Guest Post: Obama’s Plan for the Auto Industry

My Yale Law School colleague Ilya Podolyako comments on the Obama administration’s plan for the auto industry and the tension between public goals – preserving jobs, increasing fuel efficiency, etc. – and private goals – profitability.

By now, the dust seems to have settled around Obama’s rescue plan for two-thirds of the long-ago “Big 3″ (in 2007, Chrysler ranked 12th in the world in total auto sales; GM has ranked 2nd; Ford, which is not receiving government assistance, was 4th). The policy itself seems prudent enough. The President’s Task Force on the Auto Industry recognized that due to its small scale, reliance on light trucks, and objectively low product quality, Chrysler is not viable as a stand-alone company. On the other hand, General Motors has large economies of scale and makes certain well-received products (the report mentions the Chevy Malibu and Cadillac CTS by name, though one could add the Cavalier, Corvette, and Escalade to those lists), but faces exorbitant legacy costs for its nearly one million retirees and low margins on its fuel-efficient vehicles. Given this fact pattern, the plan does as good of a job as anyone could in offering a helping hand to iconic American manufacturers while preserving some incentives for efficient private-sector operation.

My problem with the restructuring proposal comes not from any one of its details, nor even its general spirit. At this point, I feel fairly neutral about heavy-handed government involvement in US industrial policy. Admittedly, I am from Michigan and really like cars (despite consistent problems, I keep driving Fords, though I am not sure why), so I have some emotional connection to the industry to balance against the gross, obvious inefficiency of pouring money into enterprises that, by their own admission, will at best break even by 2014. I also do believe that a GM bankruptcy would lead to the net loss of a significant number of jobs that would permanently cripple Michigan’s already desperate economy.

I am concerned, however, with the absence of any apparent long-term vision for the “American” automobile industry within Obama’s proposal. A New York Times story provides a nice contrast to our own state of affairs when it explains that “Chinese leaders have adopted a plan aimed at turning the country into one of the leading producers of hybrid and all-electric vehicles within three years, and making it the world leader in electric cars and buses after that.”

Mechanically, the Chinese policy does not seem to be that different than that of the United States. If anything, it is facially less intrusive into the affairs of the automakers, though the fact that the government continues to own a controlling stake in most such entities makes this difference illusory. The national government will provide research funds for the development of alternative-fuel vehicles, coupled with direct subsidies for consumer purchases of such products. The PRC’s policy motivations look similar to those present on our shores too: cut down on pollution, preserve national stability in the face of shrinking foreign oil supplies, and foster industrial excellence.

The issue is that whereas the Chinese government is content with spending public money for an indefinite period to promote these well-defined (and fairly reasonable goals), the U.S. executive branch cannot be. American leaders are directly accountable to voters, who generally dislike state-directed industry. Yet this feature of our political system runs counter to the motivations for the automaker bailout. These seem to be, in order of importance:

  1. National pride: The United States of America became a superpower while leading the world in car manufacturing; people in and out of government associate the two phenomena with each other. Accordingly, they want to retain the symbolic value of GM or Chrysler.
  2. Job preservation: No explanation necessary, though the jobs in question are localized. No one has made the argument that the collapse of GM or Chrysler would pose a systemic risk to the national economy as whole.
  3. Environmental considerations: The President appears to believe that U.S. automakers can play an important role in the larger effort to reduce greenhouse gas emissions by manufacturing fuel-efficient cars.

The above considerations are fundamentally political; they are not the ingredients of a profit-making business. With these goals, inquiry into the potential viability of GM or Chrysler as a private enterprise matters only as a way to distract voters frustrated with selective government handouts.

But this strategy is both unsustainable and unwise. First, if Obama intends to keep the auto-companies as a federal jobs program, he shouldn’t pay large, institutional investors in the process. That’s what TARP II, EESA, and PPIP are for. Second, one would think that for both the employment and the environmental goals, there is no need to combine the bureaucracy of the Department of Treasury with that of General Motors. I am willing to accept that, given the track record of private sector management at the Big 3, the government may have at least as good of an idea of what consumers want as the people who designed the Pontiac Aztec. Of course, if that is the case, members of the Auto Task Force should be managing the R&D and Manufacturing divisions directly instead of making a slightly reshuffled deck of top executives drive back to Washington every two months for progress reports. Third, selling off GM’s relatively well-performing European operations, along with its prized partnership with China’s SAIC, would diminish the company’s stature as an American powerhouse while undercutting the very economies of scale that give it remaining strength.

So, where do we go from here? If Obama’s goals for the intervention are actually those that I identified, he should be frank with the population, if only because the current plan is so clearly incompatible with business logic. The proposal should function for now and buy the Administration some time to recoup political capital, but in these tumultuous times, the notion of a gently nationalized car industry may not do too poorly. On the other hand, if Obama wants to see GM and Chrysler survive as smaller, profit-making companies, he should write off the $20 billion in aid that, under the current plan, would stick with the “good” GM, let the bondholders go through bankruptcy, and use his stature to negotiate some sort of a politically favorable but economically sustainable agreement with UAW.

