A Bailout for Detroit

It was bound to happen. In this “Year of the bailout,” why shouldn’t Detroit get into the act? The financial community has maintained a death-watch over GM and Ford for months as they hemorrhage floods of red ink. Bankruptcy is viewed more as a matter of “when,” not “if.”

On August 5, John Dingell, the powerful Michigan congressman whose district lies in the heart of “Big Three” country, acted. Dingell has proposed a government “loan” of $25 billion to the Big Three, ostensibly to speed up the transition to manufacturing alternative-fuel cars.

Question: If it’s just a lack of capital that is preventing the Big Three from making the transition to a profitable future, then why aren’t private, profit-seeking lenders issuing loans to them? For that matter, since the stock prices of GM and Ford are so depressed that the two companies combined are priced at less than $17 billion, then why doesn’t some deep-pocket value investor like Warren Buffett just buy them?

The reason nobody in the private sector wants to invest in GM or Ford, or to buy privately owned Chrysler, is that their business models aren’t viable. Their cost structure—particularly their cost of labor—is prohibitively expensive. The consensus is that, regardless of what kind of fuel their cars use, the Big Three simply can’t compete with lower-cost producers. Cars can be profitably made in the United States with labor compensation packages in the $40-$50/hour range (Honda, Toyota, and Nissan have demonstrated that) but not when labor legacy costs and compensation packages total over $70 per hour, as they do at GM.

The Big Three have been surviving by selling off assets and shrinking their operations. What they clearly must do to avoid shrinking to nothing is to reduce their labor costs. And if GM and Ford continue to operate at a loss, how would they ever repay the government’s “loan?” Answer: They wouldn’t; thus, what Dingell calls a “loan” is a euphemism for a bailout.

This bailout is economically destructive. Without the companies correcting their fundamental problem of too-high labor costs, giving them more money would amount to throwing good money after bad. It also ignores the basic economic truth that the bigger a money-losing company is, the better it is for society if it shuts down. That may seem counterintuitive, so let’s think it through:

When a corporation suffers chronic losses, it means that society’s limited supply of factors of production are being used uneconomically—that, on a net basis, the company is extinguishing wealth. The larger the company, the more assets are being employed uneconomically. The sooner the unprofitable company folds, the sooner its assets can be reallocated to economic production that earns a positive return—that is, that generates rather than destroys wealth for society. In the case of a potential GM liquidation, its erstwhile employees and manufacturing plants might even be used for making cars, but at lower salaries and wages.

There are ethical problems with a Detroit bailout, too. To subsidize the Big Three under any circumstances is bad enough. Why should Congress rescue these particular businesses when Congress allows thousands of other businesses to fold all the time? It is manifestly unfair to transfer wealth from millions of Americans who earn far less than their blue-collar and white-collar counterparts to those higher-paid workers.

Despite the economic and ethical problems with a Big Three bailout, politically there is an excellent chance that it will happen. Given the immense financial clout of the unions, any political leader who opposed such a bailout would be pilloried as an enemy of America’s workers. That, of course, would be a misrepresentation. A bailout of the big Three would do nothing for most American workers, but would help only a minority of workers—the elite, the aristocrats, of the American blue-collar worker, who make far more than most of their fellow workers.

If the Big Three receive a bailout, it will be due to the immense power of unions. For decades, the unions have extracted premium wage packages from their fellow Americans through unnecessarily high-priced autos. Now that it appears they have finally killed the goose that laid their golden egg (i.e., the domestic car companies), unions like the UAW will continue to siphon money from fellow Americans and fellow workers into their own bank accounts. The only difference is that the government, rather than Ford and GM, will collect the money for them.

A Big Three bailout would be a travesty. It would be another sad instance of special-interest politics trumping economic rationality in America. And guess who is going to pay the bill?