The VW Scandal and its Challenge to Codetermination

For those without subscriptions to the business press, the best coverage of this issue has been at the Union-Firms-Markets blog of Mathias Bolton:

• Co-Determination In Germany Under Threat As Volkswagen Dispute Worsens, July 5;
  
• More on Volkswagen and the Threat to Germany's Industrial Relations Model, July 6;
  
• BusinessWeek on Labor Problems at Volkswagen, July 8;
  
• Another Volkswagen Scandal Article, July 8;
  
• More on Change at Volkswagen, July 10;
  
• Germany to Be the Vanguard of Moving the EU Closer to the US Economic Model? Political and Business Climate Shifting, July 14

First, some background on the scandal, courtesy of Fistful of Euros blog:

So imagine the fun had by all as amazing revelations began to emerge from Wolfsburg. VW management, it seems, had a long-term policy of keeping the Betriebsrat -- the works council -- sweet. Sensible enough, you might say, and in keeping with that German consensus approach. But even Ludwig Erhard would surely have scowled at some of the sweeteners: front firms set up to ladle secret cash to top labour representatives; all-in junkets to Brazil, including (if the rumours are true) the services of a profession rather older than auto-making.

Just a garden variety corporate scandal, you might think? Not quite, at least if the German business and conservative political establishments have their way.

From the FT, "VW dispute descends into open warfare," July 5 (sub req'd):

The scandal, which has led to the departure of two senior VW managers and the head of the works council, is highly embarrassing for the carmaker but many, such as Mr Wulff and Bernd Pischetsrieder, VW's chief executive, see it as a chance to push through reform. . . .

One particular target of the opposition Christian Democrats is likely to be the principle of co-determination under which workers are involved in strategic decision-making.

Also from the FT, "Scandal Could Taint A Whole Labour System," July 6 (sub req'd):

[M]any trade unionists fear the scandal could have negative labour relations implications reaching far beyond VW.

The views of the business class are summarized well in this Business Week article, "The Real Scandal at Volkswagen":

Volkswagen's burgeoning scandal exposes a deeper problem for Corporate Germany than alleged fraud. It highlights an underlying cause of the country's economic stagnation -- Germany's co-determination law, which gives workers' representatives 50% of the seats on the supervisory boards of all large companies. What started out conceptually as a law to ensure a balance between the interests of management and labor in many large companies has morphed into an insidious alliance aimed at not rocking the boat. CEOs and top managers depend on votes from the labor reps to be reappointed. Instead of making tough decisions on restructuring or job cuts, German managers are inclined to delay or avoid change and instead curry favor with union bosses sitting on their boards, often to the detriment of their companies.

And of course the Economist ("An Icon Under Fire", July 8) chimes in:

Critics argue that this co-determination discourages bosses from taking tough measures that might annoy the board's labour representatives. It slows decision-making. It tends to deter foreign investors. And it may tempt managers to buy labour's support. . . .

The German government is now forming a committee to examine reform of co-determination. Last year the Confederation of German Employers demanded change. . . .

The scandal may have a silver lining for VW. Bernd Pischetsrieder, the chief executive, and his ally, Wolfgang Bernhard, are trying to make the firm more "Anglo-Saxon", with more focus on [financial] performance. . . . the alleged scandal may be just what the management needs to be able to push through the changes it wants. . . .

As we saw in part I, however, this general view is not consistent with the reality of the German codetermination system, which helped industries such as steel, automobiles, and consumer electronics navigate tough economic times in the 1970s, 80s, and 90s by promoting rationalization and economic adjustment, not retarding it, and making sure that any such adjustments took workers' interests into account. It is also not consistent with recent German performance in terms of labor productivity and international competitiveness. As the Economist reports, to its credit, some enlightened German executives still realize this:

But some executives, including Jürgen Schrempp, boss of DaimlerChrysler, another carmaker, like the system. Workers accept tough measures more readily if they are part of the decision-making, they say.

