Nov 21 2008

Eight basic economic arguments against a bailout of the auto industry

This week the CEOs of the “Big Three” US auto makers boarded their private jets in Detroit and touched down in Washington to beg and plead in front of Congress for a “low-interest bridge loan” from the US government to help them avoid bankruptcy. They are asking Congress for $25 billion of taxpayer money to give them the chance to re-structure and re-equip themselves for the future.


Below are eight arguments based on basic economic principles for why a bailout of the United States automobile industry is a bad idea and is bound to fail:

  1. Incentives matter: A bailout of the US auto industry ignores the basic economic principle that incentives matter. Individuals and firms respond to incentives, pursuing behavior that is likely to bring them the greatest rewards. In the face of falling demand for their product and ever-increasing competition from more efficient foreign producers, providing a $25 billion bailout creates a disincentive to drastically reduce costs and increase competitiveness, and an incentive to continue using tired old techniques and providing the same old models for which demand has declined among Americans for over a decade.
  2. Comparative advantage: The basic economic principle of comparative advantage states that in an era of free trade and globalization, countries should produce the types of goods for which they have the lowest opportunity cost. Since the average American car of a particular class costs the Big Three $2000 more in wages and benefits for workers than its Japanese counterpart, it makes sense that Japan (and other lower-cost countries) produce more cars, and the Big Three produce less.
  3. Efficient allocation of resources: The United Auto Workers Union has a member ship of over 400,000 workers. Since the 1970s the union has lost over 1 million workers. Clearly the US auto industry has been in decline for decades, a fact that should be taken as a sign: resources employed in America’s car industry are inefficient and represent a over-allocation of resources. A drastic down-sizing of the auto industry, while resulting in short-run hardships for the hundreds of thousands whose jobs will be lost, will in the long run strengthen the US economy as labor and other resources will be freed up to be employed in sectors in which the US has comparative advantage.
  4. Economic Darwinism or “the survival of the most efficient”: America has stood for free trade in the world since helping found GATT in 1948 and later the WTO. The gains from embracing free trade are shared among all stakeholders in the economy. Consumers enjoy lower prices (thus higher real income), firms enjoy access to cheaper inputs and larger markets for their products, and governments enjoy the increased tax revenues from rising incomes driven by export-led economic growth. To bail out an uncompetitive, inefficient, and long-declining industry is to spit in the eye of free trade and denies America any moral suasion it may hold in the future over potential trading nations in our attempt to open their markets to our nation’s products. To protect our own dying industry now will send a clear message to our trading partners. “America does NOT stand for free trade”. If we believe in free trade and the allocative power of markets, then we must let the dinosaurs of American industry meet the fate the natural selection of the marketplace has determined for it.
  5. The benefits enjoyed by the few represent costs born by the many: A bailout by the US government of the auto industry will protect a few hundred thousand jobs for a few years at the most but spells a reduction in the disposable incomes and spending power of millions for years to come. The US does not have $25 billion laying around to give the Big Three, which means the money must be borrowed. Increased government borrowing raises interest rates now (further tightening the credit markets) and will result in increased taxes down the road. All government debt must eventually be paid off, and in the immediate future interest on this debt must be paid directly from tax revenue. A $25 billion bailout is the same as a subsidy, meaning it redistributes income and welfare from consumers to producers. Millions are asked to sacrifice for the continued survival of a few hundred thousand in an industry that has failed to evolve in a global auto market that has seen increased competition and efficiency from foreign firms for decades.
  6. Moral hazard: Bailing out the Big Three today represent a classic case of moral hazard. When American industries fail to take steps to increase their efficiency and remain competitive in the face of increased global competition, they find themselves not surprisingly on the brink of collapse. To reward these firms by taking money out of Americans’ pockets and handing it to them to do as they will, we send the wrong message and create the wrong incentives in the American economy. The message is: “Don’t worry, the market doesn’t choose the winners and losers in the economy, the government does, and certain industries are too big to fail”.
  7. Market failure, or Firm Failure?: The fate of the auto industry is in the hands of the US government. But so is the fate of the free market. My fear now is that the pendulum will swing too far to the left in America’s state of panic over the ill-fated downfall of the financial markets, rooted in the irrational exuberance and over-leveraging of big financial institutions. The failure of the financial markets, however, is an entirely different story from that of a dinosaur industry like automobiles. The Big Three have had decades to reform themselves, lower their costs, improve their products, and remain competitive. THEY have failed, NOT the market. Government intervention is necessary in instances of market failure, but NOT IN CASES OF FIRMS’ FAILURE TO COMPETE IN A WELL FUNCTIONING MARKET like the global auto industry.
  8. Inflexible labor markets: I saw the president of the UAW on the news today giving 101 reasons why the government should approve a bailout deal for the Big Three. In fact, the unions that supposedly represent American Auto Workers are a big part of the problem the industry is facing. For decades the UAW has fought against wage and benefit cuts for auto workers, lobbying instead for higher tariffs and other barriers aimed at keeping foreign cars out of the country. This anti-competitive behavior is a major reason the Big Three cannot compete with European and Asian car makers today. Wage inflexibility leads to higher unemployment. Unions keep wages from going down, leaving the Big Three with one of two choices: Drastically downsize your workforce and employ fewer high paid auto workers, or beg the government for a multi-billion dollar subsidy to that the unions can be placated and you can survive for a couple more years until you’re in the same situation all over again. The unions helped cause the problem, now they should pay the price by experiencing the downsizing their demands inevitably foretold.

