IN appearances before the US Senate Banking Committee, the chief executives of Detroit's Big Three auto makers, General Motors Corporation, Ford Motor Co and Chrysler LLC, appealed in dire language for US taxpayers to help their industry. Executives of the automobile giants argued that those Big Three could run out of funds without the government's support, and the volatile US economic situation could not withstand a collapse of any of the companies. So far, the US Congress is now considering a federal bailout for Big Three auto giants by granting them at least $ 25 billion from the $ 700 billion Troubled Asset Relief Program (TARP) on top of $ 25 billion in low-interest loans approved earlier this year. But do Detroit's Big Three deserve a government bailout?
Consider the example of General Motors (GM). After 42 years of eroding US market share from 53 per cent to 20 per cent, GM still has eight US brands. As for its more successful competitors, Toyota (19 per cent market share) has three, and Honda (11 per cent) has two. GM has about 7,000 dealers but Toyota has fewer than 1,500. Honda has about 1,000. These fewer dealers are better able to advertise, stock and service the cars they sell. This makes the brands GM sell very expensive. In fact, it would cost GM billions of dollars and many years to reduce the number of dealers it has to a number near Toyota's.
Foreign-owned manufacturers who build cars with US workers pay wages similar to GM's. But GM is contractually required to guarantee nearly full wages and benefits for workers who lose their jobs due to automation or plant closure. It supports more retirees than current workers. It has other contractual obligations such as lease payment on properties for unproductive facilities, health coverage for union retirees. All of these commitments drain its cash every month. In fact, employees, union, and suppliers - all want GM to be more or less what it is today.
Despite all the fact, the cost of terminating dealers is only a fraction of what it would cost to rebuild GM to become company size and marketed appropriately for its market portion because, contracts would have to be bought out and GM would have to shed many of its fixed obligations. Some obligations will be impossible to cut by voluntary agreement. And Eventually, GM will run out of cash and out of time.
Advocates of a bailout say saving Detroit is necessary to protect the US manufacturing base. In an article on the Wall Street Journal, "Why GM deserves support", Rick Wagoner, GM's CEO and Chairman, says, "For America to compete in the global marketplace in the 21st century, it needs a strong manufacturing base and a vital domestic auto industry... Short-term government support … will enable GM to continue as an engine for prosperity … Such assistance will save millions of jobs now, and produce enormous benefits for years to come."
But he missed one very basic principle of business: If you lose your comparative advantage over your rivals, you are not supposed to be in business, at least not in the USA. Besides an industry, in the long-run, under continuous government support hardly gain comparative advantage and provides steady contribution in the economy, either in term of employment or other kinds of benefit.
In fact, the cost of bailing-out Detroit, i.e., the Big Three could be suicidal to the USA, in the long-run. The first global cost of a bailout could be less foreign direct investment (FDI) coming into the United States. Since a critical foundation of foreign-investors' confidence in US assets has been transparent competition in product markets. To keep that up, it is important to address concerns related to allowing foreign companies to compete on US soil, not by bailing out struggling companies. If FDI flow reduces in US, thus, trade deficits will increase which will hurt the dollar too.
Matthew Slaughter, Professor at Dartmouth's Tuck School of Business, added another fact that a bailout will likely entrench and expand protectionist practices across the globe, and thus erode the foreign sales and competitiveness of US multinationals. And that would reduce these companies' employee in US, R&D and related activities, which would be bad for US. Hence, Michael Levine, professor from NYU School of Law, finds that reorganisation under chapter 11 of the bankruptcy code is the most desirable action before getting tired of feeding those auto giants. Those companies lost comparative advantage of doing business over their rivals; mostly because of huge legacy costs (e.g., retiree pension, health, insurance, and other benefits to the employee) they pay every year. But under chapter 11, State protections for dealers would disappear. Labour contracts could be renegotiated. Pension plans could be terminated and Health benefits could be renegotiated. For instance, the bankruptcy judge might order that the retiree will get 80 cents in a dollar and so on. In addition, GM can guarantee warranty support with a segregated fund if necessary. Though it would not be easy, under chapter 11, GM could be rebuilt as a company that can make vehicles people want and support itself on revenue.
However, in context of Bangladesh, one might think that filling bankruptcy means going for liquidation or going out of business. But in the USA, about 20 per cent firms that filled bankruptcy went to liquidation. And the most important thing is, research shows, that after filling bankruptcy, firms operating income skyrocketed.
Those giant auto giants' solution is to ask the federal government for the cash so that they can fight recent volatile market. But much of the cash will be go into unproductive commitments, i.e. to pay off legacy costs. And like AIG, they will be back for more in near future. But then too many such bailouts could erode competitiveness that spurs economic growth and rising average standard of living. So, not federal support but corporate rebuilding, though filling for bankruptcy under chapter 11, can save Detroit's Big Three.
*This article was published on the daily Independent in Bangladesh on November 26, 2008.
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