Asymmetrical Information

One of the biggest mysteries of the Great Depression is why wage cuts did not clear the market for labor. Maybe Gross has an explanation. And maybe if we could get Walmart to behave more "responsibly" and raise wages, we could have a re-run of the Great Depression. Wouldn't that be fun?

"One of the biggest mysteries of the Great Depression is why wage cuts did not clear the market for labor."

The basic Keynesian explanation--that we can experience an effective demand failure that leaves us at equilibrium with less than full employment--still seems pretty good to me.

The best explanation would start by looking at the expectations of the market participants. FDR's assault on the rich and the business community devastated the chances of the poor to get a job. Not just his policies, but his war of words as well (read the quotes - his rhetoric was incredibly antagonistic). Starting in 1936, net investment was negative for years.

People who wonder if their business is going to be gutted by the government do not invest. They don't hire anyone, either. The decision not to hire was based on far more important factors than the prevailing wage rate.

One wonders the extent to which The Big Three are essentially social insurance institutions trying to support themselves by selling motor vehicles. still obtains? Surely, this was true in the 1970s. But now that these companies--only two of which are American--have to compete with such far-flung companies as Daewoo and Daehatsu, surely wages and such have had to come to market levels?

I read just this week (in Fortune, I think)that $1400 per vehicle at GM goes to fund retirees. The number of retirees is expected to peak in 2008, and GM should get more competitive as that declines.

I doubt the auto companies were merely being benign. While they may have operated in a relatively uncompetitive auto market they still had to have a very large labor force.

This combination suggests two things.

First, that they would have had to be fairly generous just to attract the work force needed.

Second, if they were in fact quite profitable, strikes would have been very costly. So possibly they did not bargain as hard with the UAW as they might have had lost production not been so expensive.

"One of the biggest mysteries of the Great Depression is why wage cuts did not clear the market for labor."

Wasn't Hoover successful at convincing business and labor leaders to keep wages at artificially high levels in the wake of the crash, believing that a "high wage strategy" would win the day?

Austrian business cycle theory, IMO, does a fair job of characterizing this and other aspects of the Great Depression.

Finally, what difference does it make which Sam (government or Walmart) pays for the drugs? Isn't the money ultimately coming out of wages?

"what difference does it make which Sam (government or Walmart) pays for the drugs? Isn't the money ultimately coming out of wages?"

Sam Walton and heirs have demonstrably been more innovative, efficient, customer-responsive and debt-adverse than the other (my beloved Uncle) Sam. You want most of the assortment of pretty good drugs available in most places at a reasonably low price, Walton's methods are highly likely to work. Start raising any of those standards (EVERY drug -- RARE/NEW/CUSTOM-MADE drugs -- ALL locations, REGARDLESS of price!) and even a government will fall short, while bankrupting itself and its taxpayers in the attempt.

The source of the money does matter, but how well it is spent matters at least as much.

"Given the inability of private-market mechanisms to contain costs,..."

Did he really say that? Has he worked in corporate America? We are just getting around to squeezing out the arrogance in the executive suite and this guy wants to throw in the towel?

Please, the American future rests on manufacturing productivity. The American car makers will ultimately do like the rest of us. Innovate or perish.

If everyone would just face the music and recognize that work is how our ancestors made this country what it is and quit worrying about that moment when they do nothing but sit around the house all day turning into mindless mush.

I have two retired state tax auditors (married to each other by the way) living next to me. They are no more than 45 years old! Nothing fires me up about entitlements more than seeing his lawn mowed when I get home after 7 o'clock and I'm still pulling out the equipment.

What happened to the spirit of this country? I tell anyone who will listen, get out and make a difference!

Sorry for the rant. Some things really get under my skin.

They are social insurance institutions in that, even if they get current employee benefits down, they have huge pension obligations.

I work in the pension biz, so I follow pension news, and GM is in for a world of hurt.

Assume the quote is absolutely correct, and GM, Chrysler, and Ford are run on an "employee primacy" model rather than a "shareholder primacy" model, so what. (Reality, most big companies are run on a "CEO primacy" model, with millions going for antique umbrella stands in the CEO's girlfriend's apartment and other executive perks, but I digress). It's still in the union's interest to remain competitive so that they don't slay the golden goose. It may make their stock prices less attractive to investors, but its not going to make their cars less wll made.

