The structure of democratic firms within a socialist framework might clash with broader goals such as balanced growth and equitable income. We will need a model that can harmonize firm-level democracy with macroeconomic expansion and a soldaristic wage.
Workers set up scaffolding at a construction site on February 27, 2017, in Berlin, Germany. (Sean Gallup / Getty Images)
In a socialist society, should workers have democratic control over their own workplaces? For many socialists, the answer is obvious: of course, almost by definition. But among economists who have developed proposals for how a socialist system might work, the answer is much more controversial. Some of the most well-known models do not involve democratic workplaces.
Workplace democracy is not a feature of one major vision published in Catalyst, John Roemer’s “sharing economy,” though workers share in firm profits. In his seminal earlier proposal, A Future for Socialism, Roemer explicitly rejected labor management, at least as part of socialism’s “first step,” and possibly even as part of an ideal vision. This is in line with the famous neoclassical socialist model of Oskar Lange, which also features labor markets and conventional employment relations.
Workplace democracy is not a module that can be plugged into a socialist model without affecting the rest of it. It is tangled up with questions of finance and labor mobility. It brings challenges around risk, income distribution, and efficiency. Activity at any workplace must be coordinated within the broader division of labor across the whole economy. Roemer’s agnostic position is understandable:
My preference for the managerial proposals is based on conservatism, namely, that it is best to change features one at a time, if possible. The biological metaphor is apt: an organism with one mutation is more likely to survive than one in which two mutations occur simultaneously. I think it is more important to change the private nature of the financing of firms than the management structure as the first step.
For many of us, however, workplace democracy is not to be given up lightly. It is central to the other proposal for “Socialism for Realists” published in Catalyst, by Sam Gindin. Gindin presents an appealing model, and the present essay is broadly in line with his suggestions. But he does not respond there to the problems identified by skeptics of workplace democracy — sympathetic or otherwise.
Those problems are real. Their root is the fact that modern standards of living depend on a vast and complex division of labor, in which the individual workplace is a small node. These nodes must be coordinated to meet social needs efficiently, but if each workplace must play a part, what is the scope for local democratic decision-making? Any system must constrain the choices made within the workplace, and structure those choices with incentives to bring local interests in line with broader social needs. That is easier said than done. The critics have rightly pointed out serious flaws in some of the standard models, and this has convinced many that worker management is simply unviable.
The aim of this essay is to face the problems squarely and suggest a set of institutions that can plausibly cope with them — a model that is hopefully appealing, meeting socialist aspirations for equality, democracy, sustainability, care, and personal freedom. The problems cannot be resolved simply at the level of the workplace — they are systemic problems and so require the whole system to be built around them. In particular, workplace democracy has fundamental implications for finance, the labor market, and the relationship between the public sector and the sector of commodity-producing, democratic firms. This essay therefore gives a lot of room to the broader systemic architecture before focusing on the democratic firm itself.
The proposed system includes a large market sector of commodity-producing firms, as in both Gindin’s and Roemer’s models, as well as other prominent socialist proposals of recent decades. As Gindin argued, planning and markets are not opposites: the grid of prices and incentives emerging from and organizing market activity is a vital source of information and tools for planners. But having accepted a substantial role for markets, socialists must resolve their tensions with egalitarianism and democracy. Roemer’s proposals concentrate on the egalitarian side and reserve democracy to the state, and so they have a more limited set of tensions to resolve.
The next section discusses the entangled relationship between the commodity-producing private sector and the noncommodified public sector. It also explains the ways in which a democratic government can engage in effective planning and policy in and through the market sector. In addition to the public agencies and policy tools familiar from capitalism, the state will have two powerful sites for intervention: a public banking system, and a labor board setting benchmark wages and conditions.
Efficiency is sometimes seen as a conservative goal, but it simply means avoiding the waste of resources, including people’s time and effort. It need not imply the pursuit of maximum output.
There are many possibilities to expand public agency in new ways, as well as facilitating new kinds of community provisioning. But my attention in the rest of the essay is on the special problems of reconciling efficiency and democracy in socialist commodity production. Efficiency is sometimes seen as a conservative goal, but it simply means avoiding the waste of resources, including people’s time and effort. It need not imply the pursuit of maximum output; efficiency is just as important in maximizing leisure and minimizing environmental impacts for a given output. Waste and misallocation played a big part in the problems of state socialism in the twentieth century, and the social sustainability of any future socialism depends on a reasonable degree of efficiency.
I explain the core problems raised by economists about collective firms: the so-called horizon and common property problems, and related problems of risk management, that can keep democratic firms from investing and employing members in a way that efficiently meets social needs. In response, I propose treating investment as a partnership between public banks and democratic firms, allowing for systemically rational investment decisions and an appropriate spreading of risks and returns.
There is something to be said for Roemer’s caution in presenting a minimum viable socialism. But there is also something to be said for proposals that push further down the road to utopia, while trying not to actually be utopian by ignoring predictable problems. By wrestling with an expanded set of problems, they build the plausibility of an attractive and viable socialist alternative. We can never, of course, know if we have correctly anticipated all the problems a real program would run into — there will always be “unknown unknowns.” But by giving at least possible answers to the “known unknowns,” we make an appealing socialist alternative seem more conceivable. The point of sketching models, as Gindin stresses, is not to write recipes for the cookshops of the future — nothing would force them to use our recipes if they no longer suit the tastes or solve the problems of the time. It is to convince people in the present that there are workable recipes that make socialism worth pursuing.
The Structure of the Economy
The proposed economic system, like capitalism, is mixed. “Private” and “public” are perhaps the wrong words here, given they are even more entangled under socialism than they already are in capitalism, but they are convenient. The division is between a “private” commodity-producing sector where costs are covered by market sales, and a “public” noncommodified sector operating with publicly allocated funds. The noncommodified sector includes the government bureaucracy and public agencies under central control, but it may also include a variety of community agencies with considerable autonomy, though still financed by the public purse.
A firm in the commodity-producing sector is democratic in two ways. First, as Sam Bowles and Herbert Gintis put it, “management and administrative structure are chosen by the firm’s labor force using a democratic political process.”9 Second, each worker receives a share of the firm’s residual income. They are firms in that they are autonomous commodity-producing entities that must cover costs with revenues and meet their contractual payment obligations.
A variety of firm constitutions are possible, but the standard for a midsize to large firm would involve representative democracy, with elected directors appointing and monitoring administrators who do day-to-day management. This could be supplemented by committees and referenda as needed, but routine administration is best handled by specialist professional workers with expertise in accounting, logistics, and so on. Democracy does its job by making sure the administrators are ultimately answerable to their colleagues, and that working conditions and broad questions of strategy must have broad approval.
Capitalist firms are ultimately controlled by their owners, who are entitled to what is left from earnings after suppliers, workers, and creditors have been paid. Labor-managed firms, on the other hand, are ultimately controlled by their workers.
Financial viability constrains the democratic firm, as it does the capitalist firm. The need to cover costs and meet cash flow obligations, while competing with other firms, is what ties the firm into the broader division of labor across the economy. It ensures that it is using social resources reasonably efficiently to meet people’s needs and wants. Like capitalist firms, democratic firms receive revenue from selling their output and pay for the inputs used in producing that output. They require investment: some inputs must be paid for long before receipt of the revenue that covers those costs. This investment must be financed in some way. As with capitalist firms, their future revenues and costs are uncertain to some degree. Market demand and prices change over time. They must make investment and production decisions in the face of uncertainty and so face financial risks.
But in a fundamental way, democratic firms are very different from capitalist firms. Capitalist firms are ultimately controlled by their owners, who are also the claimants to the residual income, entitled to what is left from earnings after suppliers, workers, and creditors have been paid. Labor-managed firms, on the other hand, are ultimately controlled by their workers, who are also the residual claimants.
It might seem that this would be a simple change: ownership and all that goes with it is transferred from one group to another. But there are fundamental differences between these groups and their involvement in the firm that give rise to important side effects. The differences bring serious problems that any viable system of democratic enterprise must resolve. Before turning to these problems, I first explain why a socialist system would involve markets and commodity production at all, and I discuss the overall setup of the proposed model, including the role of the noncommodified public sector and the mechanisms democratic state planning and policy will have to work through the commodified sector.
