Cooperative Enterprise and Market Economy: Chapter 10

Introduction & Preface | Chapter 1 | Chapter 2 | Chapter 3 | Chapter 4 | Chapter 5 | Chapter 6 | Chapter 7 | Chapter 8 | Chapter 9

Translator’s note:

In Chapter 10, the author continues the presentation of a mathematical model of equilibrium in cooperative enterprises originally developed by economist and management consultant Ignacio Larraechea. Having analyzed community enterprises and subsistence collectives in Chapter 9, which operate with a different economic logic than capitalist enterprises, Razeto now turns to equilibrium in “traditional cooperatives.” Unlike community enterprises, in which the social relations of production are for the most part not mediated through commodity exchange, traditional cooperatives are market oriented, depending on the market for economic factors on which they rely and realizing gains by selling the goods or services they produce. In this respect they resemble capitalist businesses.

But cooperatives differ in fundamental ways, as Razeto has argued throughout this book. Organized around labor and community, and not capital, their objectives and methods are not the same. Different, but better? The characteristics that set cooperatives apart from capitalist firms – above all the subordination of capital to labor and community – have been considered weaknesses. Economist Jaroslav Vanek, for example, argued that cooperatives have an inherent tendency to entropy and decline. Whatever moral and ethical benefits they may have, they lack economic dynamism. Razeto takes on this argument directly. While the model he uses here is admittedly based on unrealistic assumptions (a common feature of equilibrium models), it enables him to specify the causes of traditional cooperatives’ weaknesses, with regards to growth, employment, and technical change.1 He ends the chapter by lifting assumptions made in the model, finding that traditional cooperatives are indeed economically viable, and have found ways to overcome many limitations. Nonetheless, he concludes, concerns about growth and accumulation are justified; a new model is needed.

Note: In the interests of making an already challenging text more accessible to those unfamiliar with the mathematical exposition of equilibrium theory, I have chosen to place the formulas and graphs and their explanatory text in an appendix.

- Matt Noyes

Chapter 10

The Problem of Equilibrium in Traditional Cooperatives.

1. Traditional Cooperatives

By “traditional cooperatives” we understand units of production whose property and management are in the hands of their workers, organized as equal members. Members contribute to the formation of the enterprise’s initial “capital” through membership dues and eventually through periodic additional contributions, each contributing the same amount. These individual member contributions are not recoverable by the individual member. They form part of the indivisible equity of the enterprise, which increases by means of internal savings (surplus that is not distributed but rather reinvested in the enterprise). The “capital” is owned jointly, the cooperative itself being the titular owner.

Traditional cooperatives often also obtain financing through members’ investments of their personal savings. Because these funds are considered to be from a source external to the cooperative they are recoverable, the interest paid for this type of financing being, nonetheless, fixed and limited. To the degree that the principle of “limited return on capital invested” prevails, access to external financing, whether from members or third parties, is typically constrained. In general, these cooperatives produce for the market and do not encounter other obstacles to obtaining the factors they need there.2

The question of equilibrium in this type of cooperative requires a treatment that differs from that used to understand capitalist enterprises, community enterprises, and subsistence collectives. Nonetheless, because traditional cooperatives include elements of these other forms of economic organization, our analysis of the problem of equilibrium will draw on various concepts we have already seen at work in those other cases.

Traditional cooperatives share with capitalist firms the goal of maximizing monetary gains and investing sums from which they hope to derive monetary profits. At the same time, they resemble community enterprises and subsistence collectives in that a) the gains from economic activity go directly to the workers (surplus is distributed in proportion to the labor contributions made by each member), and b) the workers themselves make the decisions (on investment, distribution of profits, intensity of work, etc.) based on a subjective evaluation of the predicted revenues and profits, and more precisely, on their time preferences with regard to income.

Defining equilibrium for an enterprise has to do, finally, with its economic objectives. As objectives differ in each type of enterprise, the problem of equilibrium must likewise be posed differently for each. This is where we see a profound difference between capitalist enterprises and cooperatives. Where capitalist enterprises seek to maximize profit on capital, traditional cooperatives seek to maximize net income per worker.

The net income obtained by workers corresponds to the total income of the cooperative, minus the costs of all the factors purchased or leased by the enterprise the value of which is not recoverable by the workers. In this type of enterprise, given its ownership structure and the way surplus is distributed, non-recoverable factors are factors obtained from outside of the cooperative, bought or leased from third parties, and factors which form part of the equity of the cooperative as collective or commonly held assets (which do not belong to individual workers). External and collective factors alike imply a monetary cost to the members of the cooperative: the use of external factors in the cooperative implies payment to third parties while the use of collectively owned factors implies member contributions to the cooperative or the retention of surplus that is therefore not distributed to them.

