On some alleged “problems” and alleged “solutions” in democratic firms

David Ellerman

doi:10.1108/jpeo-04-2020-0012

Abstract

PurposeThis paper will discuss two problems that have plagued the literature on the Ward-Domar-Vanek labor-managed firm (LMF) model, the perverse supply response problem and the horizon problem. The paper also discusses the solution to the horizon problem and the alleged “solution” of a membership market.Design/methodology/approachThis is a conceptual paper so it analyzes the two problems and shows how they can be resolved. It also shows how one alleged “solution” (membership market) is based on several conceptual mistakes about the structure of rights in a democratic firm.FindingsThe perverse supply response is based on the assumption that the members of a democratic firm can expel for no cause some members when it would benefit the remaining members. It is shown that the same perverse behavior happens conceptually and historically in a conventional firm under the same assumptions. The horizon problem is resolved by the system of internal capital accounts (ICAs) that has been independently invented at least four times.Research limitations/implicationsThe idea of a democratic firm is quite often dismissed by conventional economists: “At first it seems like a good idea but unfortunately it is plagued by structural problems such as the perverse supply response and the horizon problem.” Hence it is important to see that the first is not a problem under ordinary assumptions and that the second is a solved problem.Practical implicationsThe perverse supply response problem can be reproduced in a conventional firm under similar assumptions, and the horizon problem is real problem for social or common ownership firms but is solved in the Mondragon-type worker cooperatives by the system of ICAs. This has been known and published since the early 1980s, but conventional economists ignore the solution and still cite it as an inherent structure problem of a democratic firm.Originality/valueIt has not been previously shown in the LMF literature that the perverse supply response can be reproduced in a conventional corporation under similar assumptions since the maximand for the conventional firm is not total market value but that value per current shareholder. The solution to the horizon problem using ICAs has long been “known” but never acknowledged in the conventional literature as if it was a necessary feature of workplace democracy. The idea of a membership market is analyzed and criticized.

Highlights

Much of the analysis of the labor-managed firm (LMF) in the conventional literature naturally uses the conceptual repertoire of neoclassical economics which, when applied to institutional issues, is referred to as the “new institutional economics.”
There are certain fallacies in neoclassical theory, in the treatment of property rights, and those fallacies creep into some analysis of the alleged “problems” of a LMF and even into some proposed “solutions.”
This paper will focus on one problem of each type: (1) the problem of the perverse supply response in an LMF assumed to be willing and able to “fire” some members to increase the return to the remaining members and (2) the horizon problem in an LMF where the members have no recoupable claim on reinvested net income

Summary

Introduction

Much of the analysis of the labor-managed firm (LMF) in the conventional literature naturally uses the conceptual repertoire of neoclassical economics which, when applied to institutional issues, is referred to as the “new institutional economics.” Some alleged problems in the LMF are easy to set aside by showing that a similar problem would arise in the standard corporation under similar assumptions. In a democratic firm with ICAs, the exiting member’s share of the actual net asset value of RK/r is the balance in their capital account which is paid out over a period of time [5].

Results

Conclusion