The US government should allow the free market to function and let the dinosaurs go extinct. Cars will still be made in America, they’ll just be made by the better, more efficient firms that emerge from bankruptcy when this is all over, as well as the numerous foreign firms already making cars in the US. Survival of the most efficient, that’s what markets are all about. Allowing the market to work will strengthen the US auto industry far more than a “short-term low-interest bridge loan” ever will, it will free up labor and capital resources to be employed by industries the country is better at, and make sure household income is NOT reallocated to inefficient firms to be squandered on the manufacture of a product for which demand has steadily declined for the last decade plus.

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

38 responses so far

38 Responses to “Eight basic economic arguments against a bailout of the auto industry”

  1. METon 21 Nov 2008 at 11:52 am

    Today in my AP Economics class we had a big discussion about how the auto industrys are going downhill rapidly. A girl made a comment that really caught my attention. She said how she was listening to the radio and how everyone was saying to just let these companies go bankrupt and then help them from there rather than spend all this money trying to get them out when they are so unsure of the outcome. I totally agree with this because why would you spend money that might go to waste in the future over something that you have no control over. Best of luck to them.

  2. Joelon 21 Nov 2008 at 6:01 pm

    These are indeed very valid reasons not to bail out the auto industry. They do make economic sense, and follow theory. I would agree with the theory under normal conditions; a stable economy with good employment figures and steady growth. However, as we have seen in the last few months, we are in a situation that is anything but normal. We're facing a global recession with ever lower aggregate demand in economies around the world.

    In response to this, governments have resorted to keynsianism, injecting fiscal stimuli to try and boost aggregate demand. This is simply spending vast amounts of money in order to dig economies out of recession.

    I don't think we should look at such bail outs, such as in the auto industry, as just keeping inefficient industries in business, but we should notice the cash injection.

    I would therefore argue that BAILOUT=G

    The cash injected into ailing industries keeps them in business, while keeping their worker's jobs secure. If these people lost their jobs, there would be a decrease in consumption, and therefore even lower aggregate demand, further fuelling the recession.

    Yes, it sets a bad precedent. Yes, it keeps inefficient businesses in work. But these are tough times, and no ordinary conditions.

  3. dean faughton 21 Nov 2008 at 6:10 pm

    your classic liberal interpretations/definitions are definitely schooling your kids in the ways of adam smith… for sure ! some comments:

    incentives: US demand for inefficient US made autos has been on the wane, true, but the alternatives are made with exploited and many times non union labor… not good for the welfare of the workers involved in this 'race to the bottom'…

    comparative advantage: it is not in a country's best interest to compromise such an essential cog in an industrialized nation such as the US… it would also not be in (eg) France's best interest to sacrifice citroen/renault/peugeot to the gods of globalization… australia?? perhaps, because it is a country that is lower in population and can't really sustain a car industry… but the countries that have existing auto industries should attempt to keep them sustainable/vital… and unionized !!

    efficient allocation of resources: while it is all fine and good to advocate a switchover to 'comparative advantage sectors', the majority of the population (70%) is without a college education… making it quite difficult for said switchover to actually materialize…

    darwinism: this argument is only relevant if every other country played fair in their export policies (especially toward the US, instead of practicing 'dumping')…

    benefits of few burdening many: the US has $25 billion in loose change found in the sofa cushions of washington DC… its nonsense to say that burden would burden the tax payers for very long at all. moreover, the bailout could go a long way in making the Big Three more able to survive in the increasingly predatory trade environment…

    moral hazard: what's morally hazardous is the wages paid by the seemingly 'competitive' competition… if their standard of living was comparable to the US, their labor wages would be higher and more in line with the US…

    market or firm failure??: the global auto industry isn't a fair playing field at all. and, there is nothing wrong with essential industries receiving help from their respective governments to help level the playing field in the face of such obvious unfair trade practices from the competition…

    inflexible labor markets: union posturing is a problem i admit, but given a fair playing field, the US auto industry with a workable and flexible union would be able to compete and not go the way of extinction… it would be a suicide of national interest to allow these companies to suffer unduly in the face of such harsh inequities in labor practices world wide.

