President Obama and George W. Bush Were Right to Bailout U.S. Auto Industry

Both Presidents Barack Obama and George W. Bush have been criticized by the 2012 Republican presidential contenders for their roles in bailing out the U.S. auto industry.

Obama has proudly trumpeted the $85 billion bailouts of General Motors Co. and Chrysler Group LLC as a success story while the U.S. auto industry continues its dramatic recovery. Bush also recently defended the decision at a National Automobile Dealers Association convention in Las Vegas, saying he would “do it again.”

“I didn’t want there to be 21% unemployment,” Bush said. “I didn’t want to gamble. I didn’t want history to look back and say, ‘Bush could have done something but chose not to do it.’ And so I said, ‘No depression.’”

While it certainly would’ve made economic sense to allow the auto industry to suffer through the recession instead of continuing its infinite drain on the U.S. treasury, the consequences of such a collapse would have been devastating to America. Like the bank bailouts, while most people may not have liked it, allowing the auto companies to fail at that time would have contributed to a second Great Depression. Lawmakers are always stuck between balancing out sound economics with social instability, but the unpopularity of both will always take the higher priority with public office holders.

The American auto industry was once the centerpiece of the U.S. economy. While that’s no longer the case, it still remains important. It employs large numbers of people and purchases supplies from literally thousands of U.S. companies.

There can be endless debates of why the U.S. auto industry is in such trouble — from the decisions and makeup of management, to the unions that control much of the workforce, to the cost structures inherent in producing cars in the American economy. Whatever the reasons are, it left it woefully unprepared for the 2008 economic recession.

Recessions reveal weak businesses and destroy them, freeing up resources for new enterprises. They occur when, as is inevitable, inefficiencies and irrationalities build up in the financial and economic system. The resulting economic downturn imposes a harsh discipline that destroys the inefficient, encourages efficiencies, and opens the doors to new businesses using new technologies and business models. The year 2001 smashed the dot com technology sector in the U.S., but that opened the door for Google Inc.

The business cycle works well, but the human costs can be daunting. The collapse of inefficient businesses leaves workers without jobs, investors without money, and society less stable than before. The pain needed to rectify every country’s economy is enormous. Each country is prepared to accept a high degree of economic inefficiency to avoid, or at least postpone, the reckoning. The reckoning always comes, but for most of us, later is better than sooner. Economic rationality takes a back seat to social necessity and political common sense.

The last recession had hit the auto industry hard. The ultimate reason is the same one that destroyed the U.S. steel industry a generation ago: Given U.S. cost structures, producing commodity products is best left to countries with lower wage rates, while more expensive U.S. labor is deployed in more specialized products requiring greater expertise. Thus, there is still steel production in the U.S., but it is specialty steel production, not commodity steel.

Allowing this to happen to the U.S. auto industry sounds easy, but the transition would be a bloodletting. Current employees of both the automakers and suppliers would be devastated. Institutions that have lent money to the automakers would suffer massive or total losses. Pensioners might lose pensions and health care benefits, and an entire region of the U.S.— the industrial Midwest — would be devastated. Something stronger would grow in its place eventually, but not soon enough for many of the current employees, shareholders and creditors.

Policymakers had a decision to make. If the automakers were allowed to fail, their drain on the economy would’ve ended; the pain would’ve been shorter (if not more intense); and new industries would emerge more quickly. But though their drain on the economy would end, the impact of the automakers’ failure on the economy would’ve been seismic. Unemployment would surge, as would bankruptcies of many auto suppliers. Defaults on loans would hit the credit markets. In the Midwest, home prices would plummet and foreclosures would skyrocket. And God only knows what the impact on equity markets would be.

Few if any believe the U.S. auto industry can survive in its current form. But there was an emerging consensus in Washington that the auto industry must not be allowed to fail in 2008-2009. The argument for spending money on the auto industry was not to save it, but to postpone its failure until a less devastating and inconvenient time. In other words, fearing the social and political consequences of a recession working itself through to its logical conclusion, Washington decided to spend money it knew it might not recover to postpone the failure.

There is also a powerful counter-argument to bailing out the U.S. auto industry. This argument holds that the auto industry is a drain on the U.S. economy, that it will never be globally competitive, and that if it is dragged back from the edge, no one will then say it is time to push it to the edge and over. The next time it will be on the brink will be during the next recession, and the same argument to save it will be used. In due course, the U.S. will be so terrified of the social and political consequences of business failure that it will maintain Chinese-like state owned enterprises, full of employees and generation-old plants and business models. Clearly, short-run solutions can easily become long-term albatrosses.

Wherever there is an economic downturn, politicians must decide whether society, and their own political futures, can withstand the rigors recessions impose. Every country in the world looks inward at the impact of any recession on its economy and measures its resources. Countries decide whether they have the ability to prop up businesses that should fail, what the social consequences of business failure would be, and whether they should try to use their resources to avoid the immediate pain of recession.

Each country is also trying to answer the question of how much pain it, and its regime, can endure. The more pain imposed, the healthier countries will emerge economically, unless of course the pain kills them. Ultimately, this is where the rationality of sound economics and the reality of social stability frequently diverge.

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