Economies de Escala Versus Participacao - Um Dilema Cooperativo

37 JEOD Vol1 Issue 1 2012 Acknowledgements An earlier version of this paper was presented at the international conference Promoting the understanding of cooperatives for a better world Venice March 1516 2012 The paper has benefitted from comments from participants at that conference notably Alberto Zevi and Sonja Novkovic and also from comments by Chris Gunn Betsy Jensen Mark Klinedinst John Pencavel Jeff Pliskin and Jaroslav Vanek as well as research assistance by Matt Poterba You are free to share and to remix you must attribute the work at t r i b u t i o n 3 0 Economies of Scale Versus Participation a Cooperative Dilemma Derek C Jones Department of Economics Hamilton College Clinton NY 13323 USA djoneshamiltonedu Panu kalmi Unit of Economics Faculty of Business Studies University of Vaasa PO Box 700 65101 Vaasa Finland panukalmiuwasafi authors JEL Classification P0 P13 L25 G340 DOI 105947jeod2012003 We examine the proposition that in cooperatives the need for democracy must clash with efficiency demands To shed light on diverse issues surrounding this claim we distinguish different forms of cooperatives and identify different meanings of democratic governance and forms of economies of scale One focus is on democratic decisionmaking within individual coops including tensions between members and managers andor boards and how processes often labeled as degeneration can be averted Another focus is on coordination problems among and between groups of co ops in a network or second tier coops and how innovative forms of monitoring and forms of corporate governance may be expected to emerge in response to these potential difficulties We also integrate evidence drawn from the available econometrics literature with this discussion Our main source of empirical information is the provision of institutional evidence for the cases of Mondragon and cooperative banks in Finland We conclude that the evidence for an alleged inexorable tradeoff between democracy and efficiency is not compelling but also note the need for additional theoretical and empirical work COOPErATiVES DEMOCrACy EFFiCiENCy COrPOrATE GOVErNANCE MONDrAGON FiNLAND aBstraCt KEYWorDs Publication date 21 December 2012 Volume 1 issue 1 2012 3764 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 38 JEOD Vol1 Issue 1 2012 1 Introduction A commonly voiced proposition is that the need for democracy in cooperatives must clash with efficiency demands in a fast changing and globalized world it is argued that market pressures including the need for economies of scale require individual cooperatives to be continuously increasing their scale At the same time this need for relentless growth is said to require changes in governance that tend to undermine the democratic nature of cooperatives and thus the very essence of what makes cooperatives different eg Nilsson et al 2009 While some might object that technological changes during the last twenty years or so in particular the growth of the internet have at least undermined the economic forces that require steady increase in average plantestablishment size there are several reasons for giving close attention to this claim One reason is that there is a body of work mainly on the Mondragon cooperatives eg Cheney 1999 and Kasmir 1996 that has had considerable influence and which apparently tends to support certain issues concerning the claim A second reason this contention demands attention is that often the concern is advanced by those with a deep knowledge of cooperatives themselves eg Fulton and Hueth 2009 Parnell 2010 rather than by others including mainstream theoretical economists who may have limited firsthand knowledge of actual cooperatives1 Thirdly the claim has long legs A glance at earlier literature on coops will find that this matter has long been actively discussed within the coop literature See eg Lambert 1970 yamagishi et al 1996 Since we are unaware of any recent work that systematically examines the theoretical and empirical underpinnings for issues surrounding this claim in this paper we make a preliminary step in that direction We seek to shed light on diverse issues surrounding this alleged inexorable tradeoff between democracy and efficiency and whether or not as a result all cooperatives must be considered organizations that are necessarily unsustainable We begin by distinguishing different forms of cooperatives in the third and fourth sections we identify different meanings of democratic governance and forms of economies of scale We endeavor to show that in principle the nature and potential tradeoff between democracy and scale economies is not a straightforward matter rather it can be expected to vary depending on factors including the particular meaning of democracy We also discuss how tensions between scale economies and democracy might be predicted to appear and to vary by cooperative type as well as ways in which in principle different co operatives may be expected to respond to varying degrees to these problems One focus is on democratic decisionmaking within individual coops including tensions between members and managers andor boards and how processes often labeled as degeneration can be averted Another focus is on coordination problems among and between groups of coops in a network or second tier coops and how innovative forms of monitoring and forms of corporate governance may be expected to emerge in response to these potential difficulties We also integrate evidence drawn from the available econometrics literature with this discussion But our main source of empirical information is of a qualitative nature We focus on primarily institutional evidence for two cases for which we have most knowledge Mondragon and cooperative banks in Finland in particular we discuss ways in which these two dissimilar cooperative cases have continued to thrive in recent years and yet have responded albeit with 1 in the mainstream economics literature on cooperatives perhaps the most commonly accepted proposition concerning the behavior of one important type of cooperative the worker cooperative is that firms will respond perversely to product price increases Despite the existence of massive theoretical and empirical evidence to the contrary the conventional wisdom continues to accept the existence of a backwardbending supply curve Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 39 JEOD Vol1 Issue 1 2012 varying degrees of success to pressures to sustain democracy in the concluding section we summarize and discuss implications of our findings 2 Cooperatives Definitions For our purposes the essential features of cooperatives are given by enterprises that have two characteristics 1 Ownership is not determined solely by investment in shares but by another transaction relationship with the enterprise as employees suppliers or customers 2 Voting rights are not determined in relation to capital ownership but are divided equally among members2 This definition deemphasizes other rochdale principles including open membership limited interest on capital religious neutrality cash trading and the promotion of education Bonner 1961 Diverse forms of cooperatives exist Hansmann 1996 and Birchall 1997 amongst others provide good descriptions of cooperatives around the globe3 Empirically the most prevalent forms of primary cooperatives both in Europe North America and elsewhere appear to be cooperatives in the agricultural sector mainly in food production in banking and finance in the form of credit unions and cooperative banks in insurance either mutual or cooperative form and in retailing where cooperatives are either retailer or consumerowned the latter is fairly uncommon in the US but is very popular in some European countries Cooperatives are economically significant actors all around the globe According to the international Cooperative Alliance the combined membership in cooperatives now exceeds one billion people see iCA 2012 Moreover some cooperative types including cooperative banks are of growing importance in their sectors Fonteyne 2007 For example around 91 million inhabitants of the US were members of credit unions in 2010 WOCCU 20114 representing a substantial growth from 1996 when the membership totaled around 70 million Emmons and Schmid 1999 in France cooperative financial institutions have more than 50 market share of deposits and almost 20 million members or almost onethird of total population5 Another example is social cooperatives which have assumed prominence in sectors in several countries including italy eg Borzaga and Defourny 2004 However the importance of cooperatives does not derive solely from their economic significance but also from their democratic governance and their perceived ability to address market and government failures see eg Kalmi 2007 in part reflecting their social objectives associations of cooperatives are a prominent feature of the cooperative landscape 2 BenNer and Jones 1995 investigate the roles of variation in control and return rights among diverse enterprises including some cooperatives 3 The first cooperatives appear to have been established in the eighteenth century Early utopian writers notably robert Owen who saw cooperative communities as alternatives to competitive and individualistic capitalism were a major stimulus to the establishment of these first cooperatives Equally practical necessities such as the need to obtain unadulterated foods played major roles in the formation of early coops such as the flour mills at Woolwich in the 1760s and the famous rochdale store in 1844 Subsequently while the development of the coop movement continued to be inspired by the writings and actions of individuals such as Fourier Blanc and Buchez pragmatic considerations have always played prominent roles in the evolution of cooperatives 4 Our data on what constitute cooperatives are self reported either by coops or their associations We do not attempt to systematically assess the extent to which these different coops are democractic 5 This information comes from the European Association of Cooperative Banks EACB website wwweurocoopbankscoop augmented with information from Caisse DEpargne which is a cooperative banking group not affiliated with EACB website wwwcaisseepargnefr Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 40 JEOD Vol1 Issue 1 2012 While a wide variety of firms can be listed under the cooperative umbrella the form that has proved to be of particular interest to economists is the producer or worker cooperative in such firms the position of the worker is crucial so that membership is restricted to workermembers in the business who effectively own and control the firm One of the best known examples today of worker cooperatives is the Mondragon cooperatives see httpwwwmccesing There are also important contemporary examples in italy and France Other cases of producer cooperatives past and present that have attracted attention include the US plywood coops Craig and Pencavel 1992 PCs in Uruguay Burdin and Dean 2009 and PCs in the former Soviettype economies eg for the case of Poland Jones 19936 3 Democracy 31 Issues in individual coops To guide our subsequent theoretical discussions in this section we note that the literature on co operatives distinguishes different meanings of democracy These differing senses are in turn associated with what are potentially at least varying democratic challenges For our purposes it is especially important to note that the importance and nature of democratic challenges can be expected to vary by coop type and coop structure in particular we distinguish several matters surround the meaning and maintenance of democracy within individual coops from democratic challenges that primarily concern groups of coops For individual coops we identify three matters of especial interest First are issues concerning appropriate democratic decisionmaking procedures and structures These include matters such as the nature and form of representative