Annals of Public and Cooperative Economics 84:3 2013
pp. 241–252
PUBLIC POLICY SUPPORT FOR AGRICULTURAL COOPERATIVES: AN ORGANIZATIONAL ECONOMICS APPROACH by Constantine ILIOPOULOS∗ Agricultural Economics Research Institute & Agricultural University of Athens, Athens, Greece
ABSTRACT:
This paper addresses the issue of whether nontraditional agricultural cooperatives should be eligible for receiving public policy support. We adopt an organizational economics approach that appears to better inform policy design and suggest critical questions that both policy makers and regulators need to address before introducing measures and sanctions. After discussing the introduction of innovative cooperative models characterized by a whole new set of ownership and control rights, we recast vaguely defined property rights problems as attempts to maximize efficiency and avoid organizational decline rather than to take advantage of excessive market power in highly concentrated oligopsonistic/oligopolistic markets.
Keywords: Cooperatives, market failures, property rights constraints, ownership, control, public policy JEL classification: Q13, P13, P14, L13
´ Apoyo de las pol´ıticas publicas a las cooperativas agr´ıcolas: una ´ a la econom´ıa de las organizaciones aproximacion El art´ıculo centra la atenci´on en la cuesti´on relativa al derecho de las cooperativas agr´ıcolas no tradicionales a una pol´ıtica publica ´ de apoyo. El autor adopta el enfoque de la econom´ıa de las organizaciones adaptado para aprehender la elaboraci´on de una pol´ıtica determinada, proponiendo cuestiones cr´ıticas que los responsables pol´ıticos y los reguladores deben plantearse antes de introducir medidas y sanciones. Tras haber examinado en la introducci´on los modelos cooperativos innovadores, caracterizados por un completo conjunto de derechos de propiedad y de control, el autor reformula algunas cuestiones de los derechos de propiedad vagamente definidos, con el objetivo de maximizar la eficiencia y evitar el declive de la organizaci´on antes que obtener ventajas de un poder excesivo en mercados oligopson´ısticos/oligopol´ısticos altamente concentrados.
∗
E-mail:
[email protected]
© 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC. Published by John Wiley & Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA
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´ Support de politique publique pour les cooperatives agricoles : une ´ approche de l’economie des organisations L’article porte sur la question du droit des coop´eratives agricoles non traditionnelles a` une politique publique de soutien. L’auteur adopte une approche de l’´economie des organisations mieux adapt´ee pour appr´ehender l’´elaboration d’une politique et qui propose des questions critiques que les d´ecideurs politiques et les r´egulateurs doivent se poser avant d’introduire des mesures et des sanctions. Apr`es avoir examin´e l’introduction de mod`eles coop´eratifs innovants caract´eris´es par un nouvel ensemble complet de droits de propri´et´e et de contrˆole, l’auteur remanie certains probl`emes de droits de propri´et´e vaguement d´efinis dans le but de maximiser l’efficacit´e et e´ viter le d´eclin de l’organisation plutˆot que de tirer avantage d’un pouvoir excessif de march´e dans des march´es oligopsonistiques/oligopolistiques hautement concentr´es.