    thanks jason… it was fun!!

    nowra1 (from twitter)

  4. Horia Stanescuon 21 Nov 2008 at 6:39 pm

    The article hit the nail on the head in my opinion. Bailing out the auto-industry is not morally incorrect but economically unjust. Yes, bailing out the auto industry would lead to an increase in AD (A+I+C+G+(X-M), but it would only act as a patch over a festering wound. The 25$ billion would be much more effective if they would be invested in retraining the American car-manufacturing employees. Not only would this solve the problem constantly having to bail out a continuously failing industry, but it would increase AD (government is still spending the money) and also solve the problem for the unemployed GM/Ford/Chrysler workers and be able to employ them into an industry in which America has comparative advantage

  5. Jason Welkeron 21 Nov 2008 at 9:36 pm

    Dean, thanks so much for your comments. To respond to a couple of your points:

    "US demand for inefficient US made autos has been on the wane, true, but the alternatives are made with exploited and many times non union labor… not good for the welfare of the workers involved in this ‘race to the bottom’…"

    Which countries, exactly, are America competing with in automobiles? I would hardly suggest that the poor Japanese workers are being exploited, 2007 GDP per capita there was $33,700. In Germany, it was $33,400, and in South Korea it was $25,000. These three countries represent America's largest competitors in automobiles, yet the degree of "exploitation" is just not there. Nor is there a race to the bottom, in contrast the emergence of auto industries in East Asia has brought unprecedented wealth and prosperity to the people there.

    "the countries that have existing auto industries should attempt to keep them sustainable/vital… and unionized !!"

    This argument could be put forth for ANY industry, not just automobiles! You could have said 100 years ago that a country that has existing textile industries should attempt to keep them sustainable/vital… but that statement would sound ridiculous if spoken in America today. America is far richer without a large textile industry than it ever could have become WITH a large textile industry. The hundreds of thousands of American workers who could be tied up in a low-productivity, low-skilled sector like textiles are instead getting educations and skill that bring them far greater income and wealth. If the government had insisted on bailing out the textile industry decades ago, and keeping it alive in the name of "vitality", America's economic dynamism would have been stymied and its emergence as a superpower thwarted.

    "its nonsense to say that burden would burden the tax payers for very long at all. moreover, the bailout could go a long way in making the Big Three more able to survive in the increasingly predatory trade environment…"

    First off, this would be the SECOND $25 billion subsidy to the auto industry this year, meaning it's a total of $50 billion. Sure, what's another $50 billion here and there to the oh so strong American economy, in a time when Americans have SO MUCH disposable income to forgo in the name of propping up a dying industry. Besides, to bail out one faltering dinosaur sets a precedent to other declining industries that if you can't survive and compete on your own, worry not, the taxpayers are here to save the day! This is the moral hazard I spoke of, a bailout diminishes the incentive firms have to achieve maximum efficiency and competitiveness on their own.

    "given a fair playing field, the US auto industry with a workable and flexible union would be able to compete and not go the way of extinction…"

    This was my point precisely in placing part of the blame for the industry's decline on the union. The unions outrageous demands over the years have created an UNFAIR playing field, on which American car makers have been at a comparative DISadvantage to its Asian and European counterparts. The government does have a responsibility to workers in the auto industry, but it's not to prop up their employers for one or two more years with a bailout. It's to assure that those displaced by the downsizing of the US auto industry have access to affordable health care, education, and professional training to prepare them for new careers in fields where there will be rising demand for labor in the future when America begins to emerge from its current recession.

    Money needs to be spent, but not in the form of a handout to the firms. The US government has obligations to its people and workers harmed by globalization and recession, but it assistance should come from the bottom up, not the top down. Increasing the skills and educations and health of American workers will lead to a strong, healthy economy. Propping up dying industries will prolong America's economic decline, lengthen its recession, and restrain its ability to thrive in a competitive global economy.

    Thanks Dean, appreciate your insights.

