DRI-285 for week of 11-18-12: Twinkie Recipe: Separate Politics from Economics, Bake Cheaply and Deliver Efficiently


An Access Advertising EconBrief:

Twinkie Recipe: Separate Politics from Economics,

Bake Cheaply and Deliver Efficiently

Contemporary economic theory is now so heavily formalized by high-level mathematics and statistics as to be inaccessible to non-specialists. This has many drawbacks. Among them is the difficulty of integrating the effect of politics on markets. This is one of the few points of agreement between left- and right-wing commentators, who insist that we have a system of political economy rather than a system of markets as such.

Both sides are correct. Unfortunately, this realization causes them to neglect economics rather too much and concentrate on politics too heavily. Faced with a controversy, they tend to choose sides as if engaged in a war – by looking at the political uniform worn by the participants. Their most recent skirmish has attracted national attention. The baker, snack-food and confectioner Hostess, Inc. has filed for bankruptcy after a protracted dispute with its unions. One union in particular, the bakers’ union, has drawn the focus of attention.

The Decline and Fall of Hostess

Hostess was formerly Interstate Brands Corp., of Kansas City, MO, producer of over 30 brands of breads, cakes and snacks. These include legendary names like the Twinkie, Wonder Bread and Hostess Ding Dongs. The current dispute between Hostess and its unions is only the terminal event in a decades-long history of gradual decline. Hostess’s bankruptcy is its second; the first resulted in reorganization and the name change from IBC to Hostess. How could a company with such a distinguished roster of popular brands have fallen so low?

Some of the decline is due to a change in consumer tastes. High-calorie, high-fat, high-sugar snacks have lost favor. The realization that carbohydrate consumption carries just as much danger as fat consumption, if not more, has dampened the American enthusiasm for bread and cake. This is only part of the explanation for Hostess’s problems, though.

The longtime popularity of brands like Twinkies and Ding Dongs allowed the company to endure some highly uneconomical labor practices. The Teamsters Union – one of 12 unions operating under more than 300 collective-bargaining agreements with Hostess – forbade drivers from helping to load and unload their trucks. A stocker had to be employed to drive to the store and stock retail shelves with products transferred from storage. Some brands, such as Wonder Bread, could not share space on trucks with others.

When the falloff in brand popularity hit, Hostess could no longer subsidize this sort of inefficiency. The company has operated in bankruptcy reorganization for most of the preceding decade. The final crisis occurred within the last week, when Hostess announced that it had asked for contract concessions from the baker’s union, having already received concessions from the other 11 unions. It could not operate under the current contract and the law forbade operation without a contract. Thus, it announced that unless the bakers agreed to a deal, Hostess would once more file for bankruptcy and this time would proceed to liquidate the company’s assets.

The bakers refused. The company filed for bankruptcy. A federal judge intervened with by demanding that the parties undergo mediation. That process failed, and the bankruptcy and liquidation will now proceed.

The Left-Wing Reaction

The response on the hard left-wing, particularly among union proletarians, is that once more a company was undone by “vulture capitalism.” Private-equity firms took over the firm and ran roughshod over the rights of honest workers, raping and pillaging the firm’s assets. These commentators are doubtless fortified by the election returns, which suggest that the campaign of career-character assassination against former Bain Capital CEO Mitt Romney worked well enough to secure re-election of a fairly unpopular President.

The commentators looked at the day-to-day uniforms worn by the managers of Hostess and saw “venture capital” emblazoned thereon. Had they looked behind the scenes, however, they would have noticed that many of the particular venture capitalists involved with Hostess were closely associated with the Democrat Party. That’s right – the party of compassion, of equality and fairness, of comparable worth and social justice and the 99% and share-the-wealth and soak-the-rich. How could this be?

