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Democracy in the 21 st century: from politics to the economy

This talk explores the basics of economic power in today's society, the growth of social democracy from 1848 to 2017, the theoretical and practical implications of economics, and the potential reforms in politics. It examines the different stakeholders in corporations, the German and British corporate power structures, the history of social democracy, and the role of employee voice in governance.

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Democracy in the 21 st century: from politics to the economy

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  1. Democracy in the 21st century: from politics to the economy 18 October 2017, Paris School of Economics @ewanmcg ~ ewan.mcgaughey@kcl.ac.uk King’s College, London ~ CBR, University of Cambridge

  2. Structure of this talk: 1. Law: basics of economic power today 2. History: social democracy’s growth 1848-2017 3. Economics: theory and consequences 4. Politics: what reforms are possible?

  3. Law • Basic stakeholders in corporations are investors of capital and labour. • This doesn’t concern the regulated or socialised sectors, where consumer and public interests are also expressed in law. • The shareholding chain is invariably more elaborate. • Germany and a few others have two-tier boards: an executive (Vorstand) and a supervisory board (Aufsichtsrat), mandatory since 1937.

  4. German corporate power • 5 staff, elected work councils get 13 rights + pension voice: Work Constitution Act 1972 §§1, 87. • 20 staff, work councils can defer dismissals: WCA §111 • 500 staff, workers elect one third of supervisory board (Aufsichtsrat), which elects the executive (Vorstand): One Third Participation Act 2003 §1 ff • 2000 staff, workers elect half the supervisory board, but the chair with a casting vote is appointed by shareholders. Just one executive is a worker or union representative: Codetermination Act 1976 §§1, 7, 27-29, 33. • Banks vote about 60% of shareholder votes: Aktiengesetz 1965 §135. We don’t know exactly: statistics stop in 2005. Most money is invested by companies, not pensions.

  5. British corporate power • Board of directors mostly appoints and pays itself: Model Articles, paras 20-3, UK Corp Gov Code B.2. • Shareholders can remove directors with a 50% vote (Companies Act 2006 s 168), but are mostly asset managers holding “other people’s money”. • In pension funds, employees nominate at least one third of trustees (Pensions Act 2004 ss 241-3). • Employees rights to vote for boards exist in law at universities (e.g. London School of Economics (2006) art 10.5) but rare anywhere else (for now).

  6. American corporate power • Board of directors appoints itself, NYSE Rule 303A.04 (cf DGCL §211(b), not yet changed by SEC Rule 14a-11. • Shareholders (mostly asset managers) often can’t remove directors because of (1) multiple votes on shares, (2) staggered boards and ‘for cause’ only removal (3) no restrictions on director pay: costly: Delaware GCL §141(k). • In pensions, collectively bargained, unions appoint half the trustees, law requires employers have at least half the votes: Taft-Hartley Act 1947, 29 USC §302(c)(5)(B) • Employee voice in governance rare, with one exception: Massachussets manufacturing co’s: MGL Pt I, Title XII, ch 156, §23 says ee’s can voluntarily be appointed since 1919

  7. Bigger (income linked) state pensions mean stock markets are (1) smaller (2) less diversified, meaning (3) more blockholding shareholders. Minimum state pension systems mean more share dispersion: people have to save in occupational pensions. That money floods into the stock market, and floods out blockholding shareholders.

  8. History: growth of social democracy • In the 1848 Revolutions in Germany, representatives in Paulskirche drafted a law for employee elected work councils. After its suppression, one industrialist, Carl Degenkolb put the idea into practice in his Saxon factory. • Oxford University Act 1854 ss 16 and 21 introduced rights to vote for the governing body to reverse ‘successive interventions by which the government of the University was reduced to a narrow oligarchy.’ Cambridge University Act 1856 ss 5 and 12 followed, and now most uni’s do the same.

