Making Sense on Detroit

Jim Manzi tells the story in numbers in response to Cohn’s story from the GM public relations department: 

A dollar invested in a diversified basket of S&P 500 stocks twenty years ago would today have a face value of about $3, while a dollar invested at the same time in GM shares would today have a face value of about 7 cents (though to get true comparability you would have to calculate Total Shareholder Return, including dividends). There is no five year period that I could find in the last thirty years for which GM’s stock price outperformed the S&P 500. The market capitalization of GM is now under $2 billion, which is substantially less than that of such icons of our economy as Cognizant Technology Solutions, DaVita, Inc., Freeport-McMoRan Copper & Gold, and the Potash Corporation of Saskatchewan. GM is in danger of becoming a small-cap. Investors apparently don’t buy (literally) Cohn’s thesis.

In the face of all this evidence, Cohn wants us to believe that this time it’s different – that in spite of the forecast of the stock market, in spite of the judgment of consumers voting with their own money, and of in spite of the actual financial results, we can put tens of billions of dollars of taxpayer money at risk based on the opinion of some academics and interested parties that really, things are about to turn around.

Here’s my colleague Dan Ikenson noting that there is in fact an effective and profitable U.S. auto industry, and that, as the steel industry shows, consolidation can be a very good thing,  

If GM fails – or even GM and Ford both fail – we are not facing the loss of the U.S. auto industry. There are plenty of profitable operations, particularly those operating outside of Michigan. In 2008, the Big Three accounts for roughly 55% of light vehicle production and 50% of sales. To speak of the U.S. automobile industry these days, one must include Honda, Toyota, Nissan, Kia, Hyundai, BMW – and other foreign nameplate producers who manufacture vehicles in the U.S.

Those producers are the other half of the U.S. auto industry. They employ American workers, pay U.S. taxes, support other U.S. businesses, contribute to local charities, have genuine stakes in their local communities and face the same contracting demand for automobiles as does the Big Three. The difference is that these companies have a better track record of making products Americans want to consume and are not seeking federal assistance.

If taxpayers are forced to subsidize automobile producers, they should at least be able to subsidize the successful ones.

If one or two of the Big Three went into bankruptcy and liquidated, people would lose their jobs. But the sky would not fall. In fact, that outcome would ultimately improve prospects for the firms and workers that remain in the industry. That is precisely what happened with the U.S. steel industry, which responded to waning fortunes and dozens of bankruptcies earlier in the decade by finally allowing unproductive, inefficient mills to shut down.

In 2001, 12 firms accounted for 75% of U.S. hot-rolled steel production. In 2007, three firms accounted for more than 80% of hot-rolled steel production. The consolidation has afforded the steel industry an alternative to requesting bailouts in the face of declining demand.

Following the steel industry’s lead to an auto industry reckoning makes more sense – to the taxpayers, to the country, and ultimately to the auto industry – than another bailout.

Uiversity of Chicago economist Casey Mulligan notes the whole thing would be a massive upward transfer of wealth:

Workers at GM, Ford, and Chrysler are not among the poor by any definition: those workers’ salary and benefits total more than $70 per hour!! Yes, I typed that correctly.Very few American workers earn that much per hour.

GM, Ford, and Chrysler shareholders are not among the poor either: the poor own little if any stocks. So a GM bailout would benefit rich workers and rich shareholders. I guess the argument is that a GM bailout would trickle down to people who really are poor, or at least middle class.

A rapid and decisive GM collapse would allow us to continue to hope that President-elect Obama represents genuine change: leading politicians of the Democratic party will no longer tax the average American to bail out the rich, regardless of whether those rich do business in Detroit or in New York City.

The issue isn’t whether unemployment will surge. It will.  Or whether recovery will occur. It will. The issue is whether a small portion of American workers will be able to maintain stupendous advantages over similar workers of similar skill and productivity. Louis Uchitelle in the NYT writes:

The elimination of many more workers, most of them union members and earning upwards of $20 an hour, would be devastating in Michigan, Ohio and Indiana, where the American automakers and many of their suppliers are concentrated. In fact, many of those jobs may disappear even if the companies win government assistance.

But other employers would take their place over time. As the foreign companies stepped up production to replace what would be lost by an American company’s collapse, the transplants would add to their existing work force of 78,000, replacing many of the lost jobs, although at lower wages, with fewer benefits and at nonunion factories in other parts of the country.

And there’s the issue. This chart by University of Michigan, Flint economist Mark Perry sums it up:

Perry asks:

Should U.S. taxpayers really be providing billions of dollars to bailout companies (GM, Ford and Chrysler) that compensate their workers 52.5% more than the market (assuming Toyota wages and benefits are market), 54% more than management and professional workers, 132% more than the average manufacturing wage, and 157% more than the average compensation of all American workers? 

Maybe the country would be better off in the long run if we let the Big Three fail, and in the process break the UAW labor monopoly, and then let Toyota, Honda and Volkswagen take over the U.S. auto industry, and restore realistic, competitive, market wages to the industry. It might be the best long-run solution.

It really might be!

Author: Will Wilkinson

Vice President for Research at the Niskanen Center