[…]

We have seen in earlier chapters that the six economic factors with which enterprises operate can be divided four ways, first, as “human” or “objectified” factors and, second, as “internal” or “external” factors. Human factors are inseparable from the people who contribute them, while objectified factors are separate from the people who possess them. Internal factors form part of the equity of the enterprise, while external factors do not belong to the enterprise but are obtained on the market through an exchange with third parties which grants the right to use them for specific periods of time.

Keeping this in mind, the distinction that is most relevant for understanding the operational logic of traditional cooperatives is that between “internal human factors,” which each member contributes in a form inseparable from their person – their labor power, knowledge/skill (the technology factor), their values and community relations (the C factor), and their capacity for organization and management (the administration factor) – and the group of factors that constitute a monetary cost to the members of the cooperative. The latter can be internal objectified factors (which form part of the shared equity), external human factors (e.g. labor power, administration and management), or external objectified factors (e.g. material means of production, financing).

[…]

In community enterprises and subsistence collectives the key difference was between human and objectified factors, the distinction between internal and external factors being theoretically irrelevant because they do not operate with the logic of the market and in any case nearly all of their factors are internal. In traditional cooperatives, the distinction between internal and external factors is significant because these enterprises produce for the market, seeking to maximize the difference between what they pay for factors and the income they receive. In this respect they resemble capitalist enterprises, but they still differ in a key way: in traditional cooperatives, the distinction between human and objectified factors is crucial whereas in capitalist firms, both are treated as external costs.

In keeping with our definition of the rational economic objective of traditional cooperatives, we can say the point of equilibrium is given by the level of production and the combination of productive factors that result in the highest average net income per worker.

We proceed, then, with a simplified model, in order to identify the essential forces at work in the operation of this type of enterprise. As in any microeconomic model we must begin by specifying the basic assumptions on which it rests. These are:

a) Prices of productive factors. We assume that factor prices are constant (not varying with the amount purchased). On the other hand, we assume that the product (good or service) sold by the cooperative has a price that is constant and equal to 1 (one), such that we can identify total product with total income. […]

b) Production function. Given our assumption of constant factor and product prices, the level of production that permits the highest average net income per worker depends directly on the production function, that is, on the technological combination of factors of production. Thus, at the center of our analysis of equilibrium we find the production function, which can be of two principal types: constant returns to scale or rising returns followed by flat or declining returns.

We can say that there are constant returns to scale if, when increasing the various factors proportionally, production increases in the same proportion. In the same way, rising returns to scale will occur when production grows more rapidly than than the growth in factors, and will fall with a decline in production relative to the factors of production.

If we define a production function in which returns rise at low levels of production, becoming constant and ultimately declining as the levels increase, the quantity produced will be a determining variable in the calculation of the average net income per worker. Nonetheless, we have chosen to assume constant returns to scale, for two reasons: it permits us to considerably simplify the analysis, and the type of production function chosen does not affect our principal conclusions. […]

c) Level of internal human factors. As previously stated, each worker, by their participation, contributes certain factors which are inseparable from themselves as people. Although in reality individual members have different levels of each such factor, we choose to assume a homogeneous distribution of factors among the members, enabling us to directly link the number of workers to the level of internal human factors. […]

d) Access to external financing. Financing needed to obtain factors on the market is assumed to come only from members of the cooperative, either directly, through dues, or indirectly in the form of a reserve fund comprising that part of the surplus which the members decide not to distribute. This assumption corresponds to the situation of those cooperatives for which access to capital markets is prohibitively risky and which lack the support of institutions which would be willing to provide donations or “soft” loans. Later, we will lift this assumption.

e) Rate of time preference.3 In accordance with the preceding assumption, the acquisition of factors on the market will require member financial contributions, which implies a corresponding sacrifice of consumption or savings on their part. […] We assume, for the time being, that the rate of time preference is constant (independent of the amount contributed) and homogeneous for all members. […]

f) Depreciation and appreciation of factors. Another basic assumption in our model, normally accepted in microeconomics texts, is that the factors employed by the cooperative do not depreciate, nor does their value increase as a result of being utilized for a determined period of time.

