Wirtschaftsgeschichte Universität Bielefeld
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An economic culture of trust:
Germanys contribution to a European strategy

by Werner Abelshauser, in: Mitbestimmung. Das Magazin der Hans-Böckler-Stiftung 8/2004, S. 48-51.

Germanys social system of production has been the target of escalating criticism and has had to endure a painful examination of its sustainability.  Doubts have centered on the specifically German principles underlying the organization of the economy.  Persistent mass unemployment since the 1980s has led to more and more frequent claims that the German production regime is incapable of adapting to new, innovative product markets, for which globalization is said to require highly flexible entrepreneurial decision-making processes.  Although faith in the economic and social superiority of the Rhenish model of capitalism (Michel Albert) prevailed in the public discussion just ten years ago, and still does among many experts today, mounting skepticism prompted speculation about the possible necessity of retreat, given the political, media-related, and cultural influences of its American competitor.   The clash between American culture and Europes leading culture, the German way of doing business, entered a new stage.

Dissatisfaction with the system of industrial relations, whose German flagshipcodetermination, or the right to participate in controlling shop-floor conditions and management decision-making is especially intense. Codetermination is critisized for preventing quick decisions by senior management, and with the organization of businesses at the intercompany level, where excessive coordination by the associations leads to restraint of competition and overregulation of the labor market. Dissatisfaction also extends to corporate governance, which seems to be handicaped by workers participation at least in large enterprises and in heavy industry. Even where experts systematically consider the comparative institutional advantages of different production regimes (e.g., varieties of capitalism) and not infrequently endorse the German version, the discussion usually lacks economic analysis.

The judgment on what the German economy benefits from codetermination vacillates between two oddly indecisive, but by no means contrary, assessments.  The first one emphasizes the irenic function of codetermination, its calming and mediating influence, which serves Germanys social system of production in the same manner that a functioning welfare state does.  This view thus manifests at least fifty years of positive experience with industrial democracy but avoids a clear statement about its economic value.  The second assessment, often readable between the lines of well-meaning commentary, amounts to an assertion that codetermination in the waning industrial age islike the welfare statethreatening to become obsolete because its core functions are intimately linked with the industrial economy and will therefore go down with it.  This opinion rests on the basic assumption that the western world stands at the end of an era whose foundations were laid in the Industrial Revolution of the late eighteenth century and whose distinctly German traits have produced a system of industrial governance unique in the world.  These two judgments, if they pertain at all, do not describe the economic function of codetermination but rather, at best, one of its most obvious effects.

Codetermination is certainly anchored deep in the peculiarities of the German path to todays economy, but definitly has more in common with the German origins of the new economy than with the traditional patterns of industrialization. In the race to modernism, Germany is well known to have been one of the stragglers, which had to develop their own institutions and organizations in the nineteenth century  in order to catch up with the pioneer, Englandor better, leapfrog ahead of it. Although a legal framework for workers committees to exercise codetermination rights was first established in an amendment of the Prussian Mining Law (1905), this innovation in industrial relations had its breackthrough rather in the science based New Industries. At that time more than half of all machine-building companiesone of the New Industrieshad taken this step, and two thirds of them had rated the influence of the committees positively.  The Weimar Republic then introduced rights of codetermination at all three levels of interest intermediation: on the shop floor, with the Works Councils Act of 1920; at the sectorial level, with the Central Joint Labor-Management Board of Economic Planning and Regulation (ZAG); and at the national level, with the Provisional National Economic Council conceived of in Article 165 of the Weimar constitution.  The contentious situation surrounding each of these achievements underscored their political character and social mission, at least more so than they highlighted the necessity of codetermination as a matter of corporate policy and business economics.  In post-1945 occupied Germany, too, this preeminence of the sociopolitical dimension marked the British insistence on granting employees equal voice on the supervisory boards of the iron and steel industry.

Although the importance of stable, cooperative labor relations became readily apparent to most entrepreneurs during the long 1950s, and although codetermination was one of the essentials for long-term productivity gains, growth, and competitiveness, the orthodox liberal persuasion continued to dominate the economic theory of industrial relations.  Indeed, it still does, with codetermination seen as a strengthening of bargaining power and, hence, of the unions monopoly on the market.  If a union can behave like the holder of a monopoly, it will try to maximize the wages of its members, whereas all the affected company can do is choose the employment level at which it earns maximum profit.  From this perspective, the consequences are prices rises and misallocations of resources.  As long as codetermination seemed suitable for preserving the precarious balance of the social question in industrial society, dyed-in-the-wool liberals were quite able to accept it for the sake of social peace and the stability that codetermination was evidently able to bring to labor relations.  From this angle, too, however, it follows that the end of industrial society and the declining importance of material production mean that codetermination loses sociopolitical legitimacy.  It was created as a means of industrial stabilization, and as such, its effect seems to reach as far as the epochal significance of the Industrial Revolution itself, which has long since ceded its rank to the new paradigm of the Second Economic Revolution.

Against this backdrop, codeterminations economic value really boils down to the degree of importance that long-term cooperative labor relations have in the economic process of value creation, or more precisely, the level of transaction costs.  Such relations are evident in the way that employees and their interests are organizationally tied into the company.  To ensure that they are, and to forge cooperative labor relations, employers may be prepared to pay the employees higher wages than is customary or to give broad guarantees of job security.  Employers thereby enable themselves to invest in the basic and continued training of their employees.  This investment is a must for increased profits, especially under the conditions created by the rapid structural shift to the knowledge society.  Reduced fluctuation and intensified motivation among employees compensate for cost inflation.