¨ Staatliche Forderung von Agrargenossenschaften: Ein Organizational Economics-Ansatz Dieser Beitrag er¨ortert die Frage, ob Agrargenossenschaften nicht-traditioneller Art berechtigt sein sollten, staatliche F¨orderung zu erhalten. Gewahlt ¨ wird ein Organizational Economics-Ansatz, der geeignet erscheint, bei der Politikgestaltung besser zu informieren und kritische Fragen aufzuwerfen, mit denen sich sowohl politische Entscheidungstrager ¨ als auch Regulatoren auseinandersetzen mussen, ¨ bevor sie uber ¨ die Einfuhrung ¨ von Maβnahmen und Sanktionen entscheiden. Im Anschluss an die Er¨orterung der Einfuhrung ¨ innovativer Genossenschaftsmodelle, die sich durch eine ganze neue Reihe von Eigentums- und Kontrollrechten auszeichnen, erfolgt eine Neubefassung mit vage definierten Property Rights-Problemen als Ansatze ¨ zur Maximierung von Effizienz und zur Vermeidung organisatorischen Niedergangs anstelle der Nutzung exzessiver Marktmacht auf hoch konzentrierten oligopsonistischen/oligopolistischen Markten. ¨
1
Introduction
The objective of this paper is to address a key question puzzling cooperative scholars, practitioners, and policy makers: should agricultural cooperatives that adopt nontraditional ownership and/or governance structures be eligible for receiving public policy support? Traditionally, rationales for public policy support of cooperatives have centred on their ability to address market failures (Rhodes 1985). While the competitive yardstick role of traditional agricultural cooperatives is well established in the extant academic literature, little is known about similar effects of nontraditional forms of collective entrepreneurship. Further, other equally important contributions of cooperatives, such as the provision of a missing service, and the achievement of economic development goals that benefit the wider community often escape the attention of policy makers and regulators. It seems that public policies towards agricultural cooperatives are not informed by recent developments in the theory and practice of agricultural cooperation. This paper is a preliminary attempt to fill this gap by utilizing concepts and analytical tools from organizational economics. We focus on how alternative allocations of ownership and control rights have sought to © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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Table 1 – Public policy support for agricultural cooperatives in selected countries Policy instrument
Country Australia Canada France Germany The Netherlands USA
Friendly legal framework √ √ √ √ √ √
Antitrust exemption √
Beneficial tax treatment √ √
Access to favourable credit terms -
Technical assistance √
√
-
√
-
-
√
√
√
-
-
ameliorate a set of six basic problems facing traditional cooperatives. It is argued that addressing these problems does not represent an attempt to exercise excessive market power. Instead, it is a prerequisite for surviving in today’s hypercompetitive environment and thus fulfilling the roles envisaged by both patron-members and policy makers. The paper is organized as follows. The next section provides background information on the various forms of public policy support in selected countries and discusses rationales for such support. Subsequently, we focus on one of these rationales, namely, the ability of cooperatives to correct for industrial organization type of market failures. The fourth section analyzes the evolution of traditional cooperatives and the emergence of nontraditional cooperative structures. Particularly we focus on whether innovative allocations of ownership and control rights should question the eligibility of cooperatives for receiving public support. The last section concludes the paper and draws policy implications.
2
Public policy support for agricultural cooperatives
Traditionally, agricultural cooperatives in most market-oriented economies with an advanced agricultural sector have received public support in the form of: (i) provision of a friendly legal framework, where friendliness in this context implies that the legal framework does not discriminate against cooperatives in any way (ii) exemption from antitrust laws and regulations, (iii) beneficial tax treatment, (iv) access to favourable credit terms, and (v) technical assistance (ILO 2001; Iliopoulos 2011). The intensity and mix of policies supporting agricultural cooperatives vary significantly from country to country (Table 1). While the types, intensity and mix of policies vary by continent and country, similar rationales lay behind public policy support of agricultural cooperatives. The four most frequent justifications for public policy support of agricultural cooperatives have been (Cook 1993, Christy 1987): © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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(i) Agricultural cooperatives provide individual farmers with an institutional mecha` nism that increases their bargaining power vis-a-vis their upstream and downstream partners in food supply chains and corrects for excess supply induced prices; (ii) agricultural cooperatives address various forms of market failures and, as a result, provide their members with countervailing power. In this role, cooperatives act as a competitive yardstick that improves market performance; (iii) agricultural cooperatives improve the coordination of supply with demand for farm commodities to achieve prices more consistent with costs of production; and (iv) agricultural cooperatives are instrumental in achieving community development goals and facilitating the integration of low-income producers into community life. Extended to all types of collective action organizations, this rationale lies behind the social economy initiatives of several European countries. All of these rationales have been important in convincing legislative bodies to provide public support to agricultural cooperatives. However, the market failure-correction potential of cooperatives has been the most essential rationale in most countries that provide public support to agricultural cooperatives (Sexton and Iskow 1988).
