Will Michigan’s Right-to-Work Law Mean Larger Declines in Union Membership?

Michigan is about to become the 24th state with a “right-to-work” law.  A “right-to-work” law makes union dues voluntary by prohibiting closed union shops in the private sector.  In a closed shop workers represented by a union are compelled to pay union dues.  Once the law is signed in Michigan, workers represented by new collective bargaining agreements are free to decline paying union dues.   The Michigan law would make existing union-employer agreements exempt from the prohibition on closed shops.  An argument in favor of the Michigan law is that companies considering alternate locations for a new plant, factory or facility will face the same right-to-work environment in Michigan as in southern and western states.  For those who believe that states in the industrial Mideast have lost jobs in capital-intensive industries because of differences in labor laws, this law makes Michigan more competitive.  It is also notable that Indiana, the most manufacturing state in the country, enacted a right-to-work law in 2012.

It is surprising that Michigan has enacted a right-to-work law because from 2010-2012 it had the fourth highest union membership rate in the country behind Nevada, New York and Alaska.  Nevada is the right-to-work state with the highest union membership rate.  Nevada, Michigan and Indiana are the only right-to-work states with private sector union membership rates above the national average of 6.9%.  About 45% of total U.S. employment will now be in right-to-work states, where the average private sector union membership rate is 4.4%, less than half of the union membership rate of 8.9% in the other 26 states.

The following chart shows the uphill battle that private sector unions are likely to face at the ballot box in the years ahead.  Workers under the age of 35, who are becoming a more important force in elections, have not been members of private sector unions and therefore may be less likely to oppose right-to-work legislation.  Fewer than 3% of workers under the age of 35 in right-to-work states are union members.  Fewer than 6% of workers under 35 are union members even in states without right-to-work laws.

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Given the age gap in union membership, it should not be surprising if right-to-work laws are considered by legislatures in other states.  Politicians in states competing for new businesses and jobs will continue to make the argument that jobs are being lost overseas and to states where unions are less of a force.  As long as job creation is a primary concern legislatures will consider laws that will weaken the strength of private sector unions.

Twinkies, Unions, Debt and Bankruptcy

Hostess is shuttering its bakeries and plants that produce Twinkies, Wonder Bread and other iconic snacks because of a strike, mismanagement and shifting preferences of the American consumer.  Pro-union advocates are blaming poor management and hedge funds.  Pro-management advocates are blaming unreasonable union demands.  Clearly neither side wanted the company to liquidate its assets.  Yet what happened to Hostess, and its workforce, is what we should expect from union-management battles in the U.S.  More than twenty years ago fellow Welch Consulting economist Donald Deere and I explained why management, faced with the threat of unionization and strikes, would use debt as a tool to protect its investors.

First, recognize that the valuable asset of union membership, unlike ownership of a company, is non-transferrable.  Upon retirement older union members can’t sell the property rights to their job in a unionized plant.  This means union members discount the future more than firm owners and shareholders.  The thousands of Hostess workers who retired in the past two decades were harmed less by the decline in the profitability of the company after their retirement than they would have if they could have sold their unionized jobs to the next generation of workers.  The right to work as a union member at a healthy company would sell for far more than the right to work for an unhealthy company.  (The absence of a market for the purchase and sale of union membership rights even though these rights yield a share of firm profits is an example of incomplete markets.)

Second, recognize that unions can bargain over the return on sunk investments (plant and equipment) and not just bargain over profits.  Once a billion dollar plant has been built, a union can hold-up management for the returns on that specific investment.  If the union succeeds, investors will get a lower return than they anticipated from their investment, but as long as variable costs are covered they won’t shut down the plant.  It is impossible for a union to pre-commit to only negotiating and striking for a share of the profits.  So even if a union has good intentions and promised only to negotiate for a share of profits, investors and management would be wary and assume the worst; the returns to sunk investments are assumed to be on the negotiating table.

