Boulton: GM's troubles have been building for a long time

Boulton: GM's troubles have been building for a long time

by
IFF
April 21, 2009
IFF
April 21, 2009

The widely disseminated refrain from amongst those ‘who really know’ is that atrocious management caused GM’s demise and therefore the company should not be rewarded with a ‘bailout’. In part, they have a point and I kind of enjoyed watching Michael Moore chase then GM CEO Roger Smith around town making him look like foolish in the early 1980s. As an investment professional I knew Moore had a point and over two decades in the investment industry I never recommended the purchase of either Chrysler or GM. Ford was a different story since it had a management team that successfully responded to market conditions and today is the only one of the big three not looking for a federal handout.

That said, the real root of GM’s problems today rest in the cartel economy fostered by FDR’s New Deal that lasted through the 1960s and the corporate stasis emblematic of the 1950s. The fundamental economic policy goal of FDR’s regime was to force wages and consumer prices higher despite economic conditions calling for much a lower wage and price structure for the American economy. Typical of this effort was the Robinson Patman Act which made it illegal for retailers to sell merchandise below the manufacturer’s suggested retail price – MSRP.

This put the administration in direct conflict with economic reality and pushed the United States into a bifurcated economy – one set of conditions for the favored blue chip members of the S&P 500 and differing rules for inconvenient entrepreneurial efforts. Basically price competition undermined the ability to maintain price stability at levels above equilibrium between supply and demand. However these policies did facilitate the emergence of another cartelized segment of the American economy – unionized labor which could only amass monopoly power if the employers it worked with were oligopolies benefiting from significant barriers to entry precluding insurgent competitors.

With an oligopolistic industrial organization working with monopolistic labor contractors, which is what unions really are, a nice ordered economic environment could be maintained. Under these conditions benefiting companies could evolve slowly, bringing new technologies on line only after every ounce of profit and depreciation had been squeezed out of existing technologies with research and development carefully structured to suit the needs of evolution and avoiding the consequences of revolution (planned obsolescence).

Concurrently, competition beyond each oligopoly’s members was precluded through government mandated barriers to entry and the lack of foreign competition since the US Air Force had done a thorough job of obliterating it. Consequently prices could be pushed higher when needed to cover the cost of production without worry that doing so would cost market share. This was clearly the world of the man in the grey flannel suit where working one’s way up the corporate ladder became the accepted norm. Perks and benefits in lieu of larger incomes became more important since Rooseveltian marginal tax rates effectively confiscated most executive pay raises. Obviously bureaucratization of management became the norm since without it, the process wouldn’t work.

On the other side, labor as represented by monopolistic unions could push management to gradually increase pay and benefits – especially non-cash items like pensions and life time healthcare. Work rules aimed at maximizing employment levels could be allowed to become major negotiating points, thus removing management from the process of adjusting operations as conditions changed until it came time to renegotiate labor contracts several years later. Since strikes meant that nothing would be produced until various issues were resolved, thus damming revenue streams needed to keep company doors opened, companies were extremely reluctant to push their position beyond a certain point and thus shifted management power to union leadership.

Another reason management went along with the game was that the bill for retirement benefits wouldn’t have to be paid for decades down the road when the accumulation of retires living off the corporate revenue stream would build to unsustainable levels. It also helped that people really didn’t live that long compared to today’s life expectancy and healthcare was rather primitive to what we’re used to today.

Besides, whatever increased compensation the unions were able to extract from management could be passed on to consumers a little bit at a time without any problem.

What no one planned on in this nice cartelized existence was that the world would change dramatically once the supply of oil ceased to be in surplus compared to the demand for it. Suddenly the price of gasoline became expensive in the 1970s and the American auto market developed an instant desire for fuel economy – something Detroit wasn’t in a position to provide. In the process American car buyers discovered that foreign imports didn’t break down like domestic cars. Bingo, Detroit’s big three lost market share that they’ve never recovered until finally non-US auto manufacturers opened American plants without the hindrance of union work rules that had to be continually re-negotiated. Unlike the American manufacturers, foreign owned plants had management flexibility and didn’t need to be as bureaucratic.

In short, Detroit’s big three were screwed, but they were still able to soldier on while gradually losing market share since the average American car buyer still preferred large vehicles over small ones for a number of very practical reasons – thus the SUV. Unfortunately the run up in gasoline prices in 2008 put the kybosh on that very lucrative market, confining the demand for new autos to small fuel efficient vehicles which Detroit has never been able to produce profitably in the United States thanks to residuals from the cartelized economy of the 1950s – particularly the army of retirees GM must support to such an extent that there is no way the company can produce a car and sell it for a profit and still compete.

This is not unusual since every one of America’s heavily unionized industries have faced the same problem – only much sooner, and each has in turn, gone through industry wide bankruptcy. The airlines are only the most recent example that has included the steel industry in the 1980s, along with other metallurgical companies and the railroads in the 1970s. GM is only the last dinosaur standing and like every other old economy companies needs to follow suit – especially to dump its ongoing financial obligations to its massive force of retirees. A government ‘bailout’ only delays the inevitable. More practical would be for the federal government to assume payment of legacy retirement benefits for the auto industry through the Pension Guarantee Corporation and thus provide Detroit’s big three with a profit margin.

Craig Boulton has written a number of books on finance, economics and political economy. He has written for Cato, and is a chartered financial analyst with more than 20 years of experience in the investment industry. He's also a combat veteran.

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