Guest Post: Too Many Cooks Spoil the Broth

This post was written by my friend Ilya Podolyako, an occasional contributor here and a third-year student (though not for much longer!) at the Yale Law School.

In the last couple of days, a few disparate news pieces attracted my interest. First, as I mentioned in my last post on industrial policy, an accelerating, worldwide decrease in consumer disposable incomes is beginning to percolate through the manufacturing sector. As a result, Caterpillar, DuPont, and United Technologies posted double-digit declines in sales. Second, reports surfaced that Fiat, Obama’s designated buyer for Chrysler LLC, was looking instead to purchase GM’s Opel division. Third, Sen. Diane Feinstein (D-CA) introduced a “cash-for-clunkers” bill that would provide a credit of up to $4500 toward the price of a fuel-efficient car for individuals or government-owned fleet operators who turn in a low-mpg “clunker.”

What do all these data points have to do with each other? In my mind, they highlight the need for a structured approach to the U.S. industrial sector. The current policies are completely random and occasionally conflicting, which is not surprising, considering that they are coming from different branches of government who seem reluctant to talk to each other. For example, the purpose of the Feinstein bill seems to be to support the auto industry by lowering the effective price of a new car while also boosting aggregate fuel efficiency. Presumably, these measures would help the ailing American automakers transition from making money on SUVs to making money on hybrids. Yet in this context, a government-financed sale of Chrysler to Fiat doesn’t make very much sense. If we are concerned about rescuing the American auto industry from the bottom up, why are we selling bits and pieces of this industry to foreign companies? Imagine if GM, Chrysler, and Ford did not exist – in this world, the government could surely find a better way of spending money to combat climate change than paying Toyota and Honda to chop 20% off the sale price of a new car. Just because other countries do it, doesn’t mean we should too.

Similarly, I am skeptical of the wisdom of helping Fiat buy Chrysler when it is also looking to buy Opel. Sergio Marchionne, Fiat’s CEO, has openly stated that the company is looking to increase production volume and break into the US market. In fact, given Chrysler’s persistent inability to make cars profitably (it has failed to do so as a standalone public company, a unit of DaimlerChrysler, and a privately owned entity), the company’s main value lies in its U.S. dealer network. At the same time, Opel has designed several automobiles that had potential with the American public, such as the Sky roadster and Aura sedan. According to GM’s 10K, Opel (which accounts for the bulk of the company’s European operations) actually had an increase in both total sales and revenue from 2006 to 2007. Basically, the unit seems to be quite capable of functioning as a stand-alone, profitable car company. There is thus a real possibility that if Fiat goes through with both the Chrysler and Opel acquisitions, it will end up selling Opels at Chrysler dealerships across America, where they would compete with whatever remains of the GM portfolio.

I don’t support protectionist trade policies, but having US government pay for the above outcome seems like an unambiguously bad idea for everyone on this side of the Atlantic. To avoid the wealth transfer, Treasury could condition the promised $6 billion loan on Fiat’s promise to avoid certain follow-on acquisitions, but then the Chrysler sale may fall through altogether, exposing the fundamental instability of the Obama auto rescue plan.

Finally, an L-shaped recovery likely means more trouble ahead for industrial manufacturers outside of the automotive sector like GE or Caterpillar. If either of these companies nears insolvency, I doubt that the Obama administration would jump on the opportunity to help sell off their operations piecemeal to foreign buyers. In the optimal case, the government would just let the companies go through bankruptcy using private sector financing and scrutinize the purchasers of any sensitive assets for national security risk using an existing apparatus. Considering that the auto bailout plan hasn’t required GM or Chrysler to preserve any particular number of jobs, I just don’t see why the Two-Out-of-the-Ex-Big-Three should be treated any differently.

The Administration’s current approach to the industrial sector appears even more haphazard than its efforts to right the financial markets. The government is spending non-negligible amounts of money on dubious short-term goals that conflict with both the acute needs of certain demographics (auto workers, residents of Michigan) and the long-term interests of the American taxpayers. Federal agencies timidly pick up the tab for corporate liabilities like pensions without proportional claims to their profits. This behavior is the exact opposite of the type of directed industrial policy I suggested could be worth trying.

By Ilya Podolyako

22 thoughts on “Guest Post: Too Many Cooks Spoil the Broth

  1. Industrial policy is NOT worth trying. The confused political goals you’ve just described, that would inevitably be part of industrial policy, are reason number 1.

  2. I am myself a fairly liberal democrat – i.e. – someone not fanatically opposed to government intervention.

    These days, however, I find myself wondering why so many American businesses seem to require government intervention in order to survive.

    I am not naive – I understand government policy co-exists with economic development. I think the Bush and Obama administrations’ focus on the banking crisis has limited the examination of the many other issues and concerns with the American economy – like declines in consumer spending, the sharp rise in unemployment and the like.

    There are so many American companies in so many different industries on the verge of collapse today. Spending enormous sums to fix the financial system seems like patching a big hole in a dike that remains weakened by multiple holes and cracks and leaks. The water continues to gush in, threatening a very soggy future even as the banks get fixed.

