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.


Brent

I realized that I forgot the link to post # 12. It is:

http://autos.aol.com/article/green/_a/best-worst-automaker-fuel-economy/20080711132109990002

roger

Rather than talk about breaking the unions, why do I never hear about "organizing" the non-union scab workers so that they receive a generous wage from their foreign owners? The reason Mercedes moved to Tuskaloosa was not because of the culture, but because gullible workers were convinced to do hard monotonous work for much less money than American workers had been paid for many years. Those workers are the culprits here--it's just like offshore outsourcing, only the cheap labour is in Alabama.

Michael

Is the excite in Republican circles for a bankrupcy for GM primarily because it will break the union?

Since unions primarily support Democracts, then strangling the unions through Chapter 11 will eliminate one of the Democrat's prime constituencies!

Lawrence Boyd

There is a problem in defining these "bloated" labor costs. The figures I have seen compare $70.00-$77.00 per hour for the big three to to $44.00 per hour as the labor costs of operation. These numbers includes wages ($24.00/hr for the big three and almost identical amounts for transplants) and benefits. The health care and other hourly costs are likewise comparable. What leads to the disparity is the that the numbers includes "pension" payments for retirees which is paid out of a fully funded pension fund. If this was excluded then the rates per hour would be almost the same. A little bit of accounting jargon here, the pension fund is not really part of the operating costs the firm in the a strict sense because it represents previous payments into the fund. IIt is not a "pay as you" go system therefore only current contributions should be counted, not payments made out of the fund which are not paid out of current sales. In other words this is probably a bogus number.

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Dennis

Unions served a purpose in the past when labor laws didn't exist and work places were much more dangerous and exploitative. They made more sense when we had 10 workers for each retiree, not when we have 2-3 workers per retiree.

Current union wages are one issue as there is no incentive for quality. If you mess up as a union member you know they will go to bat for you so that you don't lose your job, whether or not you actually deserve it. Right or wrong your risk is minimized by the union.

Likewise, the workers who really stand out, and who make a quality product in a shorter amount of time aren't able to be rewarded for their productivity. Right or wrong your individual benefit is minimized by the union. It blunts the highs and the lows: evens things out, socializes the workplace.

The problem has more to do with union benefits. For example: a worker lives at home until 20 years of age. He then works for 30 years and retires at 50. He then lives another 30 years as his average life expectancy is around 80 years of age.

The retirement fund needs to pay for his retirement wages, his health insurance costs, and whatever associated costs there are.

Suppose his retirement income is 50% of his working income: during his 30 years working each year he'll need to generate 150% of that to pay for current and future monies assuming the fund is funded in a contemporaneous sense, and not funded by current workers as is usually the case.

When you have a financial contraction, and jobs are cut, you're cutting into the retirement funds available for current retirees.

Two things need to happen: our entire society needs to transition slowly from current workers supporting retired workers, to current workers funding their own retirement funds, federally managed and guaranteed.

Second thing is that the work place needs to be more competitive so that quality workers can be rewarded and poor quality workers can be penalized.

I lied, there is a third thing. CEOs need to not be paid any income if they mess up or if their company loses money. If their company makes money her salary should somehow be pegged against a benchmark. The corporate boards usually look out for each other and frequent the feeding trough.

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scott

Lawrence is right. The disparity in cost that is often quoted is arrived at by taking all wages, including benefits and pensions and dividing it across hours worked. The Big Three have hundreds of thousands of retirees they are supporting, whereas Toyota, et al, operating in this country do not. When you simply look at the hourly wage, there is not much difference.

Also, what percentage of the cost of a car is due to labor costs? I have heard that it is in the 10% ballpark.

I think the problems of the Big Three are not all union driven. Maybe they had a hand in it, but we can not make them out to be the bad guy.

Christine -Oregon

I left Michigan in the early 80's to avoid living in a state that was already on the road to collapse under the unions domination of the economy. If you weren't a big 3 employee, there was a good chance the job was dependent on the supplier revenue streams. Every time there was a strike, the entire state would shiver and finances were strained for months.

The UAW has been parasitic for far too long. They built up a domination of the working culture and the party is over.

I waited to buy my ML320 to have an American built MB, it has been efficient and reliable for 155K+ miles and still runs like new.

As a retired Quality engineer, it is the design and execution of the design that determines quality. Without a good design, the product is doomed to fail.

Most of all, Americans generally became seduced by a more is better philosophy and are as responsible as any car manufacturer or their union.

Very few people bother to look much past the number of cupholders, back seat DVD players, MP3 plug ins or how cool their friends think the car is. Sit in on a focus group or two and figure out how much the MSM and pop culture advertisers have contaminated the thought processes that should be used to make a major purchase.