democracy matters that have long interested theorists of liberal democracy such as Pateman 1976 and Laycock 1989 These arrangements are apt to be less of an issue in small coops with homogeneous membership but could assume more significance in larger and multiestablishment coops with heterogeneous memberships and representative structures for decision making Hansmann 1996 They may also assume more significance in different kinds of coops where the basis for membership differs For example in worker coops especial importance can be expected to attach to devising appropriate machinery for democracy at the workplace as well as for efficient forms of representative democracy in other words the maintenance of democratic decisionmaking structures may be challenged by economies of scale and scope which we will review in the next section Many studies on cooperatives have been pessimistic about the maintenance of cooperative governance structure when cooperatives grow in size and complexity For example Nilsson et al 2009 review evidence for agricultural coops in various countries including Sweden Canada and ireland and find that size and complexity in coops typically result in democracy being undermined They present fresh evidence for a Swedish case and by highlighting tensions between managers and members show how such 6 As such cooperatives are distinguished from most employee owned firms and firms with other financial incentives such as profit sharing and other forms of shared capitalism Kruse Freeman and Blasi 2010 in the vast majority of instances of employee ownership and unlike in cooperatives voting rights reflect ownership of capital which are not equal either amongst employees or between employee and nonemployee owners in firms with employee ownership capital owners sometimes do introduce arrangements that enable employees to have enhanced involvement in decisionmaking While this often happens it is also rarely to such a degree that firms with employee ownership and worker cooperatives are aligned in this respect instances in which this has happened such as the Eroski retail chain in Spain Arando et al 2011a or in some British consumer cooperatives where employee directors are present Jones 1987 are the exception rather than the rule Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 41 JEOD Vol1 Issue 1 2012 developments once underway are difficult to reverse in particular they document how coop members are highly sceptical of the ability of coop leadership to introduce changes that lead to significantly enhanced member control As such they echo the findings of many earlier studies such as Hind et al 19977 However their study relates only to one sector of cooperatives and therefore may not be representative for all types of cooperatives Also there appear to be many examples when tensions between members and managers and between members and boards have subsequently been radically diminished For example Workshop report 2007 discusses the case of cooperative regeneration in Fonterra in New Zealand and how after a series of governance scandals in UK cooperatives in the 1990s a new code of best practices was adopted and how this is believed to have led to several subsequent examples of cooperative regeneration A second set of issues surrounds the basis and incentives for membership in a coop in many co ops apparently this is a straightforward matter Thus in consumer coops all users buyers are eligible for membership and members typically receive rewards proportional to their coop activities such as purchases Similar situations exist in agricultural coops and many banking coops eg in Finland But the transparency of rewards and mechanisms for determining rewards varies even among a given type of coop Hence in US credit unions rewards for membership are implicitmembers do not share in surplus but rather benefit for example from lower lending and higher deposit rates And even within what seem to be simple coops the issues are often more complex than initially appears Thus in some consumer coops while a crucial task is a need to provide democracy for consumer members often there are other groups who are eligible for membership for example employees whose interests need to be accommodated Devising democratic arrangements that balance the needs of differing groups is often a challenge in worker coops the problems may be even more difficult to resolve For example will coop membership be available to all workersthe principle of free admission Estrin and Jones 1992 or do other arrangements prevail And when there are multiple classes of members how are voting rights and rewards and on what basis to these differing groups to be determined Such matters potentially constitute formidable democratic challenges A cooperative may influence the demand for membership by many things These include the general performance of the cooperative the quality of the services provided by the cooperative and its pricing attractiveness its membership policy and the structure of cooperatives Other things equal wellmanaged and reputed cooperatives are more attractive to join For many potential members the key factor in joining is pricing and quality in consumer cooperatives high quality goods and services that are competitively priced attract consumers to join the cooperative Similarly in worker cooperatives the attractiveness of the cooperative as an employer depends on a combination of working conditions and salary including the riskiness of the income stream as well as the degree of job security There are important differences in the membership policies of cooperatives in some cooperatives notably credit unions all individual customers are required to become members in most cooperatives however individuals have a choice as to whether they want to become members in these cases the policies of a cooperative often have a decisive role in member recruitment For instance a cooperative may decide whether to spend resources on informing customers on membership and to what degree whether it is easy to join the cooperative or not and what the pecuniary and nonpecuniary benefits are from membership The size of the cooperative is also likely to matter in large cooperatives andor in cooperatives with multiple membership classes the members are likely to experience a lower degree of common bond having fewer opportunities to influence the policies of the cooperative and being under lower social pressure to participate in the governance of the cooperatives Emmons and Schmid 1999 and Jones Jussila and 7 in the context of credit unions Hoel 2011 has similarly argued that members sense of ownership and the size of the credit union are inversely related Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 42 JEOD Vol1 Issue 1 2012 Kalmi 2009 explore further such tradeoffs in the extreme the current members may close the cooperative to new members which will obviously cause the membership to decline This is known as cooperative degeneration and over time will lead to conversion into a normal company unless regeneration occurs This has been a recurring theme in the economics literature on worker cooperatives that has followed the pioneering work of Ward 1958 and later Vanek 1970 where worker cooperatives are positioned within a standard microeconomic comparative static framework and it is argued they maximize income per member8 One set of issues in that literature concerns the comparative scarcity of worker cooperatives Why apparently are such firms rare compared to conventional investorowned firms As well as leading to examination of issues relating to formation this area is also concerned with matters surrounding survival and life cycle in turn one of the themes that is identified in this connection is the apparent difficulty cooperatives have in sustaining their democratic character Beginning with the work of the Webbs eg Potter 1891 and continuing with formal economic modeling by amongst others BenNer 1984 researchers have analyzed the tendency of producer co operatives to transform themselves into organizations within which control rights are vested in a small number of workermembers The key prediction is that over time PCs have a tendency to degenerate see eg BenNer 1984 Democracy is undermined because the incentive grows for workermembers to replace retiring members with employees who remain nonmembers consequently the fraction of the workforce that comprises members will inexorably decline Another degeneration prediction is that successful coops will end up being sold to private corporations Unwillingness to take in new members is a consequence of the fact that existing members are not compensated for the dilution of their ownership rights in principle tradable membership rights would eliminate this problem However there are several reasons why such markets are difficult to establish One reason is that there might be principlebased opposition to market valuation of membership shares high prices for membership may deter new members from joining thus clashing with the open membership principle of cooperatives Even where such markets are established informational problems including asymmetric information and thinness of markets make valuing such rights very difficult Dow 2003 Perhaps more importantly degeneration can be halted by establishing institutional rules that require that employees should be taken as members after a probationary period as in France see Perotin 1997 or by setting a limit to the maximum proportion of nonmembers among the workforce as in Mondragon Smith 2001 Arando et al 2011a in any case degeneration is a problem that mostly relates to worker cooperatives and it is fundamentally due to the combination of facts that the value of membership can be relatively high and the productivity differential between member and nonmember workers may be low Conversely in consumer coops where the value of membership is relatively low but the behavioral differences between members and nonmembers may be high degeneration is typically not an issue9 However the two types of democratic challenges do not always need to be in conflict When a co operative encounters economies of scale and membership produces a positive behavioral response eg members are more loyal towards the cooperative than nonmembers then incumbent members may actually benefit from allowing new members to join the cooperative even when the membership fee is nominal 8 Note that the main institutional impetus for the emergence of this theoretical literature was the perceived behavior of the yugoslav firm during the Tito era 9 Degeneration may well be an issue for other types of cooperatives as well Thus some agricultural coops with large investment needs may close membership in order to align incentives to value maximization and prevent freeriding Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 43 JEOD Vol1 Issue 1 2012 32 Cooperative groups To survive and thrive it is increasingly the case that all kinds of coops must network or develop supporting structures creating groups of coops Such groups are of foremost importance in banking co ops These structures at the groups centre typically operate as central banks for local level banks and in this capacity they provide liquidity management services and also facilitate the payments within the group and across cooperative banks and other banks They also develop products for local banks undertake investment banking activities on behalf of local banks and provide insurance and mutual funds Typically the centres coordinate advertising for the whole group and provide various other services such as iCT or training for employees and local directors in some cases the centre performs certain public services such as auditing of member banks or operating a deposit insurance scheme10 Group structures are prominent also in areas outside financial cooperatives in the field of consumer cooperatives the British Consumer Wholesale Society was launched in 1872 its predecessor being established nine years earlier in