Overview. Widening income disparities highlight the similarities of today’s economy with the Gilded Age at the turn of the twentieth century.  That era was remediated in part by adopting innovative public policies from other democracies such as minimum wages and social security.  To Americans of the day, those policies imported from abroad were as unfamiliar as the concept of codetermination is to Americans now. But like minimum wages, the practice of codetermination has a long history abroad as a successfully policy to reduce income disparities and strengthen local communities and wage growth.   It is THE defining element in the ability of powerful capitalist economies such as Germany over the last half-century to achieving broadly based income growth at the same time that American income disparities have widened and most wages stagnated. And it is the most powerful weapon in the liberal democracy’s arsenal to ensure real wage growth and thereby prevent the rise of populists as in the US in 2018 and Italy in 2018.

The election of Donald Trump reflects failure of American capitalism to uphold the goal set forth by Adam Smith in his 1776 Wealth of Nations as a device to create rising prosperity widely shared.  Misplaced corporate priorities are the primary explanation for stagnant wages, rising income disparities and job offshoring: The concerns of the broader economy, of local communities and of employees have been made subservient since the 1980s to those of shareholders as noted by Robert Reich, Joseph Stiglitz and others.  Higher quality democracies avoid this predicament because corporate priorities are crafted within a corporate governance framework of codetermination. Seminal enterprise resource allocation decisions including plant location, hiring, R&D, the degree of employee upskilling, investment rates, wages, facility modernization and the like are made by corporate boards that balance various stakeholder interests rather than just shareholder and executive suite interests.

Introduction. Corporate governance in America since the 1980s utilizes what economists call the agency framework in which executive suites de facto behave as shareholder agents, adopting policies maximizing shareholder interests.  This framework is not mandated by law. Driven by stock options, firm leadership has become unduly focused on immediate share price performance rather than longer term corporate competitiveness.  It has resulted in wage stagnation, considerable job offshoring, declining economic mobility, relatively weak investment and disassociation of executive compensation from performance; it has also caused weaker firm productivity growth and lower shareholder returns than under codetermination.  Donald Trump’s exploitation of the Obama administration’s failure to remediate these trends was one of several pivotal factors in the 2016 election.

There are a number of widely cited micro options to address income inequality including raising minimum wages, redistributive tax and government spending policies, retraining, overtime pay mandates, strengthening collective bargaining and the like embraced by Democrats. But party officials mostly ignore the only seasoned and demonstrably effective structural remedy – reorienting the goals of American corporations through adoption of codetermination.

The history of codetermination began when executive suites in northern Europe in the wake of World War II were de jure required by British and American occupation forces to add employee representatives to corporate boards. The representatives were typically progressive attorneys, economists, academicians and the like selected by enterprise employees. (The goal was to weaken the influence of senior executives and large shareholders who tended to have been Nazi sympathizers.) These reconfigured boards were viewed as agents or trustees for society writ expansively, anticipated to adopt corporate policies that promote long-horizon enterprise and job sustainability while widely broadcasting the gains from enterprise activity to employees and local communities as well as shareholders. That is, they were expected to fulfill the goals originally envisioned for capitalist enterprises by Adam Smith. The success of this postwar reform in the decades since is exemplified by higher investment and real wages across northern Europe that in the US.

Codetermination in Germany. Over the past half century, the largest, most competitive German firms such as Adidas or Daimler have had codetermination board of directors, half of whom are employee representatives. If codetermination debilitated competitiveness, productivity growth or profits, the initial postwar concept would have been discredited – with laws hurriedly changed to discard the concept decades ago. To the contrary, its success has seen codetermination spread – utilized to varying degrees today by larger firms in 19 of the 27 (post-Brexit) EU members, including all the major ones except Italy.  (Take a moment to check the board composition of any large German firm online; it will be revelatory.)

