History of state control over cooperatives in developing countries

The evolution of cooperatives in developing countries is strongly dependent on the colonial governments that implanted these institutions. Cooperatives did not intend to be independent self-help associations that emerge spontaneously, but rather to be instruments for colonial governments to implement their own economic policies (Cuevas and Fischer, Reference Cuevas and Fischer2006: 27; Münkner, Reference Münkner2013:13). The organizational nature of cooperatives changed from instruments intended to create alternative contractual arrangements that govern the relation between the members and the market – and amongst the members themselves – into government instruments that transfer credit and subsidies to mass populations and follow state policies (Cuevas and Fischer, Reference Cuevas and Fischer2006: 28). Thus, in developing countries, what are sometimes labelled as ‘cooperative organizations’, are not really cooperatives (Birchall, Reference Birchall2004: 6).

Fals-Borda et al. (Reference Fals-Borda, Apthorpe, Inayatullah, Nash, Dandler and Hopkins1976: 442) describe how most post-independence governments in developing countries have adopted a compulsory cooperative strategy to force people, especially peasants, to become members in state-organized cooperatives. Forcing people to join cooperatives was made possible through three ways: ‘(1) direct compulsion and coercion, (2) the creation of a monopolistic situation in which the individual is deprived of certain economic benefits if he decided to stay out, (3) the offering of inducements in the shape of prospective benefits’ (Fals-Borda et al., Reference Fals-Borda, Apthorpe, Inayatullah, Nash, Dandler and Hopkins1976: 442). They noted that in the 1960s, the ruling parties in Iran, Venezuela and other Latin American countries, strove to extend their political influence in order to spread their ideologies through their control over the cooperative movement. Cooperatives were organized by the State in order to secure the political support of peasants for the existing regimes. They also remarked that leaders of cooperative societies in Latin America and Africa were extremely over-controlled by government officials. Cooperative leaders ceased to be true representatives of the members, and instead, they carried out instructions from government officials and communicated them to the members and sometimes they were even members of the local administration or part of the political hierarchy. Cooperatives’ elections did not take place on a regular basis in many cases and some leaders were re-elected indefinitely (Fals-Borda et al., Reference Fals-Borda, Apthorpe, Inayatullah, Nash, Dandler and Hopkins1976: 440–441). Similarly, Gagnon (Reference Gagnon, Nash, Dandler and Hopkins1976: 376) pointed out that, during the 1960s and 1970s, cooperatives in Cuba, Senegal and Tunisia were not spontaneous grassroots movements, but were rather organized and controlled by the states and political parties in power to spread their policies and ideologies. And whenever cooperatives ‘[…] had the opportunity to become social movements, to enter the political arena, and to threat the dominant classes, they were rapidly curtailed by the ruling powers [...]’ Gagnon (Reference Gagnon, Nash, Dandler and Hopkins1976: 376).

The history of the cooperative movement in the former communist countries provides additional evident for that. In Russia, the once-autonomous consumer cooperatives were the main suppliers for basic goods to urban populations before the revolution of 1917. State control over cooperatives during the totalitarian regime that followed the revolution had abolished the movement's autonomy and was nationalized by Stalin in 1935. Agricultural cooperatives that existed before the revolution were replaced by collective farms and were falsely named ‘cooperatives’. The same trend took place in many other so-called socialist countries, in which the number of cooperatives and their members immensely grew but without any real autonomy or member control (Birchall, Reference Birchall2004: 3, 16).

Another interesting historical event was the dissolution of the Egyptian Confederation of Agricultural Cooperatives in 1976. The early founded cooperatives in Egypt were relatively independent from the state. However, the post-independence regime led by Nasser seized control of the cooperative movement and completely changed its nature to a state-controlled organization. When Sadat took office after Nasser in 1970, he chose one of his protégés, Ahmed Yunis, to be the president of the Confederation of Agricultural Cooperatives. However, Yunis tried to establish an independent movement that ‘[…] would not only fall outside the domain of state control, but which would challenge the government and demand a say in state policy making [sic] especially that related to agriculture’ (Fahmy, Reference Fahmy2002: 208–209). In 1976, Yunis refused the governmental pressure on the confederation to support the ruling party in the parliamentary elections. He stated that the confederation should be politically neutral and non-partisan, and called for the confederation's full independence from any government intervention. In return, the government led a publicity campaign against Yunis, accusing him of mismanagement and corruption (Fahmy, Reference Fahmy2002: 210). Not long after, Sadat disbanded the confederation in 1976 under Law 824 and transferred the functions of cooperatives to the state-owned Agricultural Bank. With the dissolution of the confederation, Sadat made sure that cooperatives could never be used to mobilize any opposition against his regime. The confederation remained dissolved until 1983, after Sadat's assassination. The ruling party at that time won all the seats of the confederation council in its first elections (Fahmy, Reference Fahmy2002: 211).