3
Market failures and agricultural cooperatives
Four positions regarding the relationship of agricultural cooperatives to market failures have been advanced over the years (Rhodes 1985). The ‘Cooperative Commonwealth’ approach posits that capitalistic markets are a political and social failure that should be replaced by a system of cooperatives. This school of thought views cooperatives as the only viable alternative to capitalist enterprises. It has been very popular in Europe during the early days of cooperation and has recently attracted renewed attention due to the current financial crisis (Zevi et al. 2011). The ‘Cooperatives As Investor-Owned Firms’ position argues that cooperatives have become just like for-profit firms and so farmers do not need cooperatives anymore. While they might have been an important means to addressing market failures,1 cooperatives have ended up resembling investor-owned firms (IOFs). Consequently, it is argued that governments need no more to invest resources in supporting cooperatives. The ‘Strong Market Failure Rationale’ approach states that market failure, as perceived by farmers, was and continues to be the only economic justification for a cooperative. Consequently, cooperatives are perceived by their farmer-members to be solving a market failure (Sexton and Iskow 1993). Much has been written on the contribution of cooperatives to addressing market failures since the 1920’s (e.g., Nourse 1922, Helmberger 1964). The academic literature 1
The term ‘market failure’ refers to situations where one or more of the conditions characterizing competitive markets are not satisfied. ‘The key characteristics of competitive markets are: 1) they contain a large number of both buyers and sellers, 2) firms are free to enter or exit these markets without penalty, 3) all firms within a market produce the same product (i.e., there is no product differentiation), and 4) traders in the market possess all information’ (Sexton and Iskow 1988, p. 4). © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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has focused primarily on the conditions under which cooperatives should receive public support. In other words, under what conditions do cooperatives improve market performance? Reviewing this vast literature is beyond the scope of this paper. The interested reader may find comprehensive reviews of the theoretical literature by Staatz (1989), and Cook et al. (2004). Since the early 1950’s and particularly after the publication of the classic Helmberger and Hoos (1962) paper, most theoretical analyses suggest that agricultural cooperatives do have a significant competitive yardstick effect in their markets. However, it is argued that this effect is produced only if the cooperative (1) adopts an open membership policy, and (2) does not rely extensively on unallocated retained earnings (Staatz 1989, p. 23, Sexton 1990). Empirical research seems to support the pro-competitive effects of open membership cooperatives (e.g., Rogers and Petraglia 1990, Rogers and Marion 1990). More recent research, however, has identified potential disadvantages of open membership cooperatives that a closed membership policy might eliminate (e.g., Karantininis and Zago 2001). To the best of our knowledge no empirical research has been published on the impact of high unallocated retained earnings on the ability of cooperatives to correct market failures. According to the fourth, ‘Historical View’ or ‘Soft Market Failure Rationale’ approach, market failure has been neither a necessary nor sufficient condition for the development of cooperatives. The main argument of this approach is that while market failures have been common in many countries, agricultural cooperatives did not develop equally extensively in all of these countries (Rhodes 1985). From a public policy perspective, choosing between the market failure-related and – unrelated rationales is important because it determines how one views the role of cooperatives. For example, the Nourse school of thought, associated with the ‘Strong Market Failure Rationale’ approach would see no reason for forming a cooperative in a competitive market situation (Nourse 1922, Cook 1993, pp. 158–159). On the other hand, the ‘Soft Market Failure Rationale’ approach would propose establishing and maintaining a cooperative only as long as it truly serves the needs of its members. Many countries that provide public support of any sort to agricultural cooperatives seem to adopt the ‘Strong Market Failure Rationale.’ Yet, the group of countries that switches to the ‘Soft Market Failure Rationale’ seems to be increasing. This is probably because more and more policy makers realize that cooperatives provide much more than correcting market failures. As shown by Rhodes (1985), market failures alone do not suffice to explain the development of agricultural cooperatives in some countries/regions and commodities but not in others with similar characteristics. Further, cooperatives have proven to be instrumental in addressing a number of major agricultural marketing issues far beyond market failures. Such issues include enabling price determination and discovery, achieving price and income stability, improving subsector coordination, securing market access to disadvantaged farmers, and maintaining farmer control of agriculture (Knutson 1978, Shaffer 1987). Therefore, public policy designers should take into consideration not just the potential of cooperatives to address market failures but also all of the aforementioned contributions of cooperatives to the efficient operation of the food and fiber system. Agricultural cooperatives produce and distribute many of the abovementioned public or quasi-public goods to the benefit of their members and their communities. The various contributions of cooperatives to local economic © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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development are frequently documented (e.g., Merrett and Walzer 2001, Folsom 2003). Thus receiving support in exchange for these goods might be a sound public policy. In order to be able to correct market failures and produce the aforementioned quasi-public goods, cooperatives need to ensure their viability and long-run sustainability. In addition to the challenges facing all businesses within a given industry, traditional agricultural cooperatives face several constraints unique to this institutional arrangement.
