FDR, Wage Ceiling, Arsenal of Democracy, Benefits, Big Three, Japanese Competition, Legacy Costs, Business Cycle and Bailouts

Posted by PITHOCRATES - February 14th, 2012

History 101

After the Arsenal of Democracy defeated Hitler the Wage Ceiling was Gone but Generous Benefits were here to Stay

FDR caused the automotive industry crisis of 2008-2010.  With his progressive/liberal New Deal policies.  He placed a ceiling on employee wages during the Great Depression.  The idea was to keep workers’ wages low so employers would hire more workers.  It didn’t work.  And there was an unintended consequence.  As there always is when government interferes with market forces.  The wage ceiling prevented employers from attracting the best workers by offering higher wages.  Forcing employers to think of other ways to attract the best workers.  And they found it.  Benefits.

Adolf Hitler ended the Great Depression.  His bloodlust cut the chains on American industry as they tooled up to defeat him.  The Arsenal of Democracy.  America’s factories hummed 24/7 making tanks, trucks, ships, airplanes, artillery, ammunition, etc.  The Americans out-produced the Axis.  Giving the Allies marching towards Germany everything they needed to wage modern war.  While in the end the Nazis were using horses for transport power.  This wartime production created so many jobs that they even hired women to work in their factories.  Bringing an end to the Great Depression finally after 12 years of FDR.

The Arsenal of Democracy defeated Hitler.  U.S. servicemen came home.  And the women left the factories and returned home to raise families.  With much of the world’s factories in ruins the U.S. economy continued to hum.  Only they were now making things other than the implements of war.  The auto makers returned to making cars and trucks.  The ceiling on wages was gone.  But those benefits were still there.  Greatly increasing labor costs.  But what did they care?  The American auto manufacturers had a captive audience.  If anyone wanted to buy a car or truck there was only one place to buy it.  From them.  No matter the cost.  So they just passed on those high wages and expensive benefit packages on to the consumer.  Times were good.  The Fifties were happy times.  Good jobs.  Good pay.  Free benefits.  Nice life in the suburbs.  All paid for by expensive vehicle prices.

The Big Three could not Sell Cars when there was Competition because of their Legacy Costs

But it wouldn’t last.  Because it couldn’t last.  For those factories destroyed in the war were up and running again.  And someone noticed those high prices on American cars.  The Japanese.  Who rebuilt their factories.  Which were now humming, too.  And they thought why not enter the automotive industry?  And this changed the business model for the Big Three (GM, Ford and Chrysler) as they knew it.  The Big Three had competition for the first time.  Their captive audience was gone.  For the consumer had a choice.  They could demand better value for their money.  And chose not to buy the ‘rust buckets’ they were selling in the Seventies.  Cars that rusted away after a few snowy winters.  Or a few years near the ocean coast.

The new Japanese competition started about 30 years after U.S. workers began to enjoy all those benefits.  So the U.S. car companies paid their union auto workers more and gave them far more benefits than their Japanese competition.  And those early U.S. workers were now retiring.  Giving a great advantage to the Japanese.  Because those generous benefits provided those U.S. retirees very comfortable pensions.  And all the health care they could use.  All paid for by the Big Three.  Via the price of their cars and trucks.

Well, you can see where this led to.  The Big Three could not sell cars when there was competition.  Because of these legacy costs.  Higher union wages.  Generous pension and health care benefits that workers and retirees did not contribute to.  (By the time GM and Chrysler faced bankruptcy in 2010 there were more retirees than active union workers).  The United Automobile Workers (UAW) jobs bank program where unemployed workers (laid off due to declining sales) collected 95% of their pay and benefits.  (You can find many quotes on line from a Detroit News article stating some 12,000 UAW workers were collecting pay and benefits in 2005 but not working.)  The Japanese had none of these costs.  And could easily build a higher quality vehicle for less.  Which they did.  And consumers bought them.  The Big Three conceded car sales to the Japanese (and the Europeans and South Koreans) and focused on the profitable SUV and truck markets.  To pay these high legacy costs.  Until the gas prices soared to $4/gallon.  And then the Subprime Mortgage Crises kicked off the Great Recession.  Leading to the ‘bankruptcy’ of GM and Chrysler.  And their government bailouts.

