General Motors (GM) and the City of San Diego have something in common: they made short-term pension decisions while under intense pressure from labor unions that are now costing both organizations dearly.
Business and political leaders tend to be rational people. Sit down with any one of them and you’re likely to come away with the impression that you just met with a logical person who is trying to make the best decisions they can with the information available.
Yet, General Motors is a prime example of an organization made up of rational people making seemingly irrational decisions. Why? I believe that the answer lies in understanding how short-term incentives led to massive long-term liabilities.
The story at GM is straightforward. Under pressure by Wall Street to show high quarterly earnings, GM executives struck a bargain with the United Auto Workers (UAW). In exchange for smaller salary increases, workers were promised robust pension benefits. Because all of the costs of these future benefits did not show up on the company’s profit and loss statements, short-term pressure for profitability could be alleviated and solutions to the underlying structural imbalances between labor costs and productivity put off to another day. Union leaders, in turn, could show their members a robust package of retirement benefits, helping to justify increased union dues and union leader salaries.
While attractive in the short term, the chickens have come home to roost. By some estimates, pension costs add more than $700 to each car, truck and SUV that rolls off of GM’s assemblylines. Indeed, some have argued that, as a consequence of these bargains, GM has become a pension company that manufactures cars to meet its obligations to current and future retirees.
Some might concurrently say the City of San Diego has become a pension company that collects taxes to meet its own retirement obligations to current and future retirees. Pension obligations next year will take up 15 cents of every dollar collected by the City’s general fund. The roots of this problem have striking parallels with the faustian bargain struck by GM. Faced with electoral and campaign systems that skew political power dramatically in favor of the public employee unions, but with a tax structure that thankfully makes it difficult for the politicians to raid our pocket books, council members made a “rational” short-term bargain. Agree to modest salary increases today in exchange for lavish future pension benefits in the future. The budget looked rosy and only intrepid watchdogs like Dianne Shipone could ferret out just how unstable the façade was.
Yet a critical piece of the pension puzzle differentiates GM and the City of San Diego: the City is a monopoly, GM is not. For as long as they choose to live where they do, citizens of San Diego are stuck with the same government. Would-be GM customers can instead choose to buy a Toyota.
Indeed, Toyota is reaping the rewards of avoiding short-term fixes and their focus on competitiveness. They and other Japanese car companies figured out a long time ago that a more sustainable retirement system was to create defined-contribution 401(k)-style plans for their employees. A critical advantage of such plans is that that labor costs are not pushed off into the future but rather immediately felt. In such a system, managers are less able to mortgage the future to satisfy immediate pressures. Consequently, Toyota customers are not being asked to pay high retirement legacy costs.
But have no fear, the same pressure groups that helped to create the current crisis are, of course, urging government to raise taxes to alleviate the pressure. They were sitting in a row at a recent Council budget committee hearing, nodding approvingly as council members suggested that San Diego has a “revenue problem” and that it was time for the City to enact tax increases that would impose more than a hundred dollars in new obligations on every man, woman and child in the City of San Diego. They’re doing this for the same reason the UAW tried to get Congress to impose barriers against Japanese cars: don’t bother fixing the problem, we like it just the way it is, instead just alleviate the short term pressure to reform.
The truth is, pressure from foreign competitors continues to force GM to improve itself or get out of the market. Though painful, the car company and UAW leaders are being forced to have frank conversations about what it will take to create a sustainable GM that can compete during the coming decades. Likewise, we know that when tax increases go on the table, the pressure for the City to reform itself will come off the table. As taxpayers, let’s keep the pressure on and force the kind of honest and difficult dialogue that will lead to a better San Diego.
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