Low Budget
Megan McArdle unaccountably decides to defend the “$70/hour” figure some are bandying about for UAW compensation at the Big Three, arguing that the figure is “deceptive. Sort of, but it’s actually quite apt at showing the core problem with GM.” You get the figure as follows, per Felix Salmon:
The average GM assembly-line worker makes about $28 per hour in wages, and I can assure you that GM is not paying $42 an hour in health insurance and pension plan contributions. Rather, the $70 per hour figure (or $73 an hour, or whatever) is a ridiculous number obtained by adding up GM’s total labor, health, and pension costs, and then dividing by the total number of hours worked. In other words, it includes all the healthcare and retirement costs of retired workers.
How useful is the figure really? I’m going to tell you now!
I run a car company myself, with 100 workers, whom I pay $30 an hour. Thanks to the large cohort of retired workers I have generously staked to a comfortable old age – actually, I freely agreed to their compensation years ago during successive contract negotiations in exchange for lower immediate wages, but let’s not get into a lot of who killed who – I also have retiree-related costs of eight million dollars a year, mostly pensions and medical insurance premiums and claims. I take it into my head to divide that eight million per year by 250 work days per year by eight hours per work day by 100 employees and I get $40 per employee hour. I add this to the $30 in payments to those workers and I get $70, and I say, “Wow, that’s a lot.”
Now business is bad, so I lay off twenty percent of my work force, leaving me with eighty workers. That’s the only thing I do – for pesky contractual reasons I can’t reduce my retiree-related expenses by so much as a penny. So I have 80 employees making $30 per hour and eight million (still!) in retiree costs every year. So I do my division again:
$8,000,000/year by
250 days per year by
8 hours per day by
80 workers equals
$50 per employee-hour. Which I add to their salary of $30 per hour to get -
Crap! $80! What the hell just happened! Suddenly I’m compensating my workers more lavishly??? Did I manage to get even further behind on personnel costs by cutting my workforce? The hell?
Well let’s see.
| 100 workers | 80 workers |
| x $30/hour | x $30/hour |
| x 8 hours per day | x 8 hours per day |
| x 250 days a year | x 250 days a year |
| =$6 MEELion dollars | =$4.8 MEELion dollars |
| + $8 MEELion retiree costs | + 8MEELion retiree costs |
| $14 MEELion HR costs | $12.8 MEELion HR costs |
So, my costs did in fact go materially down, but my chosen metric went up. In technical business terms, this means my metric blows. It reduces my understanding of the business rather than enhancing it. I might as meaningfully calculate a “rent per payroll hour” or “Licenses, Dues and Subscriptions per payroll hour” metric. They’d go up when I shed workers too, ceteris paribus.
The fact that the bogus “compensation per hour” figure discussed above is fatally flawed doesn’t mean I have no worries about total employee costs, or retiree costs or, for that matter, Licences, Dues and Subscriptions. I well may! I could usefully track their magnitude by dividing compensation by either revenue or units. I could do this for slices of comp – current worker OR retirees, frex – or aggregate comp. If my hundred workers produce 10 cars per work day – 2500 cars a year – then I am paying $5,600 in aggregate HR costs per vehicle. If I can get those 2500 cars off the line with my 80-employee scenario, each car includes $5,120 in labor costs.
Now you might object that if 80 workers produce 80% as many cars – 2,000 a year – then my aggregate HR costs per vehicle have risen to $6,400 per vehicle, which is an increase, even though total expenses went down. How is this any different from the situation with the funny dollars per hour figure with which we started this increasingly nerdly blog entry? Answer: the fact that my HR costs per vehicle are rising after layoffs means something. Specifically, it means it may not be such a good idea to have those layoffs. I can’t say for sure yet; I should make sure I understand my revenue per unit picture; but as a general rule, you can’t shrink your way out of fixed costs, which is what the retiree-expense is.
Indeed, the other useful metric I can look at is HR costs (slice or aggregate) as a percentage or revenue. All other things being equal, I’m less profitable if employee costs as a percent of revenue are high. Even there, my goal is the marginal dollar of net income, aka profit: all other things are rarely equal. If I can make a bottom-line, true profit of $1 BEELion dollars with, say, labor costs of 20% of revenue, OR I can make $2 BEELion dollars in true profit with labor costs of 25% of revenue, I will almost certainly choose the latter option, unless there’s some very compelling reason not to, like, my line will be blighted unto the tenth generation.