The U.S. Automotive Government Bailout cut Wage and Benefits once Set in Stone

The Big Three struggled because they operated outside normal market forces.  Thanks at first to a captive audience.  Then later to friends in government (tariffs on imports, import quotas, union-favorable legislation, etc.).  All of this just delayed the day of reckoning, though.  And making it ever more painful when it came.

During economic downturns (when supply and prices fall) their cost structure did not change.  As it should have.  Because that’s what the business cycle does.  It resets prices and supply to match demand.  With recessions.  Painful but necessary.  Just how painful depends on how fast ‘sticky’ wages can adjust down to new market levels.  And herein lies the problem that plagued the Big Three.  Their wages weren’t sticky.  They were set in stone.  So when the market set the new prices for cars and trucks it was below the cost of the Big Three.  Unable to decrease their labor (wage and benefit) costs, profits turned into losses.  Pension funds went underfunded.  And cash stockpiles disappeared.  Leading the Big Three to the brink of bankruptcy.  And begging for a government bailout.

Well, the bailout came.  The government stepped in.  Gave the union pension fund majority control of the bailed out companies.  Screwing the bondholders (and contract law) in the process.  And created a two-tier labor structure.  They grandfathered older employees at the unsustainable wage and benefit packages.  And hired new employees at wage and benefit packages that the market would bear.  Comparable to their Asian and European transplant auto plants in the right-to-work states in the southern U.S. states.  And put the market back in control of the U.S. auto industry.  For awhile, at least.

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Business Cycle

Posted by PITHOCRATES - February 13th, 2012

Economics 101

When you have a Captive Audience you can Charge whatever Prices you Want

Go to a football game lately?  Hockey?  Basketball?  Baseball?  It’s a pretty expensive day out.  Especially if you eat while in the stadium.  Those concession prices are pretty steep.  In fact, people say that stadium food is some of the most expensive food anywhere.  I don’t.  I say it is some of the highest quality and some the most fairly priced food you’ll find anywhere…in the stadium.

Stadium food is convenient food.  And that’s what you’re paying for.  Convenience.  Because it’s too great of an inconvenience to leave the stadium to buy a more reasonably priced hotdog someplace else.  And despite what the critics say of concession pricing, those concessions have long lines.  Because people may say the prices are too high.  But deep down they know what a bargain they are.  Delicious food cooked and sold only steps away from their seat.  It’s better than at home.  And there’s no cleanup.

When you have a captive audience you can pretty much charge what you want.  Because the market is fixed.  Stadiums charge a fortune for those concession spaces.  Because running a big stadium is expensive.  And it’s not really used all that often.  I mean, there are only 8 home games in the regular season in football.  Doesn’t give the stadiums much time to earn revenue to pay for these expensive things.  So they charge high fees wherever they can.  So the concessioners have to pass that cost on to the customer.  As all businesses do.  And when you have a captive audience it’s a whole lot easier to do this.  Because, where else are the people going to go?

Competition Increases Quality and Lowers Prices for Consumers

Let’s look at this in another way.  Say you have a friend who works for a catering company.  He drives a ‘roach coach’.  He stops at the factories and local construction site to sell food to hungry workers.  He sees the money these trucks make.  Considers his paycheck.  And thinks he’s tired of making his boss rich.  So he buys a truck for himself.  And looks for his own territory.

Now let’s say you go on an evening bike ride on weekends.  And you come across your friend.  He’s found some prime real estate to park his roach coach on.  In the median of a boulevard across from an automobile assembly plant gate.  Where he has a captive audience.  Hungry workers working the midnight shift with no place else to buy delicious food.  Business is good.  You stop by on your bike ride and buy a snack and chat.  Then one night you noticed a beat up Ford Pinto pull up in the median not far from your friend’s truck.  He pops the hatch.  And you start smelling something.  Something good.  Fresh pizzas.  And hot fresh subs.  This guy owns a pizzeria.  And just closed for the night.  After filling his car with fresh pizzas, hot fresh subs and soda.  And just like that business wasn’t so good for your friend anymore.  For fresh pizza and hot fresh subs are more delicious than the sandwiches and cans of stew your friend was selling.  But one thing the Pinto didn’t have that your friend did.  Ice.  He was selling warm soda.  Or trying to.  Your friend had cold soda.  And that was just what the doctor ordered on a hot, humid, summer night.  Your friend was now sharing his captive audience.  Selling less than he was.  And at lower prices because of this new competition.  But he was still able to turn a profit and make his truck payment.

