Unions, Pensions, Social Security, and Legacy Costs
by Allen Laudenslager & Bryan Neva
In the 1987 film Wall Street, the antagonist Gordon Gekko (played by Michael Douglas) didn't want to buy the airline that Bud Fox’s father, Carl Fox, worked for (played by Charlie and Martin Sheen) in order to run it; rather, he wanted to close out the pension fund, distribute the cash and arrange to pay future pensions from future earnings. Now Gekko knew full well there wouldn't be any money left when those pensions came due so his plan was to sell the company long before then.
Back in the mid-1960s, the government started “borrowing” from the social security fund (America’s pension fund) to pay for the war in Vietnam and the social programs of the Great Society. They expected to pay the money back later from future tax revenues. This mixing of funds worked so well for the government that business lobbied for the same privilege and they got it.
The American automakers then proceeded to do the same thing the government did, they collected money for future pensions and benefits as each car was sold, but they didn't put that money in a separate account, instead, they used it to cover current expenses and show bigger profits. Now, as the bill is coming due and the automakers have to actually pay the pensions and benefits, they are bemoaning their union employee’s "legacy costs." It's not the actual cost of the pensions and benefits that are the problem, it’s years of poor money management by the automakers that are the problem. So when you hear pundits bemoan the huge “legacy cost” of autoworkers’ pensions and benefits, they either don’t know what they’re talking about or they’re purposefully lying to you because those costs have already been paid. Any accountant could tell you this.
Economic theory posits that within an ideal free market, property rights are voluntarily exchanged at a price arranged solely by the mutual consent of sellers and buyers. They engage in trade simply because they both believe that what they are getting is worth as much or more than what they give up. Market prices are the result of buying and selling decisions en masse as described by the theory of supply and demand. The wages the labor unions in the United States were able to negotiate with companies were either “free market” agreements or were the result of the union’s coercing the companies into unsupportable wage agreements. But if (and this is a big if) the unions created unrealistic wage scales, how come the companies were still able to make huge profits during the heydays of unionism in the 60s, 70, and 80s?
According to Fortune Magazine, GM made $873 million dollars in profits for 1960, $14,820 million in 1970, $32,215 million in 1980, $173,297 million in 1990, and $273,921 million in 2000. If the unions were really behind the demise of GM in 2009, as some pundits claim, we should have seen a downward trend in GM’s profits over the preceding 40 years, but the reverse is actually true as profits went up not down!
If you factor in the “legacy costs” of employee’s pensions and retiree’s health care benefits, these didn’t actually cost GM anything because employee’s benefits are calculated into their hourly labor costs, which GM writes off on their taxes each year. If an employee earns “x” dollars per hour and his benefits are “y” dollars an hour, then GM’s hourly labor costs are “x + y” dollars an hour. The employee’s hourly benefits of “y” dollars are deferred compensation, and GM ideally should invest those tax-free dollars in a retirement fund so that the investment returns will lower GM’s benefits costs.
And when companies calculate the costs of making their product, they also include all the production costs for the product or service as well as raw materials, manufacturing equipment, and factory space. The production costs includes an employee’s "burden rate" which is the cost of the employee’s hourly salary plus the cost of their benefits, the cost of their share of heat, lights, their desk, computer, and any other tools or factory space, divided by the actual number of hours the employee works (usually about 1800 hours when you subtract out vacation, holidays, and sick leave). (The burden rate = (((employees salary + employees benefits) + employee’s share of infrastructural costs) / 1800 annual work hours.) And do you think GM actually pays those costs…of course not? The customer pays those costs in the price of the vehicle they purchase.
By following the current fashion in corporate management, far too many companies are focusing on squeezing every last penny of profits out of each sale. And in far too many cases, that has led to short-sighted decision making such as not saving for the retirement of their employees despite making huge profits. The government is facing the same conundrum. After over fifty years of “borrowing” from the social security fund, the bill is coming due as all the baby-boomers are retiring and there’s no money left to pay them. Now lawmakers and pundits are bemoaning the cost of their citizen’s “legacy costs.”