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20 The Possibilities of a Third Way
Central planning has many appealing features. A plan enables tasks to be prioritized rather than relying
on what seem at times to be the whims and myopia of the market. A plan can also facilitate the
mobilization of resources to achieve specific aims, such as the creation of infrastructure or the creation
of a new industrial sector. Because income from property accrues to the state, public ownership of the
means of production, which is a usual but not a necessary feature of centrally planned economies, avoids
extreme bias in the distribution of income. Despite the recent dismal economic history of centrally
planned states, planning retains an appeal. It is still considered a rational activity within a firm or a
household, and this lends some justification for planning in the management of the national economy.
However, from its earliest applications the deficiencies of centralized planning have been apparent.
Effective command planning requires the centralization of a vast amount of information, so much in fact
that it is almost impossible to process and to reconcile. This very need for data often creates perverse
incentives that encourage enterprise managers to mislead the center for their advantage. Planning has no
mechanism whereby consumer preferences are rapidly transmitted to the center, and so the preferences
of individuals must be guessed at or ignored. Finally, of particular importance is the fact that only in the
rarest of circumstances will prices in a planned system reflect relative scarcities or resource costs.
MARKET SOCIALISM AND SOCIAL MARKETS
Because each of the polar conceptions, free market capitalism and socialist command planning, has
defects, a middle way that grasps the market’s advantages in allocative efficiency and marries it to the
distributional equity of socialism is very attractive.
There are two main approaches to an economic third way1. A system in which capital is collectively
owned, generally by the state, but in which the prices of final products and inputs are determined in the
marketplace is generally referred to as market socialism. We observed this kind of economy in our
review of the former Yugoslav state. Such a system enables the market to allocate factors of production,
while coordination of the system is achieved through price signaling. Usually the one price that is not
determined by the market is that of capital. Generally it is owned by the state and is lent or rented out at
prices determined by the planners or the politicians.
A second approach is to allow a more completely operative market system, in which capital may be
privately owned and rationed by the market. However, the government puts constraints on the ultimate
outcome of the system, and prescribes how the economy will perform in terms of income distribution,
access to basic goods and services, and sometimes price determination. This kind of economy is properly
referred to as a social market economy, and we studied this in the Swedish and German cases.
Unfortunately, the distinction between true market socialism and the social market approach is
frequently confused.
MARKET SOCIALISM
We should note that “third way” as used here is not identical with the concept of the British sociologist and LSE Director
Anthony Giddens, in his book The Third Way: The Renewal of Social Democracy (London: Polity Press, 2000). Giddens’
book, which has been embraced by Tony Blair and both Bill and Hillary Clinton, is largely about politics and promotes the
ideas of liberal globalization, environmental concern and broader property ownership.
1
We turn first to discuss the advantages and flaws of market socialism. While this system appeals because
it represents the best of two worlds, providing both allocative efficiency and equity, both recent
experience and current scholarship have tended to emphasize the vital importance of an impartial capital
market for the functioning of any market system. Any attempt to maintain a competitive system of prices
in the goods and labor markets alone will fail because it divorces the functioning of those markets from
the market for capital, to which they are inescapably related.
The Function of the Capital Market
The foremost function of a capital market is to disinterestedly evaluate the performance and potential of
each firm. Those firms that are traded in equity markets have their share values determined by an
impersonal stock market, which adjusts values to reflect prospects. Those firms that borrow by issuing
bonds and paper are subject to the judgment of the bond market, again with many authors pursuing selfinterest, on the value of its credit. Those firms that borrow directly from banks have to compete with
other borrowers for capital and have to demonstrate the soundness of the business plans and pay
premiums according to the riskiness of their ventures. The Israeli economist Michael Keren has summed
up the essential function of the capital market:
The basic service the capital market supplies is the evaluation of each traded firm’s net worth. This signals
to its management and its owners how the market judges its future prospects. If this value declines relative
to that of similar firms, this may be taken as an indication that the market considers the firm’s policies
inferior to those of its competitors. In severe situations, this may convey a recommendation to change the
top management team of the firm, possibly through a takeover by an alternative team. In extreme cases,
when the market believes that the expected present value of the firm’s cash flow is negative or significantly
below the breakup value of the firm, the capital market may apply direct sanctions by bankrupting the firm. 2
Making Capital Decisions under Socialism
In the absence of an objective capital market, decisions about which firms are to be given funds for
capital investment and which denied must be made by a political process. We can conceive of two broad
institutional approaches to addressing this problem. On the one hand, we can allow allocation of capital
among competing investment projects to be in the hands of a state hierarchy, consisting of the political
leaders and the bureaucrats, the approach followed under central planning in the Soviet Union and
Soviet bloc. The politicians laid down guidelines, while the planners complied by crafting them into the
plan, and any perceived deviation by the planners from the interest of the politicians would likely be met
by their discipline or removal. The system produced, as we have seen, very mixed results: the growth of
heavy industry was both rapid and sustained, but enterprise managers had little incentive to innovate and
new enterprises were few. Bankruptcies were even more rare as the political process often acted to
preserve the status quo. These tendencies impeded the development and adoption of new technology by
the planned economies and may account for their ultimate failure in the face of the technological
revolution of the 1980s.