  9. Early 20th century thinking Louis Brandeis, later US Supreme Court judge (1916): ‘The social justice for which we are striving is an incident of our democracy, not its main end… the end for which we must strive is the attainment of rule by the people, and that involves industrial democracy as well as political democracy.’ At Industrial Relations Commission (1916) Andrew Carnegie committed to democratising pensions – this was the start of TIAA-CREF. Also, Mass Governor Calvin Coolidge enacted voluntary codetermination law in 1919. But otherwise, no law. Lloyd-George and Churchill, Port of London Act 1908 s 1(7) S Webb and B Webb, Industrial Democracy (1897) sceptical of codetermination: triple functional analysis of economy

  10. UK Railways: almost a model plan • Sidney and Beatrice Webb, The History of Trade Unionism (1920) Appendix VIII, abandoned their original view that labour should stay out of management (a ‘separation of powers’ theory). • But Sidney Webb was also writing Clause IV of the Labour Party constitution: progressive nationalisation of the means of production. Worker votes were linked to public industry. • Ministry of Transport (1920) Cmd 787, proposed one third worker directors. But the union insisted on nationalisation or nothing, and did not go along. • Labour and management hostility stopped the Act passing

  11. Post-war Germany • The most important collective agreement in history: Stinnes-Legien Abkommen 1918 §1, ‘common resolution of all economic and social questions in German industry and trade’. • Weimar Constitution 1919 art 165 codifies, worker participation in the ‘entire field of economic development’, including ‘legal representation in factory workers councils’. • Betriebsrätegesetz 1920, Aufsichtsratgesetz 1922, for work councils with binding rights and two workers on supervisory boards. But social democrats were unprepared: they had no plan ready: see Fraenkel (1924) 32(1) Journal of Political Economy 68 and Kautsky (1924). Hugo Sinzheimer

  12. Destruction and reconstruction in Germany • Hitler, with 1m DM funding from bankers and companies, abolished trade unions and codetermination immediately upon taking power in 1933-4. • Aktiengesetz 1937 mandated two-tier boards (previously a Prussian practice) and formalised banks’ practice of voting on other people’s shares. • Post-WW2, codetermination was rebuilt under Control Council Law No 22 through trade unions making collective agreements. Less enthusiasm for nationalisation as the only solution, ‘socializing power without socializing ownership’, Kerr (1954) 68 Quarterly Journal of Econ 535 • Laws in 1951, 1952 and 1976 codified the ‘codetermination bargains’.

  13. Post-WW2 codetermination in UK • There was still codetermination in gas, until the Labour Party nationalised industry, Gas Act 1948 • Industry Act 1975, statutory goal of empl. directors • Post Office Act 1977, 7 out of 19 union rep’s. • Bullock Report 1977, recommended 2x + y formula, but failed to get legislation. • Conservative government retrenched worker directors in the Post Office in 1979. • But, there have been continual proposals from all parties, including Conservatives, and Lib-Dems...

  14. Pension codetermination • Collective agreements in 1970s, 1980s, required half representation on the boards of most pension funds: union appointed or employee elected. But asset managers still exercise most votes. • Pensions Act 1995 introduced employee rights to vote in pensions. Now Pensions Act 2004 ss 241-243 requires at least one third of employee elected/appointed pension trustees. • In US, similar position: many state pension plans, Taft-Hartley plans, but not as widespread. Asset managers control votes. • Bernie Sanders’ Workplace Democracy Act of 1999 proposed half-representation. • UK Association of Member Nominated Trustees created in 2010, organising to instruct asset managers since 2016...

  15. Economics: theory and consequences • Modern ‘law and economics’ theory is typically opposed, and bitterly, to any labour voice. It ‘interferes’ with freedom of contract. This does not recognise labour’s inequality of bargaining power: • A Smith, Wealth of Nations (1776) employers can ‘hold out’ longer than workers with more resources • JS Mill, Principles of Political Economy (1848) workers have considerable collective action problems • S Jevons, Theory of Political Economy (1888) bargaining power increased with better information

  16. Law and economics • Today’s theorists want the coercive regulation of the state to enforce contracts on unjust terms, and property rights without responsibility, but reject regulation to ensure fairness and democratic voice • RA Coase (1960) 3 JLE 1, argued bargaining power only has distributive implications, but does not affect allocative or productive efficiency of the transaction. But state interference could raise transaction costs. In effect, transaction costs are a market failure, but unequal bargaining power isn’t.

