General Motors has a monkey on its back: another monkey. Actually, three point one monkeys. Writing in the August issue of The New Yorker magazine, Malcolm “Tipping Point” Gladwell explored the possibility that GM’s need to support an enormous population of retired workers is dragging the company into the abyss. Although it’s not exactly a new idea, Mr. “Blink” applied a new tool to the job: the dependency ratio.
Economists use dependency ratios as an analytical tool to examine national economies. It’s a pretty simple concept. Imagine a single man bringing down $100k a year. Mr. Man’s got sufficient liquidity to buy a brand new Corvette. Now imagine the same guy making the same money married with 2.3 kids. He can only read about the joys of Corvette ownership (probably here, for free).
The single guy's supporting one person with one income, creating a one-to-one dependency ratio. Assuming his wife doesn't work, the married man’s living not-so-large at three-point-three-to-one. The more dependents a productive worker/economy must support, the less profitable and thus, financial viable, he/it is.
Gladwell’s article applies the dependency ratio to General Motors, casting retirees as company dependants. In 1962, GM had 464k active employees generating sufficient profits to support 40k retirees. The company’s dependency ratio was one to 11.6.
By 2005, GM had 141k active workers failing to provide sufficient profits to support 453k retirees. The General’s dependency ration has increased to a startling 3.2 to 1. In other words, every GM worker has 3.2 mouths to feed.
Productivity gains– related to just-in-time manufacturing and widespread automation– have helped mitigate the impact of GM’s retiree bulge. The General produces more cars with fewer workers than it did back in the early sixties. Unfortunately, this is a fact not a competitive advantage. Everyone in the automotive industry must do more with less. (Some automakers do it a lot better than GM, but that’s a ratio for another day.)
Ford and Chrysler are in similar straits, struggling to increase productivity (and profitability) to keep pace with their increasing dependency ratio. However, no company has as many retirees as The General. As the industry’s dependency “leader,” the enormous weight of their pension and health care obligations put the company at a huge competitive disadvantage.
General Motors would not be the first American company to collapse under the strain. Gladwell cites Bethlehem Steel as an example of a dependency ratio’s ability to destroy a business, if not an entire industry. In the ‘50’s, steel was one of America’s sturdiest, most important industries. Bethlehem stood at the top of the [slag] heap.
Competition from Germans and Japanese steel mills led to smaller and smaller proft margins. Bethlehem began to flounder. Between 1960 and 2000, the company shed 90% of its workforce. In 2001, Bethlehem Steel finally broke under its $7b pension and healthcare obligations, and filed for bankruptcy. Does any of this sound familiar?
Now the “good” news. After Bethlehem Steel’s pension fund was terminated in 2003, the company’s new owners restructured other obligations and started over. The new company’s dependency ratio sank to zero to one. The steelmaker turned a profit in six months, successfully competing against Germans, Japanese and the rest of the world.
The American auto industry in general– and General Motors in specific– understand the competitive disadvantages created by their “legacy costs.” And yet, GM, and now Ford, and soon Chrysler, are downsizing their business by offering union workers “buyouts”: lump sum payments that trim payrolls but do little to relieve their health care and pension costs.
In many ways, buyouts make sense. Cutting production and workforce lets you match supply with demand, and, hopefully, make a buck. But as the company chips away at its work force, it increases its dependency ratio. Buyouts mean fewer workers with even more people to support.
The only way out of the buyout trap: make more money per car. That’s tough to do when you’ve been selling discounts, rebates and finance programs for years, and your competitors don’t share your dependency problems. The margins in the auto industry have thinned like Kojak’s pate, especially in the low to mid-range market— GM’s unhappy hunting ground. Even the once mighty margins on light trucks and SUVs have taken a hit.
Unless GM can knock one (or ten) out of the park, the only way out of the dependecy trap is… volume. Back up two paragraphs and repeat.
Of course, GM can’t repeat. Every business cycle costs money; The General lost $8.6 billion last year. The repeat is actually a spiral; the plane without an engine kind. Spend, shed, spend more, shed more. In the end, the guy with 3.2 dependants will not be forced to ogle his single buddy’s ‘Vette. The company with 3.2 dependents per worker couldn’t afford to make it in the first place.
