Auto Bailout: There’s a Better Way

Lynne Kiesling

For the past 30 years the U.S. auto industry has been like your alcoholic Uncle Bob: his self-destructive habits seem beneficial to him, despite the harm they cause him and the pain they inflict on his family and friends. You want to help him, but don’t know the best way to do so, and you know that if you confront him he will deny it and become angry and violent. You know deep down that Uncle Bob is a drunk bully, but the thought of a confrontation is so painful that you stay quiet and follow a strategy of conflict avoidance. Plus you know that the only way his health will improve is if he is the one who realizes that his habits are self-destructive and that he wants to change. At some point, the issue comes to a head, and the question becomes whether or not you have the courage to tell him what he needs to hear, for his own good and for the good of those who love him.

The issue coming to a head right now is that the U.S. auto industry has been unhealthy for decades. Chrysler’s 1979 bailout did not change that. The Big Three cannot compete with Asian and European manufacturers, particularly in the production of high-quality, reasonably-priced, fuel-efficient cars, because their labor costs eat all of the possible margins (GM and Ford manufacture such cars for sale in Europe, so it’s not a design problem). We have known this for three decades, and have followed a strategy of conflict avoidance.

In Saturday’s Wall Street Journal, David Yermack wrote a brilliant article: Just Say No to Detroit. His argument is peppered with extremely disturbing facts:

  • GM and Ford are two companies that made the most money-losing investments in the 1980s; between them they “destroyed $110 billion in capital” in the decade, according to an analysis from the careful and renowned economist Michael Jensen.
  • Over the most recent decade, “the capital destruction by GM has been breathtaking,” $182 billion, and Yermack estimates that the aggregate capital investment in GM and Ford since 1980 has let to a net reduction in capital of $465 billion.
  • This is what I find particularly disturbing: with that $465 billion, “GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan, and Volkswagen.”
  • “When a company makes money-losing investments, the cost falls upon all of society.” This observation means that we have already reduced our future economic well-being by $465 billion by his calculations, due to the persistence of these firms and their poor business decisions.

Yermack makes other important observations, including one that is crucial for policymakers to remember: if any or all of the Big Three were to declare bankruptcy, that decision would not destroy the physical assets and physical capital of the industry, but would instead free it up to be purchased by others and to be redeployed in a more productive way.

But what about the human cost? I share Will Wilkinson’s and Megan McArdle’s combination of sympathy with people in changing circumstances and expectations that can create hardship, but also with the painful reality that none of us — none of us — has any guarantees in this world. That includes job guarantees. And in this case, a bailout would mean job guarantees for now, at a great cost to everyone else, because it would mean the perpetuation of the extremely flawed business practices of the U.S. auto industry as a whole.

As much as it pains me to cite politicians favorably, I think that Senators Shelby and Kyl put it well in this Wall Street Journal article from today:

Sens. Richard Shelby of Alabama and Jon Kyl of Arizona said it would be a mistake to use any of the Wall Street rescue money to prop up the automakers. They said an auto bailout would only postpone the industry’s demise.

“Companies fail every day and others take their place. I think this is a road we should not go down,” said Sen. Shelby, the senior Republican on the Senate Banking, Housing and Urban Affairs Committee.

“They’re not building the right products,” he said. “They’ve got good workers but I don’t believe they’ve got good management. They don’t innovate. They’re a dinosaur in a sense.”

Added Sen. Kyl, the Senate’s second-ranking Republican: “Just giving them $25 billion doesn’t change anything. It just puts off for six months or so the day of reckoning.”

What’s the alternative? Let the firms fail. Use bailout money to provide unemployment assistance, education grants, and relocation grants to individuals who lose their jobs. In the long term, not only is that approach more compassionate, honest, and courageous, it’s also cheaper than perpetuating the uncompetitive business models in this domestic industry that has shown a colossally abysmal inability to adapt to changing market conditions. As Will said in the post linked above, “There is no justice, and great harm, in diminishing the whole array of future opportunity to save a few people now from a regrettable fate.” I hope we have the courage to take the bottle from Uncle Bob and tell him that we are doing it for his, and our, long-run health.


13 thoughts on “Auto Bailout: There’s a Better Way

  1. In the case of the auto-makers’ bailout, i’m relieved that in this case it’s simple: American cars tend to suck therefore people are not buying them. If GM and Ford don’t want to go out of business, they should start making decent cars.

  2. It looks like the folks in DC are hell-bent to give the stimulus package another try seeing as the first one didn’t have any real effect.

    This time it’s the car industry.

    While the sanity of blowing cash around and running the national debt up even further is questionable; it seems inevitable – so this time let’s target unemployment, create AMERICAN jobs and pump up the economy all at one time.

    Consider the following:

    Manufacturing costs of motor vehicles are 65% labor (i.e.: W-2 income), that’s not all direct but due to suppliers. GM alone has over 1300 suppliers. (That’s a lot of jobs!)

