Adam Smith and Mondragón

Joaquín Garralda. Professor. IE Business School

21 November 2013

Fagor’s definitive demise was brought about by the refusal of the other members of the Mondragón cooperative to vote in favor of injecting more money into the ailing business. A case of bad governance or is enthusiasm for the cooperative model wearing thin?

Does the cooperative model only work well in times of stable growth?  In the first chapter of his famous book “An Inquiry into the Nature and Causes of the Wealth of Nations”, Adam Smith examined the advantages of breaking production down into small tasks undertaken by specialized hands coupled with the capacity for innovation of the people who carry out said tasks as a way to reduce the amount of work involved.  The second chapter describes how when negotiating an exchange, in order to get the best possible product it is better to appeal to the interests of the baker, butcher or brewer in question, than to their sense of generosity. These two chapters culminate in the conclusion that self-interest is a key component of human behavior and that market exchange system serves as a vehicle to drive a country to greater levels of wealth, without the need to establish costly coordination mechanisms.

Cooperativism is based on a strong sense of equality among its participants – which is reflected in its decision making system – one vote per person – and in the scant difference in wage levels among the people who work in it. All this is coupled with an attitude of maximum cooperation and effort to ensure the common welfare of the cooperativists. These are the main features that are supposed to produce the advantages of cooperatives with regard to their development as a work center with human characteristics, a source of innovation and the capacity to weather adverse conditions by maintaining jobs.

Does behavior that is so beneficial for both the individual and the organization go against the search for self-interest? Is it more effective in generating wealth for the community?

Over the last few days we have been reading about how Spain’s Fagor is filing for bankrupcy. Fagor is a cooperative which forms part of the Mondragón corporation, which has had to close down several factories in Spain due to financial problems. As Adam Smith would have expected, Fagor has not been successful in its latest appeal to the generosity of the parent organization Mondragón, which has already contributed considerable funds. The reason for Mondragon’s refusal to provide further funds is that in the meetings held to reach a decision, the other Mondragón cooperatives voted against it. They believed that it could have a destabilizing effect on the other cooperatives, which have also had their own problems, and have decided that investing more money in Fagor was not the solution. Their sense of self-interest won over their sense of cooperation.

When asked about the subject, the Basque councilor for economic development and competitiveness, Arantza Tapia – according to an article published on the website of Basque daily diariovasco.com  on October 21 of 2013 – stated that she did not question the cooperative model, only its governance”. She said she is committed to its modification and revision, given that it was launched 50 years ago and “needs to be adapted”. The argument is that in a world in which it is necessary to respond to changes in the market and in which fierce global competition only leaves room for products that are either very cheap, or have marked differentiating features, the governance system of a cooperative is not able to provide an effective response.

Her diagnosis is correct, but I am not so sure about the medicine.

Is it possible for the positive effect of the corporate model to work without meeting-based governance?

Perhaps Fagor’s main problem does not lie in the economic cycle but rather in its size and the sector in which it operates. If we add the cost of coordination due to its size and the fact that it manufactures products that are subject to ferocious global competition,   the result is that it is difficult to maintain the cooperative model. In such conditions we could say that Adam Smith appears to be more effective.

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