Paying for Detroit’s Mistakes

Proposed Auto Bailout Plans are Fundamentally Flawed

Thirty-five years ago, the first oil shock allowed Japanese car manufacturers to effectively enter the US market. Since then, Detroit has had difficulty coming up with a long term solution to compete against Japanese automakers. Their current pleas for federal aid would grossly waste taxpayer dollars in a time of economic turmoil. While their cash-strapped situations and predictions of total failure certainly were accelerated by the current economic crisis, a look at their history puts the matter into perspective. Detroit has a failed business model — the cost of which it hopes to pin on the American people.

All of the Big Three auto makers reported losses of several billion in the third quarter, with GM the worst off. However, no evidence suggests that we should expect much better from these companies. GM lost nearly $2 billion dollars in 2006 and a whopping $39 billion in 2007. These losses are a result of past mistakes. In 1993, well-known economist Michael Jensen reported a list of companies that had made the worst investments in the 1980s in his presidential address to the American Finance Association. Topping the list were Ford and General Motors. According to the report, the two companies burned through $110 billion in capital with no real strategy. Not only does this present an abuse of the money that GM and Ford had, it represents an abuse of limited American capital.

General Motors, in particular, has abused its capital to an even greater extent than documented by Mr. Jensen. Between 1998 and 2007, GM invested $310 billion into the company. With $128 billion of depreciation, this means that GM managed to squander $182 billion dollars with no real response to the Japanese auto industry. Their market capitalization was $46 billion at the end of 1998, but has dropped to practically negligible levels after eating up all of that cash. This sort of money could have, for the sake of perspective, been used to buy up all the shares of Honda, Toyota, Nissan, and Volkswagen instead of making unwise investments.

Indeed, the current proposal to inject $25 billion immediately into Detroit’s auto industry would do nothing other than keep these companies on life support. As about 5 percent of the free capital that Detroit has had at its disposal for the past several years, evidence suggests that US automakers would just burn through that amount of money and come back for more. Indeed, even with a larger bailout package organized, does throwing cash at these companies with fundamental flaws in their business model do anything but delay their inevitable demise?

Moreover, the idea that the government can reform Detroit by attaching strings to the money it lends out is not realistic. Innovation can come about in a company through fundamental changes in corporate culture and serious restructuring, not external mandates to produce “green” cars. For years, GM and Ford have lobbied against fuel-efficiency standards and hitched their wagons to gas guzzling Silverados and Hummers. Asking them to crank out fuel-efficient cars would be as effective as asking Philip Morris to come up with a cure for cancer. Any car that comes out of a coupling of Detroit and Washington will likely be unable to turn a profit and only deepen the hole in which auto manufacturers find themselves. In addition, GM has been poorly structured; the company has to deal with developing, manufacturing, and marketing eight different lines of vehicle to Toyota’s three. Government mandates will change none of this.

Of course, Detroit’s “legacy costs” always come up as an excuse for their inability to compete with Japanese auto makers. Undoubtedly, until Detroit can hire workers in a competitive labor market, it is certainly true that they will not be able to beat out foreign car companies. UAW union members receive benefits the likes of which are unheard of in the manufacturing industry, even in the United States. Their medical benefits involve no co-pays or deductibles. In fact, the UAW recently even lobbied for the rights of workers to smoke at the assembly line; such absurd ideas are unheard of at Toyota or Honda plants. While Detroit should be held accountable for not dealing with the UAW earlier, doling out money to the Big Three now will not make UAW problems disappear for the US auto industry.

Companies rise and fall all the time in a free market. Americans will need cars and if GM, Chrysler, or Ford collapses, a more efficient manufacturer will move in to fill the void. Already, foreign companies employ 113,000 workers in the United States to the Big Three’s 200,000, and many of the suppliers who rely on GM could turn to foreign companies for business. While GMAC needs to be dealt with separately, saving Detroit’s car manufacturers at this point seems arbitrary and financially unsound. Should TARP (Troubled Assets Relief Program) money next go to retailers like Circuit City and Starbucks? Washington cannot prop up every failed company, and companies should not expect to survive on government money. Let’s not force American citizens to tow Detroit’s auto industry along any longer.

Karan Sagar is a member of the Class of 2012.