The most comprehensive assessments of codetermination are derived from its five-decade history in Germany.  There, board of directors must be split between shareholder and employee representatives at firms with more than 2,000 employees; board seats at the 600+ largest German firms are split in half. (Tie board votes are broken by the board chair who may cast two votes at such junctures.) At smaller firms with 500-2000 employees, a minimum one-third of board members must be employee representatives. The law applies to boards of directors equally at privately held enterprises such as Bosch as well as listed firms such as Daimler.

Higher Investment Rates. Because codetermination boards make enterprise strategic and tactical investment direction, hire CEOs and establish compensation structures, they eliminate pathologies arising from short-termism common in American executive suites – such as maximizing short-term profits, compensation delinked from performance, over-reliance on mergers for growth, dubious share buybacks and excessively short investment time horizons. The longer time horizon of firms with codetermination boards translates to greater investment:

Eurostat investigations found that investment rates at non-financial enterprises in the European Union are higher than for American firms. And an analysis of German firms for the Berlin Social Science Center (WZB) in 2016 found that the capital investment ratio (investment in capital goods – long-lived durable goods) of codetermination firms was twice that of firms whose Boards of Directors just represented shareholders.

Higher Shareholder Returns. Investor appreciation of their greater investment profile may explain why American economists Larry Fauver and Michael E. Fuerst found that financial markets rewardstockholders in codetermination firms with higher Tobin Q’s (market value divided by replacement book value of assets). In America, only privately-held firms mirror the superior investment behavior of northern European firms with codetermination governance. Analysts aver that the longer term perspective demanded by owners at privately-held US firms cause their enterprise managers to de facto mimic the behavior of enterprises with codetermination structures. That is significant because research under auspices of the NBER by Harvard and NYU economists found that investment rates (measured as shares of enterprise assets) by managers at privately-held U.S. enterprises are 2.5 times greater than rates at public U.S. firms (10 percent v 4 percent).

Minimizing Offshoring. Regarding offshoring, EY (Ernest & Young) in 2016 examined the job creation profile of firms comprising the German DAX 30 stock index, all of whom benefit from codetermination governance structures. The increase in foreign sales of these firms (28 percent) during the study period 2011-2015 considerably outpaced their creation of foreign jobs (8 percent).  The difference was made up by adding jobs and productivity-enhancing investment at home to service export markets. That is why domestic German employment at these huge firms grew by more (6 percent) than their rise in domestic sales (5 percent). It is also why a large three-quarters (4.4 million units) of German auto production is exported rather than produced abroad.  And it is why production facilities for the next generation (gen e) of cars is being constructed in Bremen (Daimler), Zuffenhausen (Porsche), Zwickau (VW) and the like.   The domestic orientation of German enterprises is the precise opposite of policies pursued by American firms, who readily offshore jobs to low-wage nations.  For example, a Wall Street Journal analysis covering the period 2000 to 2009 found that American multinational firms eliminated a net of 2.9 million domestic jobs while adding a net of 2.4 million jobs abroad. A second study by Tax Analysts found that U.S. multinationals cut a net 1.9 million domestic jobs during this period while adding a net 2.35 million jobs abroad.

Rising Real Wages. Empirical analysis has concluded that real wage and productivity growth are higher in firms with codetermination governance. German, Scandinavian and other such northern European firms have faced the same globalization and technology challenges as US firms in recent decades. Even so, they have steadily raised compensation over that period by about 1 percent annually in real terms, enabling wages adjusted for purchasing power to leapfrog American wages. As noted by Robert Reich, hourly pay adjusted for inflation in Germany, for instance, has increased nearly 30 percent since 1985, averaging about one percentage point annually. Codetermination is why labor compensation as a share of national income has rebounded in Germany since the 2007 recession, rising from 47.6 percent to nearly 51 percent. More broadly, real compensation since 2000 has increased in 18 of the 19 EU nations with codetermination practices. As documented by the US Conference Board, labor compensation per hour in the capstone manufacturing sectors in 7 northern European nations such as Germany is higher than in the US.

