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From Illyria towards capitalism: did labour-management theory teach us anything about Yugoslavia and transition in its successor states?

JEL Classifications: J54, O52, P13, P37, P52


In 1958, Benjamin Ward published his seminal paper, 'The Firm in Illyria: Market Syndicalism'. He suggested that some Eastern European economies were shifting from socialist planning towards a new economic system with many of the characteristics of market socialism (see Lange, 1936), namely state ownership of the means of production combined with the use of the market mechanism in the allocation of resources. However, he pointed out that Lange's original concept of market socialism left open the question--how these state-owned firms would actually respond to market signals--to which the practises of the 1950s reforming socialist economies might provide an answer. The country upon which he chose to base his model of socialist enterprise supply responses was Yugoslavia, which had recently emerged from a short era of Stalinist planning to introduce, in the early 1950s, a system that Ward described as 'market syndicalist'. Ward's paper was quite specific in building its assumptions from Yugoslav practices; in its second section, the legal arrangements that had been introduced by Yugoslav reformers between 1952 and 1954 were outlined in detail. (1)

Ward's paper focused on how a socialist labour-managed enterprise might actually respond to market signals and contained the first derivation of the perverse supply response, thereby spawning, with a lag, a vast new economics literature. From the outset, it was not clear whether labour-management theory was seeking (1) to model the Yugoslav economic system, as proposed originally by Ward and developed by, for example, Vanek (1970), Furubotn and Pejovich (1970) and Estrin (1983); (2) to analyse in a formal way the behaviour of cooperatives, as asserted by Domar (1966), Meade (1972) and numerous subsequent papers (eg, Nuti, 1992) surveyed by Bonin et al. (1993); or (3) as a purely theoretical construct to illustrate the implications of alternative ownership and incentive arrangements, as, for example, Dreze (1976) and Sertel (1982). The important point is that there was a single theoretical framework underlying all three strands, based on Ward's original assumptions and examining enterprises that maximise average earnings per head rather than profits. For example Domar, who titled his 1966 paper, 'The Soviet Collective Farm as a Producer Cooperative', refers to Ward's (1958) paper not as describing Yugoslavia but rather as 'The first and only attempt to construct a model of a cooperative' (p. 734); in fact he uses an identical modelling framework to Ward's, except with multiple inputs and outputs. This suggests that, in so far as Ward's paper sought to model an idealised version of the 1950s Yugoslav economy, Illyria, the entire labour-management literature could be potentially relevant to understanding the Yugoslav economy.

However, Yugoslavia was of great interest in its own right to students of comparative economic systems from the 1950s to the 1980s, as an example of a potential 'third way' between capitalism and socialism. Some 15 years before the experiments to combine public ownership with market allocation mechanisms in Hungary, Poland and later China, Yugoslav reformers implemented a model based on the ideas of, among others, Edvard Kardelj, to move from Soviet central planning to decentralised allocation based on free price formation and autonomous enterprise decision-making. Thus, as Ward quoted Kardelj (1955), 'stimulative elements ... appear above all through the interest of the enterprise in achieving through free competition with other enterprises on the market, the best results as regards quality and quantity of goods, lower costs of production and good marketing' (p. 569). In this revolutionary new economic system--socialism without central planning--there were two socialist elements: social ownership of the means of production, though firms had to pay rent for its use until 1971, and self-management--control of the firms to be entrusted to Workers Councils elected by the workforce. Thus, as Ward correctly indicated, the new Yugoslav economic system contained important elements of both Lange's market socialism and of the cooperative-syndicalist utopian movements which had existed since the 19th century in Western Europe and North America (see Oakeshott, 1978).

Yugoslavia's unique economic system stimulated considerable academic interest for several reasons. First, it seemed for several decades at the height of the cold war, and before any sustained liberalisation elsewhere in the Soviet bloc, to indicate the possibility of a 'third way', a view enhanced by President Tito's global role as one of the leaders of the 'non-aligned movement' following neither the unrestrained capitalism nor the harsh communism of the so-called First and Second worlds, respectively; see, for example, Bergson (1967), Marschak (1968) and Milenkovitch (1977). The special interest in Yugoslavia in the West may also have been motivated by Bergson's insight that, 'market socialism has been materializing ... as a successor not to capitalism but to centralist planning under socialism' (1967, p. 571).

Second, the extension of the principles of democracy in decision-making was viewed by many as an objective for an economic system in its own right. This view synthesised a diverse set of utopian models for the future of the economy, for example that of the cooperative movement with employee democracy but also with private ownership (Oakeshott, 1978; Dumas, 1981; Pryor, 1983), of syndicalism (Cole, 1944), and of Israeli kibbutzim with their extension of democracy to the collective of households (Barkai, 1977). Much of this literature in the 1970s and the 1980s contained an evangelical fervour, proposing labour-management as an alternative economic system because it combined the efficiency properties of a competitive market economy (Vanek, 1970; Horvat, 1982; Montias, 1986) with the ethical and moral superiority derived from democratic workplace decision-making. It was felt that this could provide a welfare-enhancing impact on incentives (Sertel, 1982), the distribution of income (see Meade, 1982; Sen, 1966) and the organisation of work (Putterman, 1982; Dow, 1986). Even Bergson (1967), focusing on the practical problems of market socialism, noted this aspect of Ward's syndicalism: 'systems directors in the socialist world ... may also be led to adopt a relatively inefficient form of market socialism. For example the Cooperative Variant seems distinctly less promising than the Competitive Solution, but it might still be favored ... because of its ideological or political appeal' (p. 572). Vanek (1970) would disagree with Bergson's view about the efficiency of a labour-managed market economy (the 'Cooperative Variant'); his book argues that a labour-managed economy can 'produce efficient allocations--or combinations--of real income on the one hand and effort (producing that real income) on the other' (Vanek and Espinosa, 1972, p. 1000). However, he would strongly agree with the latter, arguing that labour-management has even greater advantages than other economic systems in the context of developing economies because of the effects on incentives (see also Horvat, 1982).

The theoretical interest might not have been sustained if Yugoslav economic performance had been poor in the heyday of self-management, between the 1950s and the 1970s. But in fact it was not; the Yugoslav market socialist economy provided commentators at the time with a remarkable success story in terms of economic growth, analogous if perhaps not quite so dramatic as the economic performance of China since the late 1980s. Thus Yugoslav GDP growth averaged around 6% in the period between the start of reforms in 1952 and the late 1970s, higher than in the Soviet Union on the one hand, or capitalist market economies of Western Europe on the other. To quote Lydall (1984), 'Whether one judges Yugoslav performance by the growth of GDP or of GMP the record of growth over the period 1950-1979 has been very impressive. Moreover it has been remarkably stable ... an economic system which can generate such a rapid and stable rate of growth is to be envied' (p. 157). It should be noted, however, that signs of imbalances started to emerge from the 1970s. Average inflation increased to 20% in the 1970s and reached particularly high levels in the 1980s, while the unemployment rate (measured as the number of job-seekers in the total labour force) increased from 7.7% in 1970 to 11.9% in 1980 (Uvalic, 1992).

Academic interest in self-managed socialism was swept away with the Berlin Wall in 1989. The demise of the communist experiment was extraordinarily rapid, and affected equally both the centrally planned variant of the Soviet Union, East Germany and Czechoslovakia and the market socialist systems of Hungary and Yugoslavia. Nowhere was there any longer concern with how to combine public ownership, whether with or without labour-management, and a decentralised allocation of resources; though there remain a few exceptions, that is, China, Vietnam and Belarus. Instead, the process of transition was built around price liberalisation and privatisation; even so employee ownership initially emerged as an important privatisation method in those countries where workers and managers had to be bought off (see Estrin, 2002). It seems that Bergson was right; market socialism was not a full alternative to capitalism and communism but merely a variant of the latter and so, like its full blooded stable mate, it did not survive the reversion to capitalism.