Republicans like to talk about "jobs, jobs, jobs" but they want to tax labor, while exempting all earnings from wealth from taxation, and they think their is something inherently awful in a organization being run primarily for the benefit of its employees. Ask any employee of a big company whether management should run the company in a manner that ensures good paying jobs for the workers, and just about all of them would agree.

Sorry, I don't buy this "social insurance" business. The pensions and other retiree benefits that major corporations owe are part of the pay of their retired workers. This is not some sort of government-mandated welfare program. The benefits were earned by the employees.

The root of the problem seems to be that no one was interested in funding them properly, and squirrely accounting was used to underestimate their cost at the time they were earned. So I have little sympathy for these outfits, who are fundamentally trying to default on a legitimate obligation.

"The source of the money does matter, but how well it is spent matters at least as much."

I agree that costs tend to find their lowest levels in the private sector, where Uncle Sam typically pays a premium for goods and services.

OTOH, I believe a concerted effort on the part of business and government is necessary to reel in prescription drug costs. Allowing the market, alone, to set prices for drugs will keep them out of reach for many. However, I’m equally apprehensive about government attempting to contain costs (via price controls) through some form of supplemental Medicare benefit.

You might be surprised to learn that, as a government agency, the VA provides comparatively low-cost prescription drug coverage for its members. Of course, it has enormous purchasing power that allows it to negotiate lower prices (30-40%) than other, smaller health plans.

Obviously, size matters.

It's a huge risk to invest your whole retirement portfolio in a single security*, nevermind one that depends on always winning the technology race every quarter for half a century. Idiots who do it deserve what they get. Nobody stopped them from building a diversified portfolio: it was a choice, and they have to live with the results.

Monte said: "OTOH, I believe a concerted effort on the part of business and government is necessary to reel in prescription drug costs. Allowing the market, alone, to set prices for drugs will keep them out of reach for many."

What the hell for? The cost of nearly all drugs is dirt cheap**, on a per diem basis. The prices of some drugs are temporarily high because of patent royalties. And what paid for the development of all these nice new expensive drugs that extend life and make it happier? Patent royalties. Fine, you say, let the gov't fund R&D out of taxes. I've heard this one lots of times and it falls apart if you think it through.

Firstly, drug development is guided by intuition, guesswork, and blind luck. It isn't like building a new highway, where you can be reasonably sure what the costs and benefits are. What happens is a chemist says "that fluorine atom just doesn't feel right—the molecule doesn't look like a drug ought". Then somebody has to decide whether to start a million dollar animal trial based on that sort of crap! Maybe a gov't bureaucracy can do that job OK, but the first administrator who overestimates his insight would be funding projects basically at random. What do you think the odds are a political appointee will think he's more insightful than he actually is?

Secondly, some drugs that look really promising turn out to be worthless. All the chemists will agree the molecule looks awesome, the animal tests are stellar, but some catch comes up in human trials. So they try to fix the molecule and it still won't quite work. And they try to fix it again and it still won't quite work. Somebody has to say "Look, we've spent $100M on this this. It looked like a good idea, but it just isn't panning out. We need to move on to greener pastures. The project is hereby cancelled." There are very few gov't bureaucracies that have ever had that sort of intestinal fortitude, and it usually doesn't last over time. Whatever the faults of the pharma capitalist pigdogs, they are pretty ruthless about cancelling failed projects.

Thirdly, the vast majority of medical benefits can be had using off-patent drugs. When somebody has had umpteen bladder and sinus infections cured and lived through a few minor surgeries, all thanks to cheap generics, it rings hollow for them to complain that their life is shortened a few percent because they can't afford some expensive wonder drug. Cry me a river. You give some people 98% and the start a class war over that last 2%.

Fourthly, I look around the world and see a conspicuous absence of great new drugs coming out of Government Drug Bureaus. If that approach really worked, you'd see investors eyeing socialist Europe nervously whilst getting their pharma stock ready to sell. Instead European drug development is moving to America because it's one of the last places where the engine of progress hasn't been smashed. [Cue Ayn Rand theme song.]

*Other than instruments backed by the Federal Reserve's power to print money.

