Thursday, December 11, 2008

In Response To: Automakers Bailout (v2!)

Let me just preface the fact that this is a very similar post to another recent post of mine, which was in response to a different blog. Unfortunately I didn't reference the other one too much so there might be some repetition, but there are definitely some new, good points in this one. Enjoy:

I’ve been doing some more thinking about (and some hearing about) the automaker bailout, and once again I am dismayed at the lack of information that most of the media is spewing out to the public. Worse yet, the self-described “experts” often seem to be nothing more than political hacks with agendas (or equally uninformed, or under-educated, take your pick). At least some people I read have put in an effort to think a little critically about the topic, but it is stark minority of the media as a whole. Out of said dismay comes, yet again, inspiration to lay down the law to my spell checker, who may well be my only reader.

When dealing with problems of the economy, it is good to know a little economics. This particular subject is one I enjoyed learning, so we’ll start today with a lesson in public finance. Here’s an example of an externality where a government can potentially help a society (I believe I’ve briefly outlined this before): flood damage deals $200 per year to each of the 10 homes in a neighborhood. Building a levee costs (let's say) $1000 to build and $1000 to maintain every year after. No one homeowner is willing to front that entire cost, despite the dam's utility to society being $2000 year at a cost of $1000 year. Boom. Market failure.

In this case, a government can step in and tax all 10 homeowners $100 a year and build and maintain the government (although the tax would probably be more like $150 or higher). Now a homeowner is paying $100 a year to prevent $200 in per-year damages. A governing body intervenes, solves a market failure, and society is better off. That's how externalities work.

A key point here is that, without some sort of governing body, say with the use of a contract, no one can enforce participation. One homeowner might see that there’s a petition going around and refuse to sign it, knowing that if the other 9 pay for the dam, he gets all the benefit while paying none of the cost. Considering this incentive exists equally for all 10 homeowners, and one can begin to see why a government with some enforcement power might be required.

I hinted before at one of the flaws in the system, however: governments can never operate more efficiently than a private firm could (perfectly at $100/year tax, let's say), due to increased costs and a separation from the issue that affects incentives (why would they care as much when they are not personally affected?) and analytical measures (how will they know what the damages/costs are to set efficient taxes?).

These inherent problems mean that, when there is no market failure, the government CANNOT improve markets... when the private sector is operating without externalities, it will reach an efficient solution... the government cannot be *more* efficient than the free market. One cannot be more optimal than the optimum.

With that in mind, most likely the tax in the dam scenario would be higher than $100 which, while still improving society, would leave some deadweight loss. It's quite possible, too, that the government's additional costs could potentially surpass the damages, i.e. over $200 year per house. Add in the factor of politics and this can become a problem; a construction company who wants to build the dam could lobby the government to raise taxes to get the dam built. The dam company’s cost would be that $1000/year, naturally, which no homeowner is willing to pay for himself, but the government’s potential inefficiencies might require a tax higher than $200/year per homeowner; if not at the inception, then an increase along the way. I’ve said before, and anyone who understands economics would agree, without an externality, government intervention can ONLY make the market worse; what this example proves is that even in a case where the market is failing, there is still a chance that government intervention could make things worse.

Some might call this attitude pessimistic (or worse), but I would call it economically and logically sound. Perhaps one might begin to see how this line of thinking would lead to prudence when considering government intervention. There is another, more hate-inspiring name for being prudent: conservative. That shouldn’t surprise you, though, dear reader, since I’m a self-proclaimed fiscal conservative. As my favorite professor at UCLA taught me, when considering government intervention (or “fiscal stimulus”), one must first show that there is an externality. If there is no externality, there should be no intervention. If there is an externality, efforts should be made to internalize that externality and only to internalize that externality… other forms of intervention would only destroy properly-functioning free market mechanics. When your computer’s hard drive is broken, taking apart the monitor will be a waste of time and resources. That’s an easy one to see. Hiring your mayor to do it for you might not necessarily be the best solution either.. in fact he could potentially mess up other parts of your computer. In short, you need to be careful.

