Labor Participation and The East Asian Crisis

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Labor Participation and The East Asian Crisis

조세프 스티글리츠(Joseph Stiglitz)
세계은행 수석부충재

Table of Contents

Introduction
Principal-Agent Problems and Worker Involvement
Involvement and Productivity
Institutional Interlockingness of Systems
Two Enterprise Systems
Conclusion
References & Notes


Introduction

A Particularly disturbing aspect of the East Asian crisis has been the divergence between those who contributed to the crisis and those who are bearing much of the cost such as the workers and the poor. Labor participation in companies works in the opposite direction to soften the effect of downturns on workers and to increase the share of the benefits going to workers in good times.

Hence the most elementary consideration of social justice would promote more worker participation in corporations in the aftermath of the East Asian crisis. The corporate restructuring that is going on as a result of the crisis provides a good opportunity to introduce employee stock ownership plans (ESOPs) and other forms of employee ownership and involvement. However, in my remarks today, I wanted to review some of the economic arguments for the high involvement. However, in my remarks today, I wanted to review some of the economic arguments for the high involvement workplace and the institutional choices facing Korean policy-makers.

Much of my professional work as an economist has been focused on unpacking the failure of the assumptions behind the basic economic theorem about the efficiency of a competitive equilibrium. The idealized competitive model is quite non-robust, that is, it is sensitive to changes in the basic assumptions. Today I want to focus on the assumptions about what goes on in the “black box” of the firm. In actual cases, the competitive model has some rough plausibility in a market populated by small firms. In our Jeffersonian tradition, we celebrate the family farm, the owner-operated shop, and the small independent craftsmen. In terms of the principal-agent relation, all these cases are characterized by the unity of principal and agent, i.e., the people are self-employed. Here the assumption that the principals and agent have the same knowledge and incentives is obviously true, but how should that assumption be generalized to larger firms? For larger firms, the assumption that the principals (e.g., far-flung shareholders) are able to enforce their incentives on the agents (managers and workers in the firm) and monitor the behavior of the agents becomes a rather heroic assumption. Yet without that assumption, the basic theorem fails. [see Greenwald and Stiglitz, 1988]　

One way to formulate the basic question about the organization of production is how in the actual world can be virtues of the limit case of self-employed individuals be best generalized to multi-person firms. The problem is unfortunately just assumed away in the standard competitive model.　

Principal-Agent Problems and Worker Involvement

The shareholders are principals relative to the managers as their agents, and the managers can be seen as principlas relative to the workers as agents. In such pyramided principal-agent relationships, there may be many gaps in monitoring and incentives between the shareholders and workers. These agency relationships are a major topic in information economics since many aspects of the agents’ behavior are unobservable. Many of the unobservable factors that affect labor productivity are grouped under the label “effor.” Managers cannot directly observe the workers’ effort level, and yet effort can have a considerable effect on productivity and profits.

One approach to the effort question was developed in efficiency-wage theory as an explanation for involuntary unemployment in otherwise flexible labor markets [see Shapiro and Stiglitz 1984 and the other papers in Akerlof and Yellen 1986]. Employers are assumed to fire workers who are caught shirking (working at chronically low effort levels) but if labor markets clear at the prevailing wage, then workers will be able to readily find new employment at the prevailing wage. Assuming effort is costly and the probability of being detected shirking is low, workers would tent to operate at low effort levels. Employers may pay more that the market-clearing wage, i.e., an ”efficiency wage”, in order to give workers somethig extra to lose if they are fired for working at low effort levels. At that efficiency wage, there would be more job-seekers than vacancies resulting in involuntary unemployment. A higher level of unemployment would make dismissal more costly. Since fired workers would join the unemployment queues, there would be an incentive for work at a high effort level so as not to risk of being detected shirking and fired. This use of an efficiency wage to elicit high effort is best suited to the low involvement workplace since it assumes a credible threat to fire shirking workers and it assumes no other motivation for high effort levels.　

A high involvement workplace ( as in what we might call the “Japanese-style” workplace) uses quite different methods to elicit high effort from the workers. A high involvement labor participation program deals not just with economic variables such as pay (perhaps performance-related) and benefits but with a range of other factors such as worker-team involvement in decision-making ad control on the shopfloor or in the office. At the risk of oversimplifying the psychology, the idea is to increase each worker’s identification with the firm so that there will in effect be some unification of agent and principal and a resulting tendency for higher effort. When worker participation is coupled with worker ownership, then the movement toward principal-agent unification is even clearer. The high involvement workplace, by approaching principal-agent unification (however in quite a partial manner), provides a different method of eliciting high effort with resulting improvements in productivity.　

Involvement and Productivity

In 1990, Laura Tyson and David Levine surveyed 43 empirical studies on the connection between participation and productivity [1990]. They found that the effect of worker participation on productivity was usually positive though sometimes small or statistically insignificant-but almost never negative. The effect improves the more the participation was close to the shopfloor or office.　