**Excluding chemical monstrosities like Fuzeon, which is an entire protein synthesized from scratch.

"It's a huge risk to invest your whole retirement portfolio in a single security*, nevermind one that depends on always winning the technology race every quarter for half a century. Idiots who do it deserve what they get. Nobody stopped them from building a diversified portfolio: it was a choice, and they have to live with the results."

OK, but who are you talking about? The employees or the company? As far as know the employees had no choice. These were not 401K type plans, where participants selected their investments. They were defined-benefit plans - promises by the company to pay benefits in the future.

Now the companies could have set aside the needed funds, on a reasonably calculated present value basis, and invested them in a diversified portfolio. Instead they chose, in effect, to continually reinvest in their own business. So the companies are the idiots and, having privatized the risks, they are now eager to socialize the costs.

It seems to be a lost, virtually abstract concept that businesses exist to generate profit for their owners and shareholders first, then the rank and file. This makes sense, because those who invest the most, should receive the most in compensation, whereas someone who dropped out of school, lacks the ambition to achieve for himself and/or came to the country expecting a free ride on the taxpayers does not.
Blame should be placed at the feet of the pseudoaltruistic spiritualists in the Vatican and their eager sycophant socialist friends in Washington D. C., not on capitalism.

"As far as know the employees had no choice. These were not 401K type plans, where participants selected their investments."

Somebody held a gun to their heads and made them work at GM? The union drives for pensions were mistakes in paperwork? Somebody made them buy fast food and baubles instead of putting together a backup retirement plan?

"They were defined-benefit plans - promises by the company to pay benefits in the future."

That is the very definition of a security: a promise of future payment backed by a business plan to generate revenue. A person has a responsibility to themselves to investigate the business plan, fundamentals, and risk exposure before accepting the security as payment. A pension payment is just a dividend with another name. "GM never melted down before" and "The shop boss says it's a sure thing" do not constitute due diligence.

"Now the companies could have set aside the needed funds, on a reasonably calculated present value basis, and invested them in a diversified portfolio."

And they could have burned the money on a stone altar to get the favor of the God of Profit. So what? What matters is whether they were honest about how the plan was run. If the employees knew the truth, or could reasonably have found out, then the employees are responsible for whatever they have landed themselves in.

The fact that thousands of people didn't do due diligence on their investment, and instead built a religion around a union and a company, is their problem. Sad and unpleasant, but their problem.

"Somebody held a gun to their heads and made them work at GM? The union drives for pensions were mistakes in paperwork? Somebody made them buy fast food and baubles instead of putting together a backup retirement plan?"

Defined benefit plans were the norm throughout the US until fairly recently. Working elsewhere would likely have made little difference. And the car companies were among the biggest employers in the country, and overwhelming in the Detroit area.

And what is this nonsense about "fast food and baubles?" maybe they bought groceries and paid rent.

"That is the very definition of a security: a promise of future payment backed by a business plan to generate revenue. "

Actually, a security is simply a promise of payment. No business plan involved.

"A person has a responsibility to themselves to investigate the business plan, fundamentals, and risk exposure before accepting the security as payment. A pension payment is just a dividend with another name. "GM never melted down before" and "The shop boss says it's a sure thing" do not constitute due diligence."

At the time these were profitable companies with excellent credit ratings. Checking their performance would have made you quite likely to feel that lending them money wa safe. Were the workers supposed to predict that management was going to turn incompetent in the face of foreign competition?

"If the employees knew the truth, or could reasonably have found out, then the employees are responsible for whatever they have landed themselves in."

So in your world GM has no responsibility to meet its financial obligations?

"The fact that thousands of people didn't do due diligence on their investment, and instead built a religion around a union and a company, is their problem. Sad and unpleasant, but their problem."

Excuse me, but the car companies are not in bankruptcy. They are just trying to dodge legitimate claims by retirees. Your idea that it's OK for them just to welsh is astonishing.

Earnest Truth, according to Peter Drucker, businesses exist to provide value to their customers, and when they cease to do that, then they have no reason to exist.

Earnest Truth, according to Peter Drucker, businesses exist to provide value to their customers.

When they cease to do that, then they have no reason to exist.

"Defined benefit plans were the norm throughout the US until fairly recently."

And good riddance, too.

Far better to be paid now and be able to save whatever portion of my paycheck I want in whatever manner I choose than to get only part of my paycheck with a promise to pay the rest in 50 years, which is what a pension plan amounts to.