consumer cooperatives the centres take care of wholesale activities joint marketing strategic development research and training and especially in the past industrial production The group structures are prominent also in the field of agricultural cooperatives but they are somewhat less common among worker cooperatives although such structures are present in the most successful cases notably Mondragon of which more below in a way that roughly parallels the discussion of individual cooperatives for groups of cooperatives two types of democratic challenges may be distinguished First are issues concerning appropriate decisionmaking processes and structures Various kinds of coordination issues arise when groups of coops are established For example a key issue of importance to all coops is how much sovereignty individual units are willing to surrender to the central institutions and yet remain democratic The decisionmaking procedures in the cooperatives groups typically are less democratic than at the local level where members are rather natural legal persons for instance it is common to weight the voting rights in groups according to the size of member cooperatives though not necessarily proportionally Often the highly skewed voting arrangements may mean that the group level becomes dominated by the interests of representatives of large cooperatives which frequently rather differ from the interests of members of small perhaps rural cooperatives These tensions may lead to further consolidation within cooperatives and in extreme cases to the dissolution of the whole group such tendencies were evident in the decay of German and Austrian consumer cooperative groups in the 1980s and 1990s Brazda and Schediwy 2001 The centres are often dominated by representatives of managers rather than lay members for which reason managerial as opposed to member preferences may receive excessive weight in decisionmaking These issues may also be reflected at the local level because policies at the central level necessarily have implications for local level operations furthermore increasingly the centres have direct control rights over the local units it is interesting to note that sometimes increased centralization may promote democracy at the local level Thus when more advanced operations are provided centrally by the group local cooperatives can concentrate on issues where they have local knowledgefor instance in banking and their analysing the credit risk of local borrowers Also enhanced centralization may lead to a smaller scale of local units 10 For description of various functions of centrals in financial cooperatives see Cuevas and Fischer 2006 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 44 JEOD Vol1 Issue 1 2012 becoming economically viable11 Second and related are matters surrounding the incentives for individual coops or groups of co ops to remain in a larger coop group This may not always be entirely voluntary sometimes member cooperatives may be required to belong to a group by law sometimes seceding from the group may be difficult The potential conflicts described above managers vs members large coops vs small coops may also lead to increased pressures for secession we will investigate these issues further in our case studies Some analogies to that of degeneration in individual coops can be drawn For a group of coops is there a point at which by some critical measure the coop group is in danger of degenerating For example if a coop group admits entities that have mixed membership or in some cases no coop presence at what point might the group as a whole be considered insufficiently cooperative in some cases cooperatives acquire significant capital interests For instance sometimes the shares of the group or its subsidiaries may be traded in the stock exchange though usually the voting majority belongs directly or indirectly to cooperative members in such cases despite the fact that cooperatives own the majority of shares the capital interest may become dominant Sometimes the owner of the minority interest may also be motivated to attempt to take the control of the majority of shares which would effectively undermine the cooperative character in addition organizational isomorphism may be attributable to training or lack thereof of coop managers and institutional requirements for accounting and reporting that force coops to use practices that do not suit their character and thus resulting in a mission drift see eg Di Maggio and Powell 1983 4 Economies of scale The economics literature often distinguishes different types of scale economies12 The most relevant for our discussion are increasing returns to scale this means that firms have to increase their size in order to remain competitive A closely related idea is that of economies of scope meaning that firms gain competitive advantage from joint production or marketing of two or more related goods Which type of scale or scope economy is potentially most important may be expected to vary by coop type in turn this implies that the particular tension between democracy and economies of scale may vary by coop type Changes in economies of scale may be driven by diverse forces for instance by technological changes or changes in the competitive environment in the balance of this subsection we briefly provide illustrations by sector and type of coop One critical determining factor is that of sector Thus in manufacturing perhaps the most important type of scale economy is technical economies of scale With manufacturing firms needing evergrowing scales of operations this also requires bigger capital investments However this does not immediately 11 For instance in European tightly federated financial cooperatives the size of local unit is much smaller than it is in loosely federated financial cooperatives Ferri et al 2012 12 Our focus is on economies of rather then returns to scale Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 45 JEOD Vol1 Issue 1 2012 translate into a need for bigger individual plants or establishments13 indeed in the internet world with burgeoning possibilities for what until recently were considered to be innovative arrangements such as lean inventories and short productions runs a bigger firm may establish several distinct groupsprofit centers within it Each of these divisions would be expected to have more distinct operations than in the past Thus the minimum efficient scale may grow for the firm but not for the plant And with quickening globalization manufacturing firms also need to develop plants closer to markets and thus often distant from the home base For coops these considerations suggest that the tensions between scale and democracy are most likely to emerge between plants and also between coops rather than within a plant While this firm versus plant point applies especially forcefully in sectors such as manufacturing and mining in other sectors different economies of scale may dominate Thus in retailing arguably what is of most importance are marketing economies of scale as well as the ability of a bigger group to exercise bigger clout when buying inputs and seeking advertising Banking is an area where financial cooperatives at least initially derived competitive advantage from their small scale Financial cooperatives originated in the 19th century Then typically only a small economic elite had any access to financial services enforcement of financial contracts was very low and financial supervision was nonexistent in this situation both bankers and their customers could be expected to honor their commitments only if other types of relationships existed between borrowers and lenders Credit cooperatives could function in this environment because they were created in small areas in which borrowers depositors and managers knew each other well thus being able to impose social sanctions on those who breached their contract Guinnane 2001 These advantages of being smaller continued for a long time often into the 20th century but they have gradually been eroded by increased mobility of persons reduced costs of exit from the community and technological improvements that have changed the nature of economies of scale in the banking sector For instance Peterson and rajan 2002 have argued that advances in information technology have made borrower information quantifiable for instance via credit scoring and reduced the returns to local tacit knowledge on borrowers in many countries the global deregulation of financial services has included the removal of bankbranching restrictions in turn often this has enabled retail banks to undertake investment banking activities and also arguably has changed economies of scale in banking in favor of larger units in the social sector cooperative providers have gained new ground in recent decades especially in italy eg restakis 2010 Borzaga and Defourny 2004 This seems to be related to certain diseconomies to scale andor government failures Customers of large publicly provided organizations seem to suffer from the feelings of alienation and overly standardized care leaving insufficient space for individual attention This is also reflected in lower work morale and satisfaction in the public sector Borzaga and Tortia 2006 Sectors such as health care and nursing services may especially benefit from smallness where client needs can be individually addressed 13 in terms of the formal theory of the labor managed firm the worker maximizing firm will always under competition produce at the level of maximum economies of scale whereas the capitalist firm will produce beyond that point with lesser factor productivity With indefinitely increasing economies of scale the capitalist firm will tend towards monopoly and destruction of markets See Vanek 1970 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 46 JEOD Vol1 Issue 1 2012 42 Evidence on Alleged challenges posed by Need for Economies of Scale There is much evidence of coops merging This increase in average size apparently suggests that on average coops believe that they need to grow to reap economies of scale Thus Schroeder 1992 reports how the number of US farm supply and marketing coops declined by more than 23 from 19791988 He says attempts to improve efficiencies of operations were likely a significant force behind the merger activity Also Fulton and Hueth 2009 report how the behavior of many Canadian agricultural coops demonstrated a strong need for additional capital or a need to grow in order to reduce members risk While few mergers occurred these pressures resulted in several bankruptcies or conversions of firms into conventionally owned firms in Spain MoyanoEstrada et al 2001 report how pressures to realize diverse forms of economies of scale led to coordination and mergers among agricultural coops Thus from 1994 to 1999 the number of agricultural coops fell from 5376 to 3925 and average size increased However the available econometric evidence on whether or not coops do reap economies of scale from increasing average size is surprisingly limited in Table 1 we present a summary review of the evidence that we were able to uncover14 Since studies differ enormously in crucial respects including the type of coop investigated the size of the sample the time period covered the nature of the empirical method it is likely that they will differ in the reliability of their findings That being said it is clear that there are no consistent findings in some cases this is unsurprisingas noted earlier we would expect the importance of economies of scale to vary across sectors But other findings are more surprising Thus among agricultural supply and marketing coops it is instructive that while Schroder 1992 does find evidence of firmwide economies of scale for most product groups that he examines he does not do so for all product groups eg not for chemicals Kebede and Schreiner 1996 in their analysis of Kenyan dairy marketing cooperatives find evidence of economies of scale but they also find that these economies are exhausted for averagesized