For almost a decade, the US auto sector has managed consistently to lose money in bad years and in good years.  Sales which in the good years were above 16 million units will be less than 14 million this year and in the most recent months are only at a 10 million rate.   At that rate, this industry is bleeding cash and can sustain itself in its current form only with a major cash infusion.   A cash infusion would make sense if at the end of the tunnel there were some bright new green world for the auto sector to enjoy.  But that is a fool’s pursuit.   This very mature industry isn’t going to be saved with some new products that jack up sales to 20 million per year.   The problem is excessive capacity and crippling costs, disproportionately affecting the Big Three.   If capacity were less, in the good years firms would have pricing power and make enough profit to offset the losses in poor years.  If costs were lower, profits would be higher and losses less.

Private lenders know this.  There will be no private bailouts until the industry demonstrates its ability to cut capacity and reduce costs.

Don’t think a bailout is about saving jobs.  Jobs depend on sales volume, not on cash infusions.  We taxpayers can keep auto sector jobs high only if we start giving away new cars.   Absent a stimulus for new car sales, the only benefit for labor in this bailout is temporary sustained high rates of pay for the dwindling few who still have Big Three jobs.

I don’t buy the systemic argument about the whole industry going down if GM files for Chapter 11.  The problem isn’t how the industry is managed.  The problem is very low levels of sales and very high costs.  At 10 million units there is plenty of trouble to spread to suppliers.   For those economists who claim with great confidence that there is a huge systemic risk in a GM bankruptcy I would like some supportive evidence, not just your pontifications.  Supportive evidence is not merely a count of jobs that are related to auto sector jobs or your claims that some parts manufacturers will have to file bankruptcy as well.   That is exactly what we need – less capacity.  And please don’t premise your argument on the assumption that a bailout would magically increase sales to 16 million units.   With or without the bailout, with or without a GM bankruptcy, 2009 is going to be a very difficult year for the auto sector.

Of course, it is more than a little troubling to witness the assault on our middle class from dwindling jobs in manufacturing, but we need some coherent long-term plan on this problem, and not fight it fire by fire with an empty hose.  Surely we shouldn’t be taxing workers in retail or restaurants making $10 an hour to support temporarily the salaries of Detroit autoworkers making $75.

Let’s not squander this rare opportunity to cut capacity and costs in the auto sector.  That is the silver lining in a recession cloud

Collapse

The bankruptcy and liquidation of any of the Big Three automakers would represent a serious body blow to an already weak and declining economy.  To understand the possible impact of an automaker collapse, let’s begin with some basic employment numbers.

In November 2008 about 830,000 U.S. workers were employed in auto assembly plants and businesses involved with supplying parts for new cars and trucks.  Of these, a little less than a quarter of a million workers were employed directly by the Big Three.  The other workers were employed in auto parts supply businesses and in foreign nameplate assembly plants.  Tens of thousands of additional workers who are usually employed in assembly plants and parts factories are on temporary or indefinite layoff.  Many of these workers hope to be recalled to their jobs when the auto market recovers.

In addition to the workers engaged in making cars, more than a million U.S. workers are employed in new car dealerships and in the distribution of new cars and trucks.  An unknown percentage of these workers is employed in the distribution of cars and trucks produced by the Big Three.  Based on automakers’ market shares over the past three years, it’s plausible that well over half of the workers in the sales distribution chain have jobs that depend on the Big Three.

In total, over 2 million people hold jobs that are directly linked to the production, distribution, and sale of  new cars and trucks.  Well over half of these depend on continued production and sale of Big Three cars and trucks.  A conservative estimate of the direct impact of the failure of all of the Big Three automakers would be the immediate loss of at least a million jobs.  Thus, the direct impact of the liquidation of the Big Three would add almost a percentage point to the current unemployment rate.

