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The Progressive Economics Forum

Auto Labour Costs and Auto Industry Recovery

I was recently invited to speak to the annual management briefing conference sponsored in Michigan by the Center for Automotive Research, a fine outfit which does the best research work in the continent on auto employment, workers, and skills.  My slides are available here.

My panel was addressing the current UAW negotiations with the Detroit Three automakers – the first big contract talks since the meltdown and bailouts of 2009.  I was diplomatic enough as a visitor to the US not to make any direct comment on the UAW talks (the “host” union), but rather addressed the broader economic issue about the North American auto industry’s painful recovery, and what role — if any — labour costs have played.

Most of the media hype about these talks so far has focused on whether the union and the companies will be able to turn over a “new leaf” in their relationship.  They warn against the two sides going back to their “bad old ways,” driving up labour costs and bankrupting the companies in the process.  To try to combat this “frame,” UAW President Bob King and the lead company negotiators have gone to great lengths to stress a “new way of working,” their new sense of partnership, and their shared recognition that bargaining can’t add to labour costs or else the North American companies won’t be competitive anymore.

Implicit in both the dominant frame, and this response to it, is the assumption that high labour costs were indeed the reason why the Detroit Three got into trouble in the first place.  The flip side is the corollary claim that the reason the companies have recovered so impressively since 2009 must be because they dramatically reduced their labour costs.

Both assumptions are wrong.  Labour costs were not the key problem in the Detroit Three’s crisis.  And cuts in labour costs have not been the key reason, or even a major reason, for the subsequent improvement in their performance.

Direct labour costs account for about 7% of the total costs of designing, manufacturing, transporting, and selling a new vehicle in North America.  Yet labour costs (and labour negotiations) seem to get 99% of the attention.

In my presentation I conducted a back-of-the-envelope financial analysis to consider the relative importance of labour cost reductions in the overall profit recovery of the Detroit 3.

Between 2006 and 2010, the combined net income of the Detroit 3 improved by almost $30 billion – from a $17 billion combined loss to a $12.5 billion combined profit.

There were many different economic factors driving the change in profitability, some of them moving positively (reduced labour costs, downsizing, stronger unit revenues, reduced management expenses, lower interest costs), but some of them moving negatively (especially the impact of the recession and the painfully slow recovery on auto sales).

Here is one way to estimate the upper bound of potential labour cost savings in recent years: take the average reported reduction in the UAW’s all-in hourly rate (from low 70s in 2006 to mid-50s in 2010 – for an hourly saving of about $18-19 U.S. per hour), and multiply that by ALL the Detroit Three’s workforce in North America.  This is a huge overestimation, because not all employees suffered that size of labour cost reduction (Mexican workers, for example).  A more accurate estimate would require access to unreported data on employment and labour costs by type and country.  So this should be considered very much as an upper bound for the potential labour cost savings which the companies have enjoyed.

But then, we also have to consider the impact of the funding for the VEBA health care trusts in the U.S., which was a major part of the labour cost reduction at all three companies.  These trusts imposed certainty on the company’s retiree health costs, and allowed the companies to use some equity not cash.  But the VEBAs were certainly not “free.”  While the cost of funding the VEBAs does not appear on the labour cost tally, it is still a major cost to the company while the VEBA is being funded.  Ford in particular has publicly noted that most of its labour cost savings were the outcome of the VEBA.  After deducting the VEBA expenses (even if amortized over a long period of time – say 15 years), the net labour cost savings to the 3 companies (combined) is just $4-5 billion per year in total for the three companies.  That is about 2% of their total North American revenues. 

Compared to the reduced expenses that resulted from downsizing and plant closures, these labour cost reductions are very small.  I estimate the three companies saved much more — almost $20 billion per year — from downsizing its North American workforces.

The companies also saved many billions from other measures – such as reductions in General and Administrative expenses and interest costs.  This data is publicly available from the income statements of GM and Ford, but not for Chrysler (which was a subsidiary of Daimler in 2006, and of Fiat in 2010, and hence did not report full financial statements in either year).  For just GM and Ford, the reduction in G&A spending was worth $25 billion per year, and the decline in interest costs (mostly at GM, a happy outcome of its 2009 restructuring) worth $18 billion.

Also, compared to the improved unit revenues that companies have attained as a result of better quality product and a noted relaxation of import pressure since 2008, the labour cost savings are small.  The 3 companies together in 2010 took in over $32 billion in additional revenue as a result of the increase in the average selling price of their vehicles since 2006.  This reflects more discipline on their part regarding incentives and fleet sales, higher quality vehicles, and a relaxation of competition from offshore.  (The yen has risen 60% against the $US since 2007; that plus the quality and tsunami-related problems of Japanese producers has contributed to a substantial decline in import penetration to the U.S. market.)  Together, the companies captured about 8 times as much benefit from higher selling prices, as they did from lower hourly labour costs.  So in this regard, they had a “revenue problem,” not a “cost problem” – a point which a few free-thinking auto analysts made for years.

In short, the reduction in compensation and other labour costs was at most a small secondary factor in the recent rebound in auto industry finances.

My conclusion is that far too much attention is paid to labour negotiations in the context of the continuing struggle to recover in the industry.  Simply cutting labour costs does not address the true competitive challenges facing the Detroit Three – most of which comes from offshore, and most of which has no direct relationship to labour costs (but is driven by other factors, like product quality & innovation, exchange rates, imports, and the macroeconomic problems which continue to hamper the recovery of North American auto sales).