The bail out needs to be denied, buackruptcy will force feed a reality check on the big 3 and they should fund their warranties through a third party anyway. This would force the automakers to improve quality to lower a cash cost on their warranty purchase.

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Sanns

@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."

There really is no such concept as "deserving...a wage" in a free market. Either the market will accept the costs you chose to bear to produce, or it won't. In this case: if the average salary in a non-unionized auto plant is say $45K, then the UAW-run plants must justify that additional cost (ignoring for the sake of arguement additional overheads, such as 'Job Shops', pensions, executive jets, etc). There are three basic methods to accomplish this: unionized workers produce more, unionized workers produce better quality, or unionized workers' end goods are preferred for some reason (e.g., nationalism). Otherwise, management will be forced to impose a higher price on the end product, and buyers will be incentized to buy the non-unionized company's product instead. Popular perception is that UAW workers actually accomplish the opposite effect on all three methods with only some exception of the latter--both lingering feelings of nationalism and a heavy investment in the truck and SUV markets, which other foreign manufacturers are reluctant to invest in.

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mehmet

I have read recently @ WSJ that actually in terms of productivity American auto makers are as good as their foreign competitors. Also, labor costs (excluding legacy costs) are roughly the same. I can't remember my source, and someone else can check this, but I have also read that per vehicle the big 3 have about $3K - $3.5K of health care and retiree benefit costs. This is the central problem, not productivity.
Without knowing the union contracts or their nature, it is impossible to say anything about productivity.
Second, executive incentives need to be reconsidered. Executives are generally rewarded for short-term performance. They should be rewarded for long-term performance.
Third, labor-management relations at GM and others are antagonistic. Without that changing, I don't see these companies being competitive in the long run because any time there is profit, labor will ask for a piece of it. Instead, profits should be invested back into the firm (i.e., they should not go to neither union nor executive coffers).
Finally, the US automakers actually sell their cars cheaper, if you take into account that much of their sales are fleet sales. Taking into account fleet sales, A Ford Focus sells for $3K less than a Civic, in the same class. Honda has made about $3.2 billion more on Civic than Ford has on its Focus, year-to-date, according to price and sales data. American auto-makers know that they are not making money on the cars they sell, and yet, to meet profit or revenue projections or demands, they use fleet sales as a way to inflate sales. This also hurts the brand's strength. Japanese automakers, until recent past, would not even sell cars to rental car companies. I still do not see a Honda when I rent a car.

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Tzipporah

The government could solve a number of problems here simple by establishing a universal health care PAYMENT system. Cheaper more efficient health care reduces the burden on businesses to pay outrageous premiums, and reduces the influence of unions, since it gives small businesses a more equal footing on which to compete for these workers.

Chris

Regarding post #9: What was the magnitude of the incentives needed to sell each brand's car? Sales of Hondas, for example, required far fewer discounts and incentives than did sales of GM, Ford and Chrysler vehicles.

With all products, some brands command higher prices than others. Price does not necessarily reflect quality. Take watches as an example. You can buy a Rolex Submariner for about $6K or you could buy a more accurate and equally water resistant Seiko divers watch for perhaps $200. Why is the more accurate watch worth so much less? Because of brand positioning and value of the brand.

Regarding a rescue by the taxpayers of the auto industry:
If congress is going to bailout the auto industry -- something difficult for me to support -- there should be this condition: The amount of the bailout should be a multiple, say 500 times, the amount of the unsecured loans made by all C-suite executives and board members. These 'leaders' should be required to make unsecured loans to their companies at least equal to 75% of each individuals net worth.

If these folks aren't willing to put their net worth at risk, than taxpayers should be put at risk either.

Regarding Unions.
Management negotiated and executed the agreements with the unions. If there is a problem with contractual obligations or with inflexible conditions, it's the fault of the parties that signed the agreement.

Management has been hired by the stockholders to run the companies while looking out for the stockholders. Who among you believes that management has done what it was hired to do?

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WholeMealOfFood

Charles

Wow you guys are anti-union. Next thing, someone will be posting about how unions violate the antitrust laws and how individual workers and employers have equal bargaining power when negotiating employment terms.

Let's be honest here - unions can serve an important purpose in ensuring that workers are not completely hosed by management and shareholders. Obviously, management and shareholders get irritated with some of their requests, because they are not always working toward the same goals (e.g., shareholders and employees both want to maximize their own wealth). But without some sort of collective speaking on behalf of employees, there is every reason to believe they would get a raw deal.

