Friday, November 14, 2008

Is It "Unfair" To Let Detroit Collapse

Leave it to a conservative. In comments, CWD raises the question of whether it's fair to allow domestic auto makers to fail given the gargantuan financial industry bailout. Oh, I kid CWD. He actually argues, quite correctly, "I've pretty much always been opposed to the idea that we have to do something stupid and wasteful again just because it wouldn't be 'fair' not to do so".

Certain ideologues who favored the financial industry bail-out, while opposing an auto industry bailout, are engaged in some interesting contortions to avoid admitting their hypocrisy. Charles Krauthammer tells us that one's okay but not the other, because the financial industry is a "utility" - directly analogous to the electrical company. Except the government is not regulating the financial industry in the manner that it regulates utilities - is that something Krauthammer wants? Nor was it ever likely that the entire economy would shut down absent a bailout of the financial industry. It's not clear what would have happened, and fear has played a big role in the size of the bailout and the inadequacy of oversight. And I don't recall the federal government rushing in to save California from brownouts and rolling blackouts back in the glory days of Enron, or rushing in to update the electrical grid after the 2003 blackout.

David Brooks is more poetic in his explanation of the difference,
This is a different sort of endeavor than the $750 billion bailout of Wall Street. That money was used to save the financial system itself. It was used to save the capital markets on which the process of creative destruction depends.
Well, no. In the same sense that Brooks contends that keeping the big three from collapsing would retard "creative destruction", so does the choice to prop up large financial institutions instead of letting them fail, or letting them be carved up and sold off in smaller pieces. There's no sense in arguing the glory of "creative destruction" if you're going to simultaneously exempt from its forces the institutions that supposedly drive it. Also, isn't "creative destruction" about more than destruction - what does Brooks propose will be created in the place of the destroyed automobile industry? (One wonders, also, why Brooks isn't spending any time describing how his employer might avoid "creative destruction", beyond suggesting that it should get a bailout if Detroit is rescued.)

In an interesting series of posts at the Atlantic, Megan McArdle takes on the question of fairness, asking in some earnestness if an auto industry bailout means that the government should also bail out companies like Kodak. But that's a slippery slope argument, already implicated by the financial industry bailout. If we can draw a line before bailing out the auto industry, we can draw a line afterward. McArdle correctly argues that the bailout is unlikely to change "business as usual" at a domestic auto company or the UAW. True, but that's not a distinction from the bailout of the financial industry, which is now preparing to shower its workers with generous bonuses and pay dividends to shareholders courtesy of the U.S. taxpayer.

There are also fundamental differences between allowing a company like Kodak to fail because it didn't sufficiently anticipate and respond to the rise of digital technologies and its effect on the sales of photo chemicals, and allowing the auto industry to fail. Sorry, Kodak, but you represent a much smaller, less vital part of our economy. And unlike a context where a dinosaur is allowed to dwindle or die because it didn't respond to the market calling for a different product, this is a failure in competition between companies offering similar products. Suggestions to the contrary aside, assuming for example that GM fails, a post-collapse consumer is going to buy a roughly equivalent car from one of the remaining auto makers.

Hype green technologies all you want, but the consumer's choice is more likely to be driven by gas prices than by the availability of hybrid or flex fuel technologies, and the Japanese auto companies sell trucks and SUV's with gas engines in order to meet that demand. If the big three fail, cars will continue to be made, but the profits from those sales will flow to foreign companies and the instinct of those companies, faced with economies like the one we're in, will likely be to shutter U.S. plants ahead of those situated in the countries where they are based. High tech jobs in the auto fields will filter out of the U.S., so we need to ask ourselves whether those are the jobs we want to lose? (And that's before considering the jobs and businesses that would collapse across the country in the event of an auto industry collapse. No matter how much you hate unions, it's insane to be hoping for the death of the Big Three.)

I'm less concerned about an unlikely future where this leads to our bailing out Kodak, than I am of GM coming back in thee years, or maybe three months, begging for more cash - can we offer this bail-out without doing exactly what Henry Paulson and GW are doing with the metastatic financial industry bailout?

McArdle is correct in suggesting that any bailout should return a net gain to society, and that it is not clear that the current proposal would do so. Would bankruptcy? The fallout from bankruptcy for GM itself may be worse, but what if you instead used that bailout money to soften those consequences, or held it in reserve to potentially help a stripped-down, post-bankruptcy GM? I'm not big on the Thomas Friedman model of trying to force the Big Three to reinvent their vehicle line-up in his preferred image. The priority needs to be on creating viable companies, not on forcing them to incorporate technologies into their fleets that will either require massive government subsidies or price their vehicles far above competing models.

The WSJ proposal that if we're bailing out the auto industry to the tune of $25 billion or more, existing shareholders should be wiped out, seems to be on the mark. If we prefer a bail-out to bankruptcy, make it "bankruptcy lite" - a more efficient, industry focused version of bankruptcy, but with pretty much the same goals in mind. Not long-term stewardship, micromanagement, or redesigning vehicle fleets by committee. If you want to impose green reforms, do them legislatively and impose them on all new vehicles, so that the "new GM" can compete on equal ground. Perhaps more importantly, it isn't clear that an auto manufacture could survive bankruptcy - that they could maintain the cash flow necessary to stay in operation if they're unable to obtain and maintain enormous lines of credit. A specially legislated "bankruptcy lite" might bring about the benefits of bankruptcy without killing the company or impairing its ability to sell cars.

Something that seems to get lost in the noise, particularly the anti-union, "those workers get paid too much" noise, is that it's not only the labor cost differential that makes it hard for the Big Three to profitably sell smaller, cheaper cars. Take a look at vehicle sales in recent years. If domestic auto makers could avoid the discounting they have to offer to make their "comparable" cars competitive with cars from companies like Toyota or Honda, this would be much less of an issue. Instead, the labor cost differential is magnified by the need to offer discounts and incentives to people who are prepared to pay close to MSRP for a "comparable" quality vehicle.

Some painful truths. It isn't clear at this point that a financial industry-style bailout (no strings attached, here are billions to spend on whatever you think is best) would do more for the auto industry than forestall their collapse by a period of months or maybe years. It does not appear that, left to their own devices, the domestic auto manufacturers will get it together to manufacture vehicles that compete in terms of quality, design, or economy (in what I personally regard as an inevitable return to high gas prices) before they again hit a financial wall. But it isn't clear that any bailout, bankruptcy, or "bankruptcy lite" will turn them into viable companies - the context is created for that possibility, but these are sick giants with a corporate culture that has largely fought, tooth and nail, against the type of evolution that is required. Their progress over the past few years gives some hope, but it's only a modest beginning.

But doing nothing, if it leads to the collapse of one or more of these companies, will almost certainly deepen and prolong our recession while effectively ceding a big money, high tech manufacturing industry to foreign companies. So all said, at this point I would argue for "bankruptcy lite", for any of the Big Three that feels it cannot otherwise survive, and otherwise let market forces prevail.

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