By Ilya Podolyako

17 responses to “Guest Post: Obama’s Plan for the Auto Industry

  1. Ilya/James:

    The issue I see with the president’s Automotive Task Force, Eddie Montgomery, and the President is they are all financial and economic’s score keepers. There is no one person on the team who knows manufacturing. Costs of Manufacturing is Materials, Burden, and Labor in terms of cost and magnitude. Labor falls out as you resolve the first two issues. Both companies were well on the way to resolving those issues.

  2. “No one has made the argument that the collapse of GM or Chrysler would pose a systemic risk to the national economy as whole.”

    Actually, through their supply and dealer networks, the problems will spread far outside Michigan. I have seen a case, but don’t remember where, sorry.

    Also, Chrysler trucks and SUVs are of excellent quality, and it would be a shame to lose them.

  3. >> No one has made the argument that the collapse of GM or Chrysler would pose a systemic risk to the national economy as whole

    If “systemic risk” is defined in terms of financial paper, perhaps. If systemic risk is defined in terms of the economy’s actual capability to manufacture things, the collapse of the auto industry is an enormous risk. What do we make in this county any more besides automobiles? How many little metalworking shops, which we will need for the future manufacturing of rail vehicles, will go out of business if GM & Chrysler disappear?

  4. soylent green is sheeple

    “Job preservation: No explanation necessary, though the jobs in question are localized. No one has made the argument that the collapse of GM or Chrysler would pose a systemic risk to the national economy as whole. ”

    really?

    well, i suppose it matters how you define “whole”, but a GM bankruptcy certainly threatens ALL North American auto manufacturing as a “whole”.

    If GM goes bankrupt, Ford and Chrysler likely do as well, since they rely on the same downstream suppliers. So do any foreign manufacturers with plants on US soil.

    It’s serious and it’s systemic.

  5. adios amigos

    Raven,
    Actually, Chrysler’s trucks are poorly rated by Consumer Reports.
    AA

  6. adios amigos

    Wondering,
    You make very little, manufacturing-wise, that is of any substantial value in America. Gone to Wal-Mart lately? Losing the car biz, while catastrophic, would be an example to the unions as to why, exactly, you can’t pay a guy $60 per hour to bolt a fender on a Chevy. It didn’t work, and won’t in the future. Let them re-organize, and begin again. Perhaps is the big three go bankrupt, more efficient manufacturing entrepreneurs will enter the market, occupy their existing factories, and go forward SENSIBLY. Do you know that NOT ONE television set is produced in America anymore? You invented TV, now you don’t make even one there.

  7. How about exploring “outside the box” ideas for the auto industry. How about transitioning them from public corps into multiple worker cooperatives? I’m sure there are plenty of “desk level” and “factory level” people who have great ideas – for vehicles, efficiencies, etc. Turn the hierarchy upside down and give the employees a stake in the business (profit sharing), AND, effectively, hiring and firing power of management.

    There is a whole network of businesses run like this: Mondragon.

    http://www.mcc.es/ing/index.asp

  8. adios amigos

    Soy,
    But for how long are you willing to hold up these failed manufacturers? People are NOT buying cars at the moment, and even when it does resume (which it must, eventually), what will demand be in your new economy? No one knows. Certainly, it won’t go back up to previous levels for quite some time. GM was underwater even before the bomb went off in your economy. They had been pulling forward sales for years. They have been doing it lately with the lease deals. They were setting the residual values WAY to high, to make the payments very low in an effort to get the people to buy the cars. They were then stuck will millions of off-lease vehicles that were returned, but had WAY to much owed on the residual. BOOM. Their suppliers are going down the drain already. Plants are closing all over America. Get it over with now, rinse the debt. If you don’t you are just prolonging the pain until the inevitable happens. There are no magic pills to swallow that make 2+2=5….none.

  9. I don’t think the three goals listed: national pride (perhaps better stated as retention of manufacturing capacity), jobs and environmental protection are incompatible with recognition that long-term government intrusion is unsustainable in the US as it would be under a more planned or regulated economy. And it does not follow that Obama should be “frank with the population”. There will always be some tension between public good and private enterprises. Current economic events have brought those tensions to the fore.

    Part of the reason the big three are in such difficulties now is that they abandoned the future (R & D, clean small cars, advanced technology, etc.) to concentrate on SUVs while the getting was good. Obama knows that he must reduce government intrusion over time, but sees an opportunity to simultaneously advance his social agenda and set the companies on a long-term path to profitability.

    I think the interesting question arising out of this mess is whether we are entering a different era where private markets will no longer be fully trusted to efficiently allocate resources. Not only do we have the economic crisis but consider environmental deterioration. If global warming and other problems are severe enough, externalities will become so significant that the classic economic free rider problem will have to be addressed head-on.