For most dependency problems, there’s a rehab program. For this particular affliction, it’s not twelve steps. It’s chapter eleven.
Michael, a well thought out and incisive entry.
The fact is that not only the pension issue, but the finance arm problems, will leave GM and FoMoCo with no option but bankruptcy protection.
The “Japanese miracle” of the 1970’s was predicated upon a “jobs for life” paradigm. This has now been soundly disenfranchised, and yet the US gleefully attempted to emulate the Japanese miracle domestically, by providing a similar “jobs for life” mentality.
It doesn’t work, and flies in the face of free market rationality. The Japanese discovered this a quarter of a century ago.
I suspect it is going to be a painful and bitter readjustment…..
Michael,
You make a good point. I characterize the underfunded retiree issue as one of GM’s many sins of the past. They simply didn’t put enough money aside during the good times when these people were working to cover all the costs they would have to cover in the future.
The situation reminds me of the one the big New York banks (Chase, Morgan, Chemical and Manny Hanny) all faced in the late 80’s before they merged with one another. They had all made multi-billion dollar loans to Latin American nations, which they had on the books at face value, but which had low odds of ever getting paid. The banks’ profitability was essentially held hostage by the actions of governments that had far different constituents to please (i.e. themselves).
The strongest of the banks, JP Morgan, had a simple solution – they wrote off all the loans. Took the hit and moved on. And because they were a AAA bank with solid profitability, shareholders took it in stride. Competitors weren’t strong enough to match Morgan’s move and were left to twist in the wind for a few years as they struggled to eventually write down the debt.
If GM had the financial strength, you’d like to see them simply take a pile of cash sufficient to meet all their retiree obligations and stick it all in a separate reporting structure, so they can have a fresh start. Granted, GM would still be legally on the hook if the money they set aside proved to be not enough, but I think the psychological impact – on employees and on investors – would be powerful.
Gotta get those monkeys off your back.
dont really have much to say about the article as its alot of waht has been said before just wanted to say whoo hoo for Bethlehem steel…2miles down the street
That’s what happened to my Vette!
A very good exam of on of the main problems for the big 2.5. How do Ford and DCX stack up?
Is it me, or is the math off ?
40k reitrees supported by 464k employees = Each worker is supporting 0.086 reitrees
453k reitrees supported by 141k workers = Each worker is supporting 3.21
Are you sure these numbers are right?
If you want to look at it the other way, it’s
11.6 employees support 1 retiree or
0.3 workers to 1 retiree
I do not understand what the issue is?
In the US you want to pay low taxes (ideally no taxes) so companies or pension funds have to pick up the bill for retirees.
In most other industrial countries we pay higher social security & income/sales taxes and the state funds pensions for retirees.
I am afraid you cannot have it both ways – low taxes/social security payments and reasonable pensions!
Only the very rich can forgo pension payments, the rest of us have to be supported somehow!!
The same applies to health care.
Robstar:
I’m not exactly a math guy, but 11.6 employees supporting 1 retire is right. So is 1 to 3.2. The conceit is the flip. A real mathematician would never do this – there is no ‘retirement’ in math, that I’m aware of – that’s why there’s economists.
Graham,
The issue is burden. G.M. has to carry the burden for all of its retirees all by itself. Your right when you American’s don’t want to pay higher taxes, but the Feds aren’t necessarily the only answer. Had, back in the 50s, the auto industry collectively allowed for floating 401k-like device, particularly for United Auto Workers, the burden would be shared by everyone producing cars in the US. Honda, Toyota, BMW, etc. The playing field would be more level. This also would have given the employees more power, as in mobility, which is probably why it didn’t happen.
Here’s a newsflash for everyone: It isn’t just GM and Ford employees who are going to be screwed out of their “pensions” because Social Security is NOT going to survive for most of us to collect.
Let’s just say the truth about it: when the original social security idea was floated by the Roosevelt administration in the 1930’s, insurance industry experts volunteered their expertise to advise the administration and flat out told President Roosevelt that 10% of the average salary would need to be put aside as an investment for workers to retire on, and the administration decided that this was “much too much” and decided instead to rely upon smoke, mirrors and lies.
Well, the truth hurts but all of us in the US are going to be screwed royally over the scam which is “Social Insecurity”.
