Is Big Labor killing the Big Three?

Today’s question: U.S. automakers say the high cost of labor here gives overseas companies an unfair advantage. How much of a problem is Big Labor for Detroit? How much of an advantage -- if at all -- do Honda, Toyota and others have over U.S. companies? Previously, Burtless and Ikenson discussed the automakers’ restructuring plans and whether U.S. car manufacturers should be allowed to slip into bankruptcy.

Bad-selling gas guzzlers are the Big Three’s major problem
Point: Gary Burtless

The Big Three U.S. automakers face a cost disadvantage compared with some of their overseas and foreign-nameplate competitors that manufacture cars in the United States. Part of this disadvantage is because of the labor contracts they have negotiated with the United Auto Workers. By contrast, blue-collar workers employed in foreign-nameplate factories in the U.S. are only rarely covered by union contracts.

The basic hourly wage received by a UAW worker in a Big Three plant is close to that received by a Toyota or Honda worker in a U.S. plant. The UAW-negotiated wage was roughly $28 an hour in 2007. For new workers, the hourly wage was lower; senior workers made more money. The major cost difference between UAW members and employees in foreign-nameplate factories in the U.S. comes in fringe benefits. The UAW has been one more of the more successful American unions in fighting for generous pensions and health benefits for its members.

It is hard to compare the cost of fringe benefits provided to active workers, because foreign-nameplate auto manufacturers in the U.S. do not report all their labor costs in a way that makes a comparison easy. We do know, however, that active workers in a Big Three plant are considerably older than their foreign-nameplate counterparts, meaning the cost of funding their pensions and health benefits are higher. Providing health benefits to a 55-year-old worker can cost as much as three times the money an employer spends on a 25-year-old, even if both workers are covered by an identical plan.

Because the Big Three have an older workforce, their employee benefit costs are higher than those of their foreign-nameplate competitors. This would be the case even if both foreign and domestic producers offered the same benefits packages. Historically, however, the UAW has negotiated better benefits for its workers.

Many critics of the auto giants and the UAW claim that the average hourly wage in Big Three plants is $70 or more. This is an absurd overestimate. It would be more accurate to say that the total labor costs paid by the Big Three are more than $70 per hour actually worked on an assembly line. A large percentage of the total labor cost, however, is paid to retired workers and their dependents, not to active workers. The benefits owed to retirees must be paid by the automakers, regardless of whether any cars are produced in their factories. The legacy costs of paying retirees are vastly more expensive for the Big Three than they are for their foreign-nameplate competitors, whose factories went on line only in the last 25 years.

The Big Three and UAW were no doubt foolish to negotiate contracts that saddled the companies with such enormous legacy costs. The companies and the union have tried to lighten the load by renegotiating health benefits and reducing the companies’ required contributions for retiree benefits. Nonetheless, the companies are on the hook to pay for much higher retiree costs than the ones faced by their foreign-nameplate competitors. Reducing these legacy costs must certainly be part of any rescue package to restore the Big Three to profitability.

Some critics of the UAW claim that the union boosts Big Three costs by reducing management flexibility and cutting worker productivity. In the short run this may be true, but both the automakers and union have adapted to the competitive environment by becoming much more flexible.

The more serious problem faced by the Big Three is the shrinking popularity of their most profitable vehicles. When big, gas-guzzling vehicles were in vogue, the Big Three made a lot of money. This encouraged workers and managers to form unrealistic expectations about the affordability of costly union contracts. Gas-guzzlers are no longer in vogue, and labor costs that were affordable in more prosperous times may kill the companies now.

Gary Burtless, a senior fellow at the Brookings Institution, served in the Carter administration as a staff economist for the Department of Labor and the Department of Health, Education and Welfare.

Cut out organized labor, and GM survives
Counterpoint: Daniel J. Ikenson

Gary,

I agree with your conclusions about the adverse impact of the contracts agreed between labor and management over the years. And no doubt management’s failure to prepare for the day when big trucks and SUVs would fall out of favor is haunting the Big Three.

But something is causing you to hedge on the obvious conclusion (which flows from your own analysis) that the UAW has made the Big Three less flexible and less productive. You say, “In the short run this may be true, but both the automakers and union have adapted to the competitive environment by becoming much more flexible.” That’s like saying, “The brain damage was caused by banging my head with a hammer, but I’m not banging as hard now.” The union has no viable choice but to show maximum flexibility now -- a willingness to demand nothing. Don’t bang on your head at all!

In today’s globalized, just-in-time economy, companies need to be nimble. When the economy slows and demand shrinks, companies need to be able to cut back production and costs commensurately -- or else they shouldn’t expect to survive. That has always been exceedingly difficult for high-fixed-cost industries, but one of the main reasons the Big Three has such high fixed costs is that collective bargaining has made labor a fixed cost. Yes, it has become more variable pursuant to the most recent contract, but it’s still not variable enough. The infamous Jobs Bank is a perfect example. How can General Motors expect to cut costs when demand shrinks if it is obligated to pay obsolete workers almost their entire salaries for two years to not work?

According to GM’s 2008 tax filing, its operating costs in 2007 were $179 billion, of which $53 billion were fixed costs. Included in those fixed costs are “manufacturing labor, pension and other post retirement employee benefits (OPEB) costs, engineering expenses and marketing related costs.” The bulk of those costs is the product of labor-management negotiations. Assign blame to the parties as you see fit, but without the union in play, labor costs certainly wouldn’t be so fixed -- or so high.

Gary, you properly distinguish worker compensation from worker salaries to make the point that current wages between the Big Three and foreign-nameplate workers isn’t that vast. That’s true but, I think, irrelevant to the analysis. Total compensation is the cost of labor to the companies, and for GM it is about $73 per hour and for Toyota about $48. The average cost differential between the Big Three and all the foreign nameplate companies is about $30 per hour. That’s huge.

GM is testifying before Congress that it has two choices: to get bailed out and continue operating or go belly up at year’s end. Why does it have to be all or nothing? GM needs to cut about $2.5 billion of operating costs from its budget per month to stop the bleeding (under a scenario of no change in revenues). It might be able to do that if it had the flexibility to close plants, fire workers, cut salaries and reduce pensions and healthcare benefits. But thanks to the union contract, it doesn’t have that flexibility.

Foreign-nameplate producers account for half of auto production and sales in the United States. A quarter-century of competition between the Big Three producers and the foreign nameplates has allowed a comparison of two models of production. I think there’s plenty of evidence to conclude that the firms that don’t use organized labor are better suited to survive the current downturn in demand. Perhaps it has something to do with better management or a more efficient culture, but the fact remains that the half of the U.S. auto industry whose workers are not organized (the foreign-nameplate producers) are in much better fiscal shape than the Big Three.

Daniel J. Ikenson is associate director of the Cato Institute’s Center for Trade Policy Studies.