    And there’s no money left to patch up the other holes.

    I sincerely wish that American business leaders would put a little creative innovation into solving problems instead of creating murky tools to hide them. These are the men getting paid the very big bucks in exchange for their brilliance and leadership skills – now’s the time for them rise to the occasion. Their relentless focus on their bonuses (NY Times execs as the most recent example of this) seems to obscure the great plans they have for saving their companies….

    [Simon and James – I’d love this blog to highlight some innovative approaches taken by businesses to address the crisis. Do you know of any?]

  3. The link in the last sentence of this post does not work – it has an extra double quote at the end. Delete that and the link works.


  4. The subsidy makes complete sense if you consider the pension plans.

    The wealth transfer is simply a sly way to compensate Fiat for funding Chrysler’s pension plan. Although the deal may lead to increased competition for GM, this result is likely much cheaper long-term than the alternative of allowing the Chrysler pension plan to collapse.

    The last thing the Administration wants is to explicitly rescue any of the big three pension plans. The moment it does, there’s no reason for any U.S. corporation with a pension plan to continue funding it as opposed to having the government pick up the slack.

    I’m not sure how well funded the Pension Benefit Guarantee Corporation is, but I’d bet that losing the likes of Chrysler/GM would be a major blow.


  5. anne, if you haven’t already, I suggest you Read Galbraith Sr. The Economics of Innocent Fraud. He nails it. I’d say there is a serious crisis of ethics and competence in the management of public firms across the board in developed nations. It’s not going to be an easy problem to solve.

    The first time I worked for pubic company was in 2002. Wow. What an eye opener that was! Everything management did was about spin, PR, and pumping the stock. Their actions were clearly not intended to create a company with long term prospects. It was all about attracting (stupid) venture capital and angel investors so they could re-allocate investors money to themselves. Eventually, it all fell apart. They eventually issued convertible debentures – I suspect at the urging of a hedge fund who had taken control – which off course they used to setup a death spiral (we were a fixture on the REGSHO list). In the end they fired everyone and sold the IP. The company that bought the IP was recently liquidated in Chapter 7. Nobody was ever prosecuted.

  6. Sorry – quite seriously not intentionally spamming – but given we’re mostly concerned with blatant self-promotion these days, a glorified version of rugged American individualism, I’d just like to repeat: The first rule of Apathy Club is that you do not care about Apathy Club. You only care about yourself.

  7. Ilya – the issue is there are many variables to your solution- some you appear to be discounting.

    One of Opel’s reasons for success, and you don’t mention it, is that there IS a “cash for clunkers” program currently happening in Germany. Senator Feinstein didn’t come up with this on her own. And $4500 towards the purchace price of a new car isn’t going to motivate people like me at @ $2.50/gallon. If the government agrees with my assesmet, and they tax petroleum even more, I have the option of walking and mass transit. I can simply park my car somewhere, thake the plates and registration stickers and let the government deal with it. (I understand many can’t – but $4500 in a tax break versus 2 or 3 thousand in repairs makes many a vehicle roadworthy with no monthly payments)

    The only approach I see the administration doing is trying to ignight the fires from days gone by…redit to finance credit leveraged with even more credit. You would think by now we could conclude this model is unsustainable. Apparently, by both the past administration and the current, the Goldman Sachs executives (Paulson and Geithner) think with enough of a credit expantion, good times will roll again and we’ll all be buying houses and cars galore as long as the credit markets are unfrozen. Funny though, no mention of jobs!

    The administration thinks the root cause of the economic collapse that is underway is the failure of the credit markets and if banks simply lent money, the collapse would end. Sadly, they cannot see that more credit = more debt. If debt can’t be paid back, why issue more credit? Nobody wants to answer that. Why?

    The US economic system is DEPENDANT on prices going up. Mode debt, more credit, pay raises for politicians and municipal unions. The math breaks apart when prices go down. When stores and people cloes down and/or lose jobs, municipal funding fails. Politicians can mandate a raise, but from who? On the backs of a smaller taxpayer base? Local businesses? They’ll quit as well. And the unemployed who remain will drain the social services system.

    The Japanese can’t sell cars here and neither can GM, Ford or Chrysler. The demand is not there because unemployment continues at 600k+ per month, and continually revised even worse. We have shipped our manufacturing to China, our IT to India and cut domestic jobs month after month because it is an immediate high; akin to a financial crackhead getting one last high on the books…never to be seen again..but doing it again and again for no real gain. Only pain and loss.

    The ONLY way out of this mess is let the chips fall where they may. If Godman Sachs/JP Morgan and others fold, then the former Masters of the Universe need to be tossed into the ash heap of history. Not propped up by fewer and fewer employed American taxpayers.


  8. Sure, there are lots of businesses and industries that may deserve assistance as well as the banking industry, but without a banking industry, no business can survive or even do business. You can argue that the way the gov’t is going about saving the banking industry is flawed or that they are wasting money that could otherise be used to help other industries. But the banking industry, like it or not, is going to be first by triage.