An alternative approach might be to establish “investment boards,” made up of impartial “experts” who
could take a dispassionate view of the prospects of various potential enterprises. Unless specific
arrangements were made to protect their tenure, and hence to insulate the board members, this only
pushes the problem one step away. The performance of the boards would not be subject to an
2
Michael Keren, “On the (Im)Possibility of Market Socialism,” in The Road to Capitalism, ed. Kennett and Lieberman, 45–52
independent evaluation, but the board members would serve at the pleasure of the politicians and would
themselves be political appointees. Safeguards (such as long-term tenure) could be designed to insulate
such boards from political pressure, but they are not likely to be perfect. Under such political
uncertainty, it is hard to see how the action of any planning agency or board can effectively simulate the
performance of a financial market. In the market it is not one individual or group that decides the fate of
firms, but the weighted opinion of many market participants. The best that can be done in its place is a
considered judgment by a narrower group that can never be impersonal.
It can, however, be argued with some justification that the behavior of investment boards or planners
might in some cases be better than the behavior of the market. Markets might be short-sighted in their
evaluation of prospects, and deny capital to enterprises that, though worthy, will be slow to pay back
principal. Planners or investment boards might be more capable of taking a longer view. It is also
possible that planning might facilitate a more comprehensive view of the costs and gains of a project
than the market does. Market decisions frequently fail to take into account significant positive and
negative externalities, and, in theory at least, planners can take a more holistic view of the cost-benefit
matrix of an investment. Consider, for example, constructing a railway line. A private firm would
consider only the costs and revenues of the venture itself. A planning or investment board would want to
take in consideration a much broader set of effects: the effect of alleviating road congestion in transport,
the impact on the environment, and so forth. With respect to investments with infrastructural and
spillover consequences, the board might well arrive at a more socially optimal decision than the market.
Ludwig von Mises, the promarket Austrian economist, argued trenchantly that a socialist state would be
unable to handle the question of a railway investment very well:
Suppose, for instance, that the socialist commonwealth was contemplating a new railway line. Would a new
railway line be a good thing? If so, which of many possible routes should it cover? Under a system of
private ownership we could use money calculations to decide these questions. The new line would cheapen
the transportation of certain articles, and, on this basis, we could estimate whether the reduction in transport
charges would be great enough to counterweigh the expenditure which the building and running of the line
would involve. Such a calculation could be made only in money. We could not do it by comparing various
classes of expenditure and savings in kind. If it is out of the question to reduce to a common unit the
quantities of various kinds of skilled and unskilled labor, iron, coal, building materials of different kinds,
machinery, and the other things which the building and upkeep of railways necessitate, then it is impossible
to make them the subject of economic calculation. We can make systematic economic plans only when all
the commodities which we have to take into account can be assimilated to money. True, money calculations
are incomplete. True, they have profound deficiencies. But we have nothing better to put in their place.
And, under sound monetary conditions, they suffice for practical purposes. If we abandon them, economic
calculation becomes absolutely impossible.3
While von Mises’s point that rational planning requires valuation in terms of some comparable unit is
quite valid, it is by no means clear that his example is a good one. A government may be much more
qualified to calculate the complete benefits over space and time of a major infrastructural improvement.
For example, the establishment of a railway line will involve inevitable consequences for other means of
transportation. Roads will be less congested, pollution will be lowered, time will be saved, and other
spillovers experienced. Quite contrary to von Mises’s assertion, the planner is better able to consider the
social benefit of large-scale infrastructural change.
Ludwig von Mises, “Economic Calculation in Socialism,” in The Road to Capitalism, ed. David Kennett and Marc Lieberman (Fort
Worth, Tex.: Harcourt Brace, 1993), 38–39.
