Hostage Factories

The hidden costs of plant closing laws

Youngstown, Detroit, Newark, Cleveland, Pittsburgh, Gary, Akron—their names strike a sensitive chord among concerned readers of the daily press. In the minds of many, these cities, rightly or wrongly, epitomize urban decay, recession, and despair. All have suffered through the closing of one or more major plants, and much has been written about the resultant effects on the firms' local employees and the communities in general.

In early 1982 60 Minutes reported on the closing of a General Electric plant in Ontario, California. Mike Wallace interviewed workers who were obviously distressed by the loss of their jobs, especially since GE was closing the plant in order to shift its production of irons to foreign countries. The company argued that the switch from metal irons, which the California plant made, to plastic irons, which could be produced more economically abroad, made good business sense.

ABC ran a similar story on 20/20 a few weeks later. This time the report concerned the closing of a small New England plant that manufactured gear boxes for pleasure boats. Foreseeing the economic distress the closing would cause the employees and community, the town pulled together and raised funds to send a delegation of workers and townspeople to Wisconsin to talk with officers of the parent corporation—all to no avail. In the absence of an offer to buy the plant, the doors were shut.

On January 1, 1983, the Los Angeles Times ran a front-page story that started with a report of two firms' relocations to take advantage of lower costs. The Tonka Corp., in moving its manufacturing from Minnesota to Texas, figures that its labor costs would be slashed by two-thirds. And Blue Shield's San Francisco office was benefiting from lower salaries and rents by relocating its operating departments to 11 rural California offices hooked up to headquarters via computer. Blue Shield's move, worried the Times, would "leave a force of middle-aged minority women jobless in an already depressed urban area."

Fearing the consequences of a rising tide of plant closings, workers and communities across the country are hoping to change the way such business decisions are made. Often, plant closings are blamed on the "irresponsible" and "callous" profiteering of free enterprise. The LA Times headline on its January report read: "Profitability Edging Out Social Costs." Ellen Green, coordinator of a Plant Closures Project in California, was quoted: "Many closings are based solely on a cost-benefit analysis with no social factors considered."

Making sure that businesses pay attention to such social factors is the aim of labor and community activists who increasingly joining battle in the political arena with legislation designed to restrict plant closings. The idea is to revamp, by law, a perceived growing incompatibility between the mobility, of "financial and physical capital" and the the desire of people with "human capital" to stay put, retain their jobs, and develop their communities.

Plant closings, proponents of legislation contend, not only contribute to greater unemployment but also to:

• a reduction in national income, since many workers remain idle for long periods of time and firms that move to lower-wage areas necessarily lower their total wage bill;

• an increase in physical and mental illness and crime, since researchers have found that a one percent increase in the national unemployment rate is associated with 37,000 deaths (including 20,000 heart attacks), 920 suicides, 650 homicides, 4,000 state mental hospital admissions, and 3,300 state prison admissions;

• a reduction in tax collections, since fewer people earn an income and the property-tax base partially evaporates, and an increase in social-welfare expenditures in communities hit by plant closings;

• a decline in self-esteem and morale among workers; and

• an increase in marital and family problems, from divorce to child abuse, since any rise in mental and physical problems is felt first and most keenly in the home. To the advocates of restrictions on business, the consequences of plant closings are pervasive—and everywhere destructive.

Since 1974, various plant closing laws have been introduced in Congress. So far, the only legislation passed has been a bill requiring the Department of Labor to compile and release information on plant closings categorized by sector and by state.

More recently, a spate of bills, having common objectives and similar characteristics, have been introduced in 21 states ranging from Hawaii to Alabama to Maine. A state legislature in every major region of the country has considered at least one bill over the past two years. However, the stronghold of this new political activism remains concentrated in the northern industrial-tier states, where concern over "capital flight" and "deindustrialization" remains high.

Although the movement has the backing of national groups like Ralph Nader's Public Interest Research Groups and the AFL-CIO and a variety of state groups such as the Ohio Council of Churches, its efforts have been thwarted to date in most states primarily, as might be expected, by business interests. However, two states—Maine and Wisconsin—now have restrictive legislation on their books.

In addition, the movement's successes are gradually mounting, first by having bills introduced where a sponsor could not, at one time, be found; then by having bills emerge from committees, where they were once buried; and now, as noted, by having two states adopt relatively mild restrictions. These successes, although limited, speak to the staying power of the bills' political supporters. Much of their literature attributes plant closings to the free play of market forces, and proponents of legislative relief often perceive themselves as engaged in a long-term struggle to change fundamentally the distribution of economic power in this country—to democratize, if not humanize, entrepreneurial decisions.