cooperatives in the sample The existence of economies of scale has often been tested in the banking industry in this regard the results from the United States are the least ambiguous The US studies have found clear economies of scale for both cooperative banks rezvanian et al 1996 Mehdian and rezvanian 1998 and credit unions Emmons and Schmid 1999 Wilcox 2005 Wheelock and Wilson 2011 Wilcox and Dopico 2011 This is consistent with the significant consolidation of the credit union industry that has taken place during the past two decades or so Goddard et al 2011 However when one moves outside the US the picture looks more complicated Lang and Welzel 1996 study German cooperative banks during 19891992 and found small but positive economies of scale However in their subsequent study on the effects of mergers with data extending to 1997 Lang and Welzel 1999 they do not find any evidence that mergers between cooperative banks have been efficiency enhancing For Finland Kolari and Zardkoohi 1990 find little evidence of positive economies of scale using data on cooperative banks from the early 1980s an era when banking was a heavily regulated industry Jones and Kalmi 2011 using data for the first half of 2000s actually find some evidence on diseconomies of scale larger cooperative banks having poorer performance in Japan Deelchand and Padgett 2009 find also evidence on diseconomies of scale among a sample of Japanese cooperative banks however Glass et al 2010 find evidence that larger cooperative banks were more efficient than smaller 14 in addition there is some evidence that coops can produce in the increasing returns to zone part of the production function That is coops can manage to attain sufficient scale economies but they do not need to grow to even the average size of firms in that sector JonesBackus 1977 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 47 JEOD Vol1 Issue 1 2012 ones in sum the clearest evidence of economies of scale within financial cooperatives is related to the US experience whereas the evidence from elsewhere is more ambiguous This may be related to the above mentioned benefits of integration Collaboration among cooperative banks and the existence of second tier organizations may help local banks to maintain small scale and remain efficient The collaboration among financial cooperatives is the least extensive in the US which may expect why the clearest results on economies of scale are obtained from that market15 in addition it is clear that many coop mergers take place under conditions that differ from those characterizing investorowned firms Often the main circumstance is that of duress a merger is undertaken for reasons of solidarity to save a coop in economic distress from going under For example this was the case with many italian PCs in construction mainly during the 1990s Jones 2007 in this case presumably there is a symbiosis between scale economies and democracy 5 Case Study Evidence on Democratic Challenges and Responses within Coops in this section we discuss institutional evidence on the ability of coops to respond to democratic challenges We provide examples of institutional adaptiveness or lack thereof concerning themes that were identified in previous sections especially part three To provide a manageable account we focus on two contemporary cases the Mondragon cooperatives and cooperative banks in Finland We select these cases because we know them well and in the last thirty years or so both groups typically have experienced strong growth As such they are good test cases to investigate the challenges posed by the need for scale economies and possible tradeoffs with democracy Case 1 Mondragon16 The Mondragon group is one of the bestknown examples of real world PCs Founded in 1956 with some 25 workers in the Basque country of Spain Mondragon was originally a group of mainly industrial cooperatives Subsequently the group has grown to include firms in other areas notably retail and finance and by 2008 the Mondragon group comprised about 250 cooperatives subsidiaries and affiliated organi zations including 73 manufacturing plants overseas altogether employing almost 100000 Membership has always been closely linked with employee ownership and in the early decades essentially only and all workers were members Membership provides a guarantee of employment relocation or 80 of salary during times of slack demand as well as the right to participate in the firms General Assembly vote for and 15 it is also not clear whether the previous studies on economies of scale have adequately controlled for the fact that smaller institutions may be less risky and in particular they are less likely to impose systemic risk Klinedinst 2012 provides evidence that before and during the crisis smaller financial institutions and credit unions had higher net worth than large banks and were also much less likely to be compensate their executives excessively However we are not aware on any evidence whether large credit unions have been riskier than smaller ones or whether they have been more likely to have faced difficulties during the crisis in the US the main casualties of the crisis have been some large corporate credit unions ie secondtier organizations see Hoel 2011 However the failure of corporate credit unions does not indicate whether there is a relationship between size and risk in primarylevel credit unions 16 This sections draws on Arando et al 2011a to which the reader is referred for an extended account of the current Mondragon setup Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 48 JEOD Vol1 Issue 1 2012 serve on electoral bodies and receive a share of profits Other distinguishing features at Mondragon inclu de provision for profit pooling and a rich set of institutions to support primary firms However in recent years a large fraction of the workforce was often nonmembers The bulk of these nonmember employees work in conventionallyowned subsidiaries and joint ventures that the coops have established outside the Basque Country particularly in the Eroski retail chains in Spain approximately 30000 nonmember workers and in overseas manufacturing plants approximately 12000 nonmember workers Still several thousand others are temporary workers inside the cooperatives themselves These three situations invol ving nonmember workers have all been controversial in the Mondragon group for many years and have led to numerous major debates that in turn has produced changes in policy and practice The main driver of the Eroski distribution chains use of nonmember employees was a growth strategy initiated in 1989 characterized by massive and rapid expansion outside its traditional base in the Basque Country in response to competitive pressures especially from large French chains The majority of this growth has involved the startup and acquisition of noncooperative supermarkets and other stores as subsidiaries of the Eroski cooperative Eroskis expansion strategy was successful in business terms but the balance between cooperative and noncooperative employment gradually became very lopsided To address the issue in the late 1990s Eroski established a voluntary partial employeeownership structure called GESPA that eventually involved about 5000 employees in several of its Spanish subsidiaries17 it was very popular among employee participants Eroski concluded that it was not only capable of doing business successfully around the country but that it was also capable of using cooperative principles and related organizationalownership structures in many different places and under different circumstances As the Eroski Group continued to grow apace through the 1990s and 2000s GESPA as it was initially structured and implemented could not keep up with the speed of expansion Hence an increasing percentage of the Eroski work force came to consist of nonmember workers in conventionallyowned subsidiaries By 2008 only about 9000 18 of Eroskis roughly 50000 workers were coop members and another 5000 or so 10 participated as partial employeeowners in GESPA AltunaGabilondo 2008 As a result and based on the accumulated success of the GESPA process in 2011 Eroski began to implement a multiyear initiative to cooperativize its operations When this initiative is completed by about 201416 the great majority of Eroski workers who today are nonmember employees working in conventional subsidiaries or partial workerowners in GESPA will become workermembers of cooperative firms Thus in a short period this transformation will lift the ratio of memberstototalworkforce up to about 7075 in the Mondragon group as a whole A second pressing issue concerns the use of temporary nonmember workers mainly inside industrial cooperatives given the seasonal andor cyclical nature of production and hence demand for labor and the prohibitive cost of providing all workers with membership Precise longitudinal data are hard to come by but employment has been gradually shifting in favor of nonmember workers for at least two decades Thus by 1990 the fraction of the work force that comprised nonmembers in the average coop at Mon dragon was already 10 Moye 1993 By 2007 only 295 of the Mondragon groups total work force was a member of their coop Altuna 2008 in other words some 50 years after the founding of the first Mondragon coop a substantial majority of Mondragon workers were nonmember employees18 During 17 See Arando et al 2011 b for an extended discussion of Gespa as well as findings form a study of the comparative performance of Gespa cooperatives and conventional ownership 18 As such they have standard employment contracts with the coops and do not have the rights and responsibilities associated with membership no voting rights with respect to choosing members of elected bodies no employment guarantee and no obligation to be an employeeowner On the other hand nonmember workers do receive an annual profit share at a minimum 25 of the share a workermember at the same pay grade would receive Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 49 JEOD Vol1 Issue 1 2012 the 1990s the group began to emphasize the importance of minimizing the use of temporary workers and set a goal that a minimum of 85 of the coops internal work force should be made up of worker members While for most of the period from 19952005 there were steady if modest improvement in the membership ratio improvements have accelerated since then and in 2009 the group exceeded its 85 membership goal19 At the same time undoubtedly an important part of the improvement in membership ratios since 2008 has been the recession and the clearly differing provisions for job security for members and nonmembers The most complex of the situations involving nonmember employees is that of the overseas manufac turing subsidiaries of coops in the industrial group employing approximately 12000 people in general the coops have felt that opening up membership to workers in these plants is legally financially and culturally problematic hence in the shortterm employee ownership overseas has been viewed as nonviable or excessively risky This perspective has begun to change however A policy has been developed for overseas operations to promote employee participation in three areas decision making profits and ownership A number of coops had concrete plans to experiment with partial employee ownership in their foreign plants but these have largely been put on hold by the financial and general economic crisis Others are debating different financial legal and related strategies for achieving this threepronged participation in different countries where legislation workers economic circumstances and cultural norms vary widely The jury is still out on whether Mondragon can put in place substantial cooperative or similar employee ownership arrangements in its overseas activities Since overseas employment investment can only grow in coming years this issue bears close monitoring by researchers policymakers and others it is one of the key strategic issues the Mondragon cooperatives