Exploitation among and by the Residual Claimants in the Cooperative

Recall from chapter 4 the organizational structure of the worker coopera­tive in a market socialist system. All and only the workers are residual claimants and ultimate decision-making authorities.

This organizational structure creates numerous opportunities for exploitation. Moreover, plausible stories can be told about how those opportunities could be seized. By contrast, either these opportunities do not exist in the classical capitalist firm and the open corporation, or else there are superior damage-control mechanisms in place that limit the extent to which these opportunities can be seized. So it will be argued in the remaining sections of chapter 6 and in chapter 7. The purpose of this section is to argue that some workers, in their capacity as ultimate decision makers and residual claimants, would exploit other workers within the cooperative, whether the cooperative is small or large.

The workers’ status as ultimate decision-makers and residual claimants means that they get to decide how to divide up the revenues of the firm net of nonlabor expenses. How will they do it? Let us suppose, just for the sake of discussion, that they decide to divide it up equally. Under these circum­stances, each worker in the firm is getting the same income, yet the value of each worker’s contribution is obviously not the same. In the diamond-cut­ting cooperative, for example, those who sweep the floors make a much less valuable contribution than those who make the cuts. (How diamonds are cut makes an enormous difference to their value.) In a purely egalitari­an distribution, the ratio of income to the value of workers’ respective con­tributions would vary considerably from worker to worker within the firm.

Let us further suppose that all the workers’ cooperatives are like this. By hypothesis, the private (i.e., capitalist) sector and the state sector are insignif­icant in a market socialist system, so the workers with talent and ability really have no feasible alternative but to be members of cooperatives. So they (or at least most of them) effectively have nowhere else to go. It follows that in a society composed of radically egalitarian worker cooperatives, workers with talent and ability would be exploited by those with neither.

But why suppose that a market socialist society would consist of purely egalitarian firms? Indeed, it seems that the workers would have one com­pelling reason not to vote for equal distribution of income, namely, that those workers with especially valuable talents and abilities would go else­where. Without key personnel, the firm could not survive. This is what lies behind Saul Estrin’s speculations quoted in the final subsection of chapter 2 about the market position of those with special skills. On his view, income differences within firms would not disappear; those differences, especially as they pertain to managers, would simply be reduced relative to what one finds in capitalist societies. If the workers collectively chose an unequal dis­tribution that roughly matches income to the value of workers’ respective contributions, the skilled workers would be getting the value of their contri­butions and so would not be exploited.

It is probably correct to say that an equal distribution of income would not characterize most cooperatives, but this just refocuses our speculations: would the income distribution that emerges from the discussions and bar­gaining among the workers approximate equality closely enough that some of the workers would not be getting the value of their respective contribu­tions? Or would the workers be paid approximately in accordance with the value of their contributions, thereby precluding this form of exploitation?

The short answer to these questions is that it is difficult to know with certainty what would happen.

To begin with the empirical evidence, some studies of existing coopera­tives suggest that income differentials are noticeably smaller than they are in more hierarchical organizations.⁵ Second, an exhaustive study of wage differentials in academic departments in colleges and universities found that departments that are similar in organizational structure to coopera­tives have more egalitarian wage structures than hierarchically organized departments (Pfeffer and Langton 1988, 592-94). Finally, there is signifi­cant wage compression in the Mondragon firms (Thomas 1982, 136).⁶ All of this evidence is, of course, not conclusive for the question at issue, since existing cooperatives and the more egalitarian academic departments may not tell us what the distribution of income would be like in a market social­ist system because the latter is so profoundly different from any existing system. This evidence is, nevertheless, suggestive.

Common sense and casual empiricism lend additional support to the judgment that income distribution within the market socialist cooperative would probably be relatively egalitarian. There is a well-known tendency for human beings to be biased when judging in their own cases. In a mar­ket socialist cooperative, this means that workers without relatively scarce and valuable skills (who will be in the majority) would tend to overestimate the value of their own contributions.⁷ Because the workers are collectively the ultimate decision makers, these misjudgments would be reflected in the criteria that determine the distribution of the firm’s net income.