3
The Soft Budget Constraint
The political control of investment credit is a facet of a general problem articulated by the Hungarian
economist Janos Kornai.4 He had worked his entire career within the Hungarian planning system and
well understood the way that such a system operated. The “soft” budget constraint refers to a situation in
which the firm or enterprise is unconstrained by the basic maxim that long-run revenues must exceed
long-run costs. A “hard” budget constraint is experienced by firms in competitive markets. They cannot
expect to receive a subsidy toward the operation in the long run, and they therefore must earn enough
revenue to meet their costs of materials and factors of production including capital. Although they might
go into debt in the short run, in the long run the debt must be amortized.
In socialist economies, because both capital costs and operating costs are frequently subsidized by the
state, the soft-budget constraint is the norm, not the exception. There are subtle ways of introducing
“softness” into the system through direct subsidies, discriminatory taxation, or the manipulation of
administered prices to ensure the appearance of financial viability. In this chapter, however, what
concerns us is the existence of “soft credit,” a phenomenon that embraces two related features. The first
is the provision of credit at an interest rate that fails to reflect the opportunity cost of capital, implying
that the demand for investment funds will generally speaking exceed its supply and that it has to be
allocated or rationed by a nonprice system, opening the door to political or personal favoritism. By itself,
however, a nonprice allocation system does not necessarily represent soft credit: if payment reschedules
are required to be adhered to, then even loans at subsidized interest rates can be “hard.” If debt service
payments are not met, then the firm can be forced into bankruptcy, merger, or takeover. What makes the
system truly “soft” is a second feature, the knowledge that the political process will ensure the continued
existence and even the growth of the firm despite continued failure to meet the prescribed repayment
schedule. The soft budget constraint enables the firm to continue to exist although its long-term
obligations are not met. To put it a different way, its long-term expenditures are greater than its longterm revenue and credit continues to be granted by the authorities, although there is little prospect of
repayment.
The Impact of Soft Budget Constraints on the Conduct of the Enterprise
If the firm believes that its budget constraint is indeed soft, incentives exist for it to behave in ways that
will lower the efficiency of the economy. The firm’s elasticity of demand for inputs will become
markedly reduced. If increases in costs are compensated by external assistance, there is little reason for
an enterprise manager to economize on the use of the newly expensive factor. Under a soft budget
constraint, a rise in input prices does not lead a decision maker to change input mix or alter output level
but rather to get on the phone to persuade the planners to change prices or to grant additional credits.
While the short-term consequences may be grave, the longer term is of greater consequence. Kornai has
summarized this situation:
The most important issue is dynamic adjustment. If the budget constraint is hard, the firm
has no other option but to adjust to unfavorable circumstances by improving quality,
cutting costs, introducing new products or processes, i.e. it must behave in an
entrepreneurial manner. If, however, the budget constraint is soft, such productive efforts
are no longer imperative. Instead, the firm is likely to seek external assistance, asking for
4
Janos Kornai, “The Soft Budget Constraint,” Kyklos 39 (1986), 3–30.
compensation for unfavorable external circumstances. The State is acting like an overall
insurance company taking over all the moral hazards with the usual well-known
consequences; the insured will be less careful in protecting his wealth. [Joseph]
Schumpeter [the Austrian economist] emphasized the significance of “creative
destruction”: the elimination of old products, technologies, organizations which were
surpassed by the more efficient new ones. The soft budget constraint protects the old
production line, the inefficient firm against constructive destruction and thus impedes
innovation and development.5
The Possibility of Market Socialism
The foregoing argument suggests that the problems of capital allocation are fatal to any attempt at
market socialism. Whenever investment funds are controlled by the government, or by boards appointed
by the government, there will be some inevitable softness in capital allocation. Enterprise managers
knowing that projects are ultimately supported on political rather than economic grounds will not adopt
the behavior that results in allocative efficiency.
In Keren’s terms the vital aims of market socialism are equality and decentralized decision making. The
former requires the public ownership of productive assets. The latter requires hard budget constraints
and an absence of state intervention. However, these two aims are in conflict. The exclusion of private
market and the political bureaucratic process cannot serve as an adequate proxy. Enterprises become
aware that survival and growth are politically, not economically, determined, and their behavior changes
as a result.