face in the medium to long term 51 Maintaining democracy within individual cooperatives and cooperative groups At Mondragon important challenges also have faced individual cooperatives and cooperative groups in response there have been continuing attempts to solve the dilemma of how best to provide for a high de gree of democracy and autonomy in individual firms and yet also allow central bodies to promote changes economies of scale and sustained efficiency in the whole group During the first generation of the group Mondragon companies worked out common policy and governance arrangements through joint member ship in their own banking cooperative the Caja Laboral which is a secondtier cooperative a cooperative whose members are other cooperatives Thomas and Logan 1982 As years passed the potential advan tages of joint action for investment and employment planning training new product development expor ting and other activities became clearer Starting in 1964 the cooperative firms decided to form subgroups based on geographic proximity The growth of newer sectors such as auto parts manufacturing and retailing as well as the general sense of a need for more economically rational organizing criteria continued to create momentum for change Hence after substantial discussion and debate in the late 1980s the group decided to reorganize itself again this time with two other features principally in mind 1 the establishment of central structures for overall governance strategic coordination and the provision of management services and 2 the creation of subgroups of firms the groupsdivisions by industrial sector instead of by region in the main 19 Data for the financial group are not readily available though this represents fewer than 5 of total employment in Mondragon Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 50 JEOD Vol1 Issue 1 2012 it simply seemed to make more economic sense to the coops to join together in subgroups according to productmarket affinity and not geographic proximity in 1991 the Mondragon Cooperative Corporation MCC was born to put these ideas into practice At first three different sectoral groups were created financial manufacturing called industrial and retail Later a knowledge group was added As part of this restructuring process the manufacturing group was itself divided into a number of divisions However while the push was to move away from regional groups some regional groups have remained more or less active within this new manufacturing group eg at FAGOr and ULMA Also other structural modifications have taken place since 1991 and in 2008 the groups name was changed from MCC to simply Mondragon Nevertheless so far the basic organizing principles at Mondragon remain largely intact seeking again to balance autonomy for individual coops with strategic coordination and common governanceThese structural changes might be seen as reflecting shifting views concerning the ongoing debate on the optimal degree of decentralizationcentralization for individual firms While the changes mean that management practices and governance structures at the highest levels are not as close to the shopfloor or as participatory today as during earlier periods at the same time the evidence suggests that these organizational changes did not really affect daytoday operational fundamentals While individual firms willingly surrendered some autonomy to the groupsdivisions the balance of power continued to reside with individual firms rather than the center The existence of individual firm autonomy is perhaps best illustrated in two areas 1 those rare cases of coop closures and 2 firms decisions to enter and or leave the Mondragon group in the first area when an individual company is under serious threat Mondragon will provide consultative and even financial help so long as it seems possible to sustain the business But the decision to closeand to protect any remaining individually owned stakes is taken by the particular cooperative20 By contrast in anticipation of shifting market opportunities the center might take the initiative in suggesting concrete ways in which individual coops could shift their product mixes and even give advice on new plant locations But final decisions rest with the individual coopthose at the center do have substantial authority formal and informal but where there is disagreement they tend to negotiate decisions with individual coops and make recommendations They do not have traditional executive authority in the second area the preeminence of coop autonomy is also clear Whether to enter or remain a part of the Mondragon sectoral network depends on a decision by each coops General Assembly of workermembers A small number of coops did in fact decide not to join the MCC structure when it was first proposed eg the ULMA Group or to leave the structure in later years eg AMPO Several of these have since voted to return to the Mondragon network but the key point here is that the decisionmaking authority for these decisions rests in the individual cooperative firm not in a centralized corporate body A key issue relating to membership and democracy in groups is the legal structure of joint ventures and subsidiaries Again Mondragon has also shown itself to be very flexible in this area During the early years all enterprises in the group were cooperatives located in the Basque region and new firms entered the group as startup coops or through immediate conversions or mergers of existing firms into co ops before or upon entry Over the years however the group has purposefully evolved to include enterprises that are not restricted to cooperatives As well as the now extensive use of conventionallyowned subsidiaries outside the Basque Country particularly in the Eroski retail chain and in the industrial coops as part of the internationalization process since the late 1980s the Mondragon group has expanded by acquiring 20 An interviewee provided details of the steps surrounding the closure of two coops COViMAr and ViCON during earlier crises The process of managing this change involved many stages including pay cuts which increased over time and technical and financial assistance from the Caja Laboral on behalf of the group While sustaining jobs was a key concern repayment of creditors was also of central importance Ultimately the coop decided to close Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 51 JEOD Vol1 Issue 1 2012 existing firms both outside and inside the Basque Country While some of these later acquisitions soon became cooperatives as in the early years often the acquired companies initially at least continued to be structured as conventional firms One example was the acquisition of FABrELEC a local domestic appliance manufacturer in 1989After a fiveyear period an overwhelming majority of employees at that firm voted to became members More or less similar processes have been undertaken in other conventional firms acquired by Mondragon coops Another new organizational form that has been created is the so called mixed cooperative These emerged because of rising capital requirements in startup situations especially in capital intensive manufacturing sectors and the inability to obtain sufficient capital either from the traditional core source namely workermembers initial investments or given the high debt toequity ratios involved through standard debt from the Caja Laboral or other banks These mixed cooperatives allow for investor members generally other cooperative firms in the Mondragon group and are structured to provide modest but explicitly limited control rights for new capital suppliers An example is MULTiFOOD Thus the evidence for Mondragon does suggest that it is possible to adapt institutions in order to sustain meaningful democracy within individual coops as well as groups of cooperatives and that changes can be made that accommodate competing needs Case 2 Finnish cooperative banks Cooperative banks are very important in Finland There are two groups of cooperative banks of which the larger OPPohjola Group commanded a market share of 330 of retail lending and 324 in deposits in 2010 By both indicators it was the largest retail bank in Finland in addition OPPohjola has been heavily involved in insurance after acquiring the insurance company Pohjola in 2005 and its market share in nonlife insurance was 276 in 201021The other group POP Bank had a 20 market share in retail lending and 31 in deposits in 201022 Thus the combined markets shares of cooperative banks are over onethird Finland is one of the European countries with the highest market shares of cooperative banking Similar or somewhat higher market shares exist in France Austria and the Netherlands Fonteyne 2007 Many European cooperative banks have elaborate group structures but the Finnish OPPohjola Group is one of the most integrated groups alongside with the Dutch rabobank group Ayadi et al 2010 One of the significant features of the Finnish cooperative banks during the past two decades has been the tightening of the group structure in the following we examine how this has influenced the sustainability of member democracy within the group 21 Prior to the acquisition it was called just OP Group 22 The information on bank market shares is from FFFS 2011 The information from the insurance market share is from OP Pohjola 2011 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 52 JEOD Vol1 Issue 1 2012 52 Democratic Challenges for individual cooperatives and cooperative groups in Finland centralization of cooperative banks was in large part an outcome of regulatory preference23 The deregulation of banking markets in the 1980s generated a huge boom in bank lending and other investment activities When the economic cycle took a sharp turn for the worse in the early 1990s24 bank loan delinquencies increased to an unprecedented level The economic and banking crises were mutually enforcing While all banking groups were affected cooperative banks as a group survived the crisis relatively well whereas most savings banks the main competitors of the cooperative banks failed during the crisis and were acquired by other banks However there was significant heterogeneity among cooperative banks some larger cooperative banks made significant losses and had to be bailed out by the group Throughout the crisis the central management of the cooperative banking group was rather cautious and warned the fastestgrowing banks about risks in an overheating economy However the group center had no means to discipline banks that did not follow their advice Traditionally the local banks had been dependent on the groups central bank the OKOBank because the central bank took care of their liquidity management however during the economic boom of late 1980s that followed banking deregulation large local banks could easily obtain shortterm funding directly from the market Since the 1930s cooperative banks have had a mutual guarantee fund that was designated to bail out failing cooperative banks However in the first half of the 1990s this fund was exhausted and sound co operative banks had to make additional contributions to cover losses made by the problem banks within the group A new group structure was designed to overcome the problems in the structure that became apparent during the crisis From the perspective of the managers at the group level the key problem was that the center had no means to intervene in the operations of local banks even in cases where the actions of some local banks were creating negative externalities for the group The new group structure gave the group center some although limited rights to intervene in the management of local banks Also all banks became fully liable for each others debts whereas in the past the liability in principle was limited by the size of guarantee fund25 Ever since financial cooperatives started in Finland the central unit has audited the local banks in turn the national supervisory authorities audited the central unit This system remained a part of the new group