Overview. Widening income disparities highlight the similarities of today’s economy with the Gilded Age at the turn of the twentieth century. That era was remediated in part by adopting innovative public policies from other democracies such as minimum wages and social security. To Americans of the day, those policies imported from abroad were as unfamiliar as the concept of codetermination is to Americans now. But like minimum wages, the practice of codetermination has a long history abroad as a successfully policy to reduce income disparities and strengthen local communities and wage growth. It is THE defining element in the ability of powerful capitalist economies such as Germany over the last half-century to achieving broadly based income growth at the same time that American income disparities have widened and most wages stagnated. And it is the most powerful weapon in the liberal democracy’s arsenal to ensure real wage growth and thereby prevent the rise of populists as in the US in 2018 and Italy in 2018.
The election of Donald Trump reflects failure of American capitalism to uphold the goal set forth by Adam Smith in his 1776 Wealth of Nations as a device to create rising prosperity widely shared. Misplaced corporate priorities are the primary explanation for stagnant wages, rising income disparities and job offshoring: The concerns of the broader economy, of local communities and of employees have been made subservient since the 1980s to those of shareholders as noted by Robert Reich, Joseph Stiglitz and others. Higher quality democracies avoid this predicament because corporate priorities are crafted within a corporate governance framework of codetermination. Seminal enterprise resource allocation decisions including plant location, hiring, R&D, the degree of employee upskilling, investment rates, wages, facility modernization and the like are made by corporate boards that balance various stakeholder interests rather than just shareholder and executive suite interests.
Introduction. Corporate governance in America since the 1980s utilizes what economists call the agency framework in which executive suites de facto behave as shareholder agents, adopting policies maximizing shareholder interests. This framework is not mandated by law. Driven by stock options, firm leadership has become unduly focused on immediate share price performance rather than longer term corporate competitiveness. It has resulted in wage stagnation, considerable job offshoring, declining economic mobility, relatively weak investment and disassociation of executive compensation from performance; it has also caused weaker firm productivity growth and lower shareholder returns than under codetermination. Donald Trump’s exploitation of the Obama administration's failure to remediate these trends was one of several pivotal factors in the 2016 election.
There are a number of widely cited micro options to address income inequality including raising minimum wages, redistributive tax and government spending policies, retraining, overtime pay mandates, strengthening collective bargaining and the like embraced by Democrats. But party officials mostly ignore the only seasoned and demonstrably effective structural remedy – reorienting the goals of American corporations through adoption of codetermination.
The history of codetermination began when executive suites in northern Europe in the wake of World War II were de jure required by British and American occupation forces to add employee representatives to corporate boards. The representatives were typically progressive attorneys, economists, academicians and the like selected by enterprise employees. (The goal was to weaken the influence of senior executives and large shareholders who tended to have been Nazi sympathizers.) These reconfigured boards were viewed as agents or trustees for society writ expansively, anticipated to adopt corporate policies that promote long-horizon enterprise and job sustainability while widely broadcasting the gains from enterprise activity to employees and local communities as well as shareholders. That is, they were expected to fulfill the goals originally envisioned for capitalist enterprises by Adam Smith. The success of this postwar reform in the decades since is exemplified by higher investment and real wages across northern Europe that in the US.
Codetermination in Germany. Over the past half century, the largest, most competitive German firms such as Adidas or Daimler have had codetermination board of directors, half of whom are employee representatives. If codetermination debilitated competitiveness, productivity growth or profits, the initial postwar concept would have been discredited – with laws hurriedly changed to discard the concept decades ago. To the contrary, its success has seen codetermination spread - utilized to varying degrees today by larger firms in 19 of the 27 (post-Brexit) EU members, including all the major ones except Italy. (Take a moment to check the board composition of any large German firm online; it will be revelatory.)
The most comprehensive assessments of codetermination are derived from its five-decade history in Germany. There, board of directors must be split between shareholder and employee representatives at firms with more than 2,000 employees; board seats at the 600+ largest German firms are split in half. (Tie board votes are broken by the board chair who may cast two votes at such junctures.) At smaller firms with 500-2000 employees, a minimum one-third of board members must be employee representatives. The law applies to boards of directors equally at privately held enterprises such as Bosch as well as listed firms such as Daimler.
Higher Investment Rates. Because codetermination boards make enterprise strategic and tactical investment direction, hire CEOs and establish compensation structures, they eliminate pathologies arising from short-termism common in American executive suites – such as maximizing short-term profits, compensation delinked from performance, over-reliance on mergers for growth, dubious share buybacks and excessively short investment time horizons. The longer time horizon of firms with codetermination boards translates to greater investment:
Eurostat investigations found that investment rates at non-financial enterprises in the European Union are higher than for American firms. And an analysis of German firms for the Berlin Social Science Center (WZB) in 2016 found that the capital investment ratio (investment in capital goods - long-lived durable goods) of codetermination firms was twice that of firms whose Boards of Directors just represented shareholders.