While it is hard to pick holes in this logic, its flaw is that it sets straw men against each other. Financial
markets, because they are disinterested, are assumed to be superior to the political process in allocating
investment. However, the lessons of recent history are that private markets are capable of enormous
errors in getting funds to projects that have failed—America’s savings and loans crisis and the Southeast
banking debacle are two examples that stand out.6 Similarly, socially owned banking systems—for
example, in Taiwan or in France during “les trentes gloirieuses”—have done an adequate job in credit
allocation. A pure market can offer advantages in allocative efficiency over politically controlled
investment processes, but myopia, panic, a narrow definition of the “bottom line” are all problems that
can afflict a market system and can lead to social consequences that are hard to predict and expensive to
correct.
THE SOCIAL MARKET ECONOMY
The European Model
While market socialism seems to be largely out of favor, the search for a middle way is nevertheless
active. European nations, which had swung to the right in the 1980s, had moved back to the left by the
mid-1990s, and their economies embody high degrees of regulation and redistribution. The alternative to
nationalizing the means of production (which denies private ownership of most capital and hence the
Kornai, “The Soft Budget Constraint,” 10–11.
The indigenous financial systems of most East Asian countries relied on directed credit; however, much of the blame for the crisis must be
placed on the inflow and outflow of “hot” monies from competitive financial systems.
5
6
appropriation of its income stream by individuals) is to allow a market to operate for all goods and
factors of production, including capital, but to use the power of the state to modify, to regulate, and to
guarantee the distribution of income and to ensure access to basic services and opportunities. We have
already looked at two good examples of this kind of economic organization in Sweden (Chapter 7) and
in the Federal Republic of Germany (Chapter 9). In fact, the ethic of the entire European Union might
well be described as social market oriented.
The Stakeholder and the Stockholder
The German model of worker participation and involvement in decision-making (sometimes called the
Rhine model) calls into question the conception of the Anglo-Saxon model that a firm’s sole
responsibility is to its stockholders. In Germany the system of codetermination, with labor involved in
management decision-making, establishes the principle that others besides the “owners” of the
corporation have a stake in its future and therefore a voice in its management. This brings us to a
discussion of what is now referred to as the stakeholder economy.
A stakeholder is defined as someone who, while not a titular owner of a business, has legitimate interest
in its performance and success. The stakeholders of a corporation may include not only the shareholders
but also labor, management, customers, suppliers, lenders, and the community in which the corporation
is located. Consequently, if stakeholders have any legitimacy, they have a voice that influences the
performance of the corporation.
It is difficult to draw strong conclusions about what the legitimation of a wide range of interests in the
decisions of firms does to economic performance. If the behavior of the corporation is indeed
meaningfully modified by recognizing stakeholder preferences, and if that behavior is not consistent
with profit maximization, it should follow that the “stakeholder corporation” might be in difficulty
because it will underperform its “profit-oriented” competitors. Less profitable than a profit-maximizing
corporation unconstrained by stakeholder preferences, a stakeholder corporation would therefore be
vulnerable to, and ultimately eliminated, by market forces.
If, in fact, pleasing the stakeholders contributes to the maximization of long-term profits, then there is no
conflict. The Economist, in reviewing a recent book by John Kay, a prominent British economist, that
favored the view that the corporation is a “social institution” beholden to a range of stakeholders, rather
than a private one beholden only to its owners, declared such a view to be “either trivial or meaningless.
Few companies, bar perhaps monopoly utilities, can afford to have a miserable workforce or disgruntled
customers. If, that is, they want to be successful. Presumably that means making money for their
customers.”7
However, there are other interpretations to be considered. For example, take the issue of labor’s “stake”
in its employer. Clearly in Japan where the institution of lifetime employment covers at least some of the
workforce of the major employers, workers have a greater recognized stake than in, say, the United
States. This relationship has hampered the ability of Japanese corporations to deal with the downturn in
demand that has afflicted the economy since 1990. Productivity and profitability in Japanese firms has
been adversely affected by this inability to restructure the workforce. In the United States, in contrast,
The Economist, “Money Making,” a review of The Business of Economics by John Kay (Oxford: Oxford University Press, 1996). Review
of Books and Media, 16 November 1996, 12.
7
downturns in demand, or profitability, can be met by trimming the workforce, as in the well-documented
downsizing of the early 1990s. Similarly, if a company takes seriously its obligations to a community,
should that commitment to its neighbor/stakeholders be at the expense of shareholders?