Then the Pinto guy took it up a notch.  One night, as the workers headed out into the median on break, he pulled out a tub filled with ice.  And soda.  “Cold soda,” he barked.  “Ice cold soda.”  This squeezed your friend’s sales even more.  He had nothing left to compete with but price.  So he lowered his prices even further.  Barely breaking even.  Then one night someone else pulled up on the median.  A beat up AMC Gremlin.  Some kid just out of high school got out.  Popped the hatch.  And started barking, “Fresh McDonald Big Macs.  French fries.”  And, of course, ice cold soda.  The kid didn’t have a lot.  But what he had he was selling at a nice markup.  Which was enough for him.  Because he had no overhead.  And made enough to by some beer later that night.  A very modest sales goal.  But it split that captive audience three ways.  Soon your friend was losing money.  Then the economy went into recession.  And they discontinued the midnight shift.  Your friend lost his truck.  And went back to driving a truck for his former boss.  The Pinto guy increased his pizzeria’s delivery radius to make up for the loss business.  And hired the Gremlin kid to help with those deliveries.

The Business Cycle is a Natural and Necessary Part of the Economy and is the Only Way Supply adjusts to Demand 

From the perspective of the workers increasing competition made things better.  Competition gave them more variety.  Higher quality.  And lower prices.  Over time that competition gave them more value for their money.  This microcosm of the economy was booming for awhile.  Others jumped in.  Making investments.  Increasing their inventories.  But eventually they expanded too much.  Supply exceeded demand.  Some inventory went unsold.  Prepared food not being something you can return these people had no choice but to cut their prices.  To reduce those burgeoning inventories.  The guy with the highest overhead, your friend with the catering truck, was the first to fail.  Then the market collapsed completely with the elimination of the midnight shift.  So the other two had to shutter their operations there.

We call this the business cycle.  It’s the boom-bust cycle of the economy.  From good economic times (boom) to recessions (bust).  It’s the natural ebb and flow of economic exchange.  When the market presents a demand to be met supply flows into it.  At first prices and profits are high.  Like at a stadium with a captive audience.  Then competition moves in.  Unlike at a stadium.  That demand is now split between the competition.  Each sells less.  And profits less.  To try and increase sales they try to offer better value for the money.  Tastier food.  Colder soda.  Etc.  When that doesn’t work any longer they start lowering prices.  But because supply built up so much as eager competitors joined in get a piece of that action supply grew so much it exceeded demand.  And no amount of price cutting can fix that.  Only a recession.  To reset prices and supply to meet market demand.  Which means some businesses fail.  Those who don’t lay off employees.  To reset their prices and production to levels that meets demand.

Monetary and fiscal policy tries to massage this business cycle.  By softening the recession part of it.  By lowering interest rates.  To encourage businesses to invest and expand production.  And hire more employees.  Or by increasing government spending.  Creating jobs by building roads and bridges.  Or by simply giving more money to consumers (via tax cuts or stimulus checks) to encourage them to buy more.  Thus encouraging businesses to hire more workers.  To meet this ‘higher’ demand.  Of course, in our example, this wouldn’t have helped our three businesses.  None of them would have borrowed cheap money to increase supply.  Not when supply already exceeded demand.  In fact no amount of monetary or fiscal policy action would have helped.  It certainly wouldn’t have added back that midnight shift.  Unless the government started buying cars for people.  Which might have put people back to work on that midnight shift.  But such an expansion of government spending would have increased taxes.  So high that it would have reduced economic activity elsewhere.  As it transferred this money out of the private sector and into the public sector.  Saving a few jobs at the cost of consumers everywhere paying higher taxes.

The business cycle is a natural and necessary part of the economy.  It’s how supply adjusts to demand.  And the only way supply adjusts to demand.  Thanks to prices.  That automatic mechanism that tells businesses exactly where supply should be.  And by interfering with this you make markets operate blindly.  Unable to know when supply exceeds demand.  So supply keeps increasing even after it already exceeds demand.  Creating bubbles.  And when the bubble bursts prices plummet.  To unload those burgeoning inventories.  Making recessions longer and more painful than they need be.

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