The idea of a socialist “private sector” may seem oxymoronic, but it differs from capitalist private enterprise in three ways: (1) personal income and wealth are far more evenly distributed, (2) financial claims on firms are indirect, via a public banking system, and (3) firms are run democratically by their workers. Some of the traditional socialist objection to markets comes from their association with the wide inequalities of capitalism. If income is unevenly distributed, they give some people much more control over those ends than others. If incomes are reasonably equal, this objection no longer applies — “one dollar, one vote” becomes more democratic. Another worry is that market logics would lead socialist firms to simply reproduce the alienation of capitalism, with competition enforcing cost containment that would amount to self-exploitation. This is why workplace democracy is so important, to ensure that people are able to voice preferences about the pace and conditions of their work. Further, in the system proposed here, firms would have to meet robust benchmark wages and conditions determined centrally, channeling competition away from the “low road” of a race to the bottom with low wages, high work intensity, or both.
If income is unevenly distributed, markets give some people much more control over those ends than others. If incomes are reasonably equal, this objection no longer applies — ‘one dollar, one vote’ becomes more democratic.
External discipline is not something imposed only by markets. In any division of labor, there must be limits to the self-management of each individual unit, because they are all interdependent. Workers produce for others — either directly making consumer goods and services or making inputs for other production processes. A centrally planned economy also faces the underlying issue of interdependence and would need some other way of reconciling the operations of the countless production units with one another and with people’s desires as consumers. Constraints would need to be placed around how any workplace could arrange itself — and rightly so, since the workers there are using part of the social stock of wealth in their work and will make claims on output elsewhere for their own consumption. The proposal here provides multiple places to manage the constraints openly and democratically — at firm and more central levels — instead of fudging them. The “soft budget constraints” identified by János Kornai as a critical weakness of planned economies involved an inability to deal consistently in reconciling the preferences of work unit managers with the broader division of labor.
Market pricing and commodity production are not something socialists must reluctantly accept because of the flaws of planning. In their proper place, and in a context of egalitarian incomes and workplace democracy, they are in fact a good vehicle for democratic planning.
It is not easy to think of a better way for people to signal what should be produced than actual consumer markets. We have a monetary income, we are faced with a set of prices quoted to us by sellers, and we choose how to divide our spending among all the things available. If we are to choose what to consume at all, the trade-offs inherent in using scarce resources must be presented to us in some way, so there will be some form of relative price and budget. It is not only that it would be cumbersome for planners to get choices from us in some other way but that we do not know ourselves the answer to questions about how many coffees we would be prepared to give up for so much extra gasoline next year. This is because our demand for any one product is bound up with our demand for other ones. The amount of coffee people would choose to consume not only depends on its own price but on many other prices, too. It would depend not only on prices of substitutes like tea or Red Bull, and complements like cigarettes and cake, but also on seemingly unrelated commodities like gasoline and housing rent — since everything must be paid for from the same budget.
Because of these connections, it takes only a handful of products to make consumer choice a fiendishly complex problem for a planner. And it is not the kind of problem that can be solved by throwing computing power at it. This is because the information we need to solve it is information about what individuals would choose given many, many different configurations of trade-offs or prices. And that is not even information that we consumers ourselves have as data to input into the computers in the first place.
It takes only a handful of products to make consumer choice a fiendishly complex problem for a planner.
We can see how difficult it is by looking at textbook models of consumer choice that turn it into a problem that is solvable in principle. Each person in these models is presumed to have a complete set of preferences — i.e., a ranking of every possible combination of consumer products from most to least preferred. With such data, we could, in principle, find the trade-offs each would make in any configuration of prices and income: not only the impact of a change in the price of coffee on coffee and energy drink consumption but the impact of the price of gasoline on the demand for jeans. But it is one thing to say that each person has a ranking in the sense that they will, in practice, make a choice of how to allocate their budgets in any configuration of prices and income they find themselves in. It is another thing entirely to think of such a ranking as something the person could make explicit and communicate to a planner ahead of time for any possible future structure of prices. Even if we drastically cut the possibilities by restricting them to combinations of consumer products within some limited range of typical past choices, we are still talking about a stupendous number of possibilities.
With our actual monetary incomes and actual stores to buy from, we never have to think about it like that. Real-world consumer markets use only a limited range of information about preferences: what people buy at actual prices, given actual incomes. They do not require the information to be centralized in any way — the prices of the countless particular products are set by producers on the basis of their particular conditions of production. The set of prices that emerges presents a complete set of options to people, leaving them to work out how best to allocate their budgets. In practice, most of us buy with some combination of habit, planning, and impulse. We are not always fully considered in the trade-offs we make. But because the cycle of income and expenditure is repetitive, we have plenty of chances to adjust our choices deliberately or intuitively. Whether our typical choices are more deliberate, habitual, or impulsive, they are still choices, and one way or another, they take into account the trade-offs established by prices and our incomes. For this reason, even models of a generally planned economy have tended to allow for markets for consumer goods and services.
However, the complexity extends up through the production web. The original Austrian challenge to socialist central planning was that, without prices, there would be no way to rationally choose among the countless recipes through which a society’s resources could be transformed into consumption goods and services. Because resources are limited, the decision to produce one thing always comes at the expense of something else. As soon as we trace the consequences of consumer choice to the inputs involved in producing them, and the inputs used in producing the inputs, things quickly become vastly complex.
As soon as we trace the consequences of consumer choice to the inputs involved in producing them, and the inputs used in producing the inputs, things quickly become vastly complex.
To make this more concrete, imagine the decisions facing the planner in deciding over something as straightforward as cement — a staple intermediate good. Making cement requires the use of some inputs that otherwise could be used for something else, but there are many different techniques using different combinations of inputs. There are choices of materials — limestone or chalk, clay or shale, obtained from quarries or as the by-products of other industrial processes. There are choices of energy source, different types and sizes of furnace, and the factory can be more or less automated, calling for different types and quantities of labor. Transportation is an important part of the cost of something so bulky: Should it be shipped, trucked, or piped, and where should the production plants be located in relation to the quarries, the power sources, and the sites where it will be poured? Then there is the big question of how much should be produced. It is used as an input in the production of many things, from building materials to roads to pipes, but in each case, there are substitutes — plastic for pipes, bitumen for roads — and each of the substitutes has their own web of techniques connecting them to possible inputs and outputs. To use bitumen in place of cement frees up the quarried material for other uses or frees up the resources that would have gone into the quarrying, but it uses more energy directly as well as petroleum products that could have been used for something else, and we must take into account that bitumen requires more frequent repair and replacement.
For the planner, the decisions of how much cement to make and how to make it cannot be made without also deciding about the alternative uses for its inputs, and its substitutes, and substitutes for the things cement is an input to, and the alternative uses for all the inputs into each, and those of the inputs’ inputs, and the substitutes for their alternative outputs, and the outputs’ outputs, and so on. With consumer markets there to draw preferences from people, and knowledge of production techniques, planning the rest is actually a tractable problem in theory. But the planner designing algorithms for managing a complex division of labor so as to allocate limited resources efficiently to meet the diverse wants of the population tends to reinvent textbook economics. Indeed, neoclassical economics as we know it has been much shaped by theorists of planning, from Leonid Kantorovich and Lange to Wassily Leontief.
The problem that remains is drawing accurate information about production possibilities from the workplaces actually doing the production, and aligning their incentives with social needs. Faced with such a problem, the planner might think of ways to encourage workplaces to economize and seek better ways of doing things, by allowing the producers to keep some of the gains. They might do this by allowing work units to take the initiative when they discover new ways to produce their outputs with cheaper combinations of inputs, or new outputs that could be produced at costs buyers would be willing to pay. They might even allow people to form new work units to take advantage of such opportunities in the existing price structure. Such planners would, of course, have reinvented a kind of market production, and yet conclude that it did what they were trying to do in the first place. The price structure that formed as the result of many firms bidding against one another for inputs and competing with one another to sell outputs would — more or less — allocate resources to their most valuable uses, as ultimately judged by how individual people spent their reasonably even incomes.