4 Eligibility of non-traditional agricultural cooperatives for public policy support
4.1
The evolution of the traditional cooperative
In their constant effort to become and remain sustainable business organizations that can successfully confront competition, traditional agricultural cooperatives are faced with tremendous challenges. Cook and Burress (2009) describe this struggle as a life cycle that evolves along five distinct phases: (1) economic justification, (2) organizational design, (3) growth-glory-heterogeneity, (4) recognition and introspection, and (5) choice. After the initial group of farmer-members has decided upon the economic rationale that acts as the backbone of their organization (Phase 1), they have to decide upon the basic organizational characteristics of the new entity (Phase 2). The impact of traditional cooperative principles on the allocation of residual claimant and residual control rights results in a vaguely-defined ownership structure. In combination with a diachronically increasing member heterogeneity,2 the vaguely-defined ownership rights of traditional cooperatives result in costs that may erode the competitive advantage of the cooperative organization (Phase 3). These ownership costs arise due to six basic problems: free-rider, horizon, portfolio, free cash flow, influence, and control (ibid). Each of these problems constrains cooperatives’ ability to attract much needed risk capital and/or implement efficient decision making processes (Cook and Iliopoulos 2000, Iliopoulos and Hendrikse 2009). The next phase is characterized by membership fragmentation and a self-enforcing degenerative spiral caused by the negative consequences of heterogeneity and the resulting ill defined cooperative mission (Phase 4). Tensions between member-patrons favoring hysteresis and those preferring a strategy of quasi-rent extraction may become the norm in some cases. At the end of this phase, cooperative leaders present, or membership demands, explicit action to remedy challenges. During the final phase of the life cycle, cooperative members choose among four alternatives: reinvent, tinker, spawn, and exit before the cycle starts over again. It is the first of these options, reinvention that has resulted in several nontraditional models of cooperative organization, whose adoption entails a redistribution of 2
Cook and Burress (2009) define heterogeneity in member preferences as ‘divergent stances among members on decisions related to the allocation of residual claimant and residual control rights’ (p. 6). © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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residual claimant and control rights among patrons. Most common among these models are those that alter the redeemability of shares or reassign claimant rights to investors rather than patrons (Harris et al. 1996, Nilsson 2001, Chaddad and Cook 2004). Further, some of the vertically integrated cooperative models adopt a closed or defined membership policy (Harris et al. 1996). Sometimes the resulting ownership structure is accused of wobbling between the cooperative and IOF models. Such cases are increasingly scrutinized by scholars and policy makers with respect to whether the resulting organization should be eligible for public policy support (Ferrell 2002).