So what are my thoughts on the auto industry bailout? To answer that I’ll link yet another blog response, this time to a Freakonomics article written by blog frequenter Daniel Hammermesh, a writer that I think is a pretty smart guy, although he is retired and writes more for recreation than for true analysis. This time, at least, he’s on my side. Here’s my response, it’s probably much easier to read following my outline of public finance above:

This bailout is, as I've said before, like giving morphine to someone who's lost a limb. It's a temporary fix that may well exacerbate the problem.

US automakers have been hemorrhaging money. Why? They have been getting out-competed by international car companies. Part of this has been a change in demand (not a market failure); consumers are moving toward smaller, more fuel-efficient cars, and foreign companies have excelled at small-car production for decades. It is, one could say, their comparative advantage in the industry. US companies, on the other hand, are set up to produce large, powerful, admittedly gas-guzzling trucks and SUVs, and we are good at what we do. That's our automakers’ comparative advantage, and as consumer preferences have been shifting away from that line of products, our carmakers have been suffering accordingly. This is not a market failure... it is a change in demand.

That's not the end of the issue. Another reason our companies are not faring well has to do with the unions, as several other commenters have brought up. Needless to say, we pay our auto-workers much more than what foreign companies pay, due to the striking power of US unions. One can make an argument that this is because foreign countries pay health care and other benefits, and not the company, but the initial incentive to outsource remains for companies; why would you build factories in America when labor costs are so high that building cars abroad and shipping them over are cheaper than building in the US? This doesn't even touch on the fact that unions have "negotiated" for gold-plated benefits and pensions for retirees; a substantial chunk of the bailout money would be to pay for these non-working people's high-coverage health care and their pensions. I understand that the retirees are relying on these forms of income to live, but quite frankly, they made an arrangement with the company, not with the US taxpayer (at least I never voted to pay him that), and if that company goes out of business then hey, sorry pal, you're out of luck. That's a risk of the contract. If a bailout goes through, I would at the VERY least want those retiree contracts voided. We can't stimulate an industry that has to waste money on costs that in no way spur production or innovation. Yes I said waste.

The last issue that hasn't been brought up once again concerns our comparative advantage: namely, the fact that we have regulated our industry to produce cars not in our advantage. Liberal politicians have jumped on the opportunity to slap regulations on our auto industry by mandating MPG requirements based on the class of vehicle produced in the US. This is a regulation that sounds alright, but completely violates the principles of economics. These regulations force our carmakers to produce vehicles that our factories are not made to build, and thus that they cannot build as efficiently. If the goal behind this regulation is to decrease gas consumption, there are many much better ways to fix that problem. Example 1: make the *consumer* (this is a consumption issue, right?) pay more for gas, i.e. tax. But no, American politics would never make the voter directly pay for stuff, only indirectly. At least then consumers could still decide if they wanted bigger cars (for cheaper, since we can produce them and sell them at a lower price), which may be a bit worse on MPG, or not. Instead, the government is saying we can't have them.

So our automakers are not just operating in unfavorable market conditions due to shifting demand, they are also overpaying our labor (and 100% overpaying their retired labor), and they are operating in handcuffs put on by their own government. Unless they invent fusion-powered cars, increased cash flow will do nothing to solve these problems. The US taxpayer will be paying money to companies that are losing money (at no fault of their own, I would even venture), who will not be able to repay, who will likely receive even MORE government regulation as a condition of the bailout, and who will eventually go out of business or become nationalized. If we want to help these companies, reduce union power, terminate all existing union contracts and remove production-restricting regulation. In other words, Congress, get your hand out of the mixing bowl and let the cook work. Sprinkling shreds of cash on top will not make the cake taste any less like your hand.

The bailout as it stands today is a terrible idea.

That's all for now. If you've made it this far and you either enjoyed reading or hate my conservative guts, follow the blog to stay up to date on new posts, and as always I welcome comments. Like most badguys in movies, I consider myself someone looking out for the best interests of the country... here's hoping we don't sweep ourselves under the rug.

1 comment:

Anonymous said...

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.