Actually, the real question is: How could it be any other way? Take-over artists and private-equity managers are primarily engaged in turning around businesses, not liquidating them. A liquidation is a fire sale, in which assets are generally sold at rock-bottom prices. That is why potential buyers tend to wait out dramas like the Hostess episode rather than riding to the rescue like the Lone Ranger. The rate of return on an asset depends crucially on the price paid for it. Who wouldn’t rather pay a low price rather than a higher one? Private-equity managers are business experts, right enough, but there’s no such thing as an expert in getting a high price at a close-out sale. Ask any business owner who ever went bust or any grieving son or daughter who ever liquidated their parent’s possessions at an auction. It’s pretty tough to profit from this process and it’s just as tough to earn fees from producing outcomes like this, since nobody has an incentive to pay the fees.

No, the people who bought Hostess bought it in order to run it, not break it up. Their record shows they usually succeed in doing that. They’re liquidating Hostess now because they failed this time and there’s no point in throwing good money after bad by failing to play their hole card. That card is the fact that Hostess’s 30+ brands still have considerable market value. In fact, their individual market value – outside the company and freed from the dead weight of union presence – probably exceeds its collective value inside Hostess.

The link between private-equity and the Democrat Party is eminently logical. It is economic, not political; that is, it has no necessary connection with the political sympathies of the vulture capitalists involved. Takeover targets are failing companies that have the potential to succeed. Why does a potentially successful company fail? Answer: it is being dragged down by unions, just as Hostess was. How to overcome this roadblock? Answer: persuade the unions to cease and desist from their uneconomic practices for their own good as well as the good of the shareholders. The best people to do this are not card-carrying Republican Party members or Ayn Rand sympathizers. They are fellow Democrats, who can at least gain the ear of the union bosses and perhaps retain a shred of credibility with the rank and file. And look what happened here – Hostess’s managers succeeded in keeping the company going for over a decade and persuaded 11 of the 12 unions to sign off on their latest resuscitation plan.

So much for the standard left-wing boilerplate view of the Hostess affair. Alas, the view from the right wing is not much more cogent.

The Right-Wing Reaction

Somewhat surprisingly, the right-wing view has gained considerable momentum even in mainstream media. The baker’s union suffers from false consciousness, say the mavens of talk radio. They stubbornly cling to their high union wages and benefits at the cost of their own jobs – and the 18,500 other jobs at Hostess in the bargain! How selfish can you get? Just one more case of what “union bloody-mindedness…at work.”

Wall Street Journal columnist Holman Jenkins (11/21/2012) provides a refreshing antidote to the stereotypical thinking of both right and left. He reveals that the Hostess story is a tale of two unions, not just one. It is the Teamsters who are the stereotypical hard-liners, insisting on featherbedding work rules that have driven Hostess’s product distribution costs into the stratosphere. The bakers (the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union) have made repeated concessions, to the point where production costs hardly exceed industry norms.

From the bakers’ standpoint, they are being asked to make even more concessions now in order to protect the current status of the Teamsters, whose work rules are still hamstringing the company. No matter what you may have heard, solidarity is not “forever” – that is merely a song lyric.

As organized under laws mostly passed in the 1920s and 1930s and reinforced by labor regulations handed down for decades by the federal government, a labor union is a cartel. It is analogous to cartels set up by businessmen who sell products and services. Cartels strive to emulate the outcome of a monopoly, which is to thwart the competitive process and attain the same collective profit-maximizing outcome theoretically open to a pure monopoly seller.

In practice, a pure monopolist cannot even approach that theoretical outcome without the aid of government in restricting competition. That is even truer of cartels and much truer of labor unions. That is why the federal government has conferred their coercive powers upon unions. Unions operate to raise wages above the level that would otherwise prevail in a free labor market. The only ways to do that are to artificially hold wages high or to artificially restrict the supply of labor to the market. Unions do one or the other, depending on circumstances.

Both of these practices reduce employment in the unionized sector. This drives workers into unemployment and/or into non-unionized sectors, thereby driving down wages there. Union workers have no particular incentive to sacrifice on behalf of other union workers, who are after all merely workers like the ones whose interests have already been harmed by the union cause.

