Feb 25, 2018 - RECMA Revue internationale de l'économie sociale, 336, 94-103. Galor, Z. (2015) Equity in Service at Cost: the Case of the Classic Moshav.
Understanding Cooperatives By Dr. Zvi Galor www.coopgalor.com Introduction It is important to better understand the real nature of the co-operative and the important task of its members in its existence. I am trying to show that cooperatives are a formidable tool for development, particularly the development of poor people. Unfortunately, cooperatives do not succeed because most leaders and members don't understand this real nature. Co-ops are made up by members. It was the members who founded their cooperatives. They established their co-operative because they were looking for an economic organization that will provide them with the service or the employment they were looking for, at the lowest possible cost and at the highest possible quality. But in practice, however, in the current understanding of co-operatives, and in the current practice in cooperatives, members are not the individual owners of their co-ops. Co-ops don't render them the best possible service at the lowest possible cost (Galor, Z. 2014). The following sections of this paper will present a different way plus equitable and plus profitable and more rendering the best possible service to members, and to understanding the cooperative. The two bases of the cooperative Co-ops have two foundations in their structure and understanding. The first one is the individual equal ownership by the members of their cooperative individually. This means that each member has share capital and its value is equal to all shares. Thus, the total value of members' share capital is equal to the total value of the cooperative's fixed assets and equity. In this way, members are truly the owners of their co-op in all aspects. The second one of the cooperative is the cost of participation applied on members through their economic participation in the cooperative. Each member may have different levels of economic activity, so that each may pay different amounts of money to the cooperative for the services acquired, but the cost of each participation unit is equal to all members. It only differs according to the degree of economic activity of each member of the cooperative or the amount of units of participation realized. The total amount of the members' participation costs or price is exactly equal to the total value of the co-operative's operating expenses for a certain period of time, usually during one year. Members seek to pay the lowest possible price for participating in their co-op while the cooperative is able to operate without loss or surplus, and to cover its operating expenses. Applying these simple principles in any co-operative will allow them to survive and provide their members with the best possible service at the lowest possible cost. 1
Second international cooperative principle - democracy. The existing International Co-operative Principles were adopted by the International Co-operative Alliance (ICA) at the 1995 International Conference in Manchester, England, one hundred years after the first ICA congress in the same place. There were 7 principles adopted. I would like to elaborate on the understanding of the second principle, and I would like to present its negative effect on the existence of cooperatives. Democracy is the heart of a successful co-operative. The co-operative is established by members, and members have the ability to make decisions through democratic cooperative practice by taking decisions about all events in the life of their co-operative. But reality has shown that this principle when not applied correctly, leads cooperatives to decooperativization. Members, as a matter of principle, have the exclusive right to have and to take decisions at the general meetings. The reality shows that there is an axis in the decision-making system, where on the one hand we have the members and the general meeting, and on the other hand we find the managers and the management committee of the co-operative, and there exist many conflicts between these two sides. This phenomenon has been described as the degeneration process by which cooperatives decision process has gone from members to managers and management. The expression of this approach is the concentration of power in the hands of managers and members' inability to participate in the decision-making process of their co-operative (Chaves, R., et Sajardo-Moreno, A. 2004; Chiffoleau, Y., Dreyfus, F., et Ewert, J. 2002). One consequence of this situation is the creation of oligarchies in some cases within the cooperative, which further hampers the decisions taken by members on the axe side. In some cases, too many, this situation has opened the door to the process of decooperativization and the end of their existence (Hernandez, 2006). Members wish to participate actively, in most cases, in the democratic process in their cooperative in all aspects. This is contrary to the hierarchical structure of the cooperative's management system. This managerial structure contradicts the democratic principle of the cooperative where members are those who are supposed to make decisions (Storey et al., 2014). This contrast results in management undermining the will of members in a variety of ways and the decision-making process in one way or another ignores members' will and needs. The result was a process whereby members moved away from the business of their co-operative and became increasingly indifferent to the various issues at stake in their co-operative (Nilsson, J. et al. 2009). Another opening to decooperativization. The management system of a cooperative becomes, on several occasions, a body that opposes the democratic process. Management and managers are distant from the members and for them, the managers, the co-operative is an entity that creates surpluses and profits, from which they can deduct their management benefits. 2