  6. dean faughton 21 Nov 2008 at 11:06 pm


    your points are well taken… unions have much to answer for… they have been petulant children, for sure. the trade rules aren't equal, though, which is a problem that isn't likely to go away. i disagree with you about textiles in the same category as automobiles… the latter is a much more important industry to a nation's security, etc. on a related note, ask the workers in the mill towns of the southeast if they feel the transition has gone well for them… lastly, the emerging east asian wave of auto competition epitomizes the race to the bottom… and will seriously challenge the japanese (as well as europeans and US) in time… why? because of the comparative advantage in THE key area, labor. currently, the japanese and koreans sell their product in the american market on cut to the bone profit margins, which is unethical and unfair dumping practice…but they will look practically benevolent compared to the future practices of the emerging auto manufacturers. that is, unless the US begins to stand up for itself and demand a comprehensive fair trade/free trade schema… perhaps this will happen with a new administration 🙂

  7. Jason Welkeron 21 Nov 2008 at 11:31 pm

    Dean, thanks again, I enjoy the debate!

    In fact, we do teach in IB Economics that in a situation where there is evidence that one nation is "dumping" its products on another, protectionism like a state subsidy might in fact be warranted. However, your explanation above indicates that in fact, Korean and Japanese firms are NOT dumping their autos in America:

    "the japanese and koreans sell their product in the american market on cut to the bone profit margins, which is unethical and unfair dumping practice…"

    Dumping is defined as the selling of surplus output at below the cost of production. Narrow profit margins are not unethical, nor do they constitute dumping. Profits, by definition, indicate that Asian firms are covering all their costs, then earning additional returns on their products. Narrow profit margins are a sign of healthy competition and efficiency, not exploitation and illegal dumping.

    The emerging auto industries in China and other developing nations promise the impoverished peoples of these countries a handhold on the ladder of economic development. Just as America left farming behind for textiles, then textiles behind for automobiles, and now is leaving automobiles behind, the workers in nations like China are in the same place America was 50 years go, advancing beyond the low-skilled, labor intensive industries like textiles and transitioning into the higher productivity, capital and skill intensive industries like automobiles. I see not exploitation, but opportunity, in the future of China and other nations with emerging automobile industries.


  8. Sebastian Son 22 Nov 2008 at 12:06 am

    In my oppinion the US car industry is a sunset industry and therefor it is vital that they do not go under to fast butbit by bit so that the social cost is not to high. But to be able to do that the unions must coaperate and the government must do something else then just suppling money. What the govermant can do is to start programs where the workers are being retrained which would allow them to find a new job much easier. The unions on ther hand must realise that if they do not change their demand that they will be worse of if they do not lower the wages. Also they must realise that the automobile industry is destined to be driven of the market.With this the automobile industry could reduce its sice over time and slowly start to close down. The lower wages will force workers to find an other job and the retraining programm from the goverment or the industry can give them the opportunity to find a better one. This way the social cost of the closur of the industry will be minimal compared to sudden close down. So the goverment should bail out the car industry but it must also give it the incentive to shut down over time so that that the social cost is minimal when it does.

  9. Joelon 22 Nov 2008 at 2:44 am

    Fair point about government handouts to firms Mr. Welker. I would have to agree that handing consumers cash directly would be much more effective way of stimulating aggregate demand. However, I still maintain that this bailout is acting as a form of G.

  10. dean faughton 22 Nov 2008 at 7:42 am


    i was remiss in my slack and simplistic definition of dumping… you're right, by the strict definition, the japanese and koreans aren't 'dumping'… they are making a miniscule profit… so, instead of being accused of the easily to spot dumping practice, they manipulate an advantage through other means… like currency manipulation (the last few weeks notwithstanding for the yen…), not offering comparable pension schemes and health care to their employees, dumping in related auto parts manufacturing and related steel products. these countries also enjoy closed market ideologies that work in their favor domestically. it would be a disaster to simply allow the big three to go under or get absorbed by competitors. america needs a vital auto industry more than ever 🙂

  11. Jason Welkeron 22 Nov 2008 at 8:13 am

    Dean, I have enjoyed this debate immensely, your points are valid and I actually agree with you to a certain extent. Alas, it's late and snowing out, so I'm going skiing tomorrow, this is enough economic debate for one day! Thanks!

  12. brendanon 23 Nov 2008 at 9:25 am

    I have one question; what happens to the retired autoworker who depends on a pension if the auto makers go under?