So I agree with Megan that it’s good to express the extent to which GM has a core problem with retiree expenses. I think if GM or right-leaning economists said, $X of the price of every car that ships from a GM plant goes to pensions and retiree medical costs, that would be a figure that told people something. Or if they said, X cents out of every dollar GM makes goes to those things, likewise. But the “GM pays $70/hour to its workers” doesn’t clearly convey understanding of that point. If anything, it confuses it. You will understand GM’s business less if you carry that figure around in your head than if you carry either of the other figures around.
The only reason I can think of for propagating the “$70/hour” canard is political: to foster resentment of GM’s “lavishly paid” workforce among people who make less than $70/hour, which is most of us. I’m sure this is not Megan’s purpose, but I can’t say that for everyone throwing around that figure.
Comment by cvcobb01 —
November 21, 2008 @ 10:22 pm
Fancy example you got there. How about you just fire everybody, then try to explain why you’re still paying $42/hr for a bunch of people that aren’t there.
Comment by Jim Henley —
November 21, 2008 @ 10:26 pm
Well, I’d actually be paying #DIV!0/hr.
But what, you don’t like when I get all mathematical????
Comment by DannyK —
November 21, 2008 @ 10:58 pm
I’m convinced that McArdle is a doctrinaire republican who had the foresight to bill herself as tall-female-libertarian-blogger instead. One of every three or four posts is straight-up GOP talking points. It’s only a matter of time before she starts blaming CAFE standards for the Big Three’s problems.
Comment by Jim Henley —
November 21, 2008 @ 11:12 pm
I have my disagreements with Megan, Lord knows, and she with me. I do get frustrated when, at times when I’m moved to post a disagreement, things tend to become a seminar on the global topic of “What’s Wrong With Megan McArdle as a Person.”
Comment by Donald Johnson —
November 21, 2008 @ 11:33 pm
“I do get frustrated when, at times when I’m moved to post a disagreement, things tend to become a seminar on the global topic of “What’s Wrong With Megan McArdle as a Person.â€
Well, there’s probably a reason why this tends to happen.
Comment by Jim Henley —
November 21, 2008 @ 11:38 pm
Lack of respect for my own wishes would be one factor.
Look, there is one person more than any other who’s responsible for not just getting me to think harder about my ethical relationships to animals but giving me something concrete to do with that thinking, and it ain’t Michael Pollan.
Comment by Thoreau —
November 22, 2008 @ 2:47 am
If the Big 3 absolutely, positively, MUST be bailed out, I’d actually be comfortable with a bailout that goes directly to their pensioners. Partly because my sympathies lie with the pensioners, and so if there absolutely must be a bailout I’d rather see it go to those least able to survive without it. Partly because it will diminish some of the harm if the Big 3 go under despite the bailout (and a business model of profiting from replacement parts on gas guzzlers is obviously somewhat precarious).
But also because it would be an interesting experiment, and if we absolutely must bail out 3 big corporations we should at least try to learn something from it: If American car companies are freed from their legacy costs and able to start anew, will they finally be able to turn a profit? I doubt, but let’s find out!
On a related note, Jon Stewart played some CSPAN footage of auto executives pleading for a bailout in front of the House of Representatives. The Congressmen started bragging on camera about owning American cars, causing all sensible Americans to say “Dumbass! Buy Japanese already!”
Comment by buermann —
November 22, 2008 @ 5:37 am
This is by far the best post on this nonsense in all of blogdome.
The pensions are insured by the Pension Benefit Guaranty Corp. When/if GM or Ford go under the PBGC takes the pension fund over, and so on. Technically the pensioners are already bailed out, just as over-65 retirees’ healthcare is already bailed out (mostly, GM’s private for-life health benefits are pretty rich) by medicare.
The pensions are no more an excuse to bailout the automakers than breaking the union is an excuse not to.
Comment by Jonathan Schwarz —
November 22, 2008 @ 8:39 am
things tend to become a seminar on the global topic of “What’s Wrong With Megan McArdle as a Person.â€
I prefer to make it a seminar on the global topic of “What’s Wrong with Institutions That Hire Megan McArdle.” There are lots of human beings with lots of things wrong with them, but the Economist and Atlantic tend over and over again to hire individuals with the exact same type of problems.
Comment by abb1 —
November 22, 2008 @ 11:21 am
Nah, with all due respect, nothing’s wrong with hiring Megan McArdle.
The topic should be: What’s the Deal with Paying Megan McArdle $70/hour?
Comment by Thoreau —
November 22, 2008 @ 11:41 am
With all the money she saves by not buying meat, surely they could reduce her pay to $65/hour, yes?
Comment by ed —
November 22, 2008 @ 11:43 am
Megan McArdle unaccountably decides to…
And how many times have we all begun sentences with these exact words?