Let me put it another way – if it weren’t the U.S. Government doing the scamming, the Attorney Generals in all 50 states would have made arrests by now.
Michael:
The Europeans still have to carry the same burden. The only difference is, that they basically HAVE to do it every month, while GM & Co can just adjourn the payments and then end up with a big deficit.
In Germany for example, about 33% of the salaries go directly to pension funds and health care every month. And thats without tax. So if Mercedes or Volkswagen pay 60,000€ for you, 20,000€ go directly into social security and if your single you pay an additional 20,000€ tax. That’d leave you with a loughable 20,000€. That’s why wages are so high in Germany, because of the burden every company carries day in and day out.
If GM had put that much money into a pension fund every month, for every worker they ever had, they would have enough money and there wouldn’t be any problem at all. But they cut costs, by reducing the their pension reserves and therefor they deserve whats coming to them. The retirees have the right to get their money and GM & Co have to make sure they’ll get it.
Michael,
Glenn & Tom have reinforced my point!
In other countries the Social Security systems (they carry the “burdenâ€) are having problems paying “baby-boomers” reasonable pensions.
Retirees are getting lower & lower pension payments and the current employees and/or employers are paying higher & higher contributions.
This leads to the frequent accusation by Americans that Europeans are lazy and over paid!!!!!
As an earlier poster mentioned, my first thought was “this is like Social Security”.
I also wonder how soon it will be before we hear talk of the Federal Government picking up the health care and other cost burdens of GM and other companies in this same underfunded demographic bind so they don’t go the way of Bethlehem Steel. You know, the too big, too important to fail mentality.
BTW, I did not know Bethlehem had been revived and is doing well. Thanks for the very good news. I doubt they will be repeating old mistakes. It’s been a longtime since I saw a steel beercan.
When I lived in the UK, the actual taxes which came out of my paycheck were not terrifically higher than what came out of my paychecks once I moved back to the U.S. (if you were fair about it and included the medical costs paid out of my U.S. paycheck), and my homeowner taxes were not that far out of line from one country to the other.
Where the Brits get to pay WAY over what Americans for taxation are
– Petrol / gasoline or diesel fuel (how about $7 to $8 per U.S. gallon for fuelling up that nice big SUV?)
– Energy costs such as electricity and natural gas (this explains why British houses had instant hot water heaters to only heat water as used, instead of heating water while we sleep, while we’re at work, 24/7/365 like American hot water heaters – analagous to idling a car 100% of the time in case you might want to drive it)
– Purchase taxes (when I was there, it was 17.5% VAT on most goods, plus new cars had a 10% car tax – on which VAT was ALSO charged – a tax on a tax) – in contrast, here in Michigan, there is a 6% sales tax, no special car tax
– Drinking alcohol or smoking (never a problem since I am a non-smoking tea-totaller, but certainly a big ouch for those who smoke & imbibe). British taxes are absolutely outrageous – I euphamistically called them “sin taxes” when I lived in the UK and my UK friends always nodded their heads and said – yeah, that’s what they are I guess…
So, what happened to those legacy costs after Bethlehem Steel filed chapter 11? Did the federal government simply pick up the tab? Will it if/when GM and Ford do the same?
Glenn,
Generally in Europe employers also pay high contributions to the state by way of taxes or social security (ex: France about 45% of gross employee income). These payments are frequently not “seen” or taken into account by employees.
Also I did mention sales taxes being higher, which of course also includes purchase tax, value added tax and fuel duties.
It is not surprising that “consuming” in the US is noticeably cheaper than in Europe and other regions of the world.
I still maintain that someone has to pay somewhere and somehow, soon or later!
There are no free rides!!!!
Excellent article. I must echo the comments of some of the others. This issue begs the question: Why do current GM employees have to support retirees? Because GM under-funded its pension fund while the now-retired employees were working. If it were adequately funded throughout, today’s payments to retirees would be a non-issue.
Unfortunately the same flawed logic that GM applied to its pension fund management fund (i.e. depending on future revenue to cover disbursement of funds to retirees) is the same speculative logic that the US government is using with regard to Social Security. What we are now seeing with GM might foreshadow what is to come for America. Scary.
guyincognito:
Yep, the federal government picked up the Bethlehem Steel pension burden. Which means, in the end, we all did.