The market system is one of trial and error — any act of production for sale is speculative, carrying some risk that demand will not be there to meet supply at the predicted price.
The result is not perfect coordination. The setup of markets requires a fair amount of slack. The situation we experience as consumers is one where sellers set prices and invite us to buy as much as we want at those relatively stable prices. Prices do not fluctuate constantly to match demand and supply over short periods. This purchase-at-will environment depends on market makers who must hold inventories with enough spare to meet the uncertainties of demand at the set prices. Retailers and wholesalers of goods hold stocks: shortfalls in demand leave more than expected; excesses run the inventories down. The producers who supply retailers also keep inventories to meet fluctuations in demand. Services don’t stick around in inventories, so service providers must have more staff on shift to meet unexpected demand, or they must manage demand with a booking system. Over time, persistent errors in forecasting demand can be corrected with adjustments of supply or prices. In the meantime, there is some waste in the form of products produced that will not be sold for the anticipated price (ultimately, perhaps, offloaded in a clearance sale or a dumpster behind the store) or in the form of unmet demand. The market system is one of trial and error — any act of production for sale is speculative, carrying some risk that demand will not be there to meet supply at the predicted price. The prices we pay contain some compensation for the cost of holding inventories, transporting, and centralizing products for retail convenience, and for the risks various parties take on along the way. They also contain rewards to firms who simply enjoy strong market positions for whatever reason: markets are often far from perfectly competitive. But whether some form of planning could eliminate these risks and costs is doubtful — they would take on different forms. Mismatches of supply and demand would otherwise take the form of queues or secondhand exchange of allocated goods.
Of course, socialist policymakers would not fetishize “the free market.” The pragmatic case for commodity production is fully compatible with democratic planning. Planners do not need to work out how many toothbrushes and haircuts need to be provided. Being relieved of the need to manage everything, planning can focus on specific aims, like restricting carbon emissions, fostering investment in a poorer region, building public housing, or redistributing income. The grid of prices and networks of private income flows actually make such planning easier, by enabling meaningful accounting.
Scope of the Public Sector
It is widely acknowledged even by nonsocialists that markets are not good, and are sometimes outright bad, at dealing with some very important aspects of production. Markets transmit signals about wants and costs only between those involved in a transaction. The ideal commodity, whether a good or a service, is a discrete package of benefits enjoyed solely by the owner or hirer, whose costs of production are borne solely by the producer. Then, a voluntary purchase signals that someone finds the benefits worthwhile enough to compensate the producer for those costs, and profit-seeking producers bid for resources accordingly. Where products fit that mold for private goods, commodity production can allocate resources rationally.
But not all benefits from production flow to a buyer, and not all costs are borne by the producer. There are positive and negative externalities, so called because they are external to the parties to a transaction. In some cases, they burst the commodity package entirely, because it is hard to exclude people whether or not they paid for a product. Public safety and broadcast media are classic examples of nonexclusive goods. There are costs involved in producing them, but it is difficult to prevent anyone from enjoying them. In other cases, there is a discrete product that nonbuyers can be excluded from, but it comes with spillover effects that benefit or cost others. Education and journalism are examples of positive spillovers: it may be possible to exclude individuals from classes and newspapers if they do not pay for them, but everyone benefits from a generally educated and informed population. Carbon emissions and other pollution are examples of negative spillovers: they impose costs on people whether or not they are the ones consuming the products. Commodity production undersupplies public goods and oversupplies public bads, because prices and transactions do not carry the right signals and incentives to profit-seeking producers.
Capitalist states already address these issues by (1) regulating commodity production, (2) directly organizing noncommodified public production, (3) directly purchasing commodities and subsidizing other commodity production, and (4) artificially commodifying some products. Public spending already typically equals one-third to half of gross domestic product in capitalist countries. The public sector’s share of employment is varied but typically comprises one-tenth to one-quarter.
Commodity production undersupplies public goods and oversupplies public bads, because prices and transactions do not carry the right signals and incentives to profit-seeking producers.
Socialist public spending will probably be at or above the higher end of that spending range. There are some things produced as commodities in capitalist society that could be more efficiently provided publicly. Non-rival goods are those that can be used by one party without leaving any less for others. Many intellectual and other creative products are in this category, from pharmaceutical research to recorded music. The problem with treating them as free goods is that they have substantial costs to produce in the first place, even though the marginal cost of providing them to additional users is negligible. The traditional capitalist solution has been to commodify such products with intellectual property, making them artificially excludable goods, so that the initial costs can be covered with sales. This suppresses the potentially vast positive externalities from free use. A socialist society could reap these gains with schemes for publicly funding research, development, and artistic creation, then allowing free use of the products.
There are also a number of goods and services that could be considered private goods and so produced as commodities, but that many capitalist countries organize partly or entirely through the public sector. Health care and education are major examples. They are both costly services from which nonpayers can be excluded, but the consequences of exclusion are problematic. Even with much greater equality of income, it is hard to see commodification as appropriate. An individual’s need for health care is unpredictable, and when needs arise, the costs are often high relative to income. Private insurance has in practice rivaled public provision as an answer to this problem, but the conflicts of interest and informational problems make public models more efficient and effective. As for education, the person making the choices (the parent or adolescent) is not the person who bears the consequences (the child or mature adult), and there are good reasons of social cohesion and equality to have a comprehensive public education system.
Although socialist public spending is therefore likely to be at least as high as in a comprehensive social democratic welfare state regime, the proportion of public employment is a more open question. If firms are worker-controlled, and public agencies involve more traditional employment, the socialist preference for direct public provision over outsourcing is not always obvious. Should garbage collection be directly managed by the state, or run democratically by collectives of workers, providing services purchased by the state? Is the answer different for childcare centers, medical clinics, and schools? Concerns over quality and standardization might be dealt with through strict and well-specified contracts, combined with careful monitoring — but then, are the monitors themselves to be independently contracted democratic firms? Who contracts the contractors? For core public functions, bureaucratic organization and a public service ethic will be better suited than commerce — but where the boundaries of that core end is difficult to specify in advance, and this ultimately becomes a question for democratic politics. Different societies could answer it quite differently.
Wherever the line is drawn, should workplace democracy end at the private sector? It seems unfair to exclude public sector workers, and if workplace democracy is attractive, it may make public sector work less appealing. But private sector firms need to sell their commodities to willing customers. This requirement structures their democratic decisions in a way that ensures they do not waste social resources, and their entitlement to residual profit gives workers incentives for efficiency and innovation. (For this reason, direct public provision is better wherever there is no scope for competition among firms.) Market constraints and incentives by definition do not apply in the noncommodified public sector, and so there is a need for other methods of matching worker preferences with the social needs identified and funded by government. It still seems possible to allow for democratic decision-making in public sector workplaces over labor processes, and to enable bargaining between the workforce and those controlling the public purse further up the bureaucratic chain.
For core public functions, bureaucratic organization and a public service ethic will be better suited than commerce — but where the boundaries of that core end is difficult to specify in advance, and this ultimately becomes a question for democratic politics.
This issue actually extends into the semiprivate realm where government is the sole or main customer of an enterprise, where government charters a collective to provide a public service. Such a workplace relies on a single monopsonist customer, which therefore has considerable control over the firm even if it is legally independent. The line between public and private is again blurry. It is difficult to say exactly where bureaucratic directives end and contracts with democratic collectives begin. There is a case then for formalized processes of bargaining between bureaucracy and collective, just as with workplaces formally within the state. This gives workers a meaningful say over working conditions, while properly allowing public control over the standards of services provided.
Ultimately, the mix of public and private sector workplaces allows for standards developed in one sector to influence the other. Centrally determined benchmark minimum wages and conditions — described below — apply in both sectors. And workers can vote with their feet: if one sector or another is more attractive, they will seek to shift and exert some labor market pressure. Public sector security may compensate for the lure of private sector dividend windfalls.
In sum, the boundaries between the private and the public sector will be blurry, and beyond these general principles, they cannot be established in advance — this will be a matter for democratic debate. There will be a gray area wherever government is the main customer of dependent “private” firms. Both in that gray area and within the public sector proper, there should be mechanisms that give the workforce some genuine say over labor processes and conditions.
For the rest of this article, I focus mainly on the special problems of the “private” sector, especially the tensions between workplace democracy and commodity production.