Higher Shareholder Returns. Investor appreciation of their greater investment profile may explain why American economists Larry Fauver and Michael E. Fuerst found that financial markets reward stockholders in codetermination firms with higher Tobin Q’s (market value divided by replacement book value of assets). In America, only privately-held firms mirror the superior investment behavior of northern European firms with codetermination governance. Analysts aver that the longer term perspective demanded by owners at privately-held US firms cause their enterprise managers to de facto mimic the behavior of enterprises with codetermination structures. That is significant because research under auspices of the NBER by Harvard and NYU economists found that investment rates (measured as shares of enterprise assets) by managers at privately-held U.S. enterprises are 2.5 times greater than rates at public U.S. firms (10 percent v 4 percent).
Minimizing Offshoring. Regarding offshoring, EY (Ernest & Young) in 2016 examined the job creation profile of firms comprising the German DAX 30 stock index, all of whom benefit from codetermination governance structures. The increase in foreign sales of these firms (28 percent) during the study period 2011-2015 considerably outpaced their creation of foreign jobs (8 percent). The difference was made up by adding jobs and productivity-enhancing investment at home to service export markets. That is why domestic German employment at these huge firms grew by more (6 percent) than their rise in domestic sales (5 percent). It is also why a large three-quarters (4.4 million units) of German auto production is exported rather than produced abroad. And it is why production facilities for the next generation (gen e) of cars is being constructed in Bremen (Daimler), Zuffenhausen (Porsche), Zwickau (VW) and the like. The domestic orientation of German enterprises is the precise opposite of policies pursued by American firms, who readily offshore jobs to low-wage nations. For example, a Wall Street Journal analysis covering the period 2000 to 2009 found that American multinational firms eliminated a net of 2.9 million domestic jobs while adding a net of 2.4 million jobs abroad. A second study by Tax Analysts found that U.S. multinationals cut a net 1.9 million domestic jobs during this period while adding a net 2.35 million jobs abroad.
Rising Real Wages. Empirical analysis has concluded that real wage and productivity growth are higher in firms with codetermination governance. German, Scandinavian and other such northern European firms have faced the same globalization and technology challenges as US firms in recent decades. Even so, they have steadily raised compensation over that period by about 1 percent annually in real terms, enabling wages adjusted for purchasing power to leapfrog American wages. As noted by Robert Reich, hourly pay adjusted for inflation in Germany, for instance, has increased nearly 30 percent since 1985, averaging about one percentage point annually. Codetermination is why labor compensation as a share of national income has rebounded in Germany since the 2007 recession, rising from 47.6 percent to nearly 51 percent. More broadly, real compensation since 2000 has increased in 18 of the 19 EU nations with codetermination practices. As documented by the US Conference Board, labor compensation per hour in the capstone manufacturing sectors in 7 northern European nations such as Germany is higher than in the US.
Despite notably higher wages, codetermination firms in these democracies are highly competitive with American firms. That reality debunks the claim by US executive suites and conservative economists that globalization and technology change are responsible for stagnant American wages (and job offshoring). Indeed, compelling new independent European research has concluded that the key determinant of a nation’s wage rates is its collective bargaining environment rather than globalization or technology change. This conclusion is powerfully supported by real world evidence from German, Dutch, Danish and other northern European firms who face the same globalization and technology challenges as US firms, but remain internationally competitively despite their uniformly high-wage enterprise profiles.
Social Justice. In bringing a broader perspective to the crafting of corporate goals and objectives, codetermination enhances the corporate sector’s contribution to social justice. It would more accurately come to reflect, for instance, the foundational values expressed in Pope Leo XIII’s 1891 Rerum Novarum, in the protestant work ethic and in Judeo-Christian teachings about the dignity of hard work fairly compensated.
Summation. The centrality of codetermination to middle class prosperity is why German President Joachim Gauck terms it “an important cultural asset.” Yet, American economic journalists and economists are incurious. They devote paltry attention to codetermination despite being the only seasoned structural solution for the wage stagnation afflicting much of the American workforce. They are incurious about evidence developed by CEOs like Bill George, formerly of Medtronics and now at Harvard B School, and by economists such as Steven Hill, author of Europe’s Promise: Why the European Way is the Best Hope in an Insecure Age (2010). Many perhaps accept the narrative, debunked in recent years by German research, that codetermination retards enterprise efficiency. In reality, analysis confirms that enterprise productivity is higher when employee representatives comprise even just one-third of corporate boards.
