US Auto Industry 2.0 - "Southern, Non-Union, and Foreign Owned"

Southern Comfort
Less than two decades ago, Detroit's Big Three were the U.S. auto industry. But now there's a second auto industry: one that is nonunion, foreign-owned and Dixie-based. That's why Southern senators worked so hard to block the bailout.

"Time was, the Big Three were the U.S. auto industry. No longer. Over the past two decades, enticed by cheap labor and massive incentives, a second auto industry has emerged: nonunion, Southern-based and foreign-owned. Large plants, with names of Asian and European carmakers emblazoned upon them, now dot the Southern landscape alongside Civil War memorials. By moving aggressively into Kentucky, Tennessee, Alabama, Mississippi, South Carolina, Georgia and Texas, foreign manufacturers—call them the "Little Eight"—have transformed the economic geography of the nation's auto industry and the political debate surrounding its future.

To hear the rhetoric wafting down from Capitol Hill of late, you'd think that Toyota, Hyundai, BMW and the rest are as all-American as Mom and apple pie. And, in many ways, they now are."

Detroit is running a bloated business, it's weighted down by legacy costs from years of mismanagement and union greed. Businesses can't run bloated, not well, and not for long before someone else comes by and puts them out of business.

We're witnessing that happening now - and we're all going to be better off for it in the long run despite some temporary pains while the adjustment takes place. And there will be pain, and there might be some areas that never truly recover. I'm from Pennsylvania down near Philadelphia originally, and I've been throughout a lot of burnt out, run down industrial towns that never recovered from the downturn in the industry they've supported. Between some of the old US Steel Industry, and Coal Mining towns that are still fairly economically depressed, it causes problems. Detroit and some of the surrounding areas that support the Auto-Industry that's tied to the Big 3 might be in for that if GM, Chrysler, and Ford can't get their house in order. And that's bad, and it's terrible for the people that live there, and it's a shame, and I don't wish that on anyone, but sometimes that's just how things happen.

The northern manufacturing States like Michigan & Ohio have generated disincentives for new industry to locate there with anti-business laws that heavily favor Unions. The Southern Right to Work States on the other hand have encouraged new business there, by setting up business friendly laws that keep the Unions from wielding too much power. They don't prohibit Unions from existing, or from organizing labor - but what they do via "Right to Work" laws, is prohibit Unions from forcing all workers to have to join the Union and pay Union dues. This means means the Unions hold considerably less power in those States because they can't manipulate the situation to make it so they are the only game in town - and if they aren't the only game in town, their bargaining power is greatly reduced.

It's important to take a look at the pros and cons of Unions to understand what's going on. So far, most of my rhetoric here on the site has been pro-business and anti-Union, I make no secret of my thoughts on the situation. But here's why I got there...

In a free market system, the sum of market demand and sum of market supply cross at a point that is an efficient transfer of goods and services between those who are willing and able to purchase and those who are willing and able to supply. The greatest amount of social good comes from this efficient market equilibrium. Social good is measured by the sum of both consumer and producer surplus - effectively the difference between what a person pays or sells at and what they would have been willing to pay or sell at. Market equilibrium maximizes this surplus for both consumer and producer (though to be clear, depending on the demand and supply curves, those amount will differ), and thus maximizes social good.

Any laws or manipulation of the situation to force it out of equilibrium results in a less efficient transfer of goods and services, where some surplus changes hands (sometimes from consumer to producer or vice versa, sometimes from either one of them to the government), but in all cases some of it just gets lost - this is called dead weight loss. This dead weight loss is what is referred to when you hear the proclamation that say something like Taxes don't just redistribute pieces of the economic pie, it actually makes the whole pie smaller. Anyway, the end result is that social good is not maximized and therefore we can make the definitive positive statement that anything that distorts the market from equilibrium causes social harm.

This isn't to say something like taxes aren't necessary. There are plenty of things that a free market will never supply because there is no market force to supply it. Anything that isn't both Rivalrous and Excludable in nature will never be supplied by a market. Public goods like National Defense, or common goods like clean air, won't ever be provided by a private industry - and so there is a place for government to provide to regulate to make sure these needs are in place - and a huge part of financing public sector goods is through taxes. But you need to get into normative economics in order explain why that is necessary because you have to get into making a judgement call between what is better - no taxes & no national defense or taxes and national defense - you probably have an opinion, but it is still just that. Anyway, without going too far off track, lets get back to the Unions.

Unions exist for one reason. To drive the price of labor (otherwise known as the wage) above the market equilibrium. Now, Unions might have started off as a means of protecting workers against harsh and exploitative robber barons of business - but the fact is these days, we have laws protecting people. OSHA has safety standard laws for example which protect workers from unsafe working conditions. So the fact is that the government already provides for the vast amount of reason Unions once had to exist.