Another factor that would conspire to lead unskilled workers to overes­timate the value of their own contributions is that in a market economy, self-esteem is often tied to relative incomes.⁸ To put this point more starkly and less charitably, in a commercial society, which market socialism surely is, people tend to confuse economic worth with personal worth or worth as a human being. Economic success or failure is conflated with success or failure as a person. A relatively egalitarian income distribution within the firm would be less injurious to the self-esteem of the unskilled workers.

Finally, and in a related vein, most people are not very adept at—and, indeed, are often plainly incapable of—marginalist thinking about eco­nomic value.⁹ For example, farmers in search of subsidies admonish us to imagine what the country would be like without farmers, when the real question is what the country would be like if the current number of farmers was reduced by a few, including, quite possibly, the ones who are asking for subsidies.

None of this predicts the degree of equality that would result from the vote within the firm. The discussions and bargaining might be extremely complicated, and there is no way to predict the exact outcome. However, this discussion has pointed to some likely factors that would influence how the unskilled workers, who are in the majority, would perceive the situation. Although it is not possible to predict the precise distribution of income that would emerge over time, it is likely that the disproportionalities between income and value of contribution would be nontrivial if only because the biases responsible for them are nontrivial.¹⁰ If this is true, then the failure of reciprocity requisite for exploitation would exist.

In fact, the most likely scenario is that if market socialism were inaugu­rated, the relative incomes of skilled and unskilled workers within the firm would not change very much. (By contrast, management’s income might well tumble significantly.) However, as the workers or their representatives on the workers’ council repeatedly voted on income or the criteria by which income is determined, the systematic bias just mentioned would emerge, thereby resulting in a decline in the relative income of skilled workers. Though strict equality would probably not be the end result, at some point, the disproportionality between the value of their respective contributions and their respective incomes would entail a failure of reciprocity. If this happened in all or nearly all the firms, the skilled workers would effectively have nowhere else to go. According to the account of exploitation devel­oped in chapter 3, they would be exploited by their less skilled coworkers.

How might the defender of market socialism respond? At least two responses come to mind. One would be to concede the point about the rela­tive flattening of incomes but go on to argue that the discussion assumes an excessively narrow, economic conception of the benefits of working in a cooperative. It might be pointed out that what the worker receives from working in the cooperative is not merely income. There are other, nonpe- cuniary benefits that must be taken into account; when these other benefits are considered, there is no overall failure of reciprocity. The other response would be to deny that this egalitarian tendency would, in fact, work itself out. It might be argued that markets in skilled labor could and would oper­ate to check this tendency toward equality in the distribution of net income. In other words, it could be admitted that an excessively egalitarian distrib­ution of income would emerge if nothing else interfered, but that in point of fact, market forces would do just that. The services of skilled workers would be bid up to the point where they would be remunerated approxi­mately according to the value of their contributions. At the very least, there would be no systematic difference between free enterprise systems and market socialist systems on this score. Let us consider each of these objec­tions in turn.

The first calls attention to the nonpecuniary benefits of working in a cooperative. Such benefits may well exist and may be substantial. To ignore them would be like complaining about the high cost of living in the San Francisco Bay area without mentioning the substantial benefits that attend living in that pleasant environment. For evidence about the cooperatives, one only need to turn to Mondragon, where there is significant wage com­pression, yet the labor force is relatively stable (Thomas 1982, 136). Since the workers have alternatives in the noncooperative sector, there must be nonwage benefits that make it worth their while to stay in the cooperatives.

There are three problems with this response, however. First, the evi­dence from Mondragon may not provide much evidence about how most skilled workers would view their situation in a market socialist system. There is the selection bias mentioned in the last section. Because of this, the skilled workers in Mondragon might be the type who find the benefits of working in a cooperative adequate compensation for the effects of wage compression. It may be that most skilled workers in a market socialist sys­tem would not find the attractions of cooperatives adequate compensation for the diminished income they are forced to accept, just as not everyone finds the considerable attractions of the San Francisco Bay area sufficient compensation for the exorbitant cost of living there.