The transition process in the former socialist economies may have undermined the case for market socialism but it had less effect on the arguments in favour of workplace democracy espoused by the proponents of the cooperative movement. Hence the previously underdeveloped distinction between models of the cooperative, and of the labour-managed or Illyrian firm, which concerned ownership arrangements and systemic characteristics, were thrown into sharper relief. Producer cooperatives are collectively, or only partly privately, owned firms, whereas Illyrian firms are fully publicly/ socially owned and individual workers have no personal stakes in the firm. The work of Furubotn and Pejovich (1970) focuses on the impact of property rights differences on the behaviour of labour-managed firms and was strongly critical of social ownership. Moreover, the work of Kornai (1980, 1992) among others, which highlighted the systemic problems of market socialist economies, notably Hungary, was also of relevance to Yugoslavia (see Commisso, 1979; Sirc, 1979). Analysts such as Estrin (1983) and Uvalic (1992) showed how these factors worked together to explain particular aspects of the Yugoslav economy in the 1970s and 1980s, for example, enterprise wage determination or investment.

Probably the most damaging fact of all for the credibility of the labour-managed variant of socialism was the sharp deterioration in Yugoslavia's economic performance in the late 1970s. The Yugoslav government did not react to the 1973-1974 oil shock by lowering domestic spending, but continued with an ambitious and unbalanced economic growth strategy and high investment rates and frequent recourse to external borrowing. Yugoslavia's external debt increased from less than US$2 billion in 1970 to US$14 billion in 1979 and, following the second oil shock, to US$18 billion in 1980. Structural weaknesses emerged due to insufficient investment in crucial sectors such as energy and raw materials and rising dependence on imported inputs, parallel with excess capacity in other sectors and the duplication of plants across regions. After a record trade and current account deficit in 1979, Yugoslavia was no longer able to service its external debt and the government was forced to implement restrictive economic policies that led the economy into a deep recession. Institutional reforms in the 1970s greatly contributed to these problems. The 1971 Constitutional Amendments and the 1974 Yugoslav Constitution introduced extreme economic decentralisation, transferring competences in virtually all economic areas to individual republics that were also allowed to borrow abroad directly, with the federation as the warrant. The reforms sought to create the 'contractual economy'. At the level of inter-firm coordination, markets were suppressed to be replaced by also new mechanisms of policy coordination--social compacts and self-managed agreements. (2) This was paralleled at the enterprise level with the division of firms into 'basic organizations of associated labor' (1976 Associated Labor Act) in an attempt to buttress the self-management system.

After 1980, the Yugoslav economy was characterised by stagnating or declining Gross Social Product (GSP), (3) negative rates of investment growth (except in 1986 and 1989), falling real net wages, modest rates of employment growth, rising unemployment and inflation. The economic crisis persisted throughout the 1980s, culminating in hyperinflation in 1989 (Uvalic, 1992). Three decades of fast growth were therefore replaced by a long period of recession, high inflation, mounting international debt and growing political instability. The reforms of the 1970s brought regional issues to the fore and these gradually drifted out of control in the 1980s in such a way that the country split apart in mid-1991, ending in a number of conflicts between its successor states. (4) The crisis of the 1980s was interpreted by some Yugoslav economists who had always been critical of self-management--the few pro-liberal economists and those who had remained faithful to the centrally planned model--as proof that the predictions of theory were correct.

Fifty years after the start of the labour-management theory, and some 15 years or more into the transition process in the successor states of former Yugoslavia, this paper offers a new reading of the labour-management literature. In particular, it explores whether labour-management theory provided significant insights into the operation of the Yugoslav economy and also into the process of transition that was followed in the Yugoslav successor states. It concludes that the literature offered only modest insights into the operation of the Yugoslav economy; its most significant contributions were theoretical, addressing the central questions dealing with the supply responses of worker-controlled firms in a decentralised resource allocation mechanism and the incentive, organisational and efficiency effects of employee democracy. The important, and ultimately damaging, aspects of the labour-managed system for Yugoslavia and its successor states were (1) the ambiguous form of ownership--social property was intended as property of the whole society and this, in combination with decision-making and usus fructus rights given to enterprise workers, left room for very different interpretations and (2) a market socialist system that resolved political conflicts by increased expenditure, leading to generalised soft budget constraints and socialisation of losses instead of risk-bearing by the individual firm, and the dissipation of incentives for efficiency or profitability at the enterprise level.

The remainder of the paper is organised as follows. In the next section, we briefly summarise the economic theory of labour-management, focusing on five areas: supply responses, property rights and 'under-investment', entry, exit and entrepreneurship, labour markets and wages, and incentives and productivity. In each we consider both the theoretical arguments and the Yugoslav evidence. The third section considers the legacy of Yugoslav self-management for the transition process and the divergence of outcomes in the Yugoslav successor states. Conclusions are drawn in the fourth section.


There is a huge literature on the labour-managed firm, to which this short paper cannot hope to do justice (for an overview, see Bartlett and Uvalic, 1986). Our approach is to identify five key areas in the literature, and then to explore whether the theoretical propositions were tested upon, and provided insights into, the Yugoslav economy during its market syndicalist period between the early 1950s and the late 1970s. Since Vanek's General Theory (1970) represents a fundamental contribution to the literature, it seems appropriate to start with his definition of the labour-managed economy. An economy is labour-managed (Vanek, 1970, pp. 1-2) when:

(i) workers control and manage democratically the operation of their firm,

(ii) workers distribute among themselves all net income,

(iii) the economy is decentralised and relies on the market mechanism,

(iv) workers in the firm enjoy usufruct of the assets but not full ownership of the firm,

(v) there is freedom of employment.

It is normally assumed that these assumptions imply that the labour-managed firm maximises average earnings per head, rather than profits as in a capitalist enterprise. This is because the basic theory of the firm assumes that entrepreneurs are not inputs in the production process, so the surplus generated from the firm does not vary with their number. Hence, maximising the return per entrepreneur is equivalent to maximising the total surplus. However, when labour assumes the entrepreneurial function, revenue is a function of output, which varies directly with employment. Hence, the surplus varies with the number of entrepreneurs and the enterprise maximand of surplus per entrepreneur cannot be simplified in this case to the total surplus. As Meade (1972) notes, for a given number of capital units, maximum total profit is equivalent to maximum profit per unit of capital whereas this is not true for a variable number of labour units. The key differences that drove the theoretical literature between labour-managed and capitalist firms is that labour is variable and capital is fixed, and that incremental labour has to be hired on the same terms as current workers, while this does not necessarily pertain for capital.

Vanek's basic assumptions on the labour-managed economy do not accurately depict Yugoslav reality. For example, contrary to assumption (i), workers in Yugoslavia did not have full control over their enterprise's operations because of continuous political interference. Similarly regarding assumption (ii), workers were not in a position to distribute all net income, because part had to be used according to prescribed government regulations.

As to assumption (iv), which Vanek linked to a charge for the use of social capital, in practice this was a rather low tax in Yugoslavia which was reduced during the 1950s and the 1960s, and abolished in 1971; rather than representing a charge for the use of social capital, it was a differentiated tax on better performing enterprises. Finally and perhaps most importantly, assumption (iii) asserts the existence of a market economy, but Yugoslavia was never really a market economy, or not enough of a market economy, because of the small scope of markets: some markets remained incomplete (on the goods market prices of a number of products, including energy and housing, were administratively determined, having wide-reaching effects on many other prices), highly rigid (the labour market), or were even missing (the capital market, though not the market for capital goods). The operations of the market and enterprise autonomy were severely limited by continuous state interference (Sirc, 1979). Interestingly, Ward himself had noted these points: 'While the Yugoslav economic system thus involves a considerable measure of autonomy for the firm, it should not be thought that independence of the sort possessed within the legal framework of capitalism has been acquired by the Yugoslav firm. The state reserves the right to intervene directly to alter any decisions of which it disapproves ... legally ... or by means of the exertion of influence via the trade unions, the League of Communists, or the local governments ... But intervention was now to be viewed as the exception rather than the rule' (1958, p. 570).

This may have been the intention of Yugoslav authorities; but in practice, what was referred to as 'administrative intervention' by Yugoslav economists (see R. Uvalic (1954) cited in Ward (1958)) remained very much present throughout the decades to come, particularly after the 1970s reforms. Ample evidence on political intervention through a series of channels is found in the works of Prasnikar (1983), Prasnikar and Svejnar (1988, 1991), Uvalic (1992) and Vodopivec (1991, 1993).

