Auto Industry Wages

Sorry for the utter lack of blogging recently. I'll get back to both the MBA Oath and some immigration issue shortly.

But for today, another great example from the New York Times Sunday Magazine.

(And as an aside, why is there so much great economics in the NYT Magazine? They're not trying to write about economics, after all... It's because they're writing about really interesting real-world issues --- and economics is just the study of how lots of individuals' real-world decisions add up to the world we live in. The Economist --- great magazine, and I read it every week --- tells you about economics. But the NYT Magazine tells you about life, and that's why it's a better source of economics examples.)

Anyway, the cover story from a week ago was how the auto industry helped create a really vibrant African-American middle class in Detroit, and how the auto industry's troubles are threatening that prosperity.

It's a sad tale. African-Americans still make considerably less than whites (on average), even controlling for education and work history and all that. And unlike other "minority" groups, African-Americans haven't been able to close that gap very well.

But here's how I'm going to use the article in class. For years, union wages in auto firms have been way, way above the going wage for comparable work in other industries. As a result, auto jobs were very, very desirable. Supply far exceeded demand for such jobs.

Now, what does a "normal" firm do when supply exceeds demand? That is, what happens when you list a single job opening and get dozens or hundreds of applications? That's a good sign that maybe the wage you're offering is higher than necessary to attract interest. Profit-maximizing firms will either re-list the job with a lower starting salary, or hire someone at the listed wage, but then limit going-forward wage increases.

Auto firms can't do that. Their wages are negotiated with unions far in advance. If supply exceeds demand, there's no way for them to offer lower wages.

It's a lot like what happens when there is a binding minimum wage. If the government says the lowest wage that firms can pay is $6.50 per hour, but the market-clearing wage (that is, the wage where quantity demanded is equal to quantity supplied) is $5, then any listed job will have excess supply.

One interesting question is how firms decide who to hire. If there are 30 qualified applicants for each opening, then which of them do you select?

The answer in the auto industry? Nepotism. If there are 30 qualified applicants for each opening, then the only way to get hired is to know somebody. Which means the kids of auto workers have a leg up when it comes to getting those jobs. And there's an interesting (but short) discussion of this in the NYT piece.

Is this a good thing or a bad thing? Probably bad. One reason is that we (as a society) want the right people in the right jobs. The price mechanism helps with this (as I've noted before), so messing with prices will mess with the allocation of people to jobs. Another problem is that with any sort of favoritism significant resources can be burned in the attempt to curry favor. I'm just guessing here, but I imagine that a GM auto worker who wants to get his/her son/daughter hired by GM would have to do a lot of work to butter up the right people and grease the wheels. Probably it would be better for everyone if auto workers made autos, rather than spending all day and night trying to kiss up to a supervisor so your kid will get hired.

Anyway, it's a nice example of how resources get allocated when we don't let prices do the job.

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Update: It's a good time to discuss minimum wages --- The Federal Minimum Wage rises to $7.25 on July 24! What will this do to our (already high) unemployment rate?