Lessons from the Wal-Mart wars: why CEOs should take a hard line against programs that compensate businesses and workers who can't compete.

Most CEOs know that today's labor disputes are just a pale reflection of the huge nationwide strikes and lockouts of 100 years ago. The decline in union membership over the past 50 years shows that modern workers no longer buy into the union movement. Several reasons help account for this change: Steep dues are often spent for political causes that the rank and file opposes; upwardly mobile workers know that union membership places them under a glass ceiling; and educated and diverse workers know that no cookie-cutter standard contract fits their individual needs. In the private sector, unions are the outsiders looking in, as unionized firms flounder against their more efficient and nimble nonunion rivals.

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Notwithstanding their sluggish performance, unions remain powerful because of their political clout against nonunion firms. Exhibit A of union influence is the well-greased campaign to keep the big-box retailers like Wal-Mart, K-Mart and Target out of urban markets. Big retailers don't face much resistance from customers, suppliers and employees. But their lean cost structure and low profit margins make them fair game to unionized competitors who hope to cripple them through political action and who now have abundant political support in high circles. As Republican politicians remain squeamishly silent about these new initiatives, prominent Democratic presidential hopefuls such as Joseph Biden and Hilary Clinton happily paint Wal-Mart as the sworn enemy of the embattled middle class.

Nor do these new-age Luddites lack ammunition. The remorseless expansion of the regulatory state lets incumbent firms, backed by their unions, block new entrants under the banner of worker and community protection. They freely conjure up images of the evils of globalization and the return of sweatshop labor to prop up their cozy status quo.

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Three-Pronged Attack

The current offensive has at least three prongs: employment law, land use and banking. All these initiatives are put in the service of a single overarching objective--keeping Wal-Mart and similar big-box firms from entering urban retail markets dominated by old-line supermarkets.

So how does the counterattack work? Most notably, by selective regulation. Big-box opponents know they can't succeed under any neutral set of regulations. Wal-Mart and Target are probably more adept at satisfying any general environmental or safety target requirements than their entrenched competitors. So the key move for the opposition is to concoct regulation that hits the big boxes while leaving themselves untouched.

The first tactic of big-box opponents is to push for new laws that force large retailers to increase wages and benefits. For example, Maryland passed a law that would have required all companies with more than 10,000 employees to spend no less than 8 percent of their payroll on health care benefits. The state could have crossed out the number and inserted Wal-Mart by name, because the legislation covers no other firm. (The three other organizations that employ more than 10,000 people in Maryland--Giant Food, Northrop Grumman and Johns Hopkins University--already surpass the 8 percent requirement.) Fortunately, a federal judge recently knocked out the law on the ground that it sought to move into territory that was already covered under the federal ERISA law.

Yet that victory is likely to prove only the first battle in a long war, as other states and cities may pass laws whose stated ground is to protect workers from exploitation and abuse, but whose true intent was to make Wal-Mart and other big-box companies close up shop. Consider these numbers: Wal-Mart earns a profit of only about $6,000 per employee, so raising benefits or wages $3 per hour for the huge cohort of entry-level workers could wipe out the entire per-employee gain. Meanwhile, smaller competitors are allowed to supply their workers with whatever mix of wages and benefits produces the largest joint gains. No level playing field here.

Supporters of these initiatives rely on the oft-exploded fiction that mandated wage hikes have no impact on employment levels. We now have tangible evidence of their errors. Chicago Mayor Richard M. Daley recently vetoed a special minimum wage bill passed by a 35-14 vote in the City Council, which mandates $10 per hour minimum wages and $3 in health care benefits. The catch? It only applies to retailers with 90,000 square feet in floor space, or $1 billion in sales.

The aldermen defending the bill claim that Chicago markets are so lucrative that the big-box stores will come no matter how frosty the reception in the apparent belief that the higher the cost the greater the demand. Tell that to both Target and Wal-Mart, which have threatened to cancel development plans within the city. Tellingly, aldermen from impoverished wards opposed the bill. CEOs should oppose all legislation that "protects" the poor by limiting their options for advancement.

If mandated employee-benefit packages won't do it, then opponents of big-box stores can use zoning boards to keep out the unwelcome new entrant. For years, the Supreme Court, along with most state courts, has given local governments free rein to conduct endless zoning hearings after which a particular project can be disallowed literally on a whim, without paying the applicant a single dime. So if you can't win in the marketplace, march to City Hall. Specific zoning roadblocks have kept Wal-Mart and Target from getting into the inner-city neighborhoods that would benefit from the new jobs and low prices.

Here's the key lesson. Do not support national or state regulation of real estate markets because these regulations will send businesses packing, taking their customers in tow. For example, after Wal-Mart was spurned in Chicago, it set up shop in nearby suburban Evergreen Park, got 25,000 applications for 325 jobs, and paid $1 million in local property taxes. And its low prices draw lots of Chicago shoppers. Repeated studies have shown that Wal-Mart cuts retail prices by somewhere between 7 and 13 percent whenever it enters a new market.

The New England Consulting Group puts the consumers' savings at about $100 billion per year, or more than one-third of Wal-Mart's gross receipts. The city of Chicago may have kept Wal-Mart out, but it also lost new retail jobs, tax revenues, lower prices and consumer dollars from its own citizens.