structure in the aftermath of the crisis in the mid1990s the national supervisory authorities voiced strongly the opinion that the position of the center should be strengthened even to the point where they advocated the amalgamation of all local banks into a single nationwide cooperative bank However this was not acceptable to local cooperative banks The group structure was a compromise solution where the center gained more rights and all banks became jointly liable for each others debts However a minority of banks opposed both centralization and joint liability and in 1997 they seceded from the OPGroup to form their own competing cooperative banking group now known as POP Bank This group is a much looser affiliation of cooperative banks than the OPgroup and as noted above it is also much smaller than the OPPohjola Group The local banks in the POP group have more autonomy than do their peers in the OPPohjola group The emergence of such a split within a cooperative banking 23 The following description is adapted from Kalmi 2012 24 These problems were a combination of outside shocks dissolution of Soviet Union recession in Western Europe and domestic policy failures overvalued currency mistakes in financial deregulation 25 Although as noted in practice banks had to make additional contributions once the fund was used Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 53 JEOD Vol1 Issue 1 2012 group appears to be a unique occurrence in the history of European cooperative banks As such it is evidence that local banks may actively shape their destiny and leave the group if they do not agree with the policies of the majority Even though the degree of centralization of the OPPohjola Group is relatively high the impact of the group on the operations of local banks may still be considered relatively limited in the OPPohjola Group local banks make independent decisions on matters such as lending and interest rates both lending and deposits and personnel hiring Local banks are locally governed and their boards are appointed by local members following the one person one vote principle For many other products eg mutual funds and insurance the local banks act as agents of the group center Active involvement of group management in the activities of local banks is extremely rare and takes place only in exceptional circumstances in this way the group structure may even strengthen locallevel democracy because the local banks can be smaller and attain economies of scale through collaboration with the center There have been some mergers between cooperative banks in 2000 there were 240 cooperative banks within the OP Group by the summer of 2011 this number had fallen to 209 in the POP Group the number of banks has been reduced through mergers from 44 to 36 in practice the size of local banks varies quite a lot from very small local banks to large regional banks This is likely to impact the effectiveness of local governance One cause for concern for cooperative banks has been the low voting activity of members recently the banks in the OPPohjola Group have tried to address this issue by enabling voting using the internet But while member mobilization is likely to be dependent in part on how active the local banks are in promoting member participation it is also probably the case that most customers are not interested in bank governance per se and are likely to feel inadequately prepared to participate in bank governance For most customers access to reasonably priced services is their main issue they want from their local cooperative bank and possibilities to participate in governance are likely to be of secondary concern 53 Membership motivations Concerning the motivations of customers to become members Jones Jussila and Kalmi 2009 have found that the size of the common bond is a significant explanatory factor in accounting for differences in membership rates among coop banks in Finland This holds true both for the size of the relevant population eg banks operating in large towns or regional banks have smaller member to population ratios and for the number of customers bigger banks have smaller member to customer ratios They obtain this result after controlling for a number of other determinants of membership including economic motivations to become members Emmons and Schmid 1999 report similar results for US credit unions Concerning the openness of cooperatives to new members Finnish cooperative banks have a very good recent record in 1997 after the split in the group the number of members in the OP group was 06 million members by 2010 it was 14 million members having more than doubled in thirteen years in 2010 the POP group had around 01 million members and between 19972010 its membership growth rates were very robust 26 At least in the case of the OP Group the growth has been sustained by a very 26 Similar developments have taken place elsewhere For instance in the Dutch rabobank the membership has increased from 05 million members to 18 million members between 1999 and 2010 Groeneveld 2011 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 54 JEOD Vol1 Issue 1 2012 conscious policy of trying to gain competitive advantage through expanding membership The main motivating factor has been economic incentives through patronage dividends The attractiveness of the schemes has been increased throughout the 2000s by making the system financially more rewarding Focusing on the years 20012005 Jones and Kalmi 2011 find that increases in membership ratios are associated with better bank performance Their data also indicate that while the number of both members and customers has increased the growth rate of membership has been much faster than the growth of customers resulting in increases of membership ratio On average the member to customer ratio increased from around 35 in 2001 to 39 in 2005 Their findings concerning a positive link between membership ratios and performance differ from earlier literature on the subject that has claimed the relationship to be negative Gorton and Schmid 1999 Leggett and Strand 2002 As such the Jones and Kalmi results are more promising than most findings contained in earlier literature concerning the sustainability of cooperative democracy in total we see both improvements and potential problems in the democratic development of Finnish cooperative banks The broadening of membership has certainly made cooperative banks more democratic At the same time the trend towards centralization and increases of the average size of cooperatives may indicate potential problems in member democracy 6 Discussion and Conclusions Commenting on the literature on worker cooperatives up to the early 1990s Bonin et al 1993 noted that the literature had been theoryled and that empirical literature had lagged significantly behind At the same time it was apparent that theory building had often ignored many wellknown stylized facts early empirical studies often contained results that contradicted the most basic propositions of early theory A similar observation might be made concerning the proposition that an inevitable conflict between democracy and scale economies allegedly exists While a cursory look at the evidence might suggest support for this thesis when we probe deeper into the meaning of as well as the reasons for such a conflict we find that the conceptual basis for the claim is not straightforward and often rests on shaky ground Thus while individual cooperatives and groups of cooperatives face many challenges concerning democratic decisionmaking the nature and scope of these challenges often varies across cooperative types in some cases such as degeneration in producer co operatives it is clear that this is not necessarily an ineluctable process or even a likely outcome in other instances sometimes surprising outcomes can be expectedfor example group centralization may promote democracy at the local level Similarly diverse kinds of scale economies exist and they can be expected to have varying impacts for different cooperatives in different countries While the range and quality of the available empirical econometric evidence is patchy to date this does not lead to straightforward nor consistent support for the claim that economies of scale are always identifiable Thus the clearest evidence of economies of scale within financial cooperatives is related to the US experience whereas the evidence from elsewhere is more ambiguous However the existence of economies of scale is also dependent on regulation For instance Ferri and Pesce 2011 have argued that the increased compliance costs associated with new banking regulation generate artificial economies of scale that reduce the viability of small banking organizations To provide more detailed institutional evidence on some of these matters we review recent developments at two important cooperative cases We note that individual Mondragon firms continue to be worker owned and governed while various mechanisms point to sustained solidarity within and integration of the Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 55 JEOD Vol1 Issue 1 2012 group While some of these changes eg new types of firms and new categories of membership may be viewed as representing movements away from the founders ideals we argue that it is too early to determine whether they represent fundamental changes or not Thus to date the jury is out on whether the evidence is supportive of some aspects of the claim in this case Moreover to deal with emerging challenges the group has continued to demonstrate an ability to innovate and to make institutional adjustments Furthermore there is evidence that many of the developments that appear to represent departures from the founders ideals are not likely to be sustained but rather may turn out to be temporary phenomena This is most clearly the case with Eroski and its ongoing strategy of cooperativization There is also evidence that firms that begin as mixed cooperatives soon assume a traditional cooperative organizational form Evidence against the alleged inexorable tradeoff between democracy and efficiency and that as a result all cooperatives must be considered organizations that are necessarily unsustainable is also found from the experiences of coop banks in Finland For example changes have already been made and also continue to be made to enhance the provision of services to members and to substantially expand the membership base in addition the nature of the coop bank group continues to evolve in ways that are responsive to the needs of individual coops At the same time we are aware that our paper represents only a preliminary first step in systematic research of this topic and that substantial additional work is needed As others have noted there exists a keen need for fresh theoretical perspectives concerning diverse aspects of cooperative governance including the role of boards of directors in cooperatives Cornforth 2004 the changing role of social capital in cooperatives Nilsson et al 2012 and the determinants of cooperative membership Jones Jussila and Kalmi 2009 We also note that in this paper our institutional discussion focuses on only two cases Not only is it dangerous to generalize from such a slim empirical base but we are aware that cooperative history is littered with coop cases that have disappearedeg in the US producer cooperatives in sectors including barrelmaking and plywood and in the UK the longestablished producer cooperatives27 Undoubtedly in some of these and other cases there may have been many failures in trying to deal with the challenges posed by balancing the potentially competing needs for democracy and scale economies Equally we are aware of other cases that continue to succeed For example besides the Finnish case there are many other examples of successful cooperative financial institutions eg see Chaves et al 2008 for a discussion of the Spanish case Elsewhere prominent examples of successful coops include the Lega and social coops in italy and the SCOP coops in France it follows that