Rauh and Zingales on G.M.’s Best Hope

INSERT DESCRIPTIONMercedes-Benz plant in Tuscaloosa, Ala. (Photo: Gary Tramontina/The New York Times)

My University of Chicago colleagues Josh Rauh and Luigi Zingales have written an insightful essay on G.M.’s plight and what the government should do about it.

They, like virtually all economists, think the auto industry bailout under consideration is not the right solution. They believe the best option is a Chapter 11 bankruptcy, in which the government takes a special role in providing financing during the process. They also emphasize the need to relieve G.M. of a heavy burden of retiree pensions and medical obligations.

One thing that surprised me is that they are mostly silent on bloated labor costs. The union labor that the Big Three automakers employ is far more costly than the non-union labor used in automobile production facilities in the U.S., but as far as I know, the union labor is no more productive.

Consequently, the Big Three cannot be competitive. I often heard it said that Detroit is making cars that nobody wants to buy. The more accurate statement is they are making cars that no one wants to buy at current prices. If they could produce the cars 20 percent more cheaply, there would be many more buyers.

The U.S. automakers have dramatically increased quality in response to the challenge of the Japanese imports over the last 20 years. My guess is that if their labor costs were on equal footing, they could compete effectively.

To me, one of the greatest benefits of bankruptcy is that the bankruptcy judge could break the unions in a way that will likely never happen otherwise. It seems to me that if the Big Three are going to survive, either their labor costs will have to fall sharply, or their labor productivity has to increase dramatically without a change in wages. The latter might actually be the easiest path to follow, but it will require labor and management working together creatively. That’s not likely to happen, but mutual destruction is a pretty effective motivator.


Ben

Why does this make so much sense to everyone other than the ones who will actually decide what to do?

kdg

"The more accurate statement is they are making cars that no one wants to buy at current prices. If they could produce the cars 20 percent more cheaply, there would be many more buyers. "

No, I don't think that is it at all. Automakers are pushing the same cars, the same crappy mileage and trying to market them as efficient and progressive. I'm sorry but anything under 30 mpg in this century is not progress and a million commercials claiming it is isn't going to change that. It is my understanding that one of the first cuts Ford made was to R&D - how can you justify that when the country is finally ready for cars that will reduce our foreign oil dependence? What US automakers are lacking is leadership.

Felix

I completely agree about breaking the unions. The auto companies should be jumping at this once-in-a-lifetime chance to actually become competitive with the foreign car companies. Couple products that people actually want to buy (that work) with prices people actually want to pay, and everyone will be better off.

Daniel J. Luke

But the big labor costs are healthcare (which largely goes away for GM after the new contract goes into effect in 2010) and the pensions.

Advocating for Chapter 11, is really just advocating for GM to pawn off the pension obligations on the taxpayer, so is still just a government bailout.

I, for one, am grateful for the 5 day, 40 hour work week which we enjoy thanks to organized labor.

charles

You hit the nail on the head. So many are reluctant to say it out of fear of being some sort of badness, anti-human monger. The fact is they are stuck with agreements that can only be supported at market dominant levels. That's not reality and never will be again....so either you get the MAD that you mentioned or the Union bends. In the end I think even the Union knows they will have to bend on this one.

Daniel R. Craig

If health care is the big labor cost that it seems, why isn't GM the biggest, loudest advocate for national health care system? I've never understood that. All of corporate America, except for the insurance corporations themselves, stand to benefit enormously from health care reform. Yet they are completely silent on it. Maybe there's an ideological block on the GM execs/stockholders's parts, but it blows my mind that they aren't lobbying hard to remove health care from their liabilities. If we really want to bail them out, maybe it's a perfect opportunity to test-run a national health care system on GM?

VEH

So we should "break" the unions so their members can be pushed out of the consumer economy? Average UAW salary is $55 K. Is that extravagant? I guess if you feel that blue collar people don't deserve a middle class wage because they aren't part of the educated elite, it is.

The transplants, if they are still around in 20 years, will have rising labor costs as they support retirees. Should they be planning now how they can offload that commitment? Is it immoral in some business-school way to support your loyal workers?