The assumption that income per worker was the appropriate maximand for labour-managed firms was also highly controversial in Yugoslavia. In his critical evaluation of the Illyrian theory, Branko Horvat (1972) rightly notes that, during the process of developing the Ward model, 'the Illyrian firm was transformed into a typical labour-managed firm' (p. 288). Already in 1967, Horvat (1967) proposed a different maximand for the Yugoslav labour-managed firm: the workers' council sets in advance the 'aspiration income', the level of personal incomes it wants to achieve, which consists of the last year's income (d) and a change to be achieved in the current year ([DELTA]d). The target function of the labour-managed firm is to maximise total enterprise profits [pi] above the specified personal income payments:

[pi] - pq - [(d + [DELTA]d)x + k]

The aspiration income is a function of expected sales, incomes in other firms, incomes in the last and earlier years, labour productivity, costs of living and taxation policy; all the other variables are those known from the basic model (see Section 'The perverse supply response'). Once the aspiration income has been decided upon, it becomes an obligatory target for management. What the worker will actually get as a share in the firm's income may be different from the aspiration income, depending on the results of the firm; the actual change in income may even be negative if the firm suffers losses, but instead of reducing employment the firm will simply reduce d. Mathematically, the equation is identical to the standard neoclassical target function, and so the equilibrium conditions will be the same as for the capitalist firm (Horvat, 1972, pp. 290-291).

The theoretical literature on the labour-managed firm developed in the neoclassical tradition remained for a long time in the shadow of other discussions among economists in Yugoslavia. (5) Yugoslav economists generally believed in self-management, considering it a better alternative than the centrally planned model present in other socialist countries, which led them to actively participate in major policy debates on how to improve the efficiency of the self-managed socialist economic system.

Many Yugoslav economists were also involved in a lively theoretical debate which started in the early 1960s in the Marxian tradition and would last for over two decades, over what was the 'normal' (ie equilibrium) price in a self-managed socialist economy and whether the key category for the socialist firm was income or profit. The first school of thought, whose main representative was Miladin Korac (1961), argued that the Yugoslav firm maximises income, defined as net income after taxes and all non-labour costs are paid, thus including both wages and profits (see Korac and Vlaskalic, 1975). The second school of thought, represented (among others) by Zoran Pjanic, Ivan Maksimovic and Smiljan Jurin, argued that the 'specific price of production' would play the role of normal price in a self-managed socialist economy (see Pjanic et al., 1968; Jurin (ed), 1976). Similarly to the enterprise in a capitalist economy, the enterprise in a self-managed socialist economy will also maximise profits, but under different relations of production, specific to self-managed socialism. Horvat (1972) considered the debate between these two schools of thought irrelevant showing that, under certain assumptions, maximising income per worker or profit per worker 'comes to the same thing'.

The perverse supply response

The most powerful result in the labour-management literature is also one of the simplest. Consider the behaviour of a firm supplying a single output X on a competitive market at price p, produced through a production function (F(L,K)) using two inputs, labour (L) and capital (K). In the short run, the capital stock is fixed and the firm pays an exogenous rental for it, r. The maximand, average earnings per worker (y), can be defined as:

y = (pX - rK)/L

Average earnings are maximised where marginal revenue product equals average earnings. Capitalist firms maximise profit and also hire labour to the point where their remuneration (in this case assumed to be a fixed wage, w), equals the marginal product of labour. When product demand, indicated by the price p, increases, the capitalist firm increases output and employment because the marginal product has gone up but the wage has not, so profits can be raised by hiring more workers and producing more output. Hence a capitalist market system responds to higher demand by increasing supply. However, consider the labour-managed firm. The increase in price increases the marginal revenue product of labour, but it increases average earnings at the initial level of employment even more. The firm therefore responds by reducing employment and output. The intuition behind the result is simple. The average revenue per head of the labour-managed firm increases as membership declines because of diminishing returns to a factor. Hence, the firm would seek to shrink to a single worker to maximise average earnings if there were not a constraint imposed by the fixed costs, which motivate the firm to hire more workers to spread the burden around. In any equilibrium, these offsetting forces--to reduce employment to raise revenue per head and to increase it to reduce fixed costs per head--are in balance. When the price increases, the marginal loss from reducing membership is not affected but the marginal gain is increased. Hence the firm responds by reducing employment. The model therefore predicts that in a labour-managed market economy, price signals about changing product scarcity lead to perverse responses at the enterprise level. The model generates further perversities; a rise in capital costs, which would have no effect in a capitalist firm in the short run, leads the firm to increase output and employment.

As noted above, this model suggests that market self-management will have inefficient characteristics, with firms reducing output when demand increases, and perhaps leading to market instability. However, many authors have argued that supply responses under labour-management may not necessarily be perverse. Among these the following can be mentioned: multiple inputs and outputs (Domar, 1966), variation of labour effort (Ireland and Law, 1981), long-run analysis (Estrin, 1982) and constraints on the variation of employment (Meade, 1972). Even so, supply and employment elasticity under labour-management is always less than (or equal to) the response that would pertain in a comparable capitalist firm. It is therefore very important to know whether the perverse supply hypothesis, in its simplest or more sophisticated derivations, has been shown to shed any light on Yugoslav economic performance.

The evidence is strongly negative. No one has managed to identify convincing evidence of supply perversity in Yugoslavia or, indeed, anywhere else. Ward (1958) himself notes that this is not necessarily surprising because wages were typically determined by enterprise managers without reference to the income maximising desires of workers, and because output growth for much of the period was driven by investment rather than employment decisions. This suggests that the widespread interest in supply perversity may have been largely because of its characteristic as an academic curiosum, and for the light shed from a comparative perspective on the analysis of profit-maximising firms, rather than as a conceptual framework for understanding the Yugoslav economy.

One of the rare attempts to directly test the perverse behaviour of the labour-managed firm on Yugoslav data is found in Prasnikar et al. (1994). Econometric estimates based on fixed effects OLS estimates of an employment equation were done using firm-level panel data from 147 Yugoslav industrial firms during the 1975-1979 period and a subset of 20 firms during the entire 1975-1985 period. The results reported contradict the fundamental Ward-Domar-Vanek proposition that labour-managed firms behave perversely because they decrease employment when their output price rises. 'Overall, the evidence ... indicates that the Ward-Domar-Vanek model is not supported by the data, although certain types of firms are found to behave consistently with this model. The results from the random sample suggest that a different theoretical model is needed to capture the behavior of Yugoslav and possibly other participatory firms' (pp. 733-734). These conclusions are not surprising, since, during the period 1975-1985, there was no fixed charge for the use of capital, an important element in the Ward-Domar-Vanek model (see also Estrin et al., 1987).

Horvat (1972) firmly rejects the applicability of the theory to Yugoslavia: 'The Illyrian theory predicts that an increase in price will reduce output, or at least leave it unchanged. Nothing of this kind has been observed in the Yugoslav economy. Increases in prices, as signals of unsatisfied demand, have been followed rather quickly by efforts to increase supply. It suffices to read newspapers to realize that' (1972, p. 290). He further remarks that when the capital tax on social capital was abolished in Yugoslavia, this did not have a depressing effect on output as predicted by the Ward model. Moreover, instead of saving labour, 'The Yugoslav experience shows, on the contrary, chronic overemployment in the firms' (Horvat, 1972, p. 290).

Property rights and under-investment

Furubotn and Pejovich (1970) and Vanek (1971) developed the idea that the ownership arrangements in the labour-managed firm would lead to under-investment. The Yugoslav form of ownership, referred to as 'social ownership' has the characteristic that capital in the firm is not owned by the entrepreneurs, in this case the labour force. If the supply of capital were perfectly elastic at the market price, labour-managed and capitalist firms would make identical capital decisions. However, if external financing is limited and firms must fund investment internally, the difference in ownership rights in the two firms leads to important differences. The capitalist owns the firm, and hence in principle when he or she retires can sell the assets to recoup the investment in full. However, workers in a labour-managed firm do not own the capital; they merely have use of it to enhance their earnings during the period in which they are employed in the firm. If they retire before the end of the working life of the asset, they cannot recoup their investment beyond the resulting increase in earnings from the investment up to the retirement date. This 'truncation problem' leads the workers collective to seek a higher rate of return from investment financed by retained earnings because the principal that they have invested cannot be recovered when they leave the firm. As a result, it is hypothesised that labour-managed firms will invest less from retained earnings than the same organisation owned by capitalists. Faced with the choice of whether to invest in individual savings accounts ('owned assets') or the firm's capital stock ('non-owned assets'), workers of a labour-managed firm will favour the first. The shorter the workers' time horizon, the higher the rate of interest paid on savings deposits, the lower the cost of bank credit, and the lower the marginal productivity of capital in the firm, the less attractive will it be to invest in the firm (and conversely the more attractive to invest in savings deposits), and the less likely is self-financed investment.

