Roosevelt, Wage and Price Controls, Fringe Benefits, Health Insurance, Pensions, Unions, Bankruptcy and Bethlehem Steel

Posted by PITHOCRATES - September 3rd, 2013

History 101

(Originally published November 20th, 2012)

The Roosevelt Administration fought Inflation by Passing a Law to Cap Employee Wages

Most times when those in government try to fix things they end up making things worse.  Giving us the unintended consequences of their best intentions.  And the government had some good intentions during World War II.  They were printing money to pay for a surge in government spending to pay for war production.  As well as a host of New Deal programs.  Which sparked off some inflation.  Inflation is bad.  Enter their best intentions.

One of the biggest drivers of inflation is wages.  Higher wages increase a company’s costs.  Which they must recover in their selling prices.  So higher wages lead to higher prices.  Higher prices increase the cost of living.  Making it more difficult for workers to get by without a pay raise.  Which puts pressure on employers to raise wages.  If they do they pass on these higher costs to their customers via higher prices.  It’s a vicious cycle.  And one all governments want to avoid.  Because higher costs reduce economic activity.  And that’s how governments get their money.  Taxing economic activity.

Enter wage and price controls.  The Roosevelt administration thought the way to solve the problem of inflation was simply passing a law to cap employee wages.  To halt the vicious cycle of escalating prices and wages.  Something employers didn’t like.  For that’s how they got the best people to work for them.  By offering them higher wages.  With that no longer an option what did these employers do to get the best people to work for them?  They started offering fringe benefits.  Which became a killer of business.

As People lived longer in Retirement Retiree Pension and Health Care Expenses Soared

Employers began offering health insurance and pensions as fringe benefits for the first time.  To get around the wage and price controls of the Roosevelt administration.  Which they had to pass on to their customers via higher prices.  So the wage and price controls failed to do what they were supposed to do.  Keep a company’s costs down.  Worse, these benefits made promises many of these businesses just couldn’t keep.

Roosevelt also empowered unions.   Who would negotiate ever more generous contracts.  By demanding generous pay and benefits for current workers.  And pensions and health care for retired workers.  But it didn’t end there.  The unions also expanded their membership as much as possible.  So in those contracts they also got very costly workplace rules.  If a lamp burnt out at a workstation the worker had to call an electrician to replace the lamp.  They could not screw in a new lamp themselves.  The unions defined every work activity in a workplace and created a job classification for it.  And only a worker in that job classification could do that work.  Which swelled the labor rolls at unionized plants.  Who all were receiving generous pay and benefits.  As were a growing number of retired workers.  Greatly increasing labor costs.

For awhile businesses could absorb these costs.  Business was growing.  As was the population.  There were more younger workers entering the factories than there were older workers retiring from them.  But things started changing in the Sixties.  The population growth rate flattened out thanks to birth control and abortion.  So as the population grew slower the domestic demand for manufactured goods fell.  While in the Seventies foreign competition increased.  So you had falling demand and a rising supply.  Making it harder to pass on those high labor costs anymore.  Which proved to be a great problem as their market share fell.  For as they laid off employees fewer and fewer workers were paying the pensions and health care costs for an ever growing number of retirees.  Pensions were chronically underfunded.  Worse, people began to live longer in retirement thanks to advances in medicine.  Increasing retiree pension and health care expenses for these businesses.  Bleeding some of them dry.

Bethlehem Steel filed Bankruptcy when they had 11,500 Active Workers and 120,000 Retirees and Dependents

Bethlehem Steel helped build America.  And win World War II.  It made the steel for the Golden Gate Bridge.  And the bridges between New York and New Jersey.  Many of the skyscrapers you see on Manhattan are made with Bethlehem steel.  Little Steel.  Second only to Big Steel.  U.S. Steel.  Big Steel and Little Steel dominated the US steel industry.  Until, that is, foreign competition entered their market.  And the steel minimills arrived on the scene.  Neither of which had unionized workforces.  Or those legacy costs (retiree pension and health care expenses).  Which spelled the doom of the sprawling Bethlehem Steel.  From 1954 to 2003 hot-rolled steel sheet prices rose 220%.  While wages soared over 900%.  And it got worse.

