Economics professors critical of government auto bailout

“If we had a strong economy right now, the best remedy might indeed be to let these companies go,” said Alan Blinder ’67, economics professor and former vice chairman of the Board of Directors of the Federal Reserve System.

“Given the performance of some of these companies, they don’t deserve [a bailout],” he added.

Given the trembling economy and weak job market, however, Blinder said that letting the companies collapse now would lead to “substantial” disruption not just to the companies involved, but to the whole national economy.

“Congress has no choice but to keep them in operation,” he said, noting that if the companies fail, “it’ll throw quite a few people out of work.”

“Some of the workers cut loose by the auto companies will find jobs with [other companies],” Blinder added, “but in a very weak job market, a lot of them are going to be unemployed for a long time.”

Economics professors Henry Farber and Elizabeth Bogan, however, criticized the perception that the failure of the auto companies would lead to widespread unemployment.

“It’s being laid out to the public as a domino effect that all sorts of jobs are going to disappear,” Bogan said. “That is not the case.”

The “Big Three” American automakers — Ford, Chrysler and General Motors — are “not nearly as big as they used to be,” Farber said, adding that even if every employee of one of these companies were fired, “it would add about a 10th of a percent to the unemployment [rate].”

Unemployed auto workers from American firms will shift to foreign companies such as Toyota, Honda or BMW, which “will pick the slack” if the Big Three go under, Farber said.

He noted, however, that he is not worried about having a foreign-dominated auto industry, explaining that most of the foreign cars sold in the United States are built on American soil by American workers.

“Americans are going to continue to buy cars,” Farber said.

Losing it all?

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“I think that a bankruptcy would force Chrysler and GM to merge and that Ford would proceed with some difficulty, but be all right,” she said.

Companies often continue to operate through bankruptcy protection, she said, citing the airline industry. Both Delta and US Airways successfully emerged from Chapter 11 bankruptcy.

Shareholders would likely lose money, and retired workers not covered by the federal government’s pension guarantee program might lose their monthly checks during restructuring, but bankruptcy would not shut down the economy, Bogan and Farber said.

Farber stressed that the companies would not close down in the absence of a government bailout.

Instead, he said, “they would undergo presumably the same sort of restructuring” under bankruptcy laws as they would under a government bailout.

Though Blinder agreed that bankruptcy protection on its face might seem like a good option for the auto companies, he added that “it’s very, very messy.”

Because of the state of the credit markets, Blinder said that “it’s far from clear” that the firms would get debtor-in-possession (DIP) financing under Chapter 11. A company that receives DIP financing is lent money in return for a guarantee that that creditor will be the first to get his money back once the company pulls out of bankruptcy.

“Even if they file for Chapter 11, the federal government might have to come up with the money,” Blinder said.

The principle of getting involved

“Our history of having our government play an active role in the organization of enterprises is not great,” Farber said.

“The government should play as little [a] role as possible,” he added.

These, though, are “extraordinary times,” he added.

Blinder said that if the government gets involved, “there may be something useful accomplished by making changes in top management,” noting that the idea that shareholders would push out a management that makes a slew of poor decisions has not worked in the auto industry.

Conservative commentators have raised concerns that government action will create a moral hazard.

Bogan, however, noted that government action in the 1970s to provide a loan to Chrysler did not encourage other automakers to fail.

“Congress has occasionally made loans,” she said, “but usually it’s a one-off, special thing that doesn’t seem to make for a precedent.”

Farber, though, said he isn’t so sure.

“People will take more risks seeing that there’s a white check behind them,” he said. “They’re taking my money and my children’s money and saying that we’re going to bail out these companies that are going to fail. It doesn’t seem American.”

Having “strings attached” to the money, however, would deter frivolous bailout claims, Blinder said.

Part of that, he added, could entail cutting managerial salaries to a negligible amount and changing business strategies to encourage public benefit at the same time as company profit.

“If you’re going to pick up public money,” he said, “you ought to have some obligation to public services.”

Though Blinder said that he would not be surprised if the proposed $15 billion bailout is not the last federally financed bailout, it creates “a bad precedent,” he said.

“We don’t want to be doing this one industry after another,” he added.

Besides, Bogan said, “moral hazard can be overcome if ... what the company goes through is pretty nasty.”

Bogan noted the distinction between bailing out Wall Street and bailing out manufacturers.

Though the auto industry is one of America’s biggest, a bailout for the finance sector may have been more important to keep credit flowing to the rest of the economy, Bogan said.

“Think of capital as the blood of the economy and the financial system as the heart that pumps it all around,” Farber said. “The auto industry is ... the left leg. It’s an important appendage, but if the heart fails, the whole organism is going to die.”

Deeper problems

On Sunday, economics professor and Nobel laureate Paul Krugman told reporters in Sweden that the American auto industry would probably disappear in time.

“It is no longer sustained by the current economy,” he said. Bailout plans, he added, resulted from a “lack of willingness to accept the failure of a large industry in the midst of an economic crisis.”

Any federal loan money given to the industry, Blinder said, “is money at serious risk.”

“It’s not so clear that these companies are going to make it anyway,” he said.

Lifting the economy out of its current state will require much more than a few loans to any particular industry.

Both Bogan and Farber said that large-scale investments in infrastructure were part of the solution.

“Those are very good construction types of jobs and a more efficient use of labor than trying to hold on to every job,” Bogan said.

Farber added that some of President-elect Barack Obama’s plans for public works projects would spur employment and give people more money to buy more goods.

Falling interest rates and Obama’s plans for a large fiscal stimulus and possible tax cuts could help, too, Blinder said.

But the government can only do so much, and any effort to right the economy “is a little bit like trying to steer an ocean liner with a teaspoon,” Farber said.