Though this limited appropriability problem may have some insights for producer cooperatives (see Bonin et al., 1993), its relevance to Yugoslavia seems severely limited, although Pejovich (1992) has argued that the main predictions of this theory have been fulfilled in Yugoslavia. Much of the literature has emphasised that the fundamental Yugoslav problem was not under-investment but over-investment. Empirical evidence from Yugoslavia reveals that, at the aggregate level, high investment rates were maintained during most of the period after 1966, frequently at the expense of consumption. Even if Yugoslav statistics overestimate investment rates, World Bank estimates of Yugoslav GNP show that the gross investment/GNP ratio was very high throughout the 1961-1980 period, close to or over 30%, particularly during 1973-1980 (35.6%) (Uvalic, 1992, p. 70). Bajt's calculations have also shown that, during 1960-1980, investment rates in Yugoslavia were higher than in Greece, Portugal, Spain and Turkey, though investment efficiency, measured by a variety of methods, was lower (Bajt, 1988).

Estrin (1983) found that Yugoslav firms tended to invest relatively more after 1965 when self management was strengthened; there was acceleration in the rate of growth of capital stock; he observed similar changes in the pattern of growth of each of the 19 individual industrial sectors. After 1965, capital accumulation actually accelerated in absolute terms in 11 of these sectors, while the rate of growth of the capital stock accelerated relative to output in every sector and absolutely in a few (Estrin, 1983, pp. 154-158).

As to investment financed by firms, in the 1966-1980 period the share of enterprises in Yugoslavia's gross domestic savings registered a continuous increase (Uvalic, 1992). Yugoslav firms financed a large portion of their investment from retained earnings, of which at least a part was voluntary. Depreciation above the legally prescribed rates, in 1967-1986 a voluntary component of savings, ranged from 1% to 14% of total savings of Yugoslav enterprises, being close to or over 10% until 1975 (Uvalic, 1992, p. 76). In a sample of 147 Yugoslav firms, Prasnikar (1983) found that depreciation above the legally prescribed rates accounted for 2%-21% of accumulation during 1975-1979. Miovic (1975) similarly found that Slovenian industrial firms depreciate at more than twice the minimum rate of depreciation.

Tyson's (1977) econometric test of the savings performance of 16 industrial sectors in Yugoslavia for the period 1965-1974 shows that the long-run gross savings rates out of enterprises' net income were approximately 25 % or more in all but two of the 11 sectors that yielded statistically significant results. The hypothesis that the long-run savings rate was zero could be rejected in all but three sectors; this led Tyson to conclude that 'savings rates in many Yugoslav firms are positive and substantial rather than zero as predicted by theory' (1977, p. 407). Prasnikar's (1983) questionnaire to workers in a 1979 sample of 147 Yugoslav enterprises provides additional evidence against the Furubotn-Pejovich hypothesis. Although 50% of workers thought personal incomes had priority over accumulation, 37% considered the two categories equally important, whereas 7% viewed accumulation as primary. Indeed 47% were ready to renounce personal income in favour of investment, partly or completely (see Uvalic, 1992, p. 79).

Further evidence also suggests that the predictions of the theory were not confirmed (Uvalic, 1992, pp. 124-154). A number of OLS equations and a simultaneous equation model were estimated using aggregate data from Yugoslavia for the 1966-1984 period; savings deposits (investment in 'owned assets'), investment in fixed assets (in 'non-owned assets') and self-financed investment were the dependent variables, while the explanatory variables were workers' time horizon (labour turnover, on the assumption that the time horizon is inversely related to labour turnover), the interest rate on savings deposits, the interest rate on bank credit and capital returns represented by the profit rate. In those estimations with the best overall results (high [R.sup.2], no autocorrelation of residuals, high significance of all variables at the 1% level), four of the five signs of the estimated coefficients were of the wrong sign (Uvalic, 1992, p. 135). As an alternative explanation of investment behaviour in Yugoslavia, some of Kornai's (1980) main hypotheses on the socialist system were quantified and tested on Yugoslav data using a similar OLS procedure (including 'expansion drive', 'irresistibility' of growth, absence of failure of investment projects, tolerance limits). In testing Kornai's theory, good overall results were obtained. This seems to confirm that the investment behaviour of Yugoslav firms was determined primarily by the socialist features of the economy, rather than limited property rights.

There are several reasons why the Furubotn-Pejovich theory is not supported by empirical evidence from Yugoslavia. Furubotn and Pejovich implicitly assume, as Vanek does, that the labour-managed firm operates in a market environment and, consequently, variables such as the interest and lending rate, the marginal productivity of capital, and workers' time horizon determine whether to invest in 'owned' and 'non-owned' assets. In Yugoslavia, on the contrary, interest rates had little influence in constraining investment or in stimulating personal savings in banks, since interest rates on both bank loans and savings deposits were frequently negative in real terms. Through soft loans and 'quasi-taxation' an enormous redistribution of income between enterprises (and also between regions) was taking place that deeply affected not only savings but also workers' incentives and consequently the efficiency of enterprises (Vodopivec, 1991). As to workers' time horizons, there was limited labour mobility in Yugoslavia due to employment security which often led to lifetime employment and the labour force in the 1960s and the 1970s was relatively young, so workers' time horizons were probably rather long, which tended to reduce the 'truncation' problem.

Furthermore, the theory emphasises limited property rights, but disregards the other socialist features of the Yugoslav economic system that played an important role in encouraging investment. We can observe in Yugoslavia the presence of many of the characteristics that Kornai (1980) identified as typical for socialist economies, including the paternalistic relationship between the state and the firm, an over-investment drive, soft-budget constraints, socialisation of losses as an alternative to bankruptcy, firms' unresponsiveness to interest rate levels, uncontrolled proliferation of inter-firm credits, and cost and time overrun in completing investment projects (Uvalic, 1992).

The theory also assumes that the labour-managed firm's investment decision is voluntary, whereas in Yugoslavia a series of external regulations regarding income distribution substantially reduced enterprise autonomy, including minimum savings, limits on wage increases, the obligation to maintain the value of social capital through prescribed depreciation rates, the rule linking approval of bank loans to availability of internal funds, or the obligation to invest in the less-developed regions. The traditional instrument of state intervention in enterprise affairs was retained in Yugoslavia; the local political community, the trade unions and the League of Communists of Yugoslavia all exercised their control over enterprise policies, usually through indirect channels of influence (see Prasnikar and Svejnar, 1988; Uvalic, 1992).

Horvat (1972) has criticised the Furubotn-Pejovich theory on different grounds. Since capital in a labour-managed firm is socially owned, the work collective performs the role of an entrepreneur and therefore shows a much higher propensity to invest and to increase employment than is the case in the capitalist environment. 'Hence a high rate of investment, often not matched by adequate financing, and overemployment are to be expected. Since the firm is collectively managed, there is a great reluctance to dismiss fellow workers. In general, the firm prefers to reduce wages rather than dismiss workers ... Consequently, a labor managed economy is inherently more stable' (1972, p. 292). Greater solidarity among workers in a labour-managed firm has also been emphasised strongly in the literature as a more general argument. The reluctance to dismiss fellow workers tends to attenuate any perverse supply response: solidarity implies that any reduction of the labour force would be slow and implemented through voluntary departures.

Entry, exit and entrepreneurship

Ward identified a result central to many of the later discussions of the labour-managed firm, namely that the zero profit output of the competitive Illyrian and capitalist firm was identical. We can see this from the analysis in Section 'The perverse supply response'. Average earnings per worker equal (pX-rK/L. The capitalist firm maximises profits [pi], equal to pX-rK-wL, where w equals the wage. Thus,

w +[pi]/L = (pX - rK)/L = y

If profits equal zero, wages must equal average earnings and the levels of output and employment chosen by the comparable labour-managed and capitalist firms will be the same. Ward argued that this suggested that 'in the long run, the Illyrian conditions under competition could lead to an optimal allocation of resources wherever the capitalist competitive regime would' (p. 583). This insight was later established more rigorously by Vanek (1970) and by Dreze (1976), and illustrates the important comparative systems principle that a market system will yield an efficient allocation of resources regardless of ownership arrangements provided that there is competition including free entry and exit of firms.

