Wage cuts hurt, but they may be the only way to get Americans back to work

By Steven Pearlstein
Washington Post Staff Writer
Tuesday, October 12, 2010; 11:32 PM

Last week, General Motors and the United Auto Workers announced agreement on a new two-tier wage structure that would allow the automaker to produce its next-generation subcompact car in Michigan rather than in South Korea. Sixty percent of the workers at the Orion plant, those with the most seniority, would continue to be paid $28 per hour, while the least senior 40 percent would have to settle for $14. For the company, that works out to an overall 20 percent reduction in wages.

This story provides a interesting prism through which to think about the U.S. economy.

The fundamental economic challenge facing the United States is to get what we consume more in line with what we produce after years of living beyond our means.

Obviously there are two ways to correct this imbalance - increase production or reduce consumption - and given the magnitude of the adjustment, it's likely we're going to have to do both.

Since the economic downturn, we've made some progress. Households have gone from saving almost nothing at the height of the bubble to saving about 5 percent of their income, even as incomes have declined slightly. As a result, our collective standard of living has declined, at least in the way economists think about it.

Public goods are a different story. Although we're consuming fewer services from state and local governments, the federal government for the moment is spending considerably more. On balance, government overspending is not much worse, but not much better, either.

Put it all together and our annual overspending has gone from a high of $800 billion in 2006 to about $500 billion this year, according to the best gauge, the current account balance. It's not necessary for economic health to drive that number to zero, but at best we're only halfway to where we need to be.

One person's reduced consumption, of course, is another person's reduced income, and that reduced consumption now manifests itself in an a rate of unemployment and under-employment of 17 percent. In effect, the burden of adjustment has now fallen disproportionately on a minority of households whose incomes and standards of living have fallen much more than everyone else's.

From a policy standpoint, this appears to put us in a terrible bind: either reduce unemployment by returning to our free-spending ways, or finish the job of reducing consumption by pushing unemployment up even further. For the moment, we've decided to choose neither.

There is, of course, a way out of this bind: produce more without consuming more. For all practical purposes, that means grabbing a bigger share of global markets, either by exporting more goods and services, or replacing some of the stuff we import by producing it at home.

Which brings us back to the story of GM's Orion plant. There are lots of reasons why American companies like GM have lost market share (yes, I wrote about currency manipulation last week), but one is that in too many industries, our labor costs are now too high to be globally competitive. Reducing wages and benefits in those industries would not only help to create and save jobs, but would also force a further reduction in consumption and living standards that is necessary to bring the U.S. economy back into balance.

The question is not whether this is an ideal outcome - obviously it's not. But for the 1,550 auto workers who would be called back to work at GM's Orion plant, the real-world choice is to either accept a 20 percent wage cut or remain unemployed with little prospect of getting another job at the old union wage. For them, and for the economy as whole, the better choice is to take the jobs at the globally competitive, market-clearing wage and hope to build back up from there.

While that was the reluctant conclusion of UAW leaders, not all their members agree. When a similar proposal was put last month to workers at a GM stamping plant in Indianapolis that is slated for closure next year, they turned aside the advice of the UAW leadership and overwhelmingly rejected it, arguing that it would inevitably spread and undermine the existing union wage structure.

And, of course, they're right about that. However unfair or unpleasant, it is precisely these kinds of structural adjustments that are necessary if the U.S. economy is to find a new equilibrium, one that provides not only for full employment but a sustainable balance between how much we consume and how much we produce.

What happens in most markets when supply exceeds demand is that falling prices bring in enough new customers, or cause enough producers to cut back on their output, until supply and demand get back into balance.

But labor markets are different. Unlike the markets for tomatoes or stocks, prices - that is, wages - don't necessarily rise or fall for everyone based on the result of the last transaction. Workers tend to get very grumpy if their pay is reduced, while employers don't want to risk losing their best workers by forcing them to take a pay cut.

As a result, companies generally respond to falling sales by laying off workers, which, when it happens economy-wide, creates a vicious cycle that depresses sales and employment even further. That's the trap we're in right now.

In many cases, a better alternative to layoffs is to cut everyone's hours and pay and spread the pain more widely. That's a popular approach in Germany, where the export sector is booming and the unemployment rate is now comfortably well below ours. California has also experimented successfully with a job-sharing plan, as it is sometimes called, using money from the state's unemployment insurance fund to help compensate employees for the reduction in pay.

I'm sure many of you are reading this and thinking that if anyone is forced to take a pay cut to rebalance the economy, surely it ought to be overpaid investment bankers, corporate executives and newspaper columnists. That's how things would work in a socialist paradise, but not in market economies, which are much better at producing efficiency than fairness.

Unless we're prepared to settle for 10 percent unemployment for the next decade, we might want to follow the lead of GM and the UAW and look for creative new wage structures that will allow us to better spread the burden of getting the economy back into balance and make it possible to increase what we produce rather than what we consume.

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