In brief, as Develtere and Pollet (Reference Develtere, Pollet, Develtere, Pollet and Wanyama2008: 64–65) explained, governments can either maintain cooperatives’ autonomy and independence or they can take control over the sector. Government control can be ‘defensive’ or ‘instrumental’. A ‘Defensive’ attitude is when a government attempts to keep tight control over all civil society activities for its own political interests. ‘Instrumental’ attitude on the other hand is when a government uses cooperatives as instruments to implement its economic development policy.

Theories of pressure groups

Olson (Reference Olson1965: 111–112) relates the development of pressure group theories to the rise of pluralism; a political philosophy that argues for a greater constitutional and political role for private associations of all types – especially labour unions, churches and cooperatives – whilst the state should have limited control over these associations. ‘Pluralism tends to create a mood favourable to pressure groups primarily because it emphasizes the spontaneity, the liberty and the voluntary quality of the private association’ Olson (Reference Olson1965: 112). Politics can be affected by organized groups in two ways: directly, by lobbying to influence political decision-makers, and indirectly, by mobilizing voters or demonstrations. Modern pressure group theories emphasize the influence of pressures produced by different groups, as the fundamental determinant of economic structure and distribution of political power in a society (Becker, Reference Becker1983; Bentley, Reference Bentley1908; Commons, Reference Commons1950; Latham, Reference Latham1952; Truman, Reference Truman1958). Pressure group theories date back to the 19th and early 20th Century political philosophers, especially Alexis de Tocqueville (1805–1859) and Pierre–Joseph Proudhon (1809–1865).

In the United States, Arthur Bentley (1870–1957) argued that conflicting group pressures are the key to understanding government policies. He shaped his argument in denying any significance to individual interests, stressing that the main effective forces in societies are groups’ interests and actions. Nevertheless, as no one group can represent all the members in a society; people will naturally tend to group together in associations, unions, cooperatives and other representative associations that can protect their interests and increase their bargaining power. Bentley states that ‘all phenomena of government are phenomena of groups pressing one another, forming one another and pushing out new groups and group representatives’ (Bentley, Reference Bentley1908: 269). Following Bentley's view, Earl Latham (Reference Latham1952) stressed the importance of studying groups’ interests as the primary force in economics and politics. For him, ‘the structure of society is associational’ (Latham, Reference Latham1952: 17). Like Bentley and Latham, David Truman (Reference Truman1958: 33–35) pointed out that there are inevitable disturbances and dislocations from economic institutions that will naturally lead to the formation of occupational associations like workers and farmers associations, in order to influence government policies.

Commons (Reference Commons1950: 30) had strongly supported the formation of economic pressure groups, arguing these groups, such as cooperatives, labour unions and farmers’ associations, were the most dynamic institutions and ‘the lifeblood of democracy’ (Olson, Reference Olson1965: 116). Commons promoted occupational pressure groups as the ideal representative and beneficial actors in economic policies. He based his argument on the view that market mechanisms alone cannot bring fair outcomes for all groups in the economy, and the reason behind that is the unequal bargaining power that different groups possess. Such inequalities in bargaining power will exist as long as the wealthy group dominates political institutions, and thus, pressure groups are essential in Commons’ argument to achieve a just and rational economic system (Olson, Reference Olson1965: 115).

The most relevant part for the argument here is Commons’ opinion on the United States Bill of Rights. For him, the Bill is important not only because it guarantees freedom of speech, press and investigation, but most importantly, that it protects the rights of association. He further explains how the totalitarian authorities of Russian Communism and Italian Fascism after the First World War weakened labour unions and cooperative movements. As Commons puts it, ‘the civil liberties that make possible the voluntary associations of labour unions, farmers unions, business cooperatives, and political parties… [is] the refugee of modern Liberalism and Democracy from Communism, Fascism, or Banker Capitalism’ (Commons, Reference Commons1990: 901–903). Mancur Olson (Reference Olson1965) in the Logic of Collective Action pointed out that all large well-organized economic groups that have significant lobbying power were originally organized for another non-political purpose in the first place. He noted that, ‘[...] the common characteristic which distinguishes all of the large economic groups with significant lobbying organizations is that these groups are also organized for some other purpose’ (Olson, Reference Olson1965: 132). Olson recognized that most of group formation costs are start-up costs, and once a group has been organized, the costs associated with engaging in political actions become relatively low. Political actions, such as lobbying to influence the political and economic policies, become natural by-products of the group with relatively low-costs, since the costs of group formation has already been mobilized. Labour unions, farmers cooperatives and all large economic organizations that were able to create influential lobbies initially had ‘the capacity to mobilize a latent group with selective incentives’, in order to overcome the collective-action problem (Olson, Reference Olson1965: 132).

