Why the Domestic Auto Industry Cannot be Allowed to Fail:
The plight of the “Big 3” (GM, Ford and Chrysler) has dominated the news for the last couple of days. All three are on the verge of bankruptcy. All three are burning through cash at an incredible rate, the result of sales volume falling far below that necessary to support their infrastructure and legacy costs. GM stock is now worth less than a 1-1/2 week inventory of the cars it builds.
There seems to be a consensus that the domestic auto industry cannot be allowed to fail. Yet, there are those who say “Let them fail.” “It’s their own fault. Their labor costs are far too high. They build gas-guzzling inefficient vehicles. Who needs them? The Japanese, Korean and German carmakers can easily meet Americans’ need for vehicles. Everything else we buy is imported and we get along just fine. Why should cars be any different?”
Well, first of all, while everything else we buy does seem to be imported, we’re not really getting along fine, are we? Take a look around. Check your 401(k) statements. Read the financial pages. Our economy is in complete collapse, and the trade deficit is the root cause. The trade deficit has drained away $9.1 trillion from our economy in the last three decades, and it’s all been financed by selling off American assets, even our homes, through selling mortgage-backed securities to our foreign creditors. When we ran out of assets to sell them, the whole thing collapsed.
Imagine what would happen if the domestic auto industry collapsed, as it surely would if even one of the Big 3 goes under, taking the supplier base out from under the remaining two. In a normal year, domestic car sales total about 16 million vehicles. About half of these (a hair less) is built by the Big 3, about 8 million vehicles. At an average cost of $25,000 per vehicle, that’s $200 billion per year added to our GDP of about $14 trillion per year. Take that away, and our GDP falls to $13.8 billion. Now, import those cars to make up the difference, and our GDP falls to $13.6 billion, because imports are subtracted from GDP. (Even the government acknowledges that imports are a drag on the economy.) At the same time, our trade deficit rises to $900 billion per year. And, of that $200 billion cost of domestic cars, about $140 billion is labor cost. Eliminate those jobs and, on average, every worker in America will take a pay cut of almost $1,000 per year. Declining incomes is the real reason that home values are falling. Take $1,000 per year out of everyone’s incomes and home values will drop another 10% automatically. Looking for a sure-fire way to finally finish off the American economy? This is it!
Regarding the claim that their labor costs are too high, their legacy costs (pensions and health care for their retirees) are extremely high. But remember, these benefits were promised at a time when domestic auto makers thought they could always count on having the domestic market to themselves, or later thought that free trade would provide them with export markets equivalent to any loss of domestic market. They were suckered by economists who didn’t understand the real consequences of free trade, which was nothing more than an untested 18th century theory. But they soon discovered the bind they were in and, since then, they’ve done a great job of working with the unions to slash labor costs and improve productivity.
And regarding the claim that they only build gas-guzzlers: they were crowded out of the small car market by imports and forced to specialize on the seqment of the market where they could still make a profit – light trucks and SUVs. The only reason they build these vehicles is because that’s what Americans wanted. Every big, gas-guzzling SUV on the road is there because that’s what the owner demanded.
Now everyone wants fuel efficiency, but the small car market is glutted with overcapacity from all over the world. The Big 3 simply cannot be cast into that glut and be expected to survive.
The following article is a good summary of why the domestic auto industry can’t be allowed to fail.
“If GM were to go into a free-fall bankruptcy and didn’t pay its trade debts, then the entire domestic auto industry shuts down,” says Rodriguez. The system — the domestic auto plants and their interconnected group of suppliers — is far bigger than GM. It includes 54 North American manufacturing plants and at least 4,000 so-called Tier 1 suppliers — firms that feed parts and subassemblies directly to those plants. That includes mom-and-pop outfits but also a dozen or so large companies such as Lear, Johnson Controls and GM’s former captive Delphi. Beyond those are thousands of the suppliers’ suppliers.
Although the Detroit Three directly employed about 240,000 people last year, according to the industry-allied Center for Automotive Research (CAR) in Ann Arbor, Mich., the multiplier effect is large, which is typical in manufacturing. Throw in the partsmakers and other suppliers, and you have an additional 974,000 jobs. Together, says CAR, these 1.2 million workers spend enough to keep 1.7 million more people employed. That gets you to 2.9 million jobs tied to the Detroit Three, and even if you discount the figures because of CAR’s allegiance, it’s a big number. Shut down Detroit, and the national unemployment rate heads toward 10% in a hurry.
Even if just one of the Detroit Three — and GM is the most likely, as Ford is in better shape and Chrysler is much smaller — spiraled into a free-fall bankruptcy, the systemic effects, at least initially, would be huge. The whole industry would not be able to build cars in the U.S., because of the lack of parts. “Unlike the airlines or steel, when you look at the automobile industry and the fact that the whole supplier base is connected — to Ford, Chrysler, Toyota — it will have a ripple effect on the entire industry,” says Nicole Y. Lamb-Hale, a bankruptcy expert at the Detroit office of Foley & Lardner, a law firm that represents some GM suppliers.
And consider this: the tool and die industry, critical to all of manufacturing, not just the auto industry, is utterly dependent on the auto industry for survival. If the auto industry vanishes, so too will the tool and die makers. If they go, the entire manufacturing sector of our economy is toast.
How to Save the Big 3:
There’s no way that any of the Big 3 can survive even six more months without some kind of federal assistance. And, just as the government is doing with the banks, it makes no sense to use taxpayer money to bail them out without taking a stake in the company. So the first step is to provide whatever cash is needed to keep them going and take a 90% ownership stake in each. It’s not such a crazy idea. As the following article attests, that’s exactly what’s being considered.
Frank’s legislation would carve out a portion of the $700 billion financial rescue program for the Big Three automakers, letting the government take an equity stake in them in exchange for the loans, said Frank’s spokesman, Steven Adamske.
The Treasury could take warrants to share in a portion of future profits and would have to be paid back before any other shareholder. The car companies would face tougher restrictions on awarding pay packages to executives and dividends to their shareholders than the financial companies that get a piece of the original bailout.
Secondly, as I mentioned above, the Big 3 can’t survive in the glutted small car market. At best, they would become the “Little 3,” not as bad as failing altogether, but not much better. So the time has come to carve out a sufficient share of the domestic market to assure their survival. This means that tariffs should immediately be imposed on every Japanese, Korean, German and Mexican car imported into the U.S. Any tariff structure would help, but the one I proposed in Five Short Blasts, based on population density, would be ideal. Such a tariff structure would impose a 5% tariff on cars from Mexico (even if they carry a “Big 3” brand), a 25% tariff on cars from Germany, a 40% tariff on Japanese cars and a 55% tariff on Korean cars. The same tariffs should be applied to imported parts as well. The result would be an explosion in demand for domestic cars and, within a few short years, the government could begin selling its stake in these companies at at least a 1,000% profit. And don’t forget the tariff revenue that could be used to offset income taxes, providing a tax break to consumers.
It’s time to abandon the blind faith that we’ve put in economic theories that pre-date electricity and steam engines, a time when the world’s population was one seventh of today’s and vast regions of the world remained unexplored. It’s time to evaluate the results of free trade and globalization and make some adjustments to our theories. The United States will be of little benefit to the global economy if it’s own domestic economy is in shambles, and there’s no hope of correcting the damage done to our economy without restoring a balance of trade. Of course tariffs will impose severe hardships on nations dependent on exports to support their bloated labor forces, but how else will they be forced to come to grips with the effects of overpopulation? Why should the U.S. function as a relief valve for their problems? We’ve tried and it doesn’t work. A global economy will work when each nation tends to its own problems first instead of looking for someplace to dump them.