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Don’t Bail Out the Big Three

Friday, November 21, 2008

The U.S. auto industry needs a shakeout, not a bailout. What we are witnessing is an attempted shakedown.

One day before the CEOs of General Motors, Ford, and Chrysler told the Senate Banking Committee that their industry faced imminent collapse without an emergency infusion of $25 billion, a new automobile assembly plant opened for business in Greensburg, Indiana. Although the hearing on Capitol Hill received far more media coverage, the unveiling of Honda’s latest facility in the American heartland speaks volumes about the future of the U.S. car industry—and shows why the proposed bailout of Detroit’s Big Three is so misguided.

The intellectual arguments against an auto industry bailout are well established. Taxpayers should never be forced to subsidize any company, let alone a poorly run company. Subsidizing the Big Three would be tantamount to subsidizing failure. That’s bad policy.

Corporate bailouts are clearly unfair to taxpayers, but they are also unfair to the successful firms in a particular industry, who are implicitly taxed and burdened when their competition is subsidized. In a properly functioning market economy, the better firms—the ones that are more innovative, more efficient, and more popular among consumers—gain market share or increase profits, while the lesser firms contract. This process ensures that limited resources are used most productively.

Some iconic U.S. automakers are now in dire straits, but the car industry itself is not in crisis. Even if one or all of the Big Three failed, there would still be plenty of strong auto companies operating throughout the United States. The Big Three currently account for slightly more than half of all light vehicle production and slightly less than half of all light vehicle sales in the United States. The rest of the U.S. auto industry includes Honda, Toyota, Nissan, Kia, Hyundai, BMW, and the other foreign nameplate producers who manufacture vehicles here. These companies employ American workers, pay U.S. taxes, support local businesses, contribute to local charities, have genuine stakes in their communities, and face the same cyclical contraction in demand as do the Big Three. The difference is that they have been making more products that Americans want to buy and will endure this recession without any taxpayer assistance because they have more efficient cost structures.

Even if one or all of the Big Three failed, there would still be plenty of strong auto companies operating throughout the United States.

The decline of the Big Three is hardly a recent phenomenon. Detroit has been losing market share for decades. It has not produced a top-five selling passenger car in years. Detroit’s once-popular SUVs and large pickup trucks have fallen out of favor with consumers. The Big Three failed to sufficiently diversify into reliable, efficient, and aesthetic passenger cars when they were earning big profits and had the money to do so. Their bloated cost structures have given non-Detroit competitors a $30-per-hour advantage in labor costs.

Want proof that automobile production remains alive and well in the United States? Just look at the success of Honda’s operations in Ohio, Toyota’s in Kentucky, Nissan’s in Tennessee, BMW’s in South Carolina, and Hyundai’s in Alabama, as well as the proliferation of new plants across the country, such as the new Honda facility in Indiana and the new Kia plant in Georgia.

If one or two of the Big Three went under, people would lose their jobs. That’s what happens in an economic recession, when less competitive firms are forced to contract. But the number of job losses wouldn’t be anywhere near as large as Detroit is telling us. Realistically, the failure of one or two major auto producers would improve prospects for the firms and workers who remain in the industry. If GM fails, the market shares of Ford and Chrysler (not to mention those of the foreign nameplate producers) are likely to increase, as they compete for GM’s former customers and best workers.

The bailout sought by Detroit would interfere with the adjustment process, while doing nothing to make the Big Three more competitive. A $25 billion infusion for companies that are losing $6 billion each month is not a rescue plan; it’s an expensive way of kicking the can down the road.

Funneling $25 billion to the Big Three would amount to a waste of taxpayer dollars and also a tax on the successful auto companies, such as Honda and Toyota. Indeed, bailing out Detroit would discourage the successful companies from opening new facilities in the United States.

To dampen criticism, Congressional Democrats speak of a bailout “with strings attached.” But even a strings-attached bailout poses problems.

First, Congress doesn’t know enough about the auto business to dictate operational conditions. “Strings” that cap executive compensation will chase talent away. Strings that force Detroit to produce high-mileage vehicles when gas prices are plummeting will lead to a repetition of past mistakes.

Bailing out Detroit is unnecessary. After all, this is why we have the bankruptcy process.

Second, strings will make it easier for the Big Three to come back for more federal aid after they blow through the first $25 billion. Their CEOs will be able to say that they complied with the conditions of the original bailout, which happened to make matters worse for them.

Bailing out Detroit is unnecessary. After all, this is why we have the bankruptcy process. If companies in Chapter 11 can be salvaged, a bankruptcy judge will help them find the way. In the case of the Big Three, a bankruptcy process would almost certainly require them to dissolve their current union contracts. Revamping their labor structures is the single most important change that GM, Ford, and Chrysler could make—and yet it is the one change that many pro-bailout Democrats wish to ignore.

The Big Three, the United Auto Workers (UAW), the Michigan Congressional delegation, Michigan Governor Jennifer Granholm, House Speaker Nancy Pelosi, and Senate Majority Leader Harry Reid all know that $25 billion is nowhere near enough money to fix the problems ailing Detroit. The politicians must know that bankruptcy is the better course for auto companies and their workers (indeed, it could save 100,000 jobs). But they also know who fills their political coffers, and the UAW leadership is opposed to Chapter 11 because its labor contracts would be deemed toxic and abrogated by a bankruptcy judge.

The U.S. auto industry needs a shakeout, not a bailout. What we are witnessing, unfortunately, is an attempted shakedown. Let’s hope it doesn’t succeed.

Daniel J. Ikenson is associate director of the Cato Institute’s Center for Trade Policy Studies.

 

Image by Darren Wamboldt/Bergman Group.

 

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