Jenkins points out that the bakers had a strong case for not agreeing to Hostess’s offer. Why not “hold back further concessions, let the company liquidate, and try their luck with a new owner or owners who might materialize for its bakery operations. These new owners presumably would be in a position to invest cash in marketing and promotion… They would benefit from the deluge in free media that has befallen the Twinkies brand this week. All the more so given that Hostess plans to close or sell some of the bakery plants anyway, that unemployment benefits are generous, that bakery jobs have become crummy-paying thanks to previous givebacks, that the government-run Pension Benefit Guaranty Corp. will be assuming the Hostess pensions in any case.”

So it seems that the bakers are not dumbbells after all. They are pursuing their own interests rationally given the cards they were dealt under a system they didn’t design. The right wing is repeating a frequent mistake of blaming victims of progressive socialism for acting in their own behalf. The right should instead expend all its energies working to change the system.

Jenkins observes that “one could always ask about the wisdom of a labor-law structure that causes companies like Hostess to drag on for decades without adapting to their marketplaces.” Indeed. This is a structural consequence of the substitution of politics for economics.

The Vocabulary of Political Theater

The medium of political theater employs a vocabulary of perception rather than one of real meaning. Words are assigned a political meaning unrelated to their substantive economic impact. One such word is “corporation.”

A corporation is a set of meanings that assign claims to various assets. But the political meaning of the word “corporation” describes a personified entity that is “large,” “wealthy,” “powerful,” “insensitive,” and “evil” when remotely viewed, or “paternalistic,” “secure” and (still) “wealthy” when viewed up close – say, from the perspective of an employee. All these traits are those of individual human beings; the political view of a corporation equates it to a person.

When a corporation goes out of business, it closes – often declaring bankruptcy – and its assets are liquidated. When a person goes out of business, he or she dies. A person cannot undergo “asset liquidation” even though a person’s assets can be liquidated. Thus, a person is not a corporation. But because politics views a corporation as a person, bankruptcy is viewed as akin to human death, even though it is not.

Bankruptcy is a process of evaluating the business to determine whether, and in what form, the business should go forward. That evaluation will gauge whether the business’s assets are worth more in combination or singly. This determination is a vital social process because your welfare and mine suffers if business assets are misused. True, we may not be owners of the business, but the real beneficiaries of a business are consumers, who benefit from what the business produces. That, after all, is the whole purpose of businesses – to produce goods and services for consumption.

When companies like Hostess die lingering deaths of a thousand union and bureaucratic cuts, all of us experience imperceptible losses. We pay more for government regulatory and bureaucratic functions. We pay more for the goods and services those businesses produce and we get less. Perhaps we are able to buy less in the coin of a depreciated currency.

Bankruptcy is in no sense analogous to human death. If an analogy is absolutely necessary, the “burnoff” of dead, accumulated brush that occurs in nature would be a good one. This pruning away of dead, useless stuff enables the remaining ecosystem to thrive.

One of the most destructive of all political terms is “economics,” which means “macroeconomics.” Currently, there really is no such coherent economic theory. Even less is there a set of valid, generally recognized policy prescriptions that could be grouped under that heading. The only valid meaning for the term “economics” would be described by the sub-head “microeconomics,” with the proviso that this would include the specialty of monetary theory and the study of business-cycle dynamics. One of the two sub-disciplines of microeconomics is the theory of the firm. That logic is of more help in understanding Hostess than anything provided by the Council of Economic Advisors.

A politico-economic term that has no meaningful economic referent is “job creation.” The purpose of economics is not to create jobs but to create value. Human labor is the key means of doing that, but it is the value, not the labor itself, that is the desired end product. Totalitarian regimes are wonderful job creators; there was no unemployment in ancient Egypt or in Soviet Russia or Communist China under Mao. The trick is not putting people to work; it is getting the most out of the work they do. That is what the “labor-law structure” referred to by Holman Jenkins completely overlooks.

Whither Twinkies, et al?

A few observers are sheepishly acknowledging that maybe we haven’t seen the last of Twinkies after all. The current owners of Hostess intend to sell the rights to produce all those branded products, which portends a bright future for any brand not encumbered by the same union rules that felled Hostess. And it may well mean a brighter future for many of those in the baker’s union as well.