Within the German model the most important stakeholders in the firm are, on the one hand, the
employees and, on the other, the bankers, who lend the enterprise most of its capital. Often the same
banks also own some of the shares of the firm, which is allowed under German law, but this is generally
quite a small part of total equity.8 However, the banks have considerable influence in the firm because
they were often represented on the supervisory boards and also control the voting power of the shares
they hold for clients in their role as stockbrokers and mutual fund managers. A growing criticism in
Germany has been that the interest of the banks as lenders may be in conflict with the interest of the
shareholders, and recent years have seen rising activism by shareholders about maximizing the return to
their capital. Table 20.1 shows the dominance of banks in decision-making in major German
corporations; this power originates not primarily from bank ownership of stock but its ability to vote by
proxy the shares that are held in investment funds and in customer accounts.
TABLE 20.1
Banks’ Share of Voting Rights at AGMs of Large German Companies, 1992
Shares Owned By:
Subsidiary
Total
Investment
Bank
Company
Banks
Funds
Proxy Votes
Votes
Siemens
—
9.87
85.61
95.48
Volkswagen
—
8.89
35.16
44.05
Hoechst
—
10.74
87.72
98.46
BASF
0.09
13.61
81.01
94.71
Bayer
—
11.23
80.09
91.32
Thyssen
6.77
3.62
34.98
45.37
VEBA
—
12.62
78.23
90.85
Mannesmann
—
7.76
90.35
98.11
Deutsche Bank
—
12.41
82.32
94.73
MAN
8.67
12.69
26.84
48.2
SOURCE: The Economist, 3 June 1995, 66.
Stakeholders as Shareholders
One way in which the potential conflict between the rights of shareholders and the claims of other
stakeholders might be resolved is by extension of share ownership to stakeholders. This arrangement
could be used to resolve to some degree the principal-agent issues that have traditionally affected the
labor-capital relationship. A growing number of firms are providing incentives for workers in the form
of preferential employee ownership schemes, which tend to bring interests of capital and labor into much
closer alignment. A similar solution might also be possible in the case of a local government, which
could take an equity holding in a major local employer. Such an arrangement would, however, raise
complexities of the municipalities’ attitude to new entrants and competitors and might bias the level
playing field.
8
In 1994 private banks directly held about 0.4 percent of German industrial capital, down from 1.3 percent in 1976. The Economist,
3 January 1995.
The government in the United States has actively favored the extension of employee ownership and
offers considerable tax advantages to firms that institute employee stock ownership programs, the result
of which has been a rise in worker ownership of firms. Table 20.2 shows the 10 largest majority
employee-owned corporations in the United States. Although some are quite large, they are clearly only
a tiny fraction of the total economy and tend to be concentrated in service industries. It is also worth
observing that even employee ownership does not mean that there will be peace between the
management and the workforce. The roles of worker and owner might be in conflict. In the fall of 2002
the machinists union, whose members are among the majority ownership of the United Airlines,
embarked upon a damaging strike against the airline.
TABLE 20.2
The 10 Largest Firms in the United States with Employee Holdings above 50 Percent of Total Equity, 2002
Number
of
Company
Plan
Business
Employees
United Parcel Service
401k
Package Delivery
344,000
Publix Supermarkets
ESOP,stock purchase Supermarkets
111,000
United Airlines
ESOP
Airline
98,400
Hy-Vee
ESOP
Supermarkets
46,000
ScienceApplications Intl. multiple
R&D/Computer Systems
41,000
Lifetouch
ESOP
Photography Studios
25,890
Dyncorp
ESOP
IT/Technical Services
23,000
Tharaldson Motels
ESOP
Motel Management
18,980
Amsted Industries
ESOP
Industrial Production
12,500
CH2M Hill, Inc.
stock purchase
Engineering& Construction
12,000
SOURCE: National Center for Employee Ownership: The Employee Ownership 100, www.nceo.org/
In addition to the firms of Table 20.2 in which the employees have more than 50% of equity, there are
many more companies in which the employees have some stake. The ESOP Association reports that
more than 10,000 US corporations have employee stock option plans in place – and about 10% of these,
1,00 companies, are publicly listed. Moreover, many workers in the United States and elsewhere have a
financial interest in their employer. One avenue is by the heavy investment of corporate pension funds
in employer stock. One study found that employer stock represented almost 20% of assets in defined
benefit corporate pension plans9. Another is the widespread use of 401k schemes that often give strong
incentives to workers who invest in company stock.
There is some evidence to suggest that involving employees as formal “at risk” stakeholders does lead
to better performance than the conventional corporation, in which workers have no ownership stake in
the company. In 2000 Blasi and others concluded that corporations with ESOP plans grew faster (at a
rate of 2.3% per annum) than did firms without10. However, this improvement is not automatic. Kruse
9
Committee on Education Workforce, US Congress, Testimony of Dr. Douglas Kruse, Ph.D., Rutgers University,
Wednesday, February, 13, 2002.
