The Auto Bailout Issue—Posner

I’ve enjoyed Justice Posner’s writing elsewhere, and I enjoy his blog. Interesting take on auto bailout, basically advocating this to delay bankruptcy / liquidation until the US economy has enough positive sentiment to stomach it.

via The Becker-Posner Blog on 12/14/08

We blogged on November 18 about whether the government should provide money to the U.S. auto manufacturers to keep them alive. (I was for; Becker was against.) In the short period since then, there have been important developments bearing on the issue, culminating this past Friday in the blocking by Senate Republicans of the Democrats’ modest ($15 billion) auto bailout bill, and the announcement by the Bush Administration that it might, after all, agree to use part of the $700 billion financial-sector bailout to keep the U.S. auto manufacturers going until President-elect Obama takes office. So Becker and I have decided to return to the issue.

The issue has a political and an economic dimension. From a political standpoint, the current position–no bailout legislation, but possible allocation of part of the financial-sector bailout money to the domestic auto manufacturers–represents, unusually, a victory for both political parties. The Republican Senators have stood up for principle–that freedom to fail is basic to capitalism, that wages and benefits should be set by free labor markets rather than by powerful unions, which are worker cartels, that government should not manage businesses, and that government expenditures should be minimized–and for the interests of Toyota and the other foreign manufacturers that have plants in the United States; for those plants are mainly in the South, which is the stronghold of the Republican Party. By opposing an auto bailout the Republican Senators have also distanced themselves from the Bush Administration, which is at once unpopular and believed by many Republicans to have betrayed Republican small-government principles. There is a grave risk that, as I argued in my November 18 posting, a collapse of the domestic auto industry could have serious adverse consequences for the U.S. economy as a whole, which would expose the Republican Senators to criticism. But that risk is buffered by the Administration’s apparent willingness to bail out the auto industry without new legislation.

The Democrats (including the incoming administration) have scored points among their constituencies by standing up for union workers, for the “greening†of the automobile industry, for states in which the domestic auto industry is centered that voted Democratic in the November election (Michigan, Ohio, and Indiana), for the principle of active government, and for trying to avert a deepening of the current depression.

The bailout bill was a mess, but a harmless one, if I am right that the domestic producers should not be allowed to collapse at a time of profound and, it appears, worsening economic distress. The bill was a mess because of the conditions that it would have imposed on the industry, conditions that earned the justified ire of the Republican Senators because of its failure to lean hard on the collective bargaining agreements negotiated by the United Auto Workers, because of the divided control of the industry that the bill if enacted would have brought about–divided among the manufacturers, a federal “car czar,” and intrusive congressional oversight–and because of the considerable element of fantasy in the idea that Congress plus the President can revitalize the domestic auto industry. Nowhere is it written that the United States, let alone the midwest, where the domestic auto manufacturers are centered, has a comparative advantage over other countries, or other regions of the United States, in manufacturing motor vehicles. Evidently it does not, and Congress and the President cannot change that, as Japan learned from the failure of its “industrial policy” administered by Japan’s once-admired Ministry of International Trade and Industry.

For the problem of the Detroit manufacturers is not just a matter of higher wages, to be solved by renegotiation of their collective bargaining agreements. The wage difference (actually the benefits difference–the hourly wages of the auto workers employed by the domestic manufacturers are only slightly higher than the wages of the workers employed in the U.S. plants of Toyota and other foreign manufacturers) is an important but not the decisive factor in the decline of the domestic auto industry. The difference in the wage and benefits package between employees of the domestic manufacturers and of the foreign ones in the United States has been exaggerated by treating as a part of that package the annual payments to retired workers divided by the number of hours worked annually by current workers. The money owed the retirees is a fixed cost, like any other debt. Eliminating those payments, like reducing the industry’s bond debt, would improve the industry’s balance sheet by reducing its fixed costs, but would not reduce the cost of making cars, or increase their quality. Merely wiping out existing debt, the main consequence of reorganization in bankruptcy, does not improve the efficiency or competitive position of the reorganized firm, which is why most reorganizations end in liquidation. What would improve the efficiency of the domestic auto manufacturers, besides reducing wages and current workers’ benefits, would be jettisoning union-imposed work rules; that was part of Republican Senator Corker’s ingenious proposal (of course rejected by the union) to condition a bailout on the union’s agreeing to a reduction in the wages and benefits of the Detroit auto makers’ workers to the level prevailing in the southern automobile plants of the foreign auto companies. The adoption of his proposal would have been tantamount to putting the United Auto Workers out of business–if unionized workers have the identical wages, benefits, and working conditions as nonunionized ones, why would anyone pay union dues?