The second international co-operative principle on democracy should take this criticism into account in order to create a principle that would be followed by and beneficial to cooperative members. The third co-operative principle The third cooperative principle of the ICA is detailed below. It consists of two paragraphs, each of which is important for our discussion, and each one influences the conduct of the co-operative and its relations with its members. Here is the text of the principle as published by the International Co-operative Alliance. Principle 3: Member Economic Participation Members contribute equitably to, and democratically control, the capital of their co-operative. At least part of that capital is usually the common property of the co-operative. Members usually receive limited compensation, if any, on capital subscribed as a condition of membership. Members allocate surpluses for any or all of the following purposes: developing their co-operative, possibly by setting up reserves, part of which at least would be indivisible; benefiting members in proportion to their transactions with the co-operative; and supporting other activities approved by the membership (I.C.A., 1995). Components of the principle The text of the principle raises a number of issues. The first topic includes an axis describing the member's degree of ownership in his or her co-operative. This axis has two poles: On the one hand, there is full individual ownership by members of their co-operative, while on the other hand, there is a collective ownership by members of the co-operative, and then the organization is a separate entity from members. The second theme contains an axis describing the member's participation price in his or her co-operative. This axis has two poles. On one hand, the cooperative is presented as operating at cost price, without surplus, profit or deficit, and leaves the maximum reward for members through their participation. At the other end of this axis, the cooperative maximizes the annual profit and keeps the maximum not to members. The member is left with less money because of these activities and therefore pays a higher price for participating in the co-operative's economic activities. The first element - members and ownership The first paragraph of the principle states that members finance the establishment and foundation of their cooperative's assets. They pay the assets, according to the third cooperative principle, by paying their share capital into the cooperative. The financial value of the share capital of a cooperative is of a very low value and kept in its nominal value in the books of the cooperative 3
(Österberg et al. 2009). As a result, the total value of members' shares is at least ten times, or in many cases hundreds of time, less than the real value of the cooperative. The third principle states that members pay only for a small portion of the assets and therefore their individual ownership of these assets is very low. The principle gives members collective ownership over the cooperative. In fact, most cooperatives in the world do not legally, constitutionally, intelligently and practically belong to their members individually (Bijman and Verhees 2011). There are scholars who pretend that members do not finance the assets of their cooperative (Comeau 1995; Siebel 1996; Novkovic 2008; Ridley-Duff 2009;
El Ouafy and Slimane. 2014).
However, and here I am presenting a position in opposed to that of the third principle, members are actually financing entirely co-operative assets, but they do so indirectly and in a way that is not transparent to them. Contrary to the principle, in reality, in most cases, co-op members actually finance its fixed assets without being themselves aware of it. They do so in the following way: the cooperative charges the members participation with the amount needed to pay back the whole credit that was needed for the creation of the fixed assets, through two types of payments. One, as mentioned above, is paid, usually a relatively small amount, for the members' share capital. The second is the members cost of participation (cost of participation = price of participation) in the economic activity of the cooperative, and by charging an additional small amount added to the cost of participation and by so doing these charges become transparent to members. The payment of this small additional charge covers the monthly payment of the cooperative reimbursing of the loans contracted to constitute its fixed assets (Royer, 1992; Kislev et al., 1993; Lerman and Parliament, 1993). The current procedure in most parts of the world is that the cooperative undertakes long-term loans to finance its fixed assets, but it does not directly bind this financial obligation to members who pay out of their own pockets indirectly for the repayment of these loans. Members pay, in proportion to their economic participation in the activities of the cooperative, the assets that finally do not belong to members individually. The co-op's funding is derived from the uneven economic participation of members in its activities. Each member participates in the cooperative's activities, buys his needs and sells his work or products. The total value of all member cost of participation is equal to the total value of the total operating expenses of the co-operative (Galor, 1994; Galor, 1996). Members pay for the cooperative's assets, but they do not own them individually. Second element of the principle - surplus generation The second paragraph of the third principle deals with the finance of the cooperative's operating system. This is the total expenditure necessary for its operation. Each member pays according to his use of the services or goods provided by the co-operative. The total amount that all members payment to the co-operative for the use of these services in a year is exactly equal to the total of the 4
co-operative's annual operating expenses (Galor, 2003). The co-op creates a surplus when it increases the cost of member participation over the need to cover operating costs. This means an increase of the cost participation, and therefore a deterioration in the quality of the service the cooperative provides to members. At this point, it is important to explain another unclear concept to members and leaders and that is loss in the co-operative. Co-ops don't lose money. Loss occurs when cooperatives do not charge their members the correct cost of participation that covers their operating costs. When the total cost of members participation is less than the total operating expenses, a loss is generated. Members should cover this loss by increasing the cost of their participation in the same year the loss was created. The practice of using the financing out of the reserve fund to cover possible losses is erroneous and misleading. This practice means that the financial lack of the current members' participation price is covered by the participation price collected from members in previous years, and sometimes even decades. This is a misconception, both in terms of basic management procedures and fairness and equity, of past members who pay for the losses caused by current members. Part of the co-op's surplus is intended to distribute dividends members share capital, very minimal in real value, while much of it is used for a variety of purposes, which are very important in nature in the cooperative, but it is not permitted, as presented here, to fund these activities out of the surplus. The practice is, as directed by the 3rd ICA principle to utilize the resources out of the surplus to finance the development of the cooperative, the education of members and leaders, and other tasks. The misunderstanding of the role of surplus existed long time ago and we find it already in a discussion about co-ops nature in the first half of the last century. It was noted then that members can create