Ignorance or inattention to codetermination leaves Americans unaware of the powerful contemporary capitalist mechanism being utilized by other rich democracies to steadily raise middle class wages and minimize job offshoring. That inattention is abating somewhat with the introduction of legislation in March by Democratic Senators Baldwin (WI), Warren (MA) and Schatz (HI) requiring that boards of directors at all publicly-listed US firms be one-third employees.
Introducing Codetermination to America. Wage stagnation is a structural challenge that is ameliorated with codetermination. Its advocates will need to overcome opposition from executive suites and their Republican Party allies who argue spuriously that codetermination harms firm efficiency. In reality, evidence from Germany and elsewhere document that it reduces executive compensation while enhancing enterprise performance and shareholder returns. Frustrated Americans are open to innovative solutions to wage stagnation including codetermination. In fact, an April 2018 survey on Vox found that, once familiarized with the practice of codetermination, a majority of American respondents support the concept; indeed, they favored it by a margin of well over 2:1 (53% vs. 22%).
George Tyler, former economist for Senators Hubert Humphrey and Lloyd Bentsen, Senior Economist on the Joint Economic Committee, Conceptual author of Drugs for Neglected Diseases Initiative (Genève) and a DAS at the Clinton administration Treasury Department.
Codetermination is nearly always accompanied by the establishment of Works Councils.
Works Councils Explanation
From Cantner, Gerstlsberger and Roy, “Works Councils, Training Activities and Innovation: A Study of German Firms,” Jena Economic Research Papers, 2014, https://www.econstor.eu/bitstream/10419/98440/1/780578392.pdf .
“In Germany, works councils have a particularly strong position due to legal regulation (German Works Constitution Act 1952) that guarantees employees in establishments or firms with five or more permanent employees the right to establish a works council. Often, but not necessarily, works council candidates are nominated by the union or unions corresponding to the specific industry. However, the works councils have to represent all regular employees of their establishment or firm and are committed to support its economic stability in the first line and union interests in the second…. The main tasks of works councils comprise the protection of employee rights in various human resource management practices such as recruiting, layoffs, reorganization, vocational education and training, co-determination of incentive schemes, vacations and leave grants, flexi-time and overtime regulation, conflict handling, and prevention.”
by George Tyler on 22 June 2018 on Social Europe Journal
Amid authoritarian and illiberal forces buffeting social democracies, it is helpful to renew appreciation for their political architectures, especially the central role developed over a century and a half for the principle of proportional representation (PR). Its absence is one factor responsible for the poor quality of American democracy documented in Billionaire Democracy.
In contrast to the PR systems widespread in Europe, the American political system is designed to render voters unequal. It also rejects the seminal principle of democracy, with majority rule occurring only randomly. In addition, it is corrupt (pay-to-play) by judicial fiat and plagued by fake news exploited by the Republican Party and Russians alike.
Adding to this dark picture is the undemocratic 18th century American electoral system – judged by political scientists with the Electoral Integrity Project to be the least responsive system among all rich democracies – of lower quality even than election systems in Barbados, Brazil, Croatia, Mongolia, Rwanda, South Africa or Tunisia.
Readers may be familiar with the slavery-era Electoral College responsible for vaulting American losers like George W. Bush and Donald Trump over popular vote winners to become president. Less familiar is the structure of America’s electoral system responsible for its gigantic number of impotent or wasted votes and the nation’s widespread erratic and only coincidental relationship with majority rule: single-member legislative districts featuring plurality (winner-take-all) elections.
The PR system common in higher quality democracies was advocated by John Stuart Mill and Alexis de Tocqueville and has spread since instituted in Denmark during the 1850s to more than 20 European nations. Under PR, political parties are awarded legislative seats according to their share of all votes cast. This causes each voter’s voice to bear weight in legislative deliberations and to be reflected in policy compromises that are the hallmark of PR governance.
In contrast, the American single-member/plurality system is designed to silence voices. It results in about half of all votes cast carrying no weight when legislatures craft public policies. The preferences of losing-candidate supporters are ignored, their votes wasted. Indeed, in the common American electoral scenario where three or more candidates compete, it is not unusual for more than half the votes cast to be wasted.
For Want of a Nail… This apocryphal lament by Shakespeare’s ill-starred Richard III at Bosworth Field evokes the spectre of tiny events yielding hugely consequential outcomes. That concept is exemplified by an election in 2017 in the state of Virginia decided by one vote – dramatising how the American electoral system wastes votes. One-vote margin elections (or ties) are extremely rare, with only a handful having occurred in elections since 1839 across the globe ranging from Austria, Canada, India, UK, Philippines to the US. Of that tiny number, only a few were consequential, including a Philippine mayoral election and two (Zanzibar in 1961 and Virginia in 2017) that determined control of an entire legislature.