Management of the Market Sector
Macroeconomic problems and market failures come with the territory of commodity production. A socialist system with a substantial role for markets must expect to face them. Policymakers have all the options available to capitalist states for regulation, to ban, limit, or guide some activities of firms. It will also engage in macroeconomic policy to manage effective demand, ideally employing as much labor as people want to perform without inflationary pressure. It would be wishful thinking to expect a perfected policy regime: we know from decades of experience that policy problems often appear as dilemmas, with multiple aims pulling instruments in different directions. Policymakers face unknown futures with instruments subject to lags of implementation and effect. Beyond macroeconomics, more ambitious democratic planning will still have to cope with very real differences of interest between groups, along with the potential for political capture and paralysis.
Nevertheless, the system proposed here does have some additional points of leverage through which policy will be able to influence the commodity sector.
Public Banking System
Finance for commodity production will be the province of a set of public banks. Investment in productive capital assets involves a partnership between the democratic firm that uses them and a public institution that finances them. Democratic firms do not accumulate wealth — they are custodians of capital, not owners. The reasons for this, and the workings of the partnership, are explored below.
All finance is channeled by these banks: individuals do not hold direct claims on firms, but they can hold savings with the banks in the form of deposits and mutual funds. The state treasury also holds public wealth in the banking system and is the owner of the banks’ equity. The ultimate claims on the capital used by firms are thus owned partly publicly and partly by individuals but are all mediated by the banks.
The banks are public utilities, their management appointed by the state, but they operate as semiautonomous institutions. The basic mandate for most is to manage their balance sheet and finance projects to generate as much return as possible for a given level of risk across their balance sheet. The acceptable level of risk is determined by the treasury as ultimate owner, as well as regulatory liquidity and capital requirements. There are a number of banks to allow for differences of strategy and judgment. Firms can get second opinions if turned down by one bank. The performance of each bank can be compared with others and strategies adjusted.
Democratic firms do not accumulate wealth — they are custodians of capital, not owners.
The autonomy and narrow basic mandate keeps most banks at arm’s length from policy in order to avoid the temptation to loosen budget constraints, which has plagued some socialist models. But there is a role for one or more public development banks, which would be more directly controlled by policymakers and tasked with financing development, green, and other industrial policy projects that may not otherwise find funding. A central bank will also have control over the basic interest rate through open market operations and the refinancing terms it offers to the banks. It could use preferential refinancing rates and terms for particular kinds of asset as another kind of industrial policy.
The banks are not limited only to partnering with existing democratic firms. They are encouraged to take an active role in forming new ones. This is an essential entrepreneurial role in the system. Democratic firms have less of a drive toward expansion than capitalist ones: the need to share all profits with new members means that incumbents have no incentive to expand once increasing returns to scale have been exhausted. Banks, with their wealth of economic data, are well placed to identify niches where new collectives could thrive and play an active role in assembling people in search of work.
Wealth and Income Distribution
People receive monetary income within the system from three main sources: from work, as financial returns on funds in the bank, and from government transfers. Policy will have several mechanisms to counteract inequalities emerging from market forces in the commodity sector and meet welfare needs.
Wealth distribution is simplified by the funneling of all finance for commodity production through the public banks. All capital income from commodity production flows initially to the banks and is then distributed to holders of their deposits and funds. Bank liabilities will be held partly by the public treasury and partly as private wealth by individuals (with firms also holding working deposits).
Unlike in a typical capitalist society, the state receives considerable capital income from treasury holdings of bank liabilities, which can be distributed in several ways, as determined by policy,
to fund public sector activity and spending, as a substitute for tax;
as a social dividend distributed to citizens in an egalitarian way; and
as targeted transfers for welfare purposes.
Every person would receive their share of private wealth upon reaching a certain age, and this can be kept reasonably evenly distributed by not allowing inheritance or large gifts. Inequalities would develop from differences of income and savings, but these would be relatively modest, and at death, individual wealth would return to the public purse to be redistributed to the living. There are few opportunities for private capital gains or windfalls, removing a major source of wealth inequality.
Every person would receive their share of private wealth upon reaching a certain age, and this can be kept reasonably evenly distributed by not allowing inheritance or large gifts.
There will be other forms of public and private wealth outside the banking system: consumer durables, housing, and the real estate and public means of production owned directly by public agencies. Housing typically accounts for around half the value of the capital stock of a developed capitalist country. There are a number of ways a socialist country might choose to organize the construction, financing, and allocation of housing — and their implications for public and private wealth — but this is beyond the scope of this essay.
Taxes and transfers can be used to counteract undesirable inequalities in labor income, and the returns on public wealth give the state more options for redistribution. The ability to adjust the timing of payouts of any social dividend from public wealth potentially makes for a flexible macroeconomic instrument — though transfers for welfare purposes should not be hostage to macroeconomic conditions.
Worker-members receive two forms of income from their firms. They earn a regular wage, known in advance, and an occasional dividend, their share of the firm’s profit. Since worker-members are the firm’s residual claimants — entitled to what is left from firm income once all others have been paid — it may seem redundant to divide their entitlement between wage and dividend. But a fixed wage has a number of advantages.
It allows for differences in pay among members. Some differences are justifiable even on egalitarian grounds: they compensate people for doing jobs that are more difficult, strenuous, or otherwise unpleasant, for putting in extra effort, and for developing skills that are in demand. The wage is specific to a particular type of work, and potentially to an individual. Each wage must at least meet a benchmark for that work type, which is determined centrally, as described below. But the firm has the discretion to pay margins above the benchmark — this is a decision for the collective. The firm might decide to pay extra for all members doing a particular type of work, or to use individual promotion or bonus schemes to motivate effort. Such payments subtract from the dividends that are paid evenly to all members, so members are likely to agree to them only if they expect them to pay off — i.e., that they are at least matched by the productivity gains they motivate.
There is undeniably a tension between the egalitarian and efficiency aims here. Firms will try to attract members with skills and talents that are in short supply, and the wages for these attributes will be bid up across the economy. If this leads to wage premiums that encourage the development of undersupplied skills, this is positive and self-limiting, as the supply of people with those skills adjusts to meet needs over time. But talents — personal attributes less responsive to training — are a different story, and the talented will enjoy persistent market rents, i.e., compensation above what would be necessary to induce them to bear the difficulties of the work itself. The system must face the reality of persistent differences in talent, and use extra-market tools to limit income differentials, such as progressive income tax and transfers.
The system must face the reality of persistent differences in talent, and use extra-market tools to limit income differentials, such as progressive income tax and transfers.
Another reason for the fixed wages is that they provide a vital reference point for price setting and accounting. Labor is often the largest component of production costs for a capitalist firm, and so wages are the foundation of the price system. Without fixed wages, the democratic firm misses this guide for pricing and cost accounting. It becomes more difficult to make rational production plans without some idea about what an hour of labor is worth, and more difficult to negotiate the employment of new members without a signal of the baseline income they can expect.
Therefore, in this system, the democratic firm treats precommitted wages as an accounting cost, even though they form part of member income. Residual profit after meeting wages and other costs is then divided evenly among firm members — whether on a head count basis or according to hours worked. A firm that is unable to meet its wage commitments is considered to be in debt to its own members and potentially insolvent. These wage costs can then be used as reference points elsewhere in the system — for example, in contracting with a bank to insure a minimum level of income.
Wage-Setting and the National Labor Board
The wages and conditions firms set must be at least as high as benchmarks set by a national labor board. Benchmarks would be specified for particular job categories, with margins for skill and experience, and potentially allowing for regional differences. The benchmarks function as a minimum, with firms free to set higher wages, but the council would aim to keep the benchmarks reasonably close to market norms — they are intended as genuine benchmarks, not safety nets.
There are three main reasons for this framework. First, it counteracts a likely side effect of workplace democracy — a labor market that is relatively slow to respond to changes in conditions. Security of livelihood is one of the great advantages of the system — workers need fear arbitrary unemployment much less. Democratic firms can downsize, but this would happen more reluctantly, and with negotiation of agreeable severance packages. But because this makes labor a more fixed cost for democratic firms, they will be more cautious in expanding in the first place. Further, incumbent members must share profits on the whole business with new members. If members have some reason to expect persistent profits on their operations, they have a material interest in expanding employment only so long as the additional members add more value than incumbents lose from the smaller share.