Several dozen new studies have been conducted since then, several of which have particularly strong research designs and data quality. Their conclusions reinforce the earlier findings: A small-scale employee involvement plan, just as a small amount of training or a modest change in pay systems, may have some beneficial effects, particularly in the short run. Furthermore, a system of high involvement, strong rewards, and high levels of skill and information, integrated with a corporate strategy that relies on front-line employees’ ideas and creativity, is capable of impressive improvements in organizational performance. [Levine 1995, 81]　

The literature on ESOPs and other forms of employee-ownership has generally, but not always, found a positive relationship between ownership and performance. But when the ownership is coupled with genuine participation, the positive relationship is quite clear.(1)　

Institutional Interlockingness of Systems

The contrasts between the low and high involvement workplaces are part of a larger story about the interlocking attributes of different types of systems [see Aoki 1994]. Indeed, one way to look at the East Asian crisis is as the turmoil at the interface between two systems just as an earthquake is produced by the collision and rubbing of tectonic plates. In a system of information-rich and stable but highly leveraged relationships between firms and financiers, distress in handled with understanding and lenience on the part of the lenders. The high trust in the firm-financier relationship pairs together with the high leverage as part of a workable system.　

But when the same firms start to become indebted with arm’s-length short-term borrowing, there will be little slack in the face of distress and the high leverage may lead to crisis. Low trust and arm’s-length finance relationships need to be paired with lower debt-equity ratios to provide more flexibility under distress. The point is not that one system or the other is “better” but that an unwise mixture of the two systems may be quite prone to crisis.　

Yet the world changes; new circumstances arise. Each system must find ways to adjust their set of interlocking attributes to address the new realities and yet avoid unstable mixtures prone to crisis.　

Just to be even-handed, let me mention the opposite sort of problem when a low trust system adopts a sub-system from a high trust system. Many firms in the US and Europe have wanted to cut inventory costs and to foster the problem-solving induced by the just-in-time inventory system. But the JIT inventory system interlocks with rather cooperative labor relationships both in the firm and in the suppliers and truckers who supply the parts “just in time.” In a more confrontational labor environment, the JIT system is rather unworkable.　

Two Enterprise Systems

We will proceed by outlining the two systems introduced as two way of addressing the effort problem in the agency relationship and the more general problem of opportunistic behavior in contractual relationships. The two stylized enterprise systems will be characterized with generic characteristics (e.g., low trust & involvement versus high trust & involvement) rather than geography?even though one system is commonly thought to be Anglo-American and the other is identified with Japanese or more generally East Asian systems.　

In terms of Hirschman’s exit-voice distinction [1970], dissatisfaction in a relationship leads in a low trust/involvement system to exit and the search for a better partner. In a high trust/involvement system, contractual relationships are more stable and longer-term. Each partner is expected to have higher commitment to the relationship and more trust that the partner will not act opportunistically.(2) In the workplace, dissatisfaction would be addressed through various voice mechanisms (e.g., grievance procedures and labor-management committees) rather than termination and exit. To paraphrase an old advertising slogan, the partners would “rather fight (to improve the relationship) than switch.”　

The characteristics of the two systems interlock and reinforce each other so there should be two different equilibria. An equilibrium in any given case might be disturbed if certain variables start to deteriorate and some participants start to adopt the mechanisms of the other system?as seems to have happened in the East Asian crisis.　

High trust is developed between workers and managers by managers exercising the self-restraint to not use their power to enrich themselves and to take advantage of the workers. On their side, the workers choose to be cooperative without feeling that they are exposing themselves to being opportunistically exploited by self-aggrandizing managers. That mutual cooperativeness in the high trust management-labor relationship is the basis for high “X-efficiency.”(3) In a high trust and involvement environment, the genuine participation of the workers leads to their increased buy-in to the goals of the immediate work group, if not to some goals of the broader enterprise. As a result of this socialization into the enterprise, the worker tends to identify with and to affect the goals of the whole effort. Instead of better threats and monitoring to reduce opportunistic behavior in the agency relation, the high trust/involvement system strives towards identification of principals and agents.　

The body of employees is, together with the body of shareholders, explicitly or implicitly recognized as a constituent of the firm, and its interests are considered in the formation of managerial policy. [Aoki 1987, 283-4]

The fundamental principle underlying the Japanese model of mixed economy is anthropocentricism, or what Keisuke Itami refers to as “peoplism.” Peoplism is given concrete expression in the form of employee sovereignty with the corporation, and an emphasis on the independent, land-owning farmer within agriculture. [Sakakibara 1993, p.4]　

The system tries to generalize to larger enterprises the virtues of the family farmer, small producer, or shopkeeper who is self-employed.　

The following table tries to concisely give the flavor of the two systems and their internal interlocks.(4)
　 Enterprise Characteristic
Low Trust and Involvement
High Trust and Involvement

　
　
　

LABOR MARKET
　
　

Inducement to high effort
High unemployment and efficiency wage
High involvement induces effort even with low unemployment

Compensation
Contractual wages
Wages plus profit sharing

Wage differentials
High differential as incentive for individual advancement
Low differential for increased group solidarity and cohesiveness.