Taken together with the perverse supply response, this suggests that while the labour-managed economy will not allocate resources differently from a capitalist one in long-run equilibrium, the processes whereby the two systems adjust to external shocks will be different. In the capitalist economy, with identical firms, two sectors and two inputs, a shift in demand from sector A to B will lead initially to an increase in the relative price of A, motivating existing firms to expand production in A and reduce production in B initially via employment and in the long run through adjustments in the capital stock. If during this process sector A is profitable, while B is loss making, firms will close in B and enter A until profitability is equated. However, under labour-management, the initial phase of the adjustment is perverse; employment will shift from the high to the low value marginal product use and relative prices will move even further apart. The adjustment of capital is the same as under capitalism, but is unlikely to equalise the marginal revenue products of labour (and therefore earnings) between A and B. If there is free entry and exit, entrepreneurs (or perhaps the state) (6) will observe that earnings are higher in sector A, and create new labour-managed firms in that industry while earnings in sector B will be lower, encouraging workers to quit their firms in search of higher incomes in A. Once again, in this model it is not entirely clear whether firms in sector B will actually go bankrupt. Indeed, the conditions leading a labour-managed firm to declare bankruptcy are not obvious because employees unlike wage earners do not have primacy among creditors (see Vanek, 1970). The process may instead rely entirely on labour market flows to new firms in sector A.

The point remains that an important ramification of labour-management theory is that the economic system is predicted to rely relatively more on entry of new firms (and either exit of firms or labour market flows) to adjust to exogenous shocks. In practice, this was not the case in Yugoslavia where there was relatively limited entry and exit of firms, as well as low labour mobility that we consider in the next sub-section.

Studies on the Yugoslav industrial structure and enterprise entry and exit show that Yugoslav product markets were highly concentrated (Estrin, 1983; Sacks, 1983). There was relatively little new entry or exit of enterprises, in spite of an apparent increase in firm numbers, because the reforms in the 1970s split enterprises into 'basic organisations of associated labour'. Economic policies in Yugoslavia have tended to contribute to increased industrial concentration. The industrial structure in Yugoslavia was in fact almost as distorted as in other socialist countries, with a virtual absence of small enterprises--what has been termed 'the socialist black hole' (see Vahcic and Petrin, 1989). The long-run strategy of industrial development should have filled the 'socialist black hole' by breaking up large firms and the entry of new firms. Data on entry show that the number of firms and organisations created annually represented a low percentage of the total. The industrial structure in Yugoslavia was therefore not the result of self-management, but of the earlier, pre-self-management, planning system; hence the dominance of large firms.

Regarding exit, though Yugoslavia had more bankruptcies than other socialist countries, the level was still very low. Over the 1976-1984 period, 1,332 firms were 'liquidated' in Yugoslavia; a small percentage of the number of enterprises that ceased to exist, since a more frequent way of closing down an enterprise was to merge it with another firm. Only a small percentage of liquidated firms were actually closed: in 1983-1984, only 30 firms went bankrupt out of a total of 283 liquidated enterprises. In order to introduce more stringent conditions for firms operating at a loss, the legislation was strengthened in 1983 and again in 1986; however between 1986 and 1989, only 141 enterprises were closed due to bankruptcy, representing an extremely low percentage of the total number of firms that had ceased to exist (1.7% in 1986, 1% in 1987, 2.3% in 1988 and 0.85% in 1989). The dominant form of enterprise statutory change (more than 90% between 1986 and 1989) was 'reorganisation' (see Uvalic, 1992, pp. 106-107).

The limited entry and exit of firms in Yugoslavia was also determined by constraints on firm entry in the private sector, and by the lack of appropriate incentives in the social sector (Uvalic, 1992). When in the early 1950s social property replaced state property, enterprises were only given the right to use socially owned capital. They were not assigned other important functions of ownership, namely exposure to rewards and penalties according to market performance. Enterprise capital was officially owned by the whole society, but the real, and in the absence of an ownership transfer, also nominal owner, had remained the state. Political authorities remained responsible for a number of fundamental issues: the coverage of losses through income redistribution from profitable to loss-making firms; the use of enterprise income through regulations limiting enterprise autonomy; and the entry and exit of enterprises, which were relatively rare and largely politically driven.

Labour markets and wages

Labour management theory, though describing the behaviour of firms, identifies an inefficiency that actually stems from restrictions in the operation of the labour market. Thus there are close parallels between the labour management model and insider-outsider issues picked up in later models of employer--employee bargaining, for example by Svejnar (1981) or Ben-Ner and Estrin (1991). In these frameworks, current employees restrict the recruitment of extra workers, though it would be profitable to hire them, because current employees' earnings would thereby be reduced. Hence, in an economy subject to shocks and with limited processes of entry and exit, one would expect to observe the emergence and persistence of inter-industry wage differentials. To quote Ward, 'the labor market possesses a rigidity which prevents adjustment of supply and demand to restore a displacement from equilibrium' (p. 584).

There has been considerable research on the efficiency of Yugoslav labour markets, including Miovic (1975), Estrin (1983), Stephen (1976) and Vanek and Jovicic (1975). The evidence supports the view that Yugoslav labour markets were unusually rigid, with limited labour flows and rising unemployment as well as migration combined with rapidly growing wages for those in employment. At the same time, wage differentials between sectors and industries were unusually wide by international standards, and showed a tendency to increase rather than to narrow over time.

In Yugoslavia, due to different wage regulations in the single republics, and firm-specific income shares linked to realised profits, there were no single wage rates for equivalent occupations, so that in the 1960s and 1970s labour incomes differed very considerably across enterprises, sectors and regions (Estrin, 1983). For example, earnings dispersion for a given job in a sector across firms varied on average by as much as 2.5:1 and the range from top to bottom was generally more than 10:1. As Estrin (1983) notes 'It is hard to explain the emergence of earnings differentials so rapidly or which were so wide without reference to the distribution of enormous "pure profits" to the labor force as incomes'. Estrin went on to test a formal econometric model of wage determination under labour-management for the 1965-1974 period, which provided a good explanation of these wage differentials.

Vodopivec (1993) has analysed the system of wage determination in the 1970s and 1980s in Yugoslavia, after the reforms. He argues that by that time, workers actually had little say about their earnings and so only appeared to he residual claimants. Rather, political elites, in blatant violation of the proclaimed autonomy of workers, determined workers' earnings with the clear objective of equalising differences among firms. They achieved this through a pervasive and massive redistribution of income, implemented by discretionary taxation and subsidisation of enterprises (Vodopivec, 1993).

Efficiency and enterprise performance

The moral and political argument that democratic decision-making should be extended to the workplace, as the basis for a fairer and more participative society, has been constantly made in support of labour-management (see eg Vanek, 1970; Estrin, 1991). As we have seen, its main economic corollary is the view that the improved incentives, the reduction of workplace conflict and the enhancement of cooperative practices will raise productivity. In this formulation, the labour-management model is not a mechanism to decentralise central planning, that is, an alternative form of socialism. Instead the approach is consistent with a reformed capitalist economy in which the underlying ownership structure is private, though management functions are executed collectively through democratic processes. As such, the worker participation stream of the labour-management literature conceptually applies equally to capitalist as socialist economies (see Blinder, 1988), and the bulk of the empirical work on this issue has focused on Western cooperatives (Bonin et al., 1993).

In this case, it is typically hypothesised that democracy in the workplace increases the scope for cooperation between workers and managers and reduces the domain for conflict, thereby enhancing corporate productivity in worker/producer cooperatives. For example, Cable (1984) models the bargaining process between managers and workers over a range of company policy including innovation and the introduction of new technology as a prisoner's dilemma game in which both sides could gain from cooperating in the production process, but each had an incentive to cheat on any agreed contract. Worker's democracy provided an institutional framework in which the cooperative outcome could be achieved.