What can firms do to protect investors from union demands?  They can use debt to make management threats more credible.  Investors and management facing the scenario described above will prefer debt finance to equity finance because debt makes the threat of bankruptcy more credible.  (Union threats are another reason why the Modigliani-Miller theorem doesn’t hold.)  The more debt-financed a company is, the more likely an adverse demand shift, bad management decisions or excessive labor costs will push the firm into bankruptcy.  Debtors must be paid whereas union demands come before dividend payments to shareholders.  So companies like Hostess use debt-finance as leverage against unions, knowing that this allows them to get more wage and benefit concessions from unions.  Unions are constrained more if a company threatens to file for bankruptcy because it can’t pay its debts than if the company threatened to suspended dividend payments to its shareholders.

The high debt to equity policy for management is similar to the sequestration policy agreed to by the President and the Congress.  At the time the sequestration deal was made, neither branch of government wanted to go over the fiscal cliff.  The deal’s purpose was to constrain the negotiations of the parties going forward.  Likewise, the owners of Hostess did not want their negotiations to end in the liquidation of the company.  They put in place a mechanism designed to limit future union wage demands even though they knew it would increase bankruptcy risk.  They likely made such a choice in order to protect their profits and the return on their sunk investments.  The lesson is that poison pills designed to constrain bargaining positions will sometimes have to be swallowed.

NFL Replacement Referees are Less Disruptive than the 2011 Player Lockout

Work stoppages are costly to labor and management.  One cost of a strike in professional sports is the diminished quality of play that results from missed practices.  Some teams and players, especially those with less experience, are harmed more by reductions in practice time.  In an earlier blog post I demonstrated that strikes in the NBA are associated with subsequent reductions in the shooting efficiency of players.  This post compares the impact of the NFL player lockout of 2011 to the referee lockout of 2012 on NFL game outcomes.

Itis clear to NFL fans that the replacement referees, used in the first two games of 2012, make more imistakes than experienced referees.  Although the lockout with referees seems to introduce additional noise into game outcomes, it appears that referee errors are largely uncorrelated with teams’ strengths and weaknesses.  In contrast, it appears that the lockout with players favored stronger and more experienced teams.

The player lockout of 2011 drastically reduced the amount of practice time prior to the beginning of the season.  One would expect this to have a larger effect on teams with less experienced players and teams that made more roster and coaching changes prior to the season.  Successful teams are likely to have greater stability in their personnel, have more experience playing as a team, and are less likely to change offensive or defensive coaching philosophies.  Therefore it would not be surprising that a loss in pre-season practice time harmed the weaker teams more than the stronger teams.  This is exactly what happened last year.  Final score differentials in NFL games were unusually high in the first two weeks of the 2011 season, immediately after the lockout.

In contrast there is less reason to expect that the use of replacement referees during the NFL’s lockout with the more experienced referees would tend to favor stronger or weaker teams.  In fact, the final score differentials in the two weeks of the 2012 season are only slightly higher than in earlier seasons despite the use of replacement referees.

The margin of victory in an NFL game includes signals of the opposing teams’ strengths and noise due to luck, player injuries, weather, and other factors.  These factors include the impact of a shortened training camp due to the player lockout in 2011 and the use of replacement referees in 2012.  The following chart shows the mean absolute score differential for games in the first two weeks of the 2009 through 2012 seasons.The mean score differential was 26% higher early in the 2011 season than it was in the first two weeks of the 2009 and 2010 seasons.  Games were more lopsided by about 2.66 points per game in the first two weeks of 2011.  If the team most disadvantaged by the shortened preseason always lost the game, the average impact of lost practice time is a 2.66 points advantage for the winning team.  If missed practices sometimes worked to the detriment of the winning team the average gross effect on scoring would be somewhat larger.  (If the impact of reduced practice time was uncorrelated with team strength the gross impact could be as high as a swing of 5.32 points per game.)  It seems likely that shortened practices altered outcomes by at least 3 to 4 points per game and sometimes worked to the disadvantage of the team that ultimately won the game.