Not only am I not assured that my company will still be in business in 50 years, it would be a very bad thing if most presently existing companies were still in existence 50 years from now. Underperforming companies are supposed to fail, and it's a lot better if the employees of such companies have already been fully paid for their work and aren't getting screwed out of what they were supposed to be paid 50 years later.

“The cost of nearly all drugs is dirt cheap**, on a per diem basis.”

Compared to what? American consumers pay more for prescription drugs than anyone else in the world. So much so, in fact, that many have resorted to crossing the border into Canada or Mexico to purchase them for dimes on the dollar. In the absence of adequate insurance or a prescription drug benefit of any kind, some patients may find themselves paying as much as $100 a bottle!

Roughly 10% of the people in this country are currently uninsured. What good are nice new expensive drugs that extend life and make it happier to those who can’t afford them?

“The prices of some drugs are temporarily high because of patent royalties.”

Temporary, in this case, is typically 12 to 15 years. That’s a life time to most patients undergoing drug therapy.

Notably conspicuous, as well, is the fact that the pharmaceutical industry has been more profitable than any other over the last 20 years, with an average return of approximately 20%. I suspect that maintaining that profit margin is the primary objective of PhRMA (the industry’s trade org), in throwing the full weight of their lobbying effort against any attempts by government to advocate for the consumer.

I understand R&D is expensive and pharmaceutical companies must recoup their losses by inflating the price of their successful drugs. But if they continue to resist working with government to bottom out on this, we’re going to see market conditions rapidly deteriorate from serious to critical. If that happens, cost controls are sure to be prescribed by our political practitioners, and that could be extremely painful.

Ken,

** "Defined benefit plans were the norm throughout the US until fairly recently."

And good riddance, too. **

I agree.

Did Arnold Kling really just suggest that Wal-Mart paying higher wages would cause another Great Depression, or was that an impersonator?

"But if they continue to resist working with government to bottom out on this, we’re going to see market conditions rapidly deteriorate from serious to critical. If that happens, cost controls are sure to be prescribed by our political practitioners, and that could be extremely painful."

If you continue to resist working with me to share the contents of your wallet, my market conditions will rapidly deteriorate from serious to critical. If that happens, a lead projectile is sure to be prescribed, and that could be extremely painful.

"If you continue to resist working with me to share the contents of your wallet, my market conditions will rapidly deteriorate from serious to critical. If that happens, a lead projectile is sure to be prescribed, and that could be extremely painful."

I didn't realize a consortium between business and government constituted a criminal act. In either case, greed has killed more people than guns.

If your only choice was death, which method would you choose?

>What good are nice new expensive drugs that extend life and make it happier to those who can’t afford them?
They go off patent and become much more affordable, which is preferable to the incentives get so screwed up that it takes even longer than going off patent for them to even be invented.

"They go off patent and become much more affordable, which is preferable to the incentives get so screwed up that it takes even longer than going off patent for them to even be invented."

So we need to preserve the market at the expense of a few million uninsured who, over the 12-15 year patent period, will not be able to afford the new drugs?

This is a blanket reply to various commentors.

"And what is this nonsense about "fast food and baubles?" maybe they bought groceries and paid rent."

And never got a raise? And never bought bulk generics instead of single-serving name brands? $5/week of investment is affordable for nearly everyone, and results in a major increase in retirement income. But most choose to avoid it, for the instant gratification of a couple of boxes of name-brand cereal, or the laziness of running up credit card debt until the interest starts to hurt.

"Were the workers supposed to predict that management was going to turn incompetent in the face of foreign competition?"

Yes. "My name is Ozymandius, king of kings: look on my works, ye mighty, and despair!"

"They are just trying to dodge legitimate claims by retirees. Your idea that it's OK for them just to welsh is astonishing."

I never argued that their obligations should be forgiven, or that employee pensions should be considered different than any other corporate debt.

"Compared to what? American consumers pay more for prescription drugs than anyone else in the world. So much so, in fact, that many have resorted to crossing the border into Canada or Mexico to purchase them for dimes on the dollar."

Those other countries have either busted the patents, or threatened to do so convincingly enough to extort price cuts from the pharmaceutical companies. Much of the world are free riders who have skipped out on their fair share of drug development costs.

