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Monday, December 05, 2005

Who Pays for the Failure of Management?

In an attempt to save companies like GM, workers are being asked to pay for the failures of  management through the elimination of health and other benefits. With apologies to Brad DeLong for the trademark violation, why weren't there more "midnight thuds and screams," within the automaker's palaces while all of this was going on? Did management earn those high salaries and if not, where was the "creative destruction" of their positions? While the measures that U.S. automakers could have taken in the past would have involved some downsizing and therefore would not have been painless for labor, and some problems arose from mistakes made by union leadership, it would have left the companies in a much stronger competitive position today. As the article notes, when you look at the total U.S. employment in the auto industry as a whole including German, Japanese, and Korean companies who pay "American-style ... health benefits," employment has held steady over the last decade:

Mr. Ford's Wrong Turn Why U.S. Automakers Can't Blame Japan, by James P. Womack, Washington Post: On Nov. 22 after a speech at the National Press Club, Ford Motor Co. Chairman Bill Ford told the media, with apparent earnestness, that his company "can compete with Toyota, but we can't compete with Japan." This is an old myth. Ford's competitive problem, according to its chief executive, is driven by the unfair advantages that the Japanese government allegedly bestows on its auto companies -- government-funded health care for workers, government support for the pension system and subsidies to develop the batteries needed for hybrid vehicles. What makes this claim so extraordinary is that Japanese companies, led by Toyota Motor Corp., are thrashing Ford by building vehicles in North American factories with North American-made parts and North American workers, who receive American-style wages and health benefits. And increasingly, these Japanese brand vehicles are engineered in America by Americans.

Consider a few facts about Toyota. About 65 percent of the vehicles the firm sells in North America it assembles in North America, and it would assemble a much higher proportion here if it could only keep up with its rapid sales growth. Toyota will open its seventh North American assembly line in Texas next summer and an eighth line in Ontario in 2008. It may start assembling vehicles at a Subaru plant in Indiana in 2009, and it is said to be looking for yet another assembly location. In addition, it has three engine manufacturing plants and is looking for a site for a fourth. By the end of the decade, Toyota will be able to assemble about as many cars as Chrysler does in North America, and it is closing in on the capacity Ford will have after plant closings that are widely expected to be announced in January.

In fact, thanks to hiring by Japanese, Korean and German auto makers, total employment in the U.S. motor vehicle industry over the past decade has held steady at about 1.1 million. So the problem is not Japan Inc. In fact, that country has been a striking industrial failure over the last 15 years. The latest firms to slide down the competitive slope are the big Japanese consumer electronics makers such as Sony Corp. and Panasonic, ... (In the video game wars, Sony is even getting beaten by an American company -- Microsoft Corp.) The electronics giants are following the downward path of most Japanese auto firms, which have either fallen into foreign hands (Nissan Motor Co. Ltd. and Mazda Motor Corp., the latter now controlled by Ford) or dramatically lost market share (Mitsubishi Motors and Isuzu Motors Ltd.). ...

There were two elements to the Detroit system. The mass production part, pioneered by Henry Ford in 1914, replaced craft workers with assembly lines. It was so successful that Ford was able to pay decent hourly wages and still dominate the U.S. auto industry, along with General Motors and Chrysler. ... On the labor side, the UAW held a monopoly. Thanks to rising demand for cars, there were plenty of profits to go around. Periodically the three vertically integrated companies and the union engaged in a bargaining ritual to determine how to split the loot. As long as improvements in mass-production offset the ever-higher wage rates by reducing the number of labor hours per vehicle, the cost of cars for consumers held stable.

The threat to this cozy arrangement came when foreign firms started investing in U.S. production facilities, beginning with Honda in Ohio in 1982, followed by Toyota in a joint venture with GM in California in 1984, and then Toyota again in its massive Georgetown, Ky., complex in 1986. ... The Japanese auto makers had an outlook different from that of the Big Three. The purveyors of the old Ford-GM-Chrysler-UAW system assumed that all production laborers in the industry, including workers making parts, should be paid the same rate. The corporate and union leaders further assumed that their position was impregnable and that they could promise to pay defined-benefit pensions and other benefits decades into the future. The architects of the new Toyota-Honda system assumed that production labor would be paid different rates... Final-assembly workers would receive a premium and less skilled employees of parts makers ... would work for prevailing market wages. These Japanese firms also assumed that ... no company could commit to benefits decades ahead. Better to base pensions on defined contributions made during work years rather than by guaranteeing payments in the far future. ...

This new Toyota system -- ... labeled "lean production" -- uses less human effort and less capital to design products faster and with fewer defects. What's more -- and this best describes Bill Ford's problems -- the leading Japanese car companies are making more money than their U.S. competitors not only because of lower costs, but because their lean design, production and purchasing system is turning out vehicles so desirable that Toyota and Honda can charge much higher prices for products in the same segment of the market. Indeed, these Japanese companies are giving wages and health packages to current workers in North America similar to those provided by their U.S. rivals, but they're selling vehicles today for $2,500 more than comparably equipped cars made by Ford and GM. This revenue difference, more than the production cost issue, lies at the real heart of Motown's problem.

Ford and GM have tried to embrace lean production methods, ... but the main way to do that under "life-time employment" union contracts has been to encourage early retirement. This has solved one problem -- too many active workers. But it created a second -- too many retired workers for the active workers to support. It's little wonder that money-losing Ford doesn't have the funds to invest in new technologies and is asking Washington for help. ...

The ... question is how to cope with the pension and health care commitments of U.S. companies on the road to financial ruin. ... One approach would be to stand back and let the auto companies fail. A bankruptcy judge could then explain that the promises made to retirees are much more extravagant than what most other Americans are getting. The judge could then call the deal off and pay out pension benefits at maybe 50 cents on the dollar. Another alternative would be to transfer the obligations to the government. This would ease the pain of a generation caught in a historic industrial transition. But how can the government take on such a burden when it is already saddled with war costs and budget deficits? ...

Another potential cost of fiscal irresponsibility. One thing I don't know that makes this hard to evaluate is how the total compensation package, wages and benefits combined, would change for a worker moving from a closed GM plant to a new Toyota plant. But the answer to that question does not alter the failure of the management of U.S. auto and other companies to respond adequately to competitive challenges.

When you hear talk about flexibility, there is perhaps a lesson here. Market power matters. When firms are allowed to attain a high degree of monoply power, there is a danger they will become complacent, less flexible, less able to respond to competitive challenges from within or from the foreign sector. As we continue to endorse free market principles in the name of flexibility and further remove government regulatory authority over markets, we should be careful we don't end up undermining flexibility by failing to challenge concentrations of market power as they arise. We can give it names like "creative destruction" that try to make the adjustment process sound better and even desirable, but in the end it is workers who pay the lion's share of the costs of failure.

    Posted by on Monday, December 5, 2005 at 12:12 AM in Economics, Unemployment | Permalink  TrackBack (0)  Comments (32)


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