Eight basic economic arguments against a bailout of the auto industry

This week the CEOs of the “Big Three” US auto makers boarded their private jets in Detroit and touched down in Washington to beg and plead in front of Congress for a “low-interest bridge loan” from the US government to help them avoid bankruptcy. They are asking Congress for $25 billion of taxpayer money to give them the chance to re-structure and re-equip themselves for the future.

Below are eight arguments based on basic economic principles for why a bailout of the United States automobile industry is a bad idea and is bound to fail:

  1. Incentives matter: A bailout of the US auto industry ignores the basic economic principle that incentives matter. Individuals and firms respond to incentives, pursuing behavior that is likely to bring them the greatest rewards. In the face of falling demand for their product and ever-increasing competition from more efficient foreign producers, providing a $25 billion bailout creates a disincentive to drastically reduce costs and increase competitiveness, and an incentive to continue using tired old techniques and providing the same old models for which demand has declined among Americans for over a decade.
  2. Comparative advantage: The basic economic principle of comparative advantage states that in an era of free trade and globalization, countries should produce the types of goods for which they have the lowest opportunity cost. Since the average American car of a particular class costs the Big Three $2000 more in wages and benefits for workers than its Japanese counterpart, it makes sense that Japan (and other lower-cost countries) produce more cars, and the Big Three produce less.
  3. Efficient allocation of resources: The United Auto Workers Union has a member ship of over 400,000 workers. Since the 1970s the union has lost over 1 million workers. Clearly the US auto industry has been in decline for decades, a fact that should be taken as a sign: resources employed in America’s car industry are inefficient and represent a over-allocation of resources. A drastic down-sizing of the auto industry, while resulting in short-run hardships for the hundreds of thousands whose jobs will be lost, will in the long run strengthen the US economy as labor and other resources will be freed up to be employed in sectors in which the US has comparative advantage.
  4. Economic Darwinism or “the survival of the most efficient”: America has stood for free trade in the world since helping found GATT in 1948 and later the WTO. The gains from embracing free trade are shared among all stakeholders in the economy. Consumers enjoy lower prices (thus higher real income), firms enjoy access to cheaper inputs and larger markets for their products, and governments enjoy the increased tax revenues from rising incomes driven by export-led economic growth. To bail out an uncompetitive, inefficient, and long-declining industry is to spit in the eye of free trade and denies America any moral suasion it may hold in the future over potential trading nations in our attempt to open their markets to our nation’s products. To protect our own dying industry now will send a clear message to our trading partners. “America does NOT stand for free trade”. If we believe in free trade and the allocative power of markets, then we must let the dinosaurs of American industry meet the fate the natural selection of the marketplace has determined for it.
  5. The benefits enjoyed by the few represent costs born by the many: A bailout by the US government of the auto industry will protect a few hundred thousand jobs for a few years at the most but spells a reduction in the disposable incomes and spending power of millions for years to come. The US does not have $25 billion laying around to give the Big Three, which means the money must be borrowed. Increased government borrowing raises interest rates now (further tightening the credit markets) and will result in increased taxes down the road. All government debt must eventually be paid off, and in the immediate future interest on this debt must be paid directly from tax revenue. A $25 billion bailout is the same as a subsidy, meaning it redistributes income and welfare from consumers to producers. Millions are asked to sacrifice for the continued survival of a few hundred thousand in an industry that has failed to evolve in a global auto market that has seen increased competition and efficiency from foreign firms for decades.
  6. Moral hazard: Bailing out the Big Three today represent a classic case of moral hazard. When American industries fail to take steps to increase their efficiency and remain competitive in the face of increased global competition, they find themselves not surprisingly on the brink of collapse. To reward these firms by taking money out of Americans’ pockets and handing it to them to do as they will, we send the wrong message and create the wrong incentives in the American economy. The message is: “Don’t worry, the market doesn’t choose the winners and losers in the economy, the government does, and certain industries are too big to fail”.
  7. Market failure, or Firm Failure?: The fate of the auto industry is in the hands of the US government. But so is the fate of the free market. My fear now is that the pendulum will swing too far to the left in America’s state of panic over the ill-fated downfall of the financial markets, rooted in the irrational exuberance and over-leveraging of big financial institutions. The failure of the financial markets, however, is an entirely different story from that of a dinosaur industry like automobiles. The Big Three have had decades to reform themselves, lower their costs, improve their products, and remain competitive. THEY have failed, NOT the market. Government intervention is necessary in instances of market failure, but NOT IN CASES OF FIRMS’ FAILURE TO COMPETE IN A WELL FUNCTIONING MARKET like the global auto industry.
  8. Inflexible labor markets: I saw the president of the UAW on the news today giving 101 reasons why the government should approve a bailout deal for the Big Three. In fact, the unions that supposedly represent American Auto Workers are a big part of the problem the industry is facing. For decades the UAW has fought against wage and benefit cuts for auto workers, lobbying instead for higher tariffs and other barriers aimed at keeping foreign cars out of the country. This anti-competitive behavior is a major reason the Big Three cannot compete with European and Asian car makers today. Wage inflexibility leads to higher unemployment. Unions keep wages from going down, leaving the Big Three with one of two choices: Drastically downsize your workforce and employ fewer high paid auto workers, or beg the government for a multi-billion dollar subsidy to that the unions can be placated and you can survive for a couple more years until you’re in the same situation all over again. The unions helped cause the problem, now they should pay the price by experiencing the downsizing their demands inevitably foretold.

