Thursday, September 22, 2005

Legacy Costs

You hear the argument made that American automakers like Ford and GM are at a disadvantage compared to other automakers because of their massive pension costs -- legacy costs; a similar claim is made about the legacy airlines. This is almost certainly the case in some narrow, presentist way: these pension costs mean that these companies have higher total labor costs than their younger competitors.

But: what's always bothered me about this argument is that it leaves out the answer to the question: why do these companies have these legacy costs? The answer is that they bought something with them. Namely, if you guarantee someone a very nice pension, then they ought to be willing to take a lower salary during their working life (because what workers care about is their total compensation over a life time). You can think about large pension schemes as being deferred compensation from, say, 20 years ago. Which means that 20 years ago explicit labor costs were lower than they "should have" been. Hence, these companies gained an advantage -- increased their profits -- 20 years ago, only to have lower profits now.

But this only happens because companies don't really believe in Ricardian equivalence for their own books: they didn't put away the implicit savings to pay for the pension fund 20 years out. There is Federal law about guaranteeing pensions -- and the Pensions Benefit Corporation, or whatever, which insures pensions -- but apparently it isn't sufficiently rigorous, which it probably oughtn't be. We're all about leaving companies with a bit of discretion (to extend the macro. language to the firm: a bit of deficit spending might occasionally be in order), but if they have that discretion, they should bear the blame when they misuse it. And this is one such case: firms didn't put away enough money in their pension funds x number of years ago because x number of years ago they wanted higher profits. Don't feel sorry for them and their disadvantage: they screwed up.

Now the problem here is that a corporation is really just a collection of individuals who we happen to care about in the abstract, which makes the situation rather more complicated. Plus, you could argue that those generous pensions were part of a different kind of capitalism which, perhaps, we like more than this current incarnation of capitalism. So we shouldn't be objecting to those arrangement. In any case, I'm very confused.


Blogger henry said...

The pension costs should be sunk, right? You are contracting with a worker to pay them large amounts later for their labor now. If the contract is binding, the cost is sunk. But corporations need to be successful to hold up their end of the deal, if their revenue doesn't exceed their total pension costs, someone's not getting their money. Or they could issue bonds or more stock, but for anyone to buy them they need to have growing profits (i.e. be successful.) Otherwise they default. So the worker signing that labor contract is sort of like a bank making a loan. They'll loan the corporation some labor but they get a big pension. Many of those loans turned out to be bad since the corporations weren't quite as sucessful as they had expected thirty years down the road. The government bailing out corporate pension accounts is just the same moral hazard problem as when a government bails out banks who make bad loans.

So the corporations *are* deficit spending, that's what the pensions do. Borrowing labor and paying it back in cash later. But they aren't smoothing profits, if that is what Ricardian equivalence means for a corporation. Perhaps that's impossible. What conditions would be required for a corporation to make exactly $1 per share over 50 years? Considering they face different costs over the 50 years (very high capital costs at the beginning, lower later) maybe the pension accounts are a way of smoothing costs, but not profit.

9:32 AM  

Post a Comment

<< Home