"In the absence of adequate insurance or a prescription drug benefit of any kind, some patients may find themselves paying as much as $100 a bottle!"

Until recently I was paying $250/bottle/month for Nexium. (Pray you never need to take that much.) Now there's Prilosec OTC, and soon generic omeprazole.

"What good are nice new expensive drugs that extend life and make it happier to those who can't afford them?"

And where would we be today if the current cheap generics hadn't been financed by patents all those years ago? Besides, if you need a drug, there's a good chance there's a generic that will do pretty good for you. Most of the popular on-patent drugs are lifestyle choices. Many of them let people be fat and lazy and still not die of a heart attack as long as they take their cholesterol and blood pressure pills. Others have simplified dosing, so you pay the on-patent price for the amazing benefit of taking one pill a day instead of two. Still others have reduced side effects compared to the older generic.

Also, most of the one-of-a-kinds are things like antibiotics and cancer drugs. When your whole life is on the line for a one-shot course of therapy, the patent royalties start to look like peanuts.

"I suspect that maintaining that profit margin is the primary objective of PhRMA (the industry's trade org), in throwing the full weight of their lobbying effort against any attempts by government to advocate for the consumer."

You are completely missing the secret of pharma: their powers of marketing border on psionic mind control. Seriously. Next time you're in a pharmacy (assuming you're in the US), look at the over-the-counter drugs. You'll find a box of brand-name Claritin for twice the price of identical generic loratidine. And people buy the Claritin! People go to their doctor's office and insist on the Purple Pill (Nexium). Compare generic aspirin to Bayer, or generic psyllium fiber to Metamucil. Hell, Rohypnol was banned by Our Gentle Defenders at the DEA on the basis of its "viral marketing" reputation, nevermind that it's a typical benzodiazepine not appreciably different than Valium! But Valium is a jet-set unwinder and rohypnol is the evil date rate drug. So much of the profit is perceptions. That amazing 20% profit margin for pharmas is largely from amazing marketing. If people bought drugs like they bought gasoline (cheaper, doesn't run too rough), pharma profits would be dismal.

"So we need to preserve the market at the expense of a few million uninsured who, over the 12-15 year patent period, will not be able to afford the new drugs?"

Well that's how everything (not just pharma) has worked so far, and things have turned out pretty damn good. The affluent of one generation pay through the nose, and the poor of the next generation get it cheap.

There's also a big issue with personal responsibility: if those poor uninsured you mentioned would eat a proper diet, get the proper amount of exercise, and take a few cheap supplements, they'd be a lot better off than any expensive drugs could make them. They'd feel better, live longer, get sick less often, develop vastly less chronic disease, and ironically have more money on account less sick leave and good food is cheaper.

If they can't be bothered not to avoid drugs at a profit, I can't be bothered to pay them to sit around on the fat asses and watch TV.

Daniel Newby:

The last part of you rant about personal responsibility I really agree with!! Especially in light of recent stats about the rate of obesity.

"And what is this nonsense about "fast food and baubles?" maybe they bought groceries and paid rent."

And never got a raise? And never bought bulk generics instead of single-serving name brands? $5/week of investment is affordable for nearly everyone, and results in a major increase in retirement income. But most choose to avoid it, for the instant gratification of a couple of boxes of name-brand cereal, or the laziness of running up credit card debt until the interest starts to hurt.

Ah yes. The undeserving poor. Are you a student of consumption patterns? Or are you just dealing in nasty stereotypes? And maybe the rent went up, and food prices rose, or the kids wanted to something wasteful, like go to college.

##"Were the workers supposed to predict that management was going to turn incompetent in the face of foreign competition?"

Yes. "My name is Ozymandius, king of kings: look on my works, ye mighty, and despair!"##

So all companies are destined to fail, and all investments to go sour. So there was no company that would have been better. I must remember to see what Shelley has to say about the stock market in the future.

##"They are just trying to dodge legitimate claims by retirees. Your idea that it's OK for them just to welsh is astonishing."

I never argued that their obligations should be forgiven, or that employee pensions should be considered different than any other corporate debt.##

Since the car companies are not going bankrupt, but just want to avoid their obligations, what are you saying?

