Innovative cooperatives for more inclusive growth

SAFE Policy Lecture: Incentive-compatible cooperatives could distribute wealth more equally, said Francesco Caselli from the London School of Economics

Traditional externally owned corporations are able to accumulate great wealth and to generate growth. However, this traditional system seems to favor capital owners. As a result, wealth is not distributed equally which generates social and political discontentment in many societies. Francesco Caselli is skeptical towards policies which aim to redistribute wealth from the rich to the poor. “Redistribution will not happen and it will not stick,” he said. Caselli is Norman Sosnow Professor of Economics at the London School of Economics. At a SAFE Policy Lecture on June 26 in Goethe University´s House of Finance, he presented his idea of how newly designed cooperatives may help to prevent income inequality.

In this concept, incentive-compatible cooperatives (IC-Coops) can gain growth and generate inclusive wealth at the same time, resolving the classic conflict between labor and capital. In contrast to traditional cooperatives, IC-Coops pay attention to incentives they create – according to Caselli, this is one reason why traditional cooperatives often fail. Therefore, IC-Coops would be more resilient, Caselli said. 

Micro and macro design of IC-Coops

In his framework, Caselli suggests replacing the production of externally owned firms with self-owned cooperatives. As a result, ownership is no longer tradable, that is, there is no stock market and, thus, no need to distribute income among production factors. Thereby, an inherent weakness of traditional cooperatives would be removed: the pronounced present bias within cooperatives. Workers typically do not benefit from future cash flows once they quit or retire; so they have little interest in long-run growth. Traditional cooperatives often fail because workers prefer to extract rents today. 

Further, IC-Coops would not suffer from free-riding problems because shirking affects every worker negatively, Caselli explained. Since remuneration of all employees is tied to the cooperative´s success, every worker has an incentive to take the job he or she is best suited for. In fact, everybody should exert high effort because workers are the residual claimant of the income earned by the cooperative, Caselli argued. Also, according to him, there is some empirical evidence to suggest that employees tend to monitor each other. Data also shows that perceived wage differentials are highly correlated with motivation and loyalty, Caselli explained. He criticized that a strategy of inducing high effort by more equalitarian pay among all employees is too often neglected in discussions.

Caselli pointed out that on the macro level, most institutions such as social insurance would remain in place. IC-Coops would still compete for customers and face bankruptcy if they run losses, he said.

More equality, less growth

In his model, markets for equity are the exception. Some cooperatives which basically act as pension funds could collect excess profits from workers and provide loans to entrepreneurs. Caselli claimed that traditional financial markets tend to amplify income inequality because only the rich are engaged. In contrast, pension funds would concern all people and naturally provide risk diversification. Even if private equity and hedge funds might be more efficient in allocating funds, he admitted, the resulting growth would be more inclusive.

But could such a production economy generate growth? According to Caselli, there is striking evidence to suggest that cooperatives could be profitable in the long run. A few modern cooperatives, he pointed out, obviously manage to co-exist with externally financed corporations. However, Caselli admitted that there is a trade-off between economic growth and inequality. Incentive-compatible cooperatives may not generate maximum growth. “My gut feeling is that there will be a small reduction in growth but much more equality,” he said.

Caselli also talked about the management of the transition of his model. The top-down approach of strengthening the position of cooperatives would require profound modifications of the civil and commercial law, he said. He would prefer cooperatives to grow organically if they overcome the present bias and become larger, more successful, and resilient. Chances of success are higher in developing countries where many small privately owned firms exist and leftist governments are willing to put these ideas into action, he said.