  9. i see jobs becoming a problem in this country, especially manufacturing. whether it is the unions, greed or healthcare costs, it’s too late now. one can’t cook the books on job loss. let’s honestly look at our situation. the minorities will become majorities in ten years or so. will they be competitive? if you ask me,,,this country is toast. it’s our own fault!

  10. We are overdue for setting an industrial policy. But unfortunately our current government structures will never allow a comprehensive industrial policy.

    As an economic officer in the Foreign Service (now retired), I found it baffling that our U.S. Treasury takes the leading role on setting economic policy in each Administration. Treasury prefers to communicate little with other U.S. agencies. It defers to the “market,” meaning that U.S. corporations and lobby groups have an enormous impact on steering economic policy within agencies like State, Commerce and USTR — which divide among themselves parts of the economic policy process. Confusion and cross purposes are common. Too few from outside government understand that Treasury’s misguided leadership plays a major role in our lack of an effective industrial policy. We simply have none. We need a “Department of the Economy” that encompasses trade and investment policies, which can wrest industrial policy from Treasury’s neglect. All the major economic powers competing with the U.S. (Japan, Germany, China, France) depend on an astute Ministry of the Economy to guide their trade and investment policies in a manner that promotes their industry’s exports and technology advantage.

  11. Well now, there is one group of people in North America that benefit unambiguously if Fiat were to start selling Opels through the Chrysler dealer network–consumers, especially car buffs. I wouldn’t mind at all having the option to look at an Opel. They are nice cars. (You can already buy the small Opel Astra as a Saturn.)

  12. Yeah, we need another government industrial policy like we need another lawyer.


  13. I too have wondered why American business is in so much trouble. Watching the debt crises unfold leads me to believe that the source of the problem is that American business relied more on debt then the creation of solid old fashion profit.

    The kind of profit that does not rely on cash equivalents, future tax savings, over valued good will or level three assets. There has been far too much manipulation in methods of accounting, mark to model, and off the books vehicles.

    Look to FASB and cheap credit as the source.

    Currently, aside from a limited commodity holding, I am out of the market. I simply cannot trust the phony balance sheets and the filings based on them. It is a difficult and time-consuming task to tell whether a company is solid. It may in fact be impossible.

    Trust in honest corporate accounting and reporting is gone. I doubt that I am alone in my opinions.

  14. …. as with everything in life, the economy has to get a whole lot worse before Obama will take the drastic steps to make it better. It has been well established by the great writers on Baseline like Simon, James and now Ilya that fundamental structural change is required. Instead, we see stitches and patches being applied like to a torn fabric. I hate to say it but we need to hope for a \ shaped economy instead of a L. It’s the wake up call, the reality check that slams them in the side of their head, not just taps them on the shoulder….., What I see are temporary repairs designed to carry the current group successfully past the next election cycle.

    Can anyone tell me, with all these abundant brilliant suggestions, what real, structural, change has been adopted? …. besides maybe shuttering yet more American manufacturing capacity.

  15. Thank you Patrick for the recommendation. I will definitely read this.

    And I agree with you that we are facing a serious crisis of ethics in business today. What has me stunned is the depth of it.

  16. Right now the banking system pretty much is these few large banks since they have a stranglehold on the system. You’re right though, propping them up at any cost does not make sense. We need to create a systems rather than a collection of a select few institutions. I think the question is when will the administration realize that a collection of super-sized institutions is not a “system” and do something about it. Seems it’s down to either they don’t recognize the real problem, they don’t think it’s politically feasible to change at this moment or they are in the back pocket of or intimidated by the oligarchs. Everyone, take your pick.

  17. Outstanding commentary Ilya Podolyako. While I still hold the underlying dynamics reach into moral or ethical realms and how we exactly define ourselve as a nation and a people. Are we wanton greedmongers, obdurate, heartless, ruthless, swindlers and theives, PONZI scheme operators – willing to stomp on, and suck off the blood of poor and middle class Americans to feed the superrich, the predatorclass, – or are we a nation that honors the Constitution, the rule of law, the core principles that formally defined America? It is a profound decision, and will shape what we are, and will become “goingforward”.

    What you have successfully acomplished though, is to inspire people from our lowly perches to re-examine the Obama approach through the lens of preventing, or minimizing economic calamity.

    The clock is ticking. Obama owns a vast well of goodwill. Many of us are distrubed by the seeming overt favoritism and hyper extraordinary government largess towards the banks, and Goldman Sach particularly, – but we are willing to afford the Obama government a bit more time to sort through this horrorshow and calamitous economic crisis we all recognize Obama inherited from the bushgov.

    Let us hope that Obama’s methodical approach truly does have the best interests of the American people, and not Goldman Sachs, or the predatorclass swindlers and thieves on Wall Street at heart.

    Yet there is no such thing as excusing or cloaking crimes. If these pericious and perfidious policies exist, – then effectively – there is no law. And in a world where there in no law, – there is no law for anyone predators.

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