The various federal and state proposals have several unifying features. First, they tend to apply to firms with a minimum number of employees, generally 50 or 100. After all, the intent of the legislation is to limit the economic impact of "major" changes in business operations.

Second, most of the proposals require plants to give notice of their intentions to close one year in advance. The legislative proposals in Ohio, Washington, and Oregon specify that notice must be given two years in advance.

Third, most of the proposals have some form of severance pay requirement. Alabama's bill is typical in that it requires firms to grant affected workers a lump-sum severance pay equal to their average weekly wage times the number of years employed. A worker, for example, who has earned an average of $300 a week for the past year and has worked for the company 20 years is entitled to a lump-sum payment of $6,000.

Fourth, many of the state proposals require companies to make restitution payments to the affected communities—to be used mainly for readjustment programs—equal to 10 or 15 percent of the previous year's total wages paid the unemployed workers.

Finally, the bills typically do not apply to bankrupt firms, to nonprofit organizations, and to governments and their agencies. (Why governments are not covered is unclear. It would appear that changes in government programs, like the relocation of a major health center, can be just as devastating to communities and workers as any closure of a private, profit-making firm.)

Before restrictions on plant closings are adopted, however, state legislators would be well advised to look carefully behind the headlines and the emotional trauma that understandably accompany plant closings. On the surface, plant closing laws appear to be a relatively simple, straightforward solution to an otherwise complex and destructive social ill. However, this new form of regulation will cut a government swath across the private economy that is both broad and deep: it will inextricably entangle state governments in the affairs of business in a way never before attempted or even imagined. State governments will, very likely, become the arbiters of literally tens of thousands of closings and changes in operations, for we can expect firms to try to escape the costs implied in the restrictions through any one of the loopholes that inevitably permeate legislation.

Evaluating the economic justifiability of many closings will not be easy. No doubt, some firms will try to work business assistance and worker buy-out provisions to their advantage. Furthermore, the laws offer firms an economic incentive to order their financial affairs so that they can declare bankruptcy when they announce their intentions to close. State officials can anticipate that firms will adjust their size and restructure their organization so that the closing laws do not apply to them. We can only wonder whether state governments, struggling to stay afloat financially and to produce traditional sorts of services like education and highways, are actually prepared to cope with the task being proposed.

Where will these laws leave states? State governments will in many respects become more than just regulators of entrepreneurship—more than just rule setters; they will likely have to attempt to become entrepreneurs themselves, for their actions to retard firm closings and relocations will necessarily affect the timing and regional distribution of the states' and nation's physical and human resources. Restrictions on plant closings are not simply restrictions on "physical things," like buildings and equipment, as they are often characterized; they are also restrictions on real people whose legitimate rights will thus be usurped and managed by state government. Nor will the restrictions affect only the owners of firms—the "greedy profit seekers" castigated by proponents of restrictions; they will also affect workers—some wealthy, some not so wealthy—who save and want to invest in efficiently run companies, who wish to buy goods and services at the lowest prices possible, and who will be less able to find the type of productive jobs they seek.

Contrary to what may be imagined, restrictions on plant closings have another hidden negative dimension: they are also restrictions on plant openings. What firm would be interested in investing in a state that has in force the smorgasbord of restrictions contained in several of the proposed laws? The question is especially relevant to areas of states that are depressed and therefore risky.

Plant closing laws accomplish one thing for sure: they increase the cost of doing business—and of staying in business. And firms must cover the prospective costs of closing with additional insurance against closing or with their own contingency fund to meet the prenotification, severance pay, and community restitution requirements.

To understand the economic impact of these proposed requirements on business, consider the case of Firestone's 1980 closing of its subsidiary Dayton Tire Company, which employed 1,800 people. The two-year notification, severance pay, health insurance, and community restitution provisions incorporated in the Ohio bill would have, if it had been in effect, cost Firestone, after allowing for sales during the notification period, more than $60 million. And Firestone closed four other plants that year.

These costs are obviously not trivial. They can portend bankruptcy and the closing down of the entire firm, not just one or several plants. They can jeopardize the jobs of workers not in the plants slated to be closed. There is reason to wonder whether Firestone would have survived its financial storm of 1980 if laws like the Ohio bill had been in effect in states where Firestone closed its facilities. The company was struggling that year through serious losses due partially to a dramatic and unexpected shift in car-buying habits and to the legal and market fiasco following defects found in its "500" tire series.