Democratic firms can downsize, but this would happen more reluctantly, and with negotiation of agreeable severance packages.
The labor market is therefore likely to be slow to adapt, with flows between jobs smaller than under capitalism, and market wages and employment changing only slowly over time. (Not that we should overstate the fluidity of capitalist labor markets — wages have always been as much about norms, industrial struggle, and institutions as about supply and demand.) Active management of central wage benchmarks can substitute for market adjustment to some extent, with policy considering market signals in setting the benchmarks. For example, where many firms are paying rates above the benchmark for a particular job category, that could be taken as a signal that the benchmark should be raised, speeding up the transmission of the wage change across the economy. But the commission could also take into account a wide range of economic data, making it an alternative center of public economic expertise alongside the banks.
The second reason for central wage benchmarks is to prevent democratic firms from getting stuck in a self-exploitational low-cost spiral. Competition over costs can take a high road involving the pursuit of more efficient techniques and technologies, or a low road of wage restraint, work intensification, or both. Even members of a democratic firm might be tempted to accept lower incomes as an alternative to restructuring around new technologies. This can hold back labor productivity growth that could free up people’s time for leisure. Steadily rising wage benchmarks — following any general movement toward higher wages — block the low road, encouraging lagging firms to catch up with new techniques and technologies, with the financial support of their bank.
Wage benchmarks can be used to maintain gender pay equity — which is undermined in labor markets if women are more likely to have time out of work for childcare and in the long shadow of historic pay penalties for traditionally feminine jobs.
Third, wage benchmarks can be a policy and planning tool. While market trends should factor into labor board decisions, they need not be decisive. Egalitarian and development goals can be taken into account. The benchmarks can be used, for example, to maintain gender pay equity — which is undermined in labor markets if women are more likely to have time out of work for childcare and in the long shadow of historic pay penalties for traditionally feminine jobs. For development purposes, benchmarks could vary between geographical areas, allowing for lower pay in lower-cost regional areas, or rising at different paces to narrow regional disparities over time.
Wage benchmarks can also be a supplementary macroeconomic tool. In the early years of macroeconomic policy, economists like Jan Tinbergen argued that influence over wages would be critical to making full employment compatible with price stability. However, in most capitalist countries, policy had little leverage in the wage-setting process and so relied on labor market slack to keep wages under control — unemployment as a disciplining device. There are precedents for centralized wage determination in capitalist countries — for example, in postwar Australia and Scandinavia — with good track records over long periods of high productivity growth and macroeconomic stability.
There is a problem with these different motivations for setting wage benchmarks: they may conflict with one another, with goals pulling in different directions. This was certainly the experience of centralized bargaining in capitalist countries. But that is democracy. Decision-making at the labor board could be set up in a number of different ways, but it should allow for a number of influences: economic expertise, worker representation, and the democratically elected national government.
Problems of the Democratic Firm
It is now time to turn to the differences between a capitalist firm and a labor-managed, democratic firm, and the problems that come with those differences. As Gregory Dow puts it, there is a “fundamental asymmetry” between capital and labor, in that “ownership of nonhuman productive assets can be transferred from one person or group to another, while this is not true for endowments of time, skill, and experience.” Both capitalist and labor-managed firms involve people working with productive assets. But there are two especially important differences.
Capitalist firms hire labor, paying a wage or salary for contracted time. They can increase or decrease employment at will, though this is often constrained by longer-term contracts. The wage is a cost from the perspective of owners — deducted from revenue along with other costs to leave residual profits. Worker-members of democratic firms supply their own labor, and the collective cannot bring in or let go workers without changing the membership of the firm. A member’s compensation includes their share of the residual — and any change in size changes how many people the residual is split among.
Ownership of a capitalist firm can be parceled into tradable shares, and equity holders need have no direct involvement in the firm. Control and income rights in a labor-managed firm are tied to active involvement in the firm, by the definition of labor management. They cannot be traded to nonparticipants.
These differences have major consequences for economic behavior that have long been treated as problems in the economic literature on the labor-managed firm. Any viable plan for an economy based on democratic firms must deal with these problems.
Perverse Responses to Market Signals?
The first problem is a supposed perverse response of democratic firms to market signals, at least in the short run. A capitalist firm is traditionally supposed to choose its level of production in order to maximize total profit. It only must pay a wage to get the output of another worker — there is no question of sharing profit with them. The democratic firm, on the other hand, is committed to sharing the residual among its workers. It is therefore presumed to aim at maximizing income per worker. Bringing more workers on board adds to both the numerator and the denominator of that equation.
Seminal neoclassical models of such behavior concluded that if such firms were dropped into a textbook “perfect competition” setting, labor-managed firms would react the “wrong” way to changes in demand and fixed costs in the short run. They would respond to a lower price of their product by producing more and to a higher price by producing less. Higher fixed costs would bring forth higher output.
This result has had outsize influence in the economic literature on labor-managed firms to this day, in spite of its dependence on unrealistic assumptions — which the original authors took pains to emphasize.
This result has had outsize influence in the economic literature on labor-managed firms to this day, in spite of its dependence on unrealistic assumptions — which the original authors took pains to emphasize. It assumes that democratic firms can easily adjust labor by taking on or expelling members but not at all by adjusting the hours that members work. It assumes a diminishing marginal product of labor, i.e., that each additional worker produces slightly less output. And it applies only in the hypothetical short run, in which firms can adjust the number of workers but not the capital equipment workers are using. In long-run equilibrium, with firms able to adjust all inputs, the standard model predicts identical behavior for capitalist and labor-managed firms.
These are not realistic conditions. In his landmark analysis, Czech American economist Jaroslav Vanek argued that democratic firms would be unlikely to adjust their membership quickly in the short run, and especially not by laying off their own members. They would be more likely to react to modest shifts in demand by adjusting the hours worked by those already in the firm, which would shift output and income but not the number of workers among whom the residual would be split. This made the “perverse” short-term results of the standard model less relevant. Empirical research on cooperatives has found that they do not tend to behave in the (capitalist) real world as the early neoclassical models suggest they would in a textbook world.
But it is not unreasonable to believe that democratic firms would be less responsive to market conditions than capitalist firms in adjusting their workforce in either direction. Turkeys are not expected to vote for Thanksgiving, so it would be harder to lay off members involuntarily. Because of that, the firms would be more reluctant to bring in new members if the longevity of the favorable conditions were uncertain.
Capitalist firms also face severance costs in laying off workers on longer-term contracts — and there is nothing stopping democratic firms from offering severance payouts to sweeten separations — so the difference is not absolute. But capitalist firms often have a buffer of workers on insecure contracts that can be adjusted at will, an option not open to the democratic firm. Security of employment is “a feature, not a bug,” but we should acknowledge that, for the democratic firm, labor input is likely to be less flexible, except to the extent that hours can be varied for existing members. Labor is more of a fixed factor, especially in the short run. Over longer periods, attrition from retirement and voluntary resignations makes downward adjustment easier. The less flexible labor market is one reason for the national labor board’s centralized benchmarks, as described above: they provide another way to transmit wage and condition changes across the economy.
Security of employment is “a feature, not a bug,” but we should acknowledge that, for the democratic firm, labor input is likely to be less flexible, except to the extent that hours can be varied for existing members.
More difficult problems come with the financial structure of democratic firms and their members’ stake in them. When the partial owner of a capitalist firm wants to exit, they can sell their equity and so recover the market value of their share in control and future income from the firm. For most large companies in a modern capitalist economy, there is an active stock market with enough liquidity that shareholders can quickly sell when they wish. The market valuation of a firm’s equity reflects participants’ expectations about future earnings prospects, becoming an important reference point in investment decisions.
But a member’s stake in a democratic firm — their share of control and earnings — is tied to their continued participation as a worker. In the standard model, they have no marketable stake to sell when they leave. (Some proposals do involve a membership market, which I discuss below.) This means that individual workers have a horizon of personal interest within the firm — their expected date of departure. That exit may be due to retirement, moving somewhere else, changing careers, or even a layoff. The end date may, of course, be very uncertain: perhaps next year, in five years, or in twenty.