Employment peaked in 1957 at 167,000 workers.  By the mid Eighties that fell to 35,000.  With some 70,000 retirees and dependents.  That is, Bethlehem’s retiree costs were about twice their active labor costs.  As business continued to fall employment fell to 11,500.  While their retirees and dependents rose to 120,000.  Just over 10 retirees for each active worker.  Unfunded pension obligations soared to $4.3 billion.  Just impossible numbers to recover from.  Which is why Bethlehem Steel is no longer with us today.  The company was dissolved in 2001.  With International Steel Group (ISG) buying some of their remaining assets.  Then, in 2005, a foreign steel company, Mittal Steel, merged with ISG.  Leaving no remnants of Bethlehem Steel in American hands.

ISG got the steelworkers union to reduce the number of job classifications in the Bethlehem plants they took over from 32 to 5.  Greatly shrinking the labor rolls.  And increasing efficiency.  Helping these remaining assets to move forward.  The pension fund was taken over.  With retirees losing only about $700 million, giving retirees a pension of up to $44,386.  But retirees lost their health care.  Some $3.1 billion in spending obligations that the company couldn’t pay.  And didn’t.  A sad ending for an American great.  A failure the Roosevelt administration was responsible for.  As their good intentions resulted in unintended consequences.  Setting businesses up to fail with costly fringe benefits.  Adding yet another demand to the union’s list of demands.  Spending obligations these businesses couldn’t pay once domestic demand fell while steel supplies rose.  Leading to the inevitable.  Bankruptcy of large unionized companies.

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Trend Analysis GM and Toyota 2005—2008

Posted by PITHOCRATES - January 29th, 2013

History 101

GM’s Problems were caused by Franklin Delano Roosevelt and his Ceiling on Wages

The GM bailout is still controversial.  It was part of the 2012 campaign.  It was why we should reelect President Obama.  Because Osama bin Laden was dead.  And General Motors was alive.  But the bailout didn’t fix what was wrong with GM.  Why it went bankrupt in the first place.  The prevailing market price for cars was below their costs.  And what was driving their costs so high?  It was labor.  It was the UAW wage and benefit package that made it impossible for GM to sell a car profitably.

GM’s problems go back to Franklin Delano Roosevelt.  The country was suffering in the Great Depression with double-digit unemployment.  He wanted to get businesses to hire people.  To reduce unemployment.  And pull us out of the Great Depression.  So how do you get businesses to hire more people?  Hmmm, he thought.  Pay people less so businesses have more money to hire more people.  It was brilliant.  So FDR imposed a ceiling on wages.  Why did FDR do this?  Because he was from a rich family who didn’t understand business or basic economics.

Of course there was one major drawback to this.  How do you get the best talent to work for you if you can’t pay top dollar?  Normally the best talent can go to whoever pays the most.  But if everyone pays the same by law you might as well work at the place closest to your house.  Or across from the best bars.  No, if a business wanted the best workers they had to figure out how to get them to drive across town in rush hour traffic and sit in that traffic on the way home.  A real pain in the you-know-what.  So how to get workers to do that if you can’t pay them more?  You give them benefits.

Toyota doesn’t have the Legacy Costs that Bankrupted an Uncompetitive GM

And this was, is, the root of GM’s problems.  Those generous pension and health care benefits.  Things we once took care of ourselves.  Before our employers started providing these.  And the UAW really put the screws to GM.  Getting great pay, benefits and workplace rules.  For both active workers.  And retirees.  Even laid-off workers.  Such as the job bank.  Where GM paid workers who had no work to do.  It’s benefits like this that have bankrupted GM.  Especially the pensions and health care costs for retired workers.  Who outnumbered active workers.  Those people actually assembling the cars they sell.

It’s these legacy costs that have made GM uncompetitive.  Toyota, for example, didn’t suffer the FDR problem.  So their costs for retired workers don’t exceed their costs for active workers.  In fact let’s compare GM and Toyota for the four years just before GM’s government bailout (2005-2008).  We pulled financial numbers from their annual reports (see GM 2005 & 2006, GM 2007 & 2008, Toyota 2005 & 2006 and Toyota 2007 & 2008).  We’ve used some standard ratios and plotted some resulting trends.  Note that this is a crude analysis that provides a general overview of the information in their annual reports.  A proper analysis is far more involved and you should not construe that the following is an appropriate way to analyze financial statements.  We believe these results show general trends.  But we offer no investment advice or endorsements.