The arguments for workers' self-management include the perceived benefits from sharpened employee incentives. These are two-fold: via the sharing of profits and through employee participation in decision-making. In contrast to profit sharing, a worker on a fixed wage has no direct economic interest in the quality or intensity of work and, because of this, firms create monitoring systems to ensure that effort levels are maintained. However, it might be argued that a single individual can have virtually no effect on the profits of a large enterprise, and individualised incentives schemes may often be preferable. Writers such as Jensen and Meckling (1979) have argued that a fixed wage system without reference to productivity is the wrong point of comparison, and that if labour-management is contrasted with individualised incentive systems, it will be found to encourage shirking. Thus, while individual incentive schemes reward each worker according to his or her personal marginal product, group incentive schemes give each worker only a small fraction of any additional profit due to his own effort; the trade-off between shirking and income is distorted in such a way as to reduce effort. Monitoring of workers and managers is needed to maintain effort levels and for this to be efficient, ownership rights, including the right to appropriate the residual surplus, must be vested in the central monitor.

We should note, however, that the benefits of individualised incentives may be more than offset in many production processes by the losses induced by rivalry and especially by competitive disruption in search of private gains (see Cable and Fitzroy, 1980). Labour-management may provide incentives against rivalrous behaviour in the workplace, and in support of positive collusion between individuals to raise effort and productivity. In these cases positive peer group pressure to increase work intensity may begin to replace the traditional tendency to overlook or even support colleagues' shirking. Employee participation may therefore perform particularly well as a group incentive scheme in firms where the production process or the nature of the product limits the prospects for individualised incentive schemes. Companies of this form include, on the one side, mass assembly plants where alienation is widespread and individual efforts cannot be effectively monitored, and, on the other, small, highly skilled, but diverse work teams such as in high technology production or among professionals.

Labour-management might also help managers and workers cooperate together, for example in changing technology. In the industrial relations literature, the impact is thought to stem from changes in workers' attitude to work and in the character of the workplace. To quote Cable and Fitzroy (1980), 'participatory firms ... will produce better outcomes than traditional firms if the negative collusion to maximize one party's share ... can be replaced by positive collusion to maximize joint wealth' (p. 166). There are many ways in which an effect of this sort could be felt. Workers may be less likely to strike for their own remuneration partly because of improved worker--manager relations. Better labour morale will show up in lower rates of labour turnover and therefore training costs, reduced absenteeism, greater willingness to work together and improved labour flexibility with respect to work practices. The empirical evidence from outside Yugoslavia broadly supports the view that employee participation in management does improve company performance (Estrin et al., 1987).

In fact, it proved to be almost impossible to test the hypothesis that labour-management processes act to enhance company productivity in Yugoslavia, because in the Yugoslav economic system all firms were labour-managed. Though one might point to the higher rates of growth, and of TFP growth, in Yugoslavia as compared with other socialist economies as evidence for the productivity benefits of the system, these are merely indicative and could be explained by a number of other factors (use of markets, investment policy, etc).


The fact that Yugoslavia was considered a labour-managed market economy did not prevent a decisive shift from the (reformed) socialist model to capitalism. Like all the other economies of Central and Eastern Europe, Yugoslavia entered the transition process in 1989. However, the existence of self-management had significant implications for the path of transition, made even more complex by the disintegration of Yugoslavia in 1991.

At the moment of the break-up of Yugoslavia in mid-June 1991, all its successor states generally had better initial conditions and less distorted economies than the centrally planned economies in Central and Eastern Europe (see Kekic, 1996; Uvalic, 2007). There were major differences among the five successor states--Bosnia and Herzegovina, Croatia, Federal Republic of Yugoslavia (Serbia and Montenegro), Former Yugoslav Republic of Macedonia, and Slovenia--for example regarding the level of development, unemployment rates and degree of openness--but the institutional set-up was essentially very similar. All the Yugoslav successor states inherited some elements of the market mechanism and the two main specific features of the Yugoslav economic system--self-management and social property--as well as a number of features related not to self-management but to the more general characteristics of the socialist economic system. Though Yugoslavia was far more of a market economy than the other socialist countries, the socialist features of the economy prevented the operation of a truly self-managed market economy and reproduced the efficiency problems typical of the socialist economic system, such as inadequate incentives and lack of entrepreneurship.

Intentions to move towards a mixed property market economy were announced and partly implemented by the last Yugoslav government in 19881990. Although these changes were too short-lived to result in widespread effective reforms, they did provide the basis for some fundamental changes to be completed after 1991 by the newly created states. The way the legacies of the previous economic system were dealt with after the disintegration of Yugoslavia has had a fundamental impact on the course of the transition and economic performance of the successor states, resulting in very different outcomes.

Legacies of socialism

Lavigne (1999) describes the three bases of the socialist economic system as being: party control of the economy, central planning (in Yugoslavia, various non-market mechanisms of resource allocation) and collective ownership of the means of production (social property in Yugoslavia). These started being dismantled in Yugoslavia before the break-up of the country, with a transition to a market economy and multiparty democracy from 1990. Thus,

(1) Party control of the economy was, at least formally, eliminated with the passage from a one-party to a multiparty political system in 1990. The dissolution of the League of Communists of Yugoslavia in January 1990 opened the doors to the emergence of new political parties and the first free multiparty elections, which took place from April to December 1990 in all the Yugoslav republics. (7)

(2) Most non-market mechanisms of resource allocation and policy coordination--for example, medium-term (five-year) plans, or social compacts and self-managed agreements--had already lost relevance in Yugoslavia in the late 1980s, when a series of important changes to the economic system were introduced through the 1988-1989 Constitutional amendments and the 1988 Company Law. They were further suppressed by the governments of the Yugoslav successor states after 1991, through transition-related economic reforms which introduced the market mechanism via the liberalisation of prices, foreign trade, foreign exchange system, interest rates, etc. However, the speed of implementation of these economic reforms varied considerably across the new countries. Whereas by 2001, Slovenia had already implemented the bulk of transition reforms (see EBRD, Transition Report, 2002), most other Yugoslav successor states were lagging behind, especially Bosnia and Herzegovina and FR Yugoslavia (Serbia and Montenegro). This is in part due to different political legacies: while the 1991 war in Slovenia was very short and had a marginal economic impact, the military conflicts in the other Yugoslav successor states have substantially delayed the transition process, in Serbia for more than a decade.

(3) We have seen that collective ownership of the means of production in Yugoslavia took the form of social ownership, under which no one had property rights over enterprises' assets that officially belonged to society as a whole. Enterprises had the right to use socially owned assets and to appropriate their product, but some important rights remained firmly in the hands of the state. However, since this was never officially recognised, there were endless debates in Yugoslavia about the real meaning of social property; as noted by Lavigne, 'This fuzzy concept was never clearly specified and only generated confusion in the legal definition and economic management of property rights in Yugoslavia' (Lavigne, 1999, p. 8).

Legacies of self-management

Of the three mentioned fundamental features of socialism, the specific legacies of self-management in the dominant social sector of the Yugoslav economy in the late 1980s were social property and the related workers' self-management rights. In 1989, the social property sector of the Yugoslav economy still contributed 86.2% of GSP, with minor variations across republics. (8) A decisive step was taken by the last Yugoslav government in 1988-1989. Enterprises' social property was to be replaced by private property through privatisation, and this property change would automatically entail the reduction and eventually abolition of workers' decision-making rights, inversely proportional to the increase of private capital.

Privatisation of social property

As elsewhere in Central and Eastern Europe, the privatisation issue in Yugoslavia provoked an intense debate. While Yugoslavia was similar to the other socialist countries in 1989 regarding the dominance of the non-private sector, the enterprise property regime was different and because of the system of self-management, many workers felt they were the real owners of their enterprise. This was in line with the interpretation that 'group property'--namely property of the employed workers--had unofficially replaced social property (see Bajt, 1988). This legacy rendered privatisation in SFR Yugoslavia and later in its successor states even more complicated than in the other former socialist countries. Since enterprises were formally owned 'by everyone and no-one', who was authorised to sell them--the state, the enterprise, employed workers? And to whom would the proceeds from privatisation go? These questions crucially influenced the course of privatisation in Yugoslavia and its successor states, often in a negative way (see Uvalic, 1997).