  13. Henry Smithon 25 Nov 2008 at 10:45 am

    I do not think that the big three should be bailed out. It was poor business decisions on the companies' part that caused their downturn. Another factor is the economy and that people are being more conservative in their purchases. They were struggling before the recession though. They made poor business decisions because they made some cars that a lot of people didn't want to buy and they put a lot of money in the production of those cars. Also, they do not compete well with foreign auto companies because the cars that GM, Ford, and Chrysler make are thousands of dollars more than the foreign cars. If there is less demand, there can be less profit and that is the case with the big three. The big three sells less and charges more for their products than foreign cars. If the big three is bailed out, they may rely on that happening again in the future if they are doing poorly. It was their fault that they are in this position, and they shouldn't rely on people's tax money to pay for their mistakes.

  14. Rob McCabeon 25 Nov 2008 at 12:50 pm

    At first glance, yes, Why not? But after looking at a number of the reasons listed on this website I found that this bailout could possibly help the economy temporarily in turn devastating the American economy forever. Reason number two, Comparative advantage, and reason number three, Efficient allocation of resources, are good points to why the bailout won’t be good. Countries should specialize on goods that have the lowest opportunity cost. It cost the Big 3 Auto industries $2000 more than foreign productions of automobiles. So why should the US try to keep producing automobiles when someone else can produce them cheaper? With the facts on the downfall of the automobile industry, trying to temporarily bailout this industry is not the right move. The US economy has put too many resources into the auto industry and reallocating these resources in other industries will temporarily cause a loss in jobs but eventually strengthen the US economy as a whole.

  15. Johnon 25 Nov 2008 at 9:56 pm

    My intial thought to this bailout plan was no, because i thought the "Big Three" should not be rewarded for struggling and failing, because that diminishes the incentive of success. But then, I realized how many people were employed by the "Big Three"(Ford, Chrysler, and Chevy). If those people lost their jobs, the unemployment rate would increase even more. Not only would the workers of these three companies be in trouble, but also the people who work for the companies that work for the "Big Three", such as manufacturing plants, would be in trouble too due to a trickle down effect. With these three companies going under, we lose too many workers and too much money and it would really put our economy into too much trouble. When the "Big Three" come back with a better buisness plan instead of just asking for 25 billion dollars, I believe they should be bailed out.

  16. Paul Grahamon 25 Nov 2008 at 10:13 pm

    I believe that the Big 3 should be bailed out but only under the circumstance in which they restructure there business plan and compromise with the UAW and retired workers. Really points 3 and 4 are what I’m going to discuss. The big three have worked with the UAW for so long and this organization has driven the wages up to an average between $50 and $75 per hour from what I have heard. The foreign automakers in the U.S. average about $35 to $40 dollars and hour. For these automakers they have not dealt with the UAW and this has saved them billions. If GM and the other two companies were to cut wages by $5 and hour of the factory workers and negotiate with the UAW they could save substantial amounts of money. For example, if the average factory worker works for 8 hours a day for 200 days a year at $45 per hour instead of $50 that would be an annual savings of $8000 a year for the company. If there are 100,000 factory workers that work for GM, that translates into an annual savings of $800,000,000 (that’s million) dollars a year. That is only for one shift. If there are 2 or 3 shifts that translates into $1,600,000,000 (billion) for 2 shifts, and $2.4 billion for 3 shifts. Also if some plants were to close and sell the land and eliminate the costs to run the factory and consolidated their workers they could make even more money by selling the land. Efficiency is the key to success and that is why Wal-Mart and these foreign automakers are not as hit by this recession. If the companies restructured they would then be eligible for the bailout money.

  17. joe priceon 26 Nov 2008 at 1:24 am

    I think the government should not bail out the U.S. automakers, GM. Foreign car makers don't have a p[roblem selling in America. So that rings a bell, "What is is GM's problem?" It is obvious that the bail out request is a desperation act. GM has made terrible decisions in the past by producing big suv cars and now its finally got to them. All those desicions caught uip on them and are on the verge of bankruptcy. The big suvs produced have bad mileage…

  18. Kathy Jensenon 26 Nov 2008 at 4:38 am

    I have the same question Brandon does, though I think we're bailout happy and who's going to bail US out when we are done with these crazy spending sprees? Seriously, what does happen to the pensioners? Someone please respond.

  19. Jason Welkeron 26 Nov 2008 at 5:38 am

    Kathy and Brendan, check out this site: The Pension Benefit Gurantee Corporation:

    "The Pension Benefit Guaranty Corporation (PBGC) protects the retirement incomes of nearly 44 million American workers in more than 29,000 private-sector defined benefit pension plans. A defined benefit plan provides a specified monthly benefit at retirement, often based on a combination of salary and years of service. PBGC was created by the Employee Retirement Income Security Act of 1974 to encourage the continuation and maintenance of private-sector defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at a minimum. Defined benefit pension plans promise to pay a specified monthly benefit at retirement, commonly based on salary and years on the job.