GM Toyota Current Ratio

We get the current ration by dividing current assets by current liabilities.  These are the assets/liabilities that will become cash or will have to be paid with cash within 12 months.  If this ratio is 1 it means current assets equals current liabilities.  Meaning that a business will have just enough cash to meet their cash needs in the next 12 months.  If the number is greater than 1 a business will have even a little extra cash.  If the number is less than 1 a business is in trouble.  As they won’t have the cash to meet their cash needs in the next 12 months.  Unless they borrow cash.  Toyota’s current ratio fell slightly during these 4 years but always remained above 1.  Falling as low as 1.01.  Whereas GM’s current ratio was never above 1 during these 4 years.  And only got worse after 2006.  Showing GM’s financial crash in 2008.

The GM Bailout did not address the Cause of their Bankruptcy—UAW Pensions and Health Care Benefits

There are two basic ways to finance a business.  With debt.  And equity.  Equity comes from outside investors (when a business issues new stock).  Or from profitable business operations.  Which typically accounts for the majority of equity.  Profitable business operations are the whole point of running a business.  And it’s what raises stock prices.  To see which is providing the financing of a business (debt or equity) we calculate the debt ratio.  We do this by dividing total liabilities by total assets.  If this number equals 1 then total assets equal total liabilities.  Meaning that 100% of a business’ assets are financed with debt.  And 0% with equity.  Lenders do not like seeing this.  And will be very reluctant to loan money to you if your business operations cannot generate enough profits to build up some equity.  And that was the problem GM had.  Their business operations could not generate any profits.  So GM had to keep borrowing.

GM Toyota Debt Ratio

GM went from bad to worse after 2005.  Their debt ratio went from 1.02 in 2006.  To 1.24 in 2007.  And to 1.94 in 2008.  Indicating massive borrowings to offset massive operating losses.   And how big were those losses?  They lost $17.806 billion in 2005.  $5.823 billion in 2006.  $4.309 billion in 2007.  And in the year of their crash (2008) they lost $21.284 billion.  Meanwhile Toyota kept their debt ratio fluctuating between 0.61 and 0.62.  Very respectable.  And where lenders like to see it.  As they will be more willing to loan money to a company that can generate almost half of their financing needs from profitable business operations.  So why can’t GM?  Because of those legacy costs.  Which increases their cost of sales.

GM Toyota Cost of Sales

GM’s cost of sales was close to 100% of automotive sales revenue these 4 years.  Even exceeding 100% in 2008.  And it’s this cost of sales that sent GM into bankruptcy.  Toyota’s was close to 80% through these 4 years.  Leaving about 20% of sales to pay their other costs.  Like selling, general and administrative (S,G&A).  Whereas GM was already losing money before they started paying these expenses.  Thanks to generous UAW pay and benefit packages.  The job bank.  And the even greater costs of pensions and health care for their retirees.  It’s not CEO compensation that bankrupted GM.  It was the UAW.  As CEO compensation comes out of S,G&A.  Which was less than 10% of sales in 2007 and 2008.  Which was even less than Toyota’s.

GM Toyota S G and A

GM’s costs kept rising.  But they couldn’t pass it on to the consumer.  For if they did the people would just buy a less expensive Toyota.  So GM kept building cars even though they couldn’t sell them competitively.  And sold them at steep discounts.  Just to make room for more new cars.  So the UAW could keep building cars.  Incurring massive losses.  Hoping they could make it up in volume.  But that volume never came.

GM Toyota Automotive Sales as percent of 2005

Toyota continued to increase sales revenue year after year.  But GM’s sales grew at a flatter rate.  Even falling in 2008.  It was just too much.  GM was such a train wreck that it would have required a massive reorganization in a bankruptcy.  Specifically dealing with the uncompetitive UAW labor.  Especially those pensions and health care benefits for retirees.  Which the government bailout did not address.  At all.  The white collar workforce lost their pensions.  But not the UAW.  In fact, the government bailout went to bolster those pension and health care plans.  So the underlying problems are still there.  And another bankruptcy is likely around the corner.

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The Taxpayers to lose Billions on the GM Bailout and likely will have to bail GM out Again

Posted by PITHOCRATES - December 22nd, 2012

Week in Review

GM could have filed bankruptcy.  Like many companies do.  They reorganize.  Fix the problems that caused them to go bankrupt.  Then they emerge leaner and meaner.  And are able to compete in the market that bankrupted them before their reorganization.  That’s the usual path.  GM did not take it.  Why?  Because the thing that bankrupted GM was its high union costs.  Especially their legacy costs.  Paying pension and health care costs for more retirees than they have active workers.