I doubt that anyone in Congress or in either the outgoing or the incoming Administration really thinks that a bailout bill will place the domestic industry on the path to salvation. The conditions imposed to achieve the “reform” of the industry are window dressing. All three domestic manufacturers (yes, Ford included) are insolvent, and while they are unlikely to close down and liquidate completely if forced into bankruptcy–Americans will probably buy 10 million motor vehicles in 2009 and they are unlikely all to be made by foreign companies (the foreign share of the U.S. car market, including both imports and cars manufactured in the U.S. plants of foreign companies, is about 50 percent, though they could take up some of the slack created by the collapse of the Detroit manufacturers, since the foreign companies’ sales are down too). Even with an infusion of federal money, there will be many plant closings and layoffs and many bankruptcies and liquidations of auto parts suppliers and auto dealers.

But formal declarations of bankruptcy by the domestic manufacturers would, I believe (as I argued in my November 18 posting), have a substantial added negative effect on the economy. Consumers are markedly reducing their purchases of durable goods because their savings are so depleted that they cannot, as in previous economic downturns, reallocate savings to consumption. Instead they are reallocating income from consumption to savings. The result is a downward spiral: consumers spend less, so output drops, resulting in layoffs that result in further reductions in consumption and in turn in output. The spiral will eventually bottom out, but it will bottom out at a lower level if hundreds of thousands of employees of auto manufacturers, auto parts suppliers, and auto dealers are terminated more or less all at once and consumers planning to buy a car in 2009 are scared off by the uncertainties associated with bankruptcy. (Will warranties be honored? Will parts be available? Will the dealership from which one bought a car survive? Will service standards slip? What about the car’s resale value? And should one believe the soothing assurances that bankruptcy is no big deal for the customers of the bankrupt firm, as long as it does not liquidate, when all the other soothing assurances by the government have proved unfounded?) Because motor vehicles are highly durable, it is easy to be prudent and defer replacing one’s existing vehicle until one’s economic situation clarifies.

Granted, with General Motors having publicly acknowledged hiring a leading bankruptcy lawyer to counsel it and announced that it will be shutting much of its North American operations for a period of months, there is increasing public recognition that the Detroit automobile industry is bankrupt in all but name. But I still fear the psychological effect of a formal declaration of bankruptcy at a time when many–probably most–Americans are anxious about their economic situation. Individually, consumer prudence is wise; collectively, it will exacerbate the depression.

The realistic goal of an auto-industry bailout is not to reform, revitalize, or restructure the domestic industry; it is merely to postpone its bankruptcy for a year or two, until the end of the depression is at least in sight and consumer confidence is restored to the point at which the bankruptcy of the domestic manufacturers can be taken in stride. To attain this goal does not require imposing conditions on the use that the auto manufacturers make of the bailout moneys. The conditions that the bill would have imposed and that any other form of government funding will impose are not an economic but a political necessity because of widespread anger at the incompetence of the industry; a majority of Americans oppose any bailout of the Detroit manufacturers.

At the very least, the Obama administration should be allowed to decide the fate of the companies; that argues for a modest government loan that will keep them out of bankruptcy until, say, February.

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2 Comments

Filed under business, news, politics

2 responses to “The Auto Bailout Issue—Posner

  1. Excellent Blog. I’ve been reading along and just wanted to say hi. I will be reading more of your posts in the future.

    – Jason.

  2. yokum

    I had a class from Judge Posner. He is an extremely intelligent person who writes prolifically.

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