GERMAN WORKS COUNCILS, PROFITS, AND INNOVATION (abridged)

John T. Addison, Claus Schnabel and Joachim Wagner

...practical manifestations of policy interest in the device are the works council directive recently enacted into law by the European Commission (Official Journal, 1994), establishing multinational works councils in European-level enterprises

I. INTRODUCTION

There is nowadays much interest in worker participation on efficiency grounds, and as regards the particular mechanisms through which such participation might be effected. The German 'model' of mandatory works councils has attracted much attention.... [P]ractical manifestations of policy interest in the device are the works council directive recently enacted into law by the European Commission (Official Journal, 1994), establishing multinational works councils in European-level enterprises, and the deliberations of the Commission on the Future of Worker-Management Relations (1994a, 1994b) in the United States which actively considered adoption of the institution.

And yet, at the levels of both theory and measurement, very little is known about the likely impact of worker participation in general... [T]he popularity of the German works council is at an all-time high in both academic and policy circles. The goal of the present exercise is thus twofold: first, to address the theoretical pedigree of the works council model; and, second, to provide new empirical evidence of works council impact on firm performance along the dimensions of firm profitability and innovation, drawing on the first large-scale German database in which the works council institution is of more than peripheral interest.

...works councils shall be elected in all establishments that normally have five or more employees...

...the size of the works council is laid down by law, ranging from one to thirty-one members for establishments with up to 3,000 employees...

...Works councils are formally independent of unions...

...works councils are representative of the entire workforce... union members but also union nominees...

...the works council has to be supplied with timely and comprehensive information on all matters related to the discharge of its function...

...in plants with more than 100 employees an economic committee (Wirtschafisausschuss)... is to be kept fully informed on the current and projected economic situation of the firm, and be given all the relevant economic and financial information...

...What distinguishes the Betriebsrat from its continental European cousins is an explicit set of codetermination rights on what are termed 'social matters'...

• working hours,
• principles of remuneration,
• introduction of new payment methods,
• pay arrangements to include the fixing of job and bonus rates
• regulation of overtime and reduced working hours,
• the introduction devices to monitor worker performance, and
• course health and safety measures.

...works council... may also negotiate social plans... which establish compensation for the dislocation caused by plant closings, changes in organization or equipment, and the introduction of new working methods...

...Where the two sides cannot agree... either can petition a conciliation board to formulate a compromise plan... the final arbiter in unresolved cases.

...works councils are excluded from reaching agreement with the employer on wages and working conditions that are settled or normally settled by collective agreements between unions and employer...

...strike activity on the part of the works council is specifically precluded...

II. INSTITUTIONAL BACKGROUND

Prior to outlining the functions of the German works council, or Betriebsrat, we have first to address the sense in which this form of worker representation is mandatory. The important point to grasp is that mandatory does not mean automatic. This subtlety is often missed by foreign observers, and the absence of official data on works council incidence has helped to obscure the distinction.

Section 1 of the enabling legislation, the Works Constitution Act (Betriebsverfassungsgesetz) of 1972, states that

'works councils shall be elected in all establishments that normally have five or more employees with voting rights, including three who are eligible (to be works councillors)'.

To complicate matters, part timers who work regularly for the firm are classified as permanent employees. Voting rights accrue to all workers aged 18 years and above, and eligible employees are all workers who have been employed by the firm for not less than six months. In other words, the size threshold requires a minimum of five permanent employees, all of whom must be at least 18 years of age and three of whom must have at least six months' service.

The procedure for setting up a works council is straightforward: just three employees with voting rights, or a trade union represented in the establishment, are necessary to call for an electoral board (Wahlvorstand), which is then responsible for conducting an election. Alternatively, a labor court can set up an electoral board, again on a petition from three employees or the union.

This, then, is the precise meaning of mandatory in the German case. To repeat, once elections for a works council are under way, the works council is a fait accompli. Note also that the size of the works council is again laid down by law, ranging from one to thirty-one members for establishments with up to 3,000 employees. For larger establishments, there are two additional members for each increment of 3,000 employees.

Works councils are formally independent of unions. In practice, however, although no seats are reserved for union members and although works councils are representative of the entire workforce, the majority of successful candidates are not only union members but also union nominees. In the latest works council elections -- these are held every four years -- some 73.5% of councillors were union members (Niedenhoff 1995) at a time when union density economy- wide approximated 35%.