Had they gone through a normal bankruptcy they would have made GM competitive again.  Which meant doing something to those costly union contracts.  But as the UAW is a valuable resource for the Democrat Party President Obama swept in and protected the UAW.  Giving them the money they needed to fund those pension plans.  Without fixing their competiveness problem.  Meaning they will likely need another bailout (see GM to benefit from tax break for years by David Shepardson posted 12/20/2012 on The Detroit News).

The Treasury Department’s decision to begin its exit from General Motors Co., despite low stock prices, means U.S. taxpayers are almost certain to incur large losses on the $49.5 billion bailout of the Detroit automaker.

At current stock prices, the government stands to lose nearly $13 billion.

To break even, it would need to sell its remaining 300 million shares for about $70 each. The Treasury will sell its remaining shares over the next 15 months, likely in a series of small sales, and that could stem some of the losses.

Unlike the 1980 Chrysler bailout, the Obama administration didn’t require GM to repay all of its government funds. Instead, the government swapped about $42 billion for a 61 percent equity stake in the automaker.

Former auto czar Steve Rattner said the government made the decision because it didn’t want the new GM to be carrying crushing debt. Instead, it gave GM billions of dollars after its bankruptcy to operate.

GM also got other financial benefits. For example, it has legally avoided paying federal income taxes since exiting bankruptcy, even though it has earned $16 billion in profits.

And GM likely will pay no income taxes for many years, because Treasury rulings let GM use $18 billion in losses from the “old GM” left behind in bankruptcy to offset profits.

Interesting.  We’re going to raise taxes on small business owners (those S corporations and LLCs who earn more than $250,000 in business profits that pass through to their personal tax returns) because those who can afford to pay a little more should.  But a company earning $16 billion (yes, that’s billion with a ‘B’) in profits doesn’t have to pay any income taxes.  Why?  Small business owners create far more jobs than GM does.  So why does GM get preferential treatment?  Because small businesses aren’t unionized.  And don’t pay union dues that feed back to the Democrat Party.

When the Carter administration bailed out Chrysler they at least got all of our money back.  They made no gifts of taxpayer money.  If that wasn’t bad enough our gift to GM didn’t fix their competitiveness problem.  So that when GM once again pays income taxes they will be right back where they were before.  Starved of cash.  And unable to fund their pension plans.

Had GM gone through a normal bankruptcy they would already be back in business.  Competitive.  And paying income taxes.  Without the taxpayers picking up the tab.  President Obama didn’t save GM.  He saved the UAW.  Who will eventually destroy GM with their legacy costs.

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Roosevelt, Wage and Price Controls, Fringe Benefits, Health Insurance, Pensions, Unions, Bankruptcy and Bethlehem Steel

Posted by PITHOCRATES - November 20th, 2012

History 101

The Roosevelt Administration fought Inflation by Passing a Law to Cap Employee Wages

Most times when those in government try to fix things they end up making things worse.  Giving us the unintended consequences of their best intentions.  And the government had some good intentions during World War II.  They were printing money to pay for a surge in government spending to pay for war production.  As well as a host of New Deal programs.  Which sparked off some inflation.  Inflation is bad.  Enter their best intentions.

One of the biggest drivers of inflation is wages.  Higher wages increase a company’s costs.  Which they must recover in their selling prices.  So higher wages lead to higher prices.  Higher prices increase the cost of living.  Making it more difficult for workers to get by without a pay raise.  Which puts pressure on employers to raise wages.  If they do they pass on these higher costs to their customers via higher prices.  It’s a vicious cycle.  And one all governments want to avoid.  Because higher costs reduce economic activity.  And that’s how governments get their money.  Taxing economic activity.

Enter wage and price controls.  The Roosevelt administration thought the way to solve the problem of inflation was simply passing a law to cap employee wages.  To halt the vicious cycle of escalating prices and wages.  Something employers didn’t like.  For that’s how they got the best people to work for them.  By offering them higher wages.  With that no longer an option what did these employers do to get the best people to work for them?  They started offering fringe benefits.  Which became a killer of business.

As People lived longer in Retirement Retiree Pension and Health Care Expenses Soared

Employers began offering health insurance and pensions as fringe benefits for the first time.  To get around the wage and price controls of the Roosevelt administration.  Which they had to pass on to their customers via higher prices.  So the wage and price controls failed to do what they were supposed to do.  Keep a company’s costs down.  Worse, these benefits made promises many of these businesses just couldn’t keep.

