The United States is currently undergoing a level of income inequality that hasn’t been seen in this country since the 1920s. In 2015, the average income of the top 1 percent of Americans was 40 times higher than the average income of the bottom 90 percent of earners. Worker productivity rose by 132.9 percent from 1979 to 2013 while hourly compensation for workers increased by only 19.1 percent. At the same time, the incomes for the top 1 percent of earners rose by 256 percent. The World Economic Forum (WEF) recently produced an explanation: an obsession by companies with short-term profits. The WEF found that a focus on raising short-term corporate profits has overridden a focus on building equitable and inclusive economies for the world’s leading countries. What’s required isn’t just a change in policies, it’s a change in corporate governance and mindsets. Germany may have the answer to responding to this crisis in the form of co-determination. This system provides a path to build an economic structure that fosters economic development, inclusive growth, and rising standards of living.
Corporate governance is the study of how and why corporations make the decisions they do. Systems of corporate governance can be largely divided into two categories: shareholder systems, in which the sole responsibility of a corporation is to produce profits for its shareholders, and stakeholder systems, in which corporate conscience is expanded to include employees and others for which the company is directly responsible. The United States operated under a stakeholder system for decades, from the 1940s through the 1970s, at a time when the economy produced both massive and inclusive growth. This period, known as “The Great Prosperity,” saw low unemployment, steadily increasing wages, and the growth of the American middle class at a time of strong government investment, as well as a strong safety net and union protections. This all came at a time of rapid economic expansion that continued for decades, while corporate managers recognized that they owed the profits of this success as much to their workers and their community as they did to their investors. Stocks were widely owned by individual households, and companies focused on providing for the long-term happiness of their workers, including health insurance and pensions.
In the 1980s and 1990s, however, a shift in government policy and corporate culture moved the country toward the shareholder-based system that we still operate in today. As the American economy declined in the mid-to-late 1970s due to high inflation and unemployment, economists like Milton Friedman advised policy changes like widespread deregulation and diminishing the power of trade unions, while an emphasis was placed on allowing companies to make “as much money as possible.” This was done not just through changes in policy, but through the ascension of the idea that the best interests of corporations was to align the incentives of shareholders and executives. The result has been a focus on “performance pay” that has vastly increased the incomes for corporate executives and board members, who now have a much larger role in the running of companies. In order to increase corporate profits, companies have hacked away at health insurance and other benefits, while the power of labor unions has been greatly curtailed. The result of this shift has been a focus by corporations on “short-termism,” or focusing solely on short-term corporate profits to ensure that shareholders are happy. This often comes at the expense of cutting costs, including wages, and thus ensuring lower standards of living for workers. But not all major, dynamic world economies developed a shareholder system during this time period.
For decades, a stakeholder-based system of corporate governance called “co-determination” has operated in Germany. The German co-determination system developed over decades, beginning with the 1920 Works Council Act. After World War II, the system was further implemented through the Works Council Act of 1952, which established a system of “works councils” to oversee integrated corporate governance. This law also required that one-third of corporate boards for large corporations be elected by workers through a system of unions integrated into the company through works councils, which act as union boards overseeing local corporate operations. One of the reasons that co-determination developed in this time period was due to the prominence of an economic philosophy in Germany called “ordoliberalism,” which emphasized the need for a free market economy to be ordered in a way that widely distributed the economy’s benefits. Ordoliberalism promised Germany a way to avoid the unmanaged chaos of the Weimar Republic and to guard against the remnants of statist authoritarianism that persisted during Nazi Germany, while widely distributing benefits to keep the country on stable footing.
In 1976, the Codetermination Act of 1976 expanded the amount of seats on corporate boards to be held by workers to 50 percent of corporate boards for companies with 2,000 workers or more. This was followed by a rocky series of years for Germany due to the Oil Crisis and the global economic downturn that affected the United States at this time. Despite this and the shock of reunification in 1989, the German economy continued to prosper into the 1980s, 1990s, and beyond. Today, the German economy is rated as the most equitable and inclusive of the G7 world economies, while also remaining Europe’s leading economy and the fourth largest in the world. A Leiden University study even found that Germany’s system of corporate governance made it far more resilient to the Great Recession than other leading world economies, including the United States.