In contrast there is a much smaller difference between the average margin of victory/loss between the 2009 and 2010 seasons and the first week of 2012.  Although replacement referees have affected the calls on the field, their impact on the typical score differential is only 41% of the increase caused by the players lockout.

Work stoppages and strikes are costly.  The 2011 player lockout caused game outcomes to be more uneven.  Weaker teams with more rookies and roster changes seemed to be harmed more than successful veteran teams by the lockout of players and loss of practice time.  The impact of the strike may have been as high as a swing of 3 to 4 points per game, on average.  In contrast the use of replacement referees in 2012 increased final score differentials by much less.

Public Sector Unions and Lessons from the Elections in Wisconsin, San Diego and San Jose

Voters in Wisconsin decided to retain Scott Walker as their governor.  Last year Walker’s job security was in doubt because he dared to take on public sector unions.  In the end Walker was rehired by voters perhaps because he signed legislation that reduced the size of the state budget deficit and limited the collective bargaining rights of government workers in Wisconsin.  In San Diego voters scrapped the city’s defined benefit pension plan for city workers and replaced it with a defined contribution (similar to a 401k) plan for most new hires.  San Diegans were apparently frustrated by city government officials who repeatedly increased pension benefits for workers without finding a way to pay for higher compensation.  Pension reform also passed by a wide margin in San Jose, California, where the cost of pensions for city workers have also soared.  In San Jose government workers will either have to contribute more for their generous defined benefit pension plan or can opt in to a less generous plan.

Wisconsin, San Diego and San Jose are not generally considered places that are hostile to unions, but the message from voters to politicians seems clear.  Voters are uncomfortable with politicians receiving political and financial support from public sector unions and then negotiating for union contracts with those same unions.  Voters perceive that they are paying too much for the total compensation (including pension and health care benefits) of government workers.  The data indicate that the voters are probably correct.

It is difficult to directly compare the wages and salaries of government and private sector workers.  However, it makes economic (and common) sense that workers are much less likely to quit a job for which they are relatively overpaid.  The following chart compares the quit rates for state and federal government employees to private sector workers in the information, business services, education, health care and financial services sectors.  This comparison is more appropriate than comparing government employees to private sector workers, overall, because government employees are primarily white-collar workers whose next best private sector opportunities would be in these sectors.  The chart clearly shows that quit rates in the public sector are only about one-third the rate of comparable workers in the private sector. 

Government workers don’t quit their jobs because their compensation, including pension and health benefits, is higher than they would receive for comparable work in the private sector.  Protests from public sector unions are to be expected because no workers, even those who are relatively overpaid, want to make concessions to management.  We will have an indication that the pension and collective bargaining reforms have gone too far if quit rates in government jobs increase above those in comparable private sector jobs, and government agencies receive fewer applications per job opening than their counterparts in the private sector.  Until that happens voters can be assured that public sector wages and benefits are high enough to attract and retain workers.

Public sector unions, which were virtually nonexistent 50 years ago, are the last stronghold of the American labor movement.  Private sector unionization rates have dropped well below 10% and members of public sector unions outnumber private sector union members.  The elections yesterday dealt quite a blow to organized labor which was unable to sway public opinion.  Unions desperately wanted to oust the Wisconsin governor and members of the state Senate who neutered their ability to collectively bargain for compensation.  Expect more governors and state legislatures to follow Wisconsin’s lead, and other cities to follow San Diego and San Jose and reduce the compensation and benefits of state and local government employees.

NBA Players Can’t Shoot Straight after the Lockout

All the excitement generated by Jeremy Lin seems to have distracted fans from what’s really happening this NBA season.  Charles Barkley is paying attention, and he said “As a NBA fan, I want to apologize to the fans.  I cannot believe how bad the NBA is right now.” Offenses are performing poorly this season and there is a simple explanation, the lockout that delayed the start of the season and all but eliminated team practices.