In my opinion, the stated reasons for the coming assault on the German industrial relations system have relatively little to do with economic necessity, and much to do with politics: a desire on the part of the German business class to redistribute economic power, income, and wealth in their favor, and to place the burdens of slow economic growth and future economic adjustment more squarely on the shoulders of German workers.

(Note: an excellent book that explains how a similar assault was successfully conducted on the economic institutions of the New Deal in the United States beginning in the mid-1970s, an era in which the post-World War II economic boom ended and a period of relative economic stagnation ensued, is Thomas Ferguson and Joel Rogers' Right Turn: The Decline of the Democrats and the Future of American Politics.)

The American "Job Loss Recovery" and its Implications for Germany

To understand the real reasons behind the coming employer offensive on German codetermination, and its probable effects on the German economy should it be successful, let's consider a recent article from Challenge: the Magazine of Economic Affairs (comes out every two months; the best source I know of, in English, for high-quality non-technical economic analysis from a center-left perspective), entitled "The Causes of the 'Job Loss' Recovery," by L. Josh Bivens of the Economic Policy Institute and Christian Weller of the Center for American Progress, both center-left U. S. think tanks.

Bivens and Weller seek to explain the roots of the recent poor labor market performance in the United States:

This economic recovery [in the US] badly needs explaining. It was the first economic recovery in the modern period in which jobs were lost, not gained. The two authors provide an exhaustive analysis of why it has been different this time around. One of their conclusions is that institutional financial power and changes in corporate governance have contributed significantly to sluggish employment.

So German executives want to address the European unemployment problem by adopting the "Anglo-Saxon" model of corporate governance? Maybe that's not such a great idea, as Bivens and Weller suggest:

For most of the first two years of the [U.S.] recovery, employment declined. . . . Given slow demand, business initially saw no need to invest, and when they finally did, it was only in a few isolated industries.

Yet, it was not for lack of resources that corporations did not invest more. In fact, corporate profitability scaled record heights. Instead of investing in plant and equipment . . . corporations spent their resources on more speculative uses, such as share repurchases and dividend payouts. The reward was a strong stock market recovery and a weak labor recovery.

Furthermore, this "job loss recovery" in the U.S. is rooted in long-term trends:

Since the late 1970s, compensation and productivity have diverged, giving rise to a continuous profit and stock market boom, rising income inequality, and increasing household debt levels. These trends were only arrested for a short spell during the boom of the late 1990s, as full employment trumped other influences and led to equalizing income growth

(data courtesy of the Economic Policy Institute; right click on chart for more readable image)

What is driving these trends? A shift in the relative power of capital and labor in the U. S. economy, according to Bivens and Weller:

Dissatisfied with low rates of return in the 1960s and 1970s, institutional shareholders [pension funds and mutual funds] used their financial and political muscle to push for changes in corporate governance, especially in the realm of executive compensation. The resulting emphasis on shareholder value creation hastened the decline in private-sector unionization, particularly by emphasizing short-term rent seeking through financial services instead of long-term value added activities.

These changes in American corporate governance are key to understanding broader changes in the macroeconomy, because:

• Corporate governance systems shape corporate investment decisions - who makes the decisions, what investments are made, how returns are allocated;
  
• The growing power of institutional investors in the US economy, and the emphasis on "shareholder value," resulted in increased allocation of resources to capital through such mechanisms as share repurchases to boost stock prices, and dividend payouts;
  
• The resources needed to finance this reallocation of corporate resources were increasingly generated by "outsourcing, downsizing, and hollowing out," and an increased emphasis on providing financial services - thus the weakness in wage growth and job creation in the US economy since the mid 1970s.

(By the way, the average US unemployment rate between 1973 and 1995 was about 7%, compared to less than 5% between 1948 and 1973, and a low of around 4% in 1999. The so-called "job creation machine" has been mostly sputtering over the last 30 years).

The implications for Germany of moving to the "Anglo-Saxon" system of corporate governance should be pretty clear by now: little or no voice for workers in corporate investment decisions, weakening domestic investment demand, stagnating wages, rising inequality, and most probably very disappointing levels of job creation, if the current American recovery is any indication. Scrapping codetermination will not solve Germany's economic problems.