4.2
Eligibility of agricultural cooperatives for public policy support
Very often policy makers, and sometimes scholars, tend to forget the unique ownership structure of traditional agricultural cooperatives and the resulting constraints. Consequently, they may fail to realize that adopting one of the nontraditional models might have been the only feasible producer strategy enabling them to correct market failures and/or produce one or more of the quasi-public goods described earlier. Before deciding whether to afford public support to any type of cooperative, policy makers should answer several important questions, including the following: 1. Does the cooperative operate as a user-owned, user-controlled, and user-benefitted business organization? These three organizational features distinguish farmer cooperatives from other types of agribusiness firms. Majority ownership and thus control of the business by patron-members is a necessary condition for directing the stream of resulting benefits towards members. Of course, it is by no means a sufficient condition. Therefore, policy makers need also look inside the cooperative firm to find out whether real, not only formal authority is exercised by the patrons of the cooperative (Aghion and Tirole 1997). A major constraint facing policy makers in conducting such analyses is the scarce academic literature informing methods of revealing and measuring the allocation of real authority, particularly in cooperatives. While user-ownership and user-control of the cooperative firm can be easily assessed if relevant accounting and other data is maintained and regularly updated by the cooperative, it might be much more difficult to understand who has real control over the business. Access to the minutes of the board of directors might provide very useful insights. Generally speaking, though, such documents are not available to outsiders. On the other hand, looking at the formal assignment of property rights in a cooperative might provide insights as to who agent has real control over the business (Chaddad and Iliopoulos 2013). Factors, such as a large span of control, urgency, reputation for moderate interventionism, performance measurement, and multiple principals may increase the real authority of management (Aghion and Tirole ibid). In the case of cooperatives, multiple principals play a role far more important than in IOFs. This seems to be the case because, in contrast to the Aghion and Tirole assumption, principals may not have similar cost functions or share the same objective function. The allocation of real versus formal authority also has other, inter-cooperative implications, beyond the scope of this paper. For example, even if control is fully exercised © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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by the members, benefits might accrue to them disproportionately; some sub-groups of members may receive more and/or pay less than their level of patronage or product portfolio would imply. 2. Do adopted policies, such as defined membership, represent attempts to gain excessive market power or are they a consequence of technical or marketing constraints? The primary objective of value-added cooperatives which adopt a defined membership policy is to operate their processing plant at maximum efficiency (Cook and Iliopoulos 1999). It is crucial that policy makers understand the primary motive of this organizational choice. By limiting the number of members (in essence the volume of product processed) admitted to the cooperative, the cooperative can ensure maximum efficiency; a prerequisite for withstanding strong competition from IOFs in the same industry. Securing control over a predetermined quantity of product is another important goal sought through the adoption of the defined membership policy (Cook and Iliopoulos 2000). Farmer cooperatives in various parts of the world still suffer coordination and marketing problems resulting from the free riding behavior of their members. In such traditional cooperatives, members have no or little sense of ownership. Rather they view the cooperative as the alternative of last resort, which will buy their produce during years of low prices. When prices increase, though, they will sell to the IOF supplying the highest price. Price discovery, coordination of supply and demand, including quality requirements, and securing beneficial contractual arrangements with downstream partners all become goals extremely difficult to attain. Competing IOFs do not face similar constraints and thus have a competitive advantage over open membership cooperatives. The defined membership restriction, therefore, might not be an attempt to control product quantity, and thus price. Instead, it might have been a necessary organizational feature whose adoption enables cooperatives to operate efficiently and without coordination handicaps absent in the case of their IOF counterparts. 3. Does the cooperative produce quasi-public goods and contribute to economic development? As argued earlier in this article, even in cases where their primary goal is to address a real or perceived market failure, agricultural cooperatives may also produce a wide range of quasi-public goods. The availability of these goods to both members and the wider community in which they operate might be another criterion by which to assess the desirability of public support for cooperatives. In numerous, well documented cases across the globe, agricultural cooperatives are shown to contribute significantly, even crucially, to the well being of their communities, not only their members. The contribution of new generation cooperatives to local economic development and the revitalization of rural communities in northern America is probably among the most studied cases of production of quasi-public goods by cooperatives (e.g., Burress et al. 2008, Walzer and Merrett 2002, Merrett and Walzer 2001). Policy makers need, therefore, ask themselves whether such benefits might have been the result of adopting organizational structures and policies different from those of the traditional cooperative. © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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Comparing such benefits with perceived and actual costs from a public policy perspective would result in more efficient public policies. 