This is the second NBA lockout serious enough to result in limited training camps and a shortened regular season; in 1999 the NBA played a 50-game schedule.  NBA lockouts reduce shooting accuracy and these negative effects may persist for several seasons.  Basketball productivity probably declined because pre-season practices, mid-season practices and rests days were curtailed in order to fit 66 games between Christmas and late April.

The following figure illustrates the average effective shooting percentage in NBA regular seasons from 1980, when the 3 point shot was introduced, to the current season (so fare).  The effective shooting percentage is a weighted average of 2 point and 3 point shooting percentages, where each 3 point shot receives one and a half the weight of a 2 point shot.  The figure indicates that although shooting accuracy varies from year to year, it dropped shortly after both work stoppages, and remained lower for several seasons after the 1999 lockout.

I estimated a simple regression that allows for differences in shooting accuracy among teams and correlation in the fluctuations in a team’s shooting percentage from one year to the next.  The regression model suggests that lockouts cause a 1.5% decline in the effective shooting percentage in the first season after a lockout.  The model also predicts that shooting percentages will remain lower because of the time series correlation in shooting accuracy.

The statistical model can be used to predict how the most recent lockout will reduce NBA scoring over the next few seasons.   Combined scoring by both teams is expected to drop by 5.5 points in 2012 and 3.3 points in 2013 due to the reduction in shooting accuracy.

NBA coaches and teams can adjust strategies to mitigate the impact of the prolonged lockout.  For example teams can attempt more (or fewer) 3 point shots and slow down (or speed up) the pace of play.  If these adjustments are made scoring reductions could be somewhat smaller than the model’s predictions.

Some fans believe that the NBA’s 82-game regular season is too long, so that a silver lining of the 2011 lockout is a shortened 66-game schedule.  Whether or not the regular season is too long, compressing a 66 game season into four months has a negative impact on offensive efficiency.  Practices and rest days are important, even for the world’s best athletes competing at the highest level.  The elimination of rest days and practices appears to be relatively more important for basketball offenses.

Vanishing Private Sector Unions

Yesterday Indiana Governor Mitch Daniels signed the law making Indiana the only right-to-work state in the Rust Belt.  Earlier this week pollster Scott Rasmussen reported that 74% of voters favor right-to-work laws that would eliminate mandatory dues and make it much more difficult for unions to organize.  Public employee unions are also being challenged.  In November Ohio voters rejected a law that restricted the collective bargaining rights of public sector unions, and Wisconsin Governor Scott Walker is facing a possible recall after signing a similar bill in Wisconsin.

Voters’ sentiments seem to reflect their labor market experiences.   Private sector unions are vanishing, which will erode support for laws and regulations that strengthen or preserve their bargaining power.  On the other hand membership has never been higher in public sector unions.  I expect well-organized opposition to bills such as the one introduced in Arizona, which limits the collective bargaining power of public sector unions.

The latest Labor Department data indicate that union members comprise only 6.9% of the private sector workforce.  Private sector union membership rates peaked in the 1940s and 1950s at about 1/3 of the workforce.  Unions were virtually nonexistent until the 1960s.  Today the situation has reversed and there are more union members in government than in the private sector.

Union members are older than non-union workers.  In the private sector there are about the same number of non-union workers under the age of 30 and age 55 and above.  Among union members there are 2.5 workers age 55 and above for each worker under 30.  The following figure illustrates private sector union membership rates for four different age cohorts.  The only age group that ever experienced membership rates in excess of 20% includes workers who are now age 55 and above.  Younger age cohorts have seen stable membership rates of 10% or less.  If these trends continue no more than 5% of the Millennial Generation will ever be (private sector) union members.

The aging of the private sector union workforce means that the issues that matter to Richard Trumka, and the AFL-CIO, are unlikely to energize younger voters.  Voters who never belonged to a union show little interest in recess appointments to the National Labor Relations Board, NLRB rules changes that give unions an organizing advantage, the NLRB’s opposition to Boeing’s plans to shift production from Washington to South Carolina, or Indiana’s right-to-work law.  In an earlier era when the AFL-CIO had more political clout, these issues would have been pivotal in an election year.