Co-determination helps companies achieve four goals: it fosters equality between the value of labor and the value of capital, it produces a more democratic economic structure, it improves workers’ lives and working conditions, and it gives workers greater control of their country’s economic power. It does this by integrating employees into corporate governance at the board and local level and ensuring that corporate boards don’t just make decisions for the sake of shareholders, but that they take worker’s views into account as well. Co-determination ensures that corporate boards are focused not just on short-term payoffs, but on long-term investment in workers, including through benefits, proper working hours, and matching wages with productivity. Works councils also ensure that corporate operations are transparent to the workers and to the wider public. The co-determination system has also seen manager pay rise over the past few decades, albeit to a smaller degree than the rises seen in the United States because the Germans have not used stock options in order to do so. (Stock options now account for 63% of average American CEO pay packages.) Although it should be noted that the focus of the American system on CEO performance pay may actually be bad for increasing corporate profit and that there are broad benefits to making workers feel invested in their output.
The movement towards employee stakeholder ownership in the United States will take a significant amount of political capital to counter the resistance it will likely incur from existing corporate boards and executives. In 2014, a Chattanooga Volkswagen plant sought to become the first place in the United States to implement a German-style works council. The plant’s owners followed with a campaign against those seeking a works council that resulted in the works council being voted down by the local United Auto Workers chapter. Additionally, as a Roosevelt Institute report explains, some unions may even resist the move, as both unions and corporations in the United States have tended to take a paternalistic view of their workers rather than the communitarian view predominant in Europe. Despite these roadblocks, the path to inclusive growth through co-determination could take many routes, each with their own benefits.
One of the first steps in this campaign could include changing laws to require corporations take into account all stakeholders in their profits when making decisions. At the very least, corporations would be further encouraged to quash malfeasance and focus on measuring value in ways other than stock prices. Additionally, other possible systems exist, like offering a special share of stock to employees that they can use toward electing a board member to represent their interests, or borrowing from the Dutch the idea of requiring representatives of various social interests to serve on corporate boards. These steps would not only improve the public images of large corporations, but would orient fiduciary considerations to be more inclusive of workers and other stakeholders, while reducing short-termism by ensuring the inclusion of long-term considerations that work for the public good.
Another route is one that has already begun to develop in the United States, called ESOPs. Employee Stock Ownership Plans (ESOPs) are corporate plans that provide employees an ownership interest in their companies. A University of Pennsylvania study found that ESOPs create greater employment stability and increased worker participation. This results in higher job satisfaction, organizational commitment, motivation, and participation in the workforce. There are currently around 7,000 ESOPs in the United States, involving 14 million employees. These companies pay their workers 5 to 12% more than traditionally-run companies, while also creating higher job growth, productivity, and firm profitability. The main use of ESOPs may be to act as an intermediary in a campaign to transition the United States back to a stakeholder form of corporate governance.
The Chattanooga case shows the long road that a drive for stakeholder corporate governance and co-determination will likely endure in the United States. A shareholder system has existed for too long and has become too powerful, especially in the wake of the Citizens United ruling in 2010, the “corporations are people” case that allows the power of shareholders and corporate executives to be felt all over the American political system. But that shouldn’t discourage a powerful campaign for co-determination being waged in the United States. With diffuse benefits and limited costs, co-determination could be a major policy option of the horizon. All that it needs is a committed policy entrepreneur or a set of them and the right timing. As efforts to revive the labor movement and union power are underway, that time may be just around the corner. Think of how just a four years ago it would have been unheard of for a mainstream presidential candidate to be talking about a single-payer healthcare system. And look at where we are now.
This article's image from German History in Documents and Images.