one key task is to try to develop a comprehensive global data base of coop cases past and present where one can confidently determine whether or not cases were able to succeed and avoid degeneration A second task is to better understand what accounts for success and failure What accounts for the demonstrated abilities of Finnish coop banks and Mondragon to continuously develop institutional responses to potential tradeoffs between democratic challenges and scale economies For example what are the underlying mechanisms that need to come into play to facilitate appropriate democratic control of managers by members Do the Finnish and Mondragon cases reflect unique cultural factors which in turn mean that there are factors that arguably cannot easily be transferred to other coops Since the two cases are so different in crucial respects our sense is that this limited transferability point is not a compelling one and there are many opportunities for their innovative approaches to corporate governance to be emulated Equally the available evidence would appear to suggest that isolated coop cases the norm with most US PCs typically experience substantially greater difficulties in thwarting degeneration than do networked coops which usually have developed supporting structures 27 See for example Jones 1980 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 56 JEOD Vol1 Issue 1 2012 Appendix Table 1 Mainly Econometric Studies that furnish evidence on economiesdiseconomies of scale in cooperatives Year Authors Type of Cooperative Data Issues Hypothesises Method Findings Comments 2011 Jones and Kalmi Finnish cooperative banks Panel data for population of all Finnish banks from the first half of the 2000s What is the impact of coop membership on performance at Finnish banks Estimate fixed effects production functions Find evidence on diseconomies of scale for Finnish cooperative banks in the first half of the 2000s 2011 Wheelock and Wilson US credit unions Random sample Annual observations from 19892006 on all non corporate credit unions Are there economies of scale present in US credit unions Is the current average size of credit unions smaller than what would be efficient Implications for policy and regulation on credit unions Nonparametric locallinear estimator for cost relationship rayscale and expansionpath economies dimension reduction technique with bootstrap methods Find significant evidence of increasing returns to scale across range of sizes observed among credit unions Suggests easing regulation on credit union membership or activity would further increase size of credit unions Wheelock and Wilson 2008 finds large banks have experienced larger increases in productivity than small banks over the past 20 years 2011 Wilcox and Dopico US credit unions Random sample Credit union mergers 1984 2009 expense revenue data 5 yrs after merger Common rationale is larger banks are more efficient lower operating costs but evidence for improvement is not compelling Yet annual of credit unions that merge remained the same Data analysis provided by Dopico and Wilcox 2009 and 2010 Mergers usually improve credit union cost efficiency economies of scale benefits include lower loan higher deposit rates credit union mergers have shifted over time to also benefit acquirers Large acquirer normal target benefits for target none for acquirer Normal acquirer normal target more equal benefit sharing 2009 Japanese cooperative banks Shinkin credit cooperatives Random sample 20032006 crosssectional panel data Implications of the relationship between size and scale economies of cooperative banks in Japan Translog costfunction methodology and intermediation approach Significant diseconomies of scale for small large coop banks Larger coop banks at cost disadvantage to smaller ones throughout most of 20036 also need stronger risk management programs 2009 Fulton and Hueth US and Canadian agricultural cooperatives Convenience sample 22 previous case studies of coops that restructured in 21st century Were the conversions and restructurings that occurred during the early 21st century isolated events or an ongoing trend Any applicable lessons for other cooperatives Case studies using prior research Structural problems of cooperatives lack of capital property right and portfolio problems do impact structure chosen by cooperatives their members Natural pursuit of growth in scale scope can lead to downfall focuses on earnings and not patron value Restructurings conversions to IOF investor owned firms to raise capital reduce member production price risk and increase member access to equity Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 57 JEOD Vol1 Issue 1 2012 Year Authors Type of Cooperative Data Issues Hypothesises Method Findings Comments 2008 Joshi and Smith Cooperative leagues of Mondragon Lega Convenience sample What are the strategic incentives of individual firms to form coops for coops to organize into a league Game theory used to model league coop formation cost structures Economies of scale for RD marketing and finance Models the scenario in which only a coop league should operate and yet firms decide to form a league despite higher marginal costs than cooperative counterparts 2005 Wilcox US Credit Unions Random sample Annual data on credit unions from 1980 to 2004 Can depository institutions achieve economies of scale Compare deposit merger trends of depository institutions vs credit unions in the US over time Find that credit unions typically experience economies of scale larger credit unions have lower average costs and higher net incomes attribute this growth to deregulation in the US Also most academic work finds that banks do not experience economies of scale 2001 Cavallo and Rossi Banks and financial institutions in France Germany Italy Netherlands Spain and UK Random sample Annual data from 6 countries for period 1992 1997 442 banks in unbalanced panel data Are cost improvements in output efficiency likely to emerge from the ongoing consolidation of European banks What implications for future market structure Model cost function using dual approach consideration of both input and output characteristics of deposits Results support view that regulatory changes technology progress have raised the optimal scale of banks consolidation justified Also show mergers should be oriented to increase bank scale for small banks to expand into new products for large banks While there are still cost inefficiencies for traditional banks commercial cooperative SL significant economies of scale and scope are present for most financial institutions 2001 Moyano Estrada Entrena and Serrano del Rosal Spanish agricultural cooperatives Convenience sample Spanish agricultural market cooperative data from 1990 1999 Analyze federations of cooperatives from ideal type of claimoriented associations farmers unions Effects of establishment of Spanish Federation of Agricultural Cooperatives CCAE Theoretical analysis discourses strategies and organizational models for European agricultural coops Steady reduction in the number of agricultural cooperatives between 1994 1999 but increased concentration indicates likely economies of scale cooperatives more important for social function than economic Agricultural cooperatives form territorial associations branchoriented interests subordinated CCAE cannot be seen as result of efficiency factors which reduce transaction costs between coops 1999 Lang and Welzel German cooperative banks Unbalanced panel of Bavarian cooperative banks 198997 Are there economies of scale for German cooperative banks Do postmerger cooperative banks exhibit greater cost efficiencies than premerger Frontier cost functions with timevariable stochastic efficiency term Find that cooperative bank postmerger does not exhibit any additional efficiency indicates economies of scale are not present 1998 Mehdian and Rezvanian US cooperative banks Annual data on cooperative banks from 199294 Do thrift institutions exhibit economies of scale and scope What was the impact of the FIRREA of 1989 on these institutions Find evidence of positive economies of scale and economies of scope for cooperative banks in the US from 199294 Also suggest there are a few specific products that exhibit economies of scale and scope during period studied 1996 Lang and Welzel German cooperative banks Annual data on 757 German cooperative banks from 19891992 Are there economies of scale for size classes of German cooperative banks Multiproduct translog cost function Find positive albeit small economies of scale exist for German cooperative banks across all size classes Find evidence of economies of scope Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 58 JEOD Vol1 Issue 1 2012 Year Authors Type of Cooperative Data Issues Hypothesises Method Findings Comments 1996 Kebede and Schreiner Dairy marketing cooperatives in the Rift Valley of Kenya Convenience sample 19891990 income statement crosssectional on 46 firms Will the current trend of the privatization of firms in Kenya in its agricultural sector wipe out agricultural marketing firms or will they be able to remain competitive and alive throughout this privatization Maximum likelihood technique used to estimate stochastic cost frontier function can therefore determine technical efficiency scale economies Estimated long run average cost curve indicates scale economies However most of scale economies are exhausted for the average size of cooperatives in sample scale elasticity significant at 10 level Cooperatives are technically efficient for observed technology can reduce unit costs by expanding volume of milk handled existing members or adding members or merging 1996 Rezvanian Mahdian and Elyasiani Cooperative depository institutions in Massachusetts Random sample within MA banks Detailed info on coop banks in MA 19891991 Do cooperative banks exhibit economies of scale and economies of scope both overall and within products Translog models for 1 overall econ of scale 2 prod spec econ of scale 3 overall econ of scope 4 prodspec econ of scope Previous literature reviewed find that scale economies are present for small depository institutions but is unclear on large banks Find that ALL cooperative banks exhibit economies of scale Find all except smallest coop banks had positive scope economies but none were statisticallysignificant CBs should increase both scale scope of operation 1992 Schroeder Farm supply and marketing cooperatives in the US Random Sample Financial records from 29 cooperatives from 19791988 Trend of decline in marketing farmer cooperatives acquired merged consolidation bankruptcy likely explained by operating costs cost economies Purpose is to estimate economies of scale scope Bootstrapping regression technique for estimation of confidence intervals for scale scope elasticity Strong support for firmwide economies of scale Find productspecific economies of scale for grain petroleum feed fertilizer and merchandise but not chemical sales Find economies of scope for all six products Common problem with estimations of economies of scale and scope is the lack of knowledge about confidence in estimates and standard confidence intervals unreliable because nonlinear cost functions 1990 Kolari and Zardkoohi Cooperative and savings banks in Finland Convenience sample 19831984 year end data on 369 coop banks 255 savings banks What does the cost structure of thrift institutions in Finland look like Modified translog cost model using advances and bills as outputs Results indicate cost curves for both savings cooperative banks are Lshaped at plant level Ushaped at firm level Find diseconomies of scope in joint production of advances and bills Implies natural monopoly conditions not present Fin thrift industry 2010 Glass Goddard McKillop Wilson Japanese cooperative banks Convenience sample from Bankscope around 400 observations of cooperative banks Returns to scale and efficiency in Japanese cooperative banks Modified translog cost model correcting for the desirability of outputs