The indirect but short-term effects of the collapse of the Big Three would add to this toll.  Many auto parts suppliers will probably enter bankruptcy if the Big Three fail.  This will hurt production of foreign-nameplate cars in the United States, because foreign assembly plants also depend on U.S. auto parts suppliers for many of the inputs that go into making their cars.  Production interruptions at foreign-nameplate factories may in turn reduce employment in foreign assembly plants and in factories that supply auto parts for those plants. 

Finally, hundreds of thousands of workers in retail stores, banks, and service-producing companies will lose their jobs in communities where auto assembly plants and auto parts factories are located.  The workers in auto assembly and parts factories earn wages that are one-quarter higher than those paid to average production workers.  The indirect impacts of auto plant closings on local employment would therefore be greater than effects that would accompany the loss of other kinds of jobs.

If the federal government does not offer the Big Three loans or loan guarantees, it is very unlikely that private lenders will step forward to offer them credit, either before or after a formal bankruptcy.  This implies that bankruptcy would soon be followed by liquidation of the automakers’ plants and assets. In the long run, when U.S. demand for new cars recovers, foreign-nameplate automakers would expand production in the United States, and some of the job losses in the auto parts supply business would be reversed.  However, an overwhelming share of the physical and human capital investment that has gone into the U.S. auto industry will be lost.

I have always believed that this loss is too staggering for the nation to permit all of the Big Three to disappear in the next year.  In a previous submission -- http://economy.nationaljournal.com/2008/12/what-if-there-is-no-auto-bailout.php -- I described conditions that should be imposed on the Big Three if the government is to provide loans or loan guarantees.  Congress should pass a law that makes loans available to the automakers under broad guidelines, but specific terms of the loan agreement should be negotiated and enforced by a federal board charged with overseeing the loans.  Loans should only go to companies that offer a business plan mapping out a credible route to company profitability.  Unless there is an unexpected recovery in the economy next year, I expect the ultimate recovery of the automakers will require loans that amount to substantially more than the $34 billion the carmakers asked for last week.

The November unemployment numbers provide additional evidence it would be reckless to allow all of the Big Three to fail.  The latest job report shows that payrolls dropped by 1.2 million in the past 3 months.  The pace of job loss is accelerating.  A major reason is the sharp falloff in consumer demand.  Not only have sales plunged in new car showrooms, consumers are also spending less money in department and discount stores.  In an environment of extremely fragile consumer and investor confidence, it would be foolhardy to injure confidence still further by permitting the collapse of the Detroit-based carmakers.
 

Collapse

Automobile industry leaders have argued that the Chapter 11 process is less well suited to carmakers than it was to airlines earlier in this decade, because automobile purchases involve more durable relationships than air travel. Buying a car manufactured by a company in bankruptcy requires more faith in the company's future than does buying a ticket to travel next week.

But this argument is compelling only if we think that providing cash to the automobile companies now will make bankruptcy in the foreseeable future unlikely. Simply delaying bankruptcy filings will make the ultimate cost of industry transition more expensive, as potential automobile purchasers continue to desert the Big 3 manufacturers. While consumers might not wish to buy a car from a company in bankruptcy, they also are rational not to want a car from a company about to enter bankruptcy. Thus, if eventual bankruptcy remains a likely outcome, as it may for companies with very uncompetitive cost structures, model choices and dealer networks, the best use of any bailout money aimed at the auto companies would be to aid in the bankruptcy process, by helping to establish new financing and cushioning the blows suffered by various affected parties, including retirees whose promised health benefits would disappear and car owners whose warranties would be voided.

Collapse

 GM and Chrysler are best advised to file for a Chapter 11 bankruptcy.  This would allow them to continue to operate while restructuring their debts.  Both the airlines and the steel companies recently restructured in this way with little effect on the whole economy.  There is no case for a federal bailout now; all this would do is to delay the day of reckoning for these companies, probably for less than a year.  This episode is not comparable to “past moments when an iconic U.S. industry died,” because there would still be substantial U.S.-based auto industry whatever is the outcome of the bankruptcy of GM and Chrysler.