Comment by ed —
November 22, 2008 @ 11:44 am
This exists for a reason.
Comment by Nell —
November 22, 2008 @ 1:01 pm
Jim: I’m sure this is not Megan’s purpose, but I can’t say that for everyone throwing around that figure.
For me, this is the passage that brings on a reflexive reaction. What makes you sure this is not her purpose, since it is assuredly the purpose of everyone else who is throwing around that figure? Surely the answer is something other than friendship or agreement on completely unrelated issues.
Comment by Donald Johnson —
November 22, 2008 @ 1:41 pm
“Lack of respect for my own wishes would be one factor.”
Most likely a secondary one. Most people who comment here respect you a lot, for good reasons–Megan elicits a different reaction, also for good reasons.
“Look, there is one person more than any other who’s responsible for not just getting me to think harder about my ethical relationships to animals but giving me something concrete to do with that thinking, and it ain’t Michael Pollan.”
Good for Megan, if she did that for you.
Comment by Thoreau —
November 22, 2008 @ 2:12 pm
Regarding the post: I am surprised that Megan, who claims to be an econoblogger, would take a fixed cost (legacy pensions) and conflate it with a variable cost (current labor) to get an inflated estimate of a variable cost per unit.
Yes, legacy pensions are related to labor, but the distinction between fixed and variable costs is absolutely crucial for figuring whether and how a company can become profitable.
Comment by ed —
November 22, 2008 @ 2:35 pm
Regarding the post: I am surprised that Megan, who claims to be an econoblogger
Well, she claims to be a libertarian too (she’s not).
Comment by Ian —
November 22, 2008 @ 3:40 pm
The easiest and fairest long term subsidy for the American auto industry would be universal health care, no?
Comment by kid bitzer —
November 22, 2008 @ 6:24 pm
i’m glad megan helped you think about your ethical relations to animals.
but i think your debt of gratitude to her is surely paid off by now.
given her overall track record, i think her contributions on the animal ethics front may just put her into blind pig territory.
(not to mention that…hitler was a vegetarian!!!!)
Comment by M —
November 23, 2008 @ 1:58 am
Megan is hot, stop bullying.
Comment by ponderingfool —
November 24, 2008 @ 11:26 am
In terms of the pension how much is for the pensions for executives? There was that Wall St. Journal Article a couples years ago entitled “As Workers’ Pensions Wither, Those for Executives Flourish” (June 23, 2008 by Ellen Schultz and Theo Francis). In it they discuss GM:
“To help explain its deep slump, General Motors Corp. often cites “legacy costs,” including pensions for its giant U.S. work force. In its latest annual report, GM wrote: “Our extensive pension and [post-employment] obligations to retirees are a competitive disadvantage for us.” Early this year, GM announced it was ending pensions for 42,000 workers.
But there’s a twist to the auto maker’s pension situation: The pension plans for its rank-and-file U.S. workers are overstuffed with cash, containing about $9 billion more than is needed to meet their obligations for years to come.
Another of GM’s pension programs, however, saddles the company with a liability of $1.4 billion. These pensions are for its executives.”
Comment by Peter —
November 26, 2008 @ 10:56 am
At GM, they use a term-of-art called “fully burdened overhead.” This number includes not only your salary, taxes (including employer portion), healthcare (and any other benefits); this also includes your portion of the capital costs of the plant including building, machinery, taxes and utilities to run the plant. These rediculous numbers are spread around as if the workers get paid this much. Arg! The stupidity! It burns!
The $70/hr (it was $65/hr when Steve Miller was trying to destroy Delphi and force the workers to take $7/hr [except where minimum wage was lower]) number is completely useless except as a political hammer to beat up people with.
Please, please, please! When discussing these sorts of things, why not take the remarkably unique step of, oh, I don’t know, maybe having a chat with someone who works at GM? Instead of repeating McCardle’s right wing barking points?
Comment by jeff —
December 11, 2008 @ 7:06 am
I work at Honda, here in Ohio. While our wages are comparable to the Detroit 3, executive compensation is nowhere near the Detroit 3 according to published reports. There does not exist the “animosity” towards executives here that appears to be a disease in the Detroit 3. Maybe it is because we work as a TEAM and understand that our executives want our company to succeed. They are not former Boeing executives looking for the next golden parachute after a couple year stint. Ours are long term members that we see on the shop floor helping us to constantly improve our products for the customer…we take GREAT pride in that.
While I am no economist, the Detroit 3 need to come together as a team and figure their business out for the sake of millions of jobs. Noone wants to see them fail, least of all us.