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Feb232011

« Wisconsin, Herbert Stein and US Airlines »

At the end of my last post, I encouraged readers to Google Herbert Stein, who served as Chairman of the Council of Economic Advisors under Presidents Nixon and Ford.  If you did, you may have seen one of my favorite Stein quotes: “If something cannot go on forever, it will stop”.  

Last week, Chairman Stein was the subject of my remarks to the 36th Annual FAA Aviation Forecast Conference -- Herbert Stein's Law and the US Airline Industry.

In this industry, Stein’s law stands. Those things that could not go on forever stopped.  Like airlines that paid an increasing share of a ticket price to a middleman just as those fares, adjusted for inflation, continued their 30-year downward trend.   Or adding capacity at rates that exceeded the growth in real GDP in order to feed the hunger of management teams that wanted market share above all else.  Or competing away the cost savings of every new technology, efficiency, product or service in the form of lower ticket prices so that savings never found their way to the bottom line.  Or watching unit labor costs increase in nominal terms at the same time output per employee wallowed for the 15-year period between 1986 and 2001. 

You get the picture.

Since 1986, the industry’s output (measured as Available Seat Miles) per labor dollar has decreased nearly 25 percent – a trend as applicable to United and American as it is to Southwest.  Even as output increased, the cost of that output increased more.  According to the MIT Airline Data Project, in 2009 American paid more per ASM for labor than any other network carrier, while Southwest was by a large margin the most expensive among the nation’s low cost carriers.  This trend is not sustainable over the long term – either for those airlines in particular or any other airline that ramps up its labor costs to buy union peace only to price themselves above the competition.  This is but one reason I believe that the job of restructuring how employees work is far from complete.

Wisconsin

Egypt, Libya and Wisconsin.  Each is undergoing a revolution.  But the labor pains in Wisconsin are probably only a precursor to what will play out in other states dealing with bloated public sector union contracts as governments seek ways to close wide budget gaps.  Unfortunately, these gaps are so large that many states have few places left to turn than the employees who in one way or another work for the state.

This story has many parallels to highly unionized private industries, like steel, autos and airlines.  The damage to the US steel industry has largely played itself out as manufacturers found lower cost places of production.  But in the end the US steel industry is but a shadow of itself; having shed nearly 75 percent of jobs from its peak.

The same is true of the US auto industry – once a global giant – but today employing a fraction of the American it once did.  As demand for US-made cars slumped further year after year, the government forced a bankruptcy-style reorganization of General Motors and Chrysler that seems to be producing positive results, while Ford has managed to survive without government intervention.  But no US carmaker can long ignore the elephant in the room – a massive liability in employee and retiree benefits and pensions.

Defined Benefit pension plans and employer-paid health care have their roots in Roosevelt’s New Deal.  Now, nearly 80 years since the tenets of FDR’s plan passed Congress, private-sector employers have decades of experience dealing with the legacy costs of Roosevelt’s deal. Public sector unions are newer to the battle, with recent flare-ups in Canada, Detroit, Philadelphia and Tulsa to name a few, while many states like Indiana, New Mexico, New York and California, are just beginning to face the budget music and the political toll of taking on the public sector union machine.

In the February 20, 2011 New York Times, Nobel Prize winning economist Paul Krugman referred to Scott Walker as “Wisconsin’s new union busting governor.”  I will grant you that some of the things Walker is seeking are overly ambitious if fixing the budget deficit is the objective - like prohibiting the state from collect union dues through payroll deductions as is standard practice and has been for decades.  Nonetheless, the fight started by Walker with Wisconsin’s unionized employees underscores the fact that neither private nor public concerns can provide the outsized, politically-protected level of benefits that were won in past negotiations and now considered downright entitlements. 

Today, most employees in private-sector companies pay roughly 25 percent of their health benefits and likely contribute some percent of their pay to a defined contribution retirement plan like a 401(k).  Walker isn’t asking for more.  In fact, he’s asking state employees to pay just 12.5 percent of their health care costs and 5.8 percent toward their pension.   According to the Bureau of Economic Analysis, public sector benefit packages cost an average of $17,000 per employee. This, according to USA Today, is about 60 percent more than benefits packages offered in the private sector (with the important exception, for Swelblog readers, of the airline industry, which even after restructuring still offers a richer pension and benefits package at an average of $18,195 than most private industries.)

