The repeated and unconvincing assertions by General Motors Chief Executive Officer Robert Wagoner that the company is not going bankrupt have caused observers to bemoan the excessive costs of GM’s pension obligations or the evils of outsourcing, or to welcome the inevitable and welcome decline in U.S. manufacturing in a high-tech future. Would a GM filing for Chapter 11 bankruptcy represent the end for U.S. manufacturing, or is there another way out?
General Motors’ pension and healthcare obligations are onerous indeed, with an actuarial deficit of $57 billion at 31st December 2004, 4.3 times the current stock market capitalization of the company. Pensions are not the main problem. After borrowing $10 billion in 2003 and injecting $18.5 billion into the pension fund, the fund was in surplus at 31st December 2004, though that surplus was only arrived at by assuming an extremely optimistic 9 percent return on GM’s pension asset pool. (Assuming you can make an excessively generous return depresses the value of your pension liabilities.) However, the bankruptcy of the auto parts manufacturer Delphi, spun off from GM in 1999, added $10 billion to GM’s unfunded pension liabilities because it triggered a GM obligation to fund Delphi’s pension deficit. Thus GM’s pension funding problem has recently become a more serious one.
GM’s pension picture is nevertheless not excessively grim. If interest rates rise, the 9 percent return assumption will become more and more realistic, while the fund, if invested conservatively, will not lose much value; thus the pension account will stay close to balance. The last few years have been difficult ones for pension funds. In the late 1990s GM and other companies had been lulled into a false sense of security by rising securities prices, which raised the value of pension fund assets without the need for the company to make pension fund contributions at all. Then a drop in the stock market reduced the value of pension fund assets, and the period of very low interest rates in 2001-04 devastated pension fund actuarial calculations by reducing the rates of return available on bonds. GM’s $18.5 billion contribution in 2003 was thus essential to the fund’s soundness, but will probably not need to be repeated on anything like the same scale, since any major drop in the stock market is likely to be balanced by a rise in interest rates.
GM’s health care obligations, on the other hand, look like an insoluble problem, but are no more so than the equivalent long term insolvency in Medicare. GM’s retiree healthcare costs are increasing at 10.5 percent per annum, even though retiree numbers are gradually declining, as the bulge of well paid, well pensioned assembly line workers taken on in the buoyant 1950s and 1960s begins to disappear from the system (from 1970, GM’s workforce began to decline; hence the company’s “baby boom” is about 20-30 years older than that of the United States as a whole.) With assets of $20 billion and liabilities of $78 billion, GM’s healthcare fund position looks hopeless. However, the liabilities are calculated assuming continued 10.5 percent increases in medical costs till infinity. If that happens, the entire U.S. economy will be destroyed by the medical bills, not just of GM retirees but of everyone else. GM has no legal obligation to fund these benefits in advance, and thus $20 billion appears a perfectly adequate cushion for a healthcare plan that in cash flow terms will only become an enormous problem if medical costs remain out of control.
Contrary to popular belief in conservative circles, the central difficulty with GM’s pension and healthcare obligations is not that a weak and short term-oriented GM management gave in to repeated blackmail by the strong United Auto Workers union. More important, promises made and actuarially costed 20 and 30 years ago were made in very different actuarial conditions from today. Life expectancies were shorter then, retirement ages were generally later and healthcare costs were lower—once you got a major disease late in life, it generally killed you fairly quickly. The heavy rate of smoking among blue collar workers no doubt also helped to keep long term costs down. The actuarial problem has however been exacerbated by GM’s tendency in every downturn from 1980 on to pressure its workforce to take early retirement at 55 or even 50. These early retirements provided short term relief from salary costs while enormously increasing the actuarial problems of GM’s pension and healthcare systems.
The rapid improvements in medical treatments have been a huge benefit to patients, and a huge cost to providers of healthcare and payers of pensions. GM’s payment of $18.5 billion into its pension fund in 2003, and its further payment of $9 billion into its healthcare fund in 2004 were far sighted actions, necessary only because of the changes in the underlying contracts between company and workers represented by its pension and healthcare plans. It must be clear even to the United Auto Workers that GM has a case in equity for relief from these burdens, and that if it does not get such relief, the company’s bankruptcy will make its retirees’ pensions and healthcare very much more precarious than they are today.