Financial cooperatives can easily overcome the ‘collective-action problem’ of group organizing identified by Olson, due to their ability to provide ‘selective incentives’. According to Olson, organizations that can provide ‘selective incentives’ are those that (1) have the ability to be coercive, or (2) have the ability to provide positive incentives. Many independent and strong cooperative federations in developing countries had succeeded in influencing the policies and legislations regulating the operations of their affiliates, for example, ANGKASA, Malaysia; SNCF, Singapore and URECOCI, Côte d'Ivoire (ILO, 2001: 63). Similarly, the Kenya Union of Savings and Credit Cooperatives (KUSCCO) had recently opposed the retrenchment policies in Kenya, mainly because many public sector employees are members in Savings and Credit Cooperative Societies (SACCOs). KUSCCO also advocated against the taxation of SACCOs (Owen, Reference Owen2007: 18), and it was behind the enactment of the SACCO Act in 2008 (Wanyama, Reference Wanyama, Develtere, Pollet and Wanyama2008: 91). On the other hand, many autocratic governments in developing countries would naturally resist the development of such representative associations because of their potential political power.

Political economy theories of financial developmentFootnote ²

Political economy theories of financial development explain the distributional output of the financial sector, and argue that political institutions shape the level of an economy's financial development. Narrow political and industrial elites, who control political institutions, will use their influence and networks to have preferential access to finance, whilst ensuring other potential competitors’ accessibility to finance is reduced. However, democracy should limit the influence of narrow elite groups and redistribute political power to a wider range of people who would favour a well-functioning financial sector (Girma and Shortland, Reference Girma and Shortland2008: 568). Rajan and Zingales (Reference Rajan and Zingales2003: 18–21) proposed an interest group theory of financial development where industrial and financial elites have a direct interest in opposing financial development. As they are small enough to organize (Olson, Reference Olson1965), and have large economic weight, these elites can successfully influence political leadership to keep the financial sector underdeveloped. Large firms can finance new opportunities without the need for external capital, or can obtain finance by pledging their assets as collaterals. Thus, in underdeveloped financial system, they have positional rent in their markets resulting from their privileged access to capital. Additionally, even if new entrants can obtain capital, the narrow group of industrial and financial elites will still be able to capture most of the returns gained by these new entrants, through higher interest rates, since they own and control financial institutions. These rents will diminish or even disappear with financial development.

Rajan and Zingales (Reference Rajan and Zingales2003: 22) argued that economic openness, in term of trade and capital flows, will weaken the industrial and financial elites’ ability to resist financial development. That is because foreign trade increases competition and reduces domestic rents, putting pressure on industrial elites. Similarly, cross-border capital flow will reduce the financiers’ oligopolistic position if domestic corporates can have access to cheaper finance. However, that does not provide a clear explanation to the behaviour of political institutions towards financial development, especially that economic openness is argued to be a political choice in itself (Perotti, Reference Perotti2014: 17). Barth et al. (Reference Barth, Caprio and Levine2006: 278–286) proposed a social conflict view of bank supervision and regulation that explains why some countries may intentionally choose inefficient banking regulatory and supervisory policies that produces inefficient outcomes. The social conflict view argues that financial regulatory and supervisory policies are not chosen by the entire society or for the benefit of the whole society. The state is more concerned about distribution and not efficiency, and the ruling group does not seek to maximize the total social welfare but rather to maximize its own. In closed autocratic regimes, financial regulations then will be chosen by those in power for the benefit of a narrow politically influential group, whereas a more open and democratic political system may reduce the power and benefits of such narrow elites. However, democracy will not totally eliminate their influence. Inefficient banking policies are also favoured by autocratic regimes because they can protect the interests of elites by limiting other groups’ economic and political potentials.

