Wednesday, November 19, 2008

Magic and pensions 

In 1981, at the age of 21 or 22 (he signed the contract in the off-season and has an August birthday), Magic Johnson signed for a contract with the Los Angeles Lakers that paid him $25 million for 25 years starting in 1984. Nobody at the time he signed it expected him to play 25 seasons. (Indeed, he retired after ten years because of the discovery of HIV infection.) There were a few attempts to come out of retirement and a year of coaching, but in effect he was done. At best, the Lakers got ten years out of that contract -- its final year would have been this season.

How do we evaluate the annual cost of Magic Johnson? Did he earn $1 million a year for 25 years, as he was paid, or did he earn $2.5 million a year ($25 million divided by ten years of playing, including the coaching year and two years in which he tried to come back?) Or $3.54 million a year for the seven years he did play? How do you factor in the time cost of money, etc.?

I bring this up in the context of Felix Salmon's post on the use of $70 or $73 per hour as a number to represent the cost of an hour of labor in producing an American automobile:

It's not true.

The average GM assembly-line worker makes about $28 per hour in wages, and I can assure you that GM is not paying $42 an hour in health insurance and pension plan contributions. Rather, the $70 per hour figure (or $73 an hour, or whatever) is a ridiculous number obtained by adding up GM's total labor, health, and pension costs, and then dividing by the total number of hours worked. In other words, it includes all the healthcare and retirement costs of retired workers.

So where do you count the pension obligations, if not there? If a sports player is injured, or retires, and has a guaranteed contract, that player's salary is considered part of the team's payroll. (There were reasons for relating to the salary cap in the NBA for the Lakers to have structured Magic's contract that way, but it isn't material to this discussion.) We could, I suppose, impute those pension costs back to the wages of those past workers. It makes sense in a way, since those pension costs are sunk -- the marginal cost of GM hiring another hour or labor isn't changed by the size of their past pension obligations.

But is changed by any additional obligations they take on. UAW-represented workers still get defined-benefit plans, so those costs do get added on even though they don't appear in current payroll figures. They are akin to the last ten years or so of Magic's contract. If you are going to subtract out the pensions of retired workers, you have to add back in the expected present value of the pensions to be paid to your current workforce. It might not be $70 or $73, but it's likely to be pretty high.

Labels: ,