Issue Briefs

By Martin Hutchinson

May 29, 2024 – The United Auto Workers’ success in unionizing a Volkswagen plant in Tennessee suggests that the reported death of private sector unions is not imminent. Fifty years ago, even in cyclical industries US unionized workers were close to Japan-style lifetime employment, with any layoffs in business downturns allocated by inverse seniority, so that after a few years a worker’s position was guaranteed. In white-collar activities, long careers were predominant and layoffs were scarce. Yet in today’s knowledge industries and elsewhere, the social contract between large corporations and their employees has become one-sided, with layoffs commonplace and lifetime employment a distant dream. This places excessive costs on employees. As the recent history of GE, Boeing and other faltering behemoths shows, it also eliminates the workforce’s knowledge and skills and destroys shareholder value.

In Adam Smith’s time more balance between employers and employees

The pure Adam Smith model of capitalism assumes that both employers and employees are atomized, because that was the norm in Adam Smith’s day (with the exception of the East India Company, which he despised). Enterprises usually had less than 100 employees, local markets and neither market power over pricing nor a significant brand identity. In such a world, the power relationship between employers and employees was balanced; companies gained local markets by preserving a good reputation, which prevented them from treating employees too badly or laying them off arbitrarily – a coterie of disgruntled ex-employees in a locality could quickly ruin the market for the company’s products.

Employers as exploiters

This changed with industrialization, which produced larger and richer employers whose relationship with employees was intrinsically unequal. Some employers exploited this. Sir Robert Peel (1750-1830, father of the prime minister) recruited his textile workers from orphanages all over the country, then indentured the children until the age of 21, thus producing a largely unpaid workforce – though after an inspection by the Salford magistrates found his factory unpleasant even by 1784 standards, he added a modest education to the child-workers’ tenure. By thus reducing his labor costs below those of his competitors, Peel became enormously rich (and did not lay off many workers in downturns – there was little point in doing so!). His son’s filial devotion to cheap labor led Britain into the economic cul-de-sac of unilateral free trade.

Better conditions for workers in the US: the Baldwin Locomotives case

In the United States, the system was less well established and less able to be “gamed” as Peel had in Britain, so early industrial working relations were much more equal. The Baldwin Locomotive Works, established in 1832, was the leading company in the then very high-tech business of manufacturing locomotives. Matthias Baldwin (1795-1866) expanded his works rapidly in 1832-37, obtaining 300 employees and a dominant market share in the business of building railway engines – he built 122 of the 272 domestically built engines delivered to U.S. railroads by the end of 1838.
Then the Panic of 1837 hit – the deepest and longest U.S. recession of the 19th century, which bankrupted the state of Pennsylvania and did not lift until 1843. Baldwin’s engine production fell from 40 in each of 1836 and 1837 to 9 in each of 1840 and 1841. More important, since he had rapidly expanded operations in 1835-36 and was poorly capitalized despite the profits of those years, he quickly fell into financial difficulties. He sold a one third share in the company for $20,000, paid over a period, but even that was insufficient to keep going. Equally, he knew that many of the company’s workers had scarce skills and had developed experience by their work in 1832-37. Hence, if he fired them, they could well be irreplaceable, as better capitalized competitors would seize the opportunity to build their own capabilities and block him out of the skilled labor market.

Keep good workers on payroll even in bad times

Baldwin therefore reduced his workforce by only a third, despite production/sales dropping by three quarters, but did not reduce wages even in the worst of the recession. Instead, he issued his workers with IOUs for part of their wages, which they could and did redeem at par once business had recovered. Meanwhile he allowed a deputy to run the day-to-day operations of the works, and concentrated on building a new model of locomotive, with power supplied to three axles rather than one, which would hold the rails much better in wet weather and on slopes, vastly improving engine performance.
By late 1841 Baldwin’s new locomotive was ready, and early orders for this new model were sufficient to begin expanding production again. While Baldwin was only the second leading locomotive supplier in 1840-57, having been outstripped in the recession by better capitalized producers such as the Norris Locomotive Works (Norris, unlike Baldwin, was independently wealthy) by the Civil War boom after the Panic of 1857 the Baldwin Locomotive Works was the world’s largest locomotive supplier, a position it kept until World War II. Baldwin’s experience during the Panic of 1837 indicated that even in an era when labor relations were contentious (in better times, Baldwin was to suffer several strikes) a trust between management and the workforce could be established that would overcome even the hardest of times.