Obviously, this assumption contradicts what we observe in reality, that is, that the means of production are “used up,” that the knowledge of the collective with regard to their tasks improves over time, that administration becomes more efficient over time (although the opposite may also occur) as the group acquires more knowledge and experience with regard to decisions to be made in given situations, that the value of money falls, that the presence of the “C factor” varies in form and intensity in different periods (the community element can be weakened or fine-tuned as members get to know each other better), etc.

Nonetheless, because we are not able to affirm with exactitude which effects weigh more heavily – appreciation or depreciation – and because the systematization of such effects would be excessively complex, we choose to assume that there is neither depreciation nor appreciation of any factor.4

g) Objective. We assume that the decisions made by the collective of workers aim at the maximization of benefits of the workers alone. Once again we are choosing to make an assumption often contradicted by reality. In effect, the values of solidarity, doctrines, or simply the subordination of operations to policy, which often characterize cooperative experiences, lead to a logic of operation in which the cooperative takes on responsibility to the external community at the expense of the collective. However, for the purposes of this chapter we feel justified in excluding this reality from the basic model.

h) Irrecoverability of contributed “capital.” As indicated at the beginning of this chapter, in traditional cooperatives individual members are not able directly to recover contributions of “capital” once made.

2. Functional dynamics.

Taking into account all of these assumptions, we can commence the study of the functional dynamics of traditional cooperatives.

In general terms, we will focus on analyzing the proportions of “internal human factors” […] and “factors that imply monetary costs,” […] which constitute, as we have seen, the two relevant variables for traditional cooperatives. […] Let us examine more closely the meaning of this distinction.

We noted that the factors that imply monetary costs may include those which are leased from third parties as well as those purchased on the market and incorporated into the equity of the cooperative. Leasing and buying these factors is accomplished either with additional monetary contributions made by members or with money drawn from the surplus generated by the enterprise. As the surplus belongs to the members and is normally allocated to them, it is up to the members to make the contributions necessary for the leasing or purchase of external factors. Thus, factors that are leased and purchased both constitute an additional monetary cost to each member.

This is how we understand the fundamental and crucial decision that members make each time they decide how much of the surplus to allocate to the members and how much to keep in the cooperative for the purchase or lease of external factors.

It is as a result of these decisions that the proportion of internal human factors and factors that imply monetary costs is established. This proportion determines the two central aspects of life in a traditional cooperative: on the one hand, the average net income received by the members, on the other, the rhythm of growth of the enterprise, insofar as increasing the amount of external factors with a given number of workers implies an investment on their part.

[…]

3. The “forces of self-extinction.”

The foregoing explains the low level of investment relative to the number of worker members, a phenomenon which is commonly witnessed in traditional cooperatives which operate with social ownership of equity that is not recoverable by the members who contribute it. We now offer an explanation of the progressive diminution experienced by traditional cooperatives sharing the same basic criteria. Yugoslav economist Jaroslav Vanek,who studied both phenomena – the tendency to “never invest” and to “never hire” – dubbed them the “forces of self-extinction” of cooperative enterprises.5

In the first place, and based on the assumption of irrecoverability of contributions, it is obvious that the collective of workers will benefit from the withdrawal of a member since that will enable them to increase the ratio of factors that imply monetary costs to the number of workers as well as the average gross income without incurring any additional cost to themselves, which amounts to an increase in their average net income (assuming the average product of labor is greater than the marginal product of labor; as the withdrawal of a member also signifies a decrease in production).

[…]

It is obvious, nonetheless, that there would be no incentive for a member to leave the cooperative, such that this dynamic would show up in the long run as a tendency to not replace departed workers, Vanek’s “never hire” effect.

Although the average net income increases with the withdrawal of members, there is a second force that tends to return the “capital/labor” relation to its previous ratio.6 In effect, given that the marginal productivity of “capital” is less than the marginal cost to the members […], the collective will decide to sell the excess “capital” because the money thus obtained will be more beneficial to them individually than it is to the cooperative. […]

As can be easily deduced, these movements will translate into a continual decrease in scale of the cooperative, as much in the number of members as in the “capital” employed, which led Vanek to conclude that such enterprises were “entropic and tended to decline.”

4. Perspectives for Growth.

The main characteristics that we have identified in traditional cooperatives permit us to consider their potential for growth due to technological change.

Returning to our distinction between the six economic factors, we can say that technological improvement leads to an increase in production, all other factors remaining the same. We now consider a production function in which the technology factor is considered independently from the other internal and external factors.

