John Gapper: German system that no longer works

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The most striking thing about the bribery and corruption scandal that has enveloped Volkswagen is the evident relief of Bernd Pischetsrieder, the company’s chief executive, that it has occurred.

You might have thought that he could live without suggestions that VW bribed members of its 67-strong works council by paying for their foreign holidays and prostitutes. But it has led to the departure of Peter Hartz, VW’s director of personnel, and given Mr Pischetsrieder a chance to crack into the company’s ossified structure of labour relations.

Looking at VW’s supervisory board, with its 50 per cent labour and union representation and seats for politicians from the state of Lower Saxony, which has an 18 per cent stake, it is not surprising that VW has problems in taking tough decisions. The board is so replete with insiders and so painfully democratic it seems a wonder any cars get made at all.

It probably ill-behoves an English person to scoff at management in Germany, given the lamentable record of labour relations and productivity among British-owned car companies. Germany’s co-determination system – the involvement of workers and unions in management – did not prevent it creating some of the world’s great car companies.

As Britain’s automotive industry foundered on the rocks of strikes and low productivity in the 1970s and 1980s, we envied Germany’s way of persuading workers to co-operate. An industrial democracy movement sprung up and unions negotiated with the government and businesses in the awfully named – and awful – tripartite era. It did little good.

So it is strange to witness – as the remains of Rover are sold once again – VW’s travails. Co-determination helped VW to succeed for decades but something that used to have a living, breathing purpose has turned into a relic. In place of worker participation, there is union bureaucracy. In place of shop-floor involvement, there is expense-account shopping.

Even if the accusations against VW’s works council (and by extension Mr Hartz and other managers) are proved, the bill for clearing away insider obstacles to management power was small beer. Compared with the $32m that Morgan Stanley gave Stephen Crawford, its co-president, to go away, VW’s shareholders can count themselves pretty lucky.

But while feather-bedding the works council was inexpensive it has not been effective. Mr Crawford is now considering his options at home. The VW works council – and its employee representatives on the supervisory board – are still there. The latter will have to approve the appointment of whoever succeeds Mr Hartz on the company’s management board.

In the 1990s, Mr Hartz was credited with cultivating harmonious labour relations that helped Volkswagen to raise productivity and keep a large manufacturing base in Germany. The figures suggest VW did not get as good a bargain as was advertised: its main Wolfsberg Wolfsburg plant is estimated by managers to have 40 per cent higher costs than competitors.

Now there is talk of how Volkswagen took things too far by involving workers in decisions on future models and personnel matters – an approach that it has dubbed “co-management”. Mr Pischetsrieder would probably like to regain management fiat and perhaps limit co-determination to consultation at the plant level with formal worker representation on the board.

The problem is that management, by balancing power among insiders – from state government politicians to bankers and workers – creaks under the strain of global competition. The stability that co-determination brought to German companies helped them to become big, but entrenchment of insiders at every level now tends towards corporate stasis.

Of course, workers are no more to blame than anybody else for favouring their own interests. “If employees sit on corporate boards their interests will diverge from those of investors on some occasions. It does not matter whether they are managers or salaried workers,” says Espen Eckbo, a finance professor at the Tuck Business School at Dartmouth College in the US.

There is one difference. Workers are more likely than managers to opt for corporate stability instead of being willing to take risks. That makes sense from their point of view: like bankers who want to preserve the value of debt, workers want to keep their jobs above all. This may act against the interests of investors, who prefer the company to take risks in order to keep on growing.

Research by Gary Gorton and Frank Schmid published by the Federal Reserve Bank of St Louis found that German companies with 50 per cent worker representation on boards – as is mandatory in companies with over more than 2,000 employees – were valued by the stock market at a 26 per cent discount to those at which worker directors occupied a one-third of the seats.

This suggests that even modest reforms of co-determination to allow more flexibility – as German employers want – would help. The shenanigans at VW are an extreme case but any company that allows itself to become co-opted by insiders runs the same risk. Twenty years ago, as Britain flirted with tripartism, Germany wrote the parity of workers and shareholders into federal law. It is time to think again.

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