Although it has not always been the case, the ties between the union movement and the works council would today appear to be very close. Thus, for example, Muller-Jentsch (1995, p. 61) refers to works councils as

...cooperation between unions and works councils is fostered by workers' education programs conducted by the union movement, and by their joint presence on the supervisory boards of companies. We have already noted that most councillors are union members, and in that capacity they may also serve on union bargaining committees.

...To this we should add that there is evidence of considerable diversity in the labor relations climate between management and works council (Kotthoff 1981, 1994).

...The participative rights of the works council are fairly easily dealt with... Beginning with information provision, the works council has to be supplied with timely and comprehensive information on all matters related to the discharge of its functions... [M]ore information has to be supplied to larger councils: in establishments with more than 20 employees, information must be given 'in full and good time' on reductions in operations and the introduction of new working methods, while in plants with more than 100 employees an economic committee (Wirtschafisausschuss) is required. The latter standing committee is to be kept fully informed on the current and projected economic situation of the firm, and be given all the relevant economic and financial information.

...[C]onsultation rights apply to planned structural alterations to the plant and prospective changes in equipment and working methods that affect job requirements, all decisions relating to manpower planning, and individual dismissals. In the latter case, where the employer fails to consult, the dismissal is rendered null and void.

The above information and consultation rights are not unique to German works councils. What distinguishes the Betriebsrat from its continental European cousins is an explicit set of codetermination rights on what are termed 'social matters'. Examples of those areas in which the works council has joint decision-making authority with management are the commencement and termination of working hours, principles of remuneration, the introduction of new payment methods, pay arrangements to include the fixing of job and bonus rates and other types of performance related pay, the regulation of overtime and reduced working hours, the introduction and operation of technical devices to monitor worker performance, and of course health and safety measures. In all such areas, failure to reach agreement leads to their adjudication through a conciliation board.

The works council also has somewhat weaker consent rights where the establishment has more than 20 employees with voting rights. These consent rights relate to individual measures of personnel policy having to do with the engagement, grading, regrading and transfer of workers within the firm. They also apply in respect of individual terminations, referred to earlier.

The works council, again in plants normally employing more than 20 workers with voting rights, may also negotiate social plans (Sozialplane), which establish compensation for the dislocation caused by plant closings or partial closings, major changes in organization or equipment, and the introduction of new working methods or production techniques. Where the two sides cannot agree on compensation and retraining measures, either can petition a conciliation board to formulate a compromise plan. The labor court is the final arbiter in unresolved cases.

Now the social plan is a special case of a works agreement (Betriebsvereinbarung). Such agreements proliferate. Although the majority of them cover issues in which the works council has enforceable codetermination rights, in large plants at least a considerable number of works agreements regulate matters that fall outside legally defined areas (Witte 1980, cited in Muller-Jentsch 1995, pp. 60-61). The indication is, then, that bilateral negotiations between the works council and the firm often seem to range well beyond those prescribed by the law.

As a formal matter, works councils are excluded from reaching agreement with the employer on wages and working conditions that are settled or normally settled by collective agreements between unions and employer federations at industry level, unless the latter explicitly authorize works agreements of this type. But not only have industry agreements in a variety of sectors made provision for supplementation at plant level, but it has also not been unusual for works councils to negotiate informally about additions to the payment bundle in one form or another....

Finally, it should be noted that strike activity on the part of the works council is specifically precluded under the Works Constitution Act. Indeed, the legislation enjoins the employer and the works council to 'work together in a spirit of mutual trust'... But... the threat to be uncooperative may be as potent a weapon as the strike threat....

In addition to its governance functions, collective voice is seen as offering a means of expressing discontent...

... improved communication and heightened workplace morale...

...Unlike the participatory firm, 'traditional firms' are said to motivate their workforces through the fear of unemployment and a sharply differentiated wage structure...

...management's use of a works council as a communicator to workers about the state of nature can yield the optimal provision of effort on the part of workers, leading them to work harder in adverse states...

...works councils improve communication from workers to managers...

III. THEORETICAL REMARKS

Much of the theory pertaining to the effect of worker representative institutions deals with unions rather than works councils per se... but there is also in the German case the added complication that unions exist alongside the works council apparatus...