Privatisation in SFR Yugoslavia started when the 1988 Enterprise Law diversified existing legal types of property and forms of enterprise, and the 1989 Law on Social Capital (amended in mid-1990, the so-called Markovic Law) laid out the framework for the privatisation of enterprises in the social sector. Privatisation was to be based on sales of enterprise shares primarily to employees at a 30%-70% discount with respect to the book value of assets, to be paid within a 10-year period. The law offered extremely favourable conditions primarily to insiders, though several limits on share issues had to be respected (Uvalic, 1992, p. 185). The maximum amount of capital that could be subscribed by insiders at favourable terms was set at three times the average annual wage bill, which meant that only around 30% of capital could be sold in this way. Hence privatisation to employees in Yugoslavia was envisaged as the transformation of previous partial ownership rights, limited to usus fructus, into full ownership rights, but restricted to non-dominant ownership at the economy-wide level. The part of social capital not subscribed at preferential terms was to be offered on sale at public auctions, but since the destination of unsold social capital was not specified, the law in no way assured its replacement with other property forms.

During 1990-1991, a number of firms throughout Yugoslavia started privatisation on the basis of the Federal law; by June 1991, some 16% of social sector enterprises had started privatisation (Uvalic, 1995, p. 200). Nevertheless, property reforms were substantially delayed by the general political, economic and institutional crisis, which also provoked criticism of the privatisation legislation. All republics considered the federal privatisation law inadequate, particularly regarding the highly generous conditions offered to insiders. Slovenia and Croatia decided to suspend the provisions of the Federal privatisation law as early as October 1990 to elaborate their own privatisation legislation, and similar moves were taken by the other republics soon after. Croatia was the first to adopt a new privatisation law (April 1991), followed by Serbia (August 1991), Montenegro (January 1992), Slovenia (November 1992) and FYR Macedonia (June 1993); in Bosnia and Herzegovina new privatisation legislation was delayed once the war started in spring 1992. Most of these laws were subsequently amended.

The Yugoslav successor states thereafter followed very different privatisation strategies, though the new privatisation laws in Croatia, FYR Macedonia, Montenegro, Serbia and Slovenia had some features in common. First, they contained a similar concern regarding insiders (workers and managers) reflecting an implicit recognition of their former self-management rights. The general conditions for sales of enterprise shares to employees were very favourable, with substantial discounts, deferred payment, priority subscription, sometimes loans or credit facilities, and in some cases the free transfer of shares (Slovenia, Croatia, Montenegro). (9) In addition, privatisations undertaken according to the previous Federal legislation were subject to formal verification and enterprises had to adjust their programmes to the new legislation.

Second, most Yugoslav successor states had a similar attitude towards social property, as they were aware of its potentially negative implications for the process of privatisation. Given the ambiguous system of property rights in Yugoslavia, most successor states, as well as Montenegro within FR Yugoslavia, decided first to eliminate social property by re-nationalisation before proceeding with privatisation. The methods of re-nationalisation included both the temporary transfer of non-privatised capital from enterprises to state-owned funds, and the creation of a state sector encompassing enterprises of strategic interest or in infrastructure, which initially were excluded from privatisation. The only exception was Serbia, where instead of eliminating social property at the outset through its renationalisation, social property has survived for 20 years up to the present day (only some strategic firms and natural monopolies in the transport, energy and other infrastructure sectors have been transferred to the state sector). The prevailing position of the government until 2001 was that social property should remain one of the main property forms. (10) Along with enterprise social property, the organs of workers' self-management, such as Workers' Councils, were also preserved for much longer in Serbia, though in most cases they had no real power but were rather kept as a decoration.

Third, the common outcome of all the new privatisation laws was the presence of some degree of employee ownership in privatised enterprises, at least initially. However, since the laws differed substantially regarding the specific conditions offered to insiders, the results varied widely. Thus, in Slovenia and Macedonia insiders became the dominant owners in a number of enterprises. Insider ownership was a somewhat less common outcome in Croatia; although the privileged conditions offered to employed workers and managers did lead to sales at a discount to a number of small shareholders, not many enterprises were sold completely and the large part of capital was transferred to government funds. In Serbia, the 1991 law offered less generous conditions to insiders than previous legislation, which slowed down the process, but many firms' shares were nevertheless sold primarily to employees.

Despite these common elements, the most fundamental difference that explains the variable outcome of privatisations in the Yugoslav successor states is the attitude towards social property. The early elimination of social property, in all countries of former Yugoslavia except Serbia, did facilitate privatisation. Serbia, as the only country that has preserved social property, has encountered the greatest delays with privatisation, also due to some other specific reasons. Most privatisations were first cancelled in 1994: because of hyperinflationary conditions in 1993-1994, amendments were adopted which introduced the obligatory ex post revaluation of capital in all privatising enterprises. The revaluation was based on inappropriate revalorisation coefficients which grossly overvalued social capital, resulting in a substantial reduction of the relative share of privatised capital, sometimes to no more than 1%-2 % of total capital (Uvalic, 2008). Privatisation was again encouraged only in 1997, through a new privatisation law which, similarly to previous legislation, was based on sales at privileged terms and some give-aways to insiders. However, by that time, some of the best firms were already privatised, frequently through spontaneous or 'wild' privatisation. Directors and managers typically founded new companies using assets and human capital of socially owned firms, by turning part of the property into a joint stock or limited liability company.

These processes of uncontrolled privatisation and asset stripping were facilitated by undefined property rights in Serbia (see Madzar, 1999). During the 1990s, social capital was indeed being eaten up, there was an erosion of capital in favour of consumption or transfer to new private firms, as predicted by the Furubotn and Pejovich theory. Wild privatisations were typical also in other countries in Central and Eastern Europe where enterprises had substantial autonomy and control rights, including Hungary, Russia, and the other Yugoslav successor states. The difference is that in Serbia the legislative vacuum related to undefined property rights has remained present for much longer and has actually not yet been completely eliminated. Although the new privatisation law, adopted in 2001 after the end of the Milosevic regime, is mainly based on the method of sales to strategic buyers, at the end of 2006 there were still more than a thousand socially owned firms that had not found potential buyers; some of these are heavily indebted loss-making firms that since 2001 have been waiting for a new bankruptcy law, adopted only in 2006 (Uvalic, 2007). Given all these problems, it is not surprising that in mid-2007, Serbia had a private sector contributing just 55 % of GDP, thus still lagging behind all the other successor states of former Yugoslavia (11) and the large majority of transition economies (all except four--Belarus, Tajikistan, Turkmenistan and Uzbekistan) (see EBRD, 2007).

Thus, the legacy of social property was twofold. It slowed privatisation in all Yugoslav successor states, especially in Serbia where it has survived until today; and it has led to a large presence of insiders as new shareholders, since all laws envisaged to a larger or greater extent sales to insiders at privileged terms. The option to offer insiders priority in privatisations was a consequence of self-management, recognition that workers' implicit rights had to be respected. Was this a good or bad outcome? Judging from Slovenia's experience where many enterprises ended in majority employee ownership, this did not prevent the country from being one of the best performers among the Central and East European economies (though the evidence on performance of Slovenian firms is mixed; see Prasnikar and Svejnar, 2007).

Workers' self-management rights

The 1988 Enterprise Law in Yugoslavia envisaged the gradual demise of self-management, by introducing various new enterprise forms in which workers' rights were to be gradually reduced in proportion to the reduction of social property. In this way, the privatisation of firms in social property was to lead to the gradual abolition of self-management. The change of ownership from social to private or state should also have brought standard corporate governance mechanisms, abolishing Workers Councils and self-management rights. However, there was a more radical break with self-management in some successor states than in others, determined by the methods of privatisation and the speed of its implementation.

In Slovenia, the demise of self-management heralded the emergence of other forms of employee participation, both via shareholding in enterprise property, and in the decision-making process. In addition to substantial employee ownership in privatised enterprises, Slovenia is the only Yugoslav successor state that has also introduced workers' representation on company boards through a law on co-determination adopted in 1995 which is similar to the German system of Mitbesttimung.