Oddly enough, closing restrictions can force closing decisions. At any moment in the economic history of a state, many firms teeter on the brink of closure. Firms must continually evaluate their future prospects, asking whether they can make it through the next six months, year, or two years. Once they announce their decision to close, their coffin will be sealed: their employees can be expected to jump ship, and their suppliers, buyers, and creditors can be expected to deal more cautiously with them. (Levi Strauss has a company policy of announcing a plant closing at least a month in advance, but this has created problems. "Even with this relatively short lead time," reported the Los Angeles Times, "some plants have been crippled because a majority of workers have left before the final closing.")

Because of the notification requirements, many firms can be expected to announce their intentions to close at a time when they would otherwise—in the absence of the notification requirement—try to ride out adverse, but possibly temporary, market conditions. In this respect, "plant closing laws" are indeed plant closing laws. States that enact restrictions can be certain that those restrictions will reduce their competitive position with other states and the effectiveness of their efforts, made at some expense to taxpayers, to attract new industries.

These are the kinds of considerations that lead many proponents of restrictions to seek federal laws, applicable to all states. Under a federal law, no state would be placed at a competitive disadvantage to other states—all would be subject to the same restrictions. But the fault of a federal approach lies precisely in its uniformity. Federal law would be everywhere the same, denying individual states and individual communities the right to competitive and creative responses to similar, but not identical, social problems.

Proponents of restrictions point to all the "job losses" attributable to plant closings. One study commissioned by the Progressive Alliance, for example, charges that 15 million US jobs were lost because of plant closings during the early 1970s. Although many people do suffer when their firm folds, focusing only on these job losses distorts the economic burden of closings. Anyone who assesses the economic stability of the banking industry by looking solely at withdrawals will necessarily conclude that all banks will eventually fail. But few banks fail—and most are indeed quite stable—because of offsetting deposits. Similarly, any dynamic economy is driven inexorably by the creative process of closings and openings—the births, renewals, and deaths of firms. Admittedly, the competitive market process is, by its very nature, destructive; the destruction is, however, "creative destruction"—when one firm goes under, its resources are released to other, more cost-effective firms that offer consumers more of what they want at better prices. As a matter of fact, during the first half of the 1970s there was a net gain of 10 million jobs created in the United States.

Some would have legislators believe that opposition to restrictions on plant closings is "antilabor" and "probusiness." That could not be further from the truth. Because of the costs imposed on business by the restrictions, they amount to a tax on business for its use of labor. The greater the use of labor, the greater the tax. Surely, such a tax will dampen business demand for labor and consequently will retard growth in wages. What would workers expect in terms of wages offered if they required 52 weeks of severance pay? What would they expect if government, acting in their stead, were to require it? Real people, primarily workers and consumers, will ultimately pay through lower wages and higher prices for the notification and severance pay benefits received.

Many suppose that since business is in the vanguard of the opposition to restrictive laws, the business community is uniformly against the proposed restrictions. That may be a serious miscalculation. Many businesses do not always want to compete, to have to worry about someone else outproducing or underpricing them. Restrictions on plant closings are as much restrictions on entry into competitive markets as they are on exits: they keep competition out of local markets by denying businesses the ability to move from elsewhere, and they discourage the emergence of new businesses—new investment and new competitors. Thus, such laws can protect established wealth by protecting established businesses, with market-proven products, from potential competitors, with goods untried in the marketplace.

The high incidence of child beating among laid-off workers is often cited as a reason for government restricting plant closings. Yet the people who are unable to find jobs or remain unemployed because new plants do not open or old plants do not expand can also take out their frustration on their children. Any children abused by their parents because of plant closing restrictions should be of no less concern than any children abused because of plant closings.

There are private alternatives for dealing effectively with the prospects of plant closings. One obvious remedy every community has is active promotion of its community to prospective industry. This is the approach taken by Pittsburgh in 1981 with full-page ads in the Wall Street Journal, portraying the city as "Dynamic Pittsburgh." (Every time a city complains bitterly of its economic distress, it can be assured that some company somewhere decides to locate elsewhere.) Another, perhaps less obvious solution, is for the community to remain competitive in terms of taxes.

Between 1965 and 1980, manufacturing employment in Massachusetts fell at a compound rate of about 0.5 percent a year. This average, however, hides a reversal in the economic hopes of the state. Since 1975, manufacturing employment there has risen at a compound rate of 3.3 percent. In October 1982, with the national unemployment rate over 10 percent, Massachusetts unemployment stood at 6.5 percent—the lowest among the top 10 industrial states.