In addition to its governance functions, collective voice is seen as offering a means of expressing discontent other than through the alternative mechanism of quits. Lower turnover implies reduced hiring and training costs, and increased firm-specific training investments. Collective voice thus offers the prospect of improved communication and heightened workplace morale; attributes judged especially important....

Levine and Tyson (1991)... present a form of prisoner's dilemma argument. They contend that were all firms to adopt participative machinery each would benefit. But participatory firms require among other things compressed wage structures to encourage 'group cohesiveness' and dismissals protection to lengthen the time horizon of workers (see below). Unlike the participatory firm, 'traditional firms' are said to motivate their workforces through the fear of unemployment and a sharply differentiated wage structure. The scene is thus set for the non-emergence of a participative equilibrium: the viability of the single participative firm will be prejudiced both by adverse selection (it will attract the work-shy), and also by an externality (the poaching of its stars by the traditional firms which can pay more). In this way, so the argument runs, the market will be systematically biased against participatory workplaces and the economy will become locked in a socially suboptimal position. Vulgo: mandates are required to shepherd the economy to a new and improved equilibrium.

Freeman and Lazear (1995)... argue that the device of the works council holds out the prospect of an improvement in the joint surplus of the enterprise as a result of information exchange, consultation, and participation/codetermination.... [A]lthough the model envisages an increase in the joint surplus of the enterprise, firms' profits are nonetheless expected to be lower in the presence of a works council. As a result of this profit effect, management will either oppose the installation of works councils or vest them with too little power. For this reason, the institution has to be imposed by government mandate....

Freeman and Lazear first construct a simple formal example to show how management's use of a works council as a communicator to workers about the state of nature can yield the optimal provision of effort on the part of workers, leading them to work harder in adverse states. Absent credible information...  workers may be too aggressive and pursue a low-effort strategy in bad times that may prejudice the survival of the firm. Similarly, it is argued that works councils improve communication from workers to managers by increasing the incentives of the former to disclose private information once the worker side has some control (via the power of the works council to share in the surplus) over how the information will be used.

Consultation and participation for their part are seen as permitting new solutions to the problems faced by the firm... that the information possessed by the worker side has value and may therefore admit of a better solution than can be reached by management alone. Freeman and Lazear recognize that there is a cost in the form of decision-making delays, so that the case for works councils does not follow automatically... Finally, codetermination on the German pattern, by providing workers with increased job security, is said to inculcate in workers a longer-run view of the prospects of the firm....

As we have seen, Freeman and Lazear propose that works councils be made mandatory since they are viewed as increasing the joint surplus of the enterprise, at least over some range of works council power beyond which the surplus is actually dissipated by rent-seeking behavior on the part of workers. They accept that workers will always demand more than the socially optimal level of power... the approach has first to squarely address the issue of 'how much participation?'....

Although there seems much to commend institutions of collective voice, it has not been established that the expression of voice can only be achieved through autonomous agencies or effected through mandates. There is also the interesting wrinkle in the German case that mandatory does not mean automatic....

SUMMARY

Of the various direct mechanisms of worker participation, the German works council in particular has attracted most academic interest and policy because of its mandatory (though not automatic) nature, participative reach, and seemingly limited distributive bargaining function....

REFERENCES

Addison, John T. and John B. Chilton (1995). Unions, Investment, and Efficiency. Unpublished paper, University of South Carolina.

Addison, John T. and John B. Chilton (1996). Models of Union Behavior, in: David Lewin, Daniel J.B. Mitchell and Mahmood A. Zaidi (eds.), Handbook of Human Resource Management. Greenwich, Connecticut: JAI Press.

Addison, John T., Joachim Genosko and Claus Schnabel (1989). Gewerkschaften, Produktivitat und Rent seeking, Jahrbucher fur Nationalokonomie und Statistik 206: 102-116.

Addison, John T., Kornelius Kraft and Joachim Wagner (1993). German Works Councils and Firm Performance, in: Brace E. Kaufman and Morris M. Kleiner (eds.), Employee Representation: Alternatives and Future Directions. Madison, Wisconsin: Industrial Relations Research Association: 305-335.

Addison, John T., Claus Schnabel and Joachim Wagner (1995). On the Determinants of 'Mandatory' Works Councils in Germany, Arbeitsbericht des Fachbereichs Wirtschafts- und Sozialwissenschaften Nr. 151, Universitat Luneburg.