In Virginia, a single vote among the nearly 2.4 million cast determined control of its legislature (House of Delegates). Legislative dominance rests on the outcome of individual elections conducted in 100 geographically distinct legislative districts in that state. Under its single-member plurality electoral system, a one-vote loss in one of those districts left the Democratic Party one parliamentary seat short (49-51) statewide following the 2017 election. The 51 Republicans have consequently ignored the preferences of the 1.3 million voters supporting their opponents.
Further Attenuating Majority Rule: Gerrymandering
That election also exemplified another way in which the American political system flouts majority rule. While the Electoral College is responsible for failure of majority rule in American presidential elections, “gerrymandering” is responsible at the legislative level. For example, the 1.3 million votes for Democratic legislative candidates topped the 1.1 million votes cast for Republican candidates in the Virginia election. Democratic candidates garnered 54 percent of all votes cast but won only 49 races, while Republicans received just 45 percent of the vote but won 51 seats. This mismatch is a consequence of gerrymandering.
A boundary redesign of America’s tens of thousands of single-member legislative districts occurs across the nation every ten years (2001, 2011, 2021). Some 37 states absurdly permit legislators themselves to redraw their own legislative districts. The results are predictable, with legislative majorities drawing district boundaries to favour their political party, de facto picking their voters. That’s what Virginia Republican legislators did in 2011. While all districts have the same population, Republicans drew boundaries to spread loyal party voters broadly in a balanced fashion among a majority of districts while cramming Democratic-leaning voters into fewer districts.
Among the most egregious recent examples of majority rule being flouted are gerrymandered districts for the US Congress. For instance, in Pennsylvania in 2012, Democrats won 50.5 percent of votes cast statewide for Congressional candidates but won only five of 18 gerrymandered Congressional seats. You read that correctly – five. Democrats won 50.6 percent of the statewide vote for Congressional candidates in North Carolina in 2012, but won only 4 of 13 seats. And in Maryland in 2016, Democratic congressional candidates won 60 percent of the vote statewide but won 7 of 8 seats.
Unfortunately, the American electoral system suffers from other pathologies beyond a gigantic 60 million wasted votes and anti-majoritarian elections. Unlike Europe, partisan state and local election officials routinely discourage opponent voting with unwarranted voter ID laws, limit opportunities to register or vote, conduct unwarranted purges of voter lists and ban non-partisan campaigns by groups like the League of Women Voters intended to expand voting.
What Can Be Done?
PR is the prescription for eliminating wasted votes and finally (after 229 years) planting true majority rule at the center of American democracy; by eliminating single member districts, it eliminates gerrymandering. PR is is resisted by US political parties. In its few American applications in the 20th century, it dramatically improved the democratic process. In New York City’s election for the Board of Aldermen in 1935, for instance, Democratic candidates received 66 percent of the vote, but won 95 percent of the gerrymandered seats. After making the switch to PR in 1939, they won 65.5 percent of the vote and 66 percent of the seats. The only vestige of PR left in the US is the city of Cambridge, Massachusetts.
There are no constitutional barriers to eliminating the American single-member plurality electoral structure or adopting PR. Yet, it is such a profound reform that – like eliminating pay-to-play or corralling fake news – it assuredly requires affirmation by the US Supreme Court. Unfortunately, Donald Trump’s 2017 court appointee has likely put such a visionary Court at least a generation away. Indeed, his appointee was the deciding vote cast in the recent Supreme Court decision that affirmed gerrymandering.
Even so, there is significant reformist ferment at the state and local levels, mostly led by private citizens. For instance, twelve states with 32 percent of the US population have acted to de facto end the Electoral College by requiring their electors in the college to vote for the national popular vote winner for president (rather than the state winner). To reduce pay-to-play, taxpayer funding of elections has been established in 12 states (most comprehensively in Arizona, Connecticut, Hawaii, Maine and Minnesota) and in numerous cities like Long Beach, California, Montgomery, Alabama, Santa Fe, New Mexico, Seattle, Washington, Tucson, Arizona and New York City. Six states have abandonedgerrymandering, with independent entities rather than legislators designing districts. Twelve states have instituted automatic voter registration whenever citizens interact with government agencies. And advocacy groups like Fairvote persist in educating voters and in urging Congress to support PR legislation like that proposed by Congressman Don Beyer.
The lesson is that steps to raise the low quality of American democracy are feasible. Citizen-led reforms are improving the American democratic experience. And that process is a dynamic one, providing valuable testing grounds and accumulating evidence to support even further reforms in the years ahead.