That said, unions can sometimes stand in the way of necessary changes, such as restructurings, etc. But it doesn't help anything for shareholders and management to blame everything on unions or to expect union employees to incur all costs of transitions. For instance, it is not unreasonable for a union to resist benefit cuts if executive compensation or shareholder dividends have not likewise been cut. Yeah, unions should not stand in the way of needed restructurings (including some layoffs and buyouts), but the problems at the Big Three have been caused much more by generally crappy management than by overgenerous labor contracts.

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PaulK

There are some really ridiculous statements that need to be corrected. The auto-makers were selling the cars people wanted (which is why GM held on as #1 in sales over Toyota), although they ceded the smallest cars and most luxury cars to imports (although US makers sell smaller cars in Europe and Asia). This worked just fine until gas more than doubled in price followed by an economic shock - this wiped out the market *for everyone*. The problem is that the huge carrying cost of pensions and health care is a burden that Toyota and others do not see (since Gov subsidized in their own countries and minimal coverage in the US). So, even though Toyota and the others also saw a huge drop in car sales, they can ride it out easier (and **will** get bailed out by their own country when/if needed).
The old saws about US car companies producing junky cars that use too much gas and no one wants just stopped being true a long time ago. Besides producing an increasing fleet of hybrids and high mileage cars, they have been doing good work on plug-in cars. But, they did not make SUVs because no one wanted them - they made them because that is what people wanted until gas shot up in price. You can say that they should have predicted that, but we know that the Japanese and Koreans did not expect it either - they were just better prepared because gas is so much more costly in their own countries that their focus is high mileage lower end cars.

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MarkC

Looks to me to be GM vs Japan. Not Gm vs Toyota. I bought a SMART car, built by French union workers. I guess this whole economic meltdown is my fault.

Mark Brucker

No. 9 says people do buy US cars. I think the numbers cited are misleading in some ways. People don't actually buy a lot of them. I think a lot of those sales are fleet sales-to rental car companies, government agencies (which are often forced to buy American), etc. Those sales generate a lot less profit than sales to individuals. Second, by using data from the first 10 months of the year it fails to reflect how drastically sales of US vehicles have declined in the last few months-much more than Toyota, Honda, etc.

David

Yea, for those who disagree, you can also read the Becker-Posner blog which also discussed this topic.

Petteri

You certainly need to level the playing field -- but why do you always want to level the playing field at labor's expense? Why not simply make the benefits unionized autoworkers enjoy mandatory for all automakers, unionized or not?

Beezer

Off loading the legacy costs will help the Big 3 competitive position, but that doesn't really hit until 2010, apparently. The recession has hit now, however, putting the Big 3 in a short term bind. Destroying these companies is unwise.

In the larger picture, most of the world is working very hard to modernize. Wages are comparatively low still, and low wages help the competitive position, particularly if the companies are able to install modern equipment bought, and often made, in more mature economies such as those in the US and Europe.

As it has been forever, labor is the lowest common denominator. No one has yet figured out how to change this dynamic. The majority of workers globally still toil for poverty wages in unsafe working conditions. We, here in America, like lower prices. Thus we have China Mart.

From a purely selfish viewpoint, Americans would prefer to enjoy stability. Most simply want a safe, productive life. But global competition will inevitably and persistantly put those desires at risk.

While much of the globe tries mightily to pull itself out of the mud of grinding poverty, America must not let itself be pulled back. We need to not only protect our industries, but to expand them.

Competition happens. We need to use all our tools, including capitalism. But we need to protect our labor as well. To impose standards that the world can emulate.

As low wage labor struggles to improve its condition, those markets will have greater domestic demand. America's role as the buyer of first, and last, resort will hopefully diminish.

There are no short term fixes here.

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Wade Shaffer

I am amazed at the anger thrust at US automakers. A year ago nobody was complaining about fuel economy and Democrats and Republicans alike voted not to raise CAFE standards on fuel economy. Everyone was buying American and Japanese SUVs and large thirsty cars. American automakers, especially Ford, was making some of the best cars in the world, but they were making and selling them everywhere but here. Why? Consumers wanted SUVs and government abstained from its responsibility to regulate and tax to encourage desirable behavior.
Blaming the unions is moronic. Yes, costs are high, mainly because of health care. Renegotiatie some of the minutiae in the contracts, but accept that organized labor is the only thing that stands between autoworker's contracts and Walmart employee's contracts.
If you really want to help the industry, try an agreement between NHTSA and its European counterpart to recognize each other's safety standards. Suddenly, Ford's Ka, Fiesta and Focus can be brought here cheaply without the need for specific US homologation. Tax the hell out of gas guzzlers. Simple steps can make an enormous difference.

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