity of, 42j l.m.f.
with uncertain price, 59 worker utility maximization,
optimal allocation of 42-54
resources, and, 6, 9, compared with bargaining
15, 16, 24 model, 44
parameter change, response compared with W-V-M model,
to, 10-11, 16-23 43
perfect competition, under response to parameter
7-21 change, 45
perverse (or negative) Workers' attitudes, 151
supply response, 1, 2, Workers' capital accounts
232 INDEX
(Mondragon), 182-6, 189, economic performance of,

191' 93' 194 5, 99, 101, 130, 131
interest on, 82, 185, 186 economic system of, 2,
Workers' Councils 97-106; banking in,
(Yugoslavia), 98, 99, 101, 102, 104, 105,
101, 102, 108, 109, 128; central planning
111-13, 142 in, 98, 99, 103-5;
in BOAL system, 111 collectivization in,
departmental, 108, 142 98, 99; decentraliz-
membership of, 108, 109 ation in, 99, 101,
Workers' self-management 102, 114, 141 ; econ-
(Yugoslavia), xi, 1, 4, omic policy in, 103;
97' 141 etatist period of, 98;
empirical studies of, 142 and labour-managed
institutions of, 106-15 firm, 106, 115, 140;
origins of, 98 markets in, 103-5;
reform of, 107-9 self-management agree-
Working capital (Mondragon), ments in, 102, 103,
178 107, 111-13, 115;
World Bank, 141 social compacts in,
102, 103; withering
Yugoslavia, away of state and, 99
accounting conventions in, economic theory and,
132-7 115-40
Basic Organizations of employment in, 131
Associated Labour enterprise business fund
(BOALs) in, 2, 106-15, in, 112, 123, 124;
141, see also separate allocations to,
entry 117-28' 133' 137' 138'
capital in, see also 142; tax on, 102, 133,
Enterprise business 136' 139' 141
fund; intensity of, enterprises in: assets of,
128; marginal cost of, 100, 112; borrowing
136, 142; marginal of, 87, 28; collective
product of, 128-40, consumption fund of,
142; market for, 130, 142; contractual
131; rationing of, obligations of, 133-8;
128; rents due to, decision-making in,
131-40; revaluation 98' 106-15' 141;
of, 138-9; tax on, depreciation in, 69,
100; underpricing of, 100, 112, 122-5, 135,
128-40 136, 140; incomes in,
communities of interest decisions on, 112;
in, 141 incomes in, dispersion
decentralization of of, 115-17, 140;
decision-making in, investment in, 100,
99' 101' 102 101, 117, 135; invest-
drought in, 141 ments in, decisions
INDEX 233
on, 103-5, 112-14; institutional reforms in,

investment in, 2
financing of, 104, interest rates in, 128,
105, 115, 117-40, 142; 139
as labour-managed investment in, 93, 100-2,
firm, 101, 106, 117' 135
115-40; legal obli- loans: interest on, 133,
gations of, 133-8; as 135, 137, 140; repay-
Organizations of ments in, 93, 124,
Associated Labour 127, 133, 135, 137,
(OALs), 106, 113, 141; 138
Managers in, 109; pensions in, 141
Managing Board in, prices in, 101
108, 109; and plan- property rights in, 67,
ning, 99, 104, 105; 69' 79' 89' 93' 96'
profits of, 100; 100' 102' 137' 140
reserve funds of, 142; right use of in, 100
saving in, 117-28, Russian embargo on, 141
140; solidarity split between Soviet
within, 113, 115; Union and, 98, 99
transfer prices self-management in, xi, 1,
within, 112, 141; 4, 97, 41; empirical
wages in, 100-2, 125, studies of, 142;
131-40; work com- institutions of,
munities in, 110, 112, 106-15; origins of, 98
113; work organiz- reform of, 107-9
ations in, 110-14; unemployment in, 102
workers' councils in, usufruct in, 100
98, 99, 101, 103, 108,
109
inflation in, 102, 124, Zafiris, Nicos, xii, 68, 93,
128' 140 94' 95' 96

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THE ECONOMIC ANALYSIS OF PRODUCERS'

In recent years, an increased interest has been shown in producers'

Frank H. Stephen is a Senior Lecturer in Economics at the

THE PERFORMANCE OF LABOUR-MANAGED

First published 1984 by

ISBN 978-1-349-06250-8 ISBN 978-1-349-06248-5 (eBook)

List of Figures viii

2 The Basic Model 4

3 Modifications of the Basic Model 26

4 Finance and Investment 65

6 Producers' Cooperatives in Western

2.1 The basic model 9

4.1 A loan financed investment project 89

This book has its origins in some fifteen years of interest

formance of a number of groups of cooperatives which have

The author and publishers gratefully acknowledge the

Figure 2.2 from J.E. Meade (1971) 'The Theory of Labour-

In this book it is hoped to draw together and synthesise the

which will modify the behaviour predicted by the W-V-M

The final chapter of the book examines the experience of

In contrast to the theory of market-socialism developed by

cations of this basic model, it seems reasonable to refer to

she calls his 'intermingling of positive analysis and norma-

(a) management is by the majority rule of all of those

The members of the enterprise are taken as selecting those

Maximise s (pX-wL-rK)/L (2.1)

subject to the production function

where s is surplus per member,

i.e. where pXL = s + w (2.3)

where XL is the marginal product of labour.

where y may be defined as income per member (or the divi-

FIGURE 2.1 The basic model

Figure (2.1), 1 2 is shown as the employment level of this

static partial equilibrium framework (see below).

d(pX/L)/dL d(rK/L)/dL (2.6)

therefore pX1 L - pX -rK,

therefore pX1 > (pX - rK)/L = y.

FIGURE 2.2 Comparative static responses of the basic model

A rise in the interest payment on capital is shown by a

the right-hand side of (2.5). A change in price affects the

with the literature on the labour-managed firm extends only

The former is simply a repet1t1on of (2.4), whilst (2.7) in-

or XLL/X + ~K/X = 1. (2.9)

Now, XLL/X = eL' where eL is the elasticity of output with

scale when it is in long-run equilibrium. This result may be

Along the ray OA, output is increasing, and it is assumed

production function, OA may be assumed to cut each isoquant

FIGURE 2.4 The long-run equilibrium of the W-V-M firm

W-V-M firm. Thus, given the same technical conditions usual-

FIGURE 2.5 Effect of a price increase on profit-maximising

firm is that at which

XL= w/p, ~ = r/p,

at the new product price. This is shown by the intersection

Without specifying the nature of the production function in

This may be rewritten as

K = pX/r - yL/r. (2.10)

(2.10) is the W-V-M firm's equivalent to the isocost line of

FIGURE 2.6 Adjustment to long-run equilibrium of the

price rises. The effect on output depends on what Estrin

fidently that if the partial derivative of scale with

risen. Meade sees this as a question of 'new firm formation

where X= f(K,L), but now

where v is a shift parameter.

In the short run, when capital is fixed, the first-order