Second, the wage compression in a market socialist system might be sig­nificantly greater than what is found in the Mondragon cooperatives because in a market socialist system, there would be very few alternative employment opportunities in the non-cooperative sector. Freed from the discipline imposed by alternative organizational forms, a highly egalitarian wage structure might evolve. Independent of all these considerations, how­ever, there is one problem that cannot be avoided. Presumably, the benefits that attend membership in a cooperative are available to all workers, skilled and unskilled alike. Assuming these benefits are equally (or at least ran­domly) distributed, the disproportionality between the value of the skilled worker’s contribution and what he receives would still exist.

Finally, the concern of this book is with economic exploitation, not exploitation in some broader, more generic sense. Economic exploitation (and, for that matter, distributive justice) is concerned with the distribution of economic wealth and income—exchangeable goods and services and the claims thereto. There is a utopian tradition in socialist thought, exemplified by Marx’s occasional musings about life in communist society, in which the economic sphere is downgraded in importance or significance. In commu­nist society, everyone’s needs are met, and the economic system has done its job by noon, or even by ten o’clock in the morning. I have argued in detail elsewhere that this scenario could not exist for as far into the future of the human race as it makes sense to look (Arnold 1990, 167-81, chap. 8). One of the attractions of market socialism is that it constitutes a decisive break with that utopian strain in the socialist tradition. By exhibiting a willingness to talk seriously about how to manage scarcity, market socialism takes eco­nomics—and the material wealth economic systems distribute—seriously.

Though the noneconomic benefits of a market socialist system might be substantial and, indeed, constitute an important reason to prefer it to a free enterprise system, economic benefits, construed broadly to include the reduction or minimization of economic exploitation, are part of the market socialist conception of the good society. So it was argued in chapter 2; this topic will be taken up again in the final section of chapter 8.

Consider now the second objection. It might be argued that markets in various kinds of skilled labor would prevent the development of an exploitative income structure within the firm. If skilled workers are being underpaid relative to the value of their respective contributions at a given firm, other firms would have an incentive to bid up the price of their ser­vices, probably by offering them bonuses to switch. The compensation com­mittees within these cooperatives would simply have to tell the rank-and- file that the firm must make adequate counteroffers to retain these work­ers. Incomes of skilled workers would thereby come to reflect more accu­rately the value of their contributions. A perfect match between income and the value of their contributions would probably not be achieved, but it would at least be approximated to the point where reciprocity would be established and exploitation thus eliminated or prevented.

What makes this response especially attractive is that it parallels exactly the kind of argument that a defender of the free enterprise system would give in response to the charge that workers are exploited in that type of system. After all, the boss in the classical capitalist firm is the ultimate deci­sion maker and sole residual claimant, and managers in the open corpora­tion who make wage offers are often substantial residual claimants—so there is the same conflict of interest between workers and those who decide on their pay. If these type of organizations pay their skilled workers about the value of their contributions, it must be because market forces prevent them from paying much less. The same thing would happen in a market socialist system.

The problem with this response is that it ignores four factors that would prevent the robust operation of labor markets in a market socialist econo­my^—factors that do not impinge on a free enterprise system. Because labor markets would not operate as well in a market socialist system, the egalitarian tendency described would have some room to work itself out.

The first factor is rooted in the fact that the workers are collectively both the ultimate decision-making authorities and the residual claimants. A cooperative is unlikely to delegate to its management decision-making authority when it comes to adding workers, because the addition of new workers can significantly affect their own income, since all workers are residual claimants. Assuming that decision making is democratic, this means that a consensus must be reached among a relatively large group that it is in the firm’s best interests to bring new members on board before expansion will take place. By contrast, in capitalist firms it is unnecessary to achieve wide consensus on the need to expand: only one person or a small group of people needs to be convinced that it is a good idea. This suggests that cooperatives in a market socialist system would be slower to expand than their free enterprise counterparts.

Second, market socialist firms would be slower to let workers go when the market called for it. If the cooperative structure reduces alienation as advertised, it will do so, at least in part, by providing greater job security for its members. It is also likely that workers would be able to insist on more elaborate due process safeguards than are found in capitalist organi­zations to prevent firings motivated by office or shop floor politics. For these reasons, in a market socialist system it is likely that there would be fewer layoffs than one would find in a free enterprise system.