Japanese cooperative banks have increasing returns to scale larger and more diversified cooperative banks are more efficient Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 59 JEOD Vol1 Issue 1 2012 References Arando S Freundlich F Gago M Jones DC Kato T 2011a Assessing Mondragon Stability and institutional Adaptation in the face of Globalization in Carberry E Ed Employee Ownership and Shared Capitalism New Directions in research Labor and Employment relations Association and iLr PressCornell University Press Arando S Gago M Jones DC Kato T 2011b Productive Efficiency in the Mondragon Cooperatives Evidence from an Econometric case study iZA Discussion Paper Ayadi r Llewellyn DT Schmidt rH Arbak E De Groen WP 2010 investigating Diversity in the Banking Sector in Europe Key Developments Performance and role of Cooperative Banks Brussels Center for European Policy Studies BenNer A 1984 On the Stability of the Cooperative Type of Organization Journal of Comparative Economics vol 8 September pp247260 doi1010160147596784900556 Birchall J 1997 The international Cooperative Movement Manchester University Press Bonner A 1961 British Cooperation Manchester Cooperative Union Bonin J Jones D Putterman L 1993 Theoretical and Empirical Studies of Producer Cooperatives Will the Twain Ever Meet Journal of Economic Literature 31 12901320 Borzaga C Defourny J 2004 The Emergence of Social Enterprise routledge London Borzaga C Tortia E 2006 Worker Motivation Job Satisfaction and Loyalty in Public and Nonprofit Social Services Nonprofit and Voluntary Sector Quarterly 352 22548 doi1011770899764006287207 Brazda J Schediwy r 2001 Preconditions for Successful Cooperative Ventures in the Light of Historical Evidence review of international Cooperation Burdin G Dean A 2009 New Evidence on wages and employment in worker cooperatives compared with capitalist firms Journal Comparative Economics vol 37 pp 517553 Chaves r Soler F Sajardo A 2008 Cooperative Governance the Case of Spanish Credit Co operatives Journal of Cooperative Studies v 41 2 August 3037 Cheney G 1999 Values at Work Employee Participation meets Market pressure at Mondragon Ny Cornell Press Craig B Pencavel J 1992 The Behavior of Worker Cooperatives The Plywood Cooperatives of the Pacific Northwest review of American Economic 82 10831105 Cornforth C 2004 The Governance of Cooperatives and Mutual Associations A Paradox Perspective Annals of Public and Cooperative Economy v 75 1 1132 doi101111j1467 8292200400241x Cuevas CE Fischer KP 2006 Cooperative Financial institutions issues in Governance regulation and Supervision Washington DC The World Bank Deelchand T Padgett C 2009 Size and Scale Economies in Japanese Cooperative Banking March iCMA Centre Discussion Paper in Finance DP 200902 University of reading Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 60 JEOD Vol1 Issue 1 2012 DiMaggio PJ Powell WW 1983 The iron Cage revisited institutional isomorphism and Collective rationality in Organizational Fields review of American Sociological 482 14760 doi1023072095101 Dow GK 2003 Governing the firm Workers control in theory and practice Cambridge Emmons Wr Schmid FA 1999 Credit Unions and the Common Bond review of Federal reserve Bank of St Louis September October 1999 41 64 Errasti AM Heras i Bakaikoa B Elgoibar P 2003 The internationalization of cooperatives the case of the Mondragon Cooperative Corporation Annals of Public and Cooperative Economics 75 4 pp 55384 doi101111j14678292200300235x Estrin S Jones DC 1992 The Viability of EmployeeOwned Firms Evidence from France review of industrial and Labor relations Vol 45 No 2 January pp 323338 doi1023072524838 Estrin S Jones DC 1995 Workers Participation Employee Ownership and Productivity results from French Producer Cooperatives Advances in the Economic Analysis of Participatory and LaborManaged Firms 5 324 Estrin S Jones DC Svejnar J 1987 The Productivity Effects of Worker Participation Producer Cooperatives in Western Economies Journal of Comparative Economics 111 4061 doi1010160147596787900400 Ferri G Kalmi P Kerola E 2012 Organizational Structure and Performance in European Banks A reassessment Working Paper University of Vaasa Ferri G Pesce G 2011 regulation and the Viability of the Cooperative Banks Working Paper University of Bari FFFS 2011 Pankit Suomessa 2010 Helsinki Federation of Finnish Financial Services Fonteyne W 2007 Cooperative Banks in Europe Policy issues iMF Working Paper 159 07 Fulton M Hueth B 2009 Cooperative Conversions Failures and restructurings caser Studies for US and Canadian Agriculture mimeo Center for study of coops Saskatchewan Glass JC McKillop DG Quinn B Wilson JOS 2010 Cooperative Bank Efficiency in Japan A Parametric Distance Function Analysis Working Paper University of St Andrews School of Management Goddard J McKillop D Wilson JOS 2011 The Corporate Demography of the US Credit Union industry Working Paper University of St Andrews School of Management Gorton G Schmid FA 1999 Corporate Governance Ownership Dispersion and Efficiency Empirical Evidence from the Austrian Cooperative Banking Journal of Corporate Finance 5 19940 doi101016S0929119998000194 Groeneveld JM 2011 The Cooperative rabobank Past Present and Perspectives Forum Financier revue Bancaire et Financière 20113 pp 127135 Guinnane TW 2001 Cooperatives as information Machines German rural Credit Cooperatives 18831914 Journal of Economic History 612 366389 doi101017S0022050701028042 Hansmann H 1996 The Ownership of Enterprise MA The Belknap Press of Harvard University Press Cambridge Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 61 JEOD Vol1 Issue 1 2012 Hoel rF 2011 Power and Governance Who really Owns Credit Unions Madison Wi Filene research institute iCA 2012 Cooperative Facts Figures httpwww2012coopenicacooperativefactsfigures Accessed April 19 2012 Jones DC 1980 Producer Cooperatives in industrialized Western Economies British Journal of industrial relations Vol 18 July pp 141154 doi101111j146785431980tb00840x Jones DC 1993 The Effects of Worker Participation on Productivity in Command Economies Evidence for the Case of Polish Producer Cooperatives Managerial and Decision Economics Vol 14 5 SeptemberOctober pp 475485 Jones DC 2007 The Productive Efficiency of italian Producer Cooperatives Evidence from Conventional and Cooperative Firms Advances in the Economic Analysis of Participatory and Labour Managed Firms vol 10 pp328 doi101016S0885333906100010 Jones DC Backus D 1977 British Producer Cooperatives in the Footwear industry An Empirical Evaluation of the Theory of Financing Economic Journal Vol 87 1977 pp 488510 doi1023072231555 Jones DC Jussila i Kalmi P 2009 What Determines Membership in Cooperatives A New Framework and Evidence from Banks Hamilton College Dept of economics Working Paper 0909 Jones DC Kalmi P 2011 Membership and Performance Evidence from Finnish Cooperative banks Mimeo Aalto University Joshi S Smith SC 2008 Endogenous formation of coops and cooperative leagues Journal of Economic Behavior Organization Elsevier vol 681 pages 217233 October doi101016j jebo200804001 Kalmi P 2007 The Disappearance of Cooperatives from Economics Textbooks Cambridge Journal of Economics 314 62547 Kalmi P 2012 Finnish Cooperative Banks and the Crisis of the Early 2000s in Boonstra W Mooij J Eds Cooperative Banking in Times of Crisis rabobank forthcoming Kasmir S 1996 The Myth of Mondragon Albany SUNT Press Kebede E Schreiner D F 1996 Economies of scale in dairy marketing cooperatives in Kenya Agribusiness 12 4 395402 doi101002SiCi1520629719960708124395AiD AGr930CO2U Klinedinst M 2012 Bank Decapitalization The impact of Excessive Compensation Working paper University of Southern Mississippi Kolari J Zardkoohi A 1990 Economies of Scale and Scope in Thrift institutions The Case of Finnish Cooperative and Savings Banks Scandinavian Journal of Economics 923 437451 doi1023073440010 Lambert L 1970 report on Concentration in Coops Annals of Public and Cooperative Economy 1 pp 529 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 62 JEOD Vol1 Issue 1 2012 Lang G Welzel P 1996 Efficiency and Technical Process in Banking Empirical results for a Panel of German Cooperative Banks Journal of Banking Finance 20 100320 doi1010160378 426695000402 Lang G Welzel P 1999 Mergers Among German Cooperative Banks A PanelBased Stochastic Frontier Analysis Small Business Economics 13 27386 Laycok D 1989 representative Economic Democracy and the Problem of Policy influence The case of Canadian Cooperatives Canadian Journl of Political Science vol 22 4 December 765792 Leggett KJ Strand r W 2002 Membership Growth Multiple Membership Groups and Agency Control at Credit Unions review of Financial Economics 111 3746 doi101016S1058 330001000325 Mehdian SM rezvanian r 1998 Production Economies of Small Depository institutions in the PostFirrea Era Evidence from Cooperative Banks Applied Economics 303 42731 doi101080000368498325949 Moye AM 1993 Mondragon Adapting Cooperative Structures to Meet the Demands of a Changing Environment Economic and industrial Democracy v 14 251276 doi1011770143831X93142006 MoyanoEstrada E Entrena F Serrano del rosal r 2001 Federations of Cooperatives and Organized interests in Agriculture An analysis of Spanish Experience Sociologica ruralis v 41 2 April 23753 doi1011111467952300180 Nilsson J Kihlen A Norell L 2009 Are Traditional Cooperatives an Endangerd species About Shrinking Satisfaction involvement and trust review of international Food and Agribusiness Management v 12 issue 4 101122 Nilsson J Svendsen GLH Svendsen GT 2012 Are Large and Complex Agricultural Cooperatives Losing their Social Capital Agribusiness issue 2 Spring pp 187204 doi101002agr21285 OPPohjola 2011 Annual report 2010 Helsinki OPPohjola Group Pateman C 1970 Participation and democratic Theory Cambridge Cambridge University Press Perotin V 1997 What Makes Coops Work institutional Viability Firm Creation Survival and Closure Among Workers Cooperatives in France Unpublished PhD Dissertation Cornell University Peterson MA rajan rr 2002 Does Distance Still Matter The information revolution in Small Business Lending Journal of Finance 576 25332570 restakis J 2010 Humanizing the Economy Cooperatives in the Age of Capital Gabriola island BC New Society Publishers rezvanian r Mehdian S Elyasiani E 1996 Economies of Scale and Scope in small depository institutions Evidence from US cooperative banks The Quarterly review of Economics and Finance 361 3954 doi101016S1062976996900289 Schroeder T 1992 Economies of Scale and scope for Agricutural Supply and Marketing Cooperatives review of Agricultural Economics vol 14 1 Jan 93102 doi1023071349610 Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 63 JEOD Vol1 Issue 1 2012 Smith SC 2001 Blooming Together or Wilting Alone Network Externalities and Mondragon and La Lega Cooperative Networks Discussion paper 27 2001 Helsinki WiDEr United Nations University Stiglitz J 2003 Towards a New Paradigm of Development in Making Globalization Good The Moral Challenges of Global Capitalism Dunning JH Eds Oxford Oxford University Press pp 76 107 doi10109301992570190030005 Vanek J 1970 The General Theory of Labor Managed Market Economies ithaca Cornell UP Ward B 1958 The firm in illyria Market syndicalism review of American Economic 48 September 566589 Wheelock DC Wilson PW 2011 Are Credit Unions too Small review of Economics and Statistics forthcoming Wilcox JA 2005 Economies of Scale and Continuing Consolidation of Credit Unions Federal reserve Bank of San Francisco Economic Letter Wilcox JA Dopico LG 2011 Credit Union Mergers Efficiencies and Benefits Federal reserve Bank of San Francisco Economic Letter 282011 Workshop report 2007 Corporate Governance and Cooperatives Global Corporate Governance Forum London February Mimeo yamagishi M Hammond Ketilson L Jonsson PO MacDonald i Ferini L 1996 Making Membership MeaningfulJoint Project on participatory Democracy iCA Economies of Scale Versus Participation a Cooperative Dilemma Jones DC Kalmi P 64 JEOD Vol1 Issue 1 2012 wwwjeodonlinecom