Roosevelt also empowered unions.   Who would negotiate ever more generous contracts.  By demanding generous pay and benefits for current workers.  And pensions and health care for retired workers.  But it didn’t end there.  The unions also expanded their membership as much as possible.  So in those contracts they also got very costly workplace rules.  If a lamp burnt out at a workstation the worker had to call an electrician to replace the lamp.  They could not screw in a new lamp themselves.  The unions defined every work activity in a workplace and created a job classification for it.  And only a worker in that job classification could do that work.  Which swelled the labor rolls at unionized plants.  Who all were receiving generous pay and benefits.  As were a growing number of retired workers.  Greatly increasing labor costs.

For awhile businesses could absorb these costs.  Business was growing.  As was the population.  There were more younger workers entering the factories than there were older workers retiring from them.  But things started changing in the Sixties.  The population growth rate flattened out thanks to birth control and abortion.  So as the population grew slower the domestic demand for manufactured goods fell.  While in the Seventies foreign competition increased.  So you had falling demand and a rising supply.  Making it harder to pass on those high labor costs anymore.  Which proved to be a great problem as their market share fell.  For as they laid off employees fewer and fewer workers were paying the pensions and health care costs for an ever growing number of retirees.  Pensions were chronically underfunded.  Worse, people began to live longer in retirement thanks to advances in medicine.  Increasing retiree pension and health care expenses for these businesses.  Bleeding some of them dry.

Bethlehem Steel filed Bankruptcy when they had 11,500 Active Workers and 120,000 Retirees and Dependents

Bethlehem Steel helped build America.  And win World War II.  It made the steel for the Golden Gate Bridge.  And the bridges between New York and New Jersey.  Many of the skyscrapers you see on Manhattan are made with Bethlehem steel.  Little Steel.  Second only to Big Steel.  U.S. Steel.  Big Steel and Little Steel dominated the US steel industry.  Until, that is, foreign competition entered their market.  And the steel minimills arrived on the scene.  Neither of which had unionized workforces.  Or those legacy costs (retiree pension and health care expenses).  Which spelled the doom of the sprawling Bethlehem Steel.  From 1954 to 2003 hot-rolled steel sheet prices rose 220%.  While wages soared over 900%.  And it got worse.

Employment peaked in 1957 at 167,000 workers.  By the mid Eighties that fell to 35,000.  With some 70,000 retirees and dependents.  That is, Bethlehem’s retiree costs were about twice their active labor costs.  As business continued to fall employment fell to 11,500.  While their retirees and dependents rose to 120,000.  Just over 10 retirees for each active worker.  Unfunded pension obligations soared to $4.3 billion.  Just impossible numbers to recover from.  Which is why Bethlehem Steel is no longer with us today.  The company was dissolved in 2001.  With International Steel Group (ISG) buying some of their remaining assets.  Then, in 2005, a foreign steel company, Mittal Steel, merged with ISG.  Leaving no remnants of Bethlehem Steel in American hands.

ISG got the steelworkers union to reduce the number of job classifications in the Bethlehem plants they took over from 32 to 5.  Greatly shrinking the labor rolls.  And increasing efficiency.  Helping these remaining assets to move forward.  The pension fund was taken over.  With retirees losing only about $700 million, giving retirees a pension of up to $44,386.  But retirees lost their health care.  Some $3.1 billion in spending obligations that the company couldn’t pay.  And didn’t.  A sad ending for an American great.  A failure the Roosevelt administration was responsible for.  As their good intentions resulted in unintended consequences.  Setting businesses up to fail with costly fringe benefits.  Adding yet another demand to the union’s list of demands.  Spending obligations these businesses couldn’t pay once domestic demand fell while steel supplies rose.  Leading to the inevitable.  Bankruptcy of large unionized companies.

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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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FT100: “Benefit recipients agree that responsible governing should start AFTER they get theirs.” -Old Pithy

Posted by PITHOCRATES - January 13th, 2012

Fundamental Truth

Legacy Health Care (and Pension) Costs Bankrupted GM

Franklin Delano Roosevelt ruined General Motors (GM).  And created the health care crisis.  How?  With price controls.  By interfering with market pricing mechanisms.  In a misguided effort to fix the economy he instituted a maximum wage.  Meaning companies couldn’t compete for good workers by offering them a higher wage.  So to compete for good workers they started us down a path that is destroying our economy.  Instead of higher wages (which were illegal) they offered benefits.  And the United States would never be the same.

