Saturday, December 13, 2008

The Auto Bailout is a Bad Idea.

The last bailout may have been questionable, this one is just plain wrong. Earlier this week the government's bailout of the automotive industry stalled in the Senate. As best I can figure, this is very good, but the story isn't over yet. The Bush administration is considering sending funds from the financial bailout to American car makers. Not only is this a clear misuse of the money's original purpose (a purpose still questionable), but it is also a bad policy decision.

To put is simply, these companies are not currently profitable in the United States. Compare General Motor's 2007 profits (-$38,730,000,000) to Toyota's (+$17,146,000,000). GM, along with Chrysler and Ford, are asking for taxpayer help because they have made bad business decisions. The biggest of these is promising too much in their 2,215 page (22 pounds) United Autoworkers Union contract. American car companies have almost double the labor costs compared to foreign companies who have plants in the US (graph). These labor differences are not bringing the poor into the middle class. The average auto employee makes $20,000 more than the average American. This problem becomes apparent when you see that GM's overseas (non-union) operations are still profitable. The solution is to allow these three companies to use the bankruptcy system, which was created for just this problem. They will then be free from impossible to keep union promises.

The response from the auto industry is that no one wants to buy cars from a bankrupt company. While I admit it does damage their reputation (which is being hurt right now anyways), it is certainly not death for these companies. In fact there have been several companies that filed for bankruptcy and have returned to profitability (Delta, Heinz, Quaker Oats, Pepsi just to name a few). There is even one guy promising to buy a bankruptcy car.

The auto executives have said "government getting a stake in the auto companies would allow taxpayers to share in future gains if they recover". The problem with this, as economist Don Boudreaux points out, is that the people already have a chance to share in any future gains; it's called the stock market. However millions of Americans and billions of people all over the world have chosen not to. Is it then okay for Congress to force us?

The failure of these businesses will not result in the disappearance of their resources. All the capital (cars waiting to sold, buildings, machines) can all be sold for more productive purposes. Just as important, the skills and talent of auto workers can also be sold to highest bidder in the labor market. Think of it as a bag of marbles. If a bag is breaking and not handling the marbles well, we should allow it to be thrown away. The marbles inside can be still be moved elsewhere. We lose the current organizational tool, but the resources can still be used. It is most likely that these businesses will simply exchange their old bag for a new one (bankruptcy). To bailout the industry is to stitch patches to a crumbling bag.

Also important to note is that these companies are not "too big to fail." First off, Americans buy more foreign cars than American cars (graph). Secondly, the size of these industries only increases the importance that they restructure. Once again, Don says it best: "the bigger the unprofitable firm, the more vital it is that it be allowed to fail." And with gas at it's lowest level in history (measured as a percentage of income), the restructuring into "green" business could actually hurt the industry.

With all the reasons not to support this bailout, why did it get through the House of Representatives. With 61% of the public opposing the bill, it seems the American people know something politicians don't, that this plan will not help. Or perhaps the almost $50 million the auto industry has given to congressmen this year is affecting their votes. I wonder exactly how much a politician costs these days?

I'll leave you with this final question: what if the government had bailed out the struggling piano industry in the 1960's? Answer: Americans in 2008 would have more expensive less quality pianos.


  1. Well said. I agree.

    I would note though that buying a car is a lot different than buying a Pepsi (or a bottle of ketchup, or oatmeal, or a plane ticket). Knowing the dealership is going to be around to perform services while your car is under warranty (and after it) is a BIG part of buying a car. No one needs a warranty for their Pepsi.

    I would buy a soda from a bankrupt company - but never a car. Would you?

  2. Its hard for me to say because I've never bought a new car before. I've never owned car with a warranty so their bankruptcy would have no effect on me. But I agree bankruptcy will definitely decrease demand for that company's car, but it certainly won't decrease it to zero. As I linked above, Tim Kane has promised to buy a car from the first company to go bankrupt, and he's trying to get people to join the pledge:

    "Here is my pledge: I will buy a new vehicle from the first American auto company to enter bankruptcy. I will buy it within six months of the date of entry, on the condition that it has to be a real bankruptcy, and the company must follow through with real restructuring. This is not an easy pledge to make, and my wife may kill me. But nothing could be more valuable for my country's economy than for one of these companies to re-organize."

  3. Great article, might be your best yet. Also, I never knew about the piano industry, but I sure am glad pianos are cheaper now.

  4. Nick Kroes10:49 PM

    Wow, great read. I wish more people were educated in this type of logic.

    It's a dangerous day in America when the government says a company can be too big to fail, no matter how poorly it's run

  5. Thanks Paul, thanks Nick.

  6. Anthony10:49 PM

    I think we both know why the Bill went through the House - politicians have different incentives than the long term well being of people. A politician's number one priority is to get re-elected which isn't always best achieved by voting with public's best interest. Activity looks better than inactivity even when inactivity is typically the better choice. Case in point - this bailout.


You are the reason why I do not write privately. I would love to hear your thoughts, whether you agree or not.