Girma and Shortland (Reference Girma and Shortland2008: 570–571) explained how in underdeveloped financial systems, access to capital will be associated with connections or wealth. The allocation of credit will depend on borrowers’ collaterals, social position and political connections, whilst a well-developed financial system allows firms and individuals to obtain credit upon the feasibility of their economic activities and needs. Therefore, the government and elite groups will tend to determine the level of financial development based on the costs of increased competition incurred from easing the accessibility of credit. In political economy theory, the ‘equilibrium’ level of financial development is then determined by the relative power of financial development beneficiaries and adversaries. Also, when the financial sector is underdeveloped, small and rural households tend to keep a portion of their savings in the form of real assets (e.g. gold and jewellery). The other portion is mobilized in the hands of few large banks that refuse to provide credit to these small depositors afterwards. In both cases, these small communities and rural areas are confronted with an inefficient resources utilization problem, because local resources are rarely utilized in productive investments inside these local communities. Financial cooperatives are best able to mobilize local resources for the benefit of the local economy (Nienhaus, Reference Nienhaus1993: 18).

Rajan and Zingales (Reference Rajan and Zingales2003) were the first to propose and provide empirical evidence that governments controlled by narrow elite groups obstruct the development of the financial sector. Similarly, Girma and Shortland (2004) also found a statistically significant relationship between the annual change in financial development and the degree of democracy and stability of the political system. Barth et al. (Reference Barth, Caprio and Levine2006: 286–305) examined the relationship between political institutions and bank supervisory and regulatory frameworks. Their findings suggest that autocratic political regimes tend to have large state-owned banks and are more likely to impose regulatory restrictions on bank operations. They argued that autocratic regimes have large state-owned banks to easily channel financial resources towards the ruling elite, and to control financiers by creating regulatory restrictions.

Briefly, a banking system dominated only by state-owned or private commercial banks, investment and lending decisions lie in the hands of the government and banks’ large shareholders. Thus, the allocation and use of depositors’ money will not be controlled by the depositors themselves, who are the real owners of the money; instead, it will be in the hands of a narrow elite group that is formulated by large capitalists and that can influence political decision-makers. As a result, an independent financial cooperative sector that can mobilize local resources for the benefit of the mass population will not be favoured by autocratic political decision-makers, as cooperatives would limit the exploitation capacity of the government and narrow elite groups.

Measuring financial cooperatives development

The development of the whole financial sector is usually measured using indicators covering the sector's size, depth, efficiency and stability (Beck and Levine, Reference Beck, Demirguc-Kunt and Levine1999). However, statistics on financial cooperatives that cover all these indicators are not available in most countries. The variables used here to measure financial cooperatives development can only reflect the sector's size and depth but do not give insight on the level of efficiency or stability of the sector. Financial cooperatives’ data were obtained from the World Council of Credit Union's (WOCCU) statistical reports, which are based on financial cooperatives responses to the WOCCU's annual survey, and are the most comprehensive dataset available for financial cooperatives. Only for India, additional data were collected from the National Federation of State Cooperative Banks regarding primary agricultural credit societies, which are not covered by the WOCCU dataset.

Three indicators are used as dependent variables that can define the degree of development in the financial cooperative sector. First variable is member penetration rate, which is calculated as the country's total number of financial cooperatives’ members as percentage of the total economically active population (obtained from International Labour Organization - ILO). The penetration rate shows the proportion of citizens who are members in financial cooperatives. This variable can reflect the financial cooperatives’ ability to attract and organize people. Second and third variables are total assets per GDP and total deposits per GDP. Both variables show the sector's size in the national economy. The three variables were log transformed to normalize data distribution. Assuming here that, high penetration rate, total assets per GDP and total deposits per GDP reflect a well-developed financial cooperative sector in a country.

Measuring the quality of political institutions

Finding reliable measurements for the quality of political institutions is challenging, mostly because the meaning of democracy has been a controversial issue in political science (Acemoglu and Robinson, Reference Acemoglu and Robinson2005: 48). Three measurements for political institutions are used here: Freedom House's political rights and civil liberties indices, and Polity index from the Polity IV Project. The Freedom House's political rights and civil liberties indices have been previously used for studying trends in democracy by various scholars including Barro (Reference Barro1999: 160–162) as well as Acemoglu and Robinson (Reference Acemoglu and Robinson2005: 48–63) who only used the political rights index. Originally, both indices range from 1 to 7, in which 7 represents the least political freedom – in terms of political rights and civil liberties – and 1 represents the freest. However, the values of both indices were reversed so that 1 becomes the lowest score in political rights and civil liberties score and 7 represents the highest score.

The Polity index was also used by Acemoglu and Robinson (Reference Acemoglu and Robinson2005: 48–63), and it ranges from +10 to −10, in which +10 represents strongly democratic institutions and −10 represents strongly autocratic ones. The Polity index is computed by subtracting the democracy and autocracy indices of the Polity IV project. Both, the democracy and autocracy indices range from 0 to 10. (Marshall, et al., Reference Marshall, Gurr and Jaggers2014: 14–16).