Addison, John T. and Joachim Wagner (1996). The Impact of German Works Councils on Profitability and Innovation: New Evidence from Micro Data, Jahrbucher fur Nationalokonomie und Statistik (in press).

Baldwin, Carliss Y. (1983). Productivity and Labor Unions: An Application of the Theory of Self-enforcing Contracts, Journal of Business. 56:155-185.

Blinder, Alan S. (ed.) (1990). Paying for Productivity -- A Look at the Evidence. Washington, D.C.: The Brookings Institution.

Brown, James N. and Orley Ashenfelter (1986). Testing the Efficiency of Employment Contracts, Journal of Political Economy. 94: 40-87.

Buchtemann, C.F. and A. Holand (1989). Befristete Arbeitsverhaltnisse nach dem Beschaftigungsforderungsgesetz, Bonn: Bundesministerium fur Arbeit und Sozialordnung.

Commission on the Future of Worker-Management Relations (1994a). Fact Finding Report. Washington, D.C.: U.S. Department of Commerce/U.S. Department of Labor.

Commission on the Future of Worker-Management Relations (1994b). Report and Recommendations. Washington, D.C.: U.S. Department of Commerce/U.S. Department of Labor.

European Commission (1993). Growth, Competitiveness, Employment. The Challenges and Ways Forward into the 21st Century. Brussels: Commission of the European Communities.

FitzRoy, Felix R. and Kornelius Kraft (1985). Unionization, Wages, and Efficiency -- Theories and Evidence from the U.S. and West Germany, Kyklos. 38: 493-504.

FitzRoy, Felix R. and Kornelius Kraft (1987). Efficiency and Internal Organization: Works Councils in West German Firms, Economica. 54: 493-504.

FitzRoy, Felix R. and Kornelius Kraft (1990). Innovation, Rent-Sharing and the Organization of Labour in the Federal Republic of Germany, Small Business Economics. 2: 95-103.

Freeman, Richard B. (1976), Individual Mobility and Union Voice in the Labor Market, American Economic Review, Papers and Proceedings. 66: 361-368.

Freeman, Richard B. and Edward P. Lazear (1995). An Economic Analysis of Works Councils, in: Joel Rogers and Wolfgang Streeck (eds.), Works Councils -- Consultation, Representation, and Cooperation in Industrial Relations. London and Chicago: University of Chicago Press: 27-52.

Freeman, Richard B. and James L. Medoff (1984). What Do Unions Do? New York: Basic Books.

Frick, Bernd and Dieter Sadowski (1995). Works Councils, Unions, and Firm Performance, in: Friedrich Buttler, Wolfgang Franz, Ronald Schettkat and David Soskice (eds.), Institutional Frameworks and Labor Market Performance -- Comparative Views on the U.S. and German Economies, London and New York: Routledge: 46-81.

Hirsch, Barry T. and Kislaya Prasad (1995). Wage-Employment Determination and a Union Tax on Capital: Can Theory and Evidence be Reconciled? Economics Letters. 48:61-71.

Hirsch, Barry T. (1991). Labor Unions and the Economic Performance of Firms. Kalamazoo, Michigan: W.E. Upjohn Institute for Employment Research.

Infratest Sozialforschung (1995). Das Hannoveraner Firmenpanel --Methodenbericht. Munich: Infratest Sozialforschung.

Jacobi, Otto and Walther Muller-Jentsch (1990). West Germany: Continuity and Structural Change, in: Guido Baglioni and Colin Crouch (eds.), European Industrial Relations: The Challenge of Flexibility. London: Sage: 127-153.

Kotthoff, Hermann (1981). Betriebsrate und betriebliche Herrschaft: Eine Typologie yon Partizipationsmustern im Industriebetrieb. Frankfurt and New York: Campus Verlag.

Kotthoff, Hermann (1994). Betriebsrate und Burgerstatus: Wandel und Kontinuitat betrieblicher Interessenvertretung. Munchen und Mehring: Rainer Hampp Verlag.

Kraft, Kornelius (1986). Exit and Voice in the Labor Market: An Empirical Study of Quits, Journal of Institutional and Empirical Economics. 142:697-715.

Kraft, Kornelius (1992). Produktivitatswachstum und gewerkschaftliche Organisation, Jahrbucher fur Nationalokonomie und Statistik. 209:419-430.