  17. Law + economics on corporate power • OE Williamson, Economic Institutions of Capitalism (1985) argued only shareholders, and never workers, make firm specific investments that cannot be protected without governance rights. That’s because shareholders get paid last: their capital is always ‘at hazard’. Also Easterbrook and Fischel (1985). • H Hansmann, Ownership of Enterprise (1996) argued that if multiple interest groups are represented on boards, there will be too much conflict, less efficient production. Homogeneity is key to success. Also Zahn (1934)

  18. Problems with law + econ theorists • It is factually incorrect that shareholders, who vote, invest capital or bear risk. Asset managers and banks risk nothing: they vote with “other people’s money”. The real investors are almost all people saving for retirement, usually employees. • There is no credible empirical evidence that codetermined companies perform worse. The evidence suggests the opposite. But even if it were true, employees could have votes in the general meeting, so that a combined board of directors is elected by a common pool of capital/labour votes. • We do know that without voice at work inequality soars...

  19. Evidence of productivity and growth? • Qualitative: pension trustees: Schuller and Hyman (1983) 12 ILJ 84 find that pension trustees collaborate efficiently • Behavioural: Mayo experiments: Blumberg (1968) and LSE Law, Society and Economy Working Papers 20/2014, good reasons to think that if people participate in decisions of their workplace, and are treated fairly, they have the inherent motive to work harder • Quantitative: Labour Regulation Index (CBR, Cambridge) 117 country database, next step econometric regression analysis, to determine relation of codetermination laws to productivity, growth, labour share, inequality, etc. • Is evidence enough for political change? Principles matter too: arguments about fairness, identity, justice, sense of self worth

  20. Politics: what reforms are possible? • (1) Spread employee codetermination happening • French law of 2013, employee director gets to vote • UK consulting now on comply/explain employee rep • Dodd-Frank Act 2010 banned broker votes • Swiss People’s Initiative 2013 banned banks voting • Bernie Sanders’ political success: backs pension votes • (2) There is growing awareness among trade unions and in pension funds for the need for change: ITUC, Committee on Workers’ Capital, AMNT Red Line Voting Initiative, to take back the votes in the economy.

  21. Manifesto for Labour Law and UK Labour Party • The Corbyn/McDonnell leadership wants meaningful change, and adopted the Manifesto for Labour Law of a group of professors/lawyers at 2016 conference. It will rebuild collective bargaining, a new MoL, and corp gov. • It’s essential to set out basic principles, not detailed rules. This is essential to building consensus, not squabble over everyone’s slightly differing ideal model. • A different set of principles has to apply to socialised or regulated sectors (uni’s, health, electricity, water, transport, media, communications, banks) where public and consumer interests are not met by the operation of competitive markets. Not only employees, but also citizens must have a voice. No one-size-fits-all regulation.

  22. Potential proposals • On corporate governance, we are drafting now. We’ll be proposing the following: • votes for employees in the general meeting, and a minimum number on boards. It must be accompanied by an anti-evasion provision, against outsourcing. • change the default company constitution rules, Model Articles, so every new startup company has employee voting rights alongside capital investors • extend voting rights to all pension types, all investment products. Duty on pensions to vote and show policy • ban asset managers, banks or any other financial intermediary from voting with other people’s money

  23. Conclusions • The economy can be more democratic: it is not like politics, but there are few justifications for the current authoritarian model of voting in companies • There is a real problem with growing inequality: this is a reflection of bargaining power and voice in contractual and corporate relations. • Legal reform would probably improve prosperity, and once the ideas are established and defended, it is very likely that we will see movement.

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