    PBGC is not funded by general tax revenues. PBGC collects insurance premiums from employers that sponsor insured pension plans, earns money from investments and receives funds from pension plans it takes over.

    PBGC pays monthly retirement benefits, up to a guaranteed maximum, to more than 640,000 retirees in 3,860 pension plans that ended. Including those who have not yet retired and participants in multiemployer plans receiving financial assistance, PBGC is responsible for the current and future pensions of about 1,305,000 people.

    The maximum pension benefit guaranteed by PBGC is set by law and adjusted yearly. For plans ended in 2009, workers who retire at age 65 can receive up to $4,500 a month ($54,000 a year). The guarantee is lower for those who retire early or when there is a benefit for a survivor. The guarantee is increased for those who retire after age 65."

  20. Paul Gackeon 26 Nov 2008 at 11:10 am


    Your most compelling argument is your last one on the "inflexible" labor markets. Businesses in the Free Market understand Economic Darwinism. Unfortunately labor unions do not. I am not opposed to labor unions, they have their place and they level the playing field against the wealthy capitalist who won the majority of the resources needed to produce. However, unions, like business have to stay competitive and at the risk of sounding like a team player, do what is best for their members by doing what is best for the business. We have a system in place that will work if we just let it. As you said, there are other businesses and entrepreneurs out there willing and able to assume control of a failed auto industry and make it competitive again. We need to stop thinking that we have to do things the way we did them 50 years ago and if other countries can build good, less expensive, fuel efficient, and desirable cars, so can we. I just showed my student the movie "Tucker", which brings this lesson home. The auto industry is acting monopolistic and they need world competition to make them better, not a government bailout. If you haven't seen Tucker, try it. It is a little old but a relatively true story.



  21. Darren Lawsonon 27 Nov 2008 at 3:59 pm

    While I fully agree with all your reasons on why not to bail-out the auto-industry, I believe that to even examine the question is somewhat absurd, given the fact the banking industry bailout is now at $7.7Trillion.

    Since most of this money will never be seen again, and is not close to the final figure, to be arguing about $25b for the auto industry seems utterly trivial and pointless (in a macro-sense).

    If AIG gets $150b, and Citibank $300b why shouldn't Detroit get another $25b? What's the difference? Does grosser mismanagement and greater losses qualify for govt help, while lesser mismanagement doesn't?


  22. Jason Welkeron 27 Nov 2008 at 5:06 pm


    The intent of a financial bailout, of course, is to increase the liquidity in the market, injecting cash into institutions whose purpose it is to, well, inject cash into the pockets of consumers and firms to finance consumption and investment. Government bailouts of banks is, I have to say, a little different than a bailout of a manufacturing industry that has failed of its own accord. (Not to say investment banks didn't make bad decisions that led to their own downfall as well). But if a financial bailout works, it will mean more credit available for the most credit-worthy firms and consumers. Once households have access to affordable credit again, THEY will be better able to decide which manufacturing industries will survive through their own consumption decisions.

    When the government decides to chose which firms to bailout in the manufacturing sector, a large misallocation of physical resources results. Capital, land and labor resources in America will continue to be allocated towards the production of cars, which by most accounts we should NOT be producing based on the failure of American auto makers to compete with their foreign competitors. By propping up the banking industry, on the other hand, there is little or no MISallocation of physical resources, since the inputs and outputs of the banking sector are financial; cash and credit, which are needed to lubricate the REAL sector of the economy.

    By supporting failing banks, the US government intends to make credit available to firms that DESERVE credit. If the auto makers were credit-worthy, they wouldn't be begging the government for a loan. For these reasons, I do believe that a bailout of banks is FUNDAMENTALLY different from a bailout of a manufacturing industry.

    Thanks for your comments!

  23. Darren Lawsonon 28 Nov 2008 at 1:37 am

    Jason, thanks for your comments. Unfortunately though, I think your modelling is way too idealistic and totally unrepresentative of the real world and the situation here. It also follows more closely the media spin rather than what the economic data actually says. Some comments on your comments:

    1. Too much household credit was one of the biggest factors in getting us into this mess. An economy build on 70% consumer spending and that financed by credit, is NOT sustainable, or an ideal position on the PPC curve. More of the same is NOT the way out.

    2. The govt made arbitrary decisions in the financial bailout so why criticise it doing the same in the manufacturing industry? Eg Bear Stearns is let fail then the following day the Fed begging window is announced. Lehmann brothers is let fail, others bailed.