Levine, David I. and Laura D'Andrea Tyson (1990). Participation, Productivity, and the Firm's Environment, in: Alan S. Blinder (ed.), Paying for Productivity -- A Look at the Evidence. Washington, D.C.: The Brookings Institution: 183-237.

Lorenz, Wilhelm and Joachim Wagner (1989). Bestimmungsgrunde yon Gewerkschaftsmitgliedschaft und Organisationsgrad, Zeitschrift fur Wirtschafts- und Sozialwissenschaften. 111: 65-82.

Mainusch, Stefan (1992). Die Gewerkschaften als Determinante von Produktivitat und Profitabilitat -- Eine empirische Analyse zur okonomischen Bedeutung der Gewerkschaft in der Bundesrepublik Deutschland. Regensburg: Transfer Verlag.

Muller-Jentsch, Walther (1995). Germany: From Collective Voice to Co-management, in: Joel Rogers and Wolfgang Streeck (eds.), Works Councils -- Consultation, Representation, and Cooperation in Industrial Relations. Chicago and London: University of Chicago Press: 53-78.

Niedenhoff, Horst- Udo (1995). Betriebsrats- und Sprecherausschubetawahlen 1994. Koln: Deutscher Instituts-Verlag.

Official Journal (1994). Council Directive 94/45/EC of Sept. 22nd, 1994 on the Establishment of a European Committee or a Procedure in Community-scale Undertakings and Community-scale Groups of Undertakings for the Purposes of Informing and Consulting Employees, Official Journal of the European Communities. No L 254 of 30.9.94: 64-72.

Sadowski, Dieter, Uschi Backes-Gellner and Bernd Frick (1995). Works Councils: Barriers or Boosts for the Competitiveness of German Firms? British Journal of Industrial Relations. 33: 493-513.

Schasse, Ulrich and Joachim Wagner (eds.) (1995). Erfolgreich Produzieren in Niedersachsen. Untersuchungen mit Daten aus der ersten Welle des Hannoveraner Firmenpanels (NIW-Vortragsreihe, Band 10). Hannover: Niedersachsisches Institut fur Wirtschaftsforschung.

Schnabel, Claus (1989). Zur okonomischen Analyse der Gewerkrchoften in der Bundesrepublik Deutschland. Frankfurt: Peter Lang.

Schnabel, Claus and Joachim Wagner (1992a). Unions and Innovative Activity in Germany, Journal of Labor Research. 8: 393-406.

Schnabel, Claus and Joachim Wagner (1992b). Unions and Innovation. Evidence from German Micro Data, Economics Letters. 39: 369-373.

Schnabel, Claus and Joachim Wagner (1994). Industrial Relations and Trade Union Effects on Innovation in Germany, Labour. 8: 489-503.

Schulenburg, J.- M. Graf v.d. and Joachim Wagner (1991). Advertising, Innovation and Market Structure: A Comparison of the United States of America and the Federal Republic of Germany, in: Zoltan J. Acs and David B. Audretsch (eds.), Innovation and Technical Change: An International Comparison. New York: Harvester: 160-182.

Siebert, Horst (ed.) (1995). Trends in Business Organization: Do Participation and Cooperation Increase Competitiveness? Tubingen: J.C.B. Mohr.

Witte, Eberhard (1980). Das Einflubetapotential der Arbeitnehmer als Grundlage der Mitbestimmung, Die Betriebswirtschaft. 40: 3-26, 541-559.

~~~~~~~~

By John T. Addison, Claus Schnabel and Joachim Wagner

Prof. Dr., Department of Economics, University of Hull, Cottingham Road, Hall HU6 7RX, England, United Kingdom, and University of South Carolina (USA), and Institut for Weltwirtschaft an der Universitat Kiel, Germany. Dr., Institut der deutschen Wirtschaft, Postfach 510670, 50942 Koln, Germany. Prof. Dr., Institut fur Volkswirtschaftslehre, Universitat Luneburg, D-21332 Luineburg, Germany. This paper uses data from the project Das Hannoveraner Finnen-panel, funded by the Volkswagen Stiftung. Addison also wishes to acknowledge the contributions of generous travel support from the John M. Olin Institute for Employment Practice and Policy at George Mason University and the award of a Riegel and Emory Research Fellowship from the University of South Carolina.

Source: Kyklos, 1996, Vol. 49 Issue 4, p555, 28p, 4 charts.
Item Number: 9612300749