[…]

Generally speaking, we can say that there are two principal forms by which an enterprise can increase its level of technology: increasing the skills of its labor force or modernizing the equipment used.7

Technological progress normally involves a cost for the enterprise, whether due to the acquisition of new machinery or the training of the labor force (in both cases, in addition to the direct monetary cost these are indirect costs due to changes in the organizational system, transitory losses of productivity, etc.). Technological change, then, is similar to an investment made by the enterprise, its profitability determined by the costs of its implementation and the resulting gains in revenue.

Returning to the case of the traditional cooperative, we can conclude that whereas, given the irrecoverability of contributions, members have little incentive to carry out technological improvement through the acquisition of new machinery and equipment, they do have an incentive to invest in upgrading their skills (the skills of the labor force); this directly benefits the workers, who thus recover the investment. Compared to capitalist firms, then, traditional cooperatives tend to show a lower level of technical change, prioritizing instead investment in training and upgrading of the labor force over the modernizing of machinery.

Alterations in the basic model.

Notwithstanding the tendencies demonstrated by the basic model, which are verifiable in reality, many cooperative experiences survive and grow. This is due to the presence of certain elements that contradict the assumptions of our “pure” model, the effects of which we shall now analyze.

a) Resistance to the reduction of members.

The first “force of self-extinction” was based on the idea that there is an incentive to reduce the number of members because of the positive effects it would have on the incomes of the remaining members. It is possible, though, to observe certain countervailing elements.

First, the irrecoverability of member contributions itself disincentivizes leaving the cooperative. Withdrawing from the cooperative has a high cost for the individual compared to the benefit that their withdrawal would constitute for the remaining members. The tendency would be, then, for members to wait for “others” to withdraw. In addition, the bylaws and rules established by cooperatives typically make arbitrary dismissals more difficult and often also disincentivize voluntary withdrawal.

Second, we should take into account the fact that the frequent turnover of members would lead to costs for the group in terms of weakening the human relationships among members (causing distrust, less group integration, etc.), disrupting internal organization, and even altering productive capacity (losses in technological complementarity already achieved). Put differently, the stability of the membership group has positive effects on quality of the community, technology, and administrative factors.

Third, we should note the importance assumed by ideological aspects and the solidarity among members of the collective and the large community. In many cases, this element of social integration not only motivates the continued existence of the collective but can even translate into making the entry of new members a goal of the cooperative, even if it leads to a decrease in the incomes of the existing members. When this happens, we know that we are in the presence of a cooperative that is not operating according to the strict economic logic of maximizing the average net income of each worker, but combing those objectives with others with a character of solidarity more typical of the community enterprises we analyzed in Chapter 9.

b) External credit and donations.

Up to now we have assumed that the only source of financing of factors that are leased or bought on the market is member contributions or surplus generated by the cooperative in its operations. Nonetheless, loans (on more lenient terms that those of the financial market, to which cooperatives do not have easy access) and donations (coming from institutional cooperation) are part of the normal operation of many cooperatives.

[…]

Subsidized loans and donations would not shift the equilibrium point of traditional cooperative organizations, but would instead be used to subsidize the consumption of worker-members, unless the person or body making the loan or donation required that it be used for investment in production. […]

c) Rising rate of time preference.

In our basic model we assumed that members’ rate of time preference is constant, that is, that it does not vary with the amount of the contributions made to the cooperative. However, in reality an increasing contribution represents a growing cost given that the first units contributed represented for the members a sacrifice of optional consumption or savings, while, if the amount increases, members might have to sacrifice consumption of goods necessary to their subsistence.

[…]

5. Conclusions

From the preceding analysis we can draw some conclusions with respect to the viability and growth of traditional cooperatives in a market economy based on exchange relations.

a) Traditional cooperatives can exist and operate normally in a market context. But the condition of their existence is that already at the moment of their formation they must dispose of a mass of accumulated “capital” sufficient to ensure that the labor (internal human factors) of their members has an adequate productivity. That mass of “capital” could consist of the infrastructure and equipment of an existing enterprise which is converted to a cooperative through the transfer of property by means of expropriation or bankruptcy, or by means of a donation made by a development agency of some kind, or the individual contribution made by members who do not hope for a return on their investment but only seek a share of the ongoing earnings of the enterprise.

b) If the cooperative enterprise operates with an equivalent technological function (a similar set of factors) to that of other, capitalist, enterprises of the same type and scale, and has adequate management, the average net income of the worker-members will be higher than that obtained by wage or salaried workers in the capitalist enterprises, because there is no need to distribute profits to capital, all net income being distributed to the members of the labor collective.

c) “Capital” accumulation, technological innovation, and increasing scale will tend to be limited or even, in some cases, negative. In any case, they will be lower than in equivalent capitalist enterprises, which poses the risk that traditional cooperatives will be gradually excluded from the market. The negative handicaps of these enterprises can nonetheless be mitigated or even annulled if broader criteria than the simple calculation of maximization of current income per worker are applied in practice. Thus, many cooperatives adopt a policy that prioritizes employment of labor power, with a social and solidarity dimension that tends toward the inclusion of new members in the cooperative movement.