Local government employees, such as teachers, sanitation workers, police and firemen, have the highest union membership rates that we have ever seen in any sector of the economy in U.S. history (43%).  The battleground for the labor movement has shifted to laws that limit the collective bargaining rights of unions representing government workers, as in Arizona, Ohio and Wisconsin.  These laws have gained support as local governments have been squeezed by declining property values and tax bases and increasing costs of health care benefits and pensions.  The result of the efforts to recall Governor Scott Walker will foreshadow whether public sector unions can maintain their bargaining power and political clout.

Sugar Beets and Lockouts

Yesterday’s New York Times describes how lockouts have become a more common tool in labor management negotiations. Management is more likely than ever to lockout union workers, hire replacement workers and pressure unions to accept wage and benefit concessions when contract re-negotiations become deadlocked.

The Times article focuses on American Crystal Sugar, the nation’s largest sugar beet processor, which is currently involved in a lockout with 1300 union workers employed at five plants. The article never mentions that profits and union compensation in the sugar beet industry rely on import tariffs, quotas on imported sugar, and protection from foreign competition.

It is simply cheaper and more efficient to import sugar than it is to process sugar from sugar beets in the US. As Mark Perry noted in his Carpe Diem blog two years ago, government intervention in the market for imported sugar has protected the sugar beet industry and raised the price of sugar for the American consumer. The sugar beet industry has received $242 million in subsidies over the past 15 years.  More importantly, as Perry explains, our policies have caused U.S. sugar prices to be about twice the world price for decades. In 2009 alone this cost consumers $2.5 billion dollars.

Remarkably, the topic of sugar subsidies was raised yesterday at the Republican debate. Newt Gingrich admitted that in all of his years in the House he was unable to eliminate sugar subsidies. His simple explanation for the durability of this anti-competitive policy was there are “just too many beet sugar districts in the United States.” This debate topic released a torrent of cynical (but funny) tweets . The consensus was: this is silly, aren’t there more important issues?

The story of sugar beets is a lesson in why inefficient government programs are difficult to eliminate. Every policy has winners and losers. The winners are the sugar beet processors and organized labor who are currently deadlocked over how to split the profits from operating in a market protected from foreign competition. The losers are American consumers. Unfortunately the stakes are so low per consumer, $8 per year, that we think it’s silly to question candidates about how they expect to change Washington if they can’t stop subsidizing and protecting sugar beets.

Carolinas and our Manufacturing Base

Unemployment is about 10% in the Carolinas as their regional economy has been hard hit by the recession. The economy is likely to be a key issue when voters go to the polls for the Republican Presidential primary in South Carolina, and later this year when Democrats nominate President Obama for re-election at their convention in Charlotte.

Forty years ago the Carolinas employed the highest fraction of workers in the manufacturing sector, accounting for almost 40% of all jobs. Textiles and apparel manufacturers were the largest employers with more than half of all manufacturing jobs.

When President Obama and the Republican Presidential candidates advocate policies to restore our manufacturing base shuttered steel mills and automobile manufacturing plants in the Rust Belt come to mind. No states have been more adversely impacted by globalization and foreign competition than the Carolinas. China now accounts for 40% of US imports of textiles and apparel, up from 12% two decades ago. Over the same time foreign imports have more than tripled while the US has lost 80% of jobs in the apparel and textile industries.

Today Indiana is the most manufacturing intensive state in the US, with about 19% of private sector jobs in manufacturing. The Indiana legislature is about to debate legislation that would make it the only right-to-work state in the “Rust Belt”. The lesson from the Carolinas is clear. When foreign labor and production costs are sufficiently low, as they are in textiles and apparel, neither tax incentives nor “right-to-work” laws will be enough to preserve manufacturing jobs. Our manufacturing base in the 21st century will be concentrated in industries where skilled labor and sophisticated capital equipment give us a comparative advantage.

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