funds from the surplus for various purposes. The sums collected in these funds are part of the cooperative's equity, but do not belong to members, and these funds are not distributed among them in any form whatsoever during a possible liquidation (Ladru, 1948). Ladru described a situation of disconnection between the members themselves and the ownership of their co-operative according to the then existing cooperative procedure. To illustrate this situation, Ladru tells us about cooperatives which designate the capital raised from members as contingency reserves, but without the issuance of certificates to members attesting to their contributions to this fund and without guaranteeing the rights of members according to the extent of their participation. The reserve fund: a negative element in the cooperative A broader look at the discussion above is the understanding of what the reserve fund is. In the third co-operative principle, the reserve fund is indivisible between members, it is owned by the co-operative. It is explained that the main purpose of the fund is to respond to unforeseen events in cooperative activity (Kennedy et al., 1995). 5
Members decide, often without fully understanding the importance of this step, to increase the amounts they pay out of their own pockets and included in their costs of participation to increase the annual surplus. This surplus serves the co-operative for a variety of purposes (Adcock, 1948), and especially the transfer to reserved and non-distributed funds. A reserve fund is a central element in cooperatives and exists in almost every country in the world. The reserve fund is created by the cooperative through a mechanism of allocating part of the funds of the annual surplus. The reserve fund is intended, as declared by many scholars (Hagen 2005; Beuchelt and Zeller 2012), to enable the co-operative to withstand economic changes, business risks and increase the co-operative's working capital in response to existing losses, especially in times of economic crisis. Sometimes it is also used for various other purposes, such as covering current losses and financing the construction of cooperative assets. All of these objectives, which supposed to be financed from the reserve funds, are wrong and they use members' money on an uneven basis to be injected into various purposes, qui supposed, in most cases, to be financed equally by all members. Members are logically supposed to finance directly these objectives directly from their own pockets, not from the reserve funds. Possible difficulties of the cooperative, such as economic changes, business risk or lack of working capital, should be financed directly by the cost of each member's participation. Current losses are part of the co-operative's current operating expenses and must be funded as well by the cost of each member's participation. The creation of reserve funds in cooperatives is based primarily on a wrongly cooperative understanding which is derived out of the third international co-operative principle. This principle recommends the creation of a surplus in a co-operative, as explained above, money which is taken out of members' pockets, through the unjustified increase in their cost of participation. This principle recommends the allocation of these funds to various tasks, as mentioned above, and including the creation of the reserve fund. This fund does not belong to members, not individually and not collectively, and in times of possible demonetarization, this fund is not distributed to them. Why this injustice, practiced in most cooperatives around the world. I mentioned above the term cost of participation. It describes how finance turns the mechanism of running the cooperative. The operation of a co-operative is based on its total revenues less total operating expenses. It should be clear that the income of the cooperative comes from the participation of its members. The way I see a co-op is that it's set up and is financed completely by members. Members establish their cooperative to give them the service or product they want, at the lowest possible cost or price. In co-operative terminology, we can call this functionality: "at cost" (Galor, 2015). It is important to note that already in the 1950s of the former century, co-operative scholars in the United States were already proposing the same thing (Hirsch, 1950; Aresvik, 1955; Trifon, 1961). 6
In Israel, the Cooperatives Act has eliminated the need for a reserve fund in cooperatives. There are many successful, economically and socially prosperous cooperatives that have been in existence for several decades now, which have no reserve funds at all and operate "at cost". These co-ops do not create surplus or deficits, since each year the members themselves, based on their economic participation in their co-operatives, cover any potential deficits and receive any potential surplus at the year end. In this way, members are better served by and for their co-ops. As a result, the best co-operative is the one that has no surplus and leaves most of its income in the pockets of its members. This beneficial situation is in total contradiction to the third co-operative principle. Summary This paper tries to elaborate a discussion showing the drawbacks of the current approach to the understanding and to realization of cooperatives everywhere around the world. It discussed the understanding of cooperatives by first of all presenting the two pillars on which each cooperative stands and operates. These pillars are the cooperative assets, fixed assets and equity, finance by the members entirely, either through their small payments for their personal share capital, or by their participation in the economic activities of the cooperative, payments which are done through their cost of participation. The second pillar is the finance members are doing while participating in the economic activities of their cooperative. Members are financing the operation cost of the cooperative not equally but according to their degree of participation. Then the article discusses two, out of seven, cooperative ICA principle. The second principle on democracy and third principle about the economic participation of the member in the cooperative. There is an emphasize on the issue of deficit, many are wrongly interpreting this term in the cooperative activity. Then the article speaks about the surplus notion in the cooperative and elaborates the negative outcomes of its realization in the cooperative. The last issue to be discussed is the reserve fund. The discussion shows the negative aspects of the existence of reserve fund in a cooperative, and the futile role it has in the cooperative economic life. The article sums up by presenting the idea that a cooperative is established by the members since they are looking to have the best possible service and for the lowest possible cost.
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