Health care.  Before FDR, we paid for our health care.  After FDR, other people paid for our health care.  And we demanded more because we weren’t paying the bill.  It worked well for awhile.  When there was an expanding population.  When there were always more younger workers than older workers.  And retirees.  But the population aged.  Thanks to birth control.  And abortion.  During FDR’s time it was common for a family to raise 10 children.  Now it’s closer to 2 or 3.  Which means a generation or two later there were no longer more younger workers than older workers and retirees.  And what does this mean?  Well, older workers and retirees consume more health care than younger workers.  So the cost of health care soared for business.

This is what bankrupted GM.  These legacy health care (and pension) costs.  Instituted during a time when they were cheap and easy to provide.  But they became unsustainable.  Because of that declining population growth rate.  Union contract after union contract discussed these legacy costs.  But the way the rank and file felt was that it was their turn.  The system may be flawed.  But it worked before them.  So let them have their benefits they say.  And fix the system after they get theirs.

Social Security and Public Sectors have the same Problems GM Had

Social Security has the same problem.  That declining population growth rate is forcing fewer and fewer workers to support a retired worker.  And they’re living a lot longer than FDR’s actuaries ever calculated thanks to better and better health care.  Which just compounds the problem.  Social Security is a pyramid scheme gone bad.  The top is far wider than the base.  There are more benefit recipients than benefit contributors.  And it will follow GM into bankruptcy.  It’s just a matter of time.

There’s been a lot of talk about privatizing Social Security to prevent its collapse.  But it always meets fierce resistance.  Especially from the elderly and retirees.  Who are stuck in the system never having provided for their own retirement because they believed in the Ponzi scheme that is Social Security.  They say the system may be flawed.  But it worked before them.  So let them have their benefits they say.  And fix the system after they get theirs.

If you combine the rising health care costs and the rising pension costs inherent with a declining birth rate we come to the public sector.  Who have always enjoyed far better benefits than those in the private sector.  But that aging population is requiring ever higher taxes to support these most generous benefits.  And the taxpayers simply can’t sustain them any longer.  Those in the public sector know these systems need to be reformed.  But they worked before them.  So let them have their benefits they say.  And reform the system after they get theirs.

This Generation will Always Kick the Can to the Next Generation

That’s the problem with bad public policy.  Everyone can agree that bad policy needs to be reformed.  But what harm could one more generation do?  So kick that can down the road.  We have time.  After all, it took generations to get where we are now.  So another generation won’t ruin the country.  Even though it very well could.  But the important thing for them is that they get their benefits.  And the responsible governing can start after they get theirs.

But that’s the problem.  This generation always wants the following generation to fix things.  They always want to kick that can down the road.  But the problem is that there will always be another generation to kick that can to.  So they always will.  And no one will fix these problems while there’s a chance to fix them.  One generation will just suffer the consequences of all this can kicking.  As will every generation that follows.

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China to Eclipse the American Empire?

Posted by PITHOCRATES - April 25th, 2011

Detroit is a Microcosm of American Decline

If you want to see a potential future of the United States, take a look at one of our big cities.  Say Detroit, for example (see Motor City finds labor clout weakened amid spending cuts, new legislation by Michael A. Fletcher posted 4/25/2011 on The Washington Post).

Bold action by Republican governors to rein in government spending and labor power by curtailing collective bargaining rights have been met with raucous, if ultimately unsuccessful, protests from union leaders and their allies in places including Wisconsin and Ohio.

But [Mayor] Bing’s move to extract new concessions from Detroit’s 12,000 municipal workers has been met with no such outpouring…

First of all, let’s get are arms around the size of 12,000 municipal workers.  On average let’s say each worker grosses $35,000 annually.  That is just under half a billion dollars in wages.  Now add in their benefits and it approaches a billion a year.  Just for wage and benefits for city workers.  It doesn’t count the cost of light bulbs, electricity, toilet paper, road salt, buildings, vehicles, etc.  That’s just the cost of people.  And that’s a lot of money.  For an impoverished city with a declining population.  And a declining tax base.

By the way, Mayor Bing is a Democrat.  He is not alone.  The sinking weight of the big city budget deficits transcends political party.

The absence of any large protest highlights the conundrum facing labor and its progressive allies as more states, cities and towns run by their putative Democratic allies are confronted with staggering debt and budget problems…

In New York and California, Democratic governors have not attacked collective bargaining, but they have also demanded major concessions from workers to help close yawning budget deficits.

