What to Do with Detroit?

November 21, 2008 |  Tagged | Comments Off on What to Do with Detroit?

Automakers this week went before Congress to try to convince them that they needed a $25 billion bailout to avoid a massive disaster that would result in the loss of millions of American jobs.  Congress remained unmoved.  Congress gave the executives of these companies a little under two weeks to come up with a plan for the proposed bailout that would inspire confidence that the money they’d receive would be used properly.  We’ll see if the executives are up to the task.

There are a lot of different viewpoints about how best to handle this situation.  There’s the approach advocated by free-marketers that say that letting Detroit automakers fail is the best thing for the economy.  Jim Lindgren at The Volokh Conspiracy takes this approach, as does David Yermack at the Wall Street Journal.   Their basic contention is that the economic resources tied up in the American auto industry are being inefficiently used and have been since the 1970s.  They contend that letting these companies fail, while initially painful, would free up those resources to be used by more efficient firms in profitable industries.  This would create more jobs long term.  These arguments make intuitive sense.  However, there is a major problem with them.  We as a nation are already faced with the worst economic conditions since the Great Depression.  Allowing the Big 3 to fail would result in the loss of MILLIONS of jobs.  Those millions of jobless people aren’t all going to be able to jump into new careers.  Many will need to be re-trained and most companies aren’t hiring right now because of the current economic conditions.  This solution doesn’t seem tenable given today’s economic realities.

Then there’s the solution offered by Robert Reich, an economic adviser to President-elect Obama.  He suggests allowing the Big 3 to reorganize with a bailout, but as a condition of the bailout, the Big 3’s executives, creditors, and shareholders take losses equivalent to what they would suffer under Chapter 11 and that the United Auto Workers take wage and benefit cuts.  The bailout and savings from the aforementioned conditions, he argues, would allow them to retool their production process towards the more fuel efficient cars that are in high demand and are produced cheaper and better by their competitors from Japan (Honda and Toyota).  Todd Zywicki at The Volokh Conspiracy advocates a similar approach, although he argues for an actual Chapter 11 filing and reorganization, and would only allow government funds to be made available after a good-faith effort was made to try to secure private debtor in possession (DIP) financing.

Meanwhile, Johnathan Cohn at The New Republic makes the case that many are making – the Big 3 need to be bailed out, albeit with a number of concessions from their executives.  He further makes the case that the American people and their government need to make “health care and retirement benefits a national responsibility.”  When America does that, labor unions won’t need to fight so hard for those things; as a result, the labor cost for American companies goes down, making them more competitive globally.  Also, the American public needs to continue to demand fuel efficient cars, even when gas prices dip.

It will be interesting in the next two weeks to see what direction Congress decides to take with Detroit, but what is clear, despite the well-thought and reasoned arguments regarding free-markets mentioned above, is that the Big 3 can’t just be allowed to fail and dissolve completely.  If we’ve learned anything from the recent fate of American investment banks, it’s that a free-market approach cannot work on its own.  Congress needs to take some action and the Big 3, both labor and management, need to do some serious belt-tightening and re-evaluating of their business model.

Photos courtesy of Flickr users DetroitDerek and InsolG.

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