  10. I don’t think the three goals listed: national pride (perhaps better stated as retention of manufacturing capacity), jobs and environmental protection are incompatible with recognition that long-term government intrusion is unsustainable in the US as it would be under a more planned or regulated economy. And it does not follow that Obama should be “frank with the population”. There will always be some tension between public good and private enterprises. Current economic events have brought those tensions to the fore.

    Part of the reason the big three are in such difficulties now is that they abandoned the future (R & D, clean small cars, advanced technology, etc.) to concentrate on SUVs while the getting was good. Obama knows that he must reduce government intrusion over time, but sees an opportunity to simultaneously advance his social agenda and set the companies on a long-term path to profitability.

    I think the interesting question arising out of this mess is whether we are entering a different era where private markets will no longer be fully trusted to efficiently allocate resources. Not only do we have the economic crisis but consider environmental deterioration. If global warming and other problems are severe enough, externalities will become so significant that the classic economic free rider problem will have to be addressed head-on.
    Sorry… forgot to say great post – can’t wait to read your next one!

  11. You make very little, manufacturing-wise, that is of any substantial value in America.

    Manufacturing production has actually increased even as manufacturing employment fell. Basically we are using more capital and less labor to produce goods. Our workers have also become more productive.

    http://angrybear.blogspot.com/2009/01/industrial-production-vs-real-gdp.html

    http://www.cafehayek.com/hayek/2008/04/the-strange-wor.html

    We are consuming much more than we produce, which is a bad thing. I’d rather that our production had kept pace with our consumption. I think many of the advocates of “free” trade are short sighted and naive at best. But, as a point of fact, our manufacturing output has increased over the past few decades.

  12. Erich Riesenberg

    Friend, the US is still the world’s largest manufacturer. Friend, we manufacturer 20% of the world’s goods with 5% of the population. Friend, can you please report on how profitable is the manufcturing of television sets?

    Thank you, friend.

  13. adios amigos

    Erich,
    I’m personally am not involved in television set manufacturing in any way. Evidently those idiots at Sony, JVC, and the mountain of other volume electronics manufacturers must not have figured out their losing money providing the planet with television sets. Erich, I believe you should call the CEO at Sony and let him know that he’s losing money peddling the TV sets. I would bet those people at walmart are probably losing money selling them retail too. You better call them too Erich.
    AA
    AA

  14. This talk “pro” and “con” on saving the U.S. auto industry should remind all of us that we are running $700 billion trade deficits every year that increaseo our huge foreign debt. We add to the problem by shifting our own production to China and Mexico while shutting down factories here that will never reopen unless we adopt a national “industrial policy” That policy must encourage and support “competition” in global markets, not “protectionism”. If we cant compete in the world’s biggest product field – automobiles – we won’t win overall, and we’ll never be able to pay off our trade debts. The financial services guys are getting most of the attention and funding now when we should be adopting and funding a strong “industrial policy”. We are late to that party, but there’s still time with the right leadership from Washington. So far, no one like that is in evidence on the Obama team
    Ken Davis – former IBM V.P./CFO and U.S. Assistant Secretary of Commerce/ International

  15. D. Christopher Leonard

    Unmentioned by any of the commentators is the issue of “legacy costs”. It is as if people who worked for automobile manufacturers had set out to sink the ‘big 3′by living past the date of their employment. It needs be remembered that the absence of either a national pension scheme or a national healthcare system are the product of resistance by large U.S. corporation in the late 1930s that was solidified during WWII. When firms collapse (e.g the steel industry two decades ago), they abrogate their contractual obligatons, dumping the cost on the federal government’s over-taxed fund.
    There is a long tradition of this behavior dating back to the origins of the insurance/pension industry at the end of the 19th century (I recommend J. Klein 2003:For All These Rights (Princton U.P.) for some much needed historical perspective).
    The viability of heavy manufacturing in the U.S. in the future may well depend to a considerable degree on the outcome of the current “debate” (or what passes for one) on healthcare.
    Every time a new frenzy of creative destruction occurs, a new batch of retired workers find that commitments made to them over their working lives are worthless.
    There is nothing to vouchsafe any industrial sector in this regard in the future. It is never just an issue of ‘industrial policy’, ‘competitiveness’ or market discipline.

  16. The industry was destroyed by its stockholders, who also sit on oil company boards and forced management to build gas sucking lemons. It would be easy to design a modern vehicle, or retool the industry to build rail and clean energy generation. But the financial industry and oil companies still call the shots. So long as the public sit on their hands and commefcial media lock out educated speech, the great rip offs will only continue.
    Likewise, the stimulus package is a huge disappointment. We need fiscally responsible, Clinton economic policy to get us out of this mess. Instead, Obama and the dems give us a Keynesian hog fest from an bygone era.
    Please see Stimulus Redux at http://a-civilife.blogspot.com

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