In Wisconsin and Ohio, new Republican governors have significantly curtailed or eliminated collective bargaining rights for public employees, moves they said were made to give themselves as well as local leaders a freer hand to make badly needed cuts.

Michigan’s new Gov. Rick Snyder (R) signed legislation last month empowering his appointed emergency financial managers to void municipal union contracts in distressed municipalities across the state.

Of course, we got here for a couple of reasons.  People are living longer.  Living retirees consume pensions and health care.  And these benefits are generous.  Created at a time when they could be generous.  Following World War II, the United States rebuilt war-torn countries.  Everyone worked.  And bought a car.  Some bought a couple.  From Detroit.  The Motor City could charge what they wanted.  For where else were people going to buy a car?  UAW line workers lived like kings.  Worked hard.  Retired early.  And doctors kept them alive with ever improving health care.  Some lived longer into retirement than they actually worked.  And all of these costs began to build up in the pipeline.  Waiting to burst out at the other end on some future generation.

And that’s what happened.  War-torn countries eventually rebuilt their manufacturing.  They began to provide for themselves.  Some even provided for others.  They started building quality products at affordable prices.  Long story short, Toyota surpassed General Motors (GM) as the number one car manufacturer.  And GM, saddled with those legacy costs from what proved to be a too generous time, went belly up, bailed out by the government.  And as went the U.S. automotive industry, so did the Motor City.

Decades ago, when Detroit earned the proud moniker Motor City, it was home to a thriving and decidedly blue-collar middle class built largely by the clout of organized labor. Detroit is now renowned as a national symbol of urban dysfunction, and as Bing tries desperately to change that reputation, he often finds himself at odds with the city’s labor unions…

Even as the city is shrinking, Bing calls the current state of city services unacceptable. And he says they are not going to improve unless he can reduce the city’s personnel costs, which are overwhelming the budget. This year, the city paid $200 million in pension benefits, which Bing said was $25 million more than the city paid for fire department and ambulance services last year.

“The old days when getting a good city job meant that you put in your 20 years with the expectation that city government could take care of you for the next 40 is no longer a realistic or viable option,” Bing said.

Generous automotive jobs could pay a lot of taxes.  And did.  The city government grew right alongside the U.S. automotive industry.   But with those auto jobs went the city’s tax base.  And now the municipal workers are going through the same thing the auto workers did.  Only worse.  Because their benefits were even more generous.

Now he wants workers to take on an additional 20 percent of their health insurance premiums. He also wants them to take smaller pensions, and to eliminate defined-benefit pensions for all new employees.

Bing said he has no choice. “If we do nothing, by 2015, fringe benefits are on pace to consume half of our entire general fund revenue,” Bing said. “That is not sustainable. We can’t afford benefit packages so rich.”

Supporters of the public sector will argue they aren’t getting rich.  They’ll argue that they could earn more in the private sector.  True, some could.  But most couldn’t.  Because if they could they would go to the private sector to make more money.  No one chooses to stay somewhere to earn less.  There’s a reason they stay.  And it’s not the wage or salary.  It’s the benefits.

That’s how it was for [a retiree], who went to work for the city as a typist in the health department in 1968. She retired as a 911 operator in 1998 at age 48, and the city is obligated to pay her $24,000 a year for life.

The current Social Security retirement age is 67 for anyone born after 1959.  And there’s talk about raising it still because people aren’t dying soon enough into retirement.  Improvements in health care are keeping people alive longer to consume ever more retirement benefits.  It’s busting the federal treasury.  As well as the treasuries in the big cities.  You just cannot have people retire at 48 years of age these days.  Not if you expect to remain solvent.

This kind of generosity is just not sustainable.  Retirees are consuming more than they ever contributed to their retirement and health care.  And the working young are paying more and more to support them while cutting into their own retirement savings.  Something’s gotta give.  To reverse the American decline.

China the new Japan of the Eighties?

What, you may ask?  What may give?  Perhaps the United States (see IMF bombshell: Age of America nears end by Brett Arends posted 4/25/2011 on MarketWatch).

According to the latest IMF official forecasts, China’s economy will surpass that of America in real terms in 2016 — just five years from now…

We have lived in a world dominated by the U.S. for so long that there is no longer anyone alive who remembers anything else. America overtook Great Britain as the world’s leading economic power in the 1890s and never looked back.

And both those countries live under very similar rules of constitutional government, respect for civil liberties and the rights of property. China has none of those. The Age of China will feel very different.