This changes the logic of investment decisions. A firm investing from retained earnings is using funds that might otherwise have been distributed as personal income to its owners or members. If it makes economic sense, the investment must be expected to increase the firm’s future earnings. Shareholders of a capitalist firm can expect to reap rewards from the investment either by enjoying higher dividends later or by selling their shares in the meantime at a higher price reflecting the higher expected dividends. They favor an investment project as long as the expected payoffs are at least as good as they could otherwise get by personally putting their funds somewhere else with an equivalent risk profile.
Members of a democratic firm, on the other hand, do not get their share of wealth out of the firm when they leave. They will be entitled to extra income generated by the investment only so long as the investment pays off, and if they are still at the firm in the future when it does. But the funds for the investment come directly out of the profit dividend they would otherwise get as personal income now. Decisions about the use of the firm’s profits thus become a trade-off between certain income now and possible income later, with the possibility of higher future earnings offset by the chance that the individual member will not be around to get them.
This may lead to divisions among members: between the young and those nearing retirement, or between those whose skills or preferences tie them to the firm and those who have opportunities elsewhere. Those who hope and expect to be with the firm long term will be more willing to invest, because they are more confident about enjoying the fruits of the investment later, while the others will be sacrificing income now for a very uncertain reward. In general, shorter-term payoffs are less risky, and long-term investment will be more difficult to support. An economy made up of such firms will tend to forgo a lot of investment that otherwise makes economic sense. This has come to be known as the horizon problem.
The other side of this is the common property problem, relating to joining rather than departing a democratic firm. The net worth of a democratic firm is essentially a form of collective wealth held by its members. When members decide to invest with retained funds, they are collectively saving, since otherwise the earnings would have been distributed to them as personal income, which they could individually decide to save or spend. But when the firm expands, new members immediately acquire their share of this collective wealth, with an equal entitlement to residual earnings, and so to returns on the wealth collectively accumulated from the sacrificed personal income of incumbents. This may make those incumbents more reluctant to take on new members than they otherwise would, or could reinforce a reluctance to invest with retained earnings in the first place, leading to suboptimal employment and investment.
The net worth of a democratic firm is essentially a form of collective wealth held by its members.
Finally, the absence of a share market deprives the economy of an institution for allocating resources and managing risk. Capitalist financial markets, at least in theory, provide information and incentives to allocate capital efficiently across the economy — that is, to where it brings the highest returns for a given level of risk. The same is true for a Roemer-style market socialism with an equitable distribution of financial claims. The parcelization of equity into tradable shares allows wealth holders (or their fund managers) to diversify their portfolios. Just by holding a diversified range of financial instruments, the individual can lower the risk they are exposed to for a given return, because the idiosyncratic risks of particular firms cancel one another out — a bad year for some is a good year for others. Some risk remains, because firms share some exposures to market upswings and downturns. But individuals can construct portfolios with the right mix of safer and riskier assets to choose their own preferred point on the risk-return trade-off curve.
The worker in a cooperative firm, on the other hand, has a substantial amount of wealth tied up in a single firm — and it is the same firm on which they rely for their employment. They have many eggs in that single basket and cannot diversify away their exposure to their firm. The more democratic firms must rely on internal finance — their own workers’ collective savings — the more the system lacks mechanisms for rationally allocating finance across the economy to where it is most useful.
The Membership Market Solution?
One solution to the horizon and common property problems is to make a worker-member’s share in the firm’s control and residual earnings a salable financial instrument — in other words, more like a capitalist share. Owning these membership rights would still be tied to working within the firm — otherwise, the firm would no longer be democratically controlled by its workers. But when a worker leaves a firm for whatever reason, they would sell the membership right to an incoming worker or back to the firm itself. If the value of these rights is in line with the present value of the worker-member’s share in the firm’s future residual earnings, the departing member no longer loses their stake in the collective assets built up by the firm during their tenure.
Existing members’ stakes are no longer diluted when the firm expands — the newcomers bring their own share of equity into the firm when they purchase a newly created membership. (If the firm chooses to expand its workforce faster than its capital stock, some of the funds brought in by new members might even be distributed as personal income to incumbent members.) When the firm reinvests with retained earnings, this increases the value of members’ stakes, so that they can keep their personal share of collective savings by selling when they leave.
The membership market is prominent in Gregory Dow’s The Labor-Managed Firm, the most thorough recent work on the economics of the democratic firm. For Dow, the idea is strongest as a response on the abstract terrain of the economic models from which the traditional problems were derived. Critics had presumed labor-managed firms were stuck with particular “realistic” constraints while traditional capitalist firms were free to enjoy all the benefits of competitive capital and labor markets. However, in idealized textbook conditions with a complete set of perfectly competitive markets, there is nothing to stop collective firms from working on the basis of salable memberships.
When a democratic firm takes on a new member, existing members get a new colleague. They care about the person as a worker as well as a source of funds.
The problem — as Dow himself makes clear — is that the real world is not one with a complete set of competitive markets. And a membership market is likely to be particularly imperfect, because of the inherent asymmetries between asset ownership (alienable) and labor (inalienable), available only as a flow of activity from a human being. The democratic firm must seek labor and funds from the same person, who must wish to both work at and invest in the same enterprise — and must have the wealth to invest in the first place or be willing to take out some kind of job mortgage. The capitalist shareholder is an absentee owner — they simply own a claim and need do nothing else but let the dividends roll in. The worker-member must actually work. The decision to buy a membership is also a decision to accept a job. And while managers of a capitalist firm can generally be indifferent about who owns its shares — hostile takeovers aside — when a democratic firm takes on a new member, existing members get a new colleague. They care about the person as a worker as well as a source of funds.
Individual members thus could not be allowed to sell to any taker at their own discretion. The outgoing member has no material interest in the appropriateness of the person replacing them — only in how much they are willing to pay for the job. Instead, the outgoing member would need to sell their stake back to the firm, which would sell new stakes to incoming workers. Taking on new members would then combine the hiring search with the selling of equity. Job interviews would combine questions about experience and education with questions about how much the candidate is willing to pay for the position. Perhaps this is not so different from negotiating over pay, but it means that the value of a membership would not simply reflect the present value of a share of the firm’s expected future earnings. It would also reflect bargaining over the value of the future work to be performed by the incoming member, with the firm interested in the worker’s productivity and the incoming worker interested in the opportunity cost of their time.
On the other side, the prospective member would lack information that incumbents have about the true situation and prospects of the firm, which may leave them cautious and unwilling to pay the full value of membership in a successful firm. The membership market could therefore be nothing like the deep, liquid share market of a capitalist economy. Memberships would be rarely traded, and the prices at which trades took place would be specific to individual workers, given the combined labor and capital transaction.
Salable membership rights thus create as many problems as they solve for the democratic firm. The proposal here takes an alternative approach — avoiding as much as possible any collective wealth accumulation by worker-members in their own firm. Finance for investment comes entirely from a public bank. This mitigates the horizon problem, because members no longer make a choice between spending their firm’s earnings on investment and receiving it as personal income. It mitigates the common property problem, because members do not actually sacrifice income to build wealth collectively within the firm that they might resent sharing with newcomers.
Salable membership rights create as many problems as they solve for the democratic firm.
It is true that members can still benefit from firm-specific returns to intangibles like market position and customer goodwill. These are not assets that can be invested in a straightforward way like capital equipment, so the firm does not owe a bank for them. They come from some combination of luck and good decisions, and members might feel they have earned those returns to some extent, leaving some trace of the common property problem. They do not pose as clear a dilemma between certain income today and uncertain extra income later. But there may still be some elements of the horizon problem: members who do not expect a long-term future with the firm might be more inclined to burn customer goodwill for short-term gain, with higher prices or lower quality.
So although the external finance solution described below will much reduce these problems, there may still be a need for mechanisms that could compensate incumbent members for losses from expanding membership or upon leaving the firm. But there are alternatives to the membership market that avoid its drawbacks. For example, there could be a time lag between joining the firm and receiving a full share of residual income, and then a period after departure where the former member continues to receive a dividend. More simply, the horizon problem at least can be dealt with via a severance payment capitalizing a departing member’s share of expected future profits.
