Current Events: Two-Tier Wages

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Economic behavior in highly specialized economies must often be frustratingly inexplicable to mainstream economists. Given the substantial share of rational exchange that occurs in large-establishment workplaces excluded from consensus market-centric general-equilibrium models, the profession is stuck with a badly truncated perspective from which to make sense out of modern price-mediated conduct.

An example of real-world behavior that apparently makes little sense occurred last week when Fiat-Chrysler and the United Automobile Workers began contract negotiations in Detroit. As reported in the Detroit News (July 15, 2015), the main storyline from the negotiators’ opening press conference had to have been  perplexing to economists who purport to understand phenomena like factor pricing:

“Fiat Chrysler Automobiles NV CEO Sergio Marchionne wants to eliminate the two-tier wage structure for the automaker and the United Auto Workers union during 2015 contract negotiations. The UAW wants to end the two-tier system too, but the devil is in the details of a way to achieve it that satisfies both sides. Marchionne, who has spoken out against the wage disparity for years, said there is a ‘better than’ 50 percent chance of eliminating the two-tier system during this round of negotiations, which officially kicked off Tuesday in Detroit. ‘I’m walking into this … with a very clear view of trying to do our best to get there. Time will tell,’ he said during a ceremonial handshake event to officially start negotiations with the union in Detroit. ‘We’re going to do our darndest to try and pull it off, if we can.’ ”

As mainstream economists continue to read the story, Marchionne’s position becomes increasingly baffling. Chrysler wage costs will be substantially increased by eliminating the two-tier structure, which was agreed to for U.S. plants in 2007 when the auto industry was faced with market conditions that threatened its survival. Entry-level workers now make $19 per hour; longtime workers make $29 per hour. The disparity is a big deal. Forty-five percent of Chrsyler’s U.S. hourly workers are now being paid the lower wage.

Why does the Fiat-Chrysler CEO want to increase his wage bill so dramatically? It is not because they want to attract more or better workers. They are doing fine in the labor market. Instead, he wants to better manage his existing workforce. He described the elimination two-tier wages as a “huge obligation” to employees. Both sides agreed that the differential wage structure is unsustainable and divides the workforce. The fundamental point here is that profit-seeking is concerned with unit costs, which introduce worker satisfaction and cooperation into the equation. The effective large-establishment management of unit costs is widely understood to require that employees receive the same pay for the same work.  Marchionne also reiterated his support for profit-sharing, a pay practice more aligned with mutually cooperative labor-management behavior.

For most in the profession, the Detroit News story will be just something else to ignore. Push it into the huge box of special cases that are somehow simply accepted as beyond the explanatory reach of economic theory. Assignment of the phenomenon to that all-too-familiar dustbin is probably accompanied by a silent prayer that some curious student will not bring up Marchionne’s inexplicable beliefs in class.

Mainstream economics professors cannot explain why top management of Fiat-Chrysler does not love the two-tier wage structure without raising fundamental questions about untenable assumptions needed in what they have been teaching all along. The correct explanation, as the Fiat-Chrysler CEO made clear, is not hard to understand. Putting it in the language of economics, the imperfect information that characterizes large-establishment workplaces greatly complicates the profit-seeking management of conscious labor input.  Workers have well documented preferences about acceptable behavior, and Marchionne must pay attention to aligning those preferences with his objectives for the firm. But, for economics professors to address the story properly implies a lot of work and some embarrassment. It requires starting the course over again with a better model, i.e., one that generalizes optimizing exchange from the marketplace to the workplace.

Starting over is, of course, facilitated by the existence of the GEM Project. The generalization of rational exchange from the marketplace to the large-establishment workplace has already been done. Indeed, Chapter 8 (on continuous general-equilibrium management) in the website’s eBook contains a substantive discussion of two-tiered wage systems and the difficult labor-relations that result. More generally, think about the eBook’s featured Two-Venue General-Equilibrium model. Think about how much easier it makes the job of being an economist. Think about how much Two-Venue General-Equilibrium modeling shrinks that embarrassing dustbin of special cases never to be mentioned in economics classrooms. Really think about the freedom to use and teach the more powerful model over the range of previous dustbin topics ranging from macroeconomics that is simultaneously coherent and stabilization-relevant to a story in the Detroit News that very directly affects some 35,000 persons and indirectly many more. What’s there not to like?

Blog Type: Policy/Topical Saint Joseph, Michigan

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