China is still communist.  Like the Soviet Union was.  So the Age of China may feel more like the Cold War.  Only without us being a superpower.  So how will that feel in America?  Possibly like it felt to live in Eastern Europe behind the Iron Curtain.  Economically dependent on your overlord.  And wholly at their mercy.

“There are two systems in collision,” said Ralph Gomory, research professor at NYU’s Stern business school. “They have a state-guided form of capitalism, and we have a much freer former of capitalism.” What we have seen, he said, is “a massive shift in capability from the U.S. to China. What we have done is traded jobs for profit. The jobs have moved to China. The capability erodes in the U.S. and grows in China. That’s very destructive. That is a big reason why the U.S. is becoming more and more polarized between a small, very rich class and an eroding middle class. The people who get the profits are very different from the people who lost the wages.”

This sounds like what they were saying during the Nineties about Japan Inc.  Just before they entered a devastating deflationary spiral.  Before that, though, some were saying here that we needed to do what the Japanese were doing.  Business and government were working together.  It wasn’t that laissez-faire capitalism nonsense we were clinging to in the United States.  Japan Inc. was a juggernaut.  They got so rich that they were buying up landmark U.S. properties.  A National Lampoon cover showed a Japanese CEO sitting at his desk with a sign saying the United States was a wholly own subsidiary of his company.  It was the end of America as we knew it.

Well, it wasn’t.  The government built a huge asset bubble.  And the thing about bubbles is that they eventually burst.  And when it did, the Japanese economy tanked.  For a decade.  Or two.  The Japanese called the Nineties the Lost Decade.  The lesson the Japanese learned?  A “state-guided form of capitalism” doesn’t work.  It may in the short term.  But not in the long term. 

China may be surging now like the Japanese were in the Eighties.  Will they be able to avoid Japan’s fate, though?

The Difference between China and the United States is Labor Costs

The MarketWatch article misses one salient fact.  First of all, let’s consider the Soviet Union.  If the state was good at ‘guiding’ an economy, why did the Soviet Union fail?  I mean, they had a prosperous manufacturing industry.  Lots of people were building things.  The problem was, they were building things that no one wanted to buy.  Whereas the things they did want to buy (soap, toilet paper, etc.) were always in short supply.  You waited in line to buy those things.  Look at Cuba.  And North Korea.  These are all state-guided.  And they all suffer from abject poverty.  And, at times, famine.  Clearly, the ‘state-guided’ is not the reason why China is doing so well.  It’s that other thing.  The capitalism.  Which the Soviet Union, Cuba and North Korea did not/do not have.

Now we have capitalism.  As did Great Britain.  And at one time, we each had the world’s largest economy.  But we surpassed Great Britain.  And China is about to surpass us.  So is there anything we can draw from this.  Something the British and the Americans have that the Chinese don’t?  I’ll give you a hint.  Think about Detroit.

How many times do we hear about unions striking Chinese industry?  Not many.  For one, there is only one Chinese trade union.  All-China Federation of Trade Unions (ACFTU).  It’s not exactly what you would think of when you think of a union in the UK or the USA.  Some would say that the ACFTU represents the government’s interests more than the workers.  And that’s the difference.  China doesn’t have the high labor costs we have (or the British).  Or the generous benefits.  And they have no legacy costs.  For their industrial workers.  (Or their municipalities.)  And this is why manufacturing jobs left the U.S. and went to China.  They could make things cheaper.  And as we pay more of our income in taxes to support an ever growing public sector, the less we have to spend on material goods. 

It’s just simple arithmetic.  It’s not a matter of greed on the consumer.  Just like union workers want higher pay and benefits, so do they.  So they can buy more stuff.  And if they can’t have the higher pay and benefits like they have in the unions, they at least want low taxes.  Or low prices.  But their paychecks aren’t as generous.  And their taxes are high.  Which leaves them with less disposable income than their union brothers and sisters.  Making them the ideal market for those low-priced Chinese imports.  And as long as the ACFTU holds Chinese wages down, they’ll keep buying those imports.

But can they?  Will the Chinese workers rise up one day?  They have nothing to lose but their chains.  As Karl Marx would say.  Will they overthrow the ‘capitalism’ in ‘state-guided capitalism’?   Making it a more pure form of communism?  More like in the former Soviet Union?  It may be the only thing that can stop this Chinese juggernaut.  A workers revolt.  An authentic communist revolution.  In already communist China.

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