Asymmetrical distribution of knowledge on the shop floor is another attribute of production relations in the knowledge society.  Nonmaterial production and the scientifically grounded qualifications it requires usually depend on expert knowledge, which is difficult to replace and whose productive use in the work process is not easy to control.  Optimal performance by an employee with expert knowledge cannot be formulated in precise contractual terms, nor could such contracts be cost-effectively monitored and enforce.  In short, the situation is a classical variation of the agency problem.   Management is thus steadily losing its ability to exercise absolute control over the workplace at somewhat reasonable cost.  And when conflict arises, employees possessing specialized knowledge can damage the company more than could the classical industrial worker, who had only generalizedand thus easily replaceableknowledge.  If the Leninist maxim of Trust is good, control is better applied to the industrial context, the opposite is true under these new conditions.  Moreover, control is the more expensive option.  As a result, management and employees or their respective representatives share control over the workplace.  Profit-sharing and codetermination provide for the necessary agreement on the utility function of principal and agent.

Long-term, stable, and low-conflict labor relations have yet another meaning, particularly in times of rapid structural change.  A high level of qualification and initiative among the employees gives the enterprise great incentive to make cost-intensive investment in fixed assets.  They also ensure that these investments can be fully used and amortized.  High fixed costs can thereby be turned into low unit costs.  Investments in new technology raise the productivity of the company, expanding its share of the market and boosting profits.  Adequate employee participation in these profits strengthens cooperative labor relations.

This is even more relevant for the postindustrial period.  The swifter the advance of nonmaterial production in the twentieth century, the steeper the rise in transaction costs and, hence, the greater the need for institutional regulations and conventions for keeping them low.  To be sure, the spark of the new production methods seldom leapt from New Industry to the rest of Germanys crisis-ridden economy, marked as it was by the conditions spawned by the two world wars and economic chaos.  After dynamic beginnings under the empire, nonmaterial production and the conditions for innovative productivity did not spread to the economy as a whole.  In fact, during the interwar period they even declined relative to what was happening elsewhere at the same time, notably in the United States.  The pioneer of the Second Economic Revolution nevertheless held to its course into the postindustrial age.  Once established, the institutional context did not change more than incrementally, despite all exogenous shocks.  Nor did codeterminationor better, the principle of cooperative labor relations within the plant.  Much the same was also true for other forms of cooperative labor beyond the plant level (e.g., ZAG), though in somewhat milder way.  Codetermination in Germany, quite apart from its organizational manifestation in the Weimar Republic and its perversion under the Third Reich, belongs to New Industrys institutional arsenal, which has repeatedly created new organizational frameworks.  Admittedly, the legal and organizational form that emerged for the principle of codetermination after 1945 was shaped by the political conditions of the times, but it was consistent with the economic needs of that period.

At the dawn of the twenty-first century, it is almost a truism that the value of human capital is measured not only in terms of its own quantity and quality but primarily in terms of a societys aptitude for sociability, that is, for trustful cooperation in the economic process.   Without it, cooperation is feasible only by means of formal rules, regulations, and coercion.  The resulting costs (transaction costs) escalate with the complexity of the tasks that a national economy must perform in order to be successful on the market (including the world market).  Practically, mistrust thus has the same effect as a tax on economic activity.  From the outset, the purpose of introducing codetermination in Germany was to minimize these costs.  With the advent of New Industry in the twentieth century, the capacity for cooperation only gained importance.  This sociability helps explain why the basic features of the German production regime, including codetermination, have survived all the political catastrophes of its era.

The high value attached to the economic culture of trust makes it understandable why new organizational forms of codeterminationwhether in the iron, coal, and steel industry or in the Labor-Management Relations Act of 1952were swiftly accepted despite their controversial beginning.  Above all, it explains their consolidation and practical development beyond their original legal setting. The new perspective taken in historical research sharpens the eye for other impacts as well.  The origins of cooperative institutional arrangementsmore narrowly, codeterminationdo not lie in the rationale of the bygone industrial age.  They are foundations of New Industry, whose patterns of nonmaterial productivity are becoming ever more apparent as old industrys share of employment and value creation through material production dramatically declines.   The economic value of codetermination and other forms of institutional cooperation does not stem solely from their irenic and sociopolitical function but also from what they do to contain and reduce production costs and transaction costs within complex market and production processes.  Of course, this realization does not compel anyone to cling to the outmoded organizational forms of codetermination.  Appropriate institutional arrangements can surely be cast in other organizational molds as well.  According to the laws of asset specificity, however, turning to such alternatives entails considerable cost.   Because institutional change cannot be planned, success would by no means be guaranteed.  There are thus many reasons for the German model of codetermination to continue developing along path-dependent linesif the capacity for cooperation that has accrued over the preceding 50 years or more is not to be written off completely.  As long as this path corresponds to the overall development of the social system of production, it will not lead to anachronisms of industrial society.  It will instead ensure purposeful expansion of the institutional groundwork of New Industry right into the heart of the New Economy.