These two factors mean that cooperatives in a market socialist system would not be as responsive to changing conditions as capitalist firms in a free enterprise system are. One consequence of this is that labor markets would be much thinner or less robust. Firms are simply not hiring and lay­ing off as much as they would be in a free enterprise system.

The third factor is that it will be harder to start new firms than in free enterprise systems because entrepreneurs who believe they see a profit opportunity will have to share any profits they make with all the other workers in the firm. If it is more difficult to start new firms, then, all else equal, there will be fewer opportunities for workers to leave their present place of employment.

The final factor that would reduce labor mobility in comparison to free enterprise systems is the absolute uncertainty that all workers face about their annual income. Workers’ income does not come solely from their labor. As residual claimants, they are entitled to a share of the firm’s total income net of nonlabor expenses. This means that a skilled worker in a marginal firm may make less than an unskilled worker in a more prosper­ous firm. Because of the inherent uncertainties of a market economy, the net income of all firms will vary from year to year. This means that all workers’ income will fluctuate, though the firms may adopt some internal distributional measures to moderate the swings from one year to the next. For example, they might set wage rates for job categories and then pay out residuals every quarter like the quarterly dividends that corporations pay to stockholders. Whatever the particulars, however, there is no getting around the fact that the remuneration a worker receives will vary more than the remuneration of his counterpart in a free enterprise system.

This feature of a market socialist system will make it more difficult for workers to evaluate offers from other firms. These offers would have to be couched in terms of bonuses or perhaps shares of income rights in the firm, but it will be unclear what these offers really mean in a dynamic market economy. This uncertainty is dramatically compounded by the lack of a stock market in a market socialist society. One function of a stock market is to offer a market-based assessment of a firm’s profitability, especially esti­mates of future profitability. Since ownership shares in the cooperatives are not bought and sold, there is no market-based assessment of a firm’s prospects. Though there may be financial reports about past performance, those reports offer a highly incomplete or misleading guide to the future; a prospective worker considering an offer of employment would be gullible indeed to rely too much on what the firm says about its own future prospects. The ignorance and uncertainty is asymmetrical, however, since most workers (especially the skilled ones) will know—or will think they know—the prospects of their own firm better than that of other firms they may be asked to join. This informational asymmetry will make workers more reluctant to change jobs.

Returning now to the situation of the skilled workers, at some point, of course, they would be willing to change jobs, and at some point, existing firms contemplating expansion would be willing to hire them. In addition, new firms will be started, even if less frequently than in free enterprise sys­tems. So, it is not as if labor markets would not exist. This is why a purely egalitarian income distribution would probably not result or would be unstable if it did. Nevertheless, these labor markets would not be as robust or active as labor markets in a free enterprise system. The relevance of all this to exploitation is that firms that pay their skilled workers less than they are worth (for reasons indicated, this is likely to include most cooperatives) would be relatively insulated from the pressures of labor markets. In conse­quence, the tendency toward equality that operates within the firm would have some room to work itself out. This would insure a failure of reciproci­ty in the relationship between the skilled and the unskilled workers within the firm. Given that many of these skilled workers would have no feasible alternatives, it follows that they would be exploited.

By contrast, in a free enterprise system this systemic problem does not arise because the four factors are absent. Decisions to expand or contract the firm’s workforce are made by one or a small number of people. Whether or not they tend to do a better job at this than cooperatives is irrelevant for present purposes. The crucial point is that labor markets are likely to be more active than in market socialist systems because of the deci­sion-making mechanisms and the incentive structures in the respective sys­tems. Because successful entrepreneurs can keep the pure profits that they earn, new firms will be started more easily than under market socialism. Finally, since workers have no nonwage income, they are better able to evaluate alternative pay offers. Of course, in a free enterprise system, labor markets, like other markets, are not always competitively efficient; some workers will be exploited in any free enterprise system. However, in a free enterprise system (without any qualifying predicates), unlike a market socialist system, there are no distinctive structural features that tend to push skilled workers’ pay below what it would receive in a competitively efficient market.