Graham said…
“I still maintain that someone has to pay somewhere and somehow, soon or later!”
Yup, *you* and more than once – and IMO the European system is more flawed and deceptive to the individual that the various ones that appear in the US (again just my opinion based on 12 years employment in the UK followed by 11 years in the US). Their demographic timebomb is going to destroy the state benefits system.
Getting back to the car industry I can’t understand why the big 3 haven’t done something like IBM. They’ve been sued as a result but haven’t had to use chapter 11 to cut huge amounts from their liability by changing the rules for retirees almost unilaterally. They did offer some buyouts and selective early retirement but most ex-IBMers still think it was sharp practice. What holds the big 3 back considering their plight?
In the 60’s, when 464K employees were enrolled for the pension plan, somebody must have thought that at some point in the future they were gonna have to pay up.
Unfortunately, it is very difficult to predict how much money to set aside. Too many unknown variables:
– how many workers will cash out (actually retire)
– how long they will live
– what’s the inflation gonna be for the next XXX years. xxx= many, more than 10.
– how much you can actually afford to set aside given your current result.
Also, setting aside that money will hinder your operations. It freezes cash that could be put to better use (or even profit). The trend will definitely to lowball the estimate. Especially under the pressure of your competitors who do the same.
Finally, predicting health care cost, leghtening of life expectancy (and associated health care cost) was hard to predict (hard = impossible) But you have to ask yourself why health care cost have skyrocketed in the last 10 years (greed, free market, insurance for doctors, lawsuits, lawyers)
pete: Getting back to the car industry I can’t understand why the big 3 haven’t done something like IBM. They’ve been sued as a result but haven’t had to use chapter 11 to cut huge amounts from their liability by changing the rules for retirees almost unilaterally. They did offer some buyouts and selective early retirement but most ex-IBMers still think it was sharp practice. What holds the big 3 back considering their plight?
Union contracts…GM can’t unilaterally alter benefits that it agreed to provide in a legally binding document.
So, was Studebaker-Packard management better at negotiating with the UAW than GM, Ford, Chrysler and AMC?
Because, in December 1963, Studebaker closed virtually all of it’s South Bend Main plant, centered production in Hamilton, Ontario and by mid-1964, stopped production of their own engines in South Bend, laid off the last of the U.S. employees, sold off the Mishawaka military truck plant (now HUMMER), and – essentially – told the UAW that the non-vested retirement plan for all of the Studebaker workers was empty, gone, used up, so sorry, bye bye, kaput, and go away, drop dead.
Obviously the UAW probably learned from Studebaker and so now, it will take Chapter 11 for GM, Ford and the U.S. side of DCX, in order to do a “Bethlehem Steel” and move most of the unfunded retirement liability into the hands of the US Government (i.e., we taxpayers will pick up the tab).
I bet that the management in GM, Ford and DCX are watching the Delphi bankruptcy restructuring (and the “some-day” decision by the bankruptcy judge re: whether the UAW contract can be unilaterally jettisoned) with high interest.
High interest indeed. It will mean the difference (for GM, Ford and DCX) between whether they must eventually choose Chapter 11 bankruptcy (after which, a few jobs will remain, along with a mere shadow of the former company) or Chapter 7 bankruptcy (bye-bye, close the doors, la morte, finito, kaput, gonesville man).
Guess who loses in the long run either way? Why, of course, we lucky U.S. taxpayers (again, still, yet).
I’d like to see some Enron style prosecution of the GM, Ford and DCX executives once all of the chips fall, though, how about you?
The Brits are apparently going after prosecuting the ex-managers of MG-Rover.
OK, yeah, I just realized the high irony of the Government of the United States going after US auto executives over the scamming (and skimming?) of the retirement plans for the workers, when the U.S. Government are the biggest scam (with Social Insecurity).
If it weren’t so potentially disastrous for all of us in the U.S. it might even be funny.
And yep, you Euros and Brits – your retirement funds are just as “safe” as ours, because you governments are just as “steady and honest” as ours.
I wasn’t trying to say that the European system is better in any way. It’s probably even worse for society in general. My point was, that European car manufacturers have the same retirement costs, if not more.
On the pension thing – in the ’50’s, people would retire in their early 60’s and collect the pension for a couple years and then die – end of pension obilgation.