The US government should allow the free market to function and let the dinosaurs go extinct. Cars will still be made in America, they’ll just be made by the better, more efficient firms that emerge from bankruptcy when this is all over, as well as the numerous foreign firms already making cars in the US. Survival of the most efficient, that’s what markets are all about. Allowing the market to work will strengthen the US auto industry far more than a “short-term low-interest bridge loan” ever will, it will free up labor and capital resources to be employed by industries the country is better at, and make sure household income is NOT reallocated to inefficient firms to be squandered on the manufacture of a product for which demand has steadily declined for the last decade plus.


Originally at Welker’s Wikinomics Blog and reproduced here with the author’s permission.

6 Responses to "Eight basic economic arguments against a bailout of the auto industry"

  1. Wayne   November 24, 2008 at 1:54 pm

    Free trade devalued our workers and increased commodity prices. It also turned a communist country into a superpower. When are you guys going to get it? Protectionism is inherent to the success of a country.

  2. Tom L   November 25, 2008 at 3:17 pm

    1. The foriegn transplant companies are ALL receivingmillions of dollars in incentives and tax breaks. We wouldn’t want to be fair and LOAN the American auto industry any money2. Free trade is bull.. the foriegn countries do not allow as many vehicles in as the U.S. does.. See US Trade deficit.3 The Big 3 and UAW have drasticlly downsized, both salary and hourly.4.Its time we regotiate NAFTA and get out of GATT. This was to bring other countries up to our standards, not for us to go down to $5/DAY. Millions of good jobs have left America. See unemployment#4 The lack of a LOAN would cause more than a miilion jobs lost in the first year and cost the taxpayer much more than 25 billion in that time.5 The Harbour Report says the Big 3 are as efficient as any other car co. J.D. Powers awrds American cars on the best Quality too. GM make over 30 vehicles that get 30mph+ !!!6.7.8. The UAW has and is giving. They now have a 2-tier wage starting at $14.XX/hr. Jason can you raise a family of 4 on that???? Can you put a kid through college on that?? Some employees are starting at $11/hr.

  3. Anonymous   December 5, 2008 at 4:35 pm

    To the argument that people cannot raise a family on 14 some dollars an hour…you are right. However, this argument leads to my argument that America needs to be more competitive all around, not just in the auto industry.We are sitting on our laurels on inflated (yet low) minimum wages, as jobs are being outsourced because A) we’re being paid more than what the market deems competitive B) people are not investing in their future. You shouldn’t be putting yourself in a situation where your only option is to raise a family on 14.00 an hour. Instead, we need to be going to college to increase our value so we can command higher salaries. This in turn will make the US more intellectually (and ultimately economically) competitive. The US, however is falling behind other countries in educational achievement, so in order to compete in a world market, American’s really need to do the most they can to further their education. High school diplomas and GEDs won’t cut it in todays market.If you are demanding a wage of xx.xx an hour a company is only going to pay that wage if it deems it financially beneficial, meaning they think you will bring them MORE than xx.xx in productivity and profit. It doesn’t matter what you think you are worth; it matters what the market thinks you are worth. The bottom line is that the auto industry isn’t bringing in much profit at all, and as such, workers will have to deal with the fact that the wage they are requiring isn’t what they are worth to that particular company. The solution is to make yourself worth as much as possible. Demanding higher wages is not really making yourself worth more, its artificially increasing your worth often times beyond what is competitive. It doesn’t matter what you think you are worth; it matters what the market thinks you are worth. Ergo, to avoid the dilemma of “these people deserve more than 14.00 an hour” they should be educating themselves so they are ACTUALLY worth more than 14.00 an hour to the companies they want to work for.As far as the argument, “many people cant afford college.” I have two responses. 1) I didn’t pay a cent for my degree because I was awarded a tuition waiver for my success in high school. This is a possibility for tens of thousands of people who may not be able to afford school, but have the merit which is rewarded (re-read Welker’s first point about incentives). 2) Then maybe your argument should be that our education systems should be bailed out rather than the auto industry. The auto industry’s failure is a symptom, not the cause of America’s inability to keep up with foreign competition.

  4. Guest   December 5, 2008 at 10:57 pm

    Good article, you have posted the most intelligent arguments I’ve seen.

  5. Guest   December 12, 2008 at 10:27 am

    Get a clue. your ignorant. When triliions of dollars of debt is defaulted on because of the massive fallout here what do you think will happen to our beloved financial industry. The widespread reach of this is too big. This is not just thousands of workers , its millions. And when thousands of comapanies default on millions and in some case as GM billions in debt. And I have not even got to personal debt that will be defaulted on. Wait till forclosures skyrocket triple what they are now. Are financial infrastructure will collapse as they are already in dissarray. There will be no amount of money that we can put back into the banks that will stop the house from falling. Its articles Like these that spread untruths and will be the downfall of the modern day roman empire and you will fall to MARK MY WORDS!!!! and as for Bankruptcy are you kidding, The secondary makets are shut down. There is not even bank to bank Lending going on except for short term. The auto industry would need billions just to enter into bankruptcy. No money available in your so called free market. Any Chapter 11 filing would certain turn to a chapter 7 liquidation. There is no liquid available to even go through Bankruptcy. Please learn a little before you write such utter garbage and get a clue of what you speak.

  6. FUBOO   December 17, 2008 at 12:06 pm

    If we dont bail out the detroit 3, like 3 million americans will lose their jobs! dont let that happen!!!