And the banks should continue to receive federal bailout money without any strings attached? Justify that position, please.

Chapter 11 makes no sense at all. A bankrupt automaker isn't going to sell a lot of cars. Cars are not like airplane flights, where once you've had the experience that you paid for, you're done. Even the most reliable cars need maintenance, and get in collisions, so you need to be confident that these things will be available in the future. Ask a body shop about getting parts for a Daewoo after they tanked.

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Jeffrey

Unions are wonderful, but there's a massive sense of entitlement and rigidity. They should tear up the current contracts with the burdensome health care and pension clauses and negotiate something new, if for no other reason than not to lose everything.

@ Dr. Levitt (and/or his sources): the Big Three spend about $2,000 more per car than Japan. That's not 20%, unless you've found an old Ford Fiesta on the lot somewhere.

@#2: you've clearly not priced or test driven an American car in at least ten years. They're vastly improved. They just don't have the price point to undercut the overpriced foreign competition.

J

“The more accurate statement is they are making cars that no one wants to buy at current prices. ”

What data are you basing this on? People DO buy domestic auto brands, even at current prices. Just look at the numbers...

Car and light truck sales in the U.S., January-October 2008 (Source: Automotive News Data Center):

GM: 2,581 K
Toyota: 1,945 K
Ford: 1,741 K
Chrysler: 1,278 K
Honda: 1,266 K
Nissan: 843 K
Hyundai-Kia: 602 K
VW: 267 K
BMW: 262 K
Daimler: 213 K
Tata: 17 K

You are absolutely right that the problem here is costs. In fact, this argument is strengthen when you look at the data, which clearly shows that domestic brands are tops in US sales. To say that people are not buying domestic brands - even at current prices - is flat out wrong.

Matt

"Why does this make so much sense to everyone other than the ones who will actually decide what to do?"

They are politicians. They make a lot of enemies (gm workers, unions) if they say chapter 11 is the best solution.

William

The absurdly high labor costs are certainly a major part of the problem, but the Democrats' political ties to the unions will keep them from suggesting pay cuts for anyone below the management level.

jonathan

Well, first, your co-professors correctly hit the main point: we can't have a bankruptcy in this climate at this time with so much riding on it without guaranteed debtor-in-possession financing that's rock solid. And that means the government.

Second, Detroit sells plenty of cars that equal or better the foreign makes in mileage and quality. It's chic to dump on them as dinosaurs but they aren't. The US car market is the richest in the world by a fairly wide margin - unless you for some odd reason lump all of Europe together - and that richness attracts the best competition. People think that somehow GM is terrible because they no longer have a 60% share, but that was a different era.

The point remains that government involvement is necessary. The idea the government provides financing in bankruptcy is interesting but it runs into the big problem of labor, meaning the only real solutions come if the UAW et al are at the table and aren't perceived as the enemy to be broken in the courts. That won't fly politically or as a business strategy.

I continue to be amazed at the lackadaisical attitude expressed toward the potential failure of giant industrial corporations. We can break apart banks and make new ones almost overnight; the branches and deposits remain, and the signs get changed and there are hirings and firings. It takes decades to build a giant industrial corporation and here we want to burn them down in a matter of weeks.

I shudder to think of the market reaction when (perhaps not if) GM files - or maybe even when Chrysler files. Many companies will likely go under, many many jobs will be lost, and the damage to our productive capacity as a nation will be extreme. Investors worldwide will over time recognize that we have weakened ourselves - ironically, choosing to fund AIG's CDS and other financial assets, many owned by foreigners - rather than preserve our actual wealth production machine. This will substantially weaken us as a nation over time.

And one day when we look back at how we've been left behind, I believe there's a substantial chance we'll rue these choices, that we'll shake our heads in disbelief that we've flushed money into grossly incompetent financial institutions without taking steps to preserve the long-term value of our productive capacity.

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Craig

Before you jump on the "same crappy mileage" bandwagon, keep in mind that the Federal regulations have added a significant weight burden to cars today and groups like the Insurance Institute for Highway safety rating system have forced the designers to focus on those issues instead of fuel economy.

