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Equilibrium unemployment as a worker insurance device: wage setting in worker owned enterprises

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Abstract

Worker co-operatives have been shown as characterised by higher wage volatility while providing higher employment stability compared with investor-owned firms (IOFs). These stylised facts show co-operatives’ stronger tendency to preserve employment more than maximising members’ incomes or profits. Most empirical tests in different national contexts also provide evidence of lower wages in worker co-operatives than in IOFs. Such evidence is unexplained to date. To fill this explanatory gap, we resort to the Shapiro and Stiglitz (Am Econ Rev 74(3):433–444, 1984) model of unemployment as a worker discipline device. Given lower agency costs, more efficient monitoring and the absence of wage premiums compensating for the expected costs of contractual failures, we show that equilibrium wages in co-operatives can be lower than in IOFs, while employment, ceteris paribus, is always higher. We draw the following conclusions: (1) Equilibrium unemployment can be at least partly interpreted as a negative external effect of labour contract failures and bilateral opportunism. (2) Shapiro and Stiglitz’s (1984) result is a special case of a broader class of equilibria characterised by contractual imperfections in the agency relation. (3) Various ownership forms can have different impacts on equilibrium unemployment and wages.

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Notes

  1. The neo-classical economic theory of the self-managed firm was formulated for the first time by Ward (1958) and the literature that followed his article has delineated different ideal types of self-managed firms: the Worker managed firm (WMF) where the social (state) ownership of capital is exclusively internally financed (Furubotn and Pejovitch 1970); the labour managed firm (LMF) in which capital is exclusively financed by borrowing (Vanek 1970).

  2. For the sake of simplicity, we equate worker co-operatives with worker-owned firms and capitalist enterprises with investor-owned firms.

  3. This equilibrium condition implies that co-operatives reduce employment in the presence of higher prices (Ellerman 1986). This second effect corresponds to the well-known “perverse” reactions of LMFs to market stimuli, implying a downward sloping supply curve. The existence of a perverse supply effect has been refuted by several empirical tests (e.g., Bonin 1981; Montias 1986; Nantz and Sparks 1990; Bartlett et al. 1992), which has led to increasing criticism against the assumptions and the implications of the Ward model (Ellerman 1986; Horvat 1986; Bonin et al. 1993; Tortia 2003). In most tests, WOFs appear to have a more rigid but not downward sloping supply curve, showing their stronger tendency to protect employment levels also in the short run. On the contrary, the former implication remains largely unquestioned, even though it does not generally pass the test of empirical verification (e.g., Bartlett et al. 1992; Bonin et al. 1993).

  4. Evidence of higher wages in co-operatives is found in a few studies and favoured by production technologies characterised by decreasing returns to scale (cf. Burdín and Dean 2009; Burdín 2016; Dean 2018 on Uruguay).

  5. The ratio of managerial pay to unskilled manual pay is almost 75% higher in private firms than in co-operatives (ibid. 110).

  6. Similar results concerning worker productivity and wage equity have been obtained in experimental settings (Frohlich et al. 1998).

  7. Laid-off members were still paid 80% of their wages.

  8. Italian law (n. 381/1991) defines social co-operatives as multi-stakeholder co-operatives, and they are not required to include workers in their membership base. However, the majority of social co-operatives can de facto be considered worker co-operatives since workers represent either the only or the dominant stakeholder group in the membership.

  9. This refers to Holmstrom’s (1982) definition of a “budget breaker” as a third party that appropriates the residual of production and monitors the team.

  10. The heterogeneity of members’ preferences is reported to substantially increase governance costs (Hansmann 1996; Belloc 2017). Although this problem is not central to our study, and our theoretical model is ill-suited to deal with it, we provide evidence that decision-making costs can be inflated by complex, time-consuming and contrasting participation processes. Consistent with Ostrom’s (1990) view, we claim that co-operatives can reduce these emerging cost categories by developing effective governance (cf. Borzaga and Tortia 2017). Supporting other authors’ positions, we also hypothesise that co-operatives tend to self-select in sectors of activities where it is possible to keep pay scales compressed and have a homogeneous workforce (Belloc 2017).

  11. These contractual failures require the introduction of both legal regulation and self-regulation, aimed at developing multi-stakeholder governance, for example, different forms of co-determination (Blair and Stout 1999). Direct worker control is understood as a radical solution to the same problem, which would imply disregarding the employment relation itself (Jossa 2014).

  12. The one-period expected utility is expressed as the sum of the utility of the current period plus the probability of state change multiplied by the change in the expected utility.

  13. The reason is that increases in \({\bar{w}}\) tighten the NSC, so all payments are made in the form of \(w\) rather than \({\bar{w}}\).

  14. In the case of constant returns to scale, \(F'(L)L = F(L)\), the market equilibrium is optimal and in A in any case.

  15. In general, it is not possible to ascertain whether the equilibrium entails too much or too little employment, and in the case of constant returns to scale, the competitive equilibrium involves too much monitoring and employment. The reason for the result is that each firm believes that the only instrument under its control to reduce shirking is to increase monitoring, but reducing employment enables society to save resources and to offset the loss from the reduced employment (Shapiro and Stiglitz 1984: 441).

  16. As stated, Bowles and Gintis (1987) demonstrate that in worker co-operatives, the risk of worker opportunism, with workers reducing their effort when not properly controlled, is lower than in capitalistic firms, and mutual monitoring is a stronger instrument that increases the probability of successful monitoring.

  17. We could extend the analysis to the effects of the reduced shirking on the levels of effort in co-operatives, measured by the second part of Eq. (7) as an incentive to increase monitoring.

  18. The demand for higher employment protection in exchange for lower wages, as in WOFs, would instead be ineffective since the employers would retain their decision-making power, hence the possibility to start too risky investment projects in order to increase the expected net income. Hidden actions would again increase the probability of workers’ layoffs.

  19. We assume that parameter d, which represents the impact of contractual failures on the NSC, is separable from the other parameters of the model; in other words, it is independent of effort and unemployment.

  20. There is only the case where the equilibrium in WOFs is associated with higher levels of wages due to different diminishing returns to the variable factor and different levels of capital that involve an APL curve positioned in a manner that the equilibrium corresponds to wages higher than wI.

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Acknowledgements

The author writes in her personal capacity. The content of the paper is the sole responsibility of the author and any opinions expressed herein should not be taken to represent an official position of the Parliament. We are grateful to Avner Ben-Ner, Carlo Borzaga, Alessandro Fedele for useful comments and suggestions. Usual disclaimer applies.

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Authors and Affiliations

  1. Department of Political Science, University of Naples Federico II, Via L. Rodinò 22, Naples, Italy

    Marina Albanese

  2. European Parliamentary Research Service, Bruxelles, Belgium

    Cecilia Navarra

  3. Department of Economics and Management, University of Trento, Via Vigilio Inama, 5, 38122, Trento, Italy

    Ermanno Tortia

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  1. Marina Albanese
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  2. Cecilia Navarra
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  3. Ermanno Tortia
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Correspondence to Marina Albanese.

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Albanese, M., Navarra, C. & Tortia, E. Equilibrium unemployment as a worker insurance device: wage setting in worker owned enterprises. Econ Polit 36, 653–671 (2019). https://doi.org/10.1007/s40888-018-00139-z

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