Montag, Dezember 01, 2008

What People Don't Understand About Economics...

One of the things that many don't understand about economics is that there can be time lags in causal chains.

Sometimes very, very long time lags as effects build up over time and then overwhelm the markets and companies.

We've seen this with the subprime crisis: those defending the CRA and the whole subprime system often claim that because there was no direct and immediate effect on, say, banking balance sheets, that the subprimes were not the cause of the current financial crisis.

These people don't understand lag effects, and how small problems snowball into larger ones when they cumulate over a longer period of time. You can't point to a single subprime loan or CDO that triggered the problem, but that doesn't mean that these aren't the problems: rather, it becomes a question of critical mass, where the obligations entered into overwhelm a contractual party's ability to pay or react.

The same is true for the Big 3.

This in the WSJ pointed me in the right direction.

It's not so much that the UAW workers get paid too much - their wages are basically in line with other wages, making the operative part of the Big 3, in terms of wage costs, competitive with their US counterparts from Toyota, Honda, BMW and others. The problem is the liabilities that the Big 3 took on in order to avoid labor strife with the UAW.

The problem is when you include benefits, and gets significantly worse when you include retirement benefits. For the Big 3, for each current worker there are no less than 3 retired workers, and the current benefits differential between base pay and employer costs is larger than the base pay: the differential is $29/hour, with wages averaging $28.

What really went wrong? To quote from the article:

Both management and unions chose to sign contracts that let them live better and work less efficiently in the short-term while condemning the companies to their current pass over time. It is deeply unfair for government now to ask taxpayers who have never earned such wages or benefits to shield the UAW and Detroit from the consequences of those contracts.

It really is as simple as that. Ignorance of lag effects, of how small things snowball to create the perfect storm. The editorialist at the WSJ is dead on: the danger is, once again, a problem of not understanding lag effects and how small individual actions will create an even worse situation: socialization of bad business decisions is an extremely dangerous path, leading to moral risks as companies learn how to use the government as buffer. Boeing, for instance, has bet the company several times in the past, leading to such successes as the B-17, the 747 and the 787; Airbus hasn't bet the company on anything, but has rather always been betting the European taxpayer's money on its products. If you don't understand the fundamental difference between the two, then you will be compelled to an economy that is inefficient and counter-productive.

Such an economy fails to provide the growth needed to provide good wages and high levels of employment. Not understanding this isn't an error of omission, but leads to the sins of commission, of taking actions that in the short-term and for a small group appear to be sensible, but in the long-term and for society as a whole are not merely dangerous, but rather downright criminal.

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