In Serbia, where privatisation has been substantially delayed, the maintenance of social property implied that some form of self-management also survived--especially in those enterprises in which social property remained the only, or the dominant, property form--though frequently in a rather restricted form because of state-appointed directors and managers. According to the provisions of the 1994 Company Law, a socially owned enterprise was to be managed by its workers, while a mixed-ownership enterprise by both its shareholders (proportional to the share of invested capital} and employed workers (proportional to the share of social property). Although a new Company Law was adopted in 1996, which reduced substantially some of these rights, this law still envisaged the existence of a socially owned enterprise, thus assuring workers' rights. Moreover, in practice many enterprises have actually not implemented these new regulations, but in mid-2001 still operated according to the provisions of the 1994 Company Law (see Uvalic, 2007).

Other problems inherited by the Yugoslav successor states have to do with a number of structural imbalances, some of which were also internationally driven (eg, debt rescheduling). These problems were not a legacy of self-management but of socialism, which would be gradually overcome, as elsewhere in Central and Eastern Europe, through transition-related economic and institutional reforms.


The ongoing analysis leads us to the following main conclusions. The theory of the labour-managed firm, though inspired by the Yugoslav experiment with self-management, was constructed and developed primarily to analyse supply responses in a hypothetical self-managed market economy, and did not reflect real-world Yugoslavia. In consequence, there are actually a limited number of testable hypotheses of relevance to understanding the behaviour of the Yugoslav economy. Few of these hypotheses have actually been tested and even fewer of them confirmed by empirical evidence. We must conclude that the labour-management literature provided only a few insights on Yugoslavia (eg on the inter-sectoral and interregional inequality), while probably offering more on producer cooperatives.

There are several reasons why the theoretical literature on the labour-managed firm, for the most, is not applicable to pre-1991 Yugoslavia. Contrary to one of the basic assumptions of the literature, Yugoslavia was not a fully fledged market economy for very long, if at all. The socialist features of the Yugoslav economy had remained dominant, in this way suppressing many elements of economic democracy. If the Yugoslav firm had substantial freedom in formulating some of its main policy decisions, even at the height of the self-managed market model from 1965 to 1971 when enterprise autonomy was greatest, there were still a number of constraints on firm behaviour which were externally (politically) determined. One might therefore speculate why academic interest in labour-managed firms was so high if the evidence as to the relevance of the theorising was so slight. Several arguments have been noted in this paper. Labour-management theory was of interest in its own right because it enhanced our understanding of profit maximising firms with participatory schemes and Western institutions, notably trade unions. Moreover, the model was appealing ideologically to some Western scholars, who were attracted to the notion of democratic decision-making in firms and therefore felt it was important to establish using rigorous methods that these organisations could be as efficient as their profit-maximising counterparts.

However, it would seem Bergson was correct: labour-management in Yugoslavia was a variant of the Soviet model, not a middle way or alternative to capitalism. There was nowhere an attempt to maintain or develop market self-management in the Yugoslav successor states, though Slovenia has explored and implemented alternative institutions for employee participation. One might have expected that the extent of market-oriented reforms undertaken in the past, which gave all the Yugoslav successor states some of the best initial conditions among former socialist countries for implementing the transition, would have been a substantial advantage and would have facilitated the transition. But instead of being the leaders among transition countries, most of them have turned out to be laggards (except Slovenia). This is not surprising, considering that Slovenia is the only country that did not have military conflicts after the split. In addition, all Yugoslav successor states implemented gradualist strategies of transition, which can in part be explained by the greater resistance to change in Yugoslavia relative to other countries in Central and Eastern Europe. Perhaps this was because the Yugoslav socialist model had a higher degree of popular support due to its specific features of self-management, greater political freedoms and the higher standard of living it assured to its citizens in comparison with other socialist countries. Popular support for the regime also derived from the deeper roots of communist ideology, since communism was not imposed from outside but through the grass-root revolution during the Second World War.

However, the gradualist strategies of transition are clearly not sufficient to explain and are not responsible, per se, for the delayed transition in most successor states of former Yugoslavia. What primarily impeded quicker economic and institutional reforms in these countries was the political and economic instability caused by the break-up of the Yugoslav federation, continuous military conflicts, international sanctions, delayed integration with the European Union and unsettled status of borders, which for some countries like Serbia have still not been definitely resolved.


The authors gratefully acknowledge research assistance from Kasia Komosa and Angela Lei, as well as conversation and suggestions from Avner Ben-Ner, Joe Brada, Bozidar Cerovic, Derek Jones, Laza Kekic, Smiljan Jurin, Mario Nuti, Louis Putterman and Milan Vodopivec. Any remaining errors are their own.


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[1] Department of Management, London School of Economics and Political Science, London WC2A2AE, UK. E-mail:

[2] Department of Economics, Finance and Statistics, Faculty of Political Sciences, University of Perugia, Perugia, Italy. E-mail:

(1) In fact, they have a remarkably contemporary feel: price liberalisation, freedom for the firm to determine its output on the basis of prices, market-based costing of labour and capital, and rules for bankruptcy.

(2) Social compacts were agreements concluded between representatives of the political authorities, trade unions, enterprises and other organisations, on policies in specific fields, such as prices, income distribution, employment and foreign trade. Self-management agreements regulated relations between enterprises and other organisations in areas of mutual interest, such as terms for the foundation of firms and banks, or joint investment projects (see Uvalic, 1992, p. 7).

(3) Gross Social Product, or Social Product in Yugoslav terminology, corresponds to Gross Material Product: it is the value added of the 'productive' sectors of the economy, thus excluding most 'non-productive' sectors such as education, health, defense, banking and other services. In this sense it is similar to the concept of Net Material Product that was used in other socialist countries, but it is gross of depreciation.

(4) It could be argued that Yugoslavia became an irrelevant testing ground for any kind of labour management in the 1970s because of political problems--the Croatian 'spring' and near civil war, the purges in Serbia in 1971, the energy-sapping disputes, the extreme decentralisation of the economy and republican self-sufficiency in many areas. However, we note above that political decentralisation occurred simultaneously with attempts to improve the self-management system. The 1976 Associated Labour Act was considered the 'Workers' Bible' because of the self-management rights supposedly guaranteed to workers.

(5) The theory of the labour-managed firm developed in the West was first presented in the works of Horvat (1967, 1972) and Suvakovic (1977), but was for a long time ignored by some of the leading Yugoslav economists, also because of its 'bourgeois' and neoclassical foundations.

(6) It is notable that the agent meant to act as entrepreneur was never fully developed in labour-management models; probably the only exception is Prasnikar et al. (1994), where a framework is employed which reflects all the three main decision-makers in Yugoslavia: workers, managers and government authorities, as well as their strategic interaction (bargaining).

(7) This did not preclude the possibility that one party could remain dominant on the political scene, as happened in Croatia (HDZ--Croatian Democratic Alliance) and Serbia (SPS--Socialist Party of Serbia).

(8) The contribution of the social property sector to GSP was close to the Yugoslav average in most cases, ranging from 84% in Bosnia and Herzegovina to 89.9% in Slovenia; the only real exception was Kosovo where it was exceptionally low, only 77%. The private sector was much more important in Kosovo than elsewhere because of the large share of agriculture and small-scale crafts, both predominantly in private hands. These shares have been calculated on the basis of data on GSP in constant 1972 prices reported in the Statistical Yearbook of Yugoslavia 1991 (Federal Office of Statistics, 1991, p. 475) (Uvalic, 2008).

(9) Still, the laws adopted by all the successor states were more restrictive than the previous Federal privatisation law regarding discounts, repayment periods, etc.

(10) This provision was included in the 1990 Serbian Constitution that guaranteed the equal treatment of four forms of property--social, private, state and cooperative (see Sluzbeni Glasnik Republike Srbije, 1990, Article 56). It was changed only in 2006, with the adoption of the new Serbian Constitution, which states that 'Private, cooperative and public property is guaranteed', whereas 'Existing social property is to be transformed into private property under conditions, methods and deadlines envisaged by law' (see Sluzbeni Glasnik Republike Srbije, 2006, Article 86).

(11) By 2007, even Bosnia and Herzegovina had a private sector contributing 60% to GDP.
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Title Annotation:50th Anniversary Essay
Author:Estrin, Saul; Uvalic, Milica
Publication:Comparative Economic Studies
Article Type:Essay
Geographic Code:4EXYU
Date:Dec 1, 2008
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