To this comparative assessment it might be objected that according to the account of the market process given in chapter 3, stagnant markets are vulnerable to successful entrepreneurship, so that the market process ought to be able to rectify the situation. The problem is that vulnerability to successful entrepreneurship can be very hypothetical (i.e., difficult to

“exploit”) if structural impediments prevent entrepreneurs from seizing the profit opportunities that stagnant markets represent. State-enforced monopoly is one such impediment, and the preceding paragraphs have described others. It is not at all obvious how an entrepreneur could get labor markets to function better, given the kind of institutional restrictions a market socialist system would impose.

These considerations do raise other possibilities that merit some attention. Since market socialism is a competitive market economy, evolutionary pres­sures that tend to minimize transaction costs in a free enterprise system should also be at work in a market socialist system, at least so far as the general framework of market socialism permits. The last section of chapter 5 briefly discussed some of the methods that have evolved in free enter­prise systems to protect workers’ quasi-rents. Of these instrumentalities, perhaps the most important are unions. Might not unions develop among the skilled workers in a market socialist system to protect their quasi-rents? Upon reflection, there seems to be no reason, in principle, why they would not; if the preceding account about what might happen initially in a market socialist system is at all plausible, they probably would. However, this possi­bility raises some puzzles and complications. If some subgroup of the workers in a cooperative unionize and threaten to strike, whom are they threatening and what are they bargaining for? They are, after all, part of the larger group that has ultimate decision-making authority and residual claimant status. Presumably, they would want more income at the expense of the rest of that group. This could take the form of increased residual shares; but it could also take the form of a guaranteed wage in exchange for which they would give up, or allow to be attenuated, their status as residual claimants. Whatever form this took, their nonunionized fellow workers would surely begin to have some concerns about the vulnerability of their own quasi­rents. One can easily imagine them saying to each other, “Might not our unionized fellow workers overestimate the value of their contributions when formulating wage demands? Maybe we ought to form a union ourselves.”

If this were to happen, complex bargaining would ensue, and while there is no way to predict the exact outcome, there is no reason to think that the outcome would match income to the value of contribution. Bargaining power, which would crucially depend on how exposed a group’s quasi-rents are, would determine the outcome. Although all labor markets are relatively stagnant in a market socialist system for reasons indi­cated, some are more stagnant than others. It is a safe guess that generally speaking, those with more specialized talents and abilities would be more exposed than those with less specialized talents and abilities. In any case, the opportunities for all workers would tend to be fewer and more inacces­sible than they would for workers in a free enterprise system because the latter does not have the structural barriers to well-functioning labor mar­kets found in a market socialist system.

The adversarial climate that would be found in the unionized coopera­tive would also bode ill for reducing alienation and encouraging attitudes of trust and solidarity necessary for dampening the penchant for oppor­tunism. This climate is traceable to the fact that the workers are collectively the residual claimants and ultimate decision makers, which in a cooperative means that all the income of the firm, net of nonlabor expenses, is up for grabs. Depending on whether they think of themselves primarily as individ­uals or as members of a subgroup, they are in a zero-sum game with other individuals or other subgroups over this revenue. Obviously, this problem does not afflict the classical capitalist firm, since only one person is the residual claimant and the wage fund is more completely determined by market forces.

Similar forces confront the open corporation, which also allow it to avoid or minimize this problem with its workers. The open corporation avoids a parallel problem among equity owners because of proportional sharing rules among shareholders. As Jensen and Meckling say of the open corporation: “It severely restricts the opportunities for any individual shareholder or group of shareholders to reallocate wealth away from other shareholders to themselves. The proportional sharing rules which govern distributions [of residuals]... make it difficult to benefit some shareholders at the expense of others” (1979, 494).