This leaves them with only one purpose, to drive up the amount of wage their workers can get - and we're talking about overall compensation, not just the actual wage rate, benefits are an important consideration of overall compensation. An important distinction here is that this manipulation of the market away from the equilibrium harms overall social good. The workers (suppliers of labor in the labor market) may get more producer surplus, but consumer surplus (through the employing business, and passed on to higher product prices for actual end consumers) goes down, and importantly some of that surplus is just flat out lost. Now, you can make an argument that people need a "living wage" and that they should be able to afford to make enough money to live on what they make so long as they don't live outside their means - but there we are getting back into "normative" economics if you try to argue that is "fair". The only measure by which we can say a wage is "fair" in the positive sense is that the wage is the market equilibrium wage. Unions by way of laws built to allow them to do so, monopolize labor and drive the price of labor away from the equilibrium, and harm the employers of such labor.

This is why I describe the Unions as greedy. There is a famous saying in economics "there is no such thing as a free lunch". It's meant to convey the idea that everything has a cost, even if it's hidden from you. Unions may get higher wages for their workers, but that comes at the expense of harm to their employers and consumers of their products.

This is why pro-Union is anti-business and ultimately anti-consumer.

You need to deal with the realities facing the market. If your labor costs are higher than your competitors, they have an advantage against you. They can lower prices and still maintain profitability, while you will run into the margin of non-profitability much sooner. Businesses will likely fail if they are not seeking their profit maximizing scenario - over a long enough time, that is gauranteed if they fail to change to a profit maximizing operation. Union wage hikes cause a business to not be able to profit maximize at the market equilibrium. Some of that can be absorbed, particularly if your product (labor in this case) isn't easily transferable. Trade Unions can work in Construction, because generally those Unions either supply most of, or hardly any at all of, the labor in a given area. You can't have a carpenter in Miami build a building in Philadelphia, while still in Miami. So the operation costs with Trade Unions for construction end up falling to a new equilibrium for the given area (assuming laws in favor of Union power in that area), and the cost is passed along to the consumer, but the Union can successfully exist.

Compare that to the Union for the Auto Industry. Cars, unlike buildings, can be built anywhere and shipped to anywhere as a final product. So if the labor costs are less expensive in the South, then Northern Union labor is replaceable. Now, this might not be the case in the short run... in the short run, you need factories to put things together, and there is already a fair amount of factory infrastructure in say some place like Detroit, that would need to be replaced in the South. And if the costs of replacing that exceed the savings of cheaper labor, then it's not worth it.

But in the long run, most things are open to change that would otherwise not be in the short run. And looking at the Auto-Industry, we're looking at the end phase of the Long Run right now. Foreign competitors have actually built factories in the South - with important upgrades in the production system where modularity allows different makes of vehicle to come off the same assembly line - unlike in Detroit where a single factory is hard wired to make one and only one type of vehicle. This is part of the reason the Foreign makers are doing better than Detroit, they were more easily able to adapt to changing market demand. Workers in the South are producing cars consumers want at cheaper labor costs, at a price consumers are willing to pay because the savings in labor costs can be passed on to the consumer to entice them to buy. Cars being built in Detroit are less responsive to consumer demand, have a reputation (deserved or not) for being lesser quality, and are more expensive due to so much legacy cost associated with the UAW.

What we are essentially witnessing is a repeat of the U.S. Steel Industry collapse. At least, we are watching a collapse of Unionized labor for such, the same way Unionized Steel collapsed back in the 1970s. When the Unions demand too much, over time those costs add up, and eventually it gets to a point the business can't bear it and continue. We must remember, cars really can be built and shipped anywhere, making the labor replaceable in the long run if one area ends up being too expensive.

With all that considered - extending bailout money to the U.S. Big 3 while the UAW refuses to bring its labor costs in line with the competition is propping up a failing business model that will ultimately crumble. Banks don't usually (ignoring the housing bubble fiasco of recent fame) make loans to people they think can't pay them back. Investors don't usually put money into things they think won't bring them a return. Likewise, the Government should not be pumping money into someplace that is likely to lose it with no real chance of return. They shouldn't be doing it particularly when it will directly harm their competition - particularly Foreign owned U.S. competition, employing U.S. citizens, using U.S. made parts, and selling to U.S. consumers.

If the government gets involved in this, we'll get right back to our dead weight loss scenario as they push the system way out of equilibrium. Don't be surprised if a lot of that lost weight is your hard earned cash, paid in taxes, that quickly spirals down the Big 3's toilet of a business model.