Misdiagnosing the problem is likely to lead to a misidentification of solutions.  If we’re concerned about the future prosperity of this industry (and there’s ample reason we should be, even before the current round of financial instability), then we should be looking at more fundamental issues like product quality and appeal, import competition, and selling prices – rather than the knee-jerk focus on trying to squeeze a little more out of labour.

In that regard, the misplaced public emphasis on the need to continue to suppress hourly labour costs (an emphasis which is being reinforced by current coverage of the UAW negotiations), is diverting us away from recognizing and addressing the true problems which continue to afflict the sector.

If we want to worry about returning to the “bad old days,” perhaps we should worry less about unions and management conspiring to fatten compensation.  And worry more about a state of affairs in which an individual CEO can make $100 million or more, and the newly-hired workers in U.S. plants (who make half the wage of other workers) can’t afford to buy a new car.  After all, here’s how Henry Ford himself put it way back in 1914:

 “The commonest laborer who sweeps the floor shall receive his $5 per day… We believe in making 20,000 men prosperous and contented rather than follow the plan of making a few slave drivers in our establishment millionaires.”

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Comments

Comment from janfromthebruce
Time: August 12, 2011, 8:30 pm

If we don’t learn from history it will repeat itself, and so Ford was right on.

In the Financial Post today, the article is “Marx was right; capitalism can destroy itself: Roubini”

“Karl Marx got it right, at some point capitalism can destroy itself,” said Mr. Roubini, in an interview with the Wall Street Journal. “We thought markets worked. They’re not working.” http://business.financialpost.com/2011/08/12/roubini-says-more-than-50-chance-of-global-recession/

Bluntly stated, ‘“Because you cannot keep shifting income from labour to capital without not having excess capacity and lack of aggregate demand. And that’s what’s happening,’ the economist said.”‘

Marx, Ford and this economist get it: when workers make money they buy the manufactured goods and services created.

Comment from Paul Tulloch
Time: August 12, 2011, 10:33 pm

I am becoming such an economic nerd, sitting here on a friday night reading the PEF and somehow being happy about it.

But I must say I have always liked Roubini.

I am for sure confounded on how one can work on a partnership when labour costs are always in front of both barrels of the management gun. Its a non-starter for me, I do recall my interest based bargaining days way back when, you cannot have a mutual gains outcome when one side is obviously holding a gun to the union’s head.

Is the whole labour cost focus a sign that America is just too hard wired against its own workers. It is the easy way out for some high priced “talent” on the management side. When will they finally start on a road to realizing the true nature of the problem. I still say they have bad design, a lack of market orientation, a very arrogant stance that they can put anything out their and it will sell.

I still believe labour process innovation combined with enlightened designers and a newly informated production process will bring on the new industrial revolution. The age of the smart worker riding the smart machine into a productive more worker friendly shop is on the horizon. At long last Braverman’s deskilling will finally be proved wrong and then we will have a car industry that will never die.

But to get there we must kill Braverman’s thesis and replace it with a combo of Turing and Marx.

Of course precariousness of work is the pathway we are currently on and that is the terminator of workers.

I will be back.

Comment from Marie Duggan
Time: August 13, 2011, 6:57 am

Thanks for this very detailed analysis, even the New Yorker blames the working man. In truth, there seems to be a trade-off between the exchange rate of the US dollar, and pressures on wages. If the dollar loses value relative to the Yen (as has happened recently), then US cars are cheaper for Americans to buy relative to imports. If US dollar is strong relative to Yen (as in 1980s), then US are are too expensive relative to imports, and pressure falls on US workers to take a massive cut in wages.

Comment from Purple Library Guy
Time: August 13, 2011, 11:18 pm

Liked the article. In context I understand why the Ford quote; it’s an appeal to an authority that the audience involved reveres.

But I still can’t resist pointing out that Ford was making a virtue of necessity. The benevolent paternalist Ford who deliberately paid his employees enough so they could afford his cars is a myth. Originally, Ford factories were places of miserly wages and ultra-high turnover. Things ended up different because of hard fought strikes with a good deal of violence; Ford tried hard to break the workers. When he couldn’t, he said some nice things which made it look like that had been his idea all along, and maybe he came around to an appreciation of workers who stuck around and got good at their jobs because they were being paid decently. But it wasn’t his idea, the working class forced his hand by hanging tough and being militant.

Comment from cnp
Time: August 18, 2011, 5:00 am

While labour costs might not be as important to the d3’s success or failure as it’s made out to be i think the reason autoworkers wages are such a big issue to people is because of the large amounts of tax payer money that have gone to these companies over the years. Here in Oshawa the gm plant, in the last decade alone, has gotten nearly a billion dollars of taxpayer money. And that’s over and above the whole bail out fiasco. Coincidentally the government handouts always seem to come in years when the d3 and the caw are in labour negotiations so it would sure seem at first glance that taxpayers are subsidizing autworkers wages and buying these companies labour peace and the people who pay these taxes dont earn anywhere near what a unionized d3 worker earns.
While it’s all well and good to claim that cost of labour at the d3 only accounts for 7% of the cost of a vehicle Mr. Stanford neglects to mention that that labour cost is only kept so low by the fact that many workers in the d3 supply chain earn significantly less than unionized d3 workers. I find it odd that a union that claims to be all about workers rights and equality will use low wages paid in an industry, with some workers in the parts supply chain earning as little as minimum wage, to justify the high wages paid to unionized d3 workers. If wages aren’t an issue then why does the caw consistently agree to have some of its work outsourced to lower wage paying companies? Make no mistake, it’s my assertion that the high wages paid to unionized d3 workers come straight on the backs of lower paid workers in the industry and I’d be interested to see an average of wages paid to Canadian workers directly involved in the production of Canadian built vehicles.

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