“The Problem with Bailouts”

Ed Glaeser doesn’t like the auto bailout:

The problem with bailouts, by Edward L. Glaeser, Commentary, Boston Globe: Recessions can … reveal weakness in seemingly invulnerable businesses, like Citibank and Toyota. But diagnosing the nature of corporate ill health may be difficult. Some firms suffer from a fatal disease; others have a temporary virus. …

The distinction between permanent and transitory troubles appears across industries, companies, and cities. The metropolitan areas of San Jose and Detroit are both suffering from double-digit unemployment rates… Despite California’s political mismanagement, San Jose has a superb base of tech-savvy entrepreneurs and a terrific climate. Silicon Valley will rise again, but the prognosis for Detroit is less rosy. Overdependence on one not very competitive industry, a shortage of college graduates, and a cold climate have led the city of Detroit to lose more than 50 percent of its population since 1950. …

When investment is private, professional investors determine which companies are doomed and which are salvageable. In the current situation, however, the government has decided that a large number of firms are too big to fail and so our elected leaders are deciding which firms to save and which to let go.

The right answer is not “save everybody.” Human and physical capital should move out of declining industries and into more productive areas, unless America wants to be a permanent, industrial underperformer. But public-sector intervention usually errs on the side of the status quo. Politicians respond to the workers in an existing firm who are … rallying to keep their jobs. The customers and employees of the new firms that will rise from a collapse have no seat at the table.

Since the collapse of Lehman Brothers, the public sector has spent billions saving the banks. While these decisions are certainly debatable, they are understandable. The US financial industry misbehaved badly,… but it is still a sector with a future. … After all, every other sector in the economy depends on banks for their financing.

But what about cars? … Does anyone, other than GM’s management, believe that this company can come back? The current treatment, cash infusion and a reduction in corporate liabilities, provides a solution for a company that is broke, not for one that is broken.

The great cost of saving GM as a single company is that … America’s car industry … might be better served with a number of smaller, nimbler firms. Across metropolitan areas and across sectors within areas, there is a strong link between small firms and economic success. Detroit was, a century ago, among the most entrepreneurial places on the planet, and it achieved automotive miracles, the scale of which ultimately turned the city into a model of big-firm stagnation.

If General Motors becomes a permanent employee-owned, state-sanctioned enterprise, the firm will lose its chance to split up and become entrepreneurial once more. This could be the great price, even greater than the tax costs, of treating a permanently plagued company like one with a temporary cash shortfall. As flawed as the free market may be, it is hard to be enthusiastic when politicians start playing financier with our tax dollars.

I don’t think anyone is planning on “a permanent employee-owned, state-sanctioned enterprise.” I don’t disagree that the auto industry needs to change. However, there is a maximum rate at which the economy can transform itself, a maximum rate at which the economy can create new industry and absorb displaced and unemployed labor, and presently there’s not much more the economy can do. Putting people out of work only to have to spend money in other ways to support those very same people through social insurance programs, losing tax revenues because of their lost income, and so on, is not wise. The transition needs to happen, and a break-up into smaller firms might very well be part of it, but it needs to happen at an acceptable rate.

When the bathtub is already draining as fast as it possibly can, dumping more water into it does not make the tub empty any faster, it only raises the water level. Similarly, right now the pool of unemployed is draining as fast as it can, and dumping more people into it will simply make the problem worse, the transformation of the economy won’t happen any faster. Yes the car companies need to change, and yes, the government support needs to end as fast as possible. But the change can only happen so fast, and trying to push it faster doesn’t do any good.

There will come a time once recovery is under way to make changes such as those discussed above. I know I don’t want a permanent state-run or state-backed enterprise, and there will come a time when the companies must stand or fall on their own. But I also don’t want to put people out of work during a recession based upon the notion that the industry must transform itself through private sector initiative when there’s very little chance of that happening until things improve.

Originally published at Economist’s view and reproduced here with the author’s permission.

28 Responses to "“The Problem with Bailouts”"

  1. Guest   June 8, 2009 at 7:00 am

    The real problem at GM was not addressed and the real problem at GM may well be just be the future of us. The aging population and entitlements. I read recently in the last 9 years GM accumulated over 40 billion in direct debt to service the pension and retirees health program. Can you imagine the drain on the company on margins and engineering trying to service that. It was said recently GM no longer was car manufacture but a pension fund company that made cars to support the pension fund.All the 7 cars I currently own are from a bankrupt auto company. I will not buy a car from a government owned company. How many Americans have the same thought I do? This is called human behavior! Something a graph or chart does not factor in. GM will fail and can only exist with continued influx of government moneyIf the rule of law would of prevailed and a dictator would of not interfered in the process the chance of success would have been greater.