With so little protection against zoning abuses, CEOs need to defend the right to exit. Gang up on taxes and permits in Chicago, and take your business to Evergreen Park. Small units are deadly when they threaten to cut communication and transportation networks into useless little pieces. But they are ideal for spawning vigorous intergovernmental competition in the retail trade.

Relocation is great protection from government expropriation. The local governments face competitive pressures and are also less harsh in dealing with local landowners who, after all, have no place to run. Any CEO who supports general restrictions on exit and entry in his "special" industry has traded in his economic birthright for a mess of regulatory porridge. Don't do it, and push hard through business associations so that your competitors, customers and suppliers avoid that deadly temptation.

The battlefront is not only in the local town meeting. With banking regulations, it moves to the state house or the national level. An example of this involves the effort of key banking organizations to keep Wal-Mart from opening its own bank. They claim that if a large company like Wal-Mart opens a bank, it could affect credit availability and lead to the concentration of resources. Here, the only principled position is that Wal-Mart meet the same capital and other requirements as its competitors. Since Wal-Mart can meet these requirements, protectionist bankers are forced to come up with more imaginative rationales for their opposition to a Wal-Mart bank.

My favorite example in this genre is that Wal-Mart shouldn't be allowed to set up banks inside its stores because it would encourage consumer impulse buying. By the same logic, credit cards and ATMs should also be banned. There's no end of mischief when desired convenience is treated as dangerous impulse. Protectionism is a disease that strikes at every level. Bad arguments stay bad, even when they aren't made by unions.

Two Tough-Minded Morals

At one level, the rise of Wal-Mart and Target deals with the major transformations that have buffeted the retailing industry in the last generation. But two wider issues should not escape comment. First, what obligations, if any, are owed to workers and businesses that lose out in the competitive struggle? Second, how should CEOs react when they think that their companies could gain from short-term protection?

The anti-Wal-Mart crowd often seeks to gain traction by pointing to the unhappy fate of those luckless merchants and workers who are turned out on the street because they can't meet the competition. CEOs sometimes consider meeting the opposition halfway by offering cautious support for relocation and retraining expenses for displaced employees.

Don't fall into this trap. All competitive processes generate losers, and this prospect knows no limits. Worse still, any effort to prop up market losers invites precarious competitors to take a dive. Adding a layer of government bureaucracy also slows down the pace of market innovation, especially if the new winners are made to compensate vanquished rivals.

The successful entrant gets zero reward for producing other winners, yet there are lots of those too. A new Wal-Mart routinely revitalizes business districts by assuring a steady flow of shoppers, which benefits other stores in the area. Those gains don't come in a day, but they won't come at all unless the new market players know that Wal-Mart is in the market for the long haul, which it won't be if it is weighed down by an ongoing regulatory guerrilla war.

These considerations explain why CEOs should take a hard line against programs that compensate businesses and workers who can't compete. Established firms, with their established customer base, are subject, if anything, to less risk than their new competitors in urban markets. The new entrant takes a real entrepreneurial risk. If it fails, it has to eat its own stock losses and repair a weakened brand. Knowing that, any new company prepares its launch. For this reason, competition is not dog-eat-dog.

Successful competitors have to pay their suppliers and employees; they have to honor their product warranties; and they can't falsely disparage their rivals. But within these vital constraints they are free to move in ways that generate large social benefits. Why make firms that create large positive spillovers pay when other firms are displaced? It's far more critical to develop a useful process, by bankruptcy or sale, to get the human and tangible resources from failed firms back in use as quickly as possible.

Lastly, it is necessary to sound a cautionary note when businesses, like unions, use the political process to upset the results of competitive markets. As the banking opposition to Wal-Mart should remind CEOs, business versus business skirmishing often replicates the worst features of labor-management disputes. Indeed, business is often its own worst enemy. Time after time, American CEOs extol the virtues of market competition in the abstract only to find reasons why it does not play well in their own backyard.

The legal assault against Wal-Mart isn't just a rerun of the earlier wars of capital against labor. Unfortunately, the truth is much more complex. In the political wars, labor unions work hand in glove with their unionized firms, as both try to keep out the non-unionized firm. Business leaders should fight this impulse. Capitalism works as a system only because new entrants can break into those privileged niches. When they do, they prove once again that short-term competitive dislocations are the strongest indicator of long-term social success.

Individual CEOs are the guardians of their own firms. But they must speak out en masse to support the only system that can ensure the long-term success of their individual companies. Nor should they defend open markets apologetically, as if they were trying to pull a fast one on the public at large. Adam Smith surely missed the odd detail when he pointed to the "invisible hand" that aligns the success of ordinary profit-seeking businesses with overall social welfare.

But he got the big picture right in insisting that the best chance for human happiness, social peace and economic progress lies in the full participation of all individuals in open and voluntary markets. CEOs should not accept anything less.

Richard A. Epstein ([e-mail]) is a professor of law at the University of Chicago and a senior fellow at the Hoover Institution. His next book, Overdose: How Government Regulation Stifles Pharmaceutical Innovation, will appear this fall from Yale University Press.