Now, with sweet early retirement deals, people retire in their 50’s and live to be 80 or older. They live on the pension for more years than they actually worked! No kidding – the pension fund money doesn’t come from a duck that lays golden eggs!. People need to figure out that they can not spend 30 years as a late life playboy/girl in Florida and are going need to continue gainful employment. That may be a second career, part time, etc.
Now, with sweet early retirement deals, people retire in their 50’s and live to be 80 or older. They live on the pension for more years than they actually worked!
That’s the heart of the problem. Some economist said it best: “Demographics are destiny.”
Given such demographics, old style pensions (like GM, Ford, and Social Security/Medicare) are un-accountable (i.e. assumptions about future costs are horrifically uncertain.) DiLorenzo over at autoextremist dot com said it best when he likened the bankruptcy at Delphi to a canary in a coal mine. Excessive pension and health costs will snuff out even the healthiest industry and government.
Good news: With more elderly and fewer young overtaxed workers, Europe will face this demographic and societal train wreck first. After watching it there, I think we can avoid it here.
Bad news: If you want to live well into your 80’s-90’s, expect to be working part time in your 70’s-80’s. I can accept that.
taking GM’s problem and relating it to a national healthcare program is what the original article did too
You can read it here by the way, unless I’m not supposed to post that
One of the interesting points that was made by Gladwell’s article is that the union wanted pensions funded by industry consortia, not by individual companies, recognizing that companies’ fortunes ebb and flow, but industries are likely to survive to fund benefits. GM and others rejected this approach, which was entirely rational short to medium term thinking. Had they assented to the union’s position, they would have been required to fund the pensions. From a long term perspective, of course, today there would be no deficits, and Honda and Toyota would be paying in as much in the U.S. as Ford and GM, thereby losing this aspect of their competitive advantage.
Promises of future benefits are always attractive to managment; they provide what appears to be substantial compensation to workers at no present cost. There is no significant incentive for management to adequately fund future pension benefits, which will only be due if the company is still around decades in the future. Few companies ever last that long, and the trade-off for funding benefits is lower current profits. Paradoxically, the dependency ratio problems GM and Ford are now facing are the result of staying in business and becoming more productive.
Not surprisingly, resistance to collective (i.e. government) payment of health and pension benefits is diminishing, as older industry members look to evade the disadvantage imposed by their legacy costs, and negate the benefit foreign competitors achieve at home through national health and pension systems.
Honda and Toyota would be paying in as much in the U.S. as Ford and GM, thereby losing this aspect of their competitive advantage.
How so? If Honda and Toyota are not unionized, then they do not need to kick into a pension fund regardless if it was in the industry or per company.
check out autolinedetroit.tv for a nice summary of how each of the major car companies does regarding profit per car, productivity, etc. GM does better than i would have thought.
401k’s were not available until 1978.
The Bethlehem Pensions were turned over to the Pension Benefit Guaranty Corp. (PBGC) ( http://www.pbgc.gov/ ). They were able to turn over 2.6 Billion. The PBGC currently has deficit of over 26 Billion for last year. With Delta and Northwest Airlines dumping pensions to the PBGC, this will no doubt grow.
The tax payers of course are on the line for this deficit.
I predict in the next 10 years all company pensions will be either frozen, or turned over to the PBGC.
Pensions have always been a terrible idea, an artifact of mass stupidity and short-sightedness during a few decades of the 20th century. People in the past eras didn’t have pensions, and people of the future won’t have them, but we contemporaries are still stuck with the mess.
It’s been clear for the past century that people were living longer and longer and it’s been clear for decades that fertility rates would tend to drop in prosperous countries, so there’s been no excuse for ignoring that fact either for GM executives or government planners or politicians or anyone.
I just wonder if GM execs of the past were aware of the risks and had a short-timer mentality, maybe they always figured they could declare bankruptcy in a pinch and shove the burden on the taxpayers, or what?
As for social security, it’s still an awful system but it won’t go “bankrupt” (whatever that might mean for a government program) because the gov’t will simply as necessary raise retirement age, reduce benefits, raise payroll taxes, borrow money. The government has a lot of levers and absolutely no legal obligation to live up to curent expectations. But it kills me that we let other countries such as Chile and even Canada(!) be more progressive in privatizing social security.