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More Bad Times for Basic Industry

A. Gary Shilling is a New York-based economic consultant and author of "Is Inflation Ending? Are You Ready?" published by McGraw-Hill

U.S. basic industries--steel, autos, rubber and textiles--are in deep trouble. Imports, pouring in at an accelerated rate, are encroaching on an ever-widening segment of U.S. markets. Direct imports plus finished products now account for about half of all U.S. steel consumption; in autos, imports have captured nearly a third of all car sales.

As a result, basic industry plants are closing, once impregnable industrial giants are filing for bankruptcy and employment is rapidly shrinking. In the past decade, the United Steelworkers has lost two-thirds of its membership.

Companies that were once proud of their involvement in basic industry are avoiding it like the plague. Even the names of products are disappearing from their corporate logos: International Harvester becomes Navistar; U.S. Steel becomes USX.

Basic industry’s many problems stem from its unwillingness to reduce costs. In the past, these highly concentrated industries were dominated by a handful of cartel-like companies who controlled the market, set the prices and could buy labor peace by granting their workers exorbitant pay increases and passing the added costs on to their customers.

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The cartel mentality dies hard. Although imports have made cartel-like control of many markets impossible, past practices persist--and both executives and workers are guilty of them. Thus, the U.S. steelworker’s total compensation, including benefits, averaged $37,635 in 1985. Yet, non-unionized workers with comparable skills earned, according to my firm’s calculations, only $22,485.

Overpaid Workers

In other words, the steel industry’s wages are 67% higher than what other Americans willingly work for. Other basic industries also overpay their workers: The auto industry pays a 66% premium, rubber 61%, paper 47%.

(To derive the market wages, we divided blue-collar employment in the industries by skill groups and then applied to each group the pay rates it earns at a typical non-union plant. The skills involved, health risks, etc. would be the same in the non-union facilities.)

Actual wages in the United States considerably exceed those in West Germany and Japan. In the steel industry, actual worker compensation in the United States was $17.36 an hour in 1984, the latest year for which foreign data is available. In West Germany, it was $13.38 and in Japan, $15.32. However, the U.S. market wage in steel was only $10.39--extremely competitive with both West Germany and Japan. A similar situation exists in other basic industries, including autos.

(Foreign wages are converted into dollars at second-quarter 1986 average exchange rates, to reflect the improvement in the U.S. competitive position since the recent decline of the dollar.)

Productivity in many U.S. industries is actually lower than abroad. Yet the anachronistic cartel-like mentality prevents unions in even the hardest-hit industries from making wage concessions that would have narrowed these differentials. On the contrary, workers sometimes choose to strike even if their companies are on the brink of bankruptcy.

Basic industries’ top brass also seem wedded to the trappings of the cartel-like past. In the 1980-85 period, as steel and auto imports surged, salaries and bonuses of these industries’ top executives grew rampantly. In steel, the chief executives enjoyed a 60% increase, compared to 16% for production workers, and auto executives’ pay rose 246% while workers got only 33% more. This was not a very good way to encourage unions to make concessions.

As a result, the atrophy of basic industry is likely to go on. Imports will probably capture even larger shares of American markets, and U.S. industrial companies will either continue to diversify out of basic industries or move production offshore. Soon, the day may come when USX will decide to modify its name yet again, this time by getting the “U.S.” part out of it: Like the “Steel” part, which disappeared a few months ago, it would no longer reflect reality.

Problems With Service Economy

“Good riddance to bad rubbish,” some may say. Indeed, why not get rid of dirty basic industries and let other countries produce our autos and steel, while we concentrate on clean, non-cyclical high tech and services?

This may seem wonderful, but, unfortunately, converting to a fully service-oriented economy would be very costly. Yes, manufacturing and mining workers are grossly overpaid by international standards, but their extra incomes add to the purchasing power in the economy. A job of a motor vehicles employees, for instance, contributes roughly twice the purchasing power of a job in service-producing industries. Using an admittedly extreme example, if all mining and manufacturing businesses and jobs in the United States disappeared and were replaced by service activities, total non-farm private sector compensation would fall 10% and total economic activity would decline 8%.

Secondly, importing all of the basic manufactures we consume would widen our already tremendous trade gap unless offsetting exports could be found. Our current account deficit--the difference between exports and imports of all goods and services--was $118 billion in 1985, which amounts to a loss of 3 million American jobs abroad. The exodus of all mining and manufacturing could raise the deficit another $900 billion and cost another 22.5 million jobs.

The necessity to finance the existing trade gap has already made the United States a net international debtor. It is questionable whether foreigners will continue to finance this deficit level indefinitely, let alone if it grows to more than $1 trillion.

How can the problem be solved? Basic industries probably won’t abandon their cartel-like mentality fast enough to become competitive--especially as production shifts from Europe and Japan to even lower-cost producers, such as the newly industrialized countries (NICs) in Asia and Latin America.

In 1985, our trade deficit with the six largest NICs--Brazil, Hong Kong, South Korea, Mexico, Singapore and Taiwan--accounted for almost a quarter of the total. And in 1986, the figures point to a further widening of this gap. By August, Taiwan’s surplus with the United States already surpassed last year’s total of $13.1 billion.

The NICs’ success is not surprising. Brazil and South Korea, for instance, paid their manufacturing workers an average of $1.27 an hour in 1984 in wages and benefits--exactly one-tenth of the average U.S. manufacturing wage. Since their cost advantages are so enormous, only capacity constraints are preventing these countries’ exports from blowing away entire U.S. industries, but their capacity is catching up fast.

As import penetration grows, calls for protectionist measures will, in all probability, get even louder, and many industries and their unions are betting that sooner or later they will be heard. Thus, the USW has apparently decided to make very few wage or work-rule concessions to domestic steelmakers, as evidenced by its current strike against USX.

The union’s president, Lynn Williams, justifies its position by noting that no amount of give-backs could solve the steel industry’s problems and that sharp curbs on steel imports are the only solution.

Despite the Reagan Administration’s determined anti-protectionist stance, import restrictions may ultimately carry the day.

Since national security probably requires basic industries of a certain size, some domestic production capacity in steel, auto, rubber, etc. will be retained through protectionist legislation. This is a solution but an unfortunate one, since these industries are likely to remain overpriced, anti-competitive and permeated with the same cartel-like mentality that makes them losers today.


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