May 25, 1992 - In the first stage we predict the adoption of the Labor Managed Firm (LMF) ... paper is dedicated to the memory of Paul Taubman. Comparative ...
Labor-Managed Firms in Transition Economies* Yochanan Shachmurove and
Uriel Spiegel Bar-Ilan University and University of Pennsylvania
This paper investigates the transition of the LMF toward its optimal size. Once the firm has decided on the optimal number of members, the question of how to move toward that equilibrium must be addressed. The firm may not currently find itself at the optimal level for two reasons. Either the current number of members may not be optimal, or new market conditions dictate a change in the firm's optimal size. The main factors that must be considered in the move toward the optimal level are the benefits to the LMF members and the costs of transition.
The disintegration and liberalization of socialist economies in the former Soviet Union and Eastern Europe have been felt everywhere, even in areas where authoritarian systems are still flourishing, such as China and North Korea. A transition from centralized planning to a market-oriented economy brings the challenge of accommodating the market structures of the transition economies, a complex and ongoing process. Inherent difficulties in ownership transformation will inevitably entail a multi-stage process. In the first stage we predict the adoption of the Labor Managed Firm (LMF) organizational structure; cooperative firms organized and managed by the workers themselves. This structure is ideal where lack of locally owned *We thank our colleagues at the University of Pennsylvania: Jere Behrman, Bill Ethier, Lawrence Klein, and Herb Levine, as well as two referees and the Editor. An earlier version of this paper was presented at the "International Conference on Theoretical and Applied Aspects of Labor-Managed Firms," May 25-28, 1992, Bar-Ban University, Ramat-Gan, Israel. This paper is dedicated to the memory of Paul Taubman.
Comparative Economic Studies
39
Vol. 37, No. 1, Spring 1995
40
SHACHMUROVE AND SPIEGEL
private capital exists. Employees "expropriate" the capital previously owned by the State. Laborers see themselves as equal partners in the firm, having an equal weight in the decision process of the organization. Laborers are likely to resist any outside management that would resemble the old centralized system, objecting also to any outside management attempting to usurp power. The LMF resembles a cooperative in which workers/members manage their own affairs to maximize their own well being. One crucial modification in transition economies is the adjustment of firm size. While some firms may be able to increase the number of workers-managers, many will find it is in their best interest to decrease this number. One cost of transition is the adjustment to the optimal number of members. The incentive to increase the LMF's size is driven by a decrease in cost per member as the number of members increases for a given quantity of the public good. When a greater number of members utilize a public good, everyone can enjoy the public good without drecreasing the other members' benefits. Public good includes investment in telecommunications and transportation systems, the efficiency of a law enforcement system, and the general business environment. The level of the public good is exogenously given and financed by an equal lump-sum tax: the larger the LMF, the lower the tax rate required from each member. I The transition costs account for a significant portion of the costs that the private entrepreneur, as well as the social planner or government, must consider when the question of remaining united or breaking up is considered. This issue is not new to international trade theoreticians. Examples of the question of whether to divide or to unite are everywhere: from southwestern provinces in China, to the failed unification of the East African federation; from the former Soviet Union, to the secessionist movement in former Yugoslavia. Recent works on this topic include Casella and Feinstein (1990) and Casella (1991), which applies the theory of clubs and markets to the issue of the European Market and its monetary unification. Wei (1991) and Roeder (1991) also study the question of whether to divide or to unite by utilizing the Nash-Equilibrium concepts. Certain conditions determine whether the LMF will choose to expand or to shrink and to what level the firm will increase or decrease its size. This new level of employment is not necessarily the a priori optimal number of members given that (fixed and variable) transition costs are incurred by the LMF. Thus, the model presented offers an explanation for the seemingly painful process of accepting or dismissing LMF members. Because of these transition costs: (1) the LMF may be reluctant to frequently adjust its labor force; and (2) it may not always have the a priori optimal number
LABOR-MANAGED FIRMS IN TRANSITION ECONOMIES
41
of members. These are important characteristics of the current state of the LMFs in the fledgling market economies of Eastern Europe and the former Soviet Union. Moreover, the model suggests that the LMF's response to expanding or shrinking the firm's size is not symmetric. This paper discusses the conditions which compel the LMF to expand, shrink, or to leave unchanged its current number of members (given its current position).2 The Transition to the Optimal Number of LMF Members Much of the literature on labor-managed firms focuses on the issue of optimal firm size.3 Recently, Shachmurove and Spiegel (1994) have noted the omission of two important elements within a micro-economic model that determines the optimal size of the LMF: The effect of coordination costs among the members of the LMF .4 The benefit of sharing a public good by the LMF members.5 In a dynamic world, organizations as well as countries are considering new arrangements and structures. The nature of these changes vary; some organizations wish to expand, others to contract.6 The costs associated with the regimes' changes are a crucial element in the decision processes regarding the question of whether to unite and expand or to divide and decentralize [see, for example, recent works by Wei (1991) and by Roeder (1991)]. In this section we explore the issue of the transition toward the optimal number of laborer-managers as a function of the initial number of members. Suppose that initially the number of laborers in the LMF is not optimal Alternatively, suppose the LMF is currently at the optimum level of employment, but it now faces a change in the economic environment