10
Blasi, Joseph, Douglas Kruse, James Sesil, Maya Kroumova, and Ryan Weeden. Stock Options, Corporate Performance,
and Organizational Change. Oakland, CA: National Center for Employee Ownership. 2000.
found that “. . . employee ownership may have positive effects if employees value ownership in itself or
perceive that it brings greater income, job security, or control over jobs and the workplace. On the other
hand, it may have negligible or even negative effects if employees perceive no difference in their
worklives, dislike the extra risk to their income or wealth, or have raised expectations that are not
fulfilled.”
Cooperative Organization
One widely spread alternate to the corporate system is provide by the cooperative movement, which can
be traced to a group of twenty-eight textile workers who organized the Rochdale Society of Equitable
Pioneers. In 1844, a group of weavers, who had been dismissed and blacklisted by mill-owners for
trying to organize a trade union, pooled ₤140 to open a small dry goods store stocked with oatmeal,
sugar, butter and flour. Out of this grew a large and successful wholesale and retailing system, and it
proved the inspiration for co-operative and mutual activity in a wide range of areas.
The founders of the movement codified their ideology into what is commonly known as the Rochdale
Principles, which survive in their broad meaning today. The Statement on Cooperative Identity defines
four fundamental principles to define coperatives:
1. Cooperatives are member-owned and -controlled businesses, in which all members have an equal
say in the governance of the business: one member, one vote. Co-ops stand in contrast to
proprietary ownership, in which one person holds all of the authority, and "traditional" corporate
ownership, in which bases control on the size of one's investment.
2. Second, cooperatives serve their members, and not the interests of speculative capital. By
establishing limits on the return of investment and on share holdings, cooperatives discourage
profit-seeking investments. Instead co-ops encourage local control and investments by the people
who use the business.
3. Third, cooperatives help the members actively govern their organization through education and
help other cooperatives to better serve their members. This is done through buying goods from
other cooperatives and providing development assistance to organizing groups.
4. Finally, cooperatives exist not just for the benefit of the members but to serve, strengthen, and
sustain local communities. They are community organizations.
The cooperative movement is a strong and diversifies one. In Sweden and Japan, cooperative businesses
figure prominently in the national economies. In many Third World countries, cooperatives such as
credit unions and agricultural organizations have been very successful in helping people provide for
themselves where private and other corporate capital do not see high profitability. In the US, cooperative
organization is seen in rural electric co-ops, agricultural co-ops and credit unions.
The Future of Stakeholding
There are conflicting trends at work about the future of stakeholder organization. While some hold it out
as an essential key to the future, some of the most long-lived stakeholder institutions are under threat. In
Britain, for example, there is, on the one hand, a movement toward a broader involvement of interested
parties in corporate decision-taking and more official recognition of the legitimacy of stakeholders’
interests. This was a feature of the electoral platform of Tony Blair’s New Labour, in which the
“stakeholder economy” was promoted without rigorous definition, serving as a rather loose collectivist
concept. In concrete terms the most obvious trend has been the increased ownership of firms by their
workers through employee stock ownership plans (ESOPs).
Running directly against a trend toward increased stakeholder, particularly employee, ownership has
been the attack mounted on some of the older forms of stakeholder involvement in recent years. In
Britain the same criticisms that had been leveled against publicly owned industry were turned against a
large mutual sector composed of retail cooperatives, building societies (mutual thrift institutions) and
mutual insurance societies. These institutions were charged with being badly managed and having low
productivity. One particular factor was most frequently cited. In private industry, the accepted solution
to the principal-agent dilemma stemming from the separation of management and ownership was to give
pecuniary incentives to top management through the use of stock options. In the mutual sector there was
no comparable way to offer rewards for management performance, and it was claimed thatbthis damaged
performance. In a very short space of time many of Britain’s large building societies, and some mutual
insurance companies, were converted into joint stock companies, distributing the shares among
management, depositors, and borrowers.