As for the problems of managing risk within the firm and across the economy, external finance raises a new set of issues, which I turn to in the next section.
Finance and the Democratic Firm
The horizon and common property problems arise from firm worker-members accumulating collective wealth in their firm, which individuals lose their claim on when they leave, and which incumbents must share with newcomers when they arrive. If the membership market solution is not viable, these problems must be solved in some other way.
The other option is to minimize workers’ collective equity in their firm. This was Jaroslav Vanek’s solution — democratic firms should be externally financed. The firm’s investment decision is then not muddled with individual member preferences about savings and consumption, or by the risk members take on when they concentrate their wealth in their own workplace. All profit is distributed to members as personal income, leaving individuals to decide how much to save and how much to consume. Instead of keeping all their eggs in one basket, individuals save financially through the public banks, diversifying their exposure.
However, requiring firms to rely on external finance raises its own serious problems, since democratic firms cannot issue shares to those who do not work there. Borrowing involves promises to pay definite amounts by definite dates, but earnings are always uncertain. Equity comes with no absolute payment commitments; its owners are entitled only to residual earnings, and so equity works as a risk cushion for capitalist firms. A debt-to-equity ratio of around 50 to 60 percent is typical, though firms vary widely in their leverage — not only because of different decisions on risk but also because different business models face different levels of earnings volatility.
Workers in a democratic firm depending largely on debt finance would find their incomes — and the very survival of their firm — highly exposed to downturns in earnings. One argument for the traditional employment relationship is that the wage gives workers more security of income than they would have as residual claimants. The wage gives the worker in a capitalist firm a predictable income as long as they remain employed — though tenure of employment may itself be uncertain. A share in the residual of a cooperative firm means the workers’ income can swing up and down unpredictably. It is not hard to imagine that many workers may prefer the certainty of a fixed-wage income, even if the riskier residual income were generally higher.
So it seems that an economic model based on democratic firms is caught in a dilemma. Either firms mainly finance investment from their retained earnings, hitting the horizon and common property problems, or they rely on borrowing, leaving them fragile and their members exposed to high income volatility.
A socialist economy may have a large commodity-producing sector and yet involve financial forms better suited to egalitarian distribution and democratic decision-making.
Fortunately, we are not stuck with the financial instruments and institutions that have evolved to meet the needs of firms and financiers under a capitalist set of property rights. A socialist economy may have a large commodity-producing sector and yet involve financial forms better suited to egalitarian distribution and democratic decision-making. That means finding a way to allocate social resources rationally, pool risk, and share returns, while taking advantage of the local knowledge and initiative of workers, giving them meaningful decisions to make while aligning their interests with social needs. This section presents a framework for reconciling these things using the public banking system.
Investment as a Partnership Between Public Bank and Democratic Firm
In the proposed model, investment in productive capital assets involves a partnership between the democratic firm that uses them and a public bank that finances them. This is consistent with the socialist principle of social ownership of wealth, and it allows for an efficient use of resources to meet people’s wants and needs.
Democratic firms are custodians of social wealth, not owners. The capital assets they use in production need to be themselves produced, with resources that might instead have been used for other purposes. It would not be fair for these assets to be treated as the collective wealth of the members of the firm that uses them. Some kinds of production are more capital-intensive than others, so power plant workers, for example, would be much wealthier than day care workers. And workers in the private sector would have collective wealth not enjoyed by those in the public sector or by those not engaged in formal employment at all. It is fair for firms to pay for the use of assets, one way or another — and since this will form part of the cost of production, it will be reflected in output prices charged to customers.
Democratic firms are custodians of social wealth, not owners.
Further, rational resource allocation requires that the services of productive assets be priced appropriately. That means not only that their own cost of production should be recovered over their productive lives — the depreciation component — but also that there should be charges to cover interest and risk. Individual firms are well placed to understand the technical possibilities of production and the present and possible futures of the market situation — this is one of the advantages of commodity production over central planning. But they do not have the wider perspective needed to say whether resources are best used to expand their own capacity rather than for something else. A socially rational financial system selects investment projects to make best use of limited resources, and this means appropriately pricing capital and risk.
What is the rationale for interest in a socialist setting? Investment in the economic sense means adding to the stock of productive real assets. Resources devoted to producing some particular capital asset might instead have been used for another kind of capital asset, or for producing goods and services for current consumption, or put to some noncommodity use, such as leisure. It is not that there is a limited pool of funds — the financial system is flexible where funds are concerned — but that there is a limited flow of labor and other productive resources.
Investment means using resources now to increase income in the future. The interest rate sets a standard for how much extra future income an investment project must promise to be worth the use of resources today. In the proposed system, the basic interest rate is set through central bank policy, guided by macroeconomic considerations. The room for investment is ultimately determined by fiscal policy and by household decisions about how much to spend and how much to save from their after-tax income. Particular kinds of investment might face higher or lower rates depending on development, environmental, and other forms of industrial policy.
Investment is inherently risky because future economic conditions are unknown. But what exactly is at risk? At a social level, the risk is simply waste: that resources are devoted to producing something, and it later turns out that those resources would have been better used for something else. Either they might have produced capital assets better suited to the future conditions that eventuated, or they might have been used to satisfy more consumer or public wants at the time instead of augmenting future production, or people might have enjoyed more leisure time instead of producing at all. It is important that a socialist financial system be designed to minimize this kind of waste, but because the future is inherently unknowable, it is impossible to eliminate it. Holding back on investment because we can’t be sure of outcomes would itself be wasteful. Ideally, the system puts a price on risk so that it is taken into account when decisions are made but allows for and even encourages risks to be taken.
It is important that a socialist financial system be designed to minimize waste, but because the future is inherently unknowable, it is impossible to eliminate it.
By pooling risks and diversifying exposures, a financial system actually lowers the amount of risk to which anyone is exposed. This is a principle of insurance and of modern portfolio theory. A socialist financial system takes full advantage of this fact. But this is where the novel financial arrangements come in, to make up for the equity financing that is not available to an economy based on democratic firms. The banking system must socialize the downside risks of commodity production, but it must also charge firms appropriately.
Under capitalism, equity finance makes it possible for shareholders to manage risk by building a diversified portfolio. In considering investment in new capital assets, a firm’s managers can assume its owners hold the firm’s stock along with that of many other firms. If it invests in a new plant making solar panels, for example, and it turns out that an unexpected new technology is about to make that plant’s processes comparatively inefficient, that is bad news for the firm’s profits. But for its stockholders, the bad luck is likely balanced out by good luck elsewhere in their portfolio: perhaps they also own stock in the firm pioneering the new technology, or in a firm that’s having a good run in a completely unrelated field. Equity holders with a diversified portfolio are not worried by a firm’s idiosyncratic risks, i.e., those risks that are uncorrelated with the ups and downs of the market as a whole. These risks, being uncorrelated, tend to cancel one another out across a portfolio.
They are, however, concerned with the extent to which a firm’s returns move with the economy as a whole — how exposed it is to the business cycle. This cannot be diversified away, but some firms, and some investment projects, are more exposed than others. For example, restaurants might be highly exposed to fluctuations in consumer demand, while grocery staples are “recession-proof.” An asset’s sensitivity to market fluctuations is measured as its beta. Individual stockholders are free to choose their own level of exposure by choosing the mix of stocks in their portfolio and combining them with virtually risk-free government securities. They will only be willing to hold high-beta assets if they expect these to bring higher returns on average.
This gives a capitalist firm a metric by which to assess its potential investment projects. Standard principles of corporate finance hold that a firm should invest in a project if its expected rate of return is high enough to compensate for its sensitivity to market risks. The assessment depends on estimates of both the expected payoffs on the investment over time and the risk profile. Neither of these are straightforward things to estimate. Average past experience on similar projects can be used to estimate the profile of future possibilities — but, of course, situations never quite repeat, the economy evolves, and there is no guarantee that the past is a good guide to the future. It is not always easy to choose appropriate comparisons against which the project should be judged: the whole firm, a set of similar firms, or a set of firms specialized in the project type being considered. The metric cannot be used mechanically, then, but it provides a structure for bringing together data and judgment to decide whether an investment is a good use of resources — if this is judged in terms of maximizing return for a chosen level of risk.
