Tuesday, November 18, 2008

General Motors Bailout or Bankruptcy?

America - the land of freedom, opportunity, free markets and government bailouts.

It's not a good time to be a car manufacturer. Several years of over supply have been exacerbated by a slump in global demand. Even falling gas prices have done little to revive a car market in the doldrums. General Motors is on the verge of bankruptcy, and it presents politicians with a difficult dilemma of what, if anything, they should do.

The Case for A Bailout.

  1. Unemployment. One in every 10 US job relies directly or indirectly on the car industry. Allowing General Motors to go bankrupt would exacerbate US unemployment at a time when it is rising fast already.
  2. Recession. With the US in recession, a government subsidy could be justified on the grounds of expansionary fiscal policy. If General Motors was to close down, the resulting unemployment and loss of confidence would cause a further fall in economic growth.
  3. Equity. The US government has bailed out (undeserving) insurance and banking giants, why should the government then ignore the ordinary worker? It wasn't the blue collar workers in Detroit who caused the current financial / economic turmoil so arguably they 'deserve' a bailout more than reckless banking managers and hedge funds.

The Case Against a Bailout

  • It Will Only Delay The Inevitable. You could try to argue that General Motors is merely facing a temporary blip due to the recession, therefore, a subsidy to help it through the next 1 year of recession is all that is needed. Unfortunately, this is not the case. General Motors was facing difficulties even during the boom period. The fundamental problem is that there are too many cars being produced in America. A government subsidy only encourages this oversupply to continue.
  • There is no guarantee that pouring more money into General Motors will actually solve the problem. GM said earlier this month that it had burnt through $6.9bn in the three months to the end of September and had drawn on the last of its credit lines from its banks. In 12 months time, they could be coming cap in hand asking for more money. The problem is that once the government starts bailing out General Motors it may find it very difficult to extricate itself. The government won't want to lose its initial investment so it will keep pouring in money into a failing company.
  • Will people buy from a bankrupt Car firm? General Motors may be given a lifeline from the government. But, will consumers trust general motors will be there in a few years. The problem is that people may not want to buy a car from a firm on the verge of bankruptcy.
  • Government subsidies rarely work In the 1970s, British Leyland was going bankrupt due to inefficient management, poor industrial relations. Because it employed so many people the UK government subsidised the firm and kept it going for another few years, but, this subsidy did nothing to turn around the company. There is no evidence that US subsidy would be able to transform General Motors.
  • Employment Patterns change. In 1945, 0.45 million people worked in British coal mines. In 2009, that figure is less than 5,000. Should the UK government have subsidised coal mines to prevent 450,000 jobs in the coal industry being lost? The simple answer is no. Although the recession will make the transition more difficult, the government should not insist on trying to avert the necessary change in the American car industry.
  • Externalities. Why should government subsidise General Motors who do little to develop alternative / cleaner energy? Why doesn't the American government subsidise new firms producing bikes / trains / cars which run on renewable resources. At least then you could justify the subsidy on the grounds of external benefits.
  • Car Industry is Not indispensable. American car workers probably do deserve a bailout more than irresponsible banks, but, unfortunately, public policy cannot always be dictate by who is deserving of a bailout. A banking system collapse would really harm the economy in a way that a car firm bankruptcy never would. The UK used to have a very important car industry, but, now we have no significant UK car firms, but, it is not the end of the economy.

From an economic perspective, it is hard to justify a huge government bailout for a declining industry. It is a very expensive and inefficient way, to prevent unemployment. If the government really have $25 billion to try and protect jobs in the car industry, they might be better off letting General Motors go under, and use this money to try and retrain workers, and stimulate investment in the towns most affected. At least the government would have something to show for their money, rather than pouring it down the black hole of General Motors accounts. The government could then say at least it is trying to help deal with the very high human cost of General Motors bankruptcy.


Anonymous said...

This article is excellent!

Anonymous said...

Real estate, the banks and financial institution fall out was the first level of failure and now many other layers of business are failing.

Will the government be able to bail out everyone? How will it pick and choose who to save and who to let fall? Isn't that the purpose of a free market economy: let market forces decide who will go and who will survive.

Government can only further complicate the issues. The reason they wanted to save the banks was to ward off panic in the markets but it didn't quite have that effect. Whatever they do will not have quite the effect they wish for.

Forbes recently said that the economic downturn has reached the bottom. I doubt that. People are not buying. They are holding onto their cash.

What about all the inventories that were purchased many months ago before the collapse? What about businesses across the nation with many employees? And if people aren't buying what will happen to those inventories,the loans on the inventories and all those employees?

There are many more layers of collapse to come. How will the government know what to do and who to save? How will it know what will be the effect of its choices?

I think the government making these fundamental kinds of economic choices will further complicate the problems.

Jason said...

Today GM suffers a loss of about $2,000 per vehicle sold. On the other hand Toyota whose employees are not part of the UAW earns a profit of about $1,200 per vehicle sold.

No Bailout until the UAW sees the light.


Anonymous said...

It's an interesting article. If the bailout can stop more than 3 million jobs that are going to be lost, then it's worth giving a try. In that case, the big three have to revamp their whole style of operation, from top to bottom. The private jet flying millionaire CEOs should be given a jolt to bring them back to reality.

Brett said...

Gone were the days when GM ruled the world and was at the top of Fortune 500 listing. So much has been said about the credit slump that banks are now offering better schemes for
car loans to lure the already declining market for car aficionados. I wish the interest rates would only be more realistic as this financial is not about to end anytime soon.