Is Walker a union buster as Krugman suggests?  Or is he simply doing the right thing for Wisconsin taxpayers and future generations that can’t afford to subsidize the outsized expectations of a protected class? Krugman suggests the fight is all about political power, but then he overstates Walker’s intentions.  Power and control are at the heart of most disputes and many competitions, including the recent mid-term elections.  And those elections sent a message that the public is calling for deficit reduction whether in federal or state government.  The largest controllable cost is labor.  So is it busting unions or making necessary corrections to something that cannot go on forever – therefore confirming Stein’s law that it must stop? Walker, after all, is a Republican and can count on support from his party colleagues in the legislature.  Imagine, then, the job liberal Democrat Jerry Brown has in California as one of his only hopes for fixing the budget mess there is to call for deep, deep cuts in the public sector payroll. 

Airlines and Wisconsin

In the airline industry, power and control defined collective bargaining until bankruptcy forced a correction.  Many public sector unions believe they don’t face that risk because states, unlike private companies, hold the power to raise taxes and produce revenues on demand. But that gets more difficult in the wake of a stubborn economic recession, when raising taxes would only lead to less money in people’s pockets to spend on goods and services and fuel the local economies dependent on consumer spending for a recovery to take hold.  Increasing taxes on business only makes the state a less attractive as a place to do business, which has its own price in discouraging job creation and driving away investment.  So raising taxes is no panacea, and may not even be a practical solution.

Ironically, some airline unions believe their pay and benefits can be restored if only the industry would increase ticket prices.  The problem there is no single airline has that kind of pricing power vis-à-vis the competition. 

In my presentation to the FAA Forecast Conference, I posed the following hypothetical question: What happens if you calculate the profit/loss per enplanement using passenger revenue only?  After covering interest costs the industry lost $12.80 per enplanement during the 1980’s; $11.49 during the 1990’s; $21.28 during the 2000’s; and $19.47 in 2010.  But the industry made money in 2010, right?  Yes, but because offsetting the loss of $19.47 per enplanement was the equivalent of $8.70 in ancillary fees, thus reducing the loss to $10.76.  Other sources of revenue made the loss a profit.  Unfortunately, raising the base fare is not the answer.  Finding other revenue sources or diligently reducing costs is.

Just as the public sector has been forced to reduce services and consolidate schools to address budget shortfalls, airlines cut capacity in the face of rising oil prices.  Headcount – a fixed cost -- was cut even further. With the continued high cost of labor in the industry, the decision to hire today is a difficult one for any airline.

It is true, as the unions contend, that total employee compensation has not kept pace with the rate of inflation since 1978.  Total compensation is made up salary, benefits and pensions and payroll taxes.  The other factor to consider, however, are the work rules that, while not compensation, dictate the headcount an airline needs to keep on the payroll to do X amount of hours of flying.  What airline unions are saying is pay workers more, but don’t touch benefits or work rules.  That cannot be done, not when the cost of benefits has risen at the cost of inflation plus 46 percent.  Like so many states are discovering upon taking a hard look at state employee contracts, it is the cost of benefits that is the biggest financial drain, an expense crowding out how much can be paid in wages.  This fact seems to be lost to the governor’s detractors in Wisconsin.

Oh, I Can Hear It Now

So let me beat you to the punch.  “Swelbar,” you might say, “You are nothing more than a union buster like the Governor of Wisconsin!  You are against the workers.  Companies get only the union they deserve.”

No I am not and no they do not.  But unions, and management, need to recognize the realities of the economic and competitive environment and let go of the power struggles of the past if they’re going to be able to survive in the future. In the midst of an incredibly difficult round of negotiations, this is a tough message.  But it’s not anti-union to make the point. It is “anti” those who believe that nothing has to change.  And that goes particularly for some union leaders who need to radically overhaul what a union is and does in 2011. 

Maybe James Sherk at The Wichita Eagle said it best:  “The labor movement is losing its customers. Private-sector union membership has fallen below 7 percent. Only 1 out of every 10 nonunion workers tells pollsters he or she wants to unionize.  The unions have only themselves to blame. They haven't adapted to the modern work force. Today's workers want — and expect — employers to recognize their individual contributions. Few want a one-size-fits-all contract that treats everyone alike. Yet that is exactly what collective bargaining offers.”

The airline unions have used, and are using, promises and unrealistic expectations to persuade members that they deserve more than most airlines are able to pay.  And that is a belief that cannot go on forever and therefore must stop.

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