On Bailouts and American Industrial Policy

First the financial industry needs a handout, now the auto industry. Events like this make policymakers start to wonder how long the line of handout requests is going to get. .  When we think about why a it might be attractive to bail out a large industry like the automakers, the main arguments are:

1) Symbolic:  the auto-industry is one of the symbols of american manufacturing strength, and letting it collapse feels like we just don't care to compete globally and we are collectively "letting ourselves go."

2) Contagion: if the auto industry collapses, it undermines confidence in other industries, which may experience equity declines and bankruptcies.

3) Employment:  if these giants go down, tens of thousands (or more) of auto workers (and potentially feeder companies that make parts, etc).

Of these reasons, #3 is clearly in the public interest, #2 is potentially a public concern, and #1 is an issue that - while not truly in the public interest - is difficult for politicians to ignore.  The fear of being punished at the ballot box for "having let the auto industry die," is almost certainly palpable for our elected officials.

From a policy perspective, therefore, what we need to do is ensure that displaced autoworkers have some kind of future that is in line with the aspirations of similarly educated and qualified Americans elsewhere across the country.  In the short term, that means helping with unemployment benefits and retraining/retooling costs.  

A main concern should be:  what if education or retraining is not enough?  Since globalization and outsourcing and offshoring became a big issue, the policy prescription has been to "create a more flexible workforce, and enable rapid retraining/retooling."  But, if auto workers are going to be unemployed, what is it, exactly, that these workers are going to be able to do, cheaper than anyone on the planet, that Americans and the rest of the world will want to buy/use?  I don't know what that is, and I don't necessarily think that government should pick choose the industry in great detail, but I would feel much more optimistic if one could at least imagine more than a very few possibilities.  Renewable energy and local infrastructure investments might be able to absorb some of these workers, but I can't it absorbing all of them.

To address, #2, we should also look into ways that we can help financial markets distinguish between economically sound industries and dying ones.  Most likely, this means not just having an industrial policy, but clearly articulating what it is and its implementation, so that market participants can correctly judge what industries might be pulled forward with government resources and which ones will be left to adapt or perish.

Thinking about point #1, what is the public interest specifically in saving the auto industry?  As Amit Etzioni points out, one might try to help auto workers by keeping their employers afloat, but is that money going to be spent efficiently?  Perhaps it would be cheaper simply to take money and send it directly to the workers. In that case, the question is whether the national interest is best served in maintaining this industry for the sake of having the industry vs. letting the industry decline and use our public resources for managing the fallout and helping new creativity rise from the ashes.

The problem is that the American auto industry has shown cannot produce quality automobiles cheaply enough to remain in business without external funding.  There is little to suggest that 50 billion dollars will probably change that over the long term.  It is true that there may be divisions producing cars that can serve future needs, and those divisions may be worth saving - but the industry as a whole is unable to compete globally.  We would do far better to find industries that can compete globally and - if we are going to use public monies to support industries - spend our money developing them.

Shortsighted management has much blame to shoulder here, but organized labor bears some of the responsibility as well. Union contracts for auto workers have been quite generous when compared with compensation for similarly educated and capable workers elsewhere in the economy. Organized labor is essential for protecting the interests of laborers, but labor costs make it extremely difficult to produce a car that the American consumer can afford in times of tight credit and rising high gas prices. Union leadership appears to have decided that management was bluffing when it showed concern about competitiveness, but the bluff might not have been a bluff after all. Although I am lax to blame labor first, if costs cannot be contained, neither management nor labor will come out with anything to show for their efforts. [Revision: Unions have indeed made a number of concessions to reduce labor costs for automakers, but they aren’t scheduled to go into effect until 2010]

It is worth remembering that bankruptcy does not destroy all value accumulated by a company.  It simply is a recognition that the company is unable to generate cash flows that will maintain or increase the firm’s economic value, which is ultimately linked to its product’s social value. The reason for bankruptcy is a recognition that maintaining the business actually destroys value and therefore the business should cease and either be reorganized or have its assets liquidated for other uses so that no more economic and social value is destroyed.

A midway solution may be to let the companies enter bankruptcy, then capitalize a holding company to strip away those parts of the companies that have a strong change of delivering a competitive global automobile that is efficient and runs on energy sources of the future:  in other words, a company compatible with national industrial policy interests.  If the government were to simply take over the company now, it would catch blame for the inevitable shedding of divisions and jobs.  Instead, the decline of the auto industry as we have known it should be handled as one would handle a terminal cancer patient - try to make the decline as painless and natural as possible.