The fairest way for GM retirees to assist the company to fund their pensions and healthcare is clear; they must continue working after retirement. Far from encouraging early retirement in its downturns, GM must contract with its employees that retirees under the age of say 70 will be available to the company for continued employment, for up to three days a week, as a condition of their pension, although they will earn additional pension service when so called upon. Rather than laying off workers and encouraging early retirement in downturns, GM will thereby have access to a pool of trained and very cheap (because already paid for) labor in upturns, balancing its employment cycle by this means, and avoiding aggressively hiring workers who will later have to be laid off. Work on an automobile assembly line is not the heavily physical endeavor it was 50 years ago, and should be readily feasible for most healthy GM retirees under 70.
On the operating side, GM is in the process of entering a normal cyclical downturn, with the normal problems it has experienced in past cyclical downturns, notably in 1973-75, 1980-92 and 1989-91. Monday’s announcement of 30,000 further layoffs and a potential saving of $7 billion per annum represents the normal and correct GM response to such downturns, although it is to be hoped that as few as possible of these layoffs are by early retirement. As usual, the company has pushed sales too hard in the latter stages of the upturn (helped in the most recent case by the Federal Reserve’s damaging cheap money policies), and has met with a movement in the market that has partially obsoleted its most profitable product range, Sports Utility Vehicles.
In past downturns, these problems have resulted in an excess inventory of un-saleable models on dealers’ forecourts, and mass bankruptcies among the GM dealer community, followed by a lengthy period of depressed sales and high retooling expenses for the new models that the market now demands. This time around, two factors have complicated the equation. First, GM has borrowed sales from the future by an aggressive financing program, depressing costs even in the pre-downturn boom and probably causing a wave of repossessions and bad debts in the future. Second, GM’s payments of nearly $30 billion into its pension and healthcare funds have left its credit rating in poor shape, and eliminated the financial flexibility with which it has been accustomed to weather the losses inevitable in a downturn in an industry with such high fixed costs. It was Hobson’s choice; if GM’s management had left the company with very large reserves of cash, the company would doubtless in recent markets have been acquired by an asset-stripper who would have removed the cash and left the operating GM even weaker than it is today.
GM has considerable ongoing strengths. Its Asian operations remain profitable, and China sales exceeded 500,000 vehicles in 2004, with the Buick brand increasing its premier position in the country. Contrary to received opinion among urban yuppies in the blue states, GM’s product range retains considerable appeal, not only in the more old fashioned parts of the United States but also among automobile consumers around the globe. GM has proved adept in adopting its models and marketing to local conditions. An examination of its Chinese Buick offerings shows automobiles laden with gadgetry, far more than in the United States, with style features calculated to appeal to the youthful and wealthy crowd that represents Buick’s Chinese customer base, rather than the older and more conservative Buick buyers in the United States. There is no reason why GM’s successes in this area cannot continue, provided it has access to the resources it needs to survive the downturn it is entering, and retains a management culture that is primarily long term oriented in nature.
Once interest rates have stabilized at an appropriately higher level and illegal immigration, undercutting the U.S. labor market, has been brought properly under control, there is no reason why a U.S. workforce cannot remain competitive in manufacturing for the world market. The proportion of a manufactured product’s output cost represented by direct labor continues in general to decline, as increased automation replaces the heavily manned production operations that were necessary in the past. Knowledge itself, in the form of the increasing computerization of an automobile’s operations, is coming to represent a greater and greater proportion of the automobile’s total value; in these areas, the United States is highly competitive.
In the next decade or two, there is likely to be much faster movement in automotive design than in the last 50 years, particularly if oil prices remain high and supplies restricted, with an increasing proportion of automobiles powered by means other than petroleum. Even more exciting is the prospect of automobiles which drive themselves, whose direction has been removed from a human driver who is probably distracted, possibly inept and conceivably drunk or stoned – this technology can potentially save a high proportion of the 50,000 lives per annum lost today on U.S. roads. This faster pace of innovation makes it likely that U.S. and Japanese technological capability will allow the automobile industry to remain a major part of these high-wage economies.
General Motors may in the next few months file for Chapter 11 bankruptcy, and then enter a period of legal and financial reorganization that would inevitably be highly disruptive to operations. If this happens, it will have been caused by a change in the implied contract between GM and its employees due to improving medical technologies that bring only benefits to the employees, only costs to GM. GM has made mistakes, and has had other mistakes (notably the SUV product dead-end) imposed on it by fatuous regulators. Nevertheless there is no reason to doubt that if the lawyers keep their dirty hands off, GM and other U.S. manufacturers can have a prosperous and important future ahead.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.