As if to prove their cars capable of travelling more than five-hundred consecutive miles, CEOs Alan Mulally of Ford, Rick Wagoner of General Motors, and Robert Nardelli of Chrysler each plan to make their ten hour journey from Detroit to Washington D.C. tonight via automobile. Yet if the chief-executives of the Big Three automakers thought public pathos was a sufficient testimony to tempt Congress into endorsing a $34 billion bailout, they are likely to be disappointed.
If nothing else, the economic cost of bailing-out General Motors, Chrysler, and Ford could cause a breakdown of the free market system; if the federal government agrees to subsidize uncompetitive—but large—companies whose closure would damage the national economy, successful competitors will have little reason to continue making profits. If Congress and Treasury Secretary Paulson will save Detroit automakers from insolvency, why wouldn’t Toyota and Honda—both of which now produce the majority of their automobiles within the United States—begin granting large pay increases to corporate executives or selling automobiles below cost, intentionally over-expanding so as to employ more workers or otherwise mismanaging their assets with relative indifference? If the federal government is going to reward incompetence, should Mr. Paulson grant pay increases to the 110th Congress?
Undoubtedly encouraging a system where failure is met with financial incentives would drag the American economy further below its production possibilities curve than if the Big Three are forced to file for bankruptcy. Even taking into account Okun’s Law—that a 1% rise in unemployment leads to a 2% decrease in production—and the human costs of unemployment—namely social stress and a lack of self-confidence—larger unemployment in the short term is economically more palatable than the potential long term unemployment that could result from compromising businesses’ motivation to earn money.
Congress is well-aware that the Treasury won’t avoid immediate costs by refusing to yield to the demands of Ford, General Motors, and Chrysler. Pension outlays, though some can be renegotiated, are federally guaranteed; if one of the automakers fails to find sufficient funding, its workers’ retirement plans become the Treasury’s responsibility
And still the ceiling on unemployment payments resulting from a full-out closure of the Big Three is less than the $25 billion bailout proposed last week and much less than the newly revised $34 billion bailout, which means Mr. Mullaly, Mr. Wagoner, and Mr. Nardelli have some convincing to do. But before that, their unproven hybrids will need to elude malfunction for one long night. That’s a tall order.
-David Lamb
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Big 3 fail means too many unemployed. You wanna keep your job? Then let them save the company.
Becky,
While there would be job losses (admit it, there is going to be job losses no matter what happens with the big three), there has been gross overestimation of how many jobs will actually be lost. The last number I heard was 3 Million people would be out of work (when you add in all the companies that supply parts to the manufacturers). However, many of these subcontractors serve other manufacturers and/or have secondary businesses, so those jobs won’t necessarily go away. Additionally, Toyota in Alabama is currently hiring at their new facility, so “skilled” workers will be recruited. Lastly, and a point that I rarely ever hear mentioned in the media, the big three can be bought by foreign manufacturers. Of course, that would require Congressional approval, but I doubt that it would be a large hurdle to clear. But anyway, with or without a bailout, jobs are going to be lost, since none of these three companies will be profitable before February 2009.
David,
I was hesitant to endorsing the bailout for the financial institutions, but I understood why I needed to be done (though they could have avoided much of this by using that $150B stimulus plan back in the Spring to refinance loans). Here, however, just blows me away. We didn’t bailout the airline industries, forcing them to merge, file bankruptcy, be sold off, etc like any other business in the nation. Why not allow the three automotive companies do the same thing? That is why Chapter 11 was created to begin with. I think this habit of throwing money at companies is just going to make things worse in the long run. Sure, the big three might be able to survive long enough in the short term, but it doesn’t resolve their core problems, and it creates a much larger debt for the nation that isn’t necessary.
David, I think you are vastly over-simplifying the situation, and while not eager to give any more taxpayer money to any large company, I don’t think we can avoid it in this case.
Further, this is not a case of the automakers simply being uncompetitive. It has much more to do with the economy — people either can’t afford to buy a car, or they can’t obtain the credit to buy because of the credit crunch created by the financial institutions, whom we did bail out. You also have to keep in mind that other factors come in to play here. Two of them:
1. Auto leasing is dead, at least for the time being, and so there is no revenue coming in from that.
2. China is dying to get in to the US market. If we do not bail out the auto industry, there is a much greater chance of that happening. I think we owe some allegiance to American companies, personally.
Thanks Common Sense and Nicole for the thorough responses. I’m glad people are so involved in this issue.
“People either can’t afford to buy a car, or they can’t obtain the credit to buy because of the credit crunch created by the financial institutions…”
-nicole
If these economics are the reason domestic auto manufacturers are near bankruptcy, we ought to solve the problem at the root with a successful financial bailout. Moreover, I don’t understand why auto leasing would be dead, as you say. Leasing is primarily used as a means for people to own a car when they can’t afford buying one. Just as the struggling American and global economies have meant falling real estate prices, because fewer people can buy homes, they have meant rising rental prices because more people are renting homes. Shouldn’t that translate to automobile leasing markets?
Even if you blame economic hard times on the Big Three’s current struggle, you have to admit that other auto manufacturers, like Toyota and Honda, are doing better. It follows that they are better run companies from an economic standpoint. Therefore my real objection to a bailout of the Big Three is that you are saving mismanaged companies. The reason evolution works is survival of the fittest, i.e. if someone is successful at something they are rewarded with more food, more more mates, a longer life, etc. If someone isn’t successful or efficient, they die off and are replaced by someone who may do a better job at what they did. If we negate evolution in our economy, a greater proportion of the American economy is going to be run by people who aren’t good at what they do. This would mean resources aren’t allocated optimally, so companies profit less, so you and I make less money. Everyone’s standard of living drops as a result. I don’t think we owe any allegiance to American companies, as you suggest. Rather, I think, if we owe allegiance to ourselves–and by extension our economy–we owe allegiance to the best managed companies or at the very least owe nothing to the worst.
I completely agree with David and CommonSense on this one.
[...] Lamb presents In Defense of Capitalism: The macroeconomic cost of a Detroit Bailout posted at Killer Buffalo. David looks at the cost of the bailout, as well as potential issues that [...]
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