A significant part of the state's employment growth is in high-technology industries, and a part of the upturn can be explained by the political efforts of the Massachusetts High Technology Council, a group of 115 or so businesses interested in boosting the supply of technicians and engineers in their area. In the late '70s, high-technology industries in Massachusetts faced a shortage of critical personnel. The business owners who formed the High Tech Council reasoned high taxes in the state were responsible. So the council turned its efforts toward reducing taxes. In 1980 it helped pass "Proposition 2½," a state constitutional restriction on property taxes similar to Proposition 13 in California. Now the council is trying to get total state and local taxation in Massachusetts constitutionally limited to the average in 17 other industrial states.

Ray Stata, one of the state's high-tech entrepreneurs and a founder of the council, stresses that its main contribution to the political dialogue was getting "acceptance of the concept that Massachusetts has to be competitive among states"—that in the maintenance of a healthy economic base, a state must keep its taxes in line and keep a watchful eye on how educational dollars are spent. And by stepping up corporate donations to regional university programs in engineering and the sciences, council members have put their money where their convictions are.

Another private means of dealing with the prospects of plant closings is for workers to remain competitive in their wages. Profit-seeking firms are spurned by advocates of restrictions, but they will not allow truly profitable plants to go down the "economic drain." Automobile workers have come around to negotiating long-term job security by way of concessions on future wages and benefits, enabling American car manufacturers to become more price competitive. In fact, the United Auto Workers' Douglas Fraser takes credit for getting the Chrysler Corp. to adopt a plant closing notification policy. The idea is to let the union know in advance so it can work out any wage and benefit concessions that might prevent the closing.

Through savings, workers can build up their own severance pay reserve. To accumulate an amount equal to the required company payments typically proposed in legislation, a worker would have to save less than two percent of his earnings and would gain the interest in the process. Legally mandated severance pay would ultimately reduce workers' paychecks by an amount equivalent to personal savings, of course. The difference is that the former is forced, regardless of the individual worker's circumstances and preferences, on all workers of a state or the country.

Plants do close down. Some firms give their workers several months' notice, as was the case in the closing of Youngstown's Lykes Sheet and Tube Company in 1977. Others, however, give little notice. Sometimes, firms lead their workers to believe operations will continue on into the indefinite future, only to announce their closing a week or two later. And some firms, especially those that intend to go out of business altogether, have an economic incentive to hide their intentions to terminate operations. Any announcement can cripple a firm's ability to continue production and can increase losses and the erosion of capital.

In all of these cases, real people often suffer. Is it the best course, however, to deal with such problems by passing laws?

It may seem that the solution to the controversy is simply to find a compromise, a shorter prenotification requirement (somewhere between no requirement and one or two years) and a smaller mandated severance pay, possibly one or two weeks' worth. The dilemma is, however, much more complex. There will be a cost attached to any uniform requirement, and those costs will, again, be borne by real people. Workers will probably bear the lion's share of the burden, and the difficulty in mandating severance pay lies in the fact that not all workers will want to make the same trade-off between severance pay and wages or other fringe benefits forgone. Yet there must be a trade-off!

Perhaps the solution to the problem of plant closings can be found in first principles of a market system. In a market system, contracts can provide for virtually anything, so long as the parties agree and are held responsible. Contracts between employers and employees concerning notification and severance pay would allow for many individual variations.

For a market system to work sensibly, contracts must be enforced. Fraud must be minimized. And laws against fraud should be just as applicable to employee-employer relationships as they are to consumer-seller relationships. To ensure efficiency as well as equity in the private sector, employers and employees must be held accountable for the bargains they strike. If employees give up a portion of their wages in exchange for a guarantee of severance pay, in the event their plant closes, then their right to severance pay must be upheld. If an employer agrees to provide advance notice of a closing in return for employees' promise to stay on until the plant actually closes, then the employer's right must be upheld.

To be held legally liable for their own actions in a market setting, people must be viewed as tolerably competent to strike their own bargains. Employees may not be as knowledgeable about the circumstances of their employment as we would like. But we must ask then whether legislatures are any better equipped to write into law regulations that can deal effectively with the varied circumstances of individual workers and communities.

In the final analysis, plant closing laws are not restrictions on capital. They are restrictions on what a free people can do. They deny the entrepreneur's right to dispose as he judges best of assets that have been freely and justly developed or purchased. Usurping entrepreneurial rights through legislation must be as morally suspect as usurping a worker's right to quit, to seek new skills, and to become employed elsewhere. Such workers' rights are also entrepreneurial rights—and human rights as well.

Richard McKenzie is the author of Bound to Be Free (1982) and Free to Close: The Economics and Politics of Plant Closings, to be published this spring by the Pacific Institute for Public Policy Research. He is an adjunct scholar at the Heritage Foundation and a professor of economics at Clemson University. This article is adapted from a monograph published by the International Institute for Economic Research.