General Motors is proof that slashing wages isn’t the ticket to profitability

By Marshall Auerback

This post first appeared on Salon.com

General Motors just gave its workers a lot less reasons to feel grateful, announcing right after the Thanksgiving holiday that the automobile manufacturer planned to cut its salaried workforce by 15 percent, to dump most of its car models and to kill off five North American plants, in Detroit and Warren, Michigan;Warren, Ohio;White Marsh, Maryland; along with its Oshawa, Ontario plant north of the border. Yes, it’s a globally competitive business, and General Motors, like other American automobile manufacturers, has faced challenges from abroad. Additionally, some of GM’s problems have been self-inflicted, given its patchy record on safety matters and its abhorrent downplay of the resultant accidents. The company also put some of the blame on Trump’s steel and aluminum tariffs, which they claimed added about $1 billion in additional costs.

Upon closer inspection, however, the layoffs can’t simply be dismissed as an inevitable byproduct of globalization, or the impairment of free trade.There is something else going on here, a consideration that goes to the heart of GM’s flawed business model. It is tied to financialization, notably the CEO stock market-based compensation, which induces decisions that might elevate the share price in the short term, but often to the detriment of the company’s long-term success (like GE).

Along with the financialization of GM, the decision to offshore manufacturing in relatively low-wage locations hasn’t helped much. Outsourcing manufacturing in this way has, paradoxically, exacerbated GM’s problems.The sedan market (where GM is experiencing a large proportion of its competitive difficulties these days) typifies this conundrum.The lower and middle ends are dominated by Asia, which operate in a market segment where GM can never get its labor costs low enough to compete against them; the high end is dominated by Audi, Mercedes and BMW, German manufacturers that have devoted considerable capital investment so as to shore up the top-of-the-line models. Here, GM is unable to match the German brands, having chosen the soft option of offshoring its labor, avoiding extensive investment that would have otherwise allowed them to upgrade their production.

As Seymour Melman has noted in his work “Dynamic Factors in Industrial Productivity,” the unremitting focus on low-cost labor, which has been a key component of business models adopted by American corporations such as GM, creates disincentives toward capital investment decisions that would otherwise drive GM’s products further up the technology curve toward higher-margin products (which in turn yield higher profits and are less prone to competitive pressures from low-end car manufacturers, thereby alleviating the need to outsource manufacturing in the first place). It is quite likely that the historic paranoia about labor organizing in the U.S. is the underlying driver for this monomania.

By contrast, the stress on high-quality domestic engineering capability is something that Germany extends to other forms of high-tech manufacturing goods and services.Economists Jesus Felipe and Utsav Kumar have conducted a study illustrating that countries such as Germany have used capital investment to move up the technology curve to all sorts of higher-end products.Hence, it has a market share of 18 percent in the total world exports of the top-100 most complex products, vs. France 3.6percent, Italy 3.1percent, and Spain 0.9percent.

Germany’s manufacturing success, therefore, is not a function of lower wages. Germany’s manufacturing unit labor costs have declined in a relative sense (especially relative to its Eurozone competitors) over the past decade, but in absolute terms, Germany’s manufacturers, including the auto producers, did not resort to a strategy of nominal wage squeezes or extensive offshoring to cheap labor locales such as China. As the economist Servaas Storm has argued: “It was German engineering ingenuity, not nominal wage restraint or the Hartz ‘reforms,’ which reduced its unit labor costs.”Engineering ingenuity largely came about through well-targeted capital investment and enabled German labor productivity to increase some 8 percent relative to its European and American counterparts.

As a result, Germany has become stronger and more productive in high-value-added, higher-tech manufacturing.Although some manufacturing has been outsourced to adjoining Eastern European countries, its leading companies have preserved an industrial ecosystem, which has enabled Germany to conserve more high-end jobs domestically in aggregate.

On the flip side, American manufacturers have generally taken the soft option of outsourcing and “demodularizing” production.As a result, they degraded industrial quality, increased development lead time, and increased unit costs in the process(Boeing’s 787 “Dreamliner” being a spectacular case in point).At this point, the U.S. doesn’t have what you could call a dynamic manufacturing economy. This has led to a perverse situation described last year by business journalist Jim Harger:

“Industry experts say that cadre of talented tool and die makers is growing in short supply in Michigan just as the demand is increasing.

“‘The average tool and die maker is 56 years old,’ says Baron, president and CEO of the Center for Automotive Research (CAR).

“‘We have not been back-filling. We are running out of talent as the cadence for cars is increasing and the launch rate is increasing.’

“About 75 percent of the tool and die makers in the workforce today are expected to retire in the next five to seven years. Meanwhile, it can take up to 10 years to train a master tool and die maker.”

So Detroit was left with production bottlenecks, because of the shortage of tool and diemakers, which represented an important missing gap in production.

Of course, if management’s main incentive is to manage the company’s stock price, rather than the underlying business, it tends to do things like offshoring, which helps to juice the short-term quarterly profits. The share price generally follows suit.The long-term cost (which is usually seen well after the stock options have been cashed and the executive compensation has been paid out) is a production deficiency in the future, which can’t be easily replaced, as Professors Gary P. Pisano and Willy C. Shih explained in Harvard Business Review:

“As manufacturing plants closed or scaled back, many people in those occupations moved on to other things or retired. Seeing fewer job prospects down the road, young people opted for other careers. And many community and vocational schools, starved of students, scaled back their technical programs.”

As if by clockwork, GM’s share price initially greeted the news of the plant shutdowns with a 5 percent upward spike (that is, until adverse comments/threats from President Donald Trump, which muted the rise). The initial market reaction is exactly the sort of thing that further incentivizes stock-laden management to continue to formulate strategy with a view toward goosing a share price, rather than focusing energies on the underlying business operations themselves.

Following a classic pattern we have seen since the 1980s, GM’s CEO, Mary Barra, is the highest–paid auto CEO in the world, via a combination of salary and stock awards. In general, highly paid American manufacturing CEOS have been compensated for their willingness to hollow out compensation to their labor force.For the last two years, Barra has earned over $21m annually.Clearly, she has neither suffered the consequences of her company’s defective ignition switches, nor her company’s declining market share in the sedan market (the ostensible rationale for the layoffs).

The GM layoffs should not be blithely dismissed as another inevitable casualty of globalization.Nor are they a parable illustrating the dangers of increased protectionism (even though that is the narrative that GM wants you to believe). In fact, it is part of a much broader story, particularly in the U.S., where workers continue to deal with the consequences of labor casualization (i.e., flexible “alternative work arrangements”), the outsourcing of manufacturing to other countries, and the ultimate blowback to these increasingly financialized corporations, such as GM, as they continue to embrace measures that degrade their workforce, diminishing America’s viability as a source of highly skilled, good-paying jobs as a consequence.

There are other alternatives, as Germany proves.We occasionally get glimpses of the scale of this homegrown deterioration when a big layoff announcement is made.But seldom do we truly examine the underlying causes, the consequences of which continue to be masked by a hitherto ebullient stock market, which has become a wealth recycling machine for corporate CEOs, even as it provides nothing more than the aura of a Potemkin-like economic prosperity for the rest of us.