Sorry, but this isn't a case of car companies wanting to avoid their obligations to workers. Ford and Chrysler do NOT make a profit selling new vehicles. Ford is saved by profits from Ford Motor Credit. GM makes a very slim profit selling new vehicles, which is augmented by GMAC. In any sector, if a company loses money selling a product, sooner or later, it makes sense to abandon that business.

Chrysler LOST $930 million in the first half of 2003, and is likely to lose more. The rumblings are growing louder that Daimler may put Chrysler on the market to cut its losses. An independent Chrysler will not last long in the competitive American market. It cannot generate the profits necessary to fund the regular redesigns of core profits.

The basic template of the UAW contracts was forged when GM, Ford, Chrysler and AMC (remember the Rambler?) controlled 95 percent of the new vehicle market. GM alone held 50 percent. The UAW controlled 100 percent of the labor used to build those vehicles. Everybody's main concern was that GM not use its economies of scale to drive down prices and put Chrysler and AMC out of business. Increased labor costs were easily passed on to consumers. In that environment, the competitive advantage of lower labor and pension costs is minimized.

Fast forward to 2003. The competition is fiercer than ever. GM no longer holds a 50 percent share of the market. And the UAW has lost its monopoly on labor. More competition means more pressure on pricing (the prices consumers have paid for new vehicles has declined by 1 percent annually since 1997!). Which means that labor and pension costs have re-emerged as a competitive issue. GM has a $1,400-per-vehicle cost disadvantage when compared to Honda and Toyota. That is $1,400 than can't be used for a more advanced engine or a better interior. (Incidentally, read the road tests in Car & Driver and Automobile. What are the biggest complaints about GM cars? That, compared to Honda and Toyota, the engines are coars and old-tech, and the interior materials are cheap.)

So, yes, this a major problem, and, no, it's not just a ploy to cheat workers out of their pensions. It may actually help to study the auto industry and its products before passing judgment on this subject.

“Those other countries have either busted the patents, or threatened to do so convincingly enough to extort price cuts from the pharmaceutical companies. Much of the world are free riders who have skipped out on their fair share of drug development costs.”

Then I would argue that our respective governments need to work with each other and the pharmaceuticals to deregulate foreign markets for prescription drugs so that costs are more evenly distributed, which was my point from the beginning.

“And where would we be today if the current cheap generics hadn't been financed by patents all those years ago? Besides, if you need a drug, there's a good chance there's a generic that will do pretty good for you.”

Lag times for generic alternatives hitting the market can be significant due to legal stays (typically 60 months or more) that are awarded by the courts to drug companies for protection against patent infringement. Many patients also experience negative reactions (or don’t respond at all) to generic alternatives.

Are those who are in this category supposed to take two aspirin and call their doctors each morning for the next several years?

“Most of the popular on-patent drugs are lifestyle choices. Many of them let people be fat and lazy and still not die of a heart attack as long as they take their cholesterol and blood pressure pills. Others have simplified dosing, so you pay the on-patent price for the amazing benefit of taking one pill a day instead of two. Still others have reduced side effects compared to the older generic.”

No argument. A healthy lifestyle is half the battle.

“Also, most of the one-of-a-kinds are things like antibiotics and cancer drugs. When your whole life is on the line for a one-shot course of therapy, the patent royalties start to look like peanuts.”

Your point is well taken. However, there a many who, as a result of this scenario, are forced to declare personal bankruptcy due to lack of insurance or financial resources. Quality of life, to some, is more important than just living.

“That amazing 20% profit margin for pharmas is largely from amazing marketing. If people bought drugs like they bought gasoline (cheaper, doesn't run too rough), pharma profits would be dismal.”

If “amazing marketing” was the main factor, we’d see this level of profits associated with every industry, not just pharmaceuticals. I find it hard to believe that PhRMA is uniquely qualified in its marketing ability to maintain profit margins so much higher than other industries.

I’m more persuaded by their political clout than I am their marketing ability.

Me: So we need to preserve the market at the expense of a few million uninsured who, over the 12-15 year patent period, will not be able to afford the new drugs?"

You: Well that's how everything (not just pharma) has worked so far, and things have turned out pretty damn good. The affluent of one generation pay through the nose, and the poor of the next generation get it cheap.

I, too, believe markets provide society with what it needs (or wants) more efficiently than any other system. But even the staunchest advocate has to concede there are gaps it fails to bridge, and it’s the government’s responsibility to help build those bridges.

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