This process has been given the rather ugly name of demutualisation. The economic rationale behind it
assumes that mutuals—which are comprehensive stakeholder organizations where customers (both
depositors and borrowers in the case of thrift associations) and potential future customers have an
interest—are less efficient organizations than conventionally organized corporations. Mutuals not only
lack the ability to offer stock option remuneration schemes, but also they cannot raise capital on the
stock market, relying instead on debt finance. These factors, it was argued, lead to inefficiency relative
to joint stock companies and unless action was taken they would lose out in the market place. However,
an alternative explanation is that the building societies have been systematically pillaged by management
and “carpetbaggers” to the detriment of other present and future stakeholders. Explanations focusing on
efficiency do not answer the question of why the mutual thrifts were so successful for such a long time
and grew to have such power.11 In the retail sector, the cooperative societies that were founded in the
19th century to give customer/stakeholders a share in the management and profit of retailing have fallen
of late on hard times. Again, this is frequently attributed to the absence of incentives for management
because of an inability to use stock option schemes.
In the United States the rapid downsizing that occurred in the early 1990s brought forth criticism,
notably from Robert Reich, then secretary of labor in the Clinton administration, that firms must be
forced to live up to their obligations to stakeholders and accept this role in and responsibility to a
broader community. This prompted a broad debate on the nature of corporate social responsibility and
a discussion as to the extent to which corporations were obliged to further the interests of others than
there shareholders. Towards the end of the 1990s the stock market boom was associated with the claims
that management was aggressively promoting shareholder value. However, the collapse of the boom and
the revelation of highly questionable accounting practices led to a realization that management interests
had been given primacy over the shareholders, and other stakeholders (workers and communities) had
been neglected almost entirely. This has sparked a debate as to whether the whole structure of corporate
governance in America should be reviewed. In particular there is the criticism that the command
structure has become too concentrated in a single individual the chief executive officer who also is
11
In July 1999 the British Treasury issued a report on Demutualisation, Ninth Report of the Select Committee of the Treasury, HMSO
(22 July 1999). It examined the case for and against mutual societies, but in general saw no reason to oppose demutualisation.
frequently the Chairman of the board of directors. A powerful independent board (a supervising board)
would be in position to provide a check on executive management behavior and practices.
Concurrent with the criticism of the management of publicly-held corporations, mutual organizations
continue to show some gains. In contrast to the United Kingdom, the fastest growing elements of the
retail financial industry in the United States are the credit unions and mutual societies where both
borrower and lender have an interest. Germany has a very large mutual sector, especially in finance
where 2,500 mutual banking institutions have more than 14 million members and 20,000 branches.
There have been few signs that these German associations will be converted into joint stock companies
as in the United Kingdom, since mutual organization conforms well to the German philosophy of
codetermination, although interest in the British experience has grown recently.12
CONCLUSION
The prospect of some kind of third way will continue to intrigue many people, and interest in it is likely
to be fed in the future by several trends. One is the widening economic disparity that has been a feature
of the economic expansion of the 1990s. Broader ownership of capital would certainly lead to a more
egalitarian distribution of income, but by what institutional structure should that reallocation be effected.
It is relatively eay to be in favor of greater equality but the heavy taxation of income, wealth and
inheritance that would be required runs counter to the prevailing political trends in most of the west.
Box
The Third Way
There is popular appeal in the current drive to find “Third Way” in politics, an appeal that has been
effectively harnessed by Tony Blair’s New Labour in Britain and by Gerhard Schroeder’s “New
Centre” in Germany. Both speak of a need to extend democracy, broaden property ownership and
take up the challenge of rapid change. Both have been apparently inspired by the book “The Third
Way: The Renewal of Social Democracy,” written by Anthony Giddens, a sociologist and the
Director of the London School of Economics. However, some critics find the rhetoric rather empty.
Ralf Dahrendorf, another sociologist, who preceded Giddings as Director of the LSE described the
“Third Way” as “as a politics that speaks of the need for hard choices but then avoids them by trying
to please everybody.” Among those who is apparently pleased is Senator Hillary Clinton who
speaks of the “Third Way” as “unified theory of life which will marry conservatism and liberalism,
capitalism and statism, and tie together practically everything: the way we are, the way we were, the
faults of man and the word of God, the end of communism and the beginning of the third
millennium." It has at least the universalism that characterized the failed “isms” of the 20th century
but in its present form it has great appeal but few teeth.
References:
Giddens, Anthony The Third Way: The Renewal of Social Democracy. London: Polity Press, 2000
DeGroot, Gerard “The Third Way,” Christian Science Monitor, June 14, 2000, page 9. Accessible at
http://csmweb2.emcweb.com/durable/2000/06/14/f-p9s1.shtml.