Employment security
Low: dismissal is credible threat for discipline
High security to promote identification with enterprise.

Training costs
Paid by individual to increase marketability
Paid by firm as long-term human capital investment

Macro-environment
Can adjust to and contribute to larger recessions with layoffs
Works better with and contributes to fewer and smaller recessions by avoiding layoffs



　 PRODUCT & FACTOR

MARKETS
　
　

Relationship
Arms’s-length, market-oriented, and competitive
Long-term relation based on commitment, trust, and loyalty

Product
Standardized (to foster competition)
Customized to buyer or seller

Curb to opportunism
Exit and competition
Voice, commitment, and trust



　 Enterprise
Characteristic
Low Trust and Involvement
High Trust and Involvement

CAPITAL MARKET
　

Relationship
Arm’s-length and market-oriented finance
Long-term relational finance

Time perspective
Short-term since hard-to-monitor human capital investments downplayed
Long-term and patient to reap return to human capital investments

Debt/equity ratios
Need low D/E ratio to provide flexibility in face of unforgiving market.
Can have higher D/E ratios with patient relationship financial sources and with involved, more flexible workers

Low costs of equity
Low costs since no sharing of income or control rights with workers
Lower costs for internal equity since workers already share some income & control rights



　

Conclusion

The policy-makers of East Asia need to understand the strengths and weaknesses of their high trust type of enterprise system. The East Asian economies in the recent past have undergone significant crises which have been interpreted by some as revealing inherent flaws in these systems. Change will be necessary, as in any living system, to face new realities. But with understanding and confidence, the changes could be made in a way that reinforces the systems that have been so successful, rather than abandoning them. Increase employee ownership and other forms of labor participation will yield the best results in a high trust and involvement enterprise system and will reinforce the characteristics of that system.

　

References

Akerlof, George and Janet Yellen, Eds. 1986. Efficiency wage models of the labor market. Cambridge: Cambridge University Press.　

Aoki, Masahiko 1987. The Japanese Firm in Trasition. In The Political Economy of Japan. Kozo Yamamura and Yasukichi Yasuba Eds. Stanford: Stanford University Press.　

Aoki, Masahiko 1994. The Japanese Firm as a System of Attributes: A Survey and Research Agenda. In The Japanese Firm: Sources of Competitive Strength. Masahiko Aoki and Ronald Dore Eds. Oxfor: Oxford University Press: 11-40　

Blinder, Alan S., Ed. 1990. Paying for Productivity. Washington DC: The Brookings Institution.　

Bowles, Samuel 1985. The Production Process in a Competitive Economy: Walrasian, Neo-Hobbesian, and Marxian Models. American Economic Review. 75(March): 16-36.　

Clark, R. 1979. The Japanese Company. New Haven: Yale University Press.　

Dore, R. 1987. Taking Japan Seriously. Stanford CA: Stanford University Press.　

Gates, Jeff 1998. The Ownership Solution. Reading: Addison-Wesley.　

Goldberg, V. 1980. Relational exchange: economics and complex contracts. American Behavioral Scientist 23 (3, January/February): 337-352.　

Greenwald, Bruce and Joseph Stiglitz 1988. Pareto Inefficiency of Market Economies: Search and Efficiency Wage Models. American Economic Review. 78 (2 May): 351-5　

Hirschman, Albert O. 1970. Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States. Cambridge: Harvard University Press.　

Leibenstein, H. 1984. The Japanese Management System: An X-Efficiency Game Theory Analysis. In The Economic Analysis of the Japanese Firm. M. Aoki Ed. Amsterdam, Elsevier: 331-357　

Leibenstein, H. 1987. Inside the Firm: The Inefficiencies of Hierachy. Cambridge: Harvard University Press.

Levine, David I. 1995. Reinventing the Workplace. Washington: The Brookings Institution.　

Levine, David I. And Laura D’Andrea Tyson 1990. Participation, Productivity, and the Firm’s Environment. In Paying for Productivity: A Look at the Evidence. Alan Blinder Ed. Washington: Brookings Institution: 183-237.　

Sakakibara, E. 1993. Beyond Capitalism: The Japanese Model of Market Economics. Lanham MD: University Press of America.　

Shapiro, Carl and Joseph Stiglitz 1984. Equilibrium Unemployment as a Worker Discipline Device. American Economic Review. 74 (June): 433-44.　


Notes

1. See Blinder 1990, Gates 1998, and the updated reports on www.nceo.org/library posted by the National Center for Employee Ownership I Oakland, California.

2. See Goldberg 1980 for a treatment of the contrast between relational contracting and arm’s-length contracting.

3. Where we might take X=effort, See Leibenstein 1984, 1987.

4. See Levine and Tyson 1990; Levine 1995 for many of the same points and see Clark 1979 or Dore 1987 for similar tables comparing Anglo-American-type and Japanese-type firms.