The presence of a tendency toward solidarity and social promotion, accompanied by a consistent moral, economic, and social education of the members leads to the application of policies of investment, development and employment in which immediate and short term interests may be sacrificed. This seems to be, in effect, a necessary component of the efficient economic operation and self-sustaining growth of traditional cooperatives.

d) In an economic and cultural context dominated by market criteria and the search for individual gain, traditional cooperativism tends to remain a subordinated subsystem. Nonetheless, it can claim superiority in terms of morality, and for its humanistic and communitarian conception of work and economy. Its capacity for transformation of the market and society depends not so much on its economic potential as on its power as a popular democratic social force.

e) From the economic point of view, the possibilities for expansion of the traditional cooperative system to the point of constituting a significant area of national production, circulation and consumption depend to a large extent on the political will of the public powers to provide financial support, tax relief, and technical assistance. At the same time, they depend on implementation of cooperative legislation that regulates its operation with norms – already present in many countries – that establish a fixed rate of investment of profits and the prohibition of reductions in the labor force. Such norms, if they do imply a certain inflexibility in the use of economic factors in response to changing conditions on the market, operate efficiently as limits on the effects of the forces of underinvestment and self-extinction analyzed above.

We end this chapter on traditional cooperatives on a rather pessimistic note, but it is important to reflect on the sources of the inefficiencies (which theory helps us understand) that we see in the practice of these organizations.

Our analysis has shown that, in the final instance, the aforementioned inefficiencies are rooted in an internal logical contradiction between the objective sought by members of the cooperative (increase in individual income based on work) and the form of ownership of equity, which is social and collective. It is the existence of this unresolved mix of the individual and the social that generates the tendencies toward underinvestment and self-extinction that we have described, because while the enterprise is based on social benefit, the members make decisions based on individual benefit. In this sense – but only in this sense – many cooperativists are right to blame the limitations or failures of certain cooperatives on insufficient values and failures of cooperation and generosity. But this problem can’t be resolved on the level of a simple moral judgment. It is necessary – as we maintain throughout this study – to build new cooperative structures in which the structural contradictions that harm the operational logic of these enterprises are overcome.

We have seen that the contradiction between individual objectives and the “social” form of property disappears in community cooperatives and we will see in the next chapter that something similar happens in worker enterprises of a new type. We saw that in community cooperatives a certain coherence is achieved with regard to the community. We will now see that in new worker enterprises coherence also can be achieved with respect to the person.

• 1

  For a thorough treatment of the economic concept of equilibrium and its uses and evolution, see Anwar Shaikh’s Capitalism, Oxford University Press, 2016. – MN

• 2

  We are aware that not all traditional cooperatives are structured in this way, nor do they all operate in the same way. As we have repeatedly indicated, the cooperative movement has included various forms of organization in its search to meet both the demands of the markets in which they operate and the ideologies of their members. The model we present here, then, presents analytical validity for traditional cooperatives that are structured in this particular way and share the assumed characteristics that we will enumerate as we proceed. For other cooperatives, the analysis retains some instrumental utility, understanding that the analysis will be more or less applicable in each case.

• 3

  The “rate of time preference” refers here to the consumer’s relative preference for current consumption over future consumption. The greater the time difference, the higher the preference for current consumption relative to future consumption. - MN

• 4

  Up to this point we have assumed that total production depends only on the six factors. Depreciation and appreciation of these factors would imply adding time as an explanatory variable.

• 5

  See Vanek, J., 1973, Some Fundamental Considerations on Financing and the Form of Ownership under Labor Management. Economic structure and development: essays in honour of Jan Tinbergen. - Amsterdam: North-Holland Publ. Comp., ISBN 0-7204-3078-X. - 1973, p. 139-152 - MN

• 6

  The “capital/labor” ratio here is the ratio of factors that imply monetary costs to the number of workers. - MN

• 7

  One can also consider here modernization of administrative techniques.