    3.The financial industry was already grossly misallocating resources – 25% of the UKs company profits were coming from the City's financial firms, likewise in the US the banking industry was taking way more share of economy than ever before. For all the fuss over the auto-cos private jets, do you really think the Wall St bonus system is a better allocation of resources?

    4. The fact that the bailout is now over $8t (yes its going up between posts!) which will be paid for by future generations in real taxes or by stealth taxes of inflation, means there is MASSIVE misallocation of resources as that money will be unavailable for more productive use elsewhere.

    5. The bailouts are not because banks are ILLIQUID despite the press releases, its because they are INSOLVENT.

    6. The money already put into the system also hasn't been used for extending credit as it was stated, but for paying bonuses and for buying up smaller financial firms.

    7. The real problem is OTC derivatives, rarely mentioned. The BIS recently put their value at $1.1 QUADRILLION! As these start to melt down, we are all dead to some degree.

    Anyway I'll stop this little rant!

    Have a good thanksgiving!



  24. Jason Welkeron 28 Nov 2008 at 7:49 am


    Thanks again! You've definitely given me more to think about and research! Thanks for keeping the conversation going! Happy Thanksgiving to you too!


  25. Chesteron 02 Dec 2008 at 8:56 am

    While it is true that it will cost many to save the auto industry, it is wrong to say that the benefits will only be enjoyed by a few. By saving the auto industry, the U.S economy can save hundreds of thousands of jobs. This means that hundreds of thousands of families will be able to continue living their lives in the same sort of fashion. If we were to let the auto industry collapse, and lay off many of its employees, then these families would no longer be able to participate in the economy in the same way. This could lead to other markets such as the restaurant industry needing help because they are losing millions of customers because their families can not afford to eat out. $25 billion will be a burden on tax payers, but this tax increase will ultimately save the jobs of millions, and sustain the industry in which they work.

  26. Neil the Econ Manon 02 Dec 2008 at 9:47 am

    I agree with Welker’s point about comparative advantage. Indeed, it is almost certain that foreign auto suppliers currently hold the advantage over those of America.

    I believe, however, that that could change. It is for this reason that I must dissent with his argument about Social Darwinism. While I do believe that foreign suppliers currently hold the advantage in the auto industry, I question wh/ether that will remain in the future. With public outcry over rising and falling gasoline prices, more innovative technologies are likely to take hold within the next decade. Even though the auto industry is not acting efficiently now does not mean that it will still be inefficient in the years to come. Provided that these firms increase their commitment to efficiency and innovation, it is possible for America to regain the advantage.

    A 13 November article in The Economist supports my claim about America’s potential for growth in the auto industry. In the words of David Cole from the Center for Automotive Research, “The river [the Big Three] are swimming across has been getting wider and deeper, but the pot of gold on the other side has been getting bigger as well.” The article even supposes that the American auto industry will make a significant comeback by 2010 or 2011. With a growth in the market for cars in China and other countries, and the growth in demand for more efficient vehicles, the automobile industry will undoubtedly have many opportunities for change and for growth. With the aid of the auto bailout plan, the American industry will still be able to compete and possibly even gain comparative advantage in the eminent future.

    The article is available at this link:….

  27. Andrew Gellerton 02 Dec 2008 at 10:27 am

    I found it interesting that you mentioned that $2000 figure with regards to labor markets, so I did a little research and found this ( article on NRO by Jim Manzi that graphically explains the problem: GM, Ford, and Chrysler all take negative profit per vehicle, and as long as the UAW retains its current position that's unlikely to change. Worker salaries and associated benefits are the biggest cost the Big 3 face right now, but cuts are nearly impossible thanks to the union. Allowing them to file bankruptcy would hopefully lead to a more efficient restructuring, and maybe make some actual profits on the cars they sell. On the other hand, a bailout does nothing but kick the problem down the road a few years. Additionally, a bailout could come with strings attached, like fuel efficiency mandates or required development of more hybrids. Forcing production of "green" cars would clearly exacerbate the problem, as past models have generally been expensive and limited in potential market, especially with the return of relatively cheap gas.

    Chester, while it's true that many auto workers would lose their jobs, bankruptcy for the Big 3 would not mean the end, only a reconfiguration. When they emerge from the other end, they will still require workers- and obviously the same workers who have been in the auto industry previously are the best candidates. There will be fewer and worse-paying auto jobs, but they won't simply disappear.

    Alternately, we could simply keep bailing out Detroit until Japan succumbs to demographic collapse. We might not have efficiency but at least we have a comparative population advantage.