Can this be adapted to socialist investment planning? Ideally, financial arrangements are set up to take advantage of banks’ ability to reduce risk through diversification. They will enable democratic firms to invest in projects with a socially desirable level of risk, while avoiding moral hazard and leaving incentives for the firms to pursue efficiency. In the system proposed here, firms will generally have a long-standing partnership with a public bank, which provides them with not only finance but also advice. The banks may even have played an active role in establishing the firm. But it is possible for firms to switch banks, getting a better deal or a second opinion on a project not favored by the current partner.
In the system proposed here, firms will generally have a long-standing partnership with a public bank, which provides them with not only finance but also advice.
A potential investment project — whether a new firm start-up or expansion of an existing firm — can be analyzed in a familiar way. It begins with a cash flow forecast: the cost of initial investments, later maintenance, and net income (after other costs) from employing the assets over their useful life. The forecast includes a central estimate of expected net cash flows in each period as well as scenario analyses considering upside and downside risks. The specific financing arrangements make a big difference in whether the firm’s members will approve investment. If fixed-rate loans are the only available financing, member income is fully exposed to the risks. Even if expected income is more than enough to cover interest payments, the downside risks — e.g., from subpar demand or cost spikes — can be substantial. With no equity cushion, worker-members could easily find their personal incomes radically cut in bad times so that the collective can meet its obligations and the firm is not vulnerable to insolvency. Since the individual firm cannot diversify its way out of its idiosyncratic risks, members face the full range of things that could go wrong, from a shift in consumer tastes to an energy price shock.
However, if banks can offer variable rate finance, the situation is transformed. There are several possible ways to structure this, with different solutions suiting different kinds of business. For example, these elements might be used by themselves or in combination:
Part or all of the payment to the bank varies with the firm’s income (revenue net of costs).
The bank guarantees a certain minimum level of income to the firm, insuring member incomes from downside risk past a certain point.
The bank owns the assets used by the firm, charging a rent whose rate varies according to industry benchmarks and economic conditions. The bank carries the risks (upside and downside) of asset ownership, while the firm converts a fixed cost into a variable one.
In each case, the bank takes on some of the risk but receives a higher average payment in return. This transforms the risk profile of an investment from the perspective of a firm’s members: cash outflows to the financier are made to correlate with uncertain revenue inflows and other cost outflows. The protection from risk comes at the cost of lower expected income, but there is a lot of room for a beneficial trade. Firm worker-members will be more risk-averse with their labor income — their bread and butter — than people and the public purse will be with their income from wealth. Further, because banks have a diversified portfolio, idiosyncratic risk has no cost to them — they need only charge according to the strength of the relationship between returns on the instrument negotiated with the firm and the ups and downs of the whole market.
The price of risk in the system ultimately depends on policy settings and potentially the preferences of bank depositors. There are regulatory capital and liquidity requirements on bank balance sheets. The public treasury, as the ultimate owner and residual claimant on the banks, can set acceptable boundaries around the volatility of bank returns and discipline management that fails to meet them. But if private bank depositors are themselves willing to take on more risk with part of their wealth, the banks might be allowed to offload some volatility to them. They do this by offering alternatives to deposits, products offering higher, variable returns without the guaranteed principal of deposits. Essentially, these would be mutual funds, with customer funds pooled and attached to diversified groups of investments in particular firms. The holders of these funds would enjoy higher average returns but would also take on the risk of lower returns.
Forecasting an investment project’s expected returns and assessing its risk profile relies on access to a wide range of data about market and production trends. It also calls for specialist judgment to draw informed conclusions about the future from historical experience.
Forecasting an investment project’s expected returns and assessing its risk profile relies on access to a wide range of data about market and production trends. It also calls for specialist judgment to draw informed conclusions about the future from historical experience. The banks will be in a good position to collect a wide range of information from their partner firms, and there could be more wide-ranging requirements for public reporting of accounting and production data. As public utilities, the banks will be empowered to assist democratic firms with their planning and decision-making. Small firms, in particular, will not have their own finance specialists and will depend on a bank for advice.
These financial partnerships allow for risk to be pooled at a social level, while still leaving incentives for democratic firms to value efficiency and seek better ways of doing things. Bank assessments of risks and expected returns are based on industry- and economy-wide benchmarks. Because members remain the residual claimants on profit, they have something to gain when their firm outperforms those benchmarks. The fact that a firm’s members may be insured against the immediate income consequences of losses does not let them off the hook indefinitely. When time for refinancing arrives, such experiences will be reviewed and factored into future arrangements: they may be assessed as temporary runs of bad luck, as a sign that the original forecasts were misjudged, or as showing that economic changes have made continuing the project unviable.
The proposal here draws on decades of debate about both workplace democracy and market socialism. As a sketch, it touches on but does not fully explore many problems that need further discussion. The intention is to bring these strands of socialist thinking back together and start a wider conversation about their possibilities and difficulties.
One of the biggest influences here is the work of Jaroslav Vanek, who proposed an egalitarian market economy with production by democratic firms. His monumental 1970 book The General Theory of Labor-Managed Market Economies crystallized the conception of democratic firms within the economic literature of the 1970s. His approach was to model labor-managed firms using the familiar economic tools of neoclassical economics.
Vanek’s strategy was similar to Oskar Lange’s in the socialist calculation debate decades earlier: use impeccably standard neoclassical theory to make the case for a socialist system. And just as Hayek had responded to Lange by arguing that neoclassical assumptions ignored important features of capitalist reality, so did Vanek’s critics. For these writers of the 1970s, the fatal weakness of the democratic firm was the incentive structure it set up, leading to the horizon problem and the common property problems discussed above. It turned out, after all, that capitalism’s property rights, financial instruments, and managerial hierarchies were ideally suited to coordinating the complex modern division of labor. The new economics of property rights, transaction costs, agency problems, incentives, information, and finance was born partly in an encounter with the democratic firm.
A second wave of thinking about democratic workplaces came in the 1990s, as part of a burst of thinking about alternatives after the collapse of the Eastern Bloc — also the milieu in which Roemer’s original model of market socialism emerged. Sam Bowles and Herbert Gintis (among others) turned the “post-Walrasian economics” that had been deployed against Vanek back in favor of workplace democracy. They argued that the capitalist employment relation was one of “contested exchange,” because what employers want from their workers cannot be fully specified in enforceable contracts. What they want is effort, but they pay for time. Drawing effort from workers depends on some combination of monitoring and loyalty, sticks and carrots — all of which are costly. With the right institutional arrangements, democratic firms could potentially beat capitalist firms in efficiency by mobilizing more loyalty with less costly monitoring. They coupled the efficiency argument with a normative argument for democratic accountability at work, building a powerful case for labor management.
With the right institutional arrangements, democratic firms could potentially beat capitalist firms in efficiency by mobilizing more loyalty with less costly monitoring.
But within this new wave, market socialism and workplace democracy came untangled. On the one side, as we have seen, John Roemer was agnostic at best about whether labor management fit with his model, the best-known vision of market socialism. On the other, the literature on democratic management increasingly focused on cooperative firms under capitalism, rather than as part of a broader socialist system. This trend is exemplified by Dow’s The Labor-Managed Firm, which brilliantly reviews decades of theoretical and empirical literature on democratic workplaces. Dow’s career-long interest in the subject was sparked by reading Vanek in the 1970s. But the political context was now very different. The driving question of Dow’s book is why labor-managed firms are so rare under capitalism, in spite of the evidence suggesting they are at least as efficient. Because part of the answer involves the difficulties cooperatives have in getting finance, he suggests they are best off mainly self-financing out of retained profits — the opposite conclusion to Vanek’s. Because the prospects for a broader systemic transition currently seem remote, Dow’s modest proposals understandably focus on policies that would foster collectives within a capitalist environment.
The essay here has the advantage of a longer, more abstract horizon. The intention is to sketch a plausible vision of a socialist economy without considering the problems of getting there from the present. This is not to deny that there are many such problems. But if one of them is a general skepticism that there is a plausible system that might be built, then sketches like this serve a purpose.Original post