that induces the LMF to consider the issue of increasing or decreasing the number of its members. This situation is characteristic of those occurring in the new market economies of Eastern Europe. This issue is important enough within the private competitive framework, but it takes on critical importance in a LMF. In a privately owned company, there are relatively few managers who decide whether to hire or fire a worker. In a LMF, the transition process is more complicated because when the number of members is altered, the number of managers accordingly changes. Any change in the size of the firm involves a change in the management of the firm, involving painful and costly structural changes. To take this to another level, from a humanistic point of view, it is harder to reduce the number of workers in the LMF because of the equality of status. Unlike the Communist centralized planning system, in which restructuring would come from above in a hierarchical pyramid, change in a LMF involves a horizontal use of power. Dismissal is not given to a random worker who is three levels below
42
SHACHMUROVE AND SPIEGEL
you in the organization; it is given to a colleague, a fellow manager. An additional point of interest is to consider the costs and benefits of the transition within the context of the time trajectory of those elements. It is possible to assume, at lest as a first approximation, that while the costs of transition to equilibrium are incurred momentarily or in the near future, the potential benefits to the organization are gained over a longer period of time. Thus, it is assumed the costs are incurred immediately, and the benefits are discounted over the long run. This can present a problem in emerging economies that have no prior experience with a market-oriented economy. The failure to see the long-run benefits, focusing only on the short-run sacrifices, may preclude the taking of the steps needed to reach the optimal number of members.
Transition Toward Expansion Consider different characteristics of the transition costs when dealing with expansion and contraction policies. First consider the case of expanding the number of members in the firm. The total transition costs of this action can be divided into two components: fixed and variable transition costs. Total fixed costs represent the costs associated with making the decision to go ahead and increase the number of members in the organization [see, for example, Wei (1991), who includes only fixed transition costs]. Such expenditures include costs of opening up training courses or other fixed costs associated with the psychological effects of adding new members to the LMF, without taking into account costs that do depend on the number of members being hired. The total variable costs are costs that depend on the difference between the optimal level of members and the current number of members in the organization. This is true for any number of members, but we are interested in the movement toward the optimal number. The existence of transition costs raises two potentially independent questions. The first considers whether or not to move from the current number of members. The second assumes that it is worthwhile to change the number of members. The firm may decide to either move from the actual number of members to the optimal number, or to move toward the optimal level, but not necessarily to the optimal point itself. To put it differently, whether the firm decides to converge to equilibrium ex-ante level depends upon the initial starting point relative to the equilibrium optimal level. To investigate the fixed transition costs more fully, the assumptions held here are:
LABOR-MANAGED FIRMS IN TRANSITION ECONOMIES
43
The public-good level, the price of output, the rent to capital, the adjustment cost term, and the tax schedule are all known parameters assumed to be constant over time. The time span considered for convergence to equilibrium runs from the present time to infinity. The experiment deals only with the expansion of the LMF. The additional per-worker income of a laborer who initially was a member of a group and now joins a larger group is equal to the difference between the two incomes of the two groups. Thus, it follows that there exists a number that, if greater than total fixed costs, will cause the organization to expand from its current size to the optimal number. If this number is less than total fixed costs, the LMF will stay at the current level and not move toward the optimal size. This implies that, as the current number of members approaches the optimal number, the incentive to make the final move to optimality decreases. Figure 1 helps to explain this purely fixed cost expansion case. Let TFC denote the total fixed costs of transition. Let V denote the present value of total benefits, or additional income, for all laborers who are members of a group or a given size, who now join the larger group of size Na. If present-value of total benefits exceeds total fixed costs of transition, (V> TFC), the organization expands from Na instantly to the optimal number of members, N.. If present-value of total benefits is less than the total fixed costs of transition (V < TFC), the LMF stays at the current level of members and it does not move to N., although Na is not the optimal number of members. Next, consider the case of expanding the size of the LMF in the case of pure variable costs. As the size of the organization approaches its optimal size, the additional net income for the current members of the organization is a positive and decreasing function, approaching zero at the optimal level. The reason is that, as average income for a worker who is already a member of LMF increases, it increases at a decreasing rate as the number of members approaches the optimal number. 7 Let TVC(N) represent the total variable costs of transition. Further, assume that TVC(N) is an increasing function of the number of members. Let V denote, as before, the present value of total additional income for all laborers who are members of a group of a given size who now join the larger group of size Na. Let VN denote the change in V as the number of members increases. It is reasonable to assume that, as the size of the firm approaches N., the additional net income for the current members of the
44
SHACHMUROVE AND SPIEGEL
FIGURE
1
V, TFC
V
FIGURE
1
TFC
Nc
No
N
LMF is a positive, but decreasing function of Na. In addition, it is reasonable to assume that the change in total benefits, VN, approaches zero at the optimum number of members, N.. In this case, as illustrated in Figure 2, if Na