4. Does the cooperative correct a market failure? Market failure correction is the standard rationale for public policy support of cooperatives. Thus in most countries that provide any support to agricultural cooperatives policy makers are familiar with this significant contribution of cooperatives. Yet, the same policy designers might not be accustomed to addressing the following, closely related question. 5. Would the cooperative be able to correct for market failures, provide a missing service or contribute to local economic development had it adopted the traditional cooperative structure? In order to be able to correct for a market failure, provide a missing service, or generate numerous quasi-public goods that result in local economic development, first and foremost, every cooperative needs to be adequately capitalized and operated at maximum efficiency. As discussed earlier, however, during their evolution traditional cooperatives have increasingly been faced with two major challenges; (1) how to attract much needed risk capital in order to be able to compete with powerful IOFs, and (2) how to implement maximum-efficiency decision making procedures. The six underlying vaguely defined property rights constraints of traditional cooperatives, mentioned above, have intensified these challenges. Without addressing these problems, agricultural cooperatives might have faded away during the past decades. The substantial wave of demutualization observed in urban cooperatives around the globe at the same period seems to support this argument. Therefore, seeking alternative organizational options to address these or similar problems could be seen by policy makers not as attempts to exercise excessive market power or as a threat to fulfilling any of the cooperatives’ traditional roles. Instead, policy makers may have to evaluate such ownership structure changes as prerequisites for keep providing any or all of the aforementioned services to their members and communities. While the traditional cooperative structure has significant pros under certain circumstances, many of the conditions facing agricultural cooperatives today may dictate a modification of ownership and control rights so that cooperatives survive in the medium to long run.
5
Conclusions
Organizational economics provides a useful lens to studying the rationales behind agricultural cooperatives’ adoption of nontraditional ownership, control, and governance structures during the last twenty years. Particularly, they provide a conceptual framework for linking organizational attributes, such as the allocation of ownership and control rights, to the ability of cooperatives to create and distribute a wide range of benefits to their patron-members and the wider community. Consequently, this strand of economic theory is very useful to policy makers who design public policies for cooperatives, as well as to regulatory authorities and courts who have to decide on whether © 2013 The Author Annals of Public and Cooperative Economics © 2013 CIRIEC
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innovative organizational structures violate current antitrust laws and regulations. This is because organizational economics informs both the evolution of traditional agricultural cooperatives and the unique capital acquisition and collective decision making constraints facing them in today’s hypercompetitive environment. These constraints, in the form of free rider, horizon, portfolio, free cash flow, influence, and control problems are caused by the vaguely defined property rights of traditional cooperatives. Without addressing these problems, agricultural cooperatives might not be able to play any of the roles envisaged by policy makers, including, but not limited to, the correction of market failures. Therefore, understanding the causes of and remedies for these problems represents a first, necessary step toward designing efficient policies and making sound regulatory decisions. For example, it is important to note that the negative consequences of vaguely defined property rights become particularly intense in highly concentrated oligopsonistic/oligopolistic markets. Yet, it is precisely in such market structures that agricultural cooperatives are expected to play a competitive yardstick role. Of course, addressing market failures is but one of the goals achieved through innovative collective entrepreneurship organizations. Policy makers need to consider whether each of the innovative organizational attributes adopted by nontraditional cooperatives distorts the basic user-owned, -controlled, and -benefited character of agricultural cooperatives. Policies that ensure that benefits accrue to farmer-members would benefit both members and the wider farming community. Further, policy makers need to consider whether cooperatives that have received significant public policy support but remain unable to generate any of the important benefits discussed above should still be eligible for support. Particularly so, if such cooperatives do not proceed with making changes in their organizational structure that would result in improved efficiency. Certainly, market power abuse issues remain important. Yet, this paper has argued that policy makers and regulators need several other pieces of relevant information in order to deal with such issues efficiently.
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