12
See “Demutualization in Germany. Inconceivable?” The Economist, 3 January 1998
A second factor that favors a different way is the growing concern for the environment in its broadest
sense, involving not only pollution but also the demise and decay of traditional patterns of settlement
and interaction. However, the greater pursuit of sustainability involves an erosion of individual property
rights in favor of a broader, intergenerational conception. Again it is not clear that this is a political
acceptable outcome in every part of the world. In Europe, it is true that the development of the EU has
involved increasing collective rights at the expense of the individual. In the United States, Russia and
China at least the reverse is true. Together, however, concern for equity and environment have focused
attention on what its proponents call the social economy that attempts to define as stakeholders a much
broader spectrum of interests than capital, labor, and government. However, attempts in the past to
follow a middle road, whether in Yugoslavia or Sweden, have found that it a more difficult path than its
inherent appeal would indicate.
KEY TERMS AND CONCEPTS
Anglo-Saxon model
Codetermination
demutualisation
employee stock ownership plans (ESOPs)
market socialism
mutual thrift institutions
Rhine model
retail cooperatives
social market economy
soft budget constraint
stakeholder
supervising board
QUESTIONS FOR DISCUSSION
1.
2.
3.
4.
Distinguish between market socialism and a social market economy. Give examples of each.
Why is the absence of a capital market potentially fatal to market socialism?
Distinguish between hard and soft budget constraints.
Which, in your view, is better to determine the social value of a major change in the transportation
system—the market or a government? Why?
5. Should stakeholders who are not owners have a say in a firm’s decision making? Will a firm who
recognizes its stakeholders’ interests be competed out of business?
6.Why does the trend to employee stock option plans offer a way out of the principal-agent problem?
7.Why are so many traditional “mutual” firms being converted into stockholder firms? Is this good in the long
run?
8. Why does the practice of issuing options to management threaten the interest of other stakeholders
RESOURCES
Web Sites
The National Center for Employee Ownership
The Association for Social Economics
http://www.nceo.org/
http://www.socialeconomics.org/
The U.K. Social Economy Forum
http://www.social-economy.org.uk/
Aries, Social Economy online
http://www.aries.eu.int/
Aries is a Euro Info Center (EIC) for the Social Economy. ARIES provides an online information, news, and networking service designed
to help social economy organizations to work together and take action at the European level.
European Confederation of Workers’ Cooperatives, Social Cooperatives, and Participative Enterprises http://www.cecop.org/
Coordinating Committee of European Cooperative Associations.
http://www.ccace.org/
The Netherlands Participation Institute (NPI)
http://www.snpi.nl/f
The Center for Economic and Social Justice
http://www.cesj.org/
The ESOP Association (United States)
Integra Review
http://www.esopassociation.org/
http://www.iol.ie/EMPLOYMENT/integra/sepp.html
Treasury Select Committee Report on Demutualisation.
http://www.parliament.the-stationery-office.co.uk/pa/cm199899/
cmselect/cmtreasy/605/60502.htm
Books and Articles
Ackerman, Bruce, and Ann Alstott. The Stakeholder Society. New Haven: Yale University Press, 1999.
Bamberger, Bill, and Cathy Davidson. Closing: The Life and Death of an American Factory. New York: W.W. Norton, 1998.
Carroll, Archie B. Business and Society: Ethics and Stakeholder Management. Cincinnati, Ohio: South-Western Publishers,
1996.
Giddens, Anthony The Third Way: The Renewal of Social Democracy. London: Polity Press, 2000.
Hutton, Bill, and David Goldblatt, eds. The Stakeholding Society: Writings on Politics and Economics. New York: Blackwell,
1999.
Kay, John. The Business of Economics. Oxford: Oxford University Press, 1996.
Kelly, Gavin, Dominic Kelly, and Andrew Gamble. Stakeholder Capitalism. New York: St. Martin’s Press, 1997.
Keren, Michael. “On the (Im)Possibility of Market Socialism,” In The Road to Capitalism, ed. David Kennett and Marc
Lieberman. Fort Worth, Tex.: Harcourt Brace, 1993. 45–52.
Le Grand, Julian, and Saul Estrin, eds. Market Socialism. Oxford: Clarendon Press, 1989.
Minford, Patrick. Markets Not Stakes: The Triumph of Capitalism and the Stakeholder Fallacy. London: Trafalgar Square,
1998.
Plender, John. A Stake in the Future: The Stakeholding Society. London: Nicholas Brealey, 1997.
Turner, Lowell. Negotiating the New Germany: Can Social Partnership Survive? Ithaca, N.Y.: ILR Press, 1997.
Yunker, James A. Socialism Revised and Modernized: The Case for Pragmatic Market Socialism. New York: Praeger, 1992.