Despite their obvious potential advantages, employee owned businesses tend to be rare. In 2004, there were an estimated 300 worker owned cooperatives in the United States. If that sounds impressive, consider that in 2001, there were over 18.3 million nonfarm proprietorships in the U.S. Nor is the situation much different overseas. The Mondragon Cooperative Corporation is typically cited as an example of a successful worker cooperative, and it is indeed quite successful . . . for a co-op. Compared to other types of businesses, however, Mondragon performs well, but not stellar. It is the seventh largest corporation in Spain, and despite being a conglomeration of more than a 100 different companies, it accounts for less than 4% of the GDP of the Basque region of Spain where it is located. When one considers that Mondragon is in all likelihood the most successful worker cooperative on the planet, the idea that the co-op’s success proves the viability of worker cooperatives generally begins to seem doubtful.

There’s nothing legally preventing people from choosing to start a workers-owned cooperative rather than some other form of business, and in fact cooperatives receive more favorable tax treatment than do standard business corporations. Why then, aren’t they more common? The question has actually inspired a fair amount of research, which has identified at least four obstacles to the success of worker owned businesses.

1. Access to capital. In order to expand (or in many cases to even get off the ground) businesses often need access to capital. Under a standard business model, this capital can come from investors, in exchange for an ownership stake in the business, or it can be borrowed (with firm assets being used as collateral). By contrast, a workers co-op can’t give investors an ownership interest in the enterprise, and they often have trouble borrowing because the main asset they have is the labor of the workers, which can’t be offered as collateral (since slavery contracts are illegal). For this reason, worker co-ops tend to be disproportionately concentrated in labor intensive, capital light industries.

2. Risk adverse employees. One of the things that distinguishing owners of an enterprise from others associated with the business is that owners are entitled to a share of the firm’s profits. The potential upside of this arrangement is readily apparent, but there is also a downside. While an employee who enters into a labor contract for a set wage has a legal right to a particular amount of compensation, a person who owns a share in a business venture is entitled only to a share of the profits, which may not materialize for years, if ever. So while the potential upside of ownership is greater than for employment, the potential downside is greater as well. In the case of a standard business corporation, investors can deal with this risk by only investing a portion of their income, and by spreading it around many different ventures. A worker, by contrast, typically must work primarily for a single firm, and this work will be his main source of income. As such, workers tend to prefer set wage contracts (with perhaps some degree of variability above a base salary) to an ownership share in the firm.

3. Production Limiting Incentives.

Even if a workers co-op manages to get off the ground, it is liable to grow more slowly and be run less efficiently than other types of firms. The reason for this has to do with the different incentive structure built into the workers co-op framework. Whereas in a typical firm profits are distributed to a distinct class of owners or investors, in a workers co-op each employee is entitled to some share of the firm’s profits. This means that every time a workers co-op hires new employees, the ownership share (and hence the claim to profits) of each existing employee is diminished. As such, it will often be the case that expanding the firm’s operations will increase overall profitability while decreasing the payout to each existing employee. But since it is the existing employees who are ultimately responsible for making these decisions, worker co-ops will tend to be less profitable than non-labor managed firms.

One solution to this problem is to create two classes of employees, one of owners, and one of non-owners. This has tended to happen in successful co-ops over time. An increasing percentage of Mondragon employees, for example, do not have an ownership stake in the company, but work for it much as they would for an ordinary business. But while this may be a solution for a particular co-operative business, it is not really a solution for the co-operative business model so much as a gradual abandonment of it.

4. Decision-Making Costs.

Finally, the management of worker coops presents serious difficulties. In his book, The Ownership of Enterprise, Henry Hansmann notes that successful businesses tend to have owners whose inputs (and hence interests) in the firm are highly homogeneous. Supply cooperatives, for example, are most successful when they involve a single commodity (milk, or eggs, or whatever). Similarly, the standard business corporation involves an owner input (money) that is about as homogeneous as it gets (since, as the saying goes, everyone’s money is the same color). And successful workers coops have tended to involve a single class of workers all of whom are doing approximately the same job. Where owners of a business have conflicting interests, by contrast, problems can easily develop. To use an example from Joseph Heath’s Filthy Lucre: Economics for People Who Hate Capitalism:

If a dairy cooperative takes both milk and eggs as input, it immediately politicizes a whole range of questions, creating controversies and factions where previously none existed. How much of the advertising budget should be used to promote butter? Should new investments be made to enhance the productivity of the cheese operation? How many quarts of milk is equivalent to a dozen eggs when it comes to dividing up revenue or assigning voting rights? In a milk-only cooperative, people may disagree over all sorts of questions, but it reflects mere differences of opinion – there is no underlying conflict of interest. A farmer who supplies only eggs, however, has very different interests from one who supplies only milk.

Likewise, a worker co-op in which employees differ significantly in skills, compensation, job responsibilities, background, and so forth are going to create a significant divergence of interests between different groups of workers, which can impede the overall functioning of the firm. These problems are heightened by the fact that, in a firm of any significant size, many management decisions are made not by the owners themselves but by their representatives. In any business, this creates a host of potential problems, as the incentives of those running the firm differ from those of the owners. In the case of a factionalized ownership, however, managers can more easily evade accountability from owners by pitting different groups of owners against each other.

It should be noted that, with the partial exception of the first item, none of these problems with worker co-ops are amenable to an easy legislative fix. Nor are these problems likely to go away any time soon. If anything, they are liable to get worse, as increased education and specialization makes labor less and less homogeneous. Yet unless these problems can be solved, it is unlikely that worker co-ops will be more than a marginal part of economic life. And that’s fine. While certain Popes have on occasion made favorable comments about worker ownership, the Church has always made clear that this form of business is not morally obligatory. If employers and employees find, for the reasons given above, that worker co-ops are less preferable than other forms in many circumstances, there is nothing wrong with that.