THE UNINTENDED CONSEQUENCES OF THE AUTO BAILOUT

Saturday's Wall Street Journal contained an excellent essay by Shikha Dalmia and Henry Payne, entitled "Detroit Bets Its Future on Washington", which argues that General Motors is not taking the bailout money in order to be competitive, but to become the government's partner in developing green technology. They note that:

"By accepting government welfare, GM rejected the chance to transform itself into a worthy competitor to foreign manufacturers. That would have required making too many hard decisions, such as confronting unions, cutting legacy costs, and slashing dealerships under a Chapter 11 filing…. But GM is not counting on market success for its comeback. It has neither the cash reserves nor the brilliant product line needed for that in a down economy, when sales are expected to be 40% lower than two years ago (the lowest volume since the 1973 Arab oil embargo.)”

Rather, they argue that GM is counting on the government to stay alive and that its new green priorities are intended to ensure another round of government funding. They expect that Washington will have to continue to give them funding in order to support such boondoggles as electric cars. This thesis may be a little far-fetched -- it seems doubtful that GM management could actually think in such a Machiavellian manner. However, it seems clear that the bailout is not going to help them succeed in the marketplace.

Before examining unintended consequences, we have to analyze Washington's intended consequences for the bailout. The Bush administration lent $17.4 billion to General Motors and Chrysler, but required them to extract concessions from workers, suppliers, dealers and other stakeholders by March 31 in order to demonstrate their economic viability. Now that the Democrats are in charge, it seems clear that renewal of the loans and further grants will require further development of green vehicles, such as the Chevrolet Volt electrical car.

The Bush administration intended to have a viable American car industry as a result of its largess. It is not at all clear that the Obama administration would be nearly as concerned about the viability of the industry, as about protection of union jobs and development of green technology.

Are the results of this bailout likely to achieve the government’s goals? The answer is undoubtedly negative -- GM and Chrysler simply do not have the leverage to negotiate the thorough reforms that are necessary to make them truly competitive. There are three major areas of the bailout at which GM and Chrysler are unlikely to succeed.

Unions -- The nature of unions is to extort as much as possible from management, and to protect the lifestyle of the worker as much as possible. The UAW will undoubtedly concede in a few areas -- moving up the implementation of the health-care changes negotiated last year, and giving up the truly amazing provision under which the automobile companies continue to almost entirely full pay to laid off workers. However, to be successful, GM and Chrysler must achieve a complete change of environment on the factory floor. An e-mail recently circulated on the Internet from an automotive supplier commented on what he had seen in the automobile factories – “our factories have been filled with the worlds most overpaid, arrogant, ignorant and laziest entitlement minded "laborers".” Will General Motors be able to get rid of the numerous petty work rules and other union impediments to efficient production? It is highly unlikely.

Dealers -- The consensus of numerous articles appears to be that GM should reduce its dealer force by about one third. However, its hands are tied by the "Dealer Day in Court” laws adopted both by the federal government and by numerous states, which make it impossible to terminate dealerships without enormous buyouts. If the government really wants the auto companies to achieve liability, it should amend the federal law and preempt state laws to encourage consolidation is dealerships, and to allow the car companies to terminate dealers on more reasonable terms.

Environmental Cars -- The constant theme of Democrats, in particular, is that the automobile companies should do more to create small, environmentally friendly cars and to ultimately get rid of the gasoline engine. However, by forcing Detroit to build these machines, the government will simply make them noncompetitive. The proposed Chevrolet Volt will cost $40,000 for an underpowered automobile they can't be used for anything except local, around-town driving. Who in their right mind would pay this much money when they could buy a comfortable small car for half the price. For political purposes, GM obviously has to build a car. However, it will lose enormous amounts of money and divert scarce engineering talent from more productive projects.

What, therefore, are the unintended consequences of the bailout -- American manufacturers will not achieve viability, and will continue at a competitive disadvantage to foreign companies that make their own cars in the US. The American taxpayer will continue to pour funds into sustaining companies that can no longer operate without government interference. And electrical cars will again be failures in the marketplace.

The recent spike in gasoline prices demonstrated that consumers react in an economically logical manner. When prices went up over four dollars per gallon, they drove less, and began switching their SUVs for smaller cars. If the government lets gasoline prices achieve such levels again in the normal marketplace, it can expect consumers to act in the same way. There will be a natural marketplace for cars that use less gasoline, and perhaps, someday, even for electric automobiles. However, the government cannot force this change -- it must be the result of the normal development of the market.