  28. Rohanon 02 Dec 2008 at 11:30 am

    Chester, where does the U.S government get the money for these bailouts? The government borrows the money from foreign countries like China and Canada, then the government raises taxes and we all get owned! Ever dollar of the bailout is taken from our pockets! How fun is that? We would be directly funding three inefficient companies, and we'd be held accountable for their stupid decisions. Hell, that 25 million dollars could be used elsewhere, in improving public transportation.

    So 300,000 jobs are being lost with the Big Three go bankrupt, I'll give you that. But, there are foreign companies like Honda in the south who would gladly welcome these potential employees. The depressed South could benefit particularly from increased production of foreign auto companies.

    American needs change, a transition from the internal combustion engine to possibly the electric car. There are a bunch of start-ups out in Silicon Valley, funded by a bunch of venture capitalists already making efficient modes of transportation.

  29. Vicky S. Keattson 09 Dec 2008 at 10:53 pm

    Why should the American people pay for the Auto Industry to go into other countries and build huge plants like the one that they have built in Brazil when our own economy is falling apart. It seems to me our Goverment now is useing us to pay for them to develope economies around the world and they are not being truthful about it either. What kind of Goverment is that? Its the kind we apparently have! Our goverment is giving our way of life to all the other countries of the world and do we get in exchange for it? NOTHING!!!!!!

  30. Sarahon 12 Dec 2008 at 10:42 am


    Incentives matter-

    The big 3 aren't asking for a handout they are asking for loans, that they will pay interest on.

    The interest costs alone is certainly incentive to innovate, American automakers are as innovative as the rest, offering hybrids and not just sardine cans but suvs also. Alone, the idea that foreign makers are outselling them is also incentive to innovate.

    Compartive advantage-

    Maybe it is less expensive to produce a car, when you aren't having to pay a real living wage with real benefits. Let's not forget the environmental standards that must be followed in the US that aren't enforced elsewhere. That doesn't mean the majority of Americans want to support other economies while their own suffers.

    Effecient allocation of resources-

    One thing that has contributed to the decline in the UAW is quite simply increased production effeciency. I mean really we are talking nearly 40 years, a lot of machinery that required people 40 years ago is now automated. Lastly part of that decline in membership IS due to down-sizing in the industry.

    Economic Darwinism-

    It is easier to be more effecient, again, when you don't have to be a responsible employer. Giving a loan does not say that the US does not stand for free trade, it says hey they are finally going to look out for their own. WHAT is the US trade deficit again? Not stand for free trade, puhleaze.

    Benefits enjoyed by the few-

    Do you know how much it will cost per capita for this? 49.50 less than fifty dollars per person.

    Let me ask you this, What about the tax burden that we will see in the form of increase unemployment compensation, food stamps, welfare, medicade and schip. What about the loss of tax revenue in the form of payroll taxes and corporate taxes. Now let's look at the trickle down effect, what about the restaurants, grocery stores, clothing stores, parts stores, recreational stores (ie bikes, skates, skis etc) game stores, gas stations and any other retail outlet you can imagine? When those outlets lay off as a result of the loss of revenue from the auto workers, we get even more people in the line for the government to give them what they need to survive.

    Moral hazard-

    You again are speaking on the premise of a handout, not a loan with interest.

    Would you let the people that raised you starve to death? The auto industry built this nation.

    Market failure-

    Whao! The financial industry and their greed and profiteering certainly did not deserve to be bailed out. They got money to open the credit markets and they went on vacations? It is the banks fault they have failed to thrive. Banks were around long before the auto industry, again the banks got greedy and stupid, now Americans are paying for it. The American auto industry is in the midst of reform, prime example being Ford, who by the way probably won't even need a LOAN from the government. Reform does take time, it doesn't happen over night. The auto industry is in fact more a victim of the market than the financial industry, if the financial industry had not collapsed, they would still be selling cars on credit.

    Inflexible labor markets-

    You are right, in that the union is part of the problem. Though not in any reasonable way.

    That raises are demanded is part of the problem. That they protect their members standard of living, hooray for them. How about we cut your pay, because your neighboor decides they want to blog and write too, it doesn't matter that you just invested in that new office, just go back to working out of the spare bedroom, you'll be more competive if you do that.

    ONCE AGAIN THE BIG THREE IS NOT ASKING FOR A HANDOUT THEY ARE ASKING FOR A LOAN ON WHICH THEY WILL PAY INTEREST. They unions should have to make concessions, ie not demanding raises every year. By the way bankruptcy will cost the taxpayers much more when we have to cover health care for retirees, unemployment and other such social benefits.

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