Theoretically, the cooperative could precommit to a distribution rule that would reflect shadow market prices for labor services, but in practice, this could not happen because in the absence of reasonably well-function­ing labor markets, there is no way to know what those prices should be. The operation of reasonably well-functioning markets is a discovery process that gropes toward revealing what the market clearing price really is. Absent such markets in human labor, it is highly unlikely that firms could (1) know what those prices would or should be or (2) make the neces­sary adjustments required by the frequent changes in the underlying deter­minants of scarcity value. To sum up, the fact that the workers are collec­tively the residual claimants and get to decide how to divide up the net income of the firm (i.e., the income of the firm net of nonlabor expenses) creates opportunities for workers to appropriate the quasi-rents of their fel­low workers who have nowhere else to go. In short, it creates opportunities for exploitation—opportunities that tend to be foreclosed or minimized in a free enterprise system by the more robust operation of labor markets.

The fact just noted that firms in a market socialist system would not be as sensitive to changes in market conditions means that all product markets in a market socialist system would tend to be less responsive to changing con­ditions that their free enterprise counterparts.¹¹ This fact of shared resid­ual claimancy creates opportunities for exploitation in a market socialist system that either do not exist or would be minimized in a free enterprise system. The reasoning can be explained as follows. Suppose that demand for a cooperative’s product increases and as a result of some combination of the four factors the cooperative decides not to add additional workers. They might, for example, try to increase production by substituting capital for labor, but this will not always be profitable, and there will usually be time lags until new capital investments come on stream. If all firms in this market reach the same decision, the rational thing for each firm to do would be to raise its price in response to this increase in demand. By con­trast, firms in free enterprise systems would be more likely to hire addi­tional workers, and increase production but not increase price, since these retarding factors are not operating in this type of system.

With regard to the market socialist system, in subsequent exchanges in this market, cooperatives would be exploiting their customers, because the price is not competitively efficient, and their customers have nowhere else to go. The price is not competitively efficient because this market is vulnera­ble—albeit hypothetically—to successful entrepreneurship. Its vulnerability consists in the fact that instead of raising prices, some firms could—and pre­sumably would—hire nonvoting wage laborers to meet the increased demand (assuming there are people willing to be “wage slaves”) if they were legally permitted to do so (which they would not be). The legal prohibition on wage labor acts like a state-imposed prohibition on competition with a monopolist. However, instead of ruling out all competition, it simply rules out competition from organizations that do not have the prescribed form. As in the case of the monopolist, the customer has nowhere else to go and is exploited when she pays the higher price.

The defender of market socialism has a response to this, which Saul Estrin explains as follows: “If existing cooperatives do not react adequate­ly to changes in consumer demand, the resulting misallocations can be tackled by brand new cooperatives. And the system provides economic incentives, in the form of higher incomes, to entrants attracted to meet shortages” (1989, 176-77). Entrepreneurship is exercised, then, by the formation of new cooperatives. The problem with this response is that it assumes that new cooperatives can be formed relatively easily, when, in point of fact, this is not the case. There are two reasons for this, one of which has already been discussed.

First, as has been pointed out, someone has to exercise the requisite entrepreneurship in spotting and acting on these profit opportunities. Because of the structure of the cooperative, however, successful entrepre­neurs in a market socialist system must share with their fellow workers any pure profits they capture; the incentive to try to take advantage of per­ceived profit opportunities would be correspondingly diminished. Clearly, a market socialist system will be less responsive to these profit opportunities than its free enterprise counterparts would be.

Second, one of the reasons why firms exist at all is that they permit the development of complementarities among the assets the firm employs— complementarities that do not exist when a new firm is formed. By the time these complementarities have developed, (i.e., by the time the new firm is up to speed), it may be too late. In 1940, the French military, ensconced in defending the Maginot Line, faced increased demand for the service they provided to the French nation (namely, national defense). At that time, there were adequate resources in America to meet this increased demand, but it did no good—at least until 1944.¹²

If cooperatives in a market socialist system would be less responsive to changing conditions, this means that product markets would be stagnant (i.e., neither competitively efficient nor in transition) more often than in free enterprise systems, leaving customers with nowhere else to go. Since these inefficiencies are induced by the fact that the ownership structure of the cooperative requires that all and only the workers share ultimate deci­sion-making authority and residual claimancy, it can be said that a market socialist system would permit or encourage a form of exploitation that tends to be minimized in a free enterprise system.