Remember the GEO Metro? A GM car that got over 40MPG. We had to stop selling due to IIHS ratings and new Govt regs.

mfw13

I also disagree with the assertion that "if GM could produce the cars 20 percent more cheaply, there would be many more buyers".

The reason most people do not buy cars from the Big Three any more is quality, not price. Foreign cars have better design, better mileage, and fewer maintenance problems, yet still manage to be very competitive on price. My wife drives a 2000 Honda Accord with 90,000 miles on it that has never had a single mechanical problem in the nine years we've owned it. I used to have a 1999 Saturn SL2, and it started having mechanical problems at around 30,000 miles.

It's the low quality that is killing the Big Three, not just their higher prices.

K

True, healthcare and pensions are big costs which will decrease in 2010.

But GM won't make it to 2010. And if they could the relief won't be total. Their costs would still be higher than competitors.

The UAW made some sensible concessions in 2007 to be phased in over three years. They aren't mad. But the economy soured beyond all expectation.

Actually GM and the UAW report the pension fund has a surplus. So tax payers wouldn't get a big hit. And if they did it would be years from now.

Chapter 11 is the way. Vehicles aren't selling and won't be for at least a year. The debt can't be handled and the costs can't be borne.

The 5 day, 40 hour work week has nothing to do with the matter.

Nick

@6 "Average UAW salary is $55 K. Is that extravagant? I guess if you feel that blue collar people don't deserve a middle class wage because they aren't part of the educated elite, it is. "

No, I don't feel people deserve just deserve $55K just for showing up to work, no matter if the position is blue collar, white collar, whatever. It's not your right as an American to a middle-class wage. Your right as an American is the freedom to go out and earn what your skills are worth. If you're not educated, you probably don't offer $55K/year in value to anyone, so why should you receive that? This is the misguided sense of entitlement that has gone a long way to putting the industry in this position.

Brent

Regarding #2, who posted: "No, I don't think that is it at all. Automakers are pushing the same cars, the same crappy mileage and trying to market them as efficient and progressive. "

Sorry, but you are misinformed. A look at the U.S. government's official fuel economy ratings (published by the Department of Energy, the Office of Energy Efficiency and the Environmental Protection Agency) might not be light reading, but it does give a new sense of perspective on what is a very complex issue.

Top 10 Best Average Fuel Economy AutoMakers
Rank Combined Manufacturer # Cars
1 27.66 mpg MINI 12
2 23.81 mpg Honda 27
3 23.36 mpg Chevrolet 88
4 22.33 mpg Lotus 3
5 22.21 mpg Volkswagen 28
6 22.20 mpg Pontiac 24
7 22.14 mpg Saturn 21
8 21.8 mpg KIA 20
9 21.77 mpg Suzuki 18
10 21.6 mpg Toyota 55

Chevrolet is third, and they are saddled with including all of their trucks in the CAFE statistics. Without the truck line, they would be much higher. Toyota is tenth, and has only one truck to average in (I think).

The reality is that it is labor costs, pure and simple.

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Jim

The talk of how GM cars cost $2000 more to build or how no one wants their SUVS and the pension obligations are killing them etc is all a Red Herring.

GM is a badly run company. Period.

At every level. It needs to change to survive.

Labor does not want to change.
Management does not want to change.

This will be painful.

ceolaf

There are a few basic ideas we need to keep in mind and not lose track of.

1) There are enormous legacy costs with pension oblgliations. There are many aspects to this, but it's big deal no matter what.

2) Healthcare costs are huge, both for retirees and for current employees. This is a problem throughout American, and is a particular problem here.

3) Unions are not necessarily bad. Particular union contracts can be bad. Interpretations of contracts are often bad. Misunderstandings of contracts (i.e. mutual belief that contracts require or prohobit things that they actually do not) are quite often atrocious.

We all would like middle class wages paid to people who can work with and are treated with dignity. Can we get there? And if not, how much do we sacrifice?

Devon M

While I believe that the labor costs are obviously a massive issue - the cost of healthcare to retirees should be carefully considered.

If the benefits package is adjusted / reduced to save costs for GM / Ford / Chrsyler who but Medicaid will pick up the slack?