    1 in 10 Americans makes all or part of their income due to the automobile industry.

    Money turns over 5 times in a year.
    Thus a vehicle with a manufacturing cost of 20K produces 13,500 in W-2 income which in turn becomes a total of 65K in 12 months due to the 5 turnovers.
    (This isn’t magic, it’s simply how the economy works.)

    Our domestic car makers are saddled with legacy costs, most of which will reduce dramatically in 2010 due to contract changes. They need to survive to get there.

    Our own over-zealous government with a virtual alphabet soup of regulatory agencies has been no help either.
    Foreign competitors have worked off-shore collectively to meet various US gov’t. imposed emission and safety standards, thus dramatically reducing those R&D costs. American car companies are prohibited from that by our FTC.

    Make no mistake; it’s no surprise that once again government has been a major part of the problem.

    Here’s the solution.

    Instead of either shipping cases of cash off to car makers; or sending us all another check:

    Send out a voucher for say $1,000 good on a motor vehicle for the percentage of the vehicle that’s domestic. (Civic = 70% Ford Explorer=80%)

    Let those not interested in a new car sell or give away their vouchers (Ebay would be loaded with them in no time flat) and those that are so inclined can use as many as they can get their hands on up to the full MSRP of the vehicle.

    This would bail out the car industry without giving them a dime directly
    Further it would reduce the overall age of the nation’s cars which would in turn;
    increase overall fuel economy
    & decrease pollution.

    Strengthen the dollar!

    Since vehicles with a higher domestic content would be moving better this would reduce our imports, strengthening our dollar which would in turn further reduce what we pay for anything imported …like gas!

    Jobs

    Instead of simply bailing out a few big companies, this would cause such a run that it would create employment throughout the industry affecting over 1300 suppliers and their workers.
    That would give the economy good swift kick right where it needs one!

    Pays for itself!

    Since money turns over 5 times, and the vouchers are only good for the domestic content of the vehicle, every dime would be spent in the United States creating taxable income.
    What is the income tax on 65,000 anyway?
    (Remember? 20K manufacturing cost = $13,500 W-2 income x 5 = $65,000)

    Another Stimulus Package?

    I’m sure you’ll agree that this makes more sense than simply sending out checks; many of which will be used to buy new flat screen TV’s usually made in Malaysia or some such place.

  3. Giving $1,000 vouchers to every taxpayer would (1) result in a $160-ish billion dollar “bailout” [assuming 160m taxpayers] (now only contemplating $25B total bailout). (2) We don’t have that money so will have to borrow from China then print money to repay the debt service. Every time a new dollar is printed, the dollar in your pocket is worth less and less and then we’llcontinue this spiral. However, the concept is good, but probably looking more like a $200 voucher which may not be enough to move people.

  4. Giving $1,000 vouchers to every taxpayer would (1) result in a $160-ish billion dollar “bailout” [assuming 160m taxpayers] (now only contemplating $25B total bailout). (2) We don’t have that money so will have to borrow from China then print money to repay the debt service. Every time a new dollar is printed, the dollar in your pocket is worth less and less and then we’llcontinue this spiral. However, the concept is good, but probably looking more like a $200 voucher which may not be enough to move people.

  5. Giving $1,000 vouchers to every taxpayer would (1) result in a $160-ish billion dollar “bailout” [assuming 160m taxpayers] (now only contemplating $25B total bailout). (2) We don’t have that money so will have to borrow from China then print money to repay the debt service. Every time a new dollar is printed, the dollar in your pocket is worth less and less and then we’llcontinue this spiral. However, the concept is good, but probably looking more like a $200 voucher which may not be enough to move people.

  6. On the one hand, as a Libertarian, I believe in limited government, especially at the federal level, and the more limited the better. We Libertarians, believing as we do in the free market, have been the targets of both major political parties: by one party for believing as we do in the separation of church and state and in the futility and outrageous cost of war; and by the other party for our naiveté that people can, for the most part, be trusted to act in their own self-interest and to regulate their own commerce. Bailouts and the diversion of large sums of taxpayer money to finance random infrastructure improvements seems sure to delay our economic recovery, possibly for years to come.

    On the other hand, as an engineer, I understand that to build anything large and complex, a system engineer is needed. Suppose for example that we did need and did want to build a new transportation system for the country, we would need government – acting as a disinterested party – to manage requirements and set standards. I’m not saying that building a new transportation is the right thing to do; I am saying that if that is decided, there is a legitimate role for government.

    My idea for a new transportation system (look for the TRICEN Solution at http://futuregroundtransport.blogspot.com/) transcends the concept of bailouts – it is more along the lines of government investment in railroads (Manifest Destiny) and Interstate Highways, dramatically updated for the next century. The automobile manufacturers in Detroit have lost the battle for the American market of today. A better plan would be to establish a new market.