In a modern economy unions prevent growth

In a modern economy, companies are far larger than in Baldwin’s time, and the relationship between employer and employee is correspondingly one-sided. Unions are not a solution to this – they work properly only in large manufacturing operations and even in those, they tend to bloat costs and impose “old Spanish customs” work practices to such an extent that the plant becomes uncompetitive. Volkswagen has a history with the UAW – its plant in Pennsylvania was unionized shortly after it opened in 1978 and was then closed owing to excessive labor costs a decade later. The Biden administration has sought to tilt the playing field of union elections in favor of unions, and the Volkswagen unionization, the first among southern automobile plants, may reverse the trend of declining union membership, but this seems unlikely to affect knowledge workers. As for the service sector, the reaction of restaurant chains to California’s new $20 per hour minimum wage, reducing their workforce and instituting robot ordering kiosks, is likely to quell any attempts at union expansion in that sector.
The intelligent chair of the Federal Trade Commission Lina Khan, who whatever her political proclivities has interesting ideas, issued a proposal this week to outlaw most non-compete agreements issued to employees by major corporations. The U.S. Chamber of Commerce is suing, of course, but in fact this rule balances usefully the bargaining position between employers and employees. If employers can (and do) fire workers at random in pursuit of some cockeyed “bottom 10%” rule, then it is egregious to prevent those employees from signing up with a competitor or starting their own company in the same field.

Bad methods adopted by employers

One thinks of non-competes as being restricted to high-paid employees, but in fact they affect 20% of U.S. employees and are common in the cosmetology industry, where annual earnings average $35,000. In the high-tech sector, according to my Reuters Breaking Views ex-colleague Robert Cyran, non-compete clauses caused the computer industry to move from Boston to California, because they prevented the creation of start-ups around Boston, thus making the local tech cluster sclerotic. Whether the employee is low- or high-paid, the balance between employer and employee becomes further disturbed by the litigiousness of employers in these circumstances; any legal proceeding between a large corporation and an individual is inherently unbalanced because of the exorbitant cost of American lawyers and the inadequacy of “legal aid” provisions which are generally not available to the middle class. As with her generally negative attitude towards mergers, Khan is on the side of ordinary people and good practice here, a rare position for a Biden administration official.
Beyond non-compete agreements, the balance between employees and employers was further disturbed in the 1980s by the arrival of Jack-Welch-style “stack ranking” in which employees are ranked each year and the bottom 10% of employees fired. This system further disempowers employees, leads to ferocious office politics and gives excessive influence to the ubiquitous HR departments, that contribute nothing to the company’s success. The decline of GE itself and Boeing in recent years is very largely due to these systems, which have weeded out the best engineers, often with prickly personalities and replaced them with incompetent diversity-hired drones, resulting in Boeing’s case in engines, wheels and doors crashing to the ground. (Disclosure: I have a modest holding in Boeing put options, which have done very nicely, thank you.)

Introduce compensation packages that make managers more accountable

It is, I suppose hopeless to hope that U.S. corporations revert to the “country club” management of the 1970s, though it should be noted that Reginald Jones as head of GE (1974-81) did a much better job than Welch. However, we can at least align top management’s incentive systems better to the well-being of the workforce. Repeal the idiotic 1993 rule that capped the corporate tax-deductibility of management salaries above $1 million, so the brass get decent locked-in salaries, and are not tempted to gamble. Limit stock options, with the same objective – no more billion-dollar stock option payouts for Elon Musk at Tesla, which has led him to create a short-termist enterprise whose stock price is about ten times the appropriate level (yes, it was even more abusive for the Delaware court to disallow the contract post facto). Ban corporate stock repurchases – the less leveraged a company is, the less likely it is to indulge in mass layoffs in downturns and the better its employees will be treated. And yes, thank you Ms. Khan, also banning non-compete agreements.
We cannot all be entrepreneurs, but society gains when there are incentives for the non-entrepreneurial non-geniuses to work hard and become corporate middle-management rather than drug-addled hippies. Harlow H. Curtice, Time magazine’s 1955 Man of the Year as President of General Motors should be the ideal role-model for large-corporation strivers.

Martin Hutchinson is a GPI Fellow and was a merchant banker with more than 25 years’ experience before moving into financial journalism. Since October 2000 he has been writing “The Bear’s Lair,” a weekly financial and economic column. He earned his undergraduate degree in mathematics from Trinity College, Cambridge, and an MBA from Harvard Business School.

This article was originally published on the True Blue Will Never Stain