Bail Out the Big Three Auto Producers? Not a Good Idea- Gary Becker

The big three American auto producers General Motors, Ford, and Chrysler, are in terrible financial shape. They have asked the government for a bailout, and the Democratic leadership in Congress is eager to give them one. The United Auto Workers union was a strong supporter of President-elect Obama and of Democratic candidates.

These companies have lost tens of billions of dollars during the past few years, and they will shortly run out of cash. GM’s shares have lost almost all their value, and Ford has not done much better. Cerberus Capital, a private equity company, owns Chrysler, and it has lost most of what it invested in the company. For this reason Cerberus is trying get out of the automobile manufacturing business. All three companies were heavily into producing trucks and SUV’s when the sharp run up in gas prices induced consumers to shift away from these gas-guzzlers and toward smaller and more fuel-efficient cars. Moreover, what money GM had been making came mainly not from car production but from its automobile credit business, (GMAC). This company would borrow from banks to lend to consumers who needed help in financing their GM car purchases. The financial crisis has dried up the money available to auto financing companies, and hence eliminated the major source of their profits.

If GM is not bailed out, the company claims it will be forced into bankruptcy within a few months, and Ford’s situation is only slightly better. GM is blitzing Congress, President Bush, and President -elect Obama with pleas for a bailout, followed by a warning that bankruptcy will also hurt auto suppliers throughout the nation that depend on GM’s business. GM is also claiming that bankruptcy will put major financial pressure on the Pension Benefit Guaranty Corp, the federal agency that insures benefits to retirees in the auto industry as well as to million of other workers.

Nevertheless, I believe bankruptcy is better than a bailout for American consumers and taxpayers. The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits. Only a couple of years ago, GM was paying $5 billion per year in health benefits to retirees and current employees because their plans had wide health coverage with minimal co-payments and deductibility on health claims by present and retired employees. In those days, the UAW was one of the most powerful unions in the US, and it bargained aggressively with the auto manufacturers, carrying out strikes when its demands were not met. When the American auto industry began to face tough competition from Japanese and German carmakers, they were saddled with excessive pay to their workers, and vastly excessive pensions and health benefits to their current and retired workers.

It is not that cars cannot be produced profitably with American workers: the American plants of Toyota and other Japanese companies, and of German auto manufacturers, have been profitable for many years. The foreign companies have achieved this mainly by setting up their factories in Southern and border states where they could avoid the UAW, and thereby introduce efficient methods of production. Their workers have been paid well but not excessively, and these companies have kept their pension and health obligations under control while still maintaining good morale among their employees. In recent years GM and the other American manufacturers have chipped away at their generous fringe benefits, but their health and retirement benefits still considerably exceed those received by American auto workers employed by foreign companies. As a result of lower costs, better management, and less hindrance from work rules imposed by the UAW, about 1/3 of all cars produced in the US now come from foreign owned plants.

Bankruptcy would help GM and Ford become more competitive by abrogating significant parts of their labor contracts with the UAW. One of the greatest needs would be sizable reduction in their health costs through sharp increases in the deductibility and co-payments, and a reduced coverage of medical procedures. Bankruptcy should also help bring the wage rates of GM and Ford in line with those of foreign producers in the US. Some of their pension liabilities may be shifted onto the Pension Benefit Guarantee Corp, but even that would be preferable to an overall bailout.

A good analogy is what happened to United Airlines. By entering bankruptcy it was able to reduce its inflated cost structure by breaking contracts it had with the pilots union and other employee unions. It exited bankruptcy a slimmer and more efficient airline. Whether it is able to compete effectively in the long run is still not certain, but it is in much better shape to compete than before it entered bankruptcy.

Bankruptcy may also force out the current management of GM and Ford. I do not know for certain whether they have competent management- GM surely did not have top management for much of its recent history. I do believe, however, that when a coach of a team loses a few games, he might legitimately explain that by injuries, bad luck, or even bad officiating. These excuses become lame when he consistently loses many games, and the correct and common practice is then to fire the coach. The same considerations apply to top management. When a company consistently does badly while some of its competitors (like Toyota) are doing well, its time to fire the management team, and see if another team can do better.

Is GM “too big” to fail? I do not believe the company is too big to go into a reorganization-which is what bankruptcy would involve. Such reorganization would abrogate its untenable labor contracts, and give it a chance to survive in long run. A bailout, by contrast, would simply postpone the needed reforms in these labor contracts, the business model of GM, and its management.

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