Despite notably higher wages, codetermination firms in these democracies are highly competitive with American firms. That reality debunks the claim by US executive suites and conservative economists that globalization and technology change are responsible for stagnant American wages (and job offshoring). Indeed, compelling new independent European research has concluded that the key determinant of a nation’s wage rates is its collective bargaining environment rather than globalization or technology change. This conclusion is powerfully supported by real world evidence from German, Dutch, Danish and other northern European firms who face the same globalization and technology challenges as US firms, but remain internationally competitively despite their uniformly high-wage enterprise profiles.

Social Justice. In bringing a broader perspective to the crafting of corporate goals and objectives, codetermination enhances the corporate sector’s contribution to social justice. It would more accurately come to reflect, for instance, the foundational values expressed in Pope Leo XIII’s 1891 Rerum Novarum, in the protestant work ethic and in Judeo-Christian teachings about the dignity of hard work fairly compensated.

Summation. The centrality of codetermination to middle class prosperity is why German President Joachim Gauck terms it “an important cultural asset.” Yet, American economic journalists and economists are incurious. They devote paltry attention to codetermination despite being the only seasoned structural solution for the wage stagnation afflicting much of the American workforce.  They are incurious about evidence developed by CEOs like Bill George, formerly of Medtronics and now at Harvard B School, and by economists such as Steven Hill, author of Europe’s Promise: Why the European Way is the Best Hope in an Insecure Age (2010).   Many perhaps accept the narrative, debunked in recent years by German research, that codetermination retards enterprise efficiency.  In reality, analysis confirms that enterprise productivity is higher when employee representatives comprise even just one-third of corporate boards.

Ignorance or inattention to codetermination leaves Americans unaware of the powerful contemporary capitalist mechanism being utilized by other rich democracies to steadily raise middle class wages and minimize job offshoring. That inattention is abating somewhat with the introduction of legislation in March by Democratic Senators Baldwin (WI), Warren (MA) and Schatz (HI) requiring that boards of directors at all publicly-listed US firms be one-third employees.

Introducing Codetermination to America. Wage stagnation is a structural challenge that is ameliorated with codetermination.  Its advocates will need to overcome opposition from executive suites and their Republican Party allies who argue spuriously that codetermination harms firm efficiency.  In reality, evidence from Germany and elsewhere document that it reduces executive compensation while enhancing enterprise performance and shareholder returns. Frustrated Americans are open to innovative solutions to wage stagnation including codetermination.  In fact, an April 2018 survey on Vox found that, once familiarized with the practice of codetermination, a majority of American respondents support the concept; indeed, they favored it by a margin of well over 2:1 (53% vs. 22%).

George Tyler, former economist for Senators Hubert Humphrey and Lloyd Bentsen, Senior Economist on the Joint Economic Committee, Conceptual author of Drugs for Neglected Diseases Initiative (Genève) and a DAS at the Clinton administration Treasury Department.

Codetermination is nearly always accompanied by the establishment of Works Councils.

Works Councils Explanation

From Cantner, Gerstlsberger and Roy, “Works Councils, Training Activities and Innovation: A Study of German Firms,” Jena Economic Research Papers, 2014, https://www.econstor.eu/bitstream/10419/98440/1/780578392.pdf .

“In Germany, works councils have a particularly strong position due to legal regulation (German Works Constitution Act 1952) that guarantees employees in establishments or firms with five or more permanent employees the right to establish a works council. Often, but not necessarily, works council candidates are nominated by the union or unions corresponding to the specific industry. However, the works councils have to represent all regular employees of their establishment or firm and are committed to support its economic stability in the first line and union interests in the second….  The main tasks of works councils comprise the protection of employee rights in various human resource management practices such as recruiting, layoffs, reorganization, vocational education and training, co-determination of incentive schemes, vacations and leave grants, flexi-time and overtime regulation, conflict handling, and prevention.”