  7. I’m from the UK and it seems to me that ultimately, the ‘legacy costs’ of the big three US automakers were always going to cause their demise.

    These costs, especially healthcare for current and retired workers, were always going to put GM, Ford and Chrysler at a big cost disadvantage compared to their competitors. Consequently, they have needed to continually outperform their competitors in other respects to make up for this disadvantage. They have ‘got away with it’ for a number of years perhaps largely because they read US market trends more quickly and had strong sales networks and sophisticated finance deals. However, at some point (i.e. now) difficult market conditions and mistakes in reading market trends (which all companies make) were always going to expose their fundamental lack of cost competitiveness.

    In other words, it’s not so much down to bad management, lack of innovation or whatever (most companies go through such cycles and recover) but down to the legacy costs.

    So what can be done about these legacy costs? The medical profession and insurance system in the US is excessively expensive – and this acts like a tax on US companies. Of course, the medical system has legal protection, the AMA operates a closed shop, and it doesn’t have to worry about international competition (unlike the automakers). While US auto companies have to bear the costs of parts of the US economy sheltered from competitive forces they will always be at a disadvantage. So the solution is indirect – introduce more price competition in the rest of the US economy, so that the auto industry doesn’t have to shoulder excessive costs levied by protected groups.

    Incidentally, in the UK, we have a similarly protected and expensive medical system – it’s just that it is government run, so we (and companies) pay higher taxes instead of direct medical insurance costs. However, the overall cost is far more limited than in the US because the cost is controlled (shockingly) through rationing (notwithstanding the huge increases in spending on the NHS – where productivity is actually falling – in recent years). Our internationally-exposed companies have also suffered in recent years through having to operate in a high cost/tax environment.

  8. Its truly sad how misinformed the public is about American automobile manufacturers. Yes they have issue, including union issues, (by the way the Wagner act is a US Federal Law.) They have also been involved in the public good for 100 years, like having real federally mandated affirmative action programs (of which their foreign competitors don’t have to meet) and supporting retirees and spouses 500,000+ some now in their 90s and higher. -These policies included substantial influx of capital investment to society for the public good including massive injections of capital in the health care system, about 25% of which is for people outside of their responsibility as a result of hospital billing models that add indigent health care to everyone’s bill. — (because of lack of government support) — All again for the public good and by the way much more than the 25 billion loan request.

    The fact, and we need to emphasize fact because most of what so many like Senator Richard Shelby say today (and for a while now) is just conjecture and concluded based on personal dislike and not real 2008 competitive analysis. The Fact is that American cars compete in every segment of the market with truly excellent vehicles. — They have to. If one really does their homework instead of what is nothing more than attacking without cause they would conclude this. Anything more is just generalization and is no less than concluding an individual is of no worth because of their race or gender. I am truly ashamed of the American public (including politcal incumbements like Shelby) for this.

    Does anyone remember the Toyota Tundra and Sequoia? Well,they should because there was huge fanfare from Toyota’s PR and marketing departments just last year when they were unveiled as “All New”. They are not fuel efficient vehicles nor are the other full line of SUVs that Toyota builds. – That’s not being green or fuel efficient.
    Funny? But it seems all, including the media turn a blind to this FACT. I often wonder why?

    As far a Senator Shelby’s position; Could he maybe be in a position where his state could benefit from a big three collapse? I challenge anyone to study this and then wonder if out of possible conflict of interest rules he should remove himself from these discussions based on the past massive handouts his state has granted to foreign automotive competitors to manufacture there.

    Well thank god up to now that we still have vehicles built in USA that offer living wages. Seems like everyone else in manufacturing form textiles to televisions decide to pull-up stakes and move to China.

  9. >>… result in a $160-ish billion dollar “bailout”

    106 million “original” stimulus checks went out; largely to couples.

    Thus at full face value it wouldn’t exceed 50 billion; seeing as there is no 100% domestic vehicle, none could be redeemed for full face value anyway.

    Further – how else do we get the entire economy moving again fast?

  10. >>… result in a $160-ish billion dollar “bailout”

    106 million “original” stimulus checks went out; largely to couples.

    Thus at full face value it wouldn’t exceed 50 billion; seeing as there is no 100% domestic vehicle, none could be redeemed for full face value anyway.

    Further – how else do we get the entire economy moving again fast?

  11. U.S. auto bailout: still a ridiculously bad idea

    Lynne Kiesling There are still so many dimensions on which to oppose a taxpayer-funded bailout of the U.S. auto industry, the mind boggles … let’s start here: this Wall Street Journal article summarizes the current proposal from the “Big Three”…

  12. U.S. auto bailout: still a ridiculously bad idea

    Lynne Kiesling There are still so many dimensions on which to oppose a taxpayer-funded